microsoft word 2007_01_02.doc   investing in human resources    jovan zubović, institute of economic sciences belgrade    key words: human resources, education system, long‐term strategies    udc: 005.96          jel: j24, e22 editorial    abstract – investing in human resources is a taboo in many countries worldwide. unlike in undevel‐ oped and transitional economies, in countries with developed economic system there is an open debate about  the need to analyse educational policies and investment policies with an aim to increase quality of human  resources. there are few blind spots which can substantially reduce long‐term value of human capital, and  diminish level of investments’ efficiency in educational systems.  introduction  as a reply to labor market demand where on one side real wages of highly educated and  qualified labour force have increase, and on the other side the wages of lower qualified and edu‐ cated labor have been reduced, there is a renewed interest for creation of policy which may enforce  social productive knowledge worldwide. politicians and sociologists often raise question about  consequences of economic inequality. it seems that it is close for a consensus to be reached, by  which an  improvement of qualification and education of nonqualified personnel would  lead to  their easier adoption by society and reduction of inequality in wages.   this  paper  reviews  the  current  policies  of  knowledge  creation.  as  a  result  of  years  long  school development policy there have been certain roles widely accepted. there is a need for an  education system of  the wider scope so as  to reach  the system  in which people  increase  their  knowledge and qualifications in such a way which is in accordance with modern economy needs.   contemporary world trends  current practice in education and qualification of people for job are based on wrong stan‐ dards of creation of socially required skills. creators of such standards have a sight only through a  prism of reached knowledge tested on iq tests regardless of social knowledge, self‐disciple and  several non‐cognitive skills which enable success in life. overweighting of cognitive and academic  “intellectuals” whose qualities are measured on tests which do not cover social adaptability and  motivation, raise doubt in valuation of investments made in development of human resources.   conventional wisdom represented by politicians, educated person and many academics –  especially professors  in education – place formal educational  institutions on  the central spot of  creation of required knowledge  in modern economies. such a practice denies  favorable role of  families  and  companies  in  knowledge  and  many  other  skills  improvement  needed  by  modern  economy.  popular  discussions  of  knowledge  creation  almost  always  focus  on  investments  in  schools  or  educational  reform,  disregarding  important  non‐institutional  sources  of  knowledge,  which by a great extent, maybe more than formal educational institutions help on creation of sev‐ eral skills needed in the world today.   investments in training and education  current situation in formal education, disregarding informal and non‐institutional sources of  knowledge is a result of three wrongly factors misunderstood by politicians and analysts.  2007 ‐ 2  •  economic analysis®  the first is in the very nature of human and comes as a result of not understanding the fact  that learning is life long process and that a lot of learning comes out of schools. learning begins in  the childhood, much before formal education begins and is continued through whole life. recent  research in psychology have shown the vital role of knowledge creation in preschool age, when  skills and motivation are created in families and non‐institutional environment. success or failure  in this phase leads to success or failure in school, and further on after school. early learning trig‐ gers later learning and early success feeds later successes, as well as failures bring more failures in  grown ages. formal or institutional education is important aspect of educational process, but ac‐ cording the recent research it is not always most important.   in the publication “colerman report” (1966) we have seen that family and environment, not  only school, according to test results have a key role in creation of motivation and education suc‐ cess. broken families create bad skills and lowly motivate students who fail in schools. favourable  family oriented policy may be more effective on improvement of success level in schools than di‐ rect investments on lecturers’ wages or computer equipment. it is more expensive to follow the  policy of covering the failures of early stages than too invest in a sophisticated education system,  and at the same time it does not recover lost potentials even if investments are very high. the later  in life we try to change mistakes from the childhood, more expensive it would be.  on the other hand, work experience and skills learned in jobs are skipped in modern debates  because they are hardly measured. after school education is a source of knowledge creation which  covers 1/3 to ½ of total knowledge in the modern economies (heckman, lochner i taber, 1998).  since a lot of such education is made in non‐formal environment, educational technocrats and poli‐ ticians deny it for the reason of equalising such knowledge with knowledge reached in schools.  once we understand the importance of non‐formal education and knowledge creation, then we  may begin with creation of knowledge improvement policy on the other way.  the second factor for many education planners and policy creators is overweighting of tests  results and measuring of cognitive skills as indicators of success in education. it is certainly correct  that cognitive skills are important in life and there are proofs of profitability of investing in them  (see cawley, heckman i vytlacil, 1999), but such a narrow focus on cognitive, diminish the full  scope  of  socially  and  economically  important  non‐cognitive  skills  and  motivation,  which  are  learned in schools, families and other environment. a special accent ought to be put on the way  how are evaluated investment programs results. on one hand the enriched investment programs  in early ages of life do not significantly change the iq level, but on the other hand they signifi‐ cantly influence non‐cognitive skills and people social status.  another mistake often made in analysis of human resources policy is the assumption that  development of skills is completed in early life age. static concept of skills is opposed to many re‐ searches made on children development. in early ages of life, core skills can be changed. education  creates knowledge, which as a result creates a need for education.  the third factor of misunderstanding in visions of most of the education planners and policy  creators is mistrust for parents’ ability to wisely choose their children education path if choice is  offered. there is disbelief to competition and system in which there is more than one choice for  improvement of success in education.   conclusion  all researches made in past give advantage to systems with high competition. monopoly in  any system of economic and social life prevent development of needs and preferences and ignore  well being of people, unlike systems with developed competition. in analysis of competition influ‐ volume 40 • spring 2007 • 3  ence in the education system it is important to separate systems where there is existent educational  policy from the others where there is no such policy. the question is not whether it is necessary to  invest in education, but rather what should be the level of these investments. increase to low level  of investments would bring significant results. increase of education quality is visible when there  is  low  level  of  investments.  if  investments  are  high  already,  increase  would  bring  no  visible  changes. for example in usa direct cost subventions for students in most state universities is 80%.  the ongoing debate is not about necessity of subventions but about possibility of increase to above  80%.  graph 1 – return of investments in hr in respect to age  there  is a fourth misunderstanding which  is not covered  in this paper and needs deeper  analysis. in many countries in the world large numbers of under qualified personnel are becoming  burden to companies and society as a result of increase in qualifications required. common mis‐ take made by policy makers is that retraining of these people would easily help them keep their  jobs. no one calculates the cost of such retraining, and in the age of strict budgets, it is obvious that  investments in retraining would bring no results except to politicians. the highest cost of these  investments is turning the emphasis of education of younger people who could learn faster (graph  1) with more effective and higher probability to have positive results in long term.  references  coleman j, campbell e, hubson c, mcpatland j, mood a, weinfeld f, york r: equality of educational opportunity, wash‐ ington d.c., u.s. government printing office, 1966  heckman j, lochner l, taber c.: explaining rising wage inequality, explorations with a dynamic general equilibrium model  of earnings with heterogeneous agents, review of economic dynamics, 1(1), 1998  cawley j, heckman j, vytlacil e.: a note on policies to reward the value added by educators, review of economics and  statistics, 1999  heckman j, law and employment: lessons from latin america and the caribbean, university of chicago press, for nber,  2004.  heckman j, borghans l., duckworth a. l., and ter weel b. the economics and psychology of personality traits,  journal of  human resources, 2008.    high capacity low capacity age r et ur n on in ve st m en ts in h r ea_2019_2_final doi: 10.28934/ea.19.52.2.pp64-70 scientific review market analysis on the presence of social responsibility in companies in bosnia and herzegovina mirjana štaka1* 1 university of e. sarajevo, faculty of economics, east sarajevo, bosnia and herzegovina abstract corporate social responsibility implies that all transactions in the company executed with respect to the economic legal and ethical principles. in bosnia and herzegovina, a relatively small number of companies expanding their economic objectives of socio economic and included in solving social problems. due to technical technological progress changes occur rapidly and result in a large number of social problems that can return a negative impact on business operations. there is a wide choice of alternatives by which companies can do business socially responsible, and each of these alternatives offers a number of benefits for all involved (company, non-profit organizations and consumers). the subject of this analysis involves, on the one point of view corporate social responsibility, and on the another the success of the company. corporate social responsibility will be examined through economic, social, environmental and ethical dimension. the aim of this thesis is to theoretically position management and social responsibility as part of the management functions in the work of the business entity. also, aim is to point out the many advantages resulting from the application of socially responsible business practices and point to the achievement of successful cooperation between of interest groups influential in the development of boards. this paper will explain the dimensions of corporate social responsibility, to point out the many benefits arising from the application of such business practices and potential problems that may occur. methodology is based on the analysis and synthesis of primary and secondary data. secondary, data were used in this study are available in the scientific and professional literature. in the development of work methods were used to analyze, synthesize, descriptions and comparisons. the research purpose and significance is to highlight the growing impact that society has on the company and / or organization and importance of corporate social responsibility as an important factor of achieving competitive advantages. the purpose of the study also explained that csr is the value and strategy, not just a means of making a profit company. key words: management, social responsibility, consumers, strategy, corporation, development jel classification: d47, m31 * e-mail: mirjana.staka@gmail.com mirjana štaka 65 introduction corporate social responsibility (csr hereafter) is defined as a concept in which companies knowingly and voluntarily increased activity arising from the primary functions of the company of increasing profits and affect their working, social and natural environment (mašić, 2010). corporate social responsibility is a new awareness of the location and meaning that companies have in the contemporary global society and the responsibilities arising from it. also, the practice of social responsibility includes the activities of companies such as: what products to buy and sell, whether they comply with legal regulations, relationship with employees, whether investing in the development of the local community and whether it contributes to the preservation of the environment. the idea of development, which affects the needs of future generations the sustainability of development. economically sustainable development is not a sufficient condition for the development of a society, a key factor for achieving sustainable development, and therefore its impact on the local community implies responsibility (milisavljević, 2007). harmonization of relations between the spheres of economy, as the pillar of development and the interests of society as a whole must not be individually monitored nor ignored. corporate responsibility in bosnia and herzegovina, also in the region poses a relatively new term applied to large companies and growing mid-sized and smaller companies. csr basically means that companies and other legal entities exercise activities mentioned above the primary function and achieving a positive impact on their working, social and natural environment. the concept of social responsibility and practices relating to the dimensions of the activities of a company or organization and all the relationships that it establishes with that. to contribute to the overall economic and social development but how to invest in the community and respect human and labor rights, to recruiting, training and influences the development of our employees and their target category, to affect the protection of the environment. according to drucker et al., (2004) corporate social responsibility means a commitment the company management to take actions that will improve the welfare of the entire society and the business system. it represents a global business imperative and the idea that it is impossible to ignore. one can say that it is a successful company that simultaniously takes account of its economic, social and environmental impact, and socially responsible business is the business model and management style in which profit is realized in a socially responsible manner (drucker et al., 2004). development of the concept emerges as a new way of doing business in global companies that are exposed to risks due to non implementation of environmental policy and employees. in future many of global companies that apply the concept of corporate social responsibility, because in it they can provide an effective means for gaining competitive advantage (muller, 2004). the concept of corporate social responsibility is not just a passing fad, but an imperative in the business world all the companies that will sooner or later have to accept if they are to keep their place in the business scene. this business concept brings multiple benefits, not only for companies, but also in world integrity. research methodology research hypothese given the proposed details in theoretical principles and the literature, the research hypotheses are formulated as follows: the general hypothesis h0: it starts with the assertion that the concept of social responsibility of business has a positive impact on the company creating significant prerequisite 66 economic analysis (2019, vol. 52, no. 2, 64-70) for the welfare of the community by making it more competitive in the market. for the purposes of the research performed and auxiliary hypotheses that help make it easier to draw conclusions that will be reached in the study. auxiliary hypothesis h1: there is insufficient appropriations from the budget of the company to finance socially responsible activities. auxiliary hypothesis h2: the ability and the integration of csr in the serb republic, bosnia and herzegovina is not pleasent position. there are significant activities in larger companies, while medium and small companies remain the primary function of the engaged business. research methods the paper is based on the collection and analysis of secondary data sources. secondary data used in this study are available in the scientific and professional literature of the problem of environmental protection in business, corporate social responsibility, also about business ethics. in the development work were used methods of analysis and synthesis, descriptions and comparisons. a method of analysis and synthesis is used in the theoretical part of the work for parsing (analysis) complex concepts and conclusions in a simpler and merging (synthesis) of simpler elements in more complex parts. the description is used to describe facts, objects and processes in nature and society without the scientific interpretation and explained, which is used in the work in theoretical and application part. in the applicative part of the work, the method of comparison, based on data from annual reports on sustainable development observed businesses available on the website, researches, comparing different events, objects on examples of companies in the same activities in order to compare their basic characteristics. reasearch findings there are many theoretical frameworks that attempt to explain why the company should strive to do business socially responsible. the following tables provides an overview of authors reaseaching of framework of corporate social responsibility since its inception until the nineties. csr activities include a strong fight against corruption and implementation of anti-corruption measures in all segments of society. in fact, in bosnia and herzegovina is particularly acute problem of corruption and useless fight against it. this, for example. as estimated by transparency international bosnia and herzegovina on the basis of the analysis of the monitoring only in 2007 more than half a billion km of budget funds was lost through corruption and illegal transactions in the process of privatization. the current status of the presence of social responsibility in companies in bosnia and herzegovina can be viewed through surveyed the marketplace. the survey included 30 questions that are sent to different mail addresses to companies selected randomly and who were willing to fill out the questionnaire and thus participate in the project. the first part of the questionnaire made by author survey, related to general information about the company, ownership structure, activities, number of employees and total revenue. the second part concerned the situation of csr in the company, the existance of csr strategy and who is responsible for its implementation.the next set of questions related to the degree of integration of iso standards and international treaties dedicated to corporate social responsibility. an important part of the questionnaire focused on the situation of employees and their rights within a company immediately thereafter, and the relationship to the community. philanthropic activities are explored through the next set of questions and in the end they sought answers to questions that deal with the relations between government and media relation activities in the field of corporate social responsibility. mirjana štaka 67 table 1. the research results are presented in the following table: activity frequency percent finance 5 14.30 industry 3 8.58 energetics 2 5.71 bussines 11 31.46 tourism 1 2.86 telecommunications 1 2.86 architecture 1 2.86 services 1 2.86 other (it and etc.) 10 28.6 total 35 100% source: author’s survey table 2. number of employees: number of employees frequency percent under 10 6 17,19 under 50 16 45,71 under 100 9 25,65 over 200 4 11,45 total 35 100% source: author’s survey table 3. availability strategies in public: availability frequency percent yes 34 97,14 no 1 2,86 total 35 100% source: author’s survey table 4. management activities of corporate social responsibility: presence frequency percent yes 19 54,34 no 16 45,66 total 35 100% source: author’s survey table 5. allocations of funds for csr activities: percent of budget frequency percent under 2% 21 60,06 from 2 to 5% 7 20,02 from 5 to 7% 5 14,30 over 7% 2 5,62 total 35 100% source: author’s survey 68 economic analysis (2019, vol. 52, no. 2, 64-70) table 6. employment of workers in accordance with international conventions and humans rights: presence frequency percent yes 35 100 no total 35 100% source: author’s survey table 7. security, safety of workers at the workplace (insurance and health care): presence frequency percent yes 35 100 no total 35 100% source: author’s survey table 8. experimental part are workers familiar with their work and how are they satisfied with their workplace and their superiors: presence frequency percent yes 21 59,85 no 14 40,15 total 35 100% source: author’s survey table 9. competence of workers to participate in social responsibility of community: presence frequency percent yes 35 100 no total 35 100% source: author’s survey table 10. are company is environmentally conscious and are they use biodegradable materials in the work/ing area: presence frequency percent yes 32 91,20 no 3 8,80 total 35 100% source: author’s survey table 11. does the company take part in humanitarian actions persence frequency percent yes 35 100 no total 35 100% source: author’s survey mirjana štaka 69 conclusion explained in a simple way, social responsibility is based on the integration of economic, social and environmental dimensions in the daily operations of the company, thus contributing to the advancement of society and the growth of the companies themselves (berčić, 2012). set the main hypothesis h0: it starts with the assertion that the concept of social responsibility of business has a positive impact on the company creating significant prerequisite for the welfare of the community by making it more competitive in the market. being socially responsible means not only to fulfill legal obligations, but to go beyond the established compliance with laws and regulations, but also to invest more in human capital, environment and relations with stakeholders. in this way, companies are investing in their future. take business by these ways, they will find that their voluntary engagement and commitment can help community development. the main hypothesis is demonstrated through the analysis of research that was used in the work. given that more than 96,90% of the companies surveyed responded that most are familiar with the impact of the concept of csr for the market and the community. auxiliary hypothesis h1 which said inadequate budget from the budget of the company to finance socially responsible activities was also confirmed as the results of the research showed that companies allocate less than 2% of the budget for the needs of socially responsible activities. bosnia and herzegovina is 103. of 137 countries in europe presenting a situation in which the country compared to other countries in the region and its modest opportunities can not do much to contribute to increasing corporate social responsibility through financing, subsidies and sponsorships and increase social responsibility in the community auxiliary hypothesis h2 which read ability and integration of csr in bosnia and herzegovina is not satisfactory position. there are significant activities in larger companies, while medium and small companies remain the engaged primary function operations, also confirmed the part of the previous hypothesis because it is causally associated with this research is proving to be big companies apply corporate social responsibility because of the complexity his business and as such have at least departments and special administration of philanthropy and help the local community. positive examples in serb republic are: m: tel, banja luka brewery business that its impact on humanitarian activities and environmental protection, approaching the trend of global business companies in place of their existing. references banja luka brewery company. (2019). “finance and audit, positioning resources for social responsibility.” research paper by company. berčić, boran. (2012). philosoph. zagreb: institute for philosophy. blog m:tel. (2019). “mtel winner for his contribution to the development of social responsibility.” http://blog.mtel.ba (accessed on may 5, 2019). center for promotion of civil society. (2019). ebrd annual meeting and business forum. http://cpcd.ba (accessed april 14, 2019). certifikatdpp. (2019). family friendly enterprise. http://certifikatdpp.si/english (accessed on april 18, 2019). chamber of commerce and industry of republic of srpska. (2019). the business environment is in the chamber of commerce and industry of republic of srpska. https://komorars.ba (accessed on april 21, 2019). drucker, peter. (2004). my view of the management. novi sad: adizes. mašić, branislav. (2010). strategic management. belgrade: university "braca karic". milisavljevic, momčilo. (2007). principles of marketing. belgrade: faculty of economics. muller, hansruedi. (2004). tourism and ecology. zagreb: mesmedia. 70 economic analysis (2019, vol. 52, no. 2, 64-70) network for social responsibillity society. (2019). connect learning to cooperate. www.mdos.si (accessed on april 19, 2019). nova banka. (2019). corporate governance. www.novabanka.com (accessed on may 2, 2019). smart kolektiv. (2019). developing impact economy. www.smartkolektiv.org (accessed march 3, 2019). social responsibility society. (2019). responsibility in bosnia and herzegovina. http://odgovornost.ba (accessed on april 4, 2019). social responsibillity society in croatia. (2019). cfp social ecology – 11th conference on corporate social responsibility. 2019. www.dop.hr (accessed on april 19, 2019). vitinka. (2019). award for contribution to the development of corporate social responsibility. www.vitinka.com (accessed on may 21, 2018). article history: received: june 25, 2019 accepted: october 3, 2019 microsoft word 2009_3_4-korigovano.doc research report analysis and planning of apple production as factor of rural development support* ivanović lana**, institute of agricultural eeconomics, belgrade jeločnik marko, institute of agricultural eeconomics, belgrade udc: 338.492 jel: q1, q18 abstarct – apple production has great importance for agriculture of republic of serbia, as for processing industry and other followed industries. for this kind of production excellent conditions exist, but also specific problems in production organization, products selling and financing of plantation establishment are presented. regardless to insufficient use of available natural resources in apple production, it has great potential for export and development of small processing capacities, so it might be relevant factor in stimulation of rural development. analysis showed that areas under apple are growing in serbia, as total quantum of apple production. that is caused by increment of apple trees number and with increment of yield per one tree. by using of trend method is estimated that in next period can be expected further growth of apple production in serbia, what is confirming importance of this fruit species for rural development. in manuscript, group of measures that can notably stimulate and improve this kind of production, are also mentioned. key words: apple, production, planning, rural development introduction apple is the most important fruit species in the world and besides plum one of the most significant fruit species which is grown on the territory of republic of serbia. it could be said that in serbia basically are predominate dessert sorts of apple. the most spread, in other words leading sorts are jonagold, gold delicious, melrose and idared. they are also economically the most valuable sorts. because of its precious characteristics, apple is widely used in food industry. among numerous products, as most important could be labeled juice, marmalade, jam, cider, etc. development of fruit production in whole, as apple production too, has great influence on development of input industry, like they are productions of preparation for herbal protection, mineral fertilizers, agricultural mechanization, packing materials, building of storage facilities, etc. parallel with modernization and intensification of apple production, it is necessary to improve and develop all following industries (input industries and * paper work is part of researching on project mntr -159004 “accession of serbian economy into eu – planning and financing of regional and rural development, as companies development policy“, financed by ministry of science and environmental protection of republic of serbia. ** address: volgina 15 street, 11060 belgrade, serbia, e-mail: lana_i@mail.iep.bg.ac.rs ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 79 processing industry), how will on that way affects on increment of serbian fruit competitiveness level on international market. good climate and soil conditions in serbia are excellent precondition for development of this production. however, disregarding those conditions, apple production is not developed in adequate measure. areas under apple plantations are small sized (atomized), great number of tree trunks still are grown in farmsteads where are achieved low yields. also significant part of plantations is old and already amortized. during production process, the biggest problems are high input prices, lack of labor, obsolete mechanization, old plantations, old-fashioned (inadequate) sorts, etc. during the sale producers are faced of with next significant problems: low prices and impossibility of total produced volume selling at once. because of introduction of new breeding technologies and new, more productive sorts, it comes to gradual development of apple production, what enables, as higher production of more qualitative fruits per area unit, as increment of total apple production in serbia. apple represents one of the agricultural products which have great export perspective for serbian agriculturalists and on that way possible significant role in rural development encouragement. because of that it is necessary to analyze previous production volume and present state in serbian apple production, as to forecast production quantum in closer future. for getting of better picture about situation in domestic apple production and chance that improvement of this agricultural branch induces rural development, it has to be parallel introspected all characteristics of european and world apple production, as to predict trends of its further development. objective and aim of reseraching researching objective in paper work is previous and in next period expected apple production in the world, europe and serbia. objective is also an analysis of factors which affect on production volume of apple in observed territories. starting from researching objective and importance of apple as fruit species, next researching goals are defined: • analysis of present condition in apple production in the world and serbia, • determination and comparison of apple production trends, • analysis of influence of natural and socio-economic conditions on apple production, • introspection of possibilities that apple production become a carrier of rural development in serbia. data resources and working method in paper work are used two basic resources for areas under apple, average yields, achieved production, etc. first resource is available statistical data of republic of serbia, while as second resource is used fao’s statistical documentation for observed years. focusing on methods which are used in analysis of statistical data, next can be separated: • tables, economic analysis (2009, vol. 42, no. 3-4, 78-85) 80 • graphs, • trend, • index and • comparative analysis. researching results general data about apple production and selling apple is produced in many countries, almost on all continents, at most spread on north hemisphere. in 2007., in the world is produced 64.255.520 t of apple. the biggest planetary producers are china, usa, iran and turkey. italy is european leader in apple production. serbia is one of the minor european and world producers, with participation of 0,36% in total world production and 1,55% in total european production. yearly consumption of apple per capita, on the world level in 2003., was around 8 kg. consumption on european level was higher, about 20 kg per capita, while in serbia and montenegro, during the same year, was achieved consumption per capita of 22 kg. during 2007., in the world were under the apple plantations 4.921.767 hectares, what is little more than 10% of total world areas under fruits (without cantaloupes and water melons). total import of apples in 2006. on the world level was 6.967.882 t (http://faostat.fao.org). the biggest importer is russian federation, which participates in total world import with 11,66%, then, deutschland with participation of 10,02% (the biggest importer within eu). significant importers are united kingdom (7,63%) and holland (5,24%) too. apple export on the world level in 2006. was 7.166.752 t. china is the largest world exporter, with participation of 11,22% in total world export, then comes chile with 10,12%. italy is most important european exporter (ranked as third exporter in the world), with participation of 9,95%. france, also, takes significant place as exporter. it participates with 9,54% in total world apple export. serbia is at once apple importer and exporter. last years the biggest importer of serbian apples was russian federation. according vlahović (2003.), regionally observed the largest production is achieving in north-bačka region (in municipalities of bačka topola, mali iđoš, subotica), which gives 12% of total domestic production. also, significant are belgrade city, south-banat, podunavski and sremski regions, which commonly give up to 50% of national apple production. absolutely, the highest production has subotica municipality. the most concentrated production is in central part of republic, almost 66%. large number of sorts is grown, from autochthonous (each year less and less) to the economically most effective sorts“. apple production trend in average, for the period of 1998-2007., surfaces under apple were 5,1 million of ha (table 1.). areas under apple plantations in the world, besides variation per analyzed years, were decreased during observed period, from 5,8 million ha in starting year to 4,9 million ha in 2007., in other words reduction amounted 14,66%. similar tendency is noticed in europe ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 81 too, with comment that decreasing trend of areas is little more expressed (index 83,23). surfaces under apple in serbia were increased for 37,04%. table 1. areas under apple plantations in period 1998 2007. world europe serbia* year area (ha) base index (1998=100) area (ha) base index (1998=100) area (ha) base index (1998=100) 1998. 5.767.416 100,00 1.584.995 100,00 27.000 100,00 1999. 5.587.710 96,88 1.578.036 99,56 27.000 100,00 2000. 5.386.836 93,40 1.581.532 99,78 27.000 100,00 2001. 5.138.881 89,10 1.526.357 96,30 27.000 100,00 2002. 4.878.245 84,58 1.421.804 89,70 20.000 74,07 2003. 4.781.818 82,91 1.358.743 85,73 32.000 118,52 2004. 4.761.005 82,55 1.356.021 85,55 27.000 100,00 2005. 4.802.133 83,26 1.323.931 83,53 27.000 100,00 2006. 4.786.350 82,99 1.257.517 79,34 35.000 129,63 2007. 4.921.767 85,34 1.319.129 83,23 37.000 137,04 average 1998-2007. 5.081.216 / 1.430.807 / 28.600 / notice: * in period 1998-2005. are shown data for serbia and montenegro, and for 2006. and 2007. only for serbia. resource: http://faostat.fao.org europe, with average surfaces under apple from 1,4 million ha, participates with 28,16% in total world surfaces under apple plantations. serbia with average areas from 28.600 ha has participation from 1,99% in total european areas under apple. table 2.. total apple production in period 1998-2007. world* europe* serbia** year production (in t) base index (1998=100) production (in t) base index (1998=100) production (in t) base index (1998=100) 1998. 56.651.712 100,00 15.832.629 100,00 177.446 100,00 1999. 57.904.585 102,21 15.366.265 97,05 196.474 110,72 2000. 59.054.808 104,24 17.733.553 112,01 197.490 100,52 2001. 57.584.159 101,65 16.441.403 103,85 135.374 68,55 2002. 55.952.172 98,77 16.265.946 102,74 95.584 53,87 2003. 58.377.086 103,05 15.798.745 99,79 246.138 138,71 2004. 62.775.656 110,81 16.968.620 107,17 183.571 103,45 2005. 62.123.069 109,66 15.112.921 95,45 198.030 100,79 2006. 63.875.324 112,75 15.087.118 95,29 240.320 135,43 2007. 64.255.520 113,42 13.950.045 88,11 245.228 138,20 average 1998-2007. 59.855.409 / 15.855.725 / 191.566 / resource: * http://faostat.fao.org, ** municipalities in serbia 1998-2008., republic of serbia, republic statistical institute, belgrade. economic analysis (2009, vol. 42, no. 3-4, 78-85) 82 average volume of apple production in world in period 1998-2007. was 59,9 million t, and production showed in observed period increment for 13,42% (table 2). apple production in europe in same period was decreased for 11,89%, while in republic of serbia was significantly increased (index 138,20). with average apple production of around 15,9 million t europe has participation from 26,49% in total world apple production. serbia with average production of 191.566 t participates in total european apple production with 1,21%. for more detailed insight of apple production flow in the world, europe and serbia, on graphs are, besides of apple production presentation in ten analyzed years, created trend lines for the period of five years, finally with 2012. during the trend line creation, the best adjusted trend lines are used. apple production in the world has growing tendency. if apple production in next five years would in accordance with previous flow, in 2012. it could be expected world apple production from 68,1 million t (graph 1). graph 1. apple production volume trend for the world in period 1998-2012. (in 000 t) y = 870,15x + 55070 r2 = 0,7223 0 10.000 20.000 30.000 40.000 50.000 60.000 70.000 80.000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 year p ro d u ct io n v o lu m e (t ) production (t) linear (production (t)) according the apple production trend line, in europe in 2012., it could be expected production from 14,1 million t. in distinction to total world and serbian production, where is, based on existing data, expected production increment, in europe according trend line is evident reduction of apple production (graph 2). production volume in serbia in 2012., in accordance to the best adjusted trend line, which determination is based on previous data, will be 262.000 t. this means, that in next 5 years apple production in serbia, if it continues previous trend, will be increased for around 17.000 t in compare to production in 2007. (graph 3). ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 83 graph 2. apple production volume trend for the europe in period 1998-2012. (in 000 t) y = 16915e-0,0121x r2 = 0,2945 0 2.000 4.000 6.000 8.000 10.000 12.000 14.000 16.000 18.000 20.000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 year p ro d uc tio n vo lu m e (t ) production (t) expon. (production (t)) graph 3. apple production volume trend for the serbia in period 1998-2012. (in 000 t) y = 7,4061x + 150,67 r2 = 0,217 0 50 100 150 200 250 300 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 year p ro du ct io n vo lu m e (t ) production (t) linear (production (t)) total apple production in serbia, as is mentioned, records permanent growth. production increment is based on higher number of fruitful tree trunks and increasing of average yield per one apple trunk. in average, in period 1998-2007. total number of apple tree trunks in serbia was 16,5 million, from that, number of fruitful trunks was around 14,6 million. economic analysis (2009, vol. 42, no. 3-4, 78-85) 84 average yield in observed period in serbia was 13,1 kg/trunk. comparing starting and last year of mentioned period, yield per one trunk is increased for 32,52%, before all, as result of apple production intensifying. so, increment of yield per trunk is achieved by higher investment in production (higher usage of plant protection preparations, mineral fertilizers, irrigation, etc.). also, individual producers in last ten years, in difference with previous period, more and more are dealt with fruit growing and apple production as professionals, looking on that not only as on additional income source. conclusion apple should have great role in development of serbian agriculture, in same time for supporting of rural development. it comes from fact that apple is second fruit species in serbia by its importance (behind plum), and that it has great export potentials (before all on market of russian federation). beside apple could be attractive export product, it could be pulled development of processing and input industry too. on that way in rural areas development it would not be focused only on agriculture, than it would be included establishing of small family processing factories, in other words employment of significant number of population. analysis showed that momentarily within world and european frame, serbia is relatively small apple producer, but at same time exist some positive tendencies which have to be maximally used in upcoming period. for example, areas under apple in world and europe are decreasing, while in serbia they are presenting increasing trend. while total apple production is mildly growing in world, or it is decreasing in europe, then total production volume of this fruit species in serbia showed significant growth in observed period. that is influenced by increment of apple trunks number, as by higher yield achieved per one trunk. also, by using of trend method is determined that in following period it could be expected further growth of apple production in serbia. for additional encouraging of apple production in serbia (rural development is included), it is necessary to introduce certain changes into the production practice, as they are new sorts, irrigation, establishing of anti-hail nets, better selling through the new established cooperative organizations, building of coolers, etc. as one of the most important factors, which could be contributed to the advancement of serbian apple production is improvement of financing conditions, at first place for long term credit arrangements. references milić, d., radojević, v. (2003): proizvodno-ekonomska i upotrebna vrednost voća i grožđa, novi sad; milić, d., kalanović bulatović branka, trmčić snežana (2009): menadžment proizvodnje voća i grožđa, univerzitet u novom sadu, poljoprivredni fakultet, novi sad; opštine u srbiji (1999 2008), republički zavod za statistiku, beograd; stanković, d., jovanović, m. (1990): opšte voćarstvo, naučna knjiga, beograd; veličković, m. (2002): voćarstvo, poljoprivredni fakultet beograd – zemun; vlahović, b. (2003): tržište poljoprivredno-prehrambenih proizvoda, specijalni deo, knjiga ii, univerzitet u novom sadu, poljoprivredni fakultet, novi sad; vlahović, b., stevanović, s., tomašević, d., zelenjak, m. (2006): agrarna proizvodnja u republici srbiji, monografija, društvo agrarnih ekonomista republike srbije, beograd; ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 85 www.agromreza.org.yu; www.poljoberza.net; www.poljoprivreda.info; http://faostat.fao.org; apstrakt – proizvodnja jabuke ima izuzetan značaj za poljoprivredu republike srbije, ali i za prehrambenu industriju i ostale prateće industrije. za ovu proizvodnju postoje odlični prirodni uslovi, ali su prisutni i određeni problemi u organizaciji proizvodnje, plasmanu i finansiranju podizanja zasada. bez obzira što se u proizvodnji jabuke još uvijek dovoljno ne koriste raspoloživi prirodni uslovi, ova proizvodnja ima odličan potencijal za izvoz i razvoj malih prerađivačkih kapaciteta, pa može biti veoma značajan faktor podsticanja ruralnog razvoja. analiza je pokazala da površine pod jabukom u srbiji rastu, kao i ukupan obim proizvodnje jabuke. to je uzrokovano povećanjem broja stabala jabuke, kao i rastom prinosa po stablu. primjenom metode trenda utvrđeno je da se u narednom periodu može očekivati dalji rast proizvodnje jabuke u srbiji, što potvrđuje značaj ove vrste voća za ruralni razvoj. u radu je takođe naveden i skup mjera kojima se može značajno podstaći i unaprediti ova proizvodnja. ključne reči: jabuka, proizvodnja, planiranje, ruralni razvoj received: 24 july 2009 article history: accepted: 15 august 2009 microsoft word 2010_1_2.doc original scientific paper the analysis of long run growth oriented fiscal policy erős adrienn*, university of miskolc, institute of economic theory, miskolc, hungary udc: 336.02(439);(415) jel: h3; n14 abstract one of the most debated questions of growth theory is whether or not government policies can be used to influence the long run growth rate of the economy. neoclassical theory states economic policy actions can only have short run effects on the growth rate of the economy, but it can’t change the long run perspectives for growth. endogenous growth theory integrated (among several other factors) fiscal policy to the growth models, enabling it to influence long run growth performance. according to these theories some elements of the government budget have positive effects on the long run growth rate of the economy (productive expenditures, and budget balance), while others are neutral (non-distortionary taxation and unproductive expenditures), or have negative consequences for growth (distortionary taxation). in my paper i summarize the theoretical and empirical literature of the relationship between fiscal policy and long run economic growth shortly. then i continue my work with using the parameter estimates of a third generation study of developed countries (which considers the budget constraint as well) to evaluate the fiscal policy actions taken in hungary and in ireland, concentrating on the overall long run trends in the last one and a half decade. i will try to give explanation for the differences in the two countries’ reactions to some of the similar fiscal policy changes mapped during my research. key words: fiscal policy, economic growth, hungary, ireland review of the research topic the most important aim of economic policy is to ensure the highest level and most general welfare possible to the citizens of a country. there can be no other way to improve welfare over the long run but stimulating intense and sustainable economic growth. that is why the analysis of economic growth is a central question in the theory of economic policy, macroand international economics. „even small differences in long-term growth rates when cumulated over a generation or more, have much greater consequences for standards of living than the kinds of short-term business fluctuations that have typically occupied most of the attention of macroeconomists. to put it another way, if we can learn about government policy options that have even small effects on the long-term growth rate, then we can contribute much more to improvements in standards of living than has been provided by the entire history of macroeconomic analysis of countercyclical policy and fine-tuning. economic growth is the part of macroeconomics that really matters.” [barro – sala-i-martin (1995) 4-5 pp.] * tel: +36 / 46 / 565-111 / 18-71, mob: +36 / 20 / 34-27-486, fax: +36 / 46 / 565-194, e-mail: geteros@unimiskolc.hu economic analysis (2010, vol. 43, no. 1-2, 25-33) 26 the above cited words perplexed me, when i first read them. i found their message a bit exaggerated, showing the self-consciousness of the researcher, his preference of his own interest. still they made me think about the question. the more i thought about their veracity, the more i had to admit they are right. i think the matter of long run economic growth is of major importance. it is a stressful and timely problem from hungary’s point of view, as after our accession to the european union, convergence got into the focus of attention. hungary’s per capita gdp, based on purchasing power parities did not reach even half of that of 25 member european union’s average a decade ago (in 1997 it was only 49,5% of that, eurostat), and even in this year, in 2007 it reaches only 64,5% of the eu average. we are facing a long period of convergence, based on these data. it is a highly logical question to ask what we can do to improve the pace of economic growth. this question belongs to the field of economic policy (among others) as well. i chose to study the fiscal instruments’ possible effects on long run economic growth in my research. i had three reasons to make this choice. on the one hand, the literature of economic growth theory focuses on fiscal policy’s growth effects, while on the other hand monetary policy (as we hope) will be lost as a national policy instrument after accessing the euro-zone. this means the only policy left at our disposal to influence economic activities (among them economic growth) will be fiscal policy. my third reason was that before this research i was concerned with taxation matters and international tax harmonization so fiscal policy was familiar to me. i chose ireland as a reference country, because she proved in the last two decades with her outstanding economic performance that convergence is not just a dream, and that economic policy (if properly done) can contribute to the pace of economic growth. research background and methodology during the empirical work (arising from the macroeconomic characteristics of the theme) i made my calculations based on data taken from different international statistical databases. the main (but not the only) source of the data i used was the sourceoecd on-line statistical database. in order to ensure comparability, i endeavoured to minimize the types of databases used. because of the methodological differences sustained by hungary till 1997 distinct data are not published for hungary in international databases. so in the case of those variables i had to rely on the data of the ksh (central statistics office of hungary), and pm ápmso áhir (hungarian finance ministry’s database). in my empirical work i analysed the relevant fiscal variables by using spss 14.0 and eviews 4.1. software. empirical analysis the question dealt with in the paper is whether there is correlation, and if yes, how strong it is, between the long run growth rate of the economy and fiscal policy. arguments can often be heard that economic policy is almighty, and the state can do anything. other experts tend to stress that the state should not involve in economic affairs and its influence on economy ought to be minimized. others add that the major aim should be (if economy evolved in such a way that state’s involvement in the economy, and mixed economy can be erös, a., the analysis of long run growth, ea (2010, vol. 43, no, 1-2, 25-33) 27 considered as natural) the maintenance of budget balance and the confine of state’s debt as a share of gdp. according to neoclassical growth theory, long run economic growth can be contributed to two exogenous factors, technological progress and the growth rate of economically active population. this attitude leaves only limited, short run, temporary effect for fiscal policy on the growth rate of the economy even though it is capable of changing the achieved level of welfare permanently. endogenous growth theory on the other hand states that fiscal policy can influence the long run growth rate of the economy as well. the most recent, third generation empirical studies based on the endogenous theory of growth use several groups of variables which can either contribute to the growth rate (like productive expenditure, budget balance), or be neutral to growth (like non-distortionary taxation and unproductive expenditure), or harm growth (like distortionary taxation). those revenue sources and expenditure types, which have ambiguous growth effect, are called other revenues and other expenditure. according to our hypothesis there is correlation among these fiscal variables and the long run growth rate of the economy, and these correlations meet the expectations concluded by surveying the relevant theoretical and empirical literature both in their strength and in their directions. based on the correlation and regression calculations made it can be concluded that the calculated results meet our expectations based on the survey of the theoretical and empirical literature in the case of most fiscal variables, even though there are some exceptions. both the indicators used to measure the extent of the state as a share of gdp (the ratio of income centralisation and the ratio of redistribution) are negatively correlated with long run growth rate of the economy in both countries. this relationship is known as scale-effect in the literature of endogenous growth theory, and its existence can be confirmed in case of the analysed countries. the ratio to gdp of distortionary taxation is negatively related with the growth rate of the economy in both countries, which tendency meets our expectations formed when surveying the theoretical and empirical literature of growth. the share of non-distortionary taxation to gdp is not significantly correlated with growth based on irish data, which trend coincides with our theoretical cognition. at the same time, hungarian data show a reverse relationship, showing significant positive correlation between the two variables. the most probable reason for this is the increase in the share of non-distortionary taxation within the generally shrinking tax wedge, while decrease in the share of distortionary taxation is positively related with growth. the increase of the ratio of non-distortionary taxation to revenue enhances growth based on both countries’ data, which result meets our expectations. productive expenditure as a share of gdp is not significantly related with the growth rate of the economy based on irish data (this results meets our expectations), while according to hungarian data the two variables correlate negatively. this contradicts the finding of theoretical and empirical literature, and the reason for it must lay in the parallel changes occurred in the structure and extension of the budget as a share of gdp. the ratio of public expenditure to gdp decreased by 8 percentage points during the period in question, while productive expenditure as a share of gdp fall back only by 2 percentage points, so their economic analysis (2010, vol. 43, no. 1-2, 25-33) 28 share of all expenses rose by 2 percentage points. the decrease of productive expenditure’s ratio to gdp must rather have been parallel in time to the rise of the growth rate than being the reason for it. the share of unproductive expenditure in gdp is not significantly correlated with the long run growth rate of the economy in ireland, in accordance with the predictions of the third generation studies. in hungary significant negative relation can be found between the two variables. this suits the findings of certain second generation studies, showing negative relation between the extension of transfer programmes and the long run growth rate of the economy. the ratio of budget balance to gdp relates positively with the long run growth rate of the economy according to all types of empirical studies. this statement can be confirmed both in the case of hungary and ireland, showing significant positive correlation between the two variables. two measures were used to characterise the relationship between long run economic growth and state debt. three and five year averages of state debt’s share in gdp relate significantly negatively with growth in both countries. three and five year average change in state debt is in significant negative correlation with the long run growth rate of the economy. these results meet our expectations formed when surveying the theoretical and empirical literature. our conjuncture is that ireland forewent the previous leaded states. what can the enviable success of ireland be attributed to? several possible reasons, like aptitudes (geographical position, english mother tongue, a young population unmatched in developed countries) economic history (doubling of the eu funds, single european market), and economic development (globalisation, foreign direct investment, change in the importance of distance, revolution of the it systems) are mentioned in literature. many of the experts stress the importance of economic policy actions (tax system and industrial policy aiming to attract fdi, activities of enterprise agencies, reform of the system of education, partnership agreements securing a low wage level for a long period of time). we think additionally to what has been mentioned the role of certain political and cultural factors, economic and social sacrifices made for success are worth attention as well. fast convergence is due to several factors. according to our analysis a possible explanation of the “irish economic miracle” can be conditional convergence. the two known forms of transition paths (delayed convergence, which occurs due to the elimination of barriers to growth and imitation based on adaptation of more developed, more productive technology) strengthened each-other, and three beneficial external factors’ synergic effect (doubling of the eu funds, european single market and a long boom of the us economy) made the convergence so fast and dynamic. we can conclude convergence has happened in ireland. further strengthening of her economic position (foregoing the present leader states) requires her to take part in developing new technologies. the country is committed to this and r&d expenses have been increased seriously even in real terms. irish enterprise agencies have noticed that their strategy needs to be reformed, as competition for international capital escalated and ireland’s traditional competitive advantages, low wages and low taxes are not unique in the eu anymore, and after the new member states in eastern europe accessed the union. new strategic directions were appointed in 2004; the aim is to form new clusters in high value erös, a., the analysis of long run growth, ea (2010, vol. 43, no, 1-2, 25-33) 29 added sectors and internationally tradable services. most of the selected industries have antecedents in the country and the necessary regulations are being formed now. based on these facts we can conclude that ireland does not rest in her laurels but takes any steps she can in order to maintain her dynamic growth. according to economic data ireland’s convergence is so successful that she has already foregone almost all her competitors with respect to per capita real gdp based on purchasing power parity (she has foregone most of her eu-member concurrent during 1997-1998, since 2001 only the performance of norway, luxembourg and the usa is higher than ireland’s). convergence has been finished in ireland, moreover, she has even foregone the previous leaders (those member states of the european union whose economic performance was better than hers), and we have witnessed the rare phenomena of leapfrogging in ireland’s case. as we have seen, the direction of the correlation between fiscal variables and the growth rate are the same in each variable’s case in both countries. at the same time, according to our hypothesis the decrease of government sector as a share of gdp (and any other budgetary variables) can not be unrestricted; the pace of growth can not be dynamized by this endlessly. this conjecture of us is strengthened by the fact that underlying processes in the two analysed countries differ. during the analyses of the correlation between most of the fiscal variables and the long run growth rate of the economy we discovered an important statutory. we found a negative relation between the certain fiscal factors and the long run growth rate of the economy in both countries’ case during correlation calculations, but when estimating regression equations we experienced that negative correlation is unambiguous based on hungarian data, but to irish data parabolic regression functions can be fitted in most cases (there are some exemptions like social security contributions, health and productive expenditure). in the case of all the other variables we can conclude that the right hand leg of the irish parabolic function can be regarded as the continuation of the negative regression fitted to hungarian data. this finding can be originated in two reasons. on the one hand, hungarian government’s extension as a share of gdp is higher, than the irish one. for example, the ratio of government expenses to gdp shrunken from 45,3% to 31,5% in ireland during the period in question, while in hungary it fall back from 63,44% to 47,4%, so it is still much higher, than the original level of ireland used to be in 1990. similar tendencies show in the other possible measure of government’s extension, government revenues’ share in gdp. on the other hand, another possible explanation for the divergence in the behaviour of the two countries can be the different situation the two countries are in on their transition paths. ireland stepped on a transition path around 1987. during the twenty years passed, convergence finished and even more, we witness the rare case of leapfrogging. hungary is in quite a different situation after the changing of the regime [erdős (2003) 294 p.], she is on a transition path as well, but her path is very different from that of ireland’s and her lag from the leaders is still very large. the gap is closing from year to year, still, even in 2007 we only achieve 64,5% of the 25 member eu member states’ average per capita gdp based on purchasing power parity. hungary still has a long convergence period to go through. that is why we do not have to expect the tendencies to turn for a long period of time, which means economic analysis (2010, vol. 43, no. 1-2, 25-33) 30 that the advices given by growth theory are worth considering in hungary’s case, based on irelands recent past. in our opinion irish fiscal policy contributes to the slow pace of the necessary fallback in the growth rate at the end of the transition path. the existence of conditional convergence is strengthened by the fact that the pace of economic growth has been slowing in ireland in the recent past. at the same time, we must consider that the present, relatively slower growth is still enviable to most developed countries. it can only be called slow after the outstandingly high growth rate experienced from 1987 to 2001. convergence (as we have already discussed above) has been enhanced by several fiscal and non-fiscal measures in ireland. based on the above analysis we can unequivocally conclude that the radical reform of fiscal policy contributed to the evolution of “irish economic miracle”, or the “celtic tiger” phenomena. figure 1. long run growth rate of the economy as a function of the share of government revenue to gdp in hungary and in ireland government revenue as a share of gdp (moving average) source: own representation source of data used: sourceoecd consistent shrinking of the government’s extension as a share of gdp, maintenance of the budget balance and the decrease of the ratio of state debt to gdp (which the fast growth of gdp used as benchmark also contributed to, of course) eventuated the result anticipated by growth theory, and even contributes to the evolution of the still very favourable (even though slowing) pace of economic growth. we endeavoured to strengthen this result by using the parameter estimates of a third generation empirical study as well. the analysis performed by the model confirmed recent year’s fiscal policy’s beneficial effects on the growth rate of the economy. our findings show that after the millennium, as the growth rate erös, a., the analysis of long run growth, ea (2010, vol. 43, no, 1-2, 25-33) 31 started falling back in ireland, fiscal policy contributed to the relatively slower decrease of the growth rate which is statutory at the end of the transition path. hungary is under pressure in forming her fiscal policy today, the most important task is (beyond growth aspects we are required to meet the maastricht criteria as well) to restore the balance of the budget. fiscal consolidation in hungary started only about a year ago, so it would be quite early to evaluate the long run effects of these policy actions now. hungarian tax wedge can be considered as averagely high compared to other eu member states (hungarian tax wedge is 39,2% of our gdp, while the average of the 25 eu member states is 40,7%). even though compared to other recently accessed member states (their average is 35,2%) and to the irish tax wedge (31,7%) it is quite high. [eurostat, issn 4020-4298] this means we have enough space to shrink the share of tax revenue to gdp, which would be beneficial to growth according to our analysis. according to these findings, from a growth oriented point of view we should rather decrease government expenses in order to restore budget balance, than increase government revenues. opposite to the expansive trends of irish fiscal policy in the 1970’s, the change in fiscal policy’s direction, a gradual shrinking of the budget’s extension as a share of gdp, which started at the end of the 1980’s contributed to the evolution of the „celtic tiger” phenomena. according to our hypothesis it is not enough to concentrate generally on the decrease of government activity’s level as a share of gdp. structure of the budget plays at least as an important role in forming growth performance. to prove our assumption we used the parameter estimates of the already mentioned third generation endogenous bleaney-gemmel-kneller model. the two countries we analyse represent too small a sample to calculate our own parameter-estimates based on them. but as both are developed countries (oecd member states) we found the study’s results (based on oecd member states’ sample) relevant for the countries in question. authors of the study (out of the seven fiscal variables they included in their research) found significant effects of three fiscal variables on long run economic growth: • the ratio of distortionary taxation to gdp, which they attributed negative growth effects to based on the original model of barro’s (1988); • the ratio of productive expenditure to gdp, which turns up with positive growth effects (again, in accordance with the model of barro), and • the ratio of budget balance to gdp (which, again meeting our expectations formed when surveying theoretical and empirical literature) has a positive coefficient the regression equation. these three relevant factors influence the complex effect of fiscal policy actions on the pace of economic growth with different weights, calculated in the third generation empirical study. when evaluating the long run growth effects of irish and hungarian fiscal policies by using the parameter-estimates of the bleaney-gemmel-kneller model we concluded that productive expenditure plays a major role in shaping the overall growth effect of fiscal policy. this was the most obtrusive in the case of ireland, where the decrease in the ratio of productive expenditure to gdp meant the main growth impulse since 2000 (since the pace of economic growth started slowing). in hungary, the dominant element in shaping the favourable long run growth effect of fiscal policy changes was the gradual decrease of the ratio of distortionary taxation to gdp. economic analysis (2010, vol. 43, no. 1-2, 25-33) 32 at the same time we have to consider the increase in the ratio of productive expenditure to gdp in the second part of the time-period, after the years of the bokros-package, which enhanced growth significantly. we calculated a neutral growth effect for the bokros-package by using parameter estimates of the third generation study. this can be attributed to the fact that the positive effect evolving from the improvement of budget balance and the decrease in the share of distortionary taxation to gdp was fully outweighed by the negative effect of the decrease in productive expenditure’s share in gdp. the dominant element again (we have to stress, just like in the case of ireland) was the decrease in the ratio of productive expenditure to gdp. altogether, we wished to demonstrate and strengthen with our analysis that adequately adopted fiscal policy actions are capable of enhancing the long run growth rate of the economy. restoration of the budget balance and gradual (but not unlimited) shrinking of government’s extension as a share of gdp are needed in order to achieve the aimed effect at the same time we must not forget the importance of the structure of revenues and expenditure. reduction of the government expenditure should be done by decreasing unproductive expenditure (as those are neutral to growth). productive expenditure (which enhances growth as we have stated above) should be maintained. references barro, r. j. (1988) government spending in a simple model of endogenous growth. national bureau of economic research working paper no. 2588 barro, r. j. (1989a) a cross-country study of growth, saving and government. national bureau of economic research working paper no. 2855 barro, r. j. sala-i-martin, x. (1990) public finance in models of economic growth. national bureau of economic research working paper no. 3362. barro, r. j. (1993) economic growth and convergence. occasional papers number 46. isbn 1-55815283-0 barro, r. j. – sala-i-martin, x. (1995) economic growth. macgraw-hill, inc. isbn 0-07-003697-7 barro, r. j. (2005) a gazdasági növekedést meghatározó tényezők. nemzeti tankönyvkiadó, budapest (determinants of economic growth. a cross-country empirical study. 1997. mit press) bleaney, m. – gemmel, n. – kneller, r. (2000) testing the endogenous growth model: public expenditure, taxation and growth over the long-run. university of nottingham discussion papers in economic no. 00/25. (issn 1360-2438) easterly, w. – rebelo, s. (1993) fiscal policy and economic growth: an empirical investigation. national bureau of economic research working paper no. 4499. engen, e. m. – skinner, j. (1992) fiscal policy and economic growth. national bureau of economic research working paper no. 4223. engen , e. m. – skinner, j. (1996) taxation and economic growth. national bureau of economic research working paper no. 5826. erdős tibor (2003) fenntartható gazdasági növekedés. akadémiai kiadó, budapest isbn 963 05 8078 0 eurostat, statistics in focus: tax revenue in the eu. (2006/2) issn 4020-4298 fölster, s. – henrekson, m. (2000) growth effects of government expenditure and taxation in rich countries. european economic review (forthcoming) gemmel, n. (2001) fiscal policy in a growth framework. world institute for development economics research discussion paper no. 2001/84 erös, a., the analysis of long run growth, ea (2010, vol. 43, no, 1-2, 25-33) 33 gemmel, n. – kneller, r. 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(2002) 15 years of new economics: what have we learnt? columbia university, department of economics, discussion paper series #0102-47 stiglitz, j. e. (2000) a kormányzati szektor gazdaságtana. kjk-kerszöv. isbn 963 224 560 1 tanzi, v. – schuknecht, l. (2003) public finances and economic growth in european countries. prepared for the conference on „fostering economic growth in europe”, vienna june 12-13, 2003. vigvári, a. (2005) közpénzügyeink. kjk kerszöv. isbn 963 224 863 5 received: 7 january 2010 article history: accepted: 16 march 2010 2013_1_2 professional paper analysis of the serbian capital market1 minović jelena2, vuković vlastimir, institute of economic sciences, belgrade, serbia udc: 336.76(497.11) jel: o16, g01, g10, g12 id: 198572044 abstract – this paper analyses the serbian capital market. its main characteristic is that it is a very narrow and depth lacking market. for analysis we used data from the belgrade stock exchange (bse), republic of serbia securities commission (sec), and national bank of serbia (nbs). the crisis has negatively influenced on the capital market in serbia. due to this fact, the analysis was done by dividing into two sub-periods: before the crisis (2006 – 2008), and during the crisis (2009 – 2011). results showed that turnover decreased for over 70% for both belex indices, while the whole capital market has notably recovered thanks to an extensive borrowing of the state. stock market capitalization has fallen. results of analysis showed that government debt securities dominate after the crisis on the capital market (93% in 2011), while other shares from privatization make a negligible part of the market (equity market dropped for over 10 times from 2006 to 2010). we concluded that the privatization in serbia significantly influenced on the features and volatility of the capital market in serbia. key words: capital market, frontier market, turnover, gdp, belex indices, liquidity introduction serbian capital market is by its characteristics categorized into the group of frontier markets (spiedell, 2011), which is specially investigated. the privatization in serbia significantly influenced on the features and volatility of the capital market in serbia. the same effects of the privatization were also noticed in other transition economies (megginson & boutchova, 2000). “frontier market” is an economic term first used in 1992 by the international finance corporation to describe a subset of very small and illiquid emerging stock markets. twenty years later there is no strict definition of frontier markets, though, by default, they are commonly viewed as those markets which are neither developed nor emerging. highlighting both their opportunity and their challenge, frontier markets represent one-fifth of the world’s population, yet less than 10% of global gdp, and only about 2% of global market 1 this paper is part of the research projects number 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and number 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. the part of the results from this paper were presented at the conference economic changes in a time of crisis: challenges and opportunities in coimbra, portugal (6-7 september, 2012). 2 institute of economic sciences, zmaj jovina 12, belgrade, serbia, e-mail : jelena.minovic@ien.bg.ac.rs economic analysis (2013, vol. 46, no. 1-2, 1-11) 2 capitalization.3 examples include the frontier markets of serbia, croatia, bulgaria, kazakhstan, nigeria, sri lanka, vietnam4, venezuela, jordan, pakistan, and argentina (speidell, 2011), (vuković & minović, 2012). some of the first authors who research and analyse the frontier and emerging markets are chuhan (1994), rouwenhorst (1999), bekaert & harvey (2002, 2003), cajueiroa & tabak (2004), bekaert, harvey & lundblad (2007), clark (2008), yeyati, schmukler & van horen (2008), hearn, piesse & strange (2009), živković & minović (2010), minović & živković (2010), speidell (2011), minović (2012a), minović (2012b), and others. sometimes progress from frontier market status to a more developed status is agonizingly slow, if it occurs at all. the upside potential of frontier equity markets has motivated many investors to consider taking positions in them, but to date, relatively few have done so. the reason stated most often for this reluctance to invest is risk (speidell, 2011), (vuković & minović, 2012). in this paper we analysed the serbian frontier capital market. we used data for total turnover on the serbian capital market, as well as turnover for both belex indices. for analysis we used data from the belgrade stock exchange (bse), republic of serbia securities commission (sec), and national bank of serbia (nbs). the crisis has also negatively influenced on the capital market in serbia. due to this fact, the analysis was done by dividing into two sub-periods: before the crisis (2006 – 2008), and during the crisis (2009 – 2011). the capital market in this analysis is segmented on bond market and equity market, as often done in the reports (ecb, 2012). we showed that government debt securities (66,7%) are the dominant segment on the capital market in serbia. shares make the rest of this market (33,3%), because there weren’t any corporate debt securities. the privatization in serbia significantly influenced on the features and volatility of the capital market in serbia. without the analysis of the privatization it would not be possible to explain the behaviour of investors and shareholders in these countries (vuković & minović, 2012). the structure of this paper is as follows: section 1 presents introduction, section 2 describes frontier capital market in serbia, in section 3 is given analysis of the turnover on the capital market in serbia, section 4 analysis turnover of belex indices on the bse, and in section 5 conclusion is given. frontier capital market in serbia gross domestic product (gdp) in the republic of serbia declined by 3.5% in 2009, due to the impact of the global economic crisis, and the resulting slowdown in economic activity (see table 1). gdp decline mainly due to the domestic demand. the largest negative contribution of gdp growth has given investment spending of private and public sector. private consumption is contributed to decline in final demand, due to rising unemployment and falling purchasing power (nbs, 2009). 3 http://blogs.cfainstitute.org/investor/2012/05/03/frontier-market-investing-inefficiency-equals-opportunity/ 4 http://www.doughroller.net/investing/frontier-markets-to-boldly-go-where-few-investors-have-gone-before/ minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 3 table 1. growth rate of gdp in republic of serbia gdp 2005 2006 2007 2008 2009 2010 2011 growth rate (in %) 5.4 3.6 5.4 3.8 -3.5 1.0 1.6 source: nbs (http://www.nbs.rs/internet/cirilica/80/index.html) gdp growth (after 2009) was dominant due to increase in foreign demand. exports grew faster than imports, leading to a significant reduction in the trade deficit. such a trend has resulted in a positive contribution of net exports to gdp growth, which was higher than the negative contribution of domestic demand (nbs, 2010). speidell (2011) pointed out that today, frontier countries account for 21.6% of the world’s population, 6% of its nominal gdp, and only 3.1% of world market capitalization. even with this imbalance, a naive investor using cap weights as his or her guideline would still want to have 3.1% of a global portfolio in frontier markets. speidell (2011) showed that serbia has a 20% weight in the msci frontier market index, and 10% weight in the russell frontier market index (see table 2). table 2. serbia in the msci, and russell frontier market indices population (millions) gdp per capita (ppp, 2008) gni per capita, atlas method (2008 us$) world bank market cap (2008 $ millions) msci frontier market index russell frontier serbia 7.4 11,456 5,700 12,165 0.2 0.1 source: speidell (2011), page 10. precisely, the serbian capital market is the belgrade stock exchange (bse), as the only organized market of this kind in the country (see figure 1). serbian capital market, as under developed market, faces many problems: small capitalization, small number of shares on the liquid segments of the market, appearance of some unsynchronized trading, irregular frequency of transactions, lack of transparency in the reports, lack of government regulations and so-called the invisible signs of risk (latković & barac, 1999), (živković & minović, 2010). from its beginning, the serbian market was not a share market but corporate market. also, this is a one-way market, considering the supply and demand. this means that the major share sellers are individual share owners who got the shares, usually free, in the process of mass privatization. major share buyers come from the corporate sector. the basic aim of investing was not the share yield, but taking over the companies. the usual chain of events was as the following: turnover volume and share liquidity rise when the firm is in a threat of being taken over. when taking over happens, the liquidity and volume drop, while the share price becomes inert. trading in these transactions is in a great measure based on informer information (živković et al., 2005), (živković & minović, 2010). economic analysis (2013, vol. 46, no. 1-2, 1-11) 4 figure 1. share trading on bse and otc5 market (in million eur) source: sec (2006) & (2010). šoškić & živković (2007) stated that in the serbian market, there are no exact rules regarding available information about company, and consequently insider information has a huge influence on investor’s decisions. better regulation in this area, with increased amount of publicly available information, can reduce the information asymmetry risk. on the other side, this will lead to decreasing transactional costs and also to reduced illiquidity risk, which could bring up the level of foreign investments. we would like to point out that there is not much papers in the capital market of the republic of serbia. some of them are papers by živković et al. (2005), erić, nikolić & zdravković (2009), živković & minović (2010), erić (2010), minović (2012b), and vuković & minović (2012). erić, nikolić & zdravković (2009) studied the movement of the belgrade stock exchange index, and compared it with the stock exchange indices in the region in order to analyze the impact of the global economic crisis. živković & minović (2010) explored causes for illiquidity of the serbian capital market for the period of 2005-2009. these authors described phenomenology of emerging and frontier financial markets in detail. their results showed that level of market liquidity was low and persistent in serbia. additionally, živković & minović (2010) showed that time-varying illiquidity and its volatility was highly unstable in this market. they identified different periods and showed that, in most cases, ups and 5 over the counter market (otc) minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 5 downs in foreign investors’ participation leads to dramatic falls and rises in market illiquidity and its volatility. minović (2012b) analysed equilibrium of the serbian stock market using the standard capital asset pricing model (capm, by sharpe, 1964, and lintner, 1965). she tested this model empirically using regression analysis on the serbian stock market. minović’s (2012b) results showed that the classic capm was good for developed and liquid markets, but it was not able to describe the equilibrium of the serbian frontier market, or the process of discovering prices on this market. minović (2012a) analysed liquidity of the croatian frontier stock market. for her analysis she used prices of all stocks listed at the the zagreb stock exchange in the period: 2005 2009. she showed that the level of liquidity for the croatian market was very low. at the same time, minović’s (2012a) results suggested that the croatian market was less illiquid than the serbian market. she concluded that low level of liquidity was one of the key problem areas facing this small, undeveloped and frontier market. minović’s (2012a) results suggested that illiquidity was persistent in the croatian stock market. turnover on the serbian capital market in the analysis, we used data for total turnover from annual reports of securities commission republic of serbia (sec, www.sec.gov.rs). however, the turnover on the serbian market was 10% less than the gdp. figure 2 presents total turnover in billion eur, on the capital market of republic of serbia. figure 2. total turnover (in billion eur), on the bse and the otc market in the republic of serbia note: rsd values of turnover trading securities are translated into euro by average exchange rate of nbs on the date of the transaction. source: sec (2006) & (2010). economic analysis (2013, vol. 46, no. 1-2, 1-11) 6 thus, the annual turnover of securities increased from 7.4 billion eur (in 2005) to 16.6 billion eur (in 2006), then reached 51.3 billion eur (in 2007), and 66.1 billion eur (in 2008). in the post crisis years total annual turnover of the securities declined to 36.2 billion eur (in 2009), and 27.4 billion eur (in 2010). the average volume, in 2009 and in 2010, on the serbian capital market has decreased by more than 55% than the average volume in the period: 2005-2008. figure 3 shows the movement of the turnover on the serbian market. alongside the total turnover, there is also the turnover on equity and bond markets. looking at this, one can notice not only the dynamics in change, but also some structural changes (vuković & minović, 2012). vuković & minović (2012) showed that turnover movement by years was very unusual: before the crisis it dropped very fast, then it was almost faster recovery during the crisis, so the record level was achieved last year (4.42 billion eur) (see figure 3). figure 3. securities trading (in million eur) without nbs securities on the serbian capital market source: sec (2006) & (2010); vuković & minović (2012). vuković & minović (2012) pointed out that the total turnover covers up a key structural change: market dynamics was determined by the equity market before the crisis, and after it minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 7 by the bond market. consequently, the share of debt securities market was increased from 20% in 2008 to predominant 93% in 2011. they said that this dramatic fall of equity market was also illustrated by the data that the total turnover over the last three years was only 1.04 billion eur. bond market was entirely consisted of government debt securities. state borrowing on the capital market explosively rose – the turnover of government bonds from 2008 to 2011 was increased for 12 times. thanks to this, the capital market not only recovered, but also significantly rose (for 1/3 compared to 2006 and 3.2 times compared to 2008). by this, there was no squeezing of corporate bonds, because they were not issued, despite the projections (jefferson institute, 2005) (vuković & minović, 2012). equity market dropped for almost 10 times from 2006 to 2010. the primary cause of market fall was not the global financial crisis6, but the nature of the shares issued with the purpose of privatization. privatizations have dramatically increased the number of shareholders; large numbers of shareholder are not a stable ownership structure (megginson & boutchova, 2000). it is not surprising why it came to the withdrawal of the attractive (liquid) shares from the turnover after the end of the taking over process7 of the privatized companies, i.e. concentration (živković, 2008). at the end, it could be seen that the expected rapid growth of equity markets (lieberman & kirkness, 1998) was not sustainable for a longterm period after the privatization (vuković & minović, 2012). underdevelopment of the domestic capital market is also shown by the information that the total turnover was below 10% gdp (nbs, 2012a). a predominant share trading was done in the bse, while the rest was in the otc (sec, 2012). a small equity market could not significantly encourage the economic growth in serbia, which is still facing the transition problems. namely, gdp has been noticeably lower during the previous years than in 1989 (ebrd, 2011), (vuković & minović, 2012). vuković & minović (2012) showed that despite a small volume turnover there was no significant reduce in market capitalization. by the bse data, stock market capitalization was 8.67 billion eur in 2008, and 7.43 billion eur in 2011. these authors said that fall in capitalization for 14% could be explained only by reserved shareholders, where many of them were waiting for the market recovery to issue the sale orders. from 2006 to 2010, there was reducing of foreign investors’ participation in trading with all the securities in the bse (from 48% to 33%, respectively). turnover of belex8 indices the belgrade stock exchange was the first re-established stock exchange after the second world war in east europe (1989). nevertheless, up until early 2002, it existed as an organization without normal rules of the game. only during that year the market began to operate in a more or less standard manner. the main classes of assets traded on serbian 6 most of other european frontier emerging stock markets showed a great resilience to the adverse effects of the financial crisis (nikkenen et al., 2011). 7 therefore, the turnover on equity market was the largest in the period 2002 – 2004 (privatization agency, 2005). 8 the belgrade stock exchange, serbia economic analysis (2013, vol. 46, no. 1-2, 1-11) 8 market are shares issued as a result of a process of insider privatization model (živković et al. 2005), (živković & minović, 2010). the belgrade stock exchange has calculated and published the index belexline since april 2, 2007, as a benchmark for monitoring broad market movements (http://www.belex.rs). belexline index is descriptive, in the statistical sense, and not investible. the index weighting is based on market capitalization. belex15 is a free-float market capitalization weighted price index, which follows the movements of the 15 most liquid shares traded by the continuous method and fulfilling criteria for inclusion in the index basket (http://www.belex.rs) (minović & živković, 2010). we use data for the turnover of both belex indices from the belgrade stock exchange (bse) for the period: october, 2005 – january, 2010. in the table 3 is the change of turnover for both belex indices that ensued by the world economic crisis. this table shows that the turnover of the both belex indices fell for more than 70% from the other half of 2008 to the end of 2009. table 3. the average value of the daily turnover expressed in rsd for belex indices, before and during the crisis, and its relative change turnover average 3.10.200512.9.2008 15.9.2008-31.12.2009. relative change belexline 1,949,045 2,508,482 702,108 -72.0% belex15 8,777,022 11,221,731 3,327,972 -70.3% source: bse & author’s calculation; vuković & minović (2012). despite the economic crisis, the reason for the decrease in total turnover, and in turnover of belex indices is reduction in the number of shares due to the withdrawal of attractive (liquid) stocks from the market, after the completion of the takeover process, or concentration (živković, 2008). in the crisis conditions, it is obvious that the lack of trust in the mechanism of publishing the fair value of the financial assets, caused a fall in the turnover and at the same time a fall in market liquidity and massive withdrawal of foreign investors (see živković & minović, 2010). the investors, especially retail investors, have the expectation that they can be expropriated by the management or more informed investors. they also have relatively low disposable income to invest in the stock market and limited resource to obtain information (zhang, 2010). he pointed out that all these factors result in the on average low trading activity in the emerging markets (minović, 2011). erić (2010) told that revenues from privatization, grants and foreign direct investments have declined, some even dried up with the increase of crisis. therefore, there is a slowdown in serbian economic growth. this author pointed out that the development of the serbian capital market is an extremely important issue and involves a very serious and responsible approach. there are no new legal regulations, the development of institutions is slow, there are no new instruments and the turnover of the existing instruments has been reduced. all these facts must be understood as an important warning (erić, 2010), (minović, 2011). minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 9 redžepagić & richet (2008) pointed out that the transformation of the western balkan countries economies into market economies could not have taken place without the assistance of the foreign capital. these authors told that the western balkan region has been transformed into a marketplace with dynamic growth, attracting a significant amount of foreign direct investments (fdi). fdi in the western balkans are mostly concentrated in the service sector (banks, telecommunications, insurance) in non-tradable inward oriented sectors (constructions, real-estate) (redžepagić & richet, 2008), (minović, 2011). conclusion the capital market of the republic of serbia lacks depth, it is small illiquid market in transition. there is not much papers in analyses of the serbian capital market. this paper contributes to this field of research. the paper analysed the serbian frontier capital market. we used data from the belgrade stock exchange (bse), republic of serbia securities commission (sec), and national bank of serbia (nbs). in analysis, we showed that government debt securities (67%) were the dominant segment on this capital market in the observed period (2006-2011). our results showed that shares made the rest of this market (33%), because there weren’t any corporate debt securities. in crises period (2011) government debt securities dominate on the capital market with 93%. other shares from privatization process make a negligible part of the serbian market. so, the privatization process in serbia significantly influenced on the features and volatility of this market. our results showed that the turnover decreased for over 70% for both belex indices, in this period (crises). however, market capitalization was not significantly reduced and it was approximately 33% of the gdp. thus, the serbian equity market dropped for over 10 times from 2006 to 2010. references bekaert, g., harvey c. r. 2002. research in emerging markets finance: looking to the future. emerging markets review. 3: 429–448. bekaert, g., harvey c. r. 2003. emerging markets finance, journal of empirical finance, 10: 3–55. bekaert, g., harvey c.r., lundblad c. 2007. liquidity and expected returns: lessons from emerging markets, review of financial studies, 20(6): 1783 1831. http://www.kelley.iu.edu/clundbla/liquidity_bhl.pdf cajueiro, d. o., tabak b. m. 2004. “the hurst exponent over time: testing the assertion that emerging markets are becoming more effcient”, physica a, 336: 521 – 537. chuhan, p. 1994. are institutional investors an important source of portfolio investment in emerging markets? washington, d.c.: international economics department, world bank. clark, a. 2008. „liquidity risk in frontier markets history, measurement and a new approach“. thomson reuters. http://thomsonreuters.com/content/financial/pdf/i_and_a/liquidity_risk.pdf european bank for reconstruction and development (ebrd). 2011. transition report 2011 – crisis and transition: the people’s perspective. european central bank (ecb). 2012. financial integration in europe, april 2012. erić, d. 2010. “what is actually capital market in serbia?”, economic growth and development of serbia new model, pp. 243-261. erić d., zdravković a. & nikolić d. 2009. "influence of world crisis on western balkans countries undertaken measures and expected effects", chapter 3 in financial system integration of economic analysis (2013, vol. 46, no. 1-2, 1-11) 10 balkan countries in the european financial system: impact of global financial crisis, university of nice sophia antipolis, nice, pp. 17-34. hearn, b., piesse j., strange r. 2009. market liquidity and stock size premia in emerging financial markets: the implications for foreign investment. international business review, 19(5): 489-501. jefferson institute. 2005. bond markets in serbia: regulatory challenges for an efficient market. belgrade: jefferson institute. latković, m. & barac, z. 1999. “optimizacija dioničkih portfelja na rubnim tržištim kapitala”. preprint, sveučilište u zagrebu. lieberman, i., kirkness, c. 1998. privatization and emerging equity markets. the world bank. megginson, w., boutchova, m. 2000. “the impact of privatiyation on capital market development and individual share ownership”. the third fibv global emerging markets conference & exhibition, federation of international stock exchanges, istanbul, turkey & the thirteenth plenary session of the advisory group on privatisation, organization for economic cooperation & development paris, france, http://www.oecd.org/daf/corporateaffairs/corporategovernanceofstateownedenterprises/2668393.pdf minović, j. & živković, b. 2010. “open issues in testing liquidity in frontier financial markets: the case of serbia”. economic annals, 55(185): 33-62. minović, j. 2012a. liquidity of the croatian stock market: an empirical analysis. economic research, 25(3): 776-802. minović j. 2012b. “empirijska analiza ravnoteže srpskog finansijskog tržišta”, anali ekonomskog fakulteta u subotici, 48(27): 121-134. minović, j. 2011. „liquidity measuring of financial markets in western balkan region: the case of serbia“, chapter 27 in contemporary issues in the integration processes of western balkan countries in the european union, 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of serbia (nbs). 2012b. foreign investor’s guide: how to invest in the serbian financial market. http://www.nbs.rs nikkenen, j., piljak, v. & rothovius, t. 2011. integration of the european frontier emerging stock markets: effects of the 2008/2009 financial crisis. the 15th international conference on macroeconomic analysis and international finance. greece, may 2011. privatization agency republic of serbia. 2005. impact assessment of privatisation in serbia. privatization agency republic of serbia. http://www.priv.rs/upload/document/impact_assessment_of_privatisation_final.pdf redžepagić, s., richet, x. 2008. “the attractiveness of the western balkans for the fdi”, economic analysis, 41(1‐2): 1‐112. republic of serbia securities commission (sec). 2006. godišnji izveštaj o radu komisije za hartije od vrednosti republike srbije i kretanjima na tržištu hartija od vrednosti u 2006. godini, http://www.sec.gov.rs/index.php?option=com_remository&itemid=47&func=search republic of serbia securities commission (sec). 2010. izveštaj o radu komisije za hartije od vrednosti republike srbije i kretanjima na organizovanom tržištu hartija od vrednosti u republici minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 11 u period: januar-decembar 2010. godine, http://www.sec.gov.rs/index.php?option=com_remository&itemid=47&func=search republic of serbia securities commission (sec). 2012. izveštaj o radu komisije za hartije od vrednosti republike srbije i kretanjima na tržištu kapitala u republici srbiji u period: januar – decembar 2011. godine. rouwenhorst, k.g. 1999. “local return factors and turnover in emerging stock markets”, journal of finance, 54: 1439-1464. speidell, l.s. 2011. frontier market equity investing: finding the winners of the future, frontier market asset management, publisher: the research foundation of cfa institute šoškić, d. b. & živković, b. r. 2007. finansijska tržišta i institucije. belgrade, serbia: faculty of economics, university of belgrade, the second edition. vuković, v. & minović, j. 2012. “needs and possibilities for enhancement of serbian financial markets”. chapter 7 in managing structural changes trends and requirements, publisher: portugal: faculty of economics (feuc), university of coimbra, portugal, pp. 129-147. yeyati, e. l., schmukler s. l., van horen n. 2008. “emerging market liquidity and crises”, journal of the european economic association, mit press, 6 (2-3): 668-682. živković, b., minović j. 2010. illiquidity of frontier financial market: case of serbia. panoeconomicus. 57(3): 349-367. (http://www.panoeconomicus.rs/casopis/2010_3/07.pdf). živković, b. 2008. “finansijski sektor”, reforme u srbiji: dostignuća i izazovi, beograd: clds. živković, b., urošević, b., cvijanović, d., drenovak, m. 2005. “serbia's financial market: 20002005”. quarterly monitor, 1: 65-72 official the belgrade stock exchange (bse) web site, http://www.belex.rs official the national bank of serbia (nbs) web site, http://www.nbs.rs official the securities commission (sec) republic of serbia web site, http://www.sec.gov.rs analiza srpskog tržišta kapitala rezime – ovaj rad analizira srpsko tržište kapitala. glavna karakteristika ovog tržišta je da je ono malo i izrazito plitko tržište. za analizu smo koristili podatke sa beogradske berze (bb), komisije za hartije od vrednosti republike srbije (khvrs) i narodne banke srbije (nbs). zapazili smo da je kriza negativno uticala na tržište kapitala u srbiji. zbog ove činjenice, našu analizu smo podelili u dva pod-perioda: pre krize (2006 – 2008), i za vreme krize (2009 – 2011). naši rezultati su pokazali da je promet opao za preko 70% za oba belex indeksa, dok je na celom tržištu kapitala zabeležen oporavak zahvaljujući ekstenzivnom zaduživanju države. tržišna kapitalizacija akcija je opala. rezultati analize su pokazali da državne dužničke hartije od vrednosti dominiraju posle krize na tržištu kapitala (93% u 2011), dok druge akcije iz privatizacije čine neznatan deo tržišta (tržište akcija je opalo 10 puta od 2006 do 2010). mi smo zaključili da je privatizacija u srbiji značajno uticala na osobine i volatilnost srpskog tržišta kapitala. ključne reči: tržište kapitala, granično tržište, promet, bdp, belex indeksi, likvidnost. article history: received: 14 february 2013 accepted: 12 march 2013 doi: 10.28934/ea.20.53.1.pp94-104 scientific review the necessity of using social networks in contemporary tourism industry and the tourist organization of serbia olja munitlak ivanović1* | lukrecija đeri1 | predrag stamenković2 | aleksandra ilić3 1 university of novi sad, faculty of sciences, department of geography, tourism and hotel management, novi sad, serbia 2 higher business school of vocational studies in leskovac, leskovac, serbia 3 national tourism organisation of serbia, beograd, serbia abstract the practice so far has shown that the tourist destination is managed through the public sector, private companies or according to the model of public-private partnership. modern business and everyday life is unthinkable without the use of social networks and e-marketing. there is an unbroken link between the products of the information sector, social networks and everyday business and private communications. tourism as a service activity is particularly dependent on social networks. potential buyers of tourism products with just “one click” can book, pay for the service, view the pictures and read comments about the desired destination. using concrete data and business on national tourism organisation of serbia, the authors point to a growing trend of using social networks in presenting serbia as a desirable destination. tourist organization of serbia (tos) uses integrated on-line marketing for promotive activities and targeting marketing campaigns. this paper discusses the importance and role of the public sector as a way of managing a tourist destination through tos, but with synergetic effects with the use of social networks. key words: tourism industry, social networks, tourist organisation of serbia (tos), digital promotion jel classification: z30, l83, l86 introduction the end of the xx and the beginning of the xxi century is characterized by a significant development of information technologies, which can even be called a revolutionary turn, that has affected all segments of life. business in all areas have significantly accelerated, facilitated, shortened in time, also the needs for some new professions have emerged, and largely have become internationalized as geographical distance has become a relative category. development of information technologies has all also influenced the changes in everyday life. the average person life, who has access to this technology has also changed dramatically and accelerated. on the one hand, business activities can be completed more quickly, and on the other hand, there is enough free time to do other activities, thanks to advanced technology. life without the internet has virtually become unthinkable. it can even be said that people have become “addicted” to monitoring current “just-in-time”. they usually carry a mobile phone, tablet or computer with * corresponding author, e-mail: olja.mi@dgt.uns.ac.rs olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 95 them, so they can follow events on social networks in a timely manner, respond to messages, take pictures of different events and simultaneously post them on social networks. the younger generation can say that "if an event was not recorded with a cellphone camera and if it was not immediately posted on one of the social networks, the event did not even happen." an ordinary day cannot be imagined without browsing through email, instagram, facebook and other social networks. this has certainly made life easier and more interesting, but it has in some ways led to alienation, as deals that took place tet-a-tet are now done via skype and other mobile applications using the possibility of simultaneous visual contact with the interviewee. this issue is the subject of serious analysis of sociological, psychological and ethical research. as all activities are covered by this process, neither the tourism industry nor the dominant tertiary (labor-intensive, service-oriented) has remained immune to new ways of communication and advertising. following the business trends and the new concept of life of the potential consumer, tourism companies have embraced information technology as the dominant way of conducting all business activities. this particularly applies to the field of marketing. to facilitate and accelerate the communication process with business partners and customers, e-commerce has become a conditio sine qua non. although there are many forms of digital marketing, the subject of this paper is to analyze the impact of social networks on promotion (ilić, 2018). as the tourist organization of serbia (tos) is the main carrier of the formation of a national brand and the promotion of tourism, the focus in analyzing the impact of social networks on marketing will be viewed from the point of view of the impact on this irreplaceable institution for serbian tourism. literature review fahy and jobber (2006) consider that marketing with the use of information technology could be defined as internet marketing, or marketing that fulfills its goals by using the internet and technologies based on it. tošić (2013) believes that internet marketing is part of the promotional mix. of course, the author obtains that in addition to this form of promotional mix, classic forms such as advertising, public relations, sales promotion, personal selling and direct marketing are still being used. nicić (2011) calls this form of marketing as electronic or e-marketing. the author points out that e-marketing encompasses all online and electronically based business activities that make it easier for manufacturers of goods and services to satisfy as many consumer desires and needs as possible in a faster and more efficient manner. almost three decades buhalis (1998) highlighted the fact that consumers are aware of and familiar with increasing use of information technology. consequently, potential consumers have more intensively started using different information tools for the purpose of organizing travel (buhalis & law, 2008). the use of social media has enabled the joint creation of tourism products, based on the experiences of other users of tourism services and their impressions (sigala, 2008). bakić (2005) pointed out that the most significant changes in marketing, in addition to economic, demographic, natural, socio-cultural and political, in the future development of tourism will be felt most in the technological environment, precisely because of the intense reason of information technology. he states that advancements in the reservation systems (crs) of airlines, reservation and management systems at hotel and travel agencies, rapid development of the data transmission network, electronic money, implementation of satellite links are leading to a new quality of marketing mix instruments. along with these processes, there is a disintermediation, which can be seen through the disappearance of classical intermediaries in the market (classic tourist agencies), due to the increasing possibilities of direct sale through the use of information technologies (spasić & rabotić, 2008). 96 economic analysis (2020, vol. 53, no. 1, 94-104) digital promotional mix instruments effectively combining the four marketing mix instruments produces an effective marketing program that, above all, should provide value to consumers. promotion, or marketing communication, is one of the elements of the marketing mix, which in order to be effective, must be coordinated with other marketing activities. increasingly, the more comprehensive term integrated marketing communication (imc) is being used. the overall effect of coordinating different communication activities is greater when they are performed independently and in some cases in conflict with each other (milojević & mikić, 2017). the importance of online promotion is steadily growing and gaining importance in budgeting and marketing efforts whether it is a text message that can change consumer behavior in the moment or keywords that can increase the number of queries or a contextual banner that changes attitudes or viral marketing that encourages people to talk about the product. online channels can do what offline channels simply cannot, e.g. some websites can promote, communicate, and create a unique experience that is unique to online users. although websites, by themselves, cannot be considered as a propaganda tool, they are an integral part of all ten elements shown in table 1. table 1. on-line equivalent promotional assets promotional mix online equivalents advertising interactive ads, pay per click, search engine advertising sale viral sales, affiliate marketing sales improvement incentives, rewards, online loyalty public relations social networks, links, newsletters, online editorials direct mail opt-in email when using e-newsletter, e-blast exhibitions virtual exhibitions product display promotional ads at trade shows, personalized recommendations packaging virtual tours, really packed online oral propaganda viral marketing, referrals to friends via email and links source: chaffey, smith, 2008. four marketing mix instruments, first of all, should answer seven important questions: 1. defining the audience, 2. defining the goal of promotion, 3. determining the topic of addressing the market, 4. developing a clear message to be conveyed, 5. choosing the medium for conveying messages, 6. defining the budget for promotion and 7. determination of mechanisms of continuous control. social networks social networks are free, interactive internet services that allow users to create public or semi-public pages with basic information about themselves, provide a list of users with whom they have a connection, and view and interact with their contact list (boyd & ellison, 2007). there are various types of social networks and they may be of a general type or may be specific to a particular geographical area, as well as to the occupations, interests and needs of users. the most popular social networks are facebook, youtube, whatsapp, wechat and instagram (figure 1). olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 97 figure 1. the world's leading social networks by number of active users source: survey conducted, 2018. pew research center the three main arguments for using social networks in tourism are: 1. high targeting easy to reach, and the promotion is tailored to market segmentation; 2. measurability any effort can be measured, and the result of the activity can be seen. statistics can provide "tons of information", it's up to the company to analyze and use them regularly; 3. accessibility and low prices the use of social networks is generally completely free. in order to increase the effects of its business appearance, the company can also use various methods of paid promotion, which, in comparison with other media, is far cheaper and accessible to everyone (stojković, 2013). many travelers ''consult'' social networks when planning a trip to find destinations, benefits, tips, and reviews from other travelers, but to what extent do social networks have the power to shape travel? not only do social networks have an impact on travel planning, they are also very present and influential during the tourists' stay in a particular destination, but also upon their return from destination to the place of residence. promotional activities of the tourist organization of serbia on the internet tourism law of 1994 established the tourist organization of serbia (tos), as the official carrier of the institutional promotion of tourism of the republic. the activity of tos is aimed at positioning the tourist product of serbia in the domestic and foreign markets and tourist valorization of serbia's comparative advantages, such as its geo-strategic position, historical, cultural and natural identity. in order to uniquely implement tourism information and propaganda activities, integrate serbia's tourism space into european tourism itineraries and strengthen bilateral cooperation in the field of tourism development, tos is present at all major tourism fairs worldwide, cooperates with other national tourism organizations and other international, regional and professional tourist associations. in addition to the above activities, tos is engaged in monitoring and placing the latest news in the field of tourism. new promotional activities can be noticed on the website: • projects from china and 17 countries in central and eastern europe (china cee 17+1), where applications for the prestigious marco polo award are encouraged. this is a 73% 68% 35% 29% 27% 25% 24% 22% 0% 10% 20% 30% 40% 50% 60% 70% 80% youtube facebook instagram pinterest snapchat linkedin twitter whatsapp 98 economic analysis (2020, vol. 53, no. 1, 94-104) logical sequence of activities, because in 2019, serbia was declared one of the most promising destinations in china. • tos promotes specific destinations that it considers extremely attractive: lepenski vir, gamzigrad, studenica, resava cave and palić lake. • tos launches internal competitions for awards in the field of tourism in serbia: exceptional destinations in serbia eden2019; tourist flower, the best photo of serbia and the like. use of the website for the purpose of promoting tourism in serbia the website is an 'id card' of every organization. primarily, because it is the first meeting of a potential user of goods and/or services, in this case tourists, with the organization through the internet. it can be said that a quality website is the equivalent of a smiling and kind person at the hotel reception, in terms of getting a first impression of the seriousness and quality of the organization/destination. second, because any additional efforts made by the organization through the internet are closely linked to the functioning of the website. this should practically mean that without a quality website there is no successful web marketing. as for the history of using websites to promote serbia as a tourist destination, it is also quite long. the first website of the tourist organization of serbia was published in 1997 and functions as a subpage of the website of the faculty of economics in belgrade. it has been modified and modernized several times since 1997. it now operates under the domain http://www.serbia.travel. the current website of the tourist organization of serbia is just over two years old. it was first presented at the tourism fair in belgrade in 2016. it has since been used as the official website of this national tourism organization. at the bottom of the homepage are links to social networks: facebook, twitter, youtube, instagram, pinterest and tripadvisor. the introductory (home) page of a website is the page where the most important things are. if viewed from this side, it can be said that this web site fulfilled this role of tos because everything that is most important for the tourists themselves is on the homepage, starting with the information about serbia itself, through all the major events to various information related to tourism in serbia. the presentation of tourism on the website is mostly dominated by pictures, which attracts tourists because the pictures best describe a particular destination. use of social networks in promotion of serbian tourism if we look at tos activities on social networks, they can be divided into three groups: 1. daily publishing of multimedia content in the form of photos, infographics, news, videos. compared to last year, the novelty in this field was the development of special creative platforms (regular sections dedicated to specific topics that they publish in a specific term). 2. organizing periodic campaigns: paid advertising campaigns and prize competitions. 3. direct communication with interested citizens through responses to comments and private messages. tos profiles on social networks publish information, news, photos and other promotional materials, answer questions of users interested in serbia's tourism offer, organize sweepstakes and publish competitions related to building an image and positioning serbia's tourist offer on the domestic and world markets. the number of tos followers on social networks has increased dramatically as a result of the excellent results that tos sites achieve, which is the result of a long-term strategic appearance on social networks that results in a large interaction of users with published content. this is also the basic criterion that facebook's algorithm takes into account when placing content as well as conducting an advertising campaign on tos pages in olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 99 serbian and english, their quality designing, which includes: target group selection, ad placement method, conceptual design, etc. the rating of a tourist destination on social networks makes a great contribution to creating a pleasant image of a tourist destination. thanks to the rating, a larger number of people participate in the exchange of opinions and experiences about a tourist destination, using social networks. good publicity contributes to the development of the reputation of duristic destinations. terms such as liking, sharing, blogging, tweeting, and the like have become part of an individual’s everyday speech in this area as well. analysis of the tourist organization of serbia facebook page the tourist organization of serbia is present on the social network facebook through facebook pages. the organization owns pages that are being updated in different world languages for different markets. the tourism organization of serbia is also responsible for the site dedicated to tos souvenir shops. tos manages two souvenir shops in belgrade. this tos activity is promoted through the instagram and facebook page of serbia travel souvenirs (@ serbiatourism.souvenirs). the site has existed since 2017 and was opened in parallel with the opening of the tos gift shop near the avala tower. the facebook page has 1740 likes, while its instagram profile is followed by 452 people. the most interesting facebook pages are the tourist organization of serbia, the site that tos has best developed and through which the largest number of advertising campaigns have been conducted and serbia travel, which tos uses as a means of communication at the international level and through which all advertising campaigns are conducted globally. content that is published daily on the site is planned two months in advance and depends on: marketing campaigns run by tos at a given moment, tourist season, significant events, markets for which it is planned and availability of materials for creating posts. most of the audience is in the following two age groups: 25-35 and 35-44. the demographic structure of tos's followers on facebook shows that the women are in the majority (figure 2 and figure 3). as for the posts themselves, tos uses a variety of formats to properly convey the message to followers of the site, such as: status with a photo, video, event, note, poll, live stream, and facebook story. figure 2. the demographic characteristics of the tos facebook page followers by gender source: https://www.facebook.com 62% 38% female followers male followers 100 economic analysis (2020, vol. 53, no. 1, 94-104) figure 3. the demographic characteristics of the tos facebook page followers by age source: https://www.facebook.com analysis of the tourist organization of serbia twitter account tos's twitter account is currently followed by 27,800 twitter users, including 129 followers with verified accounts. interestingly, even though this is a tos account that has the lowest number of followers compared to other social networks, and the only one has a verified profile tag. the account is updated daily with at least one tweet created by tos and several retweets. the tweets mostly consist of a photo, branded with a logo, hashtag and slogan, and accompanying text. in addition, there are blogs about serbia, as well as occasional surveys on serbia's tourism offer. organizations such as the european tourism commission, the world tourism organization, the national museum and other institutions on which serbia's tourist offer depends, are most commonly retweeted; famous world media that broadcast a positive image on tourism in serbia; local tourism organizations; influencers; but also smaller users who conceptualize their tweets to create a positive image of serbia as a tourist destination, in a creative and receptive way for twitter audiences. tweets are written in english. at the top of the page is a tweet, related to the campaign tos is currently running. the tos account belongs to two lists, one is a list of all accounts of tourist organizations in serbia and the other is a list of all twitter accounts of national tourist organizations. figure 4. the demographic structure of tos followers on twitter by gender source: tourist organization of serbia 0.66% 7% 18% 17% 11% 6% 2% 0.43% 5% 11% 10% 6% 3% 2% 0.00% 10.00% 20.00% 13-17 18-24 25-34 35-44 45-54 55-64 65+ male followers female followers 61% 39% male followers female followers olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 101 figure 5. the demographic structure of tos followers on twitter by age source: tourist organization of serbia unlike other female-dominated tos accounts, on twitter, these are men with 61%. the most dominant audience is 25-34. (figure 4 and figure 5). when it comes to the most successful tweets, in the period from 2015 to the present, it is a tweet with the video serbia: “the place to be”, with which, in 2017, tos presented the beauties of serbia on bbc world television and eurosport. analysis of instagram profile of tourist organization of serbia the instagram profile of the tourist organization of serbia has more than 51 thousand followers. the most dominant audience is 25-34. the demographic structure of tos's followers on instagram shows that the women are in the majority (figure 6 and figure 7). the page name is serbia travel and the username is @serbiatourism. the profile description states that this is the official profile of the serbian tourism organization, as well as a sentence stating that if you use #seeserbia or #videoserbia you give tos permission to share your content on your own page. both in english. the website included in the page description is http://serbia-the-place-tobe.serbia.travel/. the profile is in business form. the account title bar above the gallery contains shortcuts to phone number, email address, and location. the account is in the category government organization and is updated daily. there are two methods of updating: user generated content (ugc); and content from the tourist organization of serbia database. as a way of collecting content from users, the above mentioned hashtags are used to the greatest extent, as well as tags, geolocations and also online tools. photos are posted without any delusions. the descriptions are bilingual with text in serbian and english. the descriptions are enriched with hashtags, but not so much to stifle the main message. each photo contains geolocation. tos takes full advantage of this social network. instagram stories are occasionally created, some of which are featured on the profile. tos has on several occasions on this network conducted live broadcasts from different destinations in serbia, such as vrnjacka banja, cacak, nis, belgrade. igtv is also active, with two videos so far. 2.50% 8.20% 34.40% 32.10% 13.90% 6.90% 2% 0.00% 10.00% 20.00% 30.00% 40.00% 18-20 21-24 25-34 35-44 45-54 55-64 65+ followers by age 102 economic analysis (2020, vol. 53, no. 1, 94-104) figure 6. the demographic structure of tos's followers on instagram by gender source: tourist organization of serbia figure 7. the demographic structure of tos's followers on instagram by age source: tourist organization of serbia analysis of youtube channel of tourist organization of serbia youtube channel of the serbian tourism organization has been subscribed by 6,596 users. the total number of videos posted on this channel is 168, with a total of 7,183,797 views. there is no certain dynamic for video publishing, since it depends on the production. all videos on this youtube channel are the property of tos, which means that on this social network the tourist organization of serbia relies only on its own content, no user-generated content. the channel is organized into 9 playlists, but not all videos are included. videos can be divided into different series. in addition to the video series, there are also individual videos from different campaigns. the videos with the most views on this channel are: the danube in serbia: 588 impressions with 1.8 million views; serbia one journey, million impressions with 625,538 views; serbia – the land of new beginnings with 486,197 views. the tourist organization of serbia also advertises itself on this social network. the most dominant format used is the skippable and non-skippable video ad. 41% 59% male followers female followers 1% 16% 44% 25% 9% 3% 2% 0% 10% 20% 30% 40% 50% 13-17 18-24 25-34 35-44 45-54 55-64 65+ followers by age olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 103 analysis of tos account on weibo the china market is one of the most significant markets covered by the serbian tourism organization. according to tos statistics, the number of chinese tourists in serbia increased by as much as 181% in 2017, while during the first 6 months of 2018, the number of chinese tourists increased by 97%. the tourism organization of serbia, taking into account the results that serbia's tourism has achieved when it comes to the influx of tourists from china, as well as the fact that china has banned the use of the world's most dominant social networks, has found through weibo a way to bring chinese tourists closer to serbia's tourist offer online. this site is administered from china, that is, by a partner pr agency in charge of promoting serbia in the chinese market. the site is updated daily. the most dominant formats are photos and videos. what is particularly interesting is the fact that this site also makes extensive use of usergenerated content. this fact also indicates the great interest of chinese tourists in european destinations, and therefore serbia. also, this site uses celebrities from serbia known to the chinese public in order to bring serbia closer to chinese tourists, so the site can find posts related to trophies that novak djokovic wins, music by goran bregovic, bata zivojinovic, etc. conclusion the use of social networks in tourism is increasingly justified because of high targeting easy to reach, and the promotion is tailored to market segmentation; measurability any effort can be measured, and the result of the activity can be seen. statistics can provide "tons of information", it's up to the company to analyze and use them regularly; accessibility and low prices the use of social networks is generally completely free. in order to increase the effects of its business appearance, the company can also use various methods of paid promotion, which, in comparison with other media, is far cheaper and accessible to everyone. many travelers ''consult'' social networks when planning a trip to find destinations, benefits, tips, and reviews from other travelers, they are also very present and influential during the tourists' stay in a particular destination. in order to uniquely implement tourism information and propaganda activities, integrate serbia's tourism space into european tourism itineraries and strengthen bilateral cooperation in the field of tourism development, tos is present on all major social networks (facebook, twitter, instagram, youtube, weibo). tos profiles on social networks publish information, news, photos and other promotional materials, answer questions of users interested in serbia's tourism offer, organize sweepstakes and publish competitions related to building an image and positioning serbia's tourist offer on the domestic and world markets. the number of tos followers on social networks has increased dramatically as a result of the excellent results that tos sites achieve, which is the result of a long-term strategic appearance on social networks that results in a large interaction of users with published content. acknowledgements this paper is a part of research project number 01037 176020 (transformacija geoprostora srbijeprošlost, savremeni problemi i predlozi rešenja) financed by the ministry of education, science and technological development of the republic of serbia. this paper is a part of research project number iii47009 (european integrations and social and economic changes in serbian economy on the way to the eu) financed by the ministry of education, science and technological development of the republic of serbia. 104 economic analysis (2020, vol. 53, no. 1, 94-104) references bakić, o. 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(2019). http://www.serbia.travel/home.779.html (accessed june 15, 2019) article history: received: october 29, 2019 accepted: november 20, 2019 https://doi.org/10.1111/j.1083-6101.2007.00393.x https://doi.org/10.1111/j.1083-6101.2007.00393.x https://doi.org/10.1016/s0261-5177(98)00038-7 https://doi.org/10.1016/j.tourman.2008.01.005 https://www.facebook.com/ http://www.turizamiputovanja.com/primenadrustvenihmrezauturizmuiugostiteljstvu.pdf http://www.turizamiputovanja.com/primenadrustvenihmrezauturizmuiugostiteljstvu.pdf http://www.serbia.travel/home.779.html the necessity of using social networks in contemporary tourism industry and the tourist organization of serbia olja munitlak ivanović114f* | lukrecija đeri1 | predrag stamenković2 | aleksandra ilić3 introduction literature review digital promotional mix instruments social networks promotional activities of the tourist organization of serbia on the internet use of the website for the purpose of promoting tourism in serbia use of social networks in promotion of serbian tourism analysis of the tourist organization of serbia facebook page analysis of the tourist organization of serbia twitter account analysis of instagram profile of tourist organization of serbia analysis of youtube channel of tourist organization of serbia analysis of tos account on weibo conclusion acknowledgements references ea_2018_3-4 đuro kutlača 1 doi: 10.28934/ea.18.51.34.pp1-9 original scientifi paper in search for ris3 for the republic of serbia: challenges between theory and reality đuro kutlača1* 1 institute “mihailo pupin” belgrade, serbia abstract objectives of this paper are exploration of the challenges of use of methodology for creation of smart specialization strategy (s3) in serbia. s3 is focused on use of knowledge for economic development. major challenges of implementation of s3 in serbia are weak links between r&d sector and economy, and undeveloped culture of dialogue for adoption and realization of s3 priorities. in this paper are presented key challenges authors of s3 in serbia are faced with in very first trial of introduction of s3 methodology in country. paper is organized in four main parts. first part is (critical) description of the main concepts of methodology for creation of s3. the concept of s3 is a tool for realization of the strategy of the european development through "integrated industrial policy for the globalization era" and "innovation union". second part will present implication of implementation of s3 in serbia, i.e. conditions for use of one theoretical concept in reality of economy and society in serbia. third part is discussion of results of implementation of s3 in serbia achieved so far (process is not finished at the moment of writing of this article, mid 2018), analysing challenges between proposed methodology and real situation in country. fourth part is addressed to further steps in implementation of s3 in serbia, with particular attention to the aspects of dialogue which should be organized between involved stakeholders in order to achieve consensus for adoption and realization of s3 priorities in serbia. key words: smart specialization; s3 strategy; mcdm methods; priority sectors; edp; dialogue jel classification: a0, o33 introduction in the beginning of the year 2017 the government of the republic of serbia has decided to launch activities addressed to creation of a research and innovation strategy for smart specialization (ris3). first steps in this direction were creation of three working groups: first, an interministerial working body (iwb) for coordination of the activities between different ministries and governmental institutions; second and third working groups are established by iwb: the iwb has decided to establish an analytical team (at) and an operational team (ot). the european commission's (ec) joint research centre (jrc) has supported these processes in partnership with the governments of ukraine, moldova and serbia in developing ris3 (government of montenegro has joined activities six month later). the operational team consists of representatives of the republican secretariat for public policy, the ministry of education, science and technology development, the ministry of economy, the statistical office, the serbian chamber of commerce and the national employment service. their major tasks are operationalisation of activities for creation of ris3 and communication between major stakeholders: government, research and innovation (r&i) stakeholders, private sector, civil society, and jrc. the analytical team consists of representatives of the institute mihajlo pupin * e-mail: djuro.kutlaca@pupin.rs 2 economic analysis (2018, vol. 51, no. 3-4, 1-9) (imp), republic statistical office (rso), and republic secretariat for public policy (rspp) as well as some independent experts when needed. their key activities are quantitative and qualitative analyses necessary for building a strong evidence-base for of ris3. this article is organized in four main parts. first part is (critical) description of the main concepts of methodology for creation of smart specialization strategy (s3). second part will present implication of implementation of s3 in serbia, i.e. conditions for use of one theoretical concept in reality of economy and society in serbia. third part will discuss results of implementation of s3 in serbia achieved so far (process is not finished yet), analysing challenges between proposed methodology and real situation in country. fourth part will be addressed further steps in implementation of s3 in serbia, with particular attention to the aspects of dialogue which should be organized between involved stakeholders in order to achieve consensus for adoption and realization of s3 priorities in serbia. important note for readers is fact that in the moment of writing of this article (mid 2018), process of creation of ris3 is in the beginning of mentioned dialogue, which is named by the authors of s3 methodology as entrepreneurial discovery process (edp). s3 methodology the concept of “smart specialisation” is a tool for realization of the strategy of the european development through "integrated industrial policy for the globalization era" and "innovation union". s3 methodology is focused on use of knowledge for economic development, primarily is based on work of the expert group knowledge for growth (foray, david & hall, 2009), and has rapidly been implemented in eu policy as precondition for use of structural funds. elaborated by a group of academics in 2008, it very quickly made a significant impact on the policy audience, particularly in eu, as part of the preparation of the new cohesion policy for 2014–2020. major presumption is that smart specialisation strategies can ensure a more effective use of public funds and can stimulate private investment. it is mainly addressed to regions (rather than country level) to concentrate resources to a few key priorities rather than spreading investments across all business sectors. they can also be a key element in developing multi-level governance for integrated innovation policies because of use of knowledge and creativity rather than manual work. moreover, they have to be closely linked with other policy domains and require an understanding of regional strengths relative to other regions and the possible gains for interregional and transnational cooperation (european commission, 2010). the european commission has established the s3 platform in seville, in order to support national and regional actors in the process of developing research and innovation strategies for smart specialisation (ris3), providing various forms of support, e.g. in terms of information, seminars, peer reviews and guidelines. methodologically, process of development of s3 is organised in six practical steps for designing national or regional ris3 (s3 platform, 2012): step 1 – analysis of the national or regional context and potential, in relation to other nations and regions; step 2 – governance: ensuring participation and ownership – set up an inclusive structure and incentives for securing broad stakeholder involvement; step 3 – vision – produce a shared vision among stakeholders – elaboration of an overall vision for the region; step 4 – prioritisation – identification of priorities – selection of a limited number of priorities for regional development; step 5 – policy mix – definition of a coherent policy mix, road maps and action plans – combination of a mixture of policy measures and support them with road maps or action plans to secure implementation; đuro kutlača 3 step 6 – evaluation and monitoring – integration of monitoring and evaluation mechanisms – developing of systems for continuous and evidence-based monitoring of the process and follow up on results and effects, in order to learn and revise the policy mix. implementation of s3 methodology in serbia serbia as candidate country for membership in eu is in permanent transition of economy and society since 1991, facing serious problems of unemployment, brain drain, ageing, and political instability (semencenko & kutlaca, 2018). major challenges of implementation of s3 methodology in serbia are: weak links between r&d sector and economy; moderate level of innovation activities; undeveloped culture of dialogue between stakeholders involved in realization of s3 (kutlača, semenčenko and nedović, 2016). therefore, crucial support of jrc and foreign experts from fhg institute isi (karlsruhe, germany), engaged (financed) by jrc is to overcome organisational weaknesses linking stakeholders and support process of selection of priority sectors of economy which development should be realised with use of knowledge, rather than manual work, or fdi. external support has resulted firstly with roadmap for development of ris3 in serbia in 2017-18. this roadmap is adaptation of originally proposed six steps into five phases (jrc and iwb, 2017): preparatory stage: organisation of process of development of ris3 in serbia – resources necessary for effective cooperation between jrc and domestic institutions; mapping of economic, innovative and scientific potential: multi-dimensional quantitative analysis showing strongest sectors and areas of science at regional level; entrepreneurial discovery process: qualitative analysis and organized dialogue with all engaged stakeholders – edp should be organized for all selected areas of smart specialisation; establish a monitoring and evaluation system: development of indicators for monitoring of implementation and ex-post impact evaluation of ris3 in serbia; develop an implementation system: organisation and financing of implementation of ris3 in serbia. during the year 2017, and according to road map, major activities belong to phase 2 (or step 1), i.e. both external experts and domestic analytical teams were engaged in quantitative analysis of available statistical data with aim to identified priority sectors in economy of serbia which development should be relied on r&i activities. external experts (jrc and fhg) have developed procedure with two presumptions, based on already proved reach statistical bases with data available on regional level for nace 3-digit categories of economic activities in serbia1: (1) quantitative analysis could and should be organised for four statistical regions in serbia: region rs11: belgrade, region rs12: vojvodina, region rs21: šumadija and western serbia, region rs22: southern and eastern serbia (region rs23: kosovo – data are not available); (2) prioritisation of the sectors of economy within the regions should be based on their specialisation proper, i.e. an in relative terms higher importance of the sector in the regional economy than is calculated for the economy in serbia. measure for specialisation proper is the location quotient (lq) which compares the share of a sector in the regional economy with the share of a sector in the national economy. condition for selection of priority sectors is value of a location quotient of more than 1.5 i.e. only sectors that are at least 1.5 times the share in a regional economy than they do in the national economy! for 1 nace is the acronym for “nomenclature statistique des activités économiques dans la communauté européenne”; nace rev. 2 statistical classification of economic activities in the european community; isbn 978-92-79-04741-1, issn 1977-0375, ec, 2009 4 economic analysis (2018, vol. 51, no. 3-4, 1-9) example, lq for employment is given in formula 1, with e = (sectoral) employment in region and e = (sectoral) employment in nation, for nace sector x: �� = ���� ���� � ��� ��� � (1) two more characteristics must be considered for selected priority sectors: absolute size: this characteristic will exclude sectors which are employing to small number of people: and growth: with this characteristics it is possible to differentiate sectors whether they are emerging or mature sectors which should be restructured first. with these two characteristics, additional thresholds were defined, particularly minimum size of absolute value for each indicator. analysing data for period of 5-6 years only those nace 3-digit level sectors are kept as relevant if they show as stable specialisations for at least 3 times for single years across the entire economy. external experts have defined three sets of indicators that should best describe positions of the regions in terms of specialisation (kroll, schnabl & horvat, 2017): (1) indicators of economic potential of the region: − employment, according to 2011-2016 labour force survey data, − exports, according to 2012-2016 national export statistics; (2) indicators of innovative potential of the region: − innovating firms, according to the 2010-2014 national innovation survey, − patents, according to indicators developed by the mihajlo pupin institute, based on data provided by the intellectual property office; (3) indicators of scientific potential of the region: − publications, according to indicators developed by the faculty of physics and m. pupin institute, based on data collected by the faculty of physics, using web of science/frascati classifications of fields of sciences. all data, necessary for calculation of proposed indicators were provided to external experts and analytical team by the republic statistical office, with requested levels of details and accuracy. integration of all three analysed potentials (economic, innovative and scientific) is done by external experts in two steps: step 1: identifying potential priority domains based on overall thresholds; step 2: matching of results with further information on "smartness" – several more indicators are used in order to assess the relevance and potential promise of the identified economic priority domains: total employment, wages, value added, labour productivity, growth in employment. steps 1 and 2 have resulted with identification of potentially priority areas of specialisation by regions based on quantitative analysis, and should be basis for edp process between all interested stakeholders. integration of all indicators used for quantitative analysis presented within these two steps is done using excel table with calculated values, selecting nace 3-digit sectors they fulfil conditions – predefined thresholds (kroll et al., 2017): • region rs11 belgrade: − priority sectors: computer programming and ict; r&d and technical consultancy; creative economy; monetary intermediation, − potentially emerging innovative sectors: beverages, pharmaceuticals, electrical components, transport equipment, đuro kutlača 5 − science based sectors: various; • region rs12 vojvodina: − priority sectors: automotive; agricultural economy (including processing industries); petrochemical industry; plastics industry; − potentially emerging innovative sectors: agricultural machinery, measurement instruments − science based sectors: computer science, telecommunications • region rs21 šumadija and western serbia: − priority sectors: agri-/horti-/silvicultural economy (including processing industries); automotive; textile industry; plastics industry; metal industry; − potentially emerging innovative sectors: special purpose machinery − science based sectors: mechanical engineering, pharmacy • region rs22 southern and eastern serbia: − priority sectors: agri-/horticultural economy (including processing industries); textile industry; rubber industry; electrical engineering; − potentially emerging innovative sectors: food products, medical and dental − science based sectors: electrical engineering implementation of s3 in serbia: challenges between proposed methodology and real situation in country rigidity of the proposed method of selection with threshold of lq>1.5 and even with reduced threshold of lq>1.25 should be welcomed by the wider public as ability to make priorities without compromise. still, question on use of complete available data, considering all indicators of economic, innovation and scientific potentials, remain unanswered, although steps 1 and 2 presents sort of mixture of quantitative with qualitative analysis with aim to make more adequate decisions – selections. exhaustive analysis of statistical data finalised with analytical tool is result of quantitative analysis provided by external experts (fhg institute isi, karlsruhe, germany). excel table listing all nace 3-digit sectors they fulfil conditions for selection of potentially priority areas of specialisation by regions should be basis for edp process between all interested stakeholders; still 0-1 type of table could be source of numerous questions, doubts and mistrust, particularly from stakeholders they represent sectors which are not selected among potentially priority areas of specialisation. therefore, additional quantitative analysis is recommended by the analytical team – associates of “mihajlo pupin” institute (mpi) and accepted by the interministerial working body (iwb): use of single criterion as aggregate value of all proposed indicators provides rationale for extension of basic s3 approach with implementation of multiple criteria aggregation in mapping exercise. therefore, mpi associates have applied the ideal point method (ipm) compromise programming (zeleny, 1976). the ipm is implemented as follows: a set a of n sectors is compared with respect to m indicators. all sectors are compared with a sector that has ideal values for all m indicators, a so-called ideal (a reference sector). a point in mdimensional space represents each sector from the set a. the point representing the ideal sector is referred to as the ideal sector (ideal point, as name of the method suggested). the distance d (the author of ipm has recommended geometrical distance) of each point from the ideal one is calculated using formula 2. the sector, whose distance from ideal is the shortest, is the best sector. the calculated distance d is value which could be used for a ranking list of objects: 6 economic analysis (2018, vol. 51, no. 3-4, 1-9) ( ) n1,...,i ; m1,...,j ; c c ic kd p p l 1 l j maxij ijj ji ==        ×= ∑ (2) where: icj a j-th single indicator for ‘reference sector’, ci,j a j-th single indicator of an i-th observed sector, kj a weighting factor of a j-th single indicator; j – number of single indicators; i – number of observed sectors; lp used metrics, di – calculated distance for i-th sector from reference sector. with lp=2, the formula is a calculation of euclidean distance, and this case is used by analytical team. the extension of the quantitative analysis with, recommended by the analytical team, use of mcdm ideal point method compromise programming has provided one more geographical area of analysis – entire country! therefore, results of this amendment to basic s3 procedure are five ranking lists of nace 3-digit level sectors-groups: one ranking list for serbia total and four ranking lists for statistical regions (table 2; data for year 2016, excerption – only first ten nace 3-digit sectors-groups are presented and for serbia total only). table 2. ranking list of nace sectors-groups in serbia total – excerption, first ten nace 3-digit level sectors-groups, year 2016 rank nace 3-digit sectors – groups – first ten presented – serbia total 1. j62.0 computer programming 2. m73.1 advertising 3. m71.1 architectural and engineering activities 4. a1.1 growing of non-perennial crops 5. g46.9 non-spec. wholesale trade 6. m71.2 technical testing and analysis 7. c28.2 manufacture of other general-purpose machinery 8. c26.5 manufacture of instruments and appliances for measuring, testing and navigation; watches and clocks 9. c10.8 manufacture of other food products 10. m72.1 r & d natural science source: analytical team, internal working documents, 2017-2018 quantitative analysis of economic, scientific and innovative potentials of serbia in total and in all statistical regions using the basic s3 process of selection of nace 3-digit potentially priority sectors-groups in four regions and with amendment of ranking list of all nace 3-digit sectorsgroups created with aggregate criteria (mcdm aggregation and ranking) both for serbia total and for four regions, all together this information should be a basis for meaningful edp dialogue! s3 – challenges between theory and reality in serbia development and implementation of smart specialisation strategy in serbia is adventure faced with numerous challenges, some of them will be clarified as follows: 1. responsibility: which ministry should be in charge of development and implementation of the ris3 in serbia? eu member countries were firstly obliged to develop s3 in order to be eligible for use of structural funds: “this communication complements the one on the innovation union by calling on policymakers in member states at all levels to act without delay to invest more of the resources still available from the european regional development fund (erdf) in the present programming period on smart growth” (european commission, 2010). seven years later, s3 became new industrial policy for eu – the smart specialisation is, in fact, đuro kutlača 7 development of sectors of economy based on knowledge, i.e. new industrial policy relying on integration of r&d and innovation with business: “investing in a smart, innovative and sustainable industry – a renewed eu industrial policy strategy” (european commission, 2017). unlike already established mind-set in eu with orientation of s3 as main policy instrument for development of economy, situation in both western balkan countries which are in process of development of ris3 is rather puzzled. in the republic of serbia (rs) and in the montenegro (mne), ministries which are responsible for development of ris3 are ministries in charge for science: ministry of education, science and technological development in rs and ministry of science in mne. having in mind fact that development of ris3 in both countries is supported by the joint research centre of eu ipts (seville, spain), it is reasonable to expect that implementation of the ris3 will be realised through activities of (and financed by) ministries in charge of economy and other related ministries, with, eventually, coordinating role of ministries in charge of science for better allocation of research and innovation resources in countries; 2. organisation – motivation i: although development of the ris3 has all elements of project activity (institution involved, activities and responsibilities with mailstones, results, deliverables, etc. pre-defined and agreed; therefore management, financing, monitoring, etc. are clearly defined) in the republic of serbia is, primarily, voluntary based activity. there are no contracts, obligations, and consequently, there is no financing of development of ris3!? there is budget, with clearly defined roles and obligations, for jrc as supporting institution, but jrc has no obligation for creation of ris3 in rs. therefore, development of ris3 in rs relies on good will and voluntary based engagement of members of operational and analytical teams, together with involved associates of the “mihajlo pupin” institute, republic statistical office, intellectual property office, faculty of physics, and some others; 3. financing – motivation ii: having no project organisation, there is no financing of the development of ris3 in rs! this challenge, although already mentioned within previous challenge, must be stressed as serious issue which could increase risk for successful realisation of ris3 to the unacceptable level; 4. mobilisation of stakeholders – motivation iii: stakeholders, particularly representatives from companies, but also from all other relevant institutions, can be mobilised if they could find interest for this engagement. adoption of the ris3 in rs has no direct consequences in terms of launching of new programme with specific (and already allocated) funds, primarily addressed to companies which should develop new products/services in cooperation with r&d sector. such situation hardly could motivate stakeholders for active involvement in development of ris3, particularly during edp process which should serve as dialogue for (re)definition and adoption of proposed priority areas (nace 3-digit sectors/groups); 5. legal framework: because of un-clear position of involved institutions (“who is responsible for what”), there is no laws and by-laws with precise definition of the role of ris3, as well as procedures for financing (budgeting), monitoring, reporting, etc. for the process of implementation of ris3 in rs; 6. quantitative vs. qualitative analysis – selection of priority sectors: fact based decision making is regular procedure for businesses; surprisingly “believing” could be preferable approach for other sorts of decision, as this is explored in previous article, using wrong figure for gerd and number of researchers in main policy document for scientific community, official s&t strategy adopted in 2010, ignoring available official statistics (stefanovic-sestic & kutlaca, 2014). this is a reason for precaution rather than enthusiasm having such exhaustive quantitative analysis provided by external experts (fhg, jrc) and complemented by the analytical team. prejudices, hidden interest and political preferences could be stronger argument than data and information based on 8 economic analysis (2018, vol. 51, no. 3-4, 1-9) quantification of the available statistics. this challenge could be major obstacle for wider dialogue of involved stakeholders and could lead to wrong decisions; 7. culture of dialogue: entrepreneurial discovery process (edp) is one of the key phases in creation of the ris3, and should be sort of dialogue between involved stakeholders in order to reach consensus in selection of priority areas for smart development. it is necessary to consider findings related to ability and readiness for dialogue: the results of gert hofstede's research on the impact of certain components of national cultures showed that people in serbia are characterised by the disrespect of institutions and tendency towards short-term orientation rather than strategic long-term thinking (hofstede & hofstede, 2005). combining these findings with inherited legacy from socialist period of autocratic decision making it is reasonable to assume that organisation of wider democratic dialogue could be serious challenge. s3 – further steps first year of development of the ris3 in serbia has ended with quantitative analysis and mapping of economic, innovative and scientific potential in serbia (kroll et al., 2017), complemented with ranking lists of nace 3-digit level sectors-groups in serbia total and for all four regions using mcdm ideal point method compromise programming, developed by the imp associates within the analytical team. following road map, in the second year (2018) should be realised third phase, i.e. entrepreneurial discovery process (edp), or dialogue between all stakeholders and qualitative analysis of proposed priority nace sectors-groups and ranking lists of nace sectors in regions and for serbia in total. following original s3 methodology and advices from external experts (jrc), edp should be organized for all selected areas of smart specialisation, therefore, imp associates within the analytical team has proposed generalisation of ranking list of nace 3-digit level sectors-groups in serbia total. this generalisation has led to the following proposal: 1. priority areas – vertical: • digitalisation of the economy and society • smart agriculture – food and health • smart industry 4.0 and smart materials • cultural heritage and cultural industries 2. priority areas – horizontal: ket; ict; environmental protection; energy efficiency 3. with key emerging technologies (ket): micro and nano-electronics; nano-technologies; industrial biotechnology; advanced materials; photonics; advanced technologies in manufacturing. preparation of conditions for organisation of edp is ongoing activity in the time of writing this article, and results of this phase together with creation of final ris3 document together with plan for implementation of ris3 in serbia are the future steps, and possible subject for future writing about ris3 in serbia. main outcome of all mentioned activities should be consensus about identified priorities, as well as wider understanding of necessity of creation of national innovation system in serbia (edquist & johnson, 1997). acknowledgement research presented in this paper was supported by the ministry of education, science and technological development of the republic of serbia, under the project: "research and development of the platform for science based management of the scientific and technological development of the republic of serbia", reg. no. iii 47005. đuro kutlača 9 references edquist, c., and johnson, b., (1997). "institutions and organizations in systems of innovation", in edqust, c. (ed.), "systems of innovation", london, pinter european commission (2010). regional policy contributing to smart growth in europe 2020, com (2010) 553 final. european commission (2017). communication from the commission to the european parliament, the european council, the council, the european economic and social committee, the committee of the regions and the european investment bank ‘investing in a smart, innovative and sustainable industry a renewed eu industrial policy strategy’. brussels, 13.9.2017, com(2017) 479 final. foray, d., david, p.a. & hall, b. (2009). smart specialisation – the concept. knowledge economists policy brief no. 9, knowledge for growth expert group. jrc and iwb (2017). smart specialisation & organisational development: roadmap 2017-2018 for the pilot project with serbia. internal working document kroll, h., schnabl, e., & horvat, d. (2017). mapping of economic, innovative and scientific potential in serbia. karlsruhe: fraunhofer isi. kutlača, đ., semenčenko, d., nedović, v., (2016). smart specialization in serbia – challenges for governance of research and innovation, 23th scientific conference technology, culture and development, proceedings, tivat, montenegro, association “technology and culture”, isbn 97886-915151-3-7, cobiss.sr-id 230384908, pp. 7-21 foray, d. (2009). measuring smart specialization: entrepreneurial discovery, new activities and inclusiveness, smart specialisation – the concept. knowledge economists policy brief 9, june 2009 hofstede g. & hofstede g.j. (2005). cultures and organizations. mcgraw-hill s3 platform (2012). guide to research and innovation strategies for smart specialisation (ris3). retrieved from: http://ec.europa.eu/regional_policy/sources/docgener/presenta/smart_specialisation/smart_ri s3_2012.pdf semencenko, d., kutlaca, dj., (2018). shaping national innovation system in small, transitional economy – case of serbia. publisher: university of belgrade, institute "mihajlo pupin" science and technology policy research centre. pages: 186. belgrade stefanovic-sestic s. & kutlaca dj. (2014). harmonization of the sti statistics in serbia with eu standards, proceedings of the xxi scientific conference ''technology, culture, development', tivat, montenegro, pp. 212-219. zeleny, m. (1976). the theory of the displaced ideal. in zeleny, m., (ed), multiple criteria decision making, berlin-kyoto, springer-verlag, pp.153-206 article history: received: october 30, 2018 accepted: december 14, 2018 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp84-93 scientific review the determinants of capital structure and optimization: evidence from the power sector almir alihodžić1* | ajla muratović ‐ dedić1 1 faculty of economics university of zenica bosnia and herzegovina, department for finance and accounting abstract the optimal capital structure differs between companies and depends on the nature of the business, the characteristics of the business, etc. usually when business income is higher, there is a reduction in business risk, while, on the other hand, higher profits and accumulated profits lead to an increase in investments and debt. in the research 10 companies of the power sector, representing the stock exchange index ers 10 were examined. the following dependent variable was used: short term debt to total liabilities (stdtl). the following independent variables were used: current ratio (cr), return on capital employed (roce), earnings before interest taxes depreciation (ebitda), return on assets (roa), return on equity (roe), the tangibility of assets (toa), firm size (fs) and gross domestic product growth (gdp growth). the research period covered the years from 2008-2018 on a semi-annual basis. the total number of observations was 220. the main objective of the paper is to determine explanatory factors that influence the changes in short-term indebtedness and profitability. key words: capital structure, tangibility of assets, power sector, profitability, regression analysis jel classification: g3, g31, g32, m400 introduction optimal theories of capital structure depend first and foremost on which economic and business enterprises the research is based on. for example, the trade-off theory is tax based, free cash flow theory is based on agency costs, while pecking order theory is based on differences in information. the theory of financial distress states that if a company has a higher share of tangible assets, it will use more loans and debts than a company with a high proportion of intangible assets, because businesses with more tangible assets may have lower costs of financial distress in the event of bankruptcy. in emerging central and eastern european region some theories cannot be used in explaining the capital structure. delcoure (2007) demonstrates influential factors that determine capital structure are characteristics of banking systems, legal systems, sophistication of financial markets and corporate governance. also, results of this study can be used as argument for the market timing theory. the market timing theory does suggest that current conditions in financial markets have some influence on managers' capital structure decisions (frank & goyal, 2009). the power industry of republika srpska deals with the production of electricity, the exploitation of raw materials required for electricity production, the sale of electricity, project * corresponding author, e-mail: almir.dr2@gmail.com almir alihodžić, ajla muratović dedić 85 management and other activities within its jurisdiction. the capital structure of the power sector of republika srpska consists of 65% participation of parent company, 20% vouchers, 10% pension and disability insurance and 5% restitution (the power sector of republika srpska, 2019). in the post-crisis period, the power companies of republika srpska, with increased yield potential, created the basis for an increase in borrowing capacity, primarily short-term loans to banks due to the high share of current assets, and smaller amounts of cash and cash equivalents. the power sector of republika srpska is the leader in electricity exports in the region, which is evidenced by the fact that in 2018, 15% of total exports were related to foreign electricity sales, which certainly increases the yield potential (the power sector of republika srpska, 2019). this paper will test whether a partial decline in revenue potential leads to an increase in short-term debt in the first place and how is it further reflected in profitability indicators. therefore, the main objective of this paper is to investigate how firms compose their capital structure, that is, how selected independent variables influence firms to borrow short-term loans to a greater or lesser extent. the zero hypothesis supports the random effects model. on the other hand, alternative hypotheses support the fixed effects model. the following hypotheses will be tested:  h0: zero hypothesis: random-effect model is appropriate.  h1: first hypothesis: fixed effect model is appropriate. the small chi square value together with the associated small p value leads to the conclusion that the null hypothesis is true, i.e., that all variations are equal. this paper consists of four parts and a conclusion. the first part refers to the introductory considerations and defining the aim of the research. the second part is a broad literature review. the third part refers to the empirical methodology and data. the fourth part refers to the obtained results. finally, concluding considerations and specific recommendations are given. literature review traditional theories of capital structure should be tested in the transitional central and eastern european region. according to the pecking order theory, companies will first use retained earnings as their investment assets, and then move to debt and new equity only if necessary (myers, 1984). petersen and rajan (1994) point out that leverage decreases with the years of business of the enterprise and, on the other hand, increases with size. they also claim that larger companies are better diversified, have better access to the capital market and borrow at more favorable interest rates. rajan and zingles (1995) find that large firms are less susceptible to asymmetric information, more capable of acquiring equity and reducing debt capital, suggesting a negative association between leverage and size. according to titman and wessels (1988), smaller firms are less associated with financial institutions due to the impact of costs and leverage risks, and are less desirable for clients and banks charging high interest rates to smaller firms, while larger firms are offering competitive interest rates. according to ozkan (2001), i.e., according to his evidence, companies have a long-term leverage ratio and adapt to the target ratio relatively quickly, suggesting that target ratio and cost of adjustment are very important for businesses. the results also indicate that there is an inverse correlation between profitability, liquidity, growth opportunities, non-debt tax shields and the borrowing ratio of firms. furthermore, giner and reverte (2001) claim that debt represents positive signal for firms with good prospect and investors negatively perceive differences between debt-to-equity ratio and its target level. empirical contributions on association between ownership structure and capital structure provided brailsford, oliver and pua (2002). specifically, significant positive linear relation 86 economic analysis (2020, vol. 53, no. 1, 84-93) between external blockholders and leverage is suggested. at the same time, the authors find non-linear relation between managerial ownership and leverage. in their research, korajczyk and levy (2003) came to the conclusion that macroeconomic parameters change over time, which in turn changes the decision on the capital structure of an enterprise. the value of a business will depend on changes in managerial decisions based on macroeconomic changes. in order to maintain the level of debt, managers should monitor and adapt to macroeconomic changes. pittman and fortin (2004) investigated the relationship between auditor selection and debt pricing for public companies. they have come to the conclusion that riskier debtors must provide security for loans taken as interest rates rise, which is in line with business in the banking industry. delcoure (2007) points out that companies in emerging central and eastern european region follow the modified pecking order theory. furthermore, aggarwal & kyaw (2009) report the higher importance of transparency factors regarding corporate capital structure for large firms. also, using sample of 26.896 firm-years observation in the 14 european countries these authors documented that higher levels of audit intensity and financial reporting disclosures have positive association with debt ratio. empirical methodology the traditional ols regression model represents an important method of identifying and testing certain theories of the capital structure and factors influencing the structure of capital (rajan & zingales, 1995). based on the results of breusch-pagan lm test, the paper employs the pooled ols regression model (fe model) and the random-effects gls regression model to test the influence, significance and impact of selected independent variables on the determination and anticipation of the dependent variable. therefore, fixed effects regression is a common model that can be used to control for omitted variables. also, it allows us to evaluate the effects of independent variables on our dependent variable, where it is the main technique used to analyse panel data. panel data are called cross – sectional time data that include multiple cases (such as businesses, countries, etc.). there are usually two types of information in terms of time series data, namely: the cross sectional information that reflects differences between subjects and time series information within subjects. in order to decide which method we should use we applied the breusch-pagan test which is proposed by trevor breusch and adrian pagan (1979). the breusch‐pagan test tests the heteroscedasticity of regression errors. the test explains that error deviations are due to the linear function of one or more explanatory variables in the model. in order to achieve a better return on the observed variables, the following regression model has been set up: 𝑆𝐻𝑇𝐷𝑇𝐿 , 𝛼 𝛼 𝐶𝑅 , 𝛼 𝑅𝑂𝐶𝐸 , 𝛼 𝐸𝐵𝐼𝑇𝐷𝐴 , 𝛼 𝑅𝑂𝐴 , 𝛼 𝑅𝑂𝐸 , 𝛼 𝑇𝑂𝐴 , 𝛼 𝐹𝑆 , 𝛼 𝐺𝐷𝑃𝑔𝑟𝑜𝑤𝑡ℎ 𝜀 , 1 where is: 𝐶𝑅 , – current assets to total assets of the 𝑖 company in period 𝑡. 𝑅𝑂𝐶𝐸 , – return on capital employed of the 𝑖 company in period 𝑡. 𝐸𝐵𝐼𝑇𝐷𝐴i,t earnings before interest, taxes and depreciation of the 𝑖 company in period 𝑡. 𝑅𝑂𝐴 , – return on assets of the 𝑖 company in period 𝑡. 𝑅𝑂𝐸 , – return on equity of the 𝑖 company in period 𝑡. 𝑇𝑂𝐴 , – tangibility of assets of the 𝑖 company in period 𝑡. 𝐹𝑆 , – firm size of the 𝑖 company in period 𝑡. 𝐺𝐷𝑃𝑔𝑟𝑜𝑤𝑡ℎ of the 𝑖 company in period 𝑡. almir alihodžić, ajla muratović dedić 87 data data have been collected from the stock exchange index created in the power sector at the banja luka stock exchange (ers10 stock exchange index). this empirical study uses semiannual data for 10 companies. the research period covers 11 years, i.e., from 2008 to 2018. the dependent variable the ratio of short-term debt to total liabilities (stdtl) was used. eight independent variables as current ratio (cr), return on capital employed (roce), earnings before interest, taxes and depreciation (ebitda), return on assets (roa), return on equity (roe), the tangibility of assets (toa), firm size (fs) and gdp growth were used. in table 1 the explanatory variables, formulas, and expected effects of dependent and independent variables are given: table 1. a brief description of the dependent and independent variables in the model explanatory variables formula expected signs supported theories debt short term debt to total liabilities liquidity current ratio (current assets/short-term liabilities) negative (-) trade-off theory profitability return on capital employed (roce) positive (+) trade-off theory profitability earnings before interest, taxes and depreciation (ebitda) negative (-) profitability net profit/average assets (roa) positive (+) trade-off theory profitability net profit/average equity (roe) negative (-) trade-off theory tangibility of assets fixed assets/total assets negative (-) collateral view firm size ln (sales) positive (+) trade-off theory gdp growth gdp growth over the previous period positive (+) trade-off theory source: authors own study return on assets (roa) ‐ it represents the ability of management to convert assets into earnings. net profit represents the volume of earnings, but not how well the bank operates viewed relative, or in terms of their size. this is assessed by a comparison of roa banks of different sizes (đukić, 2011). return on equity (roe) ‐ measure of banks` profitability. it is decided to choose roe due to the observed increase in the equity capital of banks in the global market and higher capital requirements for banks. it is the fact that many of the bank's operations are off-balance sheet but not on-balance sheet (drozdowska & witkowski, 2016). earnings before interest, taxes and depreciation (ebitda) – is calculated by taking the net income of the business and adding interest, taxes, depreciation and amortization. so basically it takes sales revenue, and subtracts all expenses except interest, taxes, depreciation and depreciation. therefore, ebitda is a measure of the performance of a business, that is, of evaluating the performance of a business without affecting financial, tax and other decisions (marr, 2012). the tangibility of assets – represents an important balance sheet category that may cause an increase in indebtedness in the enterprise. certain theories believe there is a positive correlation between the assets tangibility and leverage. higher amounts of tangible assets can lead to increased indebtedness as tangible assets can be used as collateral for loan approval, which reduces bankruptcy costs. also, tangible assets can be used to reduce agency costs incurred due to debt monitoring costs as well as an insufficient investment due to the presence of asymmetric information. the assumption is that companies that have higher amounts of fixed assets with a 88 economic analysis (2020, vol. 53, no. 1, 84-93) larger amount of collaterals should consequently have a higher level of leverage in their capital structure (jensen & mekling, 1976). firm size (fs) ‐ smaller companies generally use less credit from banks in comparison with larger enterprises. that is for a few reasons. the core reason is that smaller companies can face the problems of asymmetric information, and banks with negative selection and moral hazard. this situation is particularly pronounced in bosnia & herzegovina. also, smaller companies tend to be less diversified in terms of debt capital, compared to larger companies, which increases the chances of financial failure. on the other hand, larger enterprises have relatively lower direct costs of bankruptcy (mc connell & pettit, 1984). in this regard, smaller companies have access to less capital, or they are offered a charge at substantially higher costs than large companies, which refuses them to use debt financing. firm size is calculated by the natural logarithm of sales. therefore, firm size is expected to be positively correlated with larger companies that use higher amounts of indebtedness. current ratio (cr) – measures the ability of the company to settle its mature short-term liabilities with the total available working capital. the current ratio is expressed as a numerical value, and as its value increases, the enterprise operates more liquid, so that is able to repay short-term liabilities to creditors on time (alihodžić, 2018). return on capital employed (roce) – the main elements of the roce indicator are operating profit as well as capital employed. therefore, roce compares earnings with the capital employed in the company. the roce indicator can be measured for several years in a row in order to find a trend of growth or decline in profitability. in other words, roce how much a business is gaining for its assets or how much it is losing from its liabilities (marr, 2012). gdp growth – gdp is a widely used indicator that best describes the difference in wealth between countries. also, gdp growth encourages businesses to make new investments. according to smith and watts (1992), gdp growth encourages companies to make new investments, which has an impact on the optimal choice of financing sources. gdp growth is measured as a percentage change in the growth rate of real gross domestic product. we assume that gdp growth will be positively correlated to leverage. results descriptive statistics of the power sector of the republika srpska are shown in the table 2. this shows that the gdp growth has a high value at 102.65% average. the tangibility of assets represents 85.25%, earnings before interest and taxes represent 26.28% and firm size represents 17.85%. in terms of standard deviation, the following independent variables recorded the highest volatility: earnings before interest, taxes, depreciation and amortization (15.08%), gdp growth (14.58%), then the current ratio (8.12%) and tangibility of assets (6.91%). table 2. descriptive statistics of dependent and independent variables of the power sector in the republic of srpska for the period: 2008-2018 variables observations mean std. dev. min max stdtl 220 8.102 7.575 0.02 29.44 cr 220 5.752 8.126 0.47 42.48 roce 220 0.509 1.726 -7.15 11.89 ebitda 220 26.279 15.081 -17.22 65.37 roa 220 0.164 1.098 -3.75 2.53 roe 220 0.170 1.283 -4.62 3.06 toa 220 85.254 6.915 66.98 97.72 fs 220 17.848 0.790 16.07 19.23 gdp growth 220 102.65 14.587 66.50 128.87 source: calculated by the authors (stata 13.0) almir alihodžić, ajla muratović dedić 89 the gross domestic product (gdp) in bosnia and herzegovina had a volatile character during the survey period, both due to the impact of the global economic crisis, the post-crisis period, and because of weakened export potential. economic growth in bosnia and herzegovina in 2008 amounted to 5.5%, which was a slight decrease compared to previous years, because the effects of the crisis did not fully reflect by the end of the observed period. just three years later, that is, in 2011, real gdp growth was only 1.9%, suggesting that the countries of southeast europe showed a vulnerability to distortions in the euro area during the recession period. in the postcrisis period, there was a certain stabilization of economic trends, where the real growth rate increased by about 2.6% as a result of the reduction of the external deficit and favourable external conditions. the real growth rate in 2017 was about 3%, which is the result of favourable economic developments in eu countries and to a lesser extent in the countries of the region. the energy sector of bosnia and herzegovina accounts for about 1/3 of total industrial production and is an important factor in its stability (directorate for economic planning, 2017). gdp growth encourages businesses to expand their businesses. korajczyk and levy (2003) conclude that macroeconomic conditions change over time, where the structure of capital also changes over time in certain sectors of activity. the average value of the fixed assets of the power sector of republika srpska for the period 2008 to 2018 was approximately 85% of total assets, which is a consequence of the nature of the activities of the selected companies. on the other hand, the average value of short-term debt to total liabilities for the period 2008 2018 was about 8%, which is a small amount of bank debt, which also leads to the conclusion that it is a healthy revenue potential that needs to be maintained. changing macroeconomic conditions will affect the change in the value of the enterprise. the table 3 shows the correlation between the dependent and independent variables of the power sector in the republic of srpska for the period: 2008-2018. table 3: correlation matrix between dependent and independent variables of the power sector in the republic of srpska for the period: 2008-2018 variables stdtl cr roce ebitda roa roe toa fs gdp growth stdtl 1.000 cr -0.528 1.000 roce 0.048 0.046 1.000 ebitda -0.567 0.620 0.237 1.000 roa 0.221 0.211 0.642 0.517 1.000 roe -0.213 0.192 0.636 0.472 0.994 1.000 toa -0.561 0.014 0.100 0.302 -0.062 -0.064 1.000 fs 0.425 0.452 0.105 0.405 0.012 0.007 0.202 1.000 gdpgrowth 0.001 0.035 0.073 0.045 0.091 0.090 0.058 0.037 1.000 source: calculated by the authors (stata 13.0) the strongest negative correlation of the dependent variable short-term debt to total liabilities (stdtl) was recorded with the following independent variables: earnings before interest taxes depreciation and amortization (-0.567), then tangibility of assets (-0.561) and the current ratio (-0.528). therefore, with the decrease in the balance sheet item of current assets (primarily referred to cash and cash equivalents), a number of companies within the power sector of republika srpska raise short-term loans with commercial banks to maintain their current liquidity. on the other hand, the following independent variables were recorded the same direction of movement with the dependent variable: firm size (0.425) and return on assets (0.221). relatively larger companies (in terms of income, assets and possibly employees) will 90 economic analysis (2020, vol. 53, no. 1, 84-93) borrow more loans from banks to finance their business than smaller companies that will finance their business mainly with equity and reduce the indebtedness due to certain restrictions imposed by commercial banks. it is also important to point out that larger companies can also use their assets as collateral, and that because of the length of their business, they have a greater reputation for granting loans from banks. rajan and zingales (1995), as well as chittendan et al. (1996) also confirm in their research a positive relationship between company size and debt ratio. the table 4 shows the results of the fixed effects regression (fe) between the selected variables in the model. the total number of observations is 220 which makes the models representative. the empirical value of the f test for 8 degrees of freedom in the numeration and 212 in the denomination was 42.84. the independent variables that showed the most significant correlation with the dependent variable in the model, that had a p-value of less than 5% were the following: tangibility of assets (0.000), current ratio (0.000) and firm size (0.032). table 4. fixed effects regression between dependent and independent variables of the power sector of republic srpska for the period: 2008 – 2018 fixed‐effects (within) regression number of obs = 220 r‐sq: within =0.6200 number of groups = 2 between =0.000 overall = 0.6200 obs per group: min = 110 avg =110 max = 110 f(8,212) = 42.84 prob > f =0.0000 stdtl (dependent) coef. std. err. t p>[t] [95% conf . interval] cr -0.390 0.056 -6.90 0.000 -0.502 -0.279 roce 0.056 0.247 0.23 0.822 -0.433 0.544 ebitda -0.019 0.042 -0.45 0.653 -0.103 0.064 roa 0.859 3.317 0.26 0.796 -5.678 7.398 roe -1.668 2.690 -0.62 0.536 -6.971 3.634 toa -0.583 0.055 -10.63 0.000 -0.691 -0.475 fs 1.046 0.485 2.16 0.032 0.089 2.003 gdpgrowth 0.016 0.023 0.71 0.480 -0.029 0.062 _cons 40.326 10.397 3.88 0.000 19.829 60.823 sigma_u 0.096 sigma_e 4.768 rho 0.0004 source: calculated by the author (stata 13.0) there is also an inverse relationship between tangibility of assets and short-term debt to total liabilities (-0.583). the average value of fixed assets of a company within the power industry for the period: 2008-2018 was about 85% of total assets, given the nature of the business they are engaged in. therefore, with the amortization of fixed assets due to the impact of depreciation, there is a need to modernize fixed assets from internal sources or external sources of financing. given that, a large number of companies had a stable yield potential, then in the upcoming period they can base their financing needs on internal (accumulated) sources of financing. almir alihodžić, ajla muratović dedić 91 table 5. random effects (gls) regression between dependent and independent variables of the power sector of republika srpska for the period: 2008 – 2018 random‐effects gls regression number of obs = 220 r-sq: within =0.000 number of groups = 2 between = 0.000 overall = 0.6200 obs per group: min = 110 avg = 110.0 max = 110.0 wald chi2 (8)=344.23 prob > chi2 = 0.000 stdtl (dependent) coef. std. err. z p>[z] [95% conf . interval] cr -0.390 0.056 -6.92 0.000 -0.501 -0.280 roce 0.056 0.247 0.23 0.820 -0.428 0.541 ebitda -0.019 0.042 -0.45 0.653 -0.101 0.064 roa 0.859 3.309 0.26 0.795 -5.626 7.345 roe -1.667 2.684 -0.62 0.535 -6.927 3.593 toa -0.583 0.055 -10.65 0.000 -0.690 -0.475 fs 1.047 0.484 2.16 0.031 0.0981 1.996 gdpgrowth 0.015 0.022 0.68 0.497 -0.028 0.058 sigma_u 0.000 sigma_e 4.768 rho 0.000 source: calculated by the author (stata 13.0) based on the results of the gls regression model, the following independent variables, with respect to p-values, had the strongest influence on the dependent variable, i.e., short-term debt to total liabilities: current ratio (0.000), tangibility of assets (0.000) and firm size (0.031). in terms of coefficient movements, the return on equity (roe) had a negative correlation with short-term debt to total liabilities. the average value of the indicator return on assets of the power sector of republika srpska for the period 2008-2018 was about 0.17%, while the average value of the indicator return on equity was about 0.16%, which is at an extremely low level. table 6. results obtained by application breusch and pagan lagrangian multiplier test variables var sd=sqrt(var) stdtl 57.393 7.575 e 22.741 4.768 u 0.00 0.00 source: calculated by the author (stata 13.0) given that the chi square value equal to zero, as p value of certain independent variables is slightly higher than zero but less than 0.05 (such as: current ratio, the tangibility of assets and firm size), then it can be concluded that independent variables had an effect on the dependent variable, and confirm the hull hypothesis, and the alternative hypothesis for slightly higher significance. 92 economic analysis (2020, vol. 53, no. 1, 84-93) conclusion a number of companies within the power industry of republika srpska entity have a stable and growing yield potential which creates the basis for higher debt capacity through corporate bond issuance and investments in new fixed asset infrastructure. the potential growth of companies within the republika srpska power industry can also have significant fiscal consequences given the contribution of the power industry to local and state budget revenues, etc. the effect of the independent variables on the dependent variable using the pooled ols regression model (fe) model and the random-effects gls regression model by using the breusch-pagan test was used. the most significant impact through the ols regression model and gls regression model had the following variables: current ratio, the tangibility of assets and firm size. therefore, these three independent variables play a decisive role in composing the capital structure of the power sector of republika srpska, with particular emphasis on tangibility of assets due to the nature of the business and the great need to invest and replace dilapidated fixed assets. also, this paper confirms both the null and alternative hypothesis with greater emphasis on the gls regression model. a number of companies in the power industry of republika srpska are increasing their shortterm indebtedness due to small amounts of cash and cash equivalents in the structure of total assets, and due to a fall in sales revenues in certain years of operation. in the upcoming period, the strategy of the power sector of republika srpska should be based primarily on reducing operating costs, building new energy facilities, and increasing business efficiency in order to achieve better business results. also, the power industry of republika srpska has a stable and growing yield potential that creates the basis for higher debt capacity through corporate bond issuance and investments in new fixed asset infrastructure. further research must test selection and inclusion of other independent variables as potential predictors of firms’ capital structure within the power sector of republika srpska. references aggarwal, r., & kyaw, n. a. 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(1992). the investment opportunity set and corporate financing, dividend, and compensation policies”, journal of financial economics, pp 263-292. the power sector of republika srpska (2019). ers internal information journal, no. 31, april – june. retrieved from: https://ers.ba/wp-content/uploads/2019/08/list-ers-31-web.pdf titman, s. and r. wessels (1988). the determinants of capital structure choice, journal of finance 43(1), 1–19. article history: received: october 10, 2019 accepted: november 19, 2019 microsoft word 2009_1_2.doc opportunities for the development of partnerships through cross-border cooperation merdža handalić, governance acountability project (gap) bih, gap office tuzla, tuzla key words: cross-border cooperation, regionalization, partnership jel: f15, 052 abstract – successful implementation of cross-border cooperation not only depends on the capacity of state institutions to successfully lead and coordinate activities in the course of realization of the program but also the ability of potential users to make as many good project proposals, crossborder related, which could be financed from funds cross-border cooperation. intensive cross-border cooperation among development actors on the principles of partnership may have influence on the development of cross-border regions and increase the absorptive capacity of these regions. introduction international cooperation of the regions or other decentralized areas is not an alternative to the current process of accession of new countries to the european union and its institutions. from the viewpoint of countries that are outside the european union, this is an opportunity for the newly established boundaries in the neighborhood not to represent the limit for those international initiatives that are available and which require an additional effort towards internal institutional modernization with a flexible and layered structure of decision-making that will not depend on strictly confronted relation between the center and neglected periphery. for most countries in the south-east of europe the process of regional cooperation and gradual strong integration into the european union is, in many ways, the issue of survival because it contains within itself not only democratic but also the development potential. regionalization and cross-border cooperation until the 80ʹs, the main actors of european integration flows were national-states on the political plan, and large business systems in the field of economy. however, as usual throughout history, not by accident but because of real reasons, i.e. the recession during those years caused by the energy crisis, the new factors of cooperation appear, as well as the regions as the political-administrative framework, on the one hand, and small and medium enterprises (sme), on the other hand. market liberalization within the european union imposed the need of association and linking the smaller business units that initiated the establishment of a transnational partner networks in the area of technology transfer and access to new markets. regional communities, especially the most developed among them, have felt the need and opened their doors to economic initiatives by establishing international regional cooperation. positive reactions of the competent authorities of the eu followed quickly, which, insight m. handalić / ea 1-2 (2009) 32-42 33 integrative capacity of regional cooperation and its importance for overall economic development, established special funds for financial support to these programs of which the known is interreg program. in the document, which the european commission produced in 20031 before of accepting ten new member states, called wider europe or a new framework of cooperation with the eastern and southern neighbors, it has been stated that the expansion of the eu brings to the need of approaching countries that remains in the boundary area of the new union. although such a demand imposed from the interests of the eu and the need to guarantee their own security, stability and development, it is also proposed to develop new instruments that will focus, above all, to the cross-border cooperation, using the experiences from the implementation of phare, interreg, tacis and the cards program, which have been used in relation to particular groups of countries that are not members. thus, in addition to logical and expected cooperation in the areas that are of importance, above all, to the safety of the union, such as ensuring a stable border regimes and cooperation in order to prevent the activities of organized crime, human trafficking and illegal migration, the goal of the people from these areas is, in the long run, the integration of the neighboring countries, the gradual adjustment of their legal and economic systems to eu standards. such a goal has been recognized in the part of the document which states that closer cooperation with neighbors can help accelerate economic and social development and reduce poverty in the boundary areas. that would be achieved by the intensification of trade exchange, increasing investment and expanding cross-border cooperation on social and economic projects, which achieves a better integration of the neighboring countries in the wider european cooperation. as a rule, proximity of the eu market directly encourages the attractively of the areas near the eu border to the neighboring countries and opens new opportunities for them. these expectations are realistic because of the fact that in the neighborhood the work force and transportation costs are cheaper. in addition to such cooperation, which conceals the mainly national arrangements, the above mentioned document specifically points to the need of strengthening direct cooperation on sub national, regional or local level, pointing out the importance that such cooperation had in the relations between the eu member states. it has also been highlighted that the intention of the new eu borders could not be an obstacle for the development and strengthening of economic, social, cultural and educational cooperation between local communities on both sides of the new border. in this way and undoubtedly the regional dimension of european foreign policy is underlined and it is given an additional importance to the previously established cross-border communication created through the enlargement of the european union. in the framework of an integrated europe, these processes of direct cooperation are given a completely new dimension, especially within the european union itself where the classical limits have disappeared. different interests that motivated the creation of regional integration are influenced on its form. the usual and simplest form of international regional cooperation takes place through the conclusion of bilateral agreements between countries or regions partner. since this cooperation over time develops into a complex structure of mutual relations, its application 1 commission of the european communities, communication from the commission paving the way for new neighborhood instrument, brussels 2003, com economic analysis 1-2 (2009) 32-42 34 often, except for the region, requires the participation of other institutions of specific countries, which are involved in different phases of the performance of obligations under the basic agreement. although we have unified regional cooperation, it still connects the two vertical structure of decision-making level, since it starts with the local community, but is linked to the intermediary and the central institutions of government. specifically speaking on the countries in transition and the southeast europe countries,2 the analysts of regional cooperation in this area suggest some specific problems, which are important to reflect their ability to develop such ways of cooperation. most often mentioned problems directly burden the local community such as unemployment, low wages, insufficient expertise and lack of experience in the approach to european institutions, massive and inefficient administration, corruption, weak civil society, etc. however, of a state point of view, the main obstacle is the presence of centralization and distrust towards any form of international sub-national units. experience shows that a number of regional connections are not given the results of what would be in normal situations expected. negotiation between the two countries, based on bilateral agreements, is only the first step in regional cooperation, which, essentially, will not happen if there are no indigenous partners such as local and regional communities on both sides of the border. regionalization was undoubtedly a process that has gradually changed an internal structure of european countries over the last several years and that was also in function of their intensive connection. strong economic incentive of the program for regional cooperation of the european union represented a crucial commitment to internal regionalization or strengthening of the already established regional autonomy in many countries. in addition, regional cooperation has the tendencies of the international grouping of countries on regional basis. countries in transition are more and more directed to different types of regional integration, which are, ultimately, part of preparations for a wider integration frameworks thought process of testing their maturity and gradually adapting to the principles of the european union. although the interest for utilization of the eu funds is growing on local and regional levels, significant obstacles in this respect are insufficient information and qualifications. experience in previous years shows an urgent need for running different informative programs for citizens, as well as business structures, with special emphasis on training of professional staff in the cities and municipalities in order to competently work with all relevant issues of eu integration. regional and cross-border cooperation through the component ii of the instrument for pre-accession assistance mechanism for utilization of the assistance in the framework of the second component of the instrument for pre-accession assistance (ipa), which refers to cross-border cooperation is different in comparison to other components, and currently provides much greater opportunities for local government projects in cross-border regions. this is important for local governments in bosnia and herzegovina because since through the ipa from 2007 to 2 european commission, regional cooperation in the western balkans, a policy priorities for the european union, office for official publications of the european communities, 2006, pg. 17-21 m. handalić / ea 1-2 (2009) 32-42 35 2013, it will be continued with funding of the cross-border programs with croatia, serbia and montenegro commenced under the regional cards and interreg iii in the previous budget period of the union. bearing in mind the amount of funds selected for cross-border programs for bih (around five million euros per year)3, as well as the number of crossborder program (three in total), we come to the conclude that local actors in bosnia and herzegovina can count on the significant funding for projects of cross-border cooperation, with respect that they, in the framework of this component, can directly apply to published calls. this provides an opportunity for local administrations to improve their capacity for absorption of eu funds, which will, in future years, be much more and actually implemented on regional and local level. the objectives of cross-border cooperation are defined on the basis of the specific needs of cross-border regions of countries participating in cross-border cooperation. the objectives of cross-border cooperation are: • promoting cross-border initiatives in the field of social development, economy and environmental protection in cross-border areas; • encouraging resolution of common problems in the field of environmental protection, public health, the prevention and fight against organized crime; • borders – strengthening the efficiency and security of borders; • promoting legal and administrative cooperation; • encouraging “people to people” local activities. through conducting the cross-border programs at the local and regional level, we are creating a long-term personal contacts and connections between people from the communities on both sides of the border, which is the basis for further cooperation and development. also, through the process of identifying projects, sign up for the funds, as well as during the implementation of projects, partners in bosnia-herzegovina arrived, therefore, valuable experience in using the funds of the eu, since all the calls for project proposals conducted in accordance with the rules of eu external assistance. regions that are eligible or regions to which those programs relate are regions of the nuts 3 level, or if there is no adopted nuts classification, as is the case in bosniaherzegovina, then it is equivalent areas along the borders of countries and potential candidates. the list of eligible regions has been included in the relevant cross-border program documents, which are prepared jointly and approved by the european commission. in addition, these documents contain the analysis of the situation of eligible areas for cooperation, the strengths and weaknesses, as well as medium-term needs and goals based on that analysis. also, these documents contain the cooperation strategy, priorities and measures for the realization of goals. each individual cross-border document is done on the basis of strategic documents of the european union, especially the multy-year indicative financial framework (miff) and the multy-year indicative planning document (mipd), as well as on the basis of relevant national and regional strategic documents. at the same time, to make a programming document has a major role and the process of consultations with potential participants in the cross-border cooperation. the co-financing arrangement of the 3 multi-annual indicative financial framework for bih miff for period of 2008 – 2011, sarajevo, 2007, pg. 22-26 economic analysis 1-2 (2009) 32-42 36 eu cannot be greater than 85% of the eligible project costs, which means that 15% should be secured by the project partners. the cross-border cooperation is being implemented on both sides of the border of the participant countries; the program requires the participation of partners from both sides under a single policy for all participants of the program. for each program, each participating country has to establish the appropriate operational authority for the implementation of these programs that are related to the given country. the task of these bodies is to cooperate in the process of drafting and implementation of cross-border cooperation. state institutions responsible for preparation and coordination of the implementation of cross-border and transnational cooperation in bosnia and herzegovina is the directorate for european integration. in addition, it is necessary to establish a common management structure to participate in the implementation of the program: the joint monitoring committee (jmc) and joint technical secretariat (jts). both of these bodies consist of representatives of countries participating in cross-border cooperation. joint monitoring committee is responsible to oversee the implementation of cross-border cooperation, approves annual reports and made the choice of projects, while the joint technical secretariat assists the joint committee for monitoring and operating structures, organizes calls for submission of proposals, offers support to applicants and over see the implementation of selected projects. the process of establishing joint bodies for three of bilateral programs of the cross-border cooperation in bosnia and herzegovina, whose implementation began the first time in 2008, has been completed, and the first calls for submission of proposals are expected very soon. since the cross-border cooperation programs, at least in its initial phase, are going to be implemented through centralized management, the ec delegation in bosnia and herzegovina will be responsible for approving the list of approved projects, contracting the approved projects and payments of the contracted amounts. programming documents for the three bilateral neighbors’ agreements have officially been approved on 18th december 2007. financial agreements between the european commission and the participating countries were signed during the 2008th and the implementation of the program will be able to start after that4. a) serbia bosnia and herzegovina the strategic goal of cross-border cooperation of bosnia-herzegovina with serbia will be connecting people, communities, and economies of the cross-border areas to the mutual activities in the area of communication development, using the advantages of this area in human, natural and economic resources.5 based on the swot analysis and determination of this strategic goal, the priorities and activities for this program have been set: • priority i the realization of socio-economic cohesion through joint action to improve the natural, business, social and institutional capacity and infrastructure; 4 available on http://ec.europa.eu/enlargement/potential-candidate-countries/ bosnia_and_herzegovina /financial _en 5 cbc programme bosnia and herzegovina and serbia, sarajevo, 2007, pg. 27-29 m. handalić / ea 1-2 (2009) 32-42 37 • measure i.1 improving productivity and economic competitiveness, rural and natural resource areas; • measure i.2 cross border initiative aimed at the exchange of people and ideas for the purpose of enhancing cooperation in the professional level and among civil society. • priority ii technical assistance. b) croatia bosnia and herzegovina the strategic goal is to create incentive to cross-border networks and partnerships and the development of unique cross-border activities with the aim of revitalization economy, protection of nature and enhance social cohesion in the area.6 determined three priorities with appropriate measures to enforcement: • priority i creating a single economic space • measure i.1 joint development of the tourism offer; • measure i.2 promoting entrepreneurship. • priority ii improving quality of life and social cohesion • measure ii.1 protection of nature and environment; • measure ii.2 improving the services available to communities in the border area. • priority iii – technical assistance c) montenegro and bosnia i herzegovina the strategic goal is to enhance sustainable development of joint cross-border areas, their economic, cultural, natural and human resources and potentials so as to strengthen the capacity of human resources and institutional network shared among local communities, private and public actors.7 two priorities are related to this program: • priority i support the creation of a unique socio-economic environment to people, • communities and the economy of border regions • measure i.1 cross border initiatives for regional development with emphasis on • tourism and rural development; • measure i.2 advocacy for the development of the environment mainly for the protection, promotion and management of natural resources; • measure i.3 social cohesion and cultural exchange through institutional and interpersonal interactions. • priority ii technical assistance to improve the administrative capacity for the management and implementation of cross-border cooperation. in addition to these programs bosnia and herzegovina has the right to participation in transnational programs. transnational program see (transnational cooperation program south east europe) aims to strengthen the territorial balanced development and territorial 6 cbc programme bosnia and herzegovina and croatia, sarajevo, 2007, pg. 30-41 7 cbc programme bosnia and herzegovina and montenegro, programme summary, sarajevo, 2007, pg. 8-11 economic analysis 1-2 (2009) 32-42 38 integration in the areas of cooperation. this program is not only a part of the eu cohesion policy which includes only the member states, but it is also a component of pre-accession assistance, and as such it is a program in which majority of the eu non-members countries are allowed to participate (candidate and potential candidate countries). this transnational program includes 17 countries: albania, austria, bosnia and herzegovina, bulgaria, romania, croatia, macedonia, greece, hungary, italy, serbia, montenegro, slovakia, slovenia, turkey, moldova and ukraine. financial resources are significantly greater than the funds that were allocated to the previous program interreg iiib cadses 2000 -2006. the main goal of this program is the development of transnational partnerships based on strategic issues for improving the process of territorial, economic and social integration and contribution to cohesion, stability and competitiveness. transnational program med (mediterranean space) is a program funded from the european regional development fund (erdf) and aims to strengthen cross-border cooperation through local and regional initiatives, strengthening transnational cooperation activities leading integrated territorial development, and strengthening interregional cooperation and exchange experiences. this program, in fact, represents the continuation of medocc and archimede that were implemented within the interreg iiib initiatives, and focuses on cooperation among regions of the eu member states in the entire mediterranean area. bosnia and herzegovina has received an invitation to participate in this program, which includes some regions of the following countries: cyprus, france, greece, italy, malta, portugal, slovenia, spain and united kingdom. the main goal of this program is to make the entire area of the mediterranean a territory that is competitive at the international level with the aim of ensuring growth and employment for future generations, support territorial cohesion and active participation in the field of environmental protection in terms of sustainable development. partnership fundamental framework of cross-border cooperation successful implementation of cross-border cooperation not only depends on the capacity of state institutions to successfully lead and coordinate activities in the course of realization of the program, but it also depends on the ability of potential users to make as many good project proposals, cross-border-related, which could be financed from funds cross-border cooperation. cross-border cooperation is therefore reflected in the joint activities and harmonized coordination of the state institutions’ program participants on both sides, as well as the program users. what is common to all projects of cooperation? first of all, it requires at least minimum documentation, such as a memorandum, an agreement or declaration of partnership. this document establishes who are participants of cooperation, their readiness to cooperate, and the planned framework of that cooperation in a specific or indefinite period of time. this agreement is recommended, even when it tales the exchange of experts solely. depending on the extent of cooperation, the partners can agree on the funds that will put at disposal for the purpose of realization of joint projects (financial resources, people, and infrastructure). and finally, when it comes to intensive cooperation, the partners can establish, for example: forums, assemblies, and agree on practical implementation aspects of m. handalić / ea 1-2 (2009) 32-42 39 cooperation. the document can be in the form of unofficial document, if a single project, or may have a legal basis of the contract or legal document, when the financial resources are involved, especially when the instruments of cooperation are being established (institutions). good partnership is not absolute guarantee that the project will be good. in fact, it is difficult to imagine a good project without a good partnership. partners should be aware that quality partnership includes the time, finances, and activities. all project partners are the ultimate beneficiaries of european funds. this means that the partners should be considered only those participants who play an active role in the preparation and implementation of the project and as such they should be put on the list of ipa agreement on co-financing. also, the partner is not only a promoter and coordinator of activities. partner, in fact, spends money for the purpose of the project and contributes to the achievement of the results of crossborder program, and concrete results of the project. it is important to note that none of the partners should come into conflict of interest with other bodies or contractors. this means that they will need to buy products and services without prejudice to the free market competition. eligible are only those costs paid directly by users (expenses paid “in the name of” or in his capacity as agents, which are not predicted by the ipa agreement on co-financing should not be allowed). it needs to clearly indicate that it cannot approve any discounts or any other benefits. furthermore, the partner must be different from suppliers and associates. namely, a partner cannot act as a supplier (i.e. can not be a contractor or subcontractor that provides services and products for a fee). generally, partners cannot enter into contracts with each other and the bodies that operate within the framework of free market competition for the activities for which bids may be submitted by other partners to be treated as suppliers. partners can select associates for the project. their role is to promote good project results, having in mind that they are not participating in the financial part; neither have any financial interest in the project. associates do not have to meet the criteria for acceptability established for partners and cannot perform as suppliers. in the event that these associate, however, become financially interested in the project, then they should be treated, taking account of their activities, as suppliers (respecting the rules of market competition) or as partners, with an update of the partnership statement. partners must be placed within the program acceptable area. if the project partnership includes partners located outside the program areas, than it should be explained why the contribution of those partners is necessary for the achievement of the project objectives, and why these activities cannot be performed a partner located within the program area. to be eligible, partners who come from outside the acceptable area must be the legal entity established in a member state, then in the country that is user of the regulation of ipa, the country that is the user of the instrument of the european neighborhood and partnership, or in a member state of european economic region. all partners must have legal, financial and operational capability to participate in the program. partners between themselves name the leading partners for each project, and they become the main user once a contract on the ipa co-financing has been signed. it will also appoint a project or functional partner, who works at the level of the project and is responsible for the functioning of the activities on the implementation of the project. economic analysis 1-2 (2009) 32-42 40 for partnership to be acceptable for cross-border cooperation, or to have the project acceptable for financing in this context, at least one condition has to be met: a) joint development. in fact, all partners should contribute to the development of the project. jointly define how the project will be carried out, participate in the development goals, immediate results and performance, and budget, determining the time, the division of responsibilities and tasks in order to achieve goals. b) joint implementation. functional partner is responsible for the overall implementation of the project, but also all the partners responsible for different parts of the process. each partner is responsible for the assigned tasks to achieve the objectives and should ensure that the necessary activities and those they found a critical point and resolved unexpected implementation challenges. c) the joint staff. all partners, participants have a role and allocate staff to fulfill this role. personnel coordinate their activities in cooperation with others involved, and regularly exchanges information. should not be unnecessary repetition of functions in different partner organizations. d) joint funding. the project has a separate budget with funds allocated to the leading partners in accordance with the activities they carry out. the budget includes annual spending targets. the programs that are mentioned in this paper have been based on the international and european level. however, not all the projects of cooperation between local administrations are of the international character. similar links are often created within the national borders since the local government in the former communist countries rather quickly realize the importance of horizontal cooperation with neighboring local communities, when it comes to the specific needs of organizations such as utilities (management of water resources, waste management, and construction of infrastructure), or with similar regional or national bodies, when it comes to lobbying at the higher levels of government. these forms of cooperation in bosnia and herzegovina are existing in the form of permanent alliance of towns and municipalities or other forms, such as associations. states have learned that they were easier to deal with alliance but loosely connected with the local administrations, where everyone is trying to promote local interests, and that on the international stage the local unit may prove as important allies. european policy in encouraging local initiatives and lobbying bodies such as the congress of local and regional authorities of europe (council of europe), the committee of the regions (european union), the assembly of european regions and the other in the post-communist countries, promoting a better understanding of the importance of cooperation between the local or regional body to the national and at international level. in the process of transition, bosnia and herzegovina is going through several important socio-historical processes. the most important is, of course, the process of integration into the european union. in trying to realize this goal it is necessary to create conditions in order to apply european standards. one of these standards is the establishment of regional structures within the country but also in the process of cooperation with neighbors. at the regional and local level in the b&h, it is necessary to review the existing partnership structure. the existing partnerships in the framework of realization of business m. handalić / ea 1-2 (2009) 32-42 41 regions’ development strategies have been focused on economic development. in addition, there are partnerships for employment and social inclusion. partnerships are mainly related to the projects and often dismiss at the end of the project. although the projects require these kinds of partnership, it is necessary to establish permanent control through the strategic partnerships. this model of partnership should include participants of wide range of areas from the level of municipalities, cantons and entities, (economic development, employment, social inclusion, education, etc.). such a partnership should mitigate any organizational or political disagreements between the different levels of government and different areas of activity. it is recommended to have a regular and relevant communication within the established, efficient organizational structure through the official agreement among the partners. partnerships may be formed on a voluntary basis with the steering board, the executive body and a broad participation of all partners. conclusion the role and importance of regionalization in the economic and political development in europe had the need for the establishment of appropriate institutions. based on the synthesis of experiences during the decades, the european union has established several important institutions dealing with different aspects of regionalization and regional development, the statistical institutions, through committees of regions to other institutions needed in the process. in addition in our country, government at the state level as a whole should do much to establish the conditions for the application of the regulations of the eu regional policy, the actors at lower levels should also be involved in the process immediately. currently in bosnia and herzegovina, we should take advantage of public administration and regional and local agencies as the leading organizations. namely, for the partnership to worked well we need professional support structure that would provide assistance with the procedures of project preparation, organization and financial management, and this would be an agency or public administration took over administrative duties while the partners, then, could focus on strategic issues. in most eu countries the international network and cooperation through the exchange of professional, non-governmental, university and entrepreneurial organizations, has been accepted as a condition for the successful management of partnerships. in addition, public administration and development agencies, in our case, organization of small and medium-sized enterprises (smes), located in the established entrepreneurial centers and industrial zones or outside them, can contribute to faster job creation, and also be very useful partner. a role of enterprises (especially smes) in partnerships is becoming more and more important, as well as the need for the provision of services by launching new businesses for what entrepreneurial centers have or should have the capacity. eu experience directs us to the potential leading role of large enterprises as sponsors of local organizations for employment and creating business links between smes and large enterprises. organization for employment, in cooperation with educational organizations can contribute to large companies get the appropriate staff. acceptance and application of the euro regions concept based on partnership relations of local and regional actors, including entrepreneurs, smes, development agencies and economic analysis 1-2 (2009) 32-42 42 associations, educational institutions and public administration in bosnia and herzegovina, but also with neighbors, in addition to opening opportunities of access to eu funds for regional development , would contribute to the internal and external economic integration of bosnia and herzegovina and the fulfillment of the conditions for the reception of our countryʹs membership in the european union. a clear political willingness of local representatives from both sides of the border is a precondition of any cooperation. such willingness of local representatives should be accompanied by a professional team, which would be responsible for managing cross-border arrangements, from the establishment of common objectives to implementation of concrete projects. successful implementation of these joint projects should be the basis for the establishment of long-term, strategic relationship with the explicit objective of improving cross-border regions and better living conditions in them. references commission of the european communities, communication from the commission paving the way for new neighborhood instrument, brussels, 2003, com. directorate for european integration of b&h, cbc programme bosnia and herzegovina and serbia, sarajevo, 2007. directorate for european integration of b&h, cbc programme bosnia and herzegovina and croatia, sarajevo, 2007. directorate for eu enlargement, cbc programme bosnia and herzegovina and montenegro, programme summary, sarajevo, 2007. commission of the european communities, multi-annual indicative financial framework to bosnia and herzegovina–miff for the period of 2008-2011, brussels, 2007. european commission, regional cooperation in the western balkans, a policy priorities for the european union, office for official publications of the european communities, brussels, 2006 ricq, c.: handbook on transfrontier cooperation for local and regional authorities in europe, council of europe, strasbourg, 2006 www.ec.europa.eu/enlargement www.cadses.net www.programmemed.eu www.dei.gov.ba www.cbib-eu.org ea_2018_3-4 jovan rabrenović 67 doi: 10.28934/ea.18.51.34.pp67-80 case report comparative analysis of tourist brand of montenegro and croatia – perspectives of the impact on the economy of the state jovan rabrenović1* 1 faculty for economy and business, mediterranean universit abstract the importance of tourism for the economy of a country, from the beginning of the 21st century, is significantly increased in relation to its traditional role as one of the segments of the economy. the speed through which tourism in the world, and therefore in the region, develops and the amount of revenues generated through it makes it the generator of the economic development of a large number of countries. examples of montenegro and croatia, as two comparable systems for the way tourism was experienced and developed in the period of the former yugoslavia, ie the time when the foundations of the tourism economy of the then republics, and today's sovereign states, as well as strategic approach and target markets, were set up is a comparison of the tourist brands of both countries, with the possibility of precisely determining the revenues realized by the two countries through the tourism sector and their two tourist brands as research purposes. the aim of the research is to determine the differences and similarity of tourist brands of montenegro and croatia, through analysis of several indicators, starting from those related to tourism and travel revenues and their impact on gdp, to the effects of the economies of these countries from capital investment and employment. finally, the main result of the analysis is the confirmation that there is a significant impact of the country's tourist brand on the level of revenue generated by the economies of the analyzed countries. the research has also shown the necessity of further development of the tourist brand montenegro in the direction of croatia. which means an active approach to solving infrastructure problems, greater application of marketing management, synchronization of campaigns with the strategies of developing the national brand of the state and building hotel capacities that meet the standards of the most developed tourism economies in europe. key words: marketing in tourism, national brand, country tourist brand, gross domestic product jel classification: m31, a10 introduction montenegro has opted for tourism as one of the three strategic directions for the development of the economy. however, the legacies of the former social and economic order are still present in this country, which is significantly contributed to by the transition period and the environment in which it was located. the nineties of the last century was characterized by the collapse of one and the transition in another way to the development of the economy and tourism as its significant segment. only in the period after the re-establishment of autonomy, montenegro is moving towards direction of noticable investment in tourism and the re-establishment of fallen tourism economy. croatia has moved to this process significantly earlier,, hence its tourist brand is better * e-mail: jovanrabrenovic@gmail.com 68 economic analysis (2018, vol. 51, no. 3-4, 67-80) positioned, and therefore the benefit to the economy is much more larger.1 from the above mentioned, we can see the need for analysis of tourist brands of montenegro and croatia, two neighboring countries with high tourist potential. the study compares tourism promotion campaigns conducted by these two countries. it analyzes the destination markets of both countries and changes in tourism revenues acomplished by these countries in the years that were taken as comparable. the economy of each country that has tourist potential has the possibility of faster development and increase in revenues, which will provide long term economic stability. the tourism economy and the fallowing activities will have a significant share in gdp if, as a support, they have favorable natural, cultural and historical heritage. through increased interest of investors, it will also enable bigger investments in tourism infrastructure, in the first place in hotel facilities, road infrastructure and air transport. over the last fifteen years, some countries in the region have given long-term lease of some of their largest airports.the croatia has done this by giving its largest airport in zagreb and montenegro is also preparing to do the same. some of the countries of the western balkans, like montenegro, have entrusted the construction of highways to foreign companies with great international experience. with the condition that at least 30% of the companies engaged in the construction of the highway are from montenegro. in croatia, as well as in montenegro, the government entrusted the construction of the largest tourist complexes to international investors. in montenegro, the amount of these investments exceeds one billion euros. all this significantly increases the value of the country's tourist brand. montenegro can use the experience of croatia to reduce possible wanderings in the selection of strategies and policies for the development, or strengthening of its tourist brand. methodology of research in order to determine the position of tourist brands of montenegro and croatia, financial and economic benefits of tourism achieved by their respective economies, the parallel comparison had to be done by all relevant and available indicators. therefore, the research method based on data from secondary sources was used, with the emphasis on the strategies for development of tourism in montenegro and croatia, the documents of ministries responsible for the tourism of the two countries, national tourist organizations, specialized journals and publications, press, internet and professional literature. important sources of information for the research were the institutions responsible for official statistics in montenegro, croatia and the european union. analysis of tourist brands of montenegro and croatia key elements of strategies for development of tourism of montenegro and croatia at this moment when the global trend of building strong tourist brands is noticeable in the countries that have tourist or complementary potentials, there are challenges of developing their own models of tourist brands in the countries of western balkan that would be competitive in the target markets. countries of this part of europe are particularly aimed at developing, or exploiting an existing, competitive advantage and assuming the role of a primary tourist destination in relation to other regional actors. the building of tourist brands should include building the image of the country and destinations, positioning at desired markets and target markets, respetively. the image of the country or national image should unite all the usable potentials that the country possesses and build a positive picture in the consumer's mind, since this can attract more interest not only to tourists but also to investors. according to that, it is crucial that the offer that certain country creates to tourists should be based on: credible arguments, promises that can be fulfilled and objective presentation of the country. on the other hand, the common mistake that the 1 internet:http://iztzg.hr/userfiles/pdf/izvjestaj-10-strategija-razvoja-turizma-rh.pdf, (accessed:21.05/18) jovan rabrenović 69 country and its institutions can make is to develop its tourism brand by hiding or denying negative aspects, which are inevitable and present in most countries. the negative image should be changed by changing the behavior of one's own administrative and business system and creating an offer that is based on superior performance that we own or develop. it is wrong approach to try with media campaigns to change the image of the country on long terms, and gain the effection and sympathy of other nations and consumer segments. tourism development strategy of montenegro and croatia are the key documents issued by the governments of both countries. they have through strategic and operational goals routed directions of tourism development and targeted emitting markets.2 it is noticeable that although, both strategies have been developed for the period until 2020, croatia has significantly processed more thoroughly and more analitically some of the key segments of the strategy. table1. presents these elements of the strategy and their comparison have been done by parallel view. table 1. key terms of strategies for tourism development of montenegro and croatia criteria montenegro croatia slogan and promotion title „montenegro wild beauty” crna gora, divlja ljepota) “croatia, full of life” (hrvatska, puna života) logo of tourist brand source: https://www.montenegro.travel source:https://htz.hr period related to strategies strategy for tourism development in montenegro for period until 2020. strategy for tourism development of republic of croatia for period until 2020. strategic goals applying the principle and goals of sustainable development, montenegro will create strong position of global high quality tourist destination; for citizens of montenegro tourism will provide enough working positions and growth of standard of living and the country will generate revenues at stable and confident manner. the main goal of the development of croatian tourism for the period untill 2020. is an increase in its atracttiveness and competitiveness , which will result in enetering into the leading 20 tourist destinations in the world according to the criterion of competitiveness. operational goals • creating the necessary tourist and supporting infrastructure into direction of achieving strategic goal • montenegro forms a particular unique sale offer • marketing marketing activities trace the transformation of croatia into a destination that offers more than a family vacation, more than summer and more than the sun and the sea. • development of tourism offer apart 2 the result of author's research with the use of strategy for tourism development in montenegro until 2020 and strategy for tourism development of republic croatia until 2020. http://www.go.me/files/1228912294.pdf, and https://mint.go.hr/strategija-razvoja-turizma11411/11411 (accessed:21.05/18) 70 economic analysis (2018, vol. 51, no. 3-4, 67-80) • montenegro is known and accepted as "all-year" tourist destination • the institutional and legal framework corresponds to the requirement of a successful and sustainable development of tourism • the local population is significantly involved in the tourism industry ("internal marketing") from the development of important products for croatian tourism, the development of a tourist offer implies completion of the privatization process, activation of tourist interesting, unused state property and improvement of accommodation and other tourist offer. • investments due to numerous limitations and barriers, the level of investment activity in croatian tourism in the past period was not satisfactory. • human resources development suitability of human resources quality, or possession of modern knowledge and practical skills, is a basic element of delivering quality tourism services and promoting the competitiveness of croatian tourism. • process management effective implementation of the conclusions of the tourism development strategy of the republic of croatia until 2020 assumes organizational adaptation at the level of the ministry of tourism, functioning of the system of tourist communities, as well as the ongoing interdepartmental cooperation of the ministry related to tourism activity. target emitting markets until 2020. • west european and north european markets, russia and more of eastern european countries (eu members). these markets are a priority. • markets of neighboring countries of serbia, bosnia and herzegovina, albania, and the local market. tourists from both the largest emitting regions do not differ very much in terms of what they want to experience on vacation, as far as financial opportunities are concerned. • leading ( germany, austria, slovenia) • promt to (czech, poland, slovakia) • challenging (russia, netherlands, • france) • neighboring (hungary, bosnia and herzegovina, serbia) • remote (usa, canada, australia) source: the result of author's research with use of strategy for tourism development in montenegro for the period until 2020. and strategy for tourism development of republic of croatia for period until 2020. the logo of the tourist brand of montenegro is in application significantly longer than the logo of croatia.3 although both designs have suffered public criticism, they are still in use, although it is noticeable that the logo of montenegro tourism has needed a long time ago to be refreshed or approached to create a new logo. 3 https://croatia.hr/documents/3583/izbor-vizualnog-identiteta-brenda-hrvatska-za-htz-hrv-.pdf i https://www.montenegro.travel/en/ [pristupljeno: 03.06/18] jovan rabrenović 71 comparison of economic indicators of montenegro and croatia with upcoming analysis of the economic indicators, the mutual relations of the economies of montenegro and croatia will be compared and changes in their value incurred during period covered by research will be presented. total accommodation capacities (hotels, tourist resorts, campsites, hostels, etc.) in montenegro in 2016 are contained in 348 facilities that have a total number of 166.842 beds. the total number of tourist facilities, as well as the total number of beds in montenegro in relation to 2010, did not change significantly. in 2010, montenegro had in total 308 facilities that had 166.288 beds. in 2016, croatia had 4.567 accommodation facilities (hotels, tourist resorts, campsites, hostels, etc.) with a total of 1.33.751 beds. compared to 2016, croatia had 909.951 beds in 2010, which were deployed in 2.117 facilities.4 the number of international tourists in 2016 in montenegro were 1.662.000. the number of arrivals in montenegro increased from 136.000 in 2002 to 1.66 million in 2016, which means that the number of arrivals is growing at an average annual rate of 23,96%. the total number of tourists who visited montenegro in 2017 increased to around 2.00.000. in the same period, croatia had 13.809.000 international tourists. their number increased from 4.18 million in 1997 to 13.8 million in 2016 and grew at an average annual rate of 7.11%. in 2017, the total number of tourists who stayed in croatia was additionally increased to 17.430.580 tourists.5 expenditures for tourism as a share in total imports in 2016 in montenegro amounted to 3.3%. these costs have significantly changed over the past few years, so in the period from 2007 they increased from 1.8% in 2016 to 3.3%. expenditures for tourism as a share in total imports in the same year for croatia amounted to 4%. this category of costs in croatia has oscillated over the past few years with a tendency of a slight increase in the period from 2005 (3.8%) to 4% in 2016.6 table 2 presents revenues from tourism in the period 2007-2016 for montenegro and croatia year montenegro croatia value in millions of dollars change% value in millions of dollars change% 2016 978,000,000 3.27% 9,820,000,000 8.89% 2015 947,000,000 -1.25% 9,018,000,000 -10.53% 2014 959,000,000 3.23% 10,079,000,000 3,75% 2013 929,000,000 8.02% 9,715,000,000 9.01% 2012 860,000,000 -7.13% 8.912.000.000 -7.15% 2011 926,000,000 21.05% 9,598,000,000 15.65% 2010 765,000,000 -3.41% 8.299.000.000 -10.76% 2009 792,000,000 -7.80% 9,300,000,000 -19.93% 2008 859,000,000 30.15% 11,615,000,000 20.78% 2007 660,000,000 9,617,000,000 15.92% montenegrin tourism revenues in 2016 amounted to 978 million dollars. it is noticeable that the revenues from tourism in montenegro, in addition to the fluctuations present in the last few 4 internet: https://tradingeconomics.com/indicators, [pristupljeno: 11.05/18] 5 the author's research based on data from eurostat, knoema.com, montstat i central bureau of statistics of croatia 6 the author's research based on data from eurostat, knoema.com, montstat i central bureau of statistics of croatia 72 economic analysis (2018, vol. 51, no. 3-4, 67-80) years, increased in the period from 2007 to 2016. tourist revenues in 2016 amounted to 9.820 million dollars for croatia.7 revenues from tourism of montenegro as a share in total exports in 2016 amounted to 55%. croatian revenues on the same basis in 2016 were 38.8%.8 table 3 presents a comparative overview of the share of tourism in total exports of montenegro and croatia in the period 20112016 table 3. revenues from tourism as a share in total exports of montenegro and croatia year montenegro croatia value in % change % value in % change in % 2016 55.0 -0.84% 38.8 5.00% 2015 55.5 6.53% 37.0 -2.61% 2014 52.1 3.28% 38.0 -2.81% 2013 50.4 -0.26% 39.1 2.55% 2012 50.5 5.07% 38.1 0.67% 2011 48.1 -5.83% 37.8 1.89% 2010 51.1 -7.34% 37.1 -12.95% 2009 55.1 16.56% 42.7 0.96% 2008 47.3 13.37% 42.3 3.38% source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia expenditures for tourist travel abroad to citizens of montenegro in 2016 amounted to 91 million dollars. montenegro's travel expenses have significantly changed over the past few years, but have generally increased in the period from 2007 to 2016. the croats spent 954 millions of dollars on travel expenses abroad in 2016. these costs have fluctuated considerably over the past few years, however, they have mostly increased in the period from 2002 to 2016.9 the direct contribution of travel and tourism to montenegro's gdp amounted to 1.1 billions of dollars in 2017. the contribution of travel and tourism to montenegro's gdp has changed over the last ten years with an alternate increase and a decrease in the share of total gdp. croatian gdp in 2013 amounted to 13.7 billions of dollars from travel and tourism. in croatia, the share of travel and tourism revenues in gdp oscillated in a comparable period.10 in table 4. presents revenue generated from travel and tourism in montenegro and croatia in the period 2007 2017. 7 ibid 8 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 9 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 10 ibid jovan rabrenović 73 table 4. contribution of travel and tourism to gdp in montenegro and croatia year montenegro croatia $ change in % $ change % 2017 1.1 8.55% 13.7 11.21% 2016 1.0 8.25% 12.4 7.05% 2015 0.9 2.08% 11.5 -11.81% 2014 0.9 2.70% 13.1 2.14% 2013 0.9 15.92% 12.8 9.36% 2012 0.8 -2.45% 11.7 -13.30% 2011 0.8 5,81% 13.5 11.19% 2010 0.8 -2,37% 12.2 -13.82% 2009 0.8 -45.62% 14.1 -19.79% 2008 1.4 53.18% 17.6 20.20% 2007 0.9 69.19% 14.6 16.78% source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia in the period from 2006 to 2017, the direct contribution of revenues generated from travel and tourism in montenegro and croatia generally had a growth trend.11 data for both countries are presented in table 5. table 5. direct contribution to the growth rate of gdp from travel and tourism in montenegro and croatia year montenegro croatia change in % change in % 2017 6.21 8.14 2016 0.67 6.09 2015 10.96 5.69 2014 0.48 3.79 2013 7.05 6.81 2012 5.05 -5.85 2011 7.31 8.36 2010 0.13 -9.63 2009 -33.81 -15.40 2008 13.91 6.61 2007 40.12 4.71 2006 58.96 3.82 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia contribution of travel and tourism to gdp (% of gdp) for montenegro in 2017 was 23.7%. the impact of this segment of the economy has not changed significantly since 2006. in the same period, the contribution of travel and tourism to gdp (% of gdp) for croatia was 25%. the contribution of travel and tourism to gdp (% of gdp) in croatia also increased in the period from 1998 to 2017.12 the following table (table 6) presents the percentage participation of travel and tourism in the gdp of montenegro and croatia. 11 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 12 the author's reseaarch based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 74 economic analysis (2018, vol. 51, no. 3-4, 67-80) table 6. contribution of travel and tourism gdp to participation in gdp in montenegro and croatia year montenegro croatia value of percentage participation change in% value of percentage participation change in% 2017 23.7 4,69% 25.0 3,84% 2016 22.6 2.44% 24.1 3.04% 2015 22.1 9.25% 23.4 2.86% 2014 20.2 -0.23% 22.7 2.98% 2013 20.3 6.14% 22.1 6.46% 2012 19.1 8.31% 20.7 -4.45% 2011 17.6 -3.50% 21.7 6,69% 2010 18.3 -1.90% 20.3 -9.83% 2009 18.6 -40.56% 22.5 -9.83% 2008 31.3 24.02% 25.0 2.57% 2007 25.3 25.12% 24.4 -1.91% 2006 20.2 24.9 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia in 2017, the direct contribution of travel and tourism to employment in montenegro amounted to 14.4 thousand persons. in croatia, this industry branch has created jobs for 138.000 people.13 table 7 presents a comparative overview of the number of employees engaged in tourism and travel business in montenegro and croatia. table 7. the direct contribution of travel and tourism to employment in montenegro and croatia year montenegro croatia number of employees in tourism change in% number of employees in tourism change in% 2017 14.4 0.72% 138.0 2.88% 2016 14.3 -1.70% 134.2 0.92% 2015 14.5 -4.33% 132.9 3.56% 2014 15.2 1.07% 128.4 1.02% 2013 15.0 18.09% 127.1 4.60% 2012 12.7 0,35% 121.5 -6.74% 2011 12.7 12.90% 130.3 7.02% 2010 11.2 -18,42% 121.7 -14.49% 2009 13.8 -23.03% 142.3 -11.36% 2008 17.9 12.13% 160.6 7.04% 2007 16.0 31.87% 150.0 2.15% 2006 12.1 146.9 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 13 the author's reseaarch based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia jovan rabrenović 75 capital investments in montenegro were at the level of 0.4 billion euros in 2017, which is higher by 18.71%. compared to 0.3 billions of euros invested in the previous year. in 2017, they reached 7.9 billions of euros in croatia, which is 3.89% more than in 2016.14 changes in capital investments for montenegro and croatia in the period 2006 2017 are presented in table 8. table 8. capital investments in montenegro and croatia in the period 2006 2017 year montenegro croatia capital investments in billions of euros change in%* capital investments in billions of euros change in% 2017 0.4 18.71% 7.9 3,86% 2016 0.3 29.81% 7.6 6.55% 2015 0.2 21.49% 7.1 9.27% 2014 0.2 8.17% 6.5 -2.46% 2013 0.2 17.09% 6.7 0.73% 2012 0.2 4.21% 6.7 -4.49% 2011 0.1 -23.20% 7.0 -3.28% 2010 0.2 3.93% 7.2 -16.32% 2009 0.2 -47.35% 8.6 -27.00% 2008 0.4 94.56% 11.8 -4.09% 2007 0.2 26.34% 12.3 -2.69% 2006 0.1 12.6 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia the share of capital investments in export of montenegro in 2017 was 35.1%. this indicator also significantly fluctuated in the period from 2009 2017. croatian capital investments as a share in exports amounted to 10.9%. the share of capital investments in croatia (%) in exports in the period 2009 2017 ranged from 10 to 12 percent.15 the next table (table 8) brings comparative data on the share of capital investments in exports of the economies of montenegro and croatia table 8. the share of capital investments in exports of montenegro and croatia montenegro croatia year share of capital investments in exports (%) change%* share of capital investments in exports (%) change in% 2017 35.1 3,22% 10.9 -0.26% 2016 34.0 4,26% 11.0 1.81% 2015 32.6 8.43% 10.8 5.00% 2014 30.1 11.62% 10.2 -0.23% 2013 26.9 8.50% 10.3 0.04% 2012 24.8 5,64% 10.3 -0.62% 2011 23.5 -18.46% 10.3 -0.02% 14 the author's reseaarch based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 15 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 76 economic analysis (2018, vol. 51, no. 3-4, 67-80) 2010 28.8 25.81% 10.3 0.02% 2009 22.9 -21.74% 10.3 -14.50% 2008 29.3 41.35% 12.1 -15.22% 2007 20.7 -29.26% 14.3 -11.84% 2006 29.3 16.2 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia in the period from 2006 to 2017, montenegro's gdp continued to increase, so in 2006 it amounted to 35% of the european union's gdp (28 countries) and in 2017 it increased to 46% of european union's gdp. in the comparative period, croatia had present gdp fluctuations in relation to the eu, and in 2006 it amounted to 58% of european union's gdp, to be at the level of 61% in 2017.16 table 9 presents the gdp of montenegro and croatia in the period 2006 2017. table 9. montenegro's and croatia's gdp (percentages) relative to gdp of eu member states (28 countries) year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 country % % % % % % % % % % % % european union 100 100 100 100 100 100 100 100 100 100 100 100 croatia 58 61 63 62 59 60 60 60 59 59 60 61 montenegro 35 39 41 40 41 42 39 41 41 42 45 46 source: result of the author 's research using the data of the eurostat website the last indicator that was analyzed was the purchasing power parity of montenegro and croatia in relation to the european union and it is presented in table 10. table 10. purchasing power parity price level indices and real costs for aggregates year 2005 2006 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 country % % % % % % % % % % % % european union 100 100 100 100 100 100 100 100 100 100 100 100 croatia 65.1 64.6 67.8 68.8 69.5 66.9 64.5 64.2 63.0 61.7 63.7 64.2 montenegro 41.8 40.8 46.1 48.9 48.4 48.2 48.9 49.6 49.1 47.8 49.0 49.9 source: result of the author 's research using the data of the eurostat website analysis of tourist brands of montenegro and croatia according to bloom consulting bloom consulting has developed one of the most reliable methods for measuring tourist brands in the countries. therefore, it follows from the view that the economic impact of the tourism sector in the country is a crucial variable in determining its place on the list of tourist brands.17 the brand of the country's tourism industry can not be strong if the country does not generate profit from tourism and travel. at bloom consulting, they are of the opinion that when choosing a destination, tourists will prefer to travel to the country with a stronger attraction and greater attractiveness 16 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 17internet:https://www.bloomconsulting.com/en/pdf/rankings/bloom_consulting_country_brand_ranki ng_tourism.pdf , pg. 6 [accessed: 07.06/18] jovan rabrenović 77 of the tourist destination.18 bloom consulting's methodology consists of four variables that together provide a methodology for ranking the country's tourist brand. the first variable consists of revenues from tourism and growth of tourism revenues. therefore, the average annual tourist revenues of international tourists visiting a country for a period of five years is taken. this eliminates possible deviations that may arise from economic or political instability. the second variable measures the attractiveness of the country's brand through market research using software that measures the total amount of search when choosing a destination for a trip. the more searches are related to tourism and the tourist offer of a country, it is the tourist brand of that country more stronger. the third variable of bloom consulting's ranking of the country evaluates the accuracy of the strategic positioning of national tourism organizations (ntos), hence consistency in the application of the strategic documents of all 193 countries included in the ranking. the fourth variable analyzes the visibility and position of the national tourism organization through the search of the official nto website. therefore, data are collected on the number of unique visits and the average total time spent per visitor on a web site. the algorithm further analyzes social media and evaluates the presence of facebook, twitter and instagram.19 according to bloom consulting, montenegro is ranked on 35th place in europe in 2017/18, which is 2 places better position in in the previous research for 2016/17. in this survey, montenegro is ranked on 99th place in the world, when it comes to the tourist brand of the country. in the comparative period of 2017/18 in europe, according to strengh of its tourist brand, croatia is ranked on 13th place and this place is for one position weaker in relation to the previous measurement. however, croatia's position on the global list of tourist brands is significantly better than montenegro, which is ranked on 27th place.20 table 11 presents the tourist brands of montenegro and croatia at the level of europe in the period 2013-2018. table 11. position of the tourist brand of montenegro and croatia at the level of europe name of the country rank 2013/14 rank 2014/15 rank 2016/17 rank 2017/18 montenegro 33 37 37 35 croatia 11 12 12 13 source: result of the author's research using the data of bloom consulting's country brand ranking tourism edition analysis of the world economic forum for 2017 index of tourism competitiveness 2017 world economic forum continuously evaluates the competitiveness of tourism of all world economies. in its report for 2017, montenegro is ranked on 72th place and croatia on 32th place, according to the index of tourist competitiveness.21 table 12 presents the detailed relation between the two countries in the period 2015 2017. 18 ibid 19 ibid 20 ibid. pg. 9 21 internet: https://www.weforum.org/reports/the-travel-tourism-competitiveness-report-2017, pg. 9 11 [accessed: 07.06/18] 78 economic analysis (2018, vol. 51, no. 3-4, 67-80) table 12. index of tourist competitiveness of montenegro and croatia name of the country rank 2017 rating change since 2015. montenegro 72 3.68 -5 croatia 32 4.42 1 source: result of author research using data from the travel & tourism competitiveness report 2015 2017 conclusion an analysis of some of the key indicators of the economy of montenegro and croatia has led to the findings confirming the views expressed in the work and the conclusion that the economies of both countries are directly related to the strength of their tourist brands and that it is necessary to permanently work on innovations in the sphere of marketing in order to make these markets more interesting to international and domestic tourists. it is evident that both countries are recognized as the dominant summer destinations and that tourists visit them mostly during this season. although tourism development strategies in montenegro and croatia have strongly anticipated the activities in order to develop the perceptions of both countries as the destination of the sun and the sea, in the reality of the economy, most of the revenues generates precisely from this offer. on the other hand, montenegro by improving its infrastructure by introducing more favorable conditions for investment, introduces international hotel chains, increases tourism revenues as well as the number of tourists, and encourages local businessmen to become more actively involved in this branch of economy through the construction of a four and five star hotel. croatia is committed to the new concept of marketing activities that provide certain results, while montenegro still does not have visible activities, although the increase in the number of tourists in the past year is a good signal to continuously improve the performance of the tourism industry. if we compare the degree of application of marketing management in the tourism of these two countries, we will note that montenegrin tourist managers are using less of marketing management in their activities. croatian managers pay more attention to the practical application of marketing in their work, which is evident in the campaigns of tourist organizations and hotels. the recommendation for montenegro would be to actively start campaigning for the branding of the montenegrin tourist destination in order to coordinate these activities with state institutions that are working on the construction and promotion of the national brand of montenegro. the development of the tourist brand, as one of the elements of the national brand of the state, should be harmonized with the strategies for the development of the national brand of montenegro, and in particular should be dedicated to modern forms of campaigns in the promotion of tourism. in the end, we can conclude that the hypothesis of the work paper is confirmed, and that the tourist brand of the state is directly related to the level of revenues that the country's economy generates. tourist brands of montenegro and croatia with smaller oscillations, increased tourist revenues and therefore strengthened their position among the tourist brands of other countries. all tested indicators give us the right to conclude that without a strong tourist brand, as part of the national brand, there will be no slightly increase in revenues and benefits for both economies. creating the preconditions for strengthening the tourist brand, the economy of the state also strengthens, and the indirect benefit, through greater engagement and employment have all branches of the economy. therefore, connecting tourism with other complementary and related business activities (agriculture, gastronomy, etc.) is a necessary step in strengthening the tourism brand and the brand of countries. literature bloom consulting and digital demand. 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http://ec.europa.eu [accessed: 03.05/18] https://www.bloomconsulting.com/en/pdf/rankings/bloom_consulting_country_brand_ranki ng_tourism.pdf, [accessed: 07.06/18] https://www.weforum.org/reports/the-travel-tourism-competitiveness-report-2017, pg. 9 11 [accessed: 07.06/18] 80 economic analysis (2018, vol. 51, no. 3-4, 67-80) http://iztzg.hr/userfiles/pdf/izvjestaj-10-strategija-razvoja-turizma-rh.pdf, [accessed: 21.05/18] article history: received: october 18, 2018 accepted: december 3, 2018 ea_2014_3-4 udc: 005.511:334.012.63/.64(497.11) 005.336.1 jel: l20, l26 cobiss.sr-id 211784204 scientific review specifics of management in small and medium-size enterprises in serbia1 lazarević-moravčević marija2, belgrade banking academy, belgrade, serbia stevanović slavica, institute of economic sciences, belgrade, serbia belopavlović grozdana, belgrade banking academy, belgrade, serbia abstract – under modern conditions for performing business, an enterprise regardless of its size or business activity must be systematically directed and run. small and medium-size enterprises have certain characteristics that make them considerably different compared to large systems, therefore it is not realistic to expect that the management process in such organizations would develop in the same way as in the large systems. the fact is that the small business often does not involve a small investment, and the management of small enterprises is constantly faced with the problem of "poverty of resources" that leads to the conclusion that the success of smes is predominantly determined by the managerial skills of managers/owners. assuming that the owners/managers of smes adequately perceive the capabilities of their enterprise, make the right decisions, finding effective solutions in terms of organization and apply modern approaches to control and the success of the company definitely will follow. in this paper theoretical and empirical research has been carried out with the aim to identify the basic characteristics of successful management of smes in serbia. the research results indicate that the managerial capacity of managers/owners of smes is the main strength of the company, and one of the key sources of growth and development. when the influence of external factors is very unfavorable for business development, the management as an internal resource of organization is increasingly gaining importance in creating business success and competitive advantage. key words: smes, management, planning, competitive advantage, organizational structure, leadership, control 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of education, science and technological development of the republic of serbia. 2 zmaj jovina 12, belgrade, serbia; marija.lazarevic@bba.edu.rs moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 105 introduction small and medium-size enterprises (smes) have certain characteristics that make them considerably different compared to large systems. in certain situations such specificities put smes in a privileged position, on the other hand, there are many features that limit their growth and make them inferior to large organizations. flexibility is the first and main advantage that stands out when it comes to smes. smaller organizations have the ability to adapt quickly to the new circumstances and market needs. unlike large companies that are characterized by sluggishness, the small enterprises without any major shocks can redirect to the new market demands, in terms of the required quality, design, after-sales services etc. also, in comparison with large organizations advantages can be found in the area of innovation, simple organizational structure, a small initial capital, ability of liaisonand collaboration. smaller companies are more prone to entrepreneurial ventures and adopt new technology solutions more quickly, especially if they do not require excessive contributions and investments. on the other hand, the problems confronting smes significantly threaten and challenge their survival and development. the factors limiting the development of small business can be found in both external environment and internal features of a small business. given that smes are not smaller versions of the large systems, it is unrealistic to expect that the key management activities in such enterprises are implemented in a manner that is appropriate for the large enterprises. due to the continuing lack of financial and human resources, smaller business volume, as well as a negative influence of factors from the external environment, the management of smes is forced to define special and in many ways specific approaches to planning, organizing and control. characteristics of planning in smes planning is the primary, and at the same time very complex phase of management in which a number of strategic and operational decisions is made on the basis of which the operations of an enterprise are then directed and coordinated. in fact, this is a phase of management which defines organizational goals determining the ways to achieve them. the need for planning exists in every enterprise, regardless of its size or business activity in which it is engaged in. the intensity of such need is determined by many factors such as corporate culture, management style, ambition of the manager/owner, size and structure of the business portfolio and the like (jovan todorović, 2004, p. 508). to these factors the features of environment should be added, especially those related to the industry in which the company operates (coulter, 2010, p. 315). a key issue related to the phenomenon of planning in the smes is whether the management in smaller organizations has enough time for effective planning due to the fact that it is burdened by numerous activities related to the implementation of the defined planned decisions. it is common opinion that spending time in an efficient manner means for managers to spend 60% of their time in planning and development, 25% on the current tasks and 15% on the routine tasks (avlijaš, 2008, p. 165). given that small business owners take on many roles and are not exclusively engaged in defining planning decisions but also in its implementation and control, it can be concluded that the planning in smaller organizations economic analysis (2014, vol. 47, no. 3-4, 104-117) 106 possess certain characteristics or that does not happen in the same way as in the large enterprises. with the aim to identify the basic characteristics and specifics of the planning in smes an empirical research has been conducted on a sample consisting of 102 entities in serbia (lazarević-moravčević, 2013, p. 196). when creating a sample the selective approach has been used. therefore the structure of the sample consists of enterprises that employ more than ten employees, achieve positive results and have a recognized potential for growth and development. according to the research results when making key decisions the management of smes in serbia takes into consideration the factors of endogenous and exogenous origin. besides numerous problems challenging them, the owners/managers of the smes have a clear intention and optimism about the direction in which they want their business grow. since the growth strategy is a dominant strategic orientation, it can be concluded that the managers in smes are characterized by ambition, desire for success and the tendency to accept risks. chart 1. characteristics of planning in smes source: authors' own research based on the results obtained, shown in chart 1, it can be seen that the key feature of the management of smes in serbia is the medium term planning. the absence of a long-term growth plan, especially present in the small business segment, is not an unexpected result, especially if we take into account the instability and volatility of the environment in which enterprises in serbia carry out their business operations. the results show that in the smes sector there is a practice of formalization of the planning process but only to a certain level. in this sense, the management of smes brings highly formalized decisions such as business policies, procedures and rules. the formalization or the adoption of permanent planning decisions improves the efficiency of decision-making and implementation of decisions and solves one of the major problems 0 10 20 30 40 50 60 70 long-term medium-term short term strategy business plan business policies procedures rules p la n n in g h or iz on p la n n in g d ec is io n s moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 107 facing the management in smes which is the "lack of time". the formalization shortens the time necessary for tasks of operational character, which also means that there is more time left to resolve issues of a strategic importance to the organization. therefore, it can be concluded thatformalization is desirable as long as results in an increase in efficiency without endangering the creativity and flexibility of the enterprise. business plan has been identified as a key business decision in the category of small and medium-sized enterprises. a business plan is a "road map" by which an entrepreneur defines his business, business expectations, sources of funding and the ways to obtain the lacking resources, as well as ways for rational use of resources ( dostić, serdarević-šestić, kulović, 2010, p. 6). business owners create this planning decision for the different needs of internal and external nature. a business plan is created when a company is launching a new business, but also when planning further business development in terms of introducing new products, markets, technologies, etc. also, the business plan is an essential document in situations when seeking financial assistance from the banks or other financiers. in such case, the planning decision has the role of a study that justifies the entrepreneurial idea. given that it can serve as a standard in control, the business plan could also be created for the internal needs of an enterprise. the structure of a business plan is determined by its purpose. therefore, differences in the individual structural elements of a business plan can occur depending on whether it is a new or already existing business. also the elements of a business plan depend on whether the business plan is created for internal use of an enterprise or to obtain funds from banks or from other investors when is necessary to adhere to the instructions given by financiers. the structure of a business plan is also determined by the characteristics of the activity (business) in which the enterprise operates, the environment in which operates, preferences and ambitions of the owner/manager etc. regardless of how it is structured and which elements contains, a business plan should be short, clear and well suited to its readers or users. it is recommended that a business plan for the small enterprisescontains 10-20 pages and 20-30 pages for medium-size enterprises, which means that in any case it is necessary to avoid verbosity and unnecessary information. through the analysis of environment the management of a market-oriented company gets an insight into the market potential of an industry, its competitive structure, identifies critical success factors, internal strengths and weaknesses, etc. taking into account the influence of competition on the business operations of enterprises, each market-oriented company when it comes to the planning of activities, needs to systematically make an analysis of the competitive environment. in this sense, an enterprise needs to get familiar with its competitors in terms of the market share, strengths and weaknesses, future steps and other aspects. since the analysis of the environment factors in an industry is of great importance for the business operations of enterprises, one part of the research has been conducted in order to establish whether the management of smes takes into consideration the behavior of competitors in the market when making key planning decisions. in the analysis it was assumed that competition is a key stakeholder, i.e. an important factor that directly determines the company's business operations. economic analysis (2014, vol. 47, no. 3-4, 104-117) 108 according to the research results, looking at the entire sample about 54% of managers know well enough their competitors in terms of their market share. on the other hand, the knowledge of future strategic steps taken by their competitors is very low. only 11% of managers of smes believe that they can predict the future moves of their competitors. similar results were obtained when assessing knowledge of the internal strengths and weaknesses of the competition. shown as percentages for the entire sample about 12% of managers know well enough their competition in the context of its internal weaknesses, while only 16% in the segment of its internal forces. chart 2. knowing the competition small enterprises, in % source: authors' own research chart 3. knowing the competition -medium-size enterprises, in % source: authors' own research 0 10 20 30 40 50 60 market share future moves internal weaknesses internal strength good enough good not enough 0 10 20 30 40 50 60 70 80 market share future moves internal weaknesses internal strength good enough good not enough moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 109 the results suggest that the management of smes is not characterized by a systematic approach and comprehensiveness in the process of analysis of factors related to the industry (competition) environment which results in a lack of knowledge regarding competition in terms of its market share, strengths and weaknesses and especially of its future strategic moves. since the actions of competitors may have a dramatic impact on the business operations of an enterprise, it is essential that a systematic and objective analysis of this environment segment becomes a practice of the smes. with the aim to overcome weakness identified in this domain, the use of certain techniques and models is recommended in order to achieve a better quality of analysis and to raise its objectivity and efficiency to a higher level. organizing and organizational design of small and medium-size enterprises defining the optimal organizational structure, or a structure that would enable an efficient use of available resources and performance of activities in an organization, is a complex and challenging task for the managers of modern enterprises, especially due to the fact that organizational design is determined by the numerous factors of external and internal nature, such as company size, life cycle phase of organization, management decisions, technology available to the company, relationships between organizational units, employees and so on (erić, 2000, p. 376). the influence also comes from a number of factors of the external environment, such as changes in the political and economic system, the intensity of competitive struggle, changes in the market in terms of consumer demands, resource availability, etc. due to the frequent changes in the environment factors, a well defined organizational structure can be an effective solution but only for a certain period of time. for this reason it is necessary to periodically review and modify the organizational design. some believe that the moderate changes in organizational design should take place at least once a year, while some radical changes should be implemented every 4-5 years. a redesign of organizational structure is necessary to carry out when the company introduces new products in its product range, new technology, or enters new markets, hires new people, shuts down production, narrows the market place, etc. more specifically, any change in the strategic orientation of a company will require an adaptation of the organizational structure and its change. by applying certain principles of organization3 smes management tries to find an optimal solution, or an organizational design which would logically connect the organizational units of the company, on the basis of which the conditions for the implementation and enforcement of strategic and operational decisions will be made. due to the fact that the smes are continuously facing the lack of financial and human resources, organizational solutions for many of such companies are unattainable. on the other hand, due to the smaller business volume the smes do not need to create the complex organizational structures. a very frequent form of organizational structure in smes, as confirmed by the results of the research, is the functional organizational structure. based on charts 4 and 5 it can be seen 3 specialization, departmentalisation, chain of command, span of control, centralization /decentralization, formalization. economic analysis (2014, vol. 47, no. 3-4, 104-117) 110 that in the category of medium-size enterprises a functional organizational structure covers about 92% and 43% of the small enterprises. chart 4. organizational structure medium-sized enterprises source: authors' own research functional organizational structure is characterized by clearly defined hierarchical levels, formalization, standardization, clearly defined jobs, tasks and roles of individuals. the advantages of this organizational form are clear and direct control, good communication and coordination of employees within the functions, specialization, savings based on the economies of scale, highly skilled workforce and a great ability to solve technical problems etc. on the other hand, the conflict of interest between certain functions, centralized decision making, unclear measuring of contribution of each functional area in the overall performance are considered to be primary disadvantages of this organizational form (erić, 2000, p. 359). according to its nature a simplified version of functional organizational structure is found in smes or a structure characterized by a smaller number of organizational units compared to the number of business functions that take place in the company. the studies have demonstrated that such organizational structures do not have separate places i.e. organizational units that would integrate activities of strategic importance for the growth and development of the company. the above primarily refers to the marketing activities, research and development. the absence of the above functional areas does not mean that the successful smes in serbia are not innovative or marketing oriented, but rather that they apply particular and very specific ways to perform those activities. the research results confirm that the small enterprises have, besides the functional organizational structures, the simple or informal structures. 43% 41% 0% 1% 15% functional structure simple structure divisional structure other refused to answer moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 111 chart 5. organizational structure small enterprises source: authors' own research a simple organizational structure is characterized by a high centralization, wide range of control, low specialization and departmentalization. the manager/owner makes all important decisions, participates in and supervises all business processes in the organization. the main advantage of a simple model of organization is a clear control system and a high level of flexibility. turbulent and dynamic conditions prevailing in the modern marketin which an enterprise operates, impose the need for permanent reviews and changes of the strategic behavior of a company. changes in the strategic orientation require adjustments in organizational terms. modern organizations are becoming smaller, simpler, more dynamic, more horizontal and open ( riderstrale, nordstrom, 2004, p. 195). the smes are adapting to the new requirements in terms of organizing or creatingan organizational design, and as one of the possible solutions that such companies may apply is the matrix organizational structure. basically this is a structure produced by combining functional and project (divisional) structure in order to minimize its limitations and disadvantages. an effective combination of vertical lines of communication and authority with the horizontal (lateral) lines, stands out as one of the main advantages of the matrix organizational structure. also, the matrix organizational structure is characterized by a high flexibility, efficient use of resources (resources and expertise are available on an equal basis to all projects), debureaucratisation of management (decentralized decision making), more efficient solving of complex problems, and the like. on the other hand, in this organizational structure one of the most important organizational principles i.e. the principle of unity of command has been broken. a dual system of management or the fact that employees are exposed to a dual supervision makes thesituation somewhat chaotic. the existence of the two key figures i.e. two managers (at the level of the project and at the level of the function) can cause a number of problems, which are usually manifested in the conflict of opinion and non-supporting attitudes 91% 5% 0% 4% functional structure simple structure divisional structure other economic analysis (2014, vol. 47, no. 3-4, 104-117) 112 between the functional and project teams. also, the lack of understanding and lack of support between these two groups in the organization is largely caused by the fact that the teams in projects and the teams in functions differ widely based on their motivation and mentality. while the experts within functions are focused on strengthening the competence, efficiency and better equipment of sector, the project teams are focused on meeting deadlines, conditions of the contract and work plan (brnjas, 2000, p. 309). the above disadvantage can be solved by strict defining of powers and responsibilities of managers at the both project and function level. although the use of matrix organizational structure is very limited, it may be an appropriate solution for smes that apply project-based work, or for businesses that are organized according to the functional principle, but intend to realize some project-based works in the coming period. one of the many options that are available to the management of smes, and which used in order to make the organizational structure more flexible is outsourcing. due to the lack of financial resources and unprofitability of establishing complex organizational structures, a great deal of activities can be transferred outside the company. in such case the enterprises develop certain management functions, and for the other business activities periodically engage external partners and consultants. by transferring those activities in which an enterprise cannot achieve uniqueness to other business entities, an enterprise acquires certain benefits, or eliminates bureaucracy, speeding up the decision making process, reducing costs, and most importantly focuses on the strengthening and upgrading of its core competence (so-called "core competence"). in the case of smes outsourcing and the use of services of specialized institutions are commonly used in the field of legal services, marketing, accounting, transportation, training and education, development of managerial skills, etc. leadership in smes leadership is a phenomenon that attracts the attention of experts for a long period of time. over decades many books and papers on the subject of leadership have been written in a quest for the most acceptable definition and interpretation of the role of leader in the creation of success of an enterprise. a significant part of the experts believes that the leadership plays a critical role in creating competitive advantage, but also that this category should not be equated with the management or entrepreneurship. generally it is believed that a leader is someone who is creative, transformer and innovator. such person approaches challenges with passion and without restraint. thanks to his/her charisma, expertise and communication skills, a leader motivates others and inspires members of the organization to take an action and to transform. on the other hand, the manager is a person who plans, organizes and controls. unlike an entrepreneur who identifies himself with the whole company, a professional manager identifies himself with the function performed in the company. his/her actions are primarily focused on the efficiency, as opposed to the leader who is focused on effectiveness. the character of a manager is determined by the persistence, rationality, analyticity, determination and prudence. an entrepreneur is the owner of the company, i.e. the person who runs the moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 113 business, takes the initiative and risk of success or failure of the organization. he is a visionary, a creative person who is dedicated to work to the maximum, but also someone who has a great need to control. the obsession of every entrepreneur is his/her business and organizational development. therefore, entrepreneurs are focused on changes, innovations, creation of new products and markets. the differences between the entrepreneurs and leaders can be found in the orientation, or in the means used to achieve a goal. while the entrepreneur is mainly focused on the task and goal, the leader is focused on people, i.e. the followers that he/she directs toward achieving the goal without coercion. under conditions of high uncertainty and turbulence, it is more than desirable that the owner or the person who runs the business, in addition to entrepreneurial and managerial skills, possess the ability to encourage, motivate and animate the members of the organization by his/her personal example towards achieving the goal. a lack of leadership qualities, as well as inability to achieve effectiveness and efficiency by taking risky undertakings, will cause a decline in the business performance and endanger the survival of the company. there is a perception that each organization throughout its life cycle in certain moments will have a greater need for individuals with managerial qualities, and in other moments will have a greater need for individuals who possess the qualities of leaders and entrepreneurs. generally in the early stages of business development a company needs people with entrepreneurial spirit and ideas. at the stage when an organization becomes more mature and stabilizes its business it is realistic to expect that the transformation from entrepreneurship to management will follow. on the other hand, in times of crisis, the organization is in need of leaders, i.e. individuals who possess the skill of managing and transforming organization (mašić et al., 2010, p. 427). taking into account that effectiveness and efficiency are indispensable for success, the modern organizations are in need of management that has the leadership and managerial and entrepreneurial abilities and skills. in fact, these three roles are not conflicting and can be successfully integrated in a single person. by combining the entrepreneurial, managerial and leadership energy the success will be guaranteed. the specifics of control processes in smes viewed in the light of conceptual sense the control in smes is not different from the control in large organizations. in the evaluation the management of smesmay use the same or similar techniques and instruments that are used in the large systems. the only significant difference between the control in the small and large enterprises is the extent to which the control is preformed. the assumption is that in the smaller organizations the control will be easier due to the smaller volume of activities, i.e. will require less time and energy. generally speaking a control mainly involves the control of effects and the control of behavior. the performance control (control of effects) aims to establish whether the planned performance is achieved, and the control of behavior is carried out in order to direct the behavior of employees towards achieving planned performance. such control is determined by the culture of organization, its system of constraints and rewards. practice has shown that organizations that have a strong organizational culture and a fair system of rewarding, in the economic analysis (2014, vol. 47, no. 3-4, 104-117) 114 process of control of behavior are less reliant on the constraints, i.e. rules, procedures and regulations (dess, lumpkin,eisner, 2007). control is an instrument used for assessing the validity of selection of a certain planning decision, as well as the efficiency of its implementation. evaluation of the business performance can be done by using a number of techniques and instruments, which are generally classified into two categories: traditional and contemporary. classic (traditional) approaches are based on the accounting concept of profit, i.e. on the information obtained from the financial accounting system. a set of regular financial reports is used for basic reports that show information about business results. the traditional approach that insists on presenting business results through financial sizes is widely used in enterprises despite certain deficiencies. the primary objections related to this approach for measuring and displaying of the business performance, are its excessive orientation to the past, short-term focus and a tendency to show profit as the main indicator of success. an excessive focus to short-term financial performance reflects the fact that the company neglects many other important elements or resources which in the long term can play an important role in creating competitive advantage, such as new product development, modernization of the production process, employee training, etc. therefore, taking into account the logic of modern business, according to which the "intangible" assets of the company are becoming a key source of the competitive advantage, the control of business performance should not be reduced only to the financial analysis, or analysis of the financial position and profitability of an enterprise. over-reliance on financial indicators in the analysis of business performance can lead to an investment in the potential short-term yields, and on the other hand may cause the negligence of the intellectual or intangible assets that generate growth of an enterprise. in accordance with the above, the control of business performance should be refined using the qualitative indicators.4 the research which was conducted in order to identify the specifics of management in the smes, found that in such enterprises there is a practice of business control from different perspectives. most of the managers surveyed analyze its business not only in terms of financial performance, but also from a consumer perspective, internal processes and innovation. shown by percentage 77% of managers said that they monitor the business performance not only using traditional, or quantitative financial indicators, but also some of the non-financial measures. viewing this in the light of the small and medium-sized enterprises, the success or failure from the aspect of non-financial nature which is extensively used in the assessment of business performance is customer satisfaction. results relating to the use of qualitative criteria in the analysis of business results, observed at the level of small and medium-sized enterprises are presented in chart 6 and 7. 4 the number of new customers, frequency of orders, number of complaints, total time of interaction with customer, customer satisfaction with quality and speed of delivery, time required to launch innovations, number of customers that have not re-used the product (service), efficiency of the production process, productivity per employee, workforce fluctuation, number of received suggestions and the like. moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 115 chart 6. criteria for measuring the business success in small enterprises, in % source: authors' own research in the category of medium-sized enterprises, in addition to customer satisfaction, as very important criteria for measuring business success are the employee satisfaction and the efficiency of the production process. chart 7. criteria for measuring the business success in medium-sized enterprises, in % source: authors' own research based on the research results, it can be concluded that the management of smes in assessing the business performance in addition to financial indicators also relies on certain qualitative criteria. the use of qualitative criteria in the analysis of business performance 0 5 10 15 20 25 30 other profitability of individual products customer profitability participation of new products in total sales rates to attract new customers customer satisfaction employee satisfaction efficiency of the production process 0 5 10 15 20 25 other profitability of individual products customer profitability participation of new products in total sales rates to attract new customers customer satisfaction employee satisfaction efficiency of the production process economic analysis (2014, vol. 47, no. 3-4, 104-117) 116 proves that the management of smes takes into consideration the role and importance of "intangible" assets in creating business success. conclusion the competitive advantage of smes in serbia is determined by a number of factors of external and internal nature. since that the negative impact of exogenous factors has been present throughout a long period, and that the environment in which the smes operate in serbia is not business-friendly, the key sources of competitive advantage should be sought in its internal strengths, primarily in the managerial skills of managers. in the modern business environment, the growth and development of an enterprise is determined by the ability of its management to create a clear vision and mission, identify factors critical for success, analyze competition, define planning decisions and formulate methods for the efficient implementation. only under the assumption that the management of smes is characterized by a proactive attitude towards events in the environment, flexibility and willingness to accept risk, there is a real chance to achieve the business success or growth and development of an organization. the results of empirical research prove that the activities taking place in the field of planning, organization and control in the smes in serbia require different approaches as compared to the solutions applied in the large systems. authorsresearch has shown that the planning process in the smes is flexible and less formal as compared to the planning in large organizations. due to its smaller business volume in smes more flexible forms of organizational structure prevail, such as the simple (informal) and functional organizational structures. the control is comprehensive and enriched by application of qualitative indicators of business success, which leads to the conclusion that the management of smes in serbia takes into consideration the role and importance of intangible assets in creating business success. references avlijaš, r. 2008. preduzetništvo i menadžment malih i srednjih preduzeća. belgrade: singidunum. brnjas, z. 2000. strategijski menadžment – teorijske osnove sa primerima iz prakse. belgrade: grmečprivredni pregled. coulter, m. 2010. strategijski menadžment na delu. belgrade: data status. dess, g. g., lumpkin, g. t., and eisner, a. b. 2007. strategijski menadžment – teorija i slučajevi. belgrade: data status. dostić, m., serdarević – šestić, m., and kulović, đ. 2010. biznis plan za mala i srednja preduzeća. sarajevo: school of economics and business. erić, d. 2000. uvod u menadžment. belgrade: čigoja štampa. lazarević-moravčević, m. 2013. faktori i pristupi u kreiranju konkurentskih strategija malih i srednjih preduzeća u srbiji. phd diss., belgrade: union university, belgrade banking academy. mašić, b., babić, l., đorđević-boljanović, j., dobrijević, g., and veselinović, s. 2010. menadžment – principi, koncepti, procesi. belgrade: singidunum. riderstrale, j.., and nordstrom, k. a. 2004. fanky business. belgrade: plato. moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 117 todorović, j. 2004. strategijski i operativni menadžment. belgrade: conzit. specifičnosti upravljanja malim i srednjim preduzećima u srbiji rezime – u savremenim uslovima poslovanja preduzeće, bez obzira na veličinu ili delatnost kojom se bavi mora biti planski usmeravano i vođeno. mala i srednja preduzeća poseduju određene karakteristike koje ih čine bitno drugačijim u odnosu na velike sisteme, stoga nije realno očekivati da se proces upravljanja u ovim organizacijama dešava na istovetan način kao i u velikim sistemima. činjenice da mali biznis često ne podrazumeva mala ulaganja, kao i da se rukovodstvo malih preduzeća konstantno suočava sa problemom „resursnog siromaštva“ navode na zaključak da je uspeh msp prevashodno determinisan upravljačkim sposobnostima menadžera/vlasnika. uz pretpostavku da vlasnici/menadžeri msp na adekvatan način sagledavaju mogućnosti preduzeća, donose ispravne odluke, pronalaze efikasna rešenja u domenu organizovanja i primenjuju savremene pristupe kontroli, uspeh preduzeća ne može izostati. sa ciljem da se identifikuju osnovne karakteristike menadžmenta uspešnih msp u srbiji, u radu je sprovedeno teorijsko i empirijsko istraživanje. rezultati istraživanja ukazuju da upravljačka sposobnost menadžera /vlasnika msp jeste osnovna snaga ovih preduzeća, odnosno jedan od ključnih izvora rasta i razvoja. kada je uticaj eksternih faktora vrlo nepovoljan za razvoj biznisa, menadžment kao interni resurs organizacije sve više dobija na važnosti u kreiranju poslovnog uspeha i konkurentske prednosti. ključne reči: msp, upravljanje, planiranje, konkurentska prednost, organizaciona struktura, liderstvo, kontrola article history: received: 6 june 2014 accepted: 11 november 2014 ea_2018_3-4 115 economic analysis (2018, vol. 51, no. 3-4, 115-124) doi: 10.28934/ea.18.51.34.pp115-124 scientific paper satisfaction and loyalty of clients towards banking products and services milica raičević1* | dijana medenica mitrović2 1 mediterranean university, faculty of economics and business, podgorica, montenegro 2 faculty for business management, bar, montenegro abstract transformation of the banking sector has led to today's banks providing a complete service financial service both on the domestic and international level. the focus of their business is the client whose loyalty depends on the operations of the bank. the aim is to indicate that there is a direct link between the quality of the banking product and the service that affects the client's satisfaction and loyalty, which directly affects the bank's business and its competitive advantage in the financial market. the paper gives a theoretical and practical overview of the quality of service, satisfaction and loyalty of clients, and the performance of the bank, which depends on clients. in the theoretical part, the concept of a client, its significance and specifics related to its influence on the bank's business, through its satisfaction and loyalty to the bank, is defined. the empirical part deals with the analysis of customer satisfaction and loyalty towards banking products and services in montenegro and how much the quality of banking services has an impact on the satisfaction and loyalty of the customer. the analysis of the factual situation will be carried out, the conclusions will be presented and recommendations made for improvement of the quality of the service, which will contribute to the greater satisfaction of the clients, and therefore the loyalty to the particular bank. all of this is directly related to the possibility of achieving the competitive advantage of banks within the banking sector where a particular bank operates. key words: quality of service, satisfaction, loyalty, client, banking sector, strategic management jel classification: j5, e5 introduction in the business world, there is a "fight" around every potential but also a permanent client. services are a key segment in achieving these goals. if we have a good placement of products and services, and most importantly, if we take care of the client and his needs, we can gain his loyalty. this is precisely the key to the success of banks, because a loyal client is satisfied with the client, and therefore the bank has secured the advantage of the bank and a secure profit. banks through the perception of quality perception by clients can improve their business and offer a better and better service that is tailored to the needs of clients. what contributes to satisfaction is building full loyalty among bank clients because clients are hitting propaganda messages that try to influence their perception. thus, when creating a service, account must be taken of the heterogeneity of the market and service supply gaps, i.e. the difference between the expectations of consumers and their perception of the delivered service (hill, 2006) and must achieve superior value for the consumer (marinković, 2012). consequently, the quality system of services becomes a lever that prevents attempts to influence customer satisfaction and loyalty. in this way, the * corresponding author, e-mail: milica.raicevic@unimediteran.net 116 economic analysis (2018, vol. 51, no. 3-4, 115-124) quality and comprehensiveness of the service is the best tool for building a sense of loyalty with banking clients. the methodology of the work includes a theoretical and practical overview of the importance and role of the quality of services, satisfaction and loyalty of clients towards banking products and services, and hence the success of the bank itself. theoretical part defines the concept of the client, his / her significance and specific features related to his / her influence on the operations of the bank, through his / her satisfaction and loyalty to the bank. the empirical part deals with the analysis of client's satisfaction and loyalty for banking products and services in montenegro and how much quality of banking services affects the satisfaction and loyalty of the client. based on the collected data, will be carried out an analysis of the factual situation, the conclusions will be drawn and recommendations made to improve the quality of the service, which will contribute to the greater satisfaction of the clients, and therefore the loyalty towards the specific bank the initial hypotheses of the paper read: h0: the quality of banking operations has a crucial role in the process of building long-term relationships with consumers. only satisfied clients are loyal clients, who make it possible for the bank to achieve long-term business goals and make profit. h1: by improving the quality of products and services, the mutual relationship between the client and the bank is improved, as well as the business environment in which both parties take part. h2: by improving the quality of banking services, a competitive advantage is achieved and the position of banks in the financial market strengthens, especially considering that banks operating in an environment which is rapidly changing. the aim of the paper is to determine whether the clients are satisfied with the quality of banking products and services, as well as in which part of the relationship there is customer dissatisfaction and how banks should act to dissatisfy dissatisfaction. only a satisfied client is a loyal client. improving the quality of mutual relations, improving the business environment, and contributing to the creation of a competitive advantage of the bank in the financial market. theory aspects of the orientation on the loyalty of the client and the quality of services relationship between the client and the quality of banking products and services each market and thus the banking sector consists of two main players bank and client (raicevic, medenica-mitrovic, 2018). on this relationship between these two actors there is a service that provides a satisfied client on the one hand, and on the other, a satisfied bank. satisfied customer satisfaction with the product and service manifested by loyalty, and the company is even better service. on the path of defining the "complete service" of the questions to be answered, according to baker (vasiljev, 1999) that the client would be satisfied and, in the future, he was loyal to the services of the given company: which goods and services should be produced and in what quantities? how to produce (resources and technology)? for whom to produce? this third question, by market research, leads us to the client's profile who buys or will buy our products and services. the goal of clients is to fulfill their needs for a specific product and service with the easiest and fastest way, with the least cost. this leads us to questions about the cost of the cost, and why and on what basis the client for a product or service is prepared to pay more, what are the "value components" of the product or service, and what is the most important for the buyer in purchasing (maričić, 2005). what we need to keep in mind when creating products and services is the fact that the client and his satisfaction are the most important for the company because the company depends on the client, that the client is the purpose of the company's existence (kotler, milica raičević. dijana medenica mitrović 117 1999) and that, based on his wishes, we create products and services and marketing activities, i.e. product synthesis, pricing, access, distribution channels and at the end of the promotion, we want to satisfy the client who will come again. thus, a company creates a loyal customer on the one hand, and on the other provides him with a competitive advantage and a secure profit. a satisfied customer is not a sufficient guarantee of success at work. what distinguishes successful companies today from unsuccessful is the phenomenon of customer loyalty (zelenović, 2015). a prerequisite for the formation of consumer loyalty is satisfaction with the product or service. if consumers are not satisfied on any basis, loyalty cannot be achieved. the more loyal consumer is the one who is absolutely satisfied with the product and the service, and the company is more important than the one who is just satisfied. it is considered that a completely satisfied client is a precondition for forming loyalty and strengthening relations with the company in the long run. the customer's first impression is very important it is crucial to achieve customer satisfaction at the first meeting, in order to have the basis for the formation of loyalty. client demands, needs and expectations represent a basic basis that enables the establishment of appropriate relationships on a client-to-client relationship in order to create good conditions for creating satisfaction, which is the main means of creating long-term consumer loyalty (rajola, 2004). thus, according to veljković (2004), all clients could be divided into four categories: absolute loyalty, unstable loyalty, relative loyalty and disloyalty. each market consists of these four segments of consumers, according to the degree of loyalty. for each company, it is very important that as many consumers are in the category of absolutely loyal. only an absolutely loyal consumer is a security for the company, that is, only such consumers will, in the long terms, be faithful to company and its services. satisfaction and loyalty of clients towards banking products and services loyalty can be defined as an attitude towards a particular brand, which results in a constant purchase over time. the service that the company markets on the market depends on consumer loyalty, so it is very important that close and effective communication is achieved with existing and potential clients. implementation of the loyalty program has a positive trend in our country as well. they are increasingly applied, and more and more companies are introducing, innovating, expanding, creating new channels of communication with consumers, but also allowing buyers to influence the creation of a range of products and services with their advice, wishes and suggestions in order to achieve long-term satisfaction. depending on the frequency of repeated purchases and the intensity of attitudes towards a particular brand, it is possible to identify four types of loyalty, according to veljković, which are (veljković, 2009): false loyalty, latent loyalty, stable loyalty and no loyalty. establishing a quality and long-term relationship with the client is a concept that has turned into a special business philosophy in the banking sector in the last decade. this approach implies putting the client in the center of business processes and planning based on an analysis of his needs, which in practical terms means a good knowledge of clients, as well as providing a timely response to their demands (gaborović, 2009). banks are struggling to adapt their service to the aforementioned concept on multiple levels in order to achieve a high quality relationship with customers. first of all, a good relationship with the client begins with the first contact in the branch office, where during a well planned meeting, the bank officials try to determine the client's profile and, on the basis of the information obtained at that time, prepare the appropriate offer of products and services. the offer should be in line with the client's financial capabilities, needs and plans for the future. the highest level of quality relationship with clients, which gives full meaning to the principle of "putting the customer at the center of attention", is the customer relationship management, which, in addition to the above, implies a proactive relationship with the client and a response to his needs prepared on the basis of the acquired knowledge of the client, through profiling and 118 economic analysis (2018, vol. 51, no. 3-4, 115-124) analysis (hanić, domazet, 2012) (hanić, domazet, drašković, 2011). by applying this method, the bank approaches the client by offering him services and products that suit his profile style of life, occupation, and even habits and interests. in this way, a long-term relationship with clients is guaranteed that meets the interests of both sides. customer relationship management (crm) or customer relationship management is an approach to managing the company through interaction with current and future consumers (jovićević, žugić, 2018). the crm approach analyzes customer data and their history with the company, in order to improve business relationships with customers / customers, with an emphasis on their retention (jokić, 2016). the challenge is to combine the information coming from different sources and which are selected in the database in the function of selling products and services crm refers to the organization of data, that derives from business relationships on all bases between the bank and the client, and even beyond. building a database is a gradual process (rajević -grujević, radević, 2016). by placing the customer at the center, crm is based on integrated market management, sales and customer service, as the key functions of banks that face daily customers. crm is a strategic approach in building value for stakeholders, through the development of customer relationships (marinković 2015). the bank should aim at the spirit of building teamwork. in the future, it is necessary to provide a high standard of quality and professionalism with the client as a central point. the goal starts with every employee, so accordingly, individual performance should include qualitative goals such as: integrity, kindness, responsibility, professionalism, knowledge, training, consistency, discipline and most other positive qualities. analysis of customer satisfaction and loyalty towards banking products and services in montenegro research methodology the subject matter of the research of this paper is whether the customers are satisfied with the quality of banking services, and whether the satisfaction with quality affects customer loyalty towards the products and services of the banks whose services they use. the aim of the paper is to determine where the dissatisfaction of clients lies regarding the available banking products and services; how banks should act to eliminate dissatisfaction and ensure, through customer satisfaction, that the client is loyal to a specific bank, which improves the quality of mutual relationship, and, consequently, the business environment as one of the factors of competitiveness. the initial hypotheses of the paper read: h0: the quality of banking operations has a crucial role in the process of building long-term relationships with consumers. only satisfied clients are loyal clients, who make it possible for the bank to achieve long-term business goals and make profit. h1: by improving the quality of products and services, the mutual relationship between the client and the bank is improved, as well as the business environment in which both parties take part. h2: by improving the quality of banking services, a competitive advantage is achieved and the position of banks in the financial market strengthens, especially considering that banks operating in an environment which is rapidly changing. quantitative exploratory research was conducted on a sample of 300 respondents. for the needs of the research, a non-random convenience sample was used. the data were collected by the survey method, using a specially designed questionnaire. the survey was carried out on-site and on-line during the period august-september 2018 in the territory of montenegro. a total of 350 questionnaires were distributed, out of which 300 or 85.71% of questionnaires were valid for processing, which is a high response for the purposes of this pilot survey. the questionnaire milica raičević. dijana medenica mitrović 119 consisted of two parts: the first part concerned the collection of general data on respondents; while the second part covered a set of questions about the habits in the use of banking services, as well as about the satisfaction of users of banking services with both products and services, and the attitude of the staff of the bank who they come into contact with. based on the processing of the questions, the findings were made that might help the managers to recognize the weaknesses of the bank’s offer, and what customers need, how they are informed and where they see the deficiencies that can affect loyalty towards the products and services of the banking sector. research findings it was found out by the descriptive statistics that 53.33% of female respondents and 46.67% of male respondents participated in the survey. as for the age, respondents belong to one of the five categories offered, with an equal number of respondents (100 of them or 33.33 per cent) belonging to the 18-28 age group and 29-38 age group, followed by respondents aged 39-48 with 15% the respondents aged 49-58 accounted for 11.67%, while the smallest percentage was of respondents over 59 years of age who accounted for 6.67%. as regards educational qualification, the majority of respondents completed higher education, 45% of them, followed by respondents with completed secondary education who accounted for 31.67%; while 15.67% of respondents have a college or university degree; followed by respondents with completed postgraduate studies, 7.66% of them; while there were no respondents among the surveyed ones who completed only elementary school. the respondents also provided answers about their employment status, with 59.33% of respondents who are employed; 27.67% of respondents are unemployed; while pensioners account for 13% of the sample. out of a total of 300 respondents, 260 of them responded that they used only the services of one bank, while 40 respondents confirmed that they used the services of more than one bank. thus, we gained an insight that the use of the services of one bank is certainly an important and non-negligible piece of information that gives us a clear picture of the loyalty of users. although, we must emphasize that in our informal conversation, the answer was mostly that "they do not want to deal with more banks, and that it is an unnecessary cost; that one bank is quite enough; and that they choose the best/most favourable one" as the most important factor for the selection of the bank, respondents noted the amount of commission (25% of respondents or 75 respondents). the vicinity of the bank was crucial for 45 users (15%). 16% of the respondents mentioned the kindness of the staff as a crucial factor in using the services of the selected bank. the competence of the staff as a factor was indicated by 40 respondents (14.67%). the quality of products and services was suggested by 70 respondents (23.33%), while the speed of service provision, as the dominant factor in the decision regarding the selection of a bank, was indicated by 18 respondents (6%). it can be concluded that the amount of commission and the quality of service are the two factors that stand out in the selection of the bank, and that the kindness and the competence of the staff, as well as the vicinity of the bank are equally and not less important factors. the respondents provided answers about whether they were satisfied with the way of communication of the staff, and the findings showed that 40% of respondents were dissatisfied, the same percentage answered they were partially satisfied, while only 20% of respondents were completely satisfied with the way employees communicate with them. this piece of information is important for the management to bear in mind when training and appointing the front office clerks, because the significance of the front office staff is often overlooked when creating an impression about the service company itself. it is these 40% of partially satisfied ones that need to be won and turned into satisfied consumers, who will also turn into the category of loyal consumers. frequently, a well-designed service or product has less value for consumers themselves if we encounter impolite staff. 120 economic analysis (2018, vol. 51, no. 3-4, 115-124) when questioned whether the respondents experienced some inconvenience in their selected bank, the majority of them 217 (72.33%) gave a negative answer, while 83 (27.67%) respondents answered that they had suffered inconvenience in the bank. the reasons for the inconvenience were the following: a lack of interest and kindness of employees to obtain the right information; a poor explanation of technical terms; inadequate explanation about the user rights and benefits; new products; unkindness at the counter, etc. as the ways of informing about the services of the bank, the highest percentage of respondents answered that they got informed through friends (30.67% or 92 respondents), almost the same percentage was of those who got informed through advertisements -tv, newspapers, the web, the internet (25%) and flyers (24%). 12.67% (or 38 respondents) go directly to the bank to get information about the products and services, while 7.66% (or 23 respondents) use call centre services to get information about the products and services of the bank. as much as 66.67% of respondents said they would not change their bank, while 33% of respondents were not satisfied with the services they receive in the bank whose clients they are, thinking that the services are of poor quality, that employees are not accurate, interested, etc. even though a high percentage of respondents would not change their bank, respondents were given the opportunity to indicate which elements mostly affect the existence of dissatisfaction or what are the elements that customers themselves would recognize the banks could improve in order to increase customer satisfaction. as reasons for dissatisfaction, the users of banking services cited crowds at the counters (97 respondents), impolite staff (63 respondents), high commission (42 respondents), high default interest rates (44 respondents), short grace period (36 respondents) and too much paperwork (18 respondents). figure 1. the evaluation of certain aspects of the bank's services source: authors' analysis, september 2018. the respondents were asked to evaluate certain aspects of the bank's services with "excellent", "good" or "bad". the clients rated: • kindness of bank clerks (“excellent“ 67 respondents, “good” -160 respondents, “poor” 73 respondents) • interaction with clients through social networks (“excellent” -63 respondents, “good” -38 respondents, “poor” 199 respondents) milica raičević. dijana medenica mitrović 121 • quality and availability of information on the website (“excellent” – 45 respondents, “good” – 48 respondents, “poor” 207 respondents) • quality of e-banking services (“excellent” -154 respondents; “good” 44 respondents, while 102 respondents did not answer the question because they do not use e-banking services) • technological innovations in the function of providing better quality services (“excellent” – 94 respondents, “good” – 63 respondents, “poor” 143 respondents) we can conclude that the respondents are particularly satisfied with the quality of e-banking, that the average rating was given for the kindness of the front office staff, while more than 50% of respondents gave a poor rating for technological innovations in the function of providing better quality services, the quality of the information available on the website, and the interaction with clients through social networks. all of the above aspects have the potential for improvement so that the clients could be more satisfied and, therefore, more loyal. as for e-banking, 66% (or 198) of respondents are users of this service, and they cited the elimination of waiting in branches, time savings and access at any time as the advantages of ebanking. of the respondents who responded positively that they used e-banking services, 57.1 % (or 113) confirmed that they used the services on a daily basis. it can be concluded that the use of e-banking is increasingly represented in our country, and that it is becoming a commonplace phenomenon. most frequently, e-banking services are used for paying bills, online shopping, checking the account balance, money transfer. 34.6% of respondents do not use e-banking services, and as the main reason they cited insecurity, insufficient information and lack of interest in this type of services. in accordance with new trends in banking and bank networking, banking operations are performed faster, safer, in a better quality and uniform manner. in the banking sector, innovations have occurred and the ebanking and virtual banks are created. innovations in banking operations primarily relate to the technology of payment operations and the transfer of funds. in line with these modern trends, the respondents were supposed to rate on a scale of 1 to 5 which of the offered services they use most: telephone banking, home banking, online banking, internet banking, or mobile banking. before the respondents even circled and gave their ratings, it was necessary to give them brief and clear explanations of what is meant by these five terms. thus, it was established during the survey that respondents did not know the difference between the terms and often did not differentiate between them. after a brief introduction and provision of information, the respondents started to fill in the questionnaires. the average rating for telephone banking is 3.1; for home banking 3.8; online banking was given an average rating of 4.4; internet banking 4.8; mobile banking was rated with an average rating of 4. from the findings of the conducted research we can conclude that the respondents are loyal to the products and services of the selected bank, and that the amount of commission and the quality of the banking product and service are indicated as the main motive for selecting the bank. the competence and kindness of the staff, as well as the vicinity of the bank, are also important factors in selecting the bank. what the banks need to improve is the training of their front office staff. clients expect from employees to be polite and professional, and it is precisely the incompetence of the staff that the clients are most complaining about and which causes the most dissatisfaction in the client-bank relationship. kindness and professionalism of the staff must also be taken into account because the respondents answered that they most frequently got informed about the bank from the experience of acquaintances/friends, so the poor user experience or dissatisfaction can have a negative impact on attracting new clients. the research showed that clients were familiar with and were using innovations of contemporary trends in banking. citizens in montenegro, although still "shy", are increasingly using electronic and mobile banking services, 122 economic analysis (2018, vol. 51, no. 3-4, 115-124) which enable them to use the banking services in a convenient, fast, but, above all, in an efficient manner. it can be concluded that this research has confirmed the set hypotheses. high quality banking plays a crucial role in building long-term relationships with consumers, as well as in building customer loyalty, especially considering that banks operate in an environment that is rapidly changing, so the basis for survival and generation of profit and competitive advantage can be seen in the strengthening and improving mutual relations between the client and the bank. the contribution of the paper and the conducted research is reflected in the fact that the attention of marketing managers in banks is drawn to the fact that, in line with the modern concept, they must not rely on an independent and blanket assessment of customer satisfaction solely on the basis of sales results, but that the quantifying of the level of client satisfaction and placing it at the level of the business goal is as important as the financial result in the overall business success. customer loyalty has always been one of the basic parameters of business success, and the client's satisfaction with bank products and services is a guarantee of long-term cooperation. conclusion the sudden changes in the banking market and the volatility of the clients and the variety of choices influence the constant increase in the level of expectations in the next purchases or transactions. a successful bank brand is created in the way that users of banking products and services build long-term relationships with the bank based on trust, emotional experience and mutual understanding. in considering the relationship of satisfaction and customer loyalty, one should bear in mind that the information obtained in the satisfaction measurement process relates to a certain moment. on the other hand, the emotional response of the client after the purchased purchase changes over time under the influence of a number of factors. in cases of using banking services, the sense of satisfaction is variable and depends on the time cycle of using a particular service, such as, for example, the use of a long-term loan. fighting for clients with competition is never greater. so many banks and each of them offers the most favorable services to future clients, but also those who already is. the decision is on the clients; they choose the best services according to their personal preferences. it is up to the banks to keep the existing ones with good offers, to try to keep improving and technological advancement, because they will only be competitive, on that way, in a market that is "ruthlessly" for all participants on it. from the findings of the conducted research we can conclude that the respondents are loyal to the products and services of the selected bank, and that the amount of commission and the quality of the banking product and service are indicated as the main motive for selecting the bank. what the banks need to improve is the training of their front office staff. clients expect from employees to be polite and professional. impoliteness of staff has proven to be the factor which causes the most dissatisfaction in the client-bank relationship. the survey has showed that clients are familiar with and are using innovations of modern trends in banking. in modern conditions of banking operations, one of the most important tasks of management is customer satisfaction and their long-term retention. the priority of retaining the existing clients in relation to winning new ones is dependent, above all, on intense competitive pressures and high costs of winning new clients. the most effective way of retaining consumers is to build customer loyalty by continuously providing satisfaction and creating high costs of switching to other brands. trust and commitment are the most important determinants of loyalty of bank's 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search for conditions that would enable their reform and further development. however, this issue is very complex and it is based on important qualities of organisational structure and functioning of public enterprises. moreover, it to an extent merges with another issue that of the quality of financial reporting. in that respect, this paper presents financial statements in the context of characteristics of public enterprises and their environment, and outlines the directions of changes aimed at their improvement key words: reforms, institutions, public enterprises, financial reporting, financial reporting oversight jel classification: l26, g32 introduction financial reporting is a specific outcome of the total economic and social circumstances of a society in which is prepared and presented. it is a phenomenon of a particular subtlety whose establishing, maintaining and enhancing necessitate meeting numerous conditions and whose high quality is sustained only if numerous harmonised forms of influence are exerted. it reflects all circumstances under which it emerges and functions and requires a constant and undivided attention. a state of financial reporting has been marked as a significant supporting factor to economic growth; for that purpose, the world bank created a special programme (rosc) and formed a special institution for monitoring the state of financial reporting in individual countries. all these efforts are aimed at strengthening the quality of financial information. only permanent monitoring and reporting on the state of financial reporting, along with adequate responsive actions on financial statements, contributes to its sustaining and improving. in the absence of these conditions, benefits derived from financial reporting are easily lost. this paper focuses on the factors determining the state of financial reporting of public enterprises in serbia and presents general economic circumstances under which financial reporting is performed; weaknesses of financial reporting; and, lastly, the prospects for its further development. general conditions financial reporting is always considered having in mind the general conditions that determine it. financial reporting is a complex meta-phenomenon in the economy, which incorporates the * e-mail: miroslav.milojevic@rsm.rs 106 economic analysis (2018, vol. 51, no. 3-4, 105-114) conditions that determine it and the state of all protagonists in the reporting chain, who are both producers/presenters and supervisors of those who maintain financial reporting discipline. general conditions of financial reporting encompass all major characteristics of a society in which they are formed as an outcome of all historically acquired circumstances and views pervading the reality of financial reporting. it that sense, it can be argued that circumstances of financial reporting are the reflection of the circumstances existing in a society and its economy. serbia has been undergoing transition towards the market economy for only less than two decades and it still deeply feels the consequences of its recent traumatic past. these less than two decades were preceded by a decade of bloody wars and general negligence. while the world was improving and constantly enhancing its standards, all standards in serbia were destroyed and, as a result, building foundations of market economy started only at the beginning of the first decade of this century. from a historical perspective, this is a very short period, since institutionalisation of a society requires a several-decades long establishing in practice. that period in serbia was marked by a provision of significant aid from the mentors from the west, who have been building their own institutionalised market societies for centuries. needless to say, there are considerable difficulties concerning adoption of a new manner of economic and social life, but also there are difficulties concerning adaptation of the existing models, which are not a product of the serbian experience, but come from the west. serbia started accepting the new orientation and institutionalisation without relying on its own experience and without a predisposition for their acceptance and application. political and economic aims as the framework of financial reporting serbia has set its main aims, which can be defined as catching up with the world and, particularly, integration into the eu. within this orientation, important factors are political and economic frameworks serbia establishes for the purpose of organisation of its society. the political direction of serbia’s course was established at the very beginning of this century, after casting off the socialist method of organisation and severe frustrations caused by dissolution of yugoslavia and a decade-long agony characterised by disorientation and wars in former yugoslavia. immediately after the change of government in 2000, a declarative policy change towards the building of a market economy society took place, and after that, towards an actual institutionalisation and practicing life based on new foundations. the efforts in the new direction were supported by advice and material aid provided by the eu and other countries. the economic direction of building a new system was marked as a free market economy, which involves discarding the old concepts of economy and founding entirely new ones. the economic values were set in a reverse direction in comparison to the previous period: instead of focusing on people, the system was focused on economic contribution; instead of a system of settling things by mutual agreement and negotiations, free-market competition was introduced; instead of collectivism, individualism was instituted; instead of self-management administrative framework, a voluminous market society regulations came into force; economic sustainability gained primacy over the social one. the results of these efforts are building and implementation of a completely new institutional system, one that channels the behaviour of economic protagonists in a completely new way. political and economic frameworks became a sign of everything that was wanted as a new reality. at the same time, they set a new touchstone by which every step in the society and economy is measured. these aims represent a considerable challenge, one that is overcome with great difficulties, since it is necessary to give up deeply entrenched habits and adopt new ones that yet need to be understood, adopted and practised and whose benefits yet need to be recognised. miroslav milojević 107 real economic circumstances a real economic basis considerably determines all occurrences in a society. the assessment of the impact of the economic reality in the previous decade, never before completely presented, indicates the following: the serbian economy is very weak and not even in 2018 did it attain its 1989 state. its recovery is the slowest in the region. in 2017, the gross domestic product (gdp) amounted to eur 31,184 million. in the period between 2006 and 2016, the growth rate peaked in 2007, when it amounted to nearly 5.9%. with the emergence of the world economic crises, the serbian economy began to deteriorate significantly. the highest gdp drop was recorded in 2009 when it amounted to 3.1%, while the negative rate was also recorded in 2012 and 2014 when the downslide amounted to – 1% and -1.8% respectively (10, https://www.nbs.rs/internet/cirilica/80/index.html). gdp per capita is very low, it is clearly seen from the national bank of serbia’s data for the period 2006 – 2007 that it dropped significantly in 2009 and 2010, recovered in 2011, then dropped again twice – in 2012 and 2014. to illustrate the above, in 2006 gdp per capita amounted to eur 4,586, while in 2017 reached the amount of eur 4,998 (10). the causes of such state of things are: firstly, a long hesitance to undergo transition, which started in 2000, after the overthrow of a long-maintained socialist system. during 1990’s, when most countries recorded high growth rates, serbia experienced a colossal drop, since it completely turned its back to progress. the losses suffered as a result of rejecting to accept the necessary reorientation were immense. secondly, the devastating consequences of the nato-imposed war, when the country’s available economic resources were demolished, making it impossible in most cases to restart production. serbia had a quite strong industrial sector, which represented an important factor of economic security. thirdly, the large number of young people left the country during 1990’s, a trend that continued in the following period, resulting in the fact that serbia lost a significant development potential. the trend of young people leaving the country in search for better conditions also continued in the liberalisation period. fourthly, serbia has an aged population. according to the 2011 census, the average age of population is 42.2 years, while 20% of the population is older than 65, which ranks serbia on the list of 10 countries with the oldest population in the world. fifthly, as a non-institutionalised country, serbia suffers additional losses. lack of order that is constantly supressed is deeply rooted, while its protagonists slowly and with difficulties discard the habits that support such state of affairs. sixthly, corruption is deeply rooted and generally affects the society at all levels. this takes its toll in form of significant gdp losses. economic circumstances determine the totality of occurrences in the entire society, above all social consciousness of its political and economic protagonists. undeveloped economy is reflected in undeveloped representations of economic concepts, which as a result has a weak stimulus coming for the sphere of mind. this inadequate social consciousness should be understood in two ways, as a product of circumstances and as a brake that halts the desperately needed faster progress. institutional circumstances during the last decade, a complete institutional re-arrangement has been accomplished. new institutions have been conformed to the eu standards, created according to the eu models and introduced with a strong assistance by the world bank and the eu. all institutional circumstances have an impact on the quality of financial reporting in a society. given below are the main characteristics of institutionalisation in the light of corporate financial reporting with an emphasis on public enterprises. 108 economic analysis (2018, vol. 51, no. 3-4, 105-114) the starting point for regulations in corporate financial reporting is the legal framework. all economic regulations affect public enterprises, some fundamentally, some marginally, some of them generally, some specifically. listed below are cardinal laws and, in outlines, their relevance for corporate financial reporting of public enterprises. the primary law in this sense is the law on economic entities, which stipulates a group of the most important determinants for constitution and functioning of economic entities. this law was last amended in 2018. those amendments introduced many innovations; however, financial reporting was not subject to any significant changes. the amended provisions of the law demonstrated the adherence of serbia to further changes, testifying to a genuine convergence with the eu framework. the 2016 law on public enterprises introduced a number of novelties that affect constitution and management of public enterprises. among many novelties, two are of central importance. the first one was introduced in the management sector. it brought about corporatisation and institutionalisation of internal audit and the audit committee. the other one is an introduction of significant reporting novelties. both groups of measures imply a considerable improvement of the quality of reporting content, as well as of the institutions functioning in the framework of public enterprises. the real changes were effected in the field of financial reporting, implemented by the ministry of economy and encompassing a number of new forms. the accounting law and the audit law have the most immediate impact on financial reporting. introduced in 2013, they are based on no longer effective eu acts. these acts treat public enterprises as any other economic entity, which they really are. public enterprises must conform to the above regulations, while the provisions of the law on public enterprises represent special forms applicable only to public enterprises. public enterprises are categorised as entities of public interest, therefore the provisions of the audit law stipulate that all public enterprises, regardless of their size, must engage an auditor for the purpose of issuing an opinion on financial information presented in their financial statements. public enterprises in serbia are legally obliged to submit annual financial statements, along with statistical financial reports, to the business registers agency, while special long-term and short-term plans should be submitted to the ministry of economy. the state of public enterprises and the quality of financial reporting the real state of affairs is shaped by both legal means and practical actions. the aims direct the reality, and the reality has its capacity to adopt what is imposed by those aims, but also to resist it, as a result of inconsonance between interested parties and officially defined interests. the following pages interpret the state of reality in the light of several most important characteristics. inadequate structural organisation structural organisation of public enterprises is predetermined by legal solutions. these solutions are adopted as a part of general efforts to conduct an organisation of public enterprises introduced an actual corporate structure, that is, a truly modern solution. that solution represents a formal compliance with the law, while essentially nothing incessant reform, in which it is recognised that the structural organisation of public enterprises must be continuously improved and solutions that are the best prerequisites for a desired efficiency must be found. although public enterprises are mostly associated with massive property, infrastructure, they are primarily intangible creation in which management structure plays an important role. new solutions for the structural have changed. those enterprises remained a field in which the will of a ruling party is demonstrated. their envoys are those who actually govern, while evading all the requirements of the law and failing to meet expectations of the public. miroslav milojević 109 corporatisation of public enterprises means introduction of a new dimension which is capable of producing results only if adequately treated. it means a group of measures by which such values are set, directions given, conditions organised that enable acting towards the chosen directions and aims and, lastly, by which actions towards attaining goals are controlled. corporate governance is above management; hence, a serious problem occurs related to interference of the former into the activities of the latter. in normal circumstances, this is not tolerable and it produces not only derogation of the management motivation and limits its operating scopes, but also represents an attack on responsible behaviour and efficiency of work of public enterprises. corporate governance is an agent of public interest and it is under ever-increasing public scrutiny, which shall certainly not subside (2,90). all issues related to insufficiently profiled structure of public enterprises are reflected in financial reporting. corporate governance and corporatisation are directly related. more powerful corporate governance bodies are necessary prerequisite for strengthening the quality of public enterprise financial reporting. firstly, corporate bodies are based on transparency, which is attained by transparent reporting. a more agile role of corporate governance would mean more pressure on management that its information becomes more transparent. in the absence of the above, a lower level of transparency occurs as an important characteristic of financial reports. secondly, in large majority of cases the internal audit function is not established in those enterprises. internal audit is a key element in that respect. without this function, there is no supervision over internal control systems of public enterprises and, consequently, no supervision of financial reporting in its entirety. a lower level of control means a higher possibility of existence of deficiencies in financial statements, that is, lower level of reliability of financial information. insufficient market orientation public enterprises are associated with public life, providing conditions for life and sustainability and development of quality of life. they are defined as enterprises, as market entities that are subject to general economic principles of doing business, on the one hand, but also as factors of the quality of life in a society, on the other. a dual nature of their aims leaves space for alternative placement of emphasis on their being a market and general social instrument. the former function becomes dominant when the ownership is undergoing privatisation and the latter when the ownership belongs to the state. serbian public enterprises are exposed to pressure to become organised in form of an economic entity, believing that it will bring betterment. the powers of mistrust towards the private ownership base their opinion on the fact that private ownership will marginalise public interest; the powers in favour of privatisation derive their arguments from the insufficient efficiency and low quality of public enterprises held by the state. it is an undeniable fact that serbian public enterprises operate with abnormally low prices and that in present conditions citizens with low purchasing power are not capable of bearing higher price of services. in any case, the market aspect here symbolises a request to organise production of public sector goods and services in a more rational manner, the request to rationalise all production factors, to cut high payroll costs which are the result of unproductive hiring, and to apply optimisation rules on all assets with respect to their aims and tasks. in addition, it is also an undeniable fact that management in public enterprises is not making a sufficient effort to increase productivity and general efficiency, because, among other things, conditions that would lead them into that direction, control them and stimulate economically, have not been met yet. in any case, the law on public enterprises includes a provision on their aims which states that public enterprises operate, among other things, in order to generate profit. in the countries in the region, public enterprises have a status of an economic entity in its true sense, as it is the case with 110 economic analysis (2018, vol. 51, no. 3-4, 105-114) any other economic entity. it is certain that in this respect we must harmonise ourselves with the requirements of eu regulations. financial reporting suffers consequences from an insufficient market orientation of public enterprises. the elements of negative impact on the quality of financial reporting are not only the mere fact that these enterprises have not enhanced the market criteria of evaluation of all items in financial statements, but also the fact that they are not sufficiently supervised by those who define the success criteria. the authorities that supervise financial reporting (local selfgovernment units, the ministry of economy and the ministry of finance) do not have capacities (they do not have established clear control instruments, while in cases where such instruments exist relevant procedures are not applied; they do not have a well-qualified staff or resources) to perform its expected and legally stipulated function; hence, they become direct causes of lowquality financial and non-financial reporting of public enterprises. insufficient efficiency public enterprises are driven by capital. capital employed in public sector is a part of the total capital of a society and there is no reason why (with specific restrictions) it should not function based on principle of maximising yield on capital. yield on capital in the economy and yield on capital in public enterprises are considered important elements of any comparison made between public and commercial sector. and the records state that public sector attains far lower results in comparison to those achieved by the commercial sector. the causes of inefficiency are looked for in the input. in this area, many facts can be observed: inappropriately high number of employees in comparison to what is actually required; inadequate structure with respect to long-term and short-term assets, excessive equipment, irrational use of materials and many others. under the condition of controlled service prices, cost-effectiveness is attained by means of rationalisation of input. the perception of the public is that public enterprises are not trying to keep the costs down. studies support this opinion. inadequate efficiency produces unsatisfactory results and their joint effect impairs the integrity of financial statements. low efficiency is a phenomenon manifested in many respects and accompanied by low salaries of public enterprise employees and general dissatisfaction. an inefficient company will hardly be able to attract highly-qualified professionals, who represent a necessary precondition for quality financial reporting. poor financial standing poor financial standing most clearly manifests itself in insolvency. it is a well-known fact that public enterprises are heavily indebted, borrowed money both excessively and without any criteria, and, as a result of burden of debts and inability to repay them, entered a deeper and deeper crisis. the situation is the gravest in large state enterprises (srbija gas, rtb bor, železnice srbije), which place a heavy burden to a serbian budget. such a difficult burden that the world bank placed it under its scrutiny, analysed and determined the ways how to organise and remove them as generators of state indebtedness, but also as driving forces of insolvency chain, as a result of their own inability to service debts in due time. a similar situation, although a far less severe, exists in many public utility enterprises. there is a complex of causes of insolvency, starting from structural factors to daily behaviour concerning disposal of liquid assets. sometimes it happens that in the beginning public enterprises do not have sufficient liquid assets, that is, not enough current assets. it is an initial handicapping factor. in other cases, inobservance of financing rules (in particular, financing investments from current assets) devastates operating financial ability of an enterprise. whatever miroslav milojević 111 the cause is, it is an undeniable fact that public enterprises in serbia suffer from a chronic lack of current assets, that is, they are chronically insolvent. poor financial standing in itself represents a threat to integrity of financial reporting, which is clearly stated in several financial reporting and audit standards. those threats have such longreaching implications that endanger the going concern assumption. other consequences are that such enterprises, for the purpose of improving unfavourable picture, are brought under pressure to apply fraudulent accounting practices, which means falsifying financial statements. management, whose reputation depends on financial constitution and financial success of public enterprises they run, is under pressure to search for and find all possible ways to avoid presentation of a real situation. furthermore, this pressure represents a threat to accounting professionals to find illegal solutions and in such manner deviate from the standards of presentation of financial information. another fact related to such state is that well-qualified accounting professionals leave public enterprises, as a result of both jeopardizing their professional integrity and poor working conditions. poor reputation all problems related to economic weaknesses of public enterprises create a precondition for their poor reputation. enterprises that do not enjoy good reputation in public can hardly attract management and professionals with high aspirations. the rule is: the higher the reputation is, the higher the power to attract is. insufficient human resource attracting power has a reversal effect on weakening the position in economic organisation and efficiency. poor reputation is a meta-phenomenon, based on all tangible and intangible circumstances of functioning of public enterprises. poor reputation in the mind of people is immediately linked with dubious financial statements. poor reputation is a synonym for general weaknesses, hence the weakness of accounting and finance function. if this function is deficient, it is immediately assumed that its products – financial statements – are poor. poorly-coordinated financial reporting institutions there is a number of factors that are above public enterprises, whose activities, if complied with regulations, would significantly contribute to accomplishing functions of public enterprises and, consequently, financial reporting. those factors are the following: the state audit institution, the ministry of economy, the ministry of finance, the property management directorate, investigating bodies and legal authorities. it is a generally-known fact that they suffer from significant weakness, which leaves an ample space for their improvement. the exception to the above is the state audit institution, which acts according to standards, undergoes constant coordination with european institutions and produces its findings, which are worth only to the extent they are applied. for financial statements of public enterprises, the condition of organisation of publicly-owned assets is important, which means functioning of all factors responsible for their management and control. the state audit institution, in its document ‘disposal of immovable property owned by the republic of serbia’, stated on the first page of its report: ‘the republic of serbia does not have accurate data on the number and value of its immovable property, as a result of lack of action by the competent authorities and users and shortcomings of regulations. the republic of serbia’s property directorate has not established uniform records of immovable property owned by the republic of serbia…’ (5.3). the report did not produce a strong impact in reality, as no one acted according to its findings and recommendations. to describe conditions in all institutions mentioned in this report is futile. not only had the state audit institution drawn attention to these institutions. a glance at the 2018 european commission report for serbia (4) can give clear signals with respect to who is resisting the calls for improvement. 112 economic analysis (2018, vol. 51, no. 3-4, 105-114) in public sector an action is taken only if willingness from the top echelons exists (and usually it does not) and in case of prosecution of those who do not observe the law (which hardly ever happens). the consequences of non-existence of the records on capital assets, such is immovable property, are immense. absence of established records and adequate valuation represent a heavy blow to the integrity of financial statements of owners and users of publicly owned property. impending changes ‘most politics have market implications. as money is getting short, the manoeuvre space for holders of political decisions is getting smaller’ claims bovaird and loeffler and continue saying that with the crisis ‘imperatives for reforms in public sector become more sluggish, while the fact remains that reforms of public services must be governed in a cost-effective and efficient manner (1.16). as a country that strives towards integration in the eu system, serbia will be under relentless pressure to reform public sector and public enterprises in particular. this is also emphasised in all documents of the world bank, international monetary fund and the eu which addressed these issues in serbia. when considering what is to be done in order to improve the quality of financial reporting, the answer leads to two paths: the first is strengthening the economic position of public enterprises, while the other concerns measures aimed at strengthening the conditions for quality financial reporting. the former is the primary field of action, whereas the latter is to a large extent conditioned by the results in the primary field of action. let us call the first group of measures strengthening the capacity of public enterprises, while the second can be named strengthening financial reporting. strengthening the capacities of public enterprises the key issue is what the structural organisation of public enterprises is, that is, what are the aims and strategies of their use. structural organisation is based on strategies and aims, stipulated by laws that regulate them. these laws are the assumption on which these enterprises are based. in many respects, legal requirements are met and public enterprises are converged with eu requirements. the issues related to the implementation of legal provisions, addressed in this paper, remain to be resolved. strengthening the capacities of public enterprises through reforms reforms and reforms. that means constant introduction of novelties into structural organisation and behaviour of public enterprises. the aim of all these activities is to improve their performances. remedies for inefficiency of public enterprises are extensively discussed and solutions are searched for. as a possible solution, privatisation is frequently mentioned. to privatise public enterprises or not? it is a question that has been lingering for decades among public, expert circles and in governments’ agendas. impression is created that they are the only two solutions available, whereas this is not the case. d. detter and s. foelster in their book, which was a planetary bestseller last year, clearly claims that the above discussions fail to mention and oversee – the right option. it concerns ‘the quality of public property management’ (1.12) as a strangely overlooked factor, a factor with a decisive role on whether the use of public property will produce the effects that it is able to produce. only effectively structured management of public property can reduce to a minimum impact of corruption, dysfunctionality and miserable results of its use. strengthening the capacities is related to all conditions which can become, by means of better management, a factor of improving the quality of services and more efficient and effective use of resources which it has at disposal. the 2016 european commission report for serbia emphasises the unfinished process of reforming public enterprises (6.41), but also high susceptibility of privatisation processes to corruption. serbian public enterprises are awaiting many reforms, miroslav milojević 113 many of which were previously marked but not implemented. the list of impending reforms includes: • consolidation of publicly-owned property consolidation of publicly-owned property has not been finished. there are many deficiencies in this respect and many losses which are not presented to public (7.21). despite substantial donations and institutionalisation, there are a number of deficiencies and problems observed in the special report prepared after performed assessments. • strengthening the market nature of public enterprises. this is a problem that still remains and resolving of which is constantly insisted on. the model for its solution can be found in the countries in the region. • introduction of corporate governance. in this area, much has been done and much has been defined by the law. what creates the problem is the fact that legislation is only formally adopted, while in fact everything remained as it was. much additional initiative and the more active role of the competent minister are required, as well as by-law regulation and supervision. • strengthening the founder’s function. the founders of public enterprises are mainly active when they insist on receiving a half of a profit payment. the founder does not possess a capacity to run public enterprises. it has no built-up bodies, no management and control instruments, it is not structured for that function. pressures aimed at bringing about a reform are expected in this area. reforms are not focused only on internal changes in public enterprises, but also on all external bodies which are a significant factor of guiding, controlling and restraint. • professionalization of management. a problem of management professionalization is still of current relevance, and concerns the issue of the status of political parties and corporate governance. • depoliticization has not been accomplished. public enterprises are in the hands of political parties and there is no decisive power in sight which would be able to break the bond between the political parties and public enterprises. as long as there are no new mechanisms for separation between political parties and public enterprises, there will be many problems. management must have a status that is dependent on economic results and not on loyalty to political parties. • activation of potential of public-private partnership. no legal conditions have been created for this activation; there is no clear and transparent way for initiating this partnership, potential protagonists are insecure; therefore no improvement in this area. strengthening of the financial reporting factor the 2018 european commission report for serbia emphasises the non-conformity between the serbian financial reporting system and eu legislation and the need for a further compliance with the requirements of aquis communaitaire (6.58). the rosc report examines in detail (3.122-130) circumstances of financial reporting in serbia and outlines the directions for further reforming of financial reporting (3.52). according to the national strategy of corporate reporting and audit 2011-2018 (9), the year 2018 has been marked as a year in which domestic financial reporting legislation is to be conformed with the eu legislation. it is the end of the year, the conformation process is in progress, but the results are still lacking. the following changes in the field of strengthening financial reporting are to be effected: • compliance with the eu legislation. new accounting and audit eu directives adopted in 2013 were not introduced into domestic legislation, this issue is on the agenda and legal 114 economic analysis (2018, vol. 51, no. 3-4, 105-114) compliance is to be performed, which will be followed by institutional changes and coordination of practical protagonists performed on new foundations. • strengthening the reporting capacities of public enterprises. poor effectiveness and low salaries and incentives for accounting professionals cannot be an attracting power for well-qualified accounting staff. financially strong enterprises can also be attractive for accountants. • stricter supervision of financial reporting. poor supervision over financial reporting of public enterprises. there is no supervising body which would focus attention on the quality of financial information of public enterprises; hence, a poor discipline of financial reporting. • stricter inspection of financial statements. financial statements of public enterprises have many irregularities, no one is addressing these issues; irregularities are not found out and the perpetrators are not indicated. • stricter prosecution of those who present irregular financial statements. legal authorities are not involved in this field, they have neither capacities nor willingness to address these issues; therefore, far more agility is expected in future from legal authorities, which requires creating proper conditions. • stronger awareness of importance of financial statements. all previously emphasised circumstances related to public enterprise financial reporting indicate that this field is much neglected, and in such conditions protagonists have neither the awareness nor understanding of importance of financial information. the world bank noticed this fact and formed a special programme for raising awareness on financial reporting. however, raising awareness depends on all the above-mentioned factors, and their activation is a significant driving force leading into this direction. to sum up, the quality of public enterprises’ financial statements is a very complex issue, which means that it is necessary to work at all levels and in a coordinated manner. only when completion of measures and their coordination are attained, a progress in this field can be expected. references bovaird, t., loefler, e. (2009). public management and governance, routledge, london busarac, r. (2018). nova rešenja u zakonu o privrednim društvima i korporativno upravljanje u javnim preduzećima, revizor vol 21 no 83/2018 cfrr, report on the observance of standards and codes on accounting and auditing, republic of serbia 2015 detter, d., s. foelster. (2015). the public wealth of nations: how management of public assets can boost or bust economic growth, palgrave macmillan, london, 2015 dri, godišnji izveštaj o radu državne revizorske institucije (http://www.dri.rs/документи/годишњи-извештаји-о-раду.43.html) europian commision, serbia 2018 report https://ec.europa.eu/neighbourhoodenlargement/sites/near/files/20180417-serbia-report.pdf milojević, m. (2018). finansijsko izveštajne promene u srbiji 2018, revizor, vol 21 no 83/2018 milojević, m. (2017). sređivanje imovine u javnoj svojini, revizor, vol 20 no 78/2017 nacionalna strategija za unapređenje korporativnog finansijskog izveštavanja i revizije 2011 – 2010, ministarstvo finansija srbije statistika nbs / https://www.nbs.rs/internet/cirilica/80/index.html article history: received: november 25, 2018 accepted: december 19, 2018 doi: 10.28934/ea.22.55.1.pp90-104 original scientific paper forecast of belex15 and belexline movement using arima model aleksandra živković121f* 1 university of novi sad, faculty of economics, department for finance and banking, subotica, republic of serbia abstract financial markets are known to be volatile and often unpredictable. movement of stock indices and stock prices over time can be labelled with big oscillations during time, so financial institutions and other investors are constantly working on forecasting these movements, in order to adjust their business decisions and increase their profit. aim of this research is to determine whether the arima model, which is often used for short-term forecast, is suitable for forecasting of movement of belgrade stock exchange indices. subject of this research is forecast of belex15 and belexline indices based on historical daily data from 5th january 2009 until 31st march 2022. arima model was used to forecast index values for the following 11 trading days from 1st april until 15th april 2022. methodology of this research consists of presenting and analysing empirical data of belex15 and belexline movements, choosing suitable arima models for forecast and forecasting index values, which were then compared with real index values. obtained results point to high accuracy of forecasted values and lead to the conclusion that arima model is corresponding econometric method for short-term forecast of belgrade stock exchange indices. key words: belex15, belexline, belgrade stock exchange, forecast, arima jel classification: g17 introduction financial markets are known for great uncertainty and volatility of stock indices and stock prices. financial institutions and other participants in financial markets, which act as investors, are constantly trying to predict movements on financial markets, as well as values of stock indices and stock prices, in order to adapt their decisions which would lead to profit. even though it is difficult to predict movement on financial markets because of their volatility, certain econometrics methods are used for forecasting, among which the arima model stands out for short-term forecasts. so far, the arima model was often used for forecasting in economics practice, but also for testing accuracy of this model when forecasting certain stock indices and stock prices movements. however, this type of empirical research has not been empirically researched in detail in serbia and on belgrade stock exchange indices (bse). subject of this research are stock indices of belgrade stock exchange – belex15 and belexline, which are analysed from 5th january 2009 until 31st march 2022 (in total number of observations is 3,336 trading days per index). empirical data has been taken from belgrade stock exchange. aim of this research is to determine whether arima model is suitable for short-term forecasting of movement of stock indices belex15 and belexline. arima model was used to * phd student, e-mail: zivkovicc.aleksandra@gmail.com aleksandra živković 91 forecast values of belex15 and belexline for 11 trading days – from 1st april 2022 until 15th april 2022. after these values have been forecasted, they were compared with real values to determine if it is possible to make an accurate forecast of belex15 and belexline using the arima model, which is based on historical data. methodology of this research contains of presenting empirical data of belex15 and belexline, basic descriptive statistics, checking of stationarity, choosing potential arima models and selecting the corresponding one, based on which forecast of indices values has been conducted and forecasted values were compared to real values. in this paper two hypotheses are defined: hypothesis h1: arima model is suitable for accurate forecast of movement of stock index belex15 in period 1st april 2022 15th april 2022. hypothesis h2: arima model is suitable for accurate forecast of movement of stock index belexline in period 1st april 2022 15th april 2022. this paper is divided into 6 parts: the first part is introduction, where subject, methodology and aim of this research are expressed and hypotheses are defined. the second part is literature review, which contains so far empirical research which has used the arima model to forecast stock prices and indices movements, in both serbian capital market and foreign markets. third part is the methodology of this research, which presents the theoretical background of the arima model, which was used as guideline for the arima model analysis and forecast. in the fourth part is presented empirical data of belex15 and belexline values, which is followed by selection of corresponding arima models for both indices, as well as forecast of belex15 and belexline indices respectively. in the fifth part of this paper are presented results of forecasts which are then compared to real values, in order to determine if it is accurate to use the arima model for precise forecast of movement of analysed indices. conclusion is the last part of this paper, where findings are expressed and recommendation for future research is given. literature review financial institutions and individuals participating in financial markets are encouraged to continuously work on and promote econometrics methods for forecasting, due to their need to make decisions about investing, as well as to plan daily and future steps on financial markets. due to the nature of financial markets, forecasting stock indices movement or stock prices is a difficult task. among techniques that stand out for forecasting is the arima model (autoregressive integrated moving average), which is known for its efficient forecast of financial time series, especially for short-term forecasts. in 1970 box and jenkins introduced the arima model, which consists of 3 steps – identification, estimation and diagnosis of the arima model (adebiyi, adewumi & ayo, 2014). among so far research, which aimed to forecast values of stock indices or stock prices movements, arima model was often used, especially for short-term forecasts. mondal, shit & goswami (2014) analysed the efficiency of the arima model to predict movement of values of 56 companies from 7 sectors from national stock exchange india (nse india). used historical data was from april 2012 until february 2014 and obtained results point to over 85% of correctly predicted values for all sectors. khan & alghulaiakh (2020) used the arima model to predict stock values of netflix, using empirical data for 5 years (from 7th april 2015 until 7th april 2020). rotela, salomon & de oliveira pamplona (2014) confirmed the efficiency of arima model for short-term forecast of bovespa stock index (index of sao paulo stock exchange), by using monthly historical data of closing price from january 2000 until december 2012. wadi, almasarweh & alsaraireh (2018) conducted a short-term forecast of closing prices of index amman stock exchange (ase) using daily historical data from january 2010 until january 2018 and they empirically confirmed efficiency of arima model for short-term forecast. li, yang & li (2017) used shanghai composite index monthly closing price from january 2005 until october 2016 to 92 economic analysis (2022, vol. 55, no. 1, 90-104) forecast the index movement for the period july 2016 until october 2016. average error of predicted values is 2,4% which confirmed efficiency of arima model for short-term forecast. meher, hawaldar, spulbar & birau (2021) used arima model to predict stock prices of selected pharmaceutical companies in india (quoted on nifty100). analysis contained historical data from 1st january 2017 until 31st december 2019 and it has confirmed that there are no significant deviations between predicted and real values. arima model has been used to predict future values of stock indices in our region and domestic indices as well. among authors which have researched forecast of index values of belgrade stock exchange, stanković, marković & radović (2015) stand out, which have conducted a research in order to determine precision of forecast of belex15 index values and its most important components (at the time of writing their paper, the most important components were: “alfa plam” a.d. vranje, “energoprojekt holding” a.d. beograd, “metalac” a.d. gornji milanovac, “sojaprotein” a.d. bečej, aik banka a.d. niš, komercijalna banka a.d. beograd). method used for the forecast was the least square support vector machine – ls-svms). obtained results point to higher precision in the forecast of values of belex15 index components than the forecast of the index itself. marković et al. (2014) have confirmed accuracy of belex15 index prediction using method ls-svm – subject of the analysis has been data of belex15 movement from 4th april 2005 until 30th march 2013. petrović (2020) used arima model to predict belex15 values for coming 10 trading days and it has been empirically confirmed that arima model was corresponding model for short-term forecast of index values. used historical data contained from index opening price from 10th january 2014 until 21st december 2018. jakšić, milanović & stojković (2020) conducted a shortterm forecast of belex15 and belexline movement (used methods were winter’s additive and winter’s multiplicative method). analysis was based on monthly data from january 2009 until february 2019. methodology in the arima model, future values of variables are predicted based on the linear combination of historical values and residuals (pai & lin, 2005). arima model is defined as arima (p,d,q), where p represents autoregressive parameter of analysed data set (number of lags of ar model), d refers to integrated parts of data set, and q represents number of moving averages (number of lags of ma model) (mondal, shit & goswami, 2014). arima model is an upgrade of arma model (autoregressive moving average), which expresses the conditional mean of yt as a function of previous values yt-1, yt-2...yt-p and previous residuals εt-1, εt-2...εt-p. number of previous values (observations) on which yt depends (p) is ar degree, whereas number of previous residuals (q) is ma degree. to determine the range of ar and ma degree, significant deviations are examined and compared on the correlogram acf and pacf (meher, hawaldar, spulbar & birau, 2021). arma (p, q) model can be presented as: 𝑌𝑌𝑡𝑡 = ∅1𝑌𝑌𝑡𝑡−1 +… + ∅𝑝𝑝𝑌𝑌𝑡𝑡−𝑝𝑝 + 𝜀𝜀𝑡𝑡 − 𝜃𝜃1𝜖𝜖𝑡𝑡−1 − ⋯ − 𝜃𝜃𝑞𝑞𝜖𝜖𝑡𝑡−𝑞𝑞 (1) where yt is observed variable, εt is random error in time t, ∅i i 𝜃𝜃i are ar and ma coefficients, p and q are number of lags in ar and ma model. arima model has an additional letter “i” in acronym of this model, which represents integrated. arma (p,q) model which is differentiated d times is arima (p, d, q) model (mustapa, hayati & mohd, 2019). to determine an appropriate model for forecasting, the first step is to define the degree of differentiation d, which is required in order to make the data stationary. method which is frequently used for this is augmented dickey-fuller test (adf test). after parameter d is defined, parameters p (autoregressive parameters defined by partial autocorrelation function (pacf)) aleksandra živković 93 and q (moving-average parameters defined by autocorrelation function (acf)) need to be determined (jarrett & kyper, 2011). acf provides information about the potential number of lags of ma model, whereas pacf provides information about the potential number of lags of ar model (prorok & paunović, 2015). in order to begin with defining the arima model, it is necessary to define is analysed data stationary – a graphic overview of the variable movement can point to this conclusion. stationary data implies that mean and variance are constant over time. beside from the graphic overview, autocorrelation function, acf plot and augmented dickey-fuller test are used to check stationarity. acf plots autocorrelation of time series among lags, which point to differences between one observation and observation which precedes. if data is not stationary, it should be differentiated and in most of the cases it is enough to differentiate the data set only once (d=1) (mustapa, hayati & mohd, 2019). belex15 and belexline – empirical data and forecast of index values by using arima model serbian stock market is considered to be new and not very developed. period after 2000 was defined with numerous privatizations of public companies, and this has led to stimulation of trading on the secondary market. until the financial crisis in 2008, the number of listed companies on market and trading volume was increasing, but after the financial crisis outburst, market liquidity has significantly decreased (petronijević, 2018). capital market in serbia is still underdeveloped, with small trading volume and turnover. it is not fully regulated and transparent and the number of domestic and foreign investors is low (kršikapa-rašajski & rankov, 2016). small number of securities and government bonds are traded, transactions are expensive and slow, market capitalization is low – these are all labels of serbian stock market today (prorok & radović, 2014). belgrade stock exchange indices belex15 and belexline are subject of this research. belex15 is a leading index of bse, which contains the most liquid serbian shares and it is calculated in real time. belexline is a general, benchmark index, which is calculated at the end of a trading day. both indices are free-float market capitalization weighted indices, which are not adjusted for paid dividends and are not protected from dilution effect resulting from dividends payout. belex15 is composed of shares traded on the regulated market, which have satisfied criteria for inclusion into the index basket. each component is limited to a maximum of 20% of the total market capitalization of the index. purpose of the belex15 index is to improve the investment process, by measuring performance and stock prices of most liquid serbian shares. it is calculated and published every working day in real time. minimum number of index components is 7, whereas maximum is 15 and this decision is made by the index committee. belexline is weighted only by free-float market capitalization. it consists of shares traded on the belex markets, which have satisfied criteria for inclusion in the index basket. components limitation is up to 10% of index capitalization. its purpose is to measure and keep track of price changes of shares which are traded on the bse (which had fulfilled criteria for index basket) and to give insight into serbian market movements. the index committee decides on composition of the index basket, which can have minimum 70 components and upper limit is not defined, since the purpose is to give good representation of total market movements (source: belgrade stock exchange; https://www.belex.rs/proizvodi_i_usluge/indeksi_opste). values of belex15 and belexline have been taken from belgrade stock exchange and they are analysed on a daily basis from 5th january 2009 until 31st march 2022. total number of observations is 3,336 for each index. in figure 1 are presented movements of belex15 and belexline during the analysed period. https://www.belex.rs/proizvodi_i_usluge/indeksi_opste 94 economic analysis (2022, vol. 55, no. 1, 90-104) figure 1. movement of belex15 (left figure) and belexline (right figure) from 5th january 2009 until 31st march 2022 source: belgrade stock exchange graphic overviews point to high volatility of both indices, but also to uniform trend of movement: significant decrease of values of both indices at the beginning of 2009 after the financial crisis outbreak, which was followed by increase of index values until the end of the same year. until 2011 both indices were fluctuating within certain frameworks (for belex15 value was fluctuating between 600 and 800 stock exchange points, whereas for belexline it was fluctuating between 1,200 and 1,600 points). until the beginning of 2013, values of both indices were significantly decreasing, after which stable growth followed, until the coronavirus pandemic outbreak, when at the beginning of 2020 values of both indices suddenly decreased. after the financial market stabilized, not only in serbia, but in the whole world, values of stock indices started increasing again. in table 1 are presented basic descriptive statistics for indices belex15 and belexline. this table presents data about the mean, standard deviation, minimum and maximum for both indices. total number of observations is 3,336 for both indices, which points to balanced data. table 1. basic descriptive statistics variable obs mean std. dev. min max belex15 3,336 659.125 103.340 354.39 865.06 belexline 3,336 1,359.479 239.507 841.99 1,789.15 source: author’s calculation first bse index for which forecast has been performed is belex15 index. precondition for using arima model for forecasting is stationarity of analysed data. if data is not stationary, it must be differentiated and afterwards checked does differentiated data satisfy the criteria of stationarity. graphic overview of index belex15 historical movement (figure 1 – left figure) points to non-stationary data because of significant oscillations. in figure 2 is presented differentiated data for belex15 which is stationary. aleksandra živković 95 figure 2. differentiated belex15 data source: author’s calculation stationarity of differentiated data can be confirmed with dickey-fuller test and these results are presented in table 2. table 2. dickey-fuller test – differentiated data of belex15 dickey-fuller test for unit root number of obs = 3,334 z (t) has t-distribution test statistic 1% critical value 5% critical value 10% critical value z (t) -48. 847 -2.327 -1.645 -1.282 p-value for z(t) = 0.0000 d2.belex15 coef. std. err. t p>|t| [95% conf. interval] belex15 ld. -.834389 .0170816 -48.85 0.000 -.8678806 -.8008975 _cons .0756504 .1012637 0.75 0.455 -.1228949 .2741957 source: author’s calculation in order to determine potential arima models, it is necessary to define values of p,d,q. value of d is 1, since data is differentiated only once, while for defining values of p and q partial autocorrelation function (pac) and autocorrelation function (ac) have been performed respectively. in figure 3 are presented models for autocorrelation and partial autocorrelation for differentiated data in order to define potential p and q values for the arima model. 96 economic analysis (2022, vol. 55, no. 1, 90-104) figure 3. autocorrelation (left figure) and partial autocorrelation (right figure) of differentiated data for belex15 source: author’s calculation by using the autocorrelation function, in the graph overview the following lags stand out: p=1,2,4,8, whereas for partial autocorrelation these lags are q=1,2,4,8. by combining potential values of p and q, following arima models have been tested to determine the most appropriate one: (1,1,1), (1,1,2), (1,1,4), (1,1,8), (2,1,1), (2,1,2), (2,1,4), (2,1,8), (4,1,1), (4,1,2), (4,1,4), (4,1,8), (8,1,1), (8,1,2), (8,1,4), (8,1,8). in table 3 is presented data about the number of p-values which are statistically significant (p<0.05), sigma sq value, log likelihood, aic and bic. model arima (8,1,8) is not presented, since statistical processing indicates that results of this model cannot be defined. table 3. analysed arima models for belex15 arima model p-value sigma loglikelihood aic bic arima (1,1,1) 1/2 5.846 -10,621.56 21,249.12 21,267.45 arima (1,1,2) 3/3 5.836 -10,616.11 21,238.22 21,256.55 arima (1,1,4) 2/5 5.839 -10,618.13 21,246.26 21,276.82 arima (1,1,8) 1/9 5.814 -10,603.40 21,226.79 21,287.91 arima (2,1,1) 2/3 5.840 -10,618.17 21,244.34 21,268.79 arima (2,1,2) 2/4 5.835 -10,615.21 21,240.42 21,270.98 arima (2,1,4) 1/6 5.818 -10,605.64 21,223.29 21,259.96 arima (2,1,8) 2/10 5.790 -10,589.65 21,201.30 21,268.53 arima (4,1,1) 3/5 5.818 -10,605.63 21,223.27 21,259.94 arima (4,1,2) 2/6 5.818 -10,605.62 21,223.25 21,259.92 arima (4,1,4) 8/8 5.811 -10,601.58 21,219.15 21,268.05 arima (4,1,8) 3/12 3.773 -10,597.31 21,218.63 21,291.97 arima (8,1,1) 4/9 5.797 -10,593.70 21,207.40 21,268.52 arima (8,1,2) 3/10 5.797 -10,593.46 21,206.91 21,268.03 arima (8,1,4) 5/12 5.785 -10,586.68 21,199.37 21,278.82 source: author’s calculation following criteria has been used to define the most appropriate arima model: 1. significance of arma parameters – choosing the model which has the most parameters that are statistically significant (p<0.05) 2. sigma sq – measure of volatility, choosing the model that has the lowest indicator 3. log likelihood – choosing the model which has the highest indicator aleksandra živković 97 4. aic – choosing the model with lowest indicator 5. bic – choosing the model with lowest indicator regarding the first criteria (significance of arma parameters) – models arima (1,1,2) and arima (4,1,4) are most appropriate, since for both models all arma parameters are statistically significant: 3/3 and 8/8 respectively. sigma sq is lowest within arima (4,1,8), loglikelihood is highest within arima (8,1,4), aic is lowest within arima (8,1,4) and bic is lowest within arima (1,1,2). this leads to the conclusion that both arima (1,1,2) and arima (8,1,4) have 2/5 fulfilled criteria. neither of these two models is unequivocally chosen, since only 2/5 criteria are met, but since model arima (8,1,4) has only 5/12 parameters which are statistically significant, chosen arima model for forecast is arima (1,1,2). in table 4 are presented its results, whereas in table 5 are presented results of aic and bic tests. table 4. arima (1,1,2) – corresponding model for belex15 sample: 09jan2009-31mar2022 number of obs = 3,334 wald chi2 (3) = 56,916.60 log likelihood = -10,616.11 prob > chi2 = 0.000 d2.belex15 coef. opg std. err. z p > |z| [95% conf. interval] arma .595 .038 15.54 0.000 .520 .671 ar l1. ma -1.452 .047 -31.07 0.000 -1.544 -1.361 l1. l2. .452 .045 10.02 0.000 .364 .541 /sigma 5.836 source: author’s calculation table 5. akaike & bayesian information criteria (aic & bic) for arima (1,1,2) – belex15 model obs 11(null) 11 (model) df aic bic 3,334 -10,616.11 3 21,238.22 21,256.55 source: author’s calculation after the appropriate arima model has been chosen, a forecast of movement of belex15 has been conducted for the coming 11 trading days (until 15th april 2022.). in table 6 are presented results of forecast from 1st april 2022 until 15th april 2022, as well as the real index value during this period (data of real values of belex15 has been taken from belgrade stock exchange). table 6. forecasted and real values of belex15 date forecasted value real value 01.04.2022. 844.468 836.00 04.04.2022. 844.878 835.78 05.04.2022. 845.159 834.80 06.04.2022. 845.361 837.87 07.04.2022. 845.518 843.55 08.04.2022. 845.647 847.95 11.04.2022. 845.759 851.15 12.04.2022. 845.862 857.23 13.04.2022. 845.959 854.22 14.04.2022. 846.052 853.27 15.04.2022. 846.144 855.73 source: author’s calculation 98 economic analysis (2022, vol. 55, no. 1, 90-104) real value of belex15 index has been lower compared to forecasted values until 7th of april, as from when the real value started to grow faster compared to forecasted value. the biggest absolute deviation between forecasted and real value has been on 12th of april and this deviation was 1.33%. as for the belex15 forecast, the same steps were taken for the belexline index, and results are presented below. same as for historical data of belex15, which is not stationary, values of belexline had similar movement, so belexline data is not stationary either. differentiation has been performed and differentiated data is presented in figure 4 – it meets the condition of stationarity. figure 4. differentiated belexline data source: author’s calculation table 7 presents results of dickey-fuller test, which confirms stationarity of differentiated data for belexline. table 7. dickey-fuller test – differentiated data for belexline dickey-fuller test for unit root number of obs = 3,334 z (t) has t-distribution test statistic 1% critical value 5% critical value 10% critical value z (t) -46.900 -2.327 -1.645 -1.282 p-value for z(t) = 0.000 d2.belexline coef. std. err. t p>|t| [95% conf. interval] belexline ld. -.795 .017 -46.90 0.000 -.829 -.762 _cons .133 .154 0.86 0.388 -.169 .435 source: author’s calculation in figure 5 are presented models for autocorrelation and partial autocorrelation for differentiated data of belexline. aleksandra živković 99 figure 5. autocorrelation (left figure) and partial autocorrelation (right figure) for differentiated data of belexline source: author’s calculation p-values for potential arima models are p=1,2,4,8 and q-values q=1,2,4,8,13. for belexline, following arima models have been analysed: (1,1,1), (1,1,2), (1,1,4), (1,1,8), (1,1,13), (2,1,1), (2,1,2), (2,1,4), (2,1,8), (2,1,13), (4,1,1), (4,1,2), (4,1,4), (4,1,8), (4,1,13), (8,1,1), (8,1,2), (8,1,4), (8,1,8), (8,1,13). in table 8 are presented results of all analysed arima models. model arima (2,1,2) is not presented, since results of this model couldn’t be defined by statistical processing. table 8. analysed arima models for belexline arima model p-value sigma loglikelihood aic bic arima (1,1,1) 2/2 8.883 -12,016.68 24,037.36 24,049.59 arima (1,1,2) 3/3 8.867 -12,010.30 24,026.60 24,044.94 arima (1,1,4) 4/5 8.870 -12,011.81 24,033.63 24,064.19 arima (1,1,8) 1/9 8.824 -11,994.06 24,008.12 24,069.24 arima (1,1,13) 1/14 8.795 -11,984.11 23,996.23 24,081.79 arima (2,1,1) 2/3 8.874 -12,013.03 24,034.05 24,058.50 arima (2,1,4) 5/6 8.829 -11,995.82 24,003.63 24,040.31 arima (2,1,8) 2/10 8.793 -11,982.50 23,987.00 24,054.23 arima (2,1,13) 1/14 8.787 -11,979.86 23,991.71 24,089.50 arima (4,1,1) 4/5 8.831 -11,996.62 24,003.24 24,033.80 arima (4,1,2) 3/6 8.830 -11,996.41 24,004.82 24,041.49 arima (4,1,4) 4/8 8.794 -11,982.51 23,979.02 24,021.81 arima (4,1,8) 4/12 8.788 -11,981.40 23,988.81 24,068.26 arima (4,1,13) 4/17 8.772 -11,974.77 23,985.54 24,095.56 arima (8,1,1) 5/9 8.800 -11,985.04 23,988.08 24,043.09 arima (8,1,2) 6/10 8.797 -11,983.82 23,987.63 24,048.75 arima (8,1,4) 5/12 8.787 -11,980.35 23,986.69 24,066.15 arima (8,1,8) 2/16 8.759 -11,969.49 23,972.98 24,076.89 arima (8,1,13) 4/21 8.737 -11,963.52 23,969.04 24,097.39 source: author’s calculation models arima (1,1,1) and arima (1,1,2) fulfil the criteria of significance of arma parameters, since all parameters are statistically significant – 2/2 and 3/3 respectively. sigma is lowest within arima (8,1,13), loglikelihood is highest within arima (8,1,13), aic is lowest within arima (8,1,13) and bic is lowest within arima (4,1,4). model arima (8,1,13) fulfills 3/5 criteria, but 100 economic analysis (2022, vol. 55, no. 1, 90-104) only 4/21 arma parameters are statistically significant which is a lack for this model. since the appropriate model is chosen by the majority of fulfilled criteria, arima (8,1,13) will be used to forecast belexline movement. results of this model are presented in table 9 and results of aic and bic tests are presented in table 10. table 9. arima (8,1,13) – corresponding model for belexline sample: 09jan2009-31mar2022 number of obs = 3,334 wald chi2 (20) = 585,157.78 log likelihood = -11,963.52 prob > chi2 = 0.000 d2.belexline coef. opg std. err. z p > |z| [95% conf. interval] arma -.242 .148 -1.64 0.101 -.531 .047 ar l1. l2. -.796 .163 -4.89 0.000 -1.115 -.476 l3. .850 .207 4.11 0.000 .445 1.256 l4. .230 .157 1.46 0.143 -.078 .538 l5. 1.077 .136 7.94 0.000 .811 1.343 l6. -.075 .179 -0.42 0.675 -.427 .276 l7. .071 .133 .54 0.592 -.189 .331 l8. -.573 .133 -4.30 0.000 -.845 -.312 ma -.567 l1. l2. .494 30.043 0.02 0.987 -58.388 59.376 l3. -1.577 154.913 -0.01 0.992 -305.200 302.046 l4. .426 58.020 0.01 0.994 -113.290 114.142 l5. -.902 44.175 -0.02 0.984 -87.484 85.680 l6. 1.024 63.969 0.02 0.987 -124.353 126.402 l7. -.137 7.966 -0.02 0.986 -15.750 15.477 l8. .784 101.609 0.01 0.994 -198.366 199.935 l9. -.500 64.981 -0.01 0.994 -127.860 126.861 l10. .086 .611 0.14 0.888 -1.111 1.283 l11. -.104 12.785 -0.01 0.993 -25.163 24.954 l12. .047 6.840 0.01 0.994 -13.358 13.453 l13. -.075 10.779 -0.01 0.994 -21.201 21.051 /sigma 8.737 629.689 0.01 0.494 0 1,242.905 source: author’s calculation table 10. akaike & bayesian information criteria (aic & bic) for arima (8,1,13) belexline model obs 11 (null) 11 (model) df aic bic 3,334 -11,963.52 21 23,969.04 24,097.39 source: author’s calculation in table 11 are presented results of forecast for the following 11 trading days, as well as real values of belexline. aleksandra živković 101 table 11. forecasted and real values of belexline index date forecasted value real value 01.04.2022. 1,743.467 1,732.07 04.04.2022. 1,745.202 1,734.43 05.04.2022. 1,745.102 1,730.73 06.04.2022. 1,745.760 1,735.43 07.04.2022. 1,747.383 1,740.18 08.04.2022. 1,749.036 1,745.12 11.04.2022. 1,749.572 1,750.03 12.04.2022. 1,750.431 1,756.38 13.04.2022. 1,751.277 1,749.34 14.04.2022. 1,752.575 1,746.44 15.04.2022. 1,754.675 1,748.98 source: author’s calculation forecasted values of belexline have been higher compared to real values of this index for a few points, with the exception of 11th, 12th and 13th of april, when real index values overcame forecasted values. the highest percentage difference has been noted on 5th of april and it was around 0.8%. discussion of results after appropriate arima models have been chosen for indices belex15 and belexline and their movement has been forecasted, in graphical overview are presented movements of real and forecasted values of these indices, in order to determine accuracy of arima model for short-term forecast. figure 6. movement of real and forecasted values of belex15 source: author’s calculation movement of belex15 is presented from the beginning of 2022 until 15th of april, which is the last day of the forecast (figure 6). forecasted values have more stable growth of index value, without significant oscillations, whereas in reality there have been some oscillations. even though there are some deviations between forecasted and real values, highest deviation was around 102 economic analysis (2022, vol. 55, no. 1, 90-104) 1.33%, which points to the conclusion that arima model is suitable for short-term forecast of belex15 index. in figure 7 are presented real and forecasted values of belexline. figure 7. movement of real and forecasted values of belexline source: author’s calculation as presented for belex15, forecasted values have a more stable ascending path compared to real index values. first half of the forecasted period had higher oscillations, which was followed by more accurate forecast during the second half of the analysed period. highest deviation was less than 1%, so the conclusion is that the arima model is suitable for forecasting the belexline index as well. even though there have been some differences with both indices, since they are not significant, the arima model is appropriate for short-term forecasts for both belgrade stock exchange indices. observed deviations are lower with belexline, so arima model is more suitable for forecasting of this index compared to belex15. the arima model has proven to be appropriate for short-term forecast in stock exchanges around the world, which leads to the conclusion that historical data can be used as a good starting point for a short-term forecast. obtained results in this research are in accordance with rotela, salomon & de oliveira pamplona (2014) who have confirmed accuracy of short-term forecast of bovespa stock index; wadi, almasarweh & alsaraireh (2018) came to the same conclusion for forecast of index amman stock exchange; li, yang & li (2017) have forecasted shanghai composite index movement by using arima model. when it comes to using arima model for short-term forecast of belgrade stock exchange indices, results by petrović (2020) are in accordance with this paper’s results and they confirm accuracy of arima model for short-term forecast of belex15. the disadvantage of both arima models chosen for forecast is that none of them have fulfilled all criteria for choosing the most appropriate arima model. when it comes to belex15, two models (arima (1,1,2) and arima (8,1,4)) have fulfilled 2/5 criteria, so a decision about using arima (1,1,2) has been made based on statistical significance of arma models. with the belexline index, arima (8,1,13) fulfilled 3/5 criteria, but the small number of arma parameters is statistically significant. aleksandra živković 103 conclusion in this paper a short-term forecast of stock indices belex15 and belexline has been conducted (from 1st until 15th of april 2022) by using arima model, in order to determine whether this model is suitable for forecast of movement of these indices. indices values have been forecasted for the following 11 trading days based on historical data from 5th january 2009 until 31st march 2022. arima (1,1,2) was a suitable model to forecast belex15 values. forecasted values of this index have more stable growth compared to real values, which recorded some oscillations. since there have not been significant differences between forecasted and real values of index belex15, conclusion is that arima model is suitable for short-term forecast and that hypothesis h1 cannot be rejected. arima (8,1,13) is the corresponding model for belexline index forecast and same as for forecasted values for belex15, forecasted values have more stable movement compared to real values of this index. oscillations between forecasted and real values of belexline are smaller compared to ones for belex15, which points to the conclusion that arima model is suitable for short-term forecast and that hypothesis h2 cannot be rejected. obtained results prove high potential of arima model for short-term forecast when it comes to belgrade stock exchange indices. executed analysis should be observed as a starting point for researching possibilities of forecasting domestic indices and expanded additionally with other econometric methods for forecasting, in order to conclude if it is possible to use other methods for financial forecast besides arima model. references adebiyi, ayodele ariyo, aderemi adewumi, and charles ayo. 2014. “stock price prediction using the arima model.” uksim-amss 16th international conference on computer modelling and simulation, 105-111. jakšić, milena, marina milanović, and dragan stojković. 2020. “short-term forecasting of belexline and belex15 movements.” facta universitatis, economics 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110-122. petrović, marijana. 2020. “estimating the movement of belex15 index values using the arima model.” journal of process management – new technologies, international, 8 (2): 1-11. prorok, vesna, and slađana paunović. 2015. “predviđanje kretanja tržišnog indeksa belexline na bazi arima modela.” synthesis 2015 – finance and banking, 432436. prorok, vesna, and dajana radović. 2014. “testiranje slabe hipoteze efikasnosti na tržištu kapitala srbije.” socioeconomica – the scientific journal for theory and practice of socioeconomic development, 3 (5): 51-64. rotela junior, paulo, fernando luiz riera salomon, and edson de oliveira pamplona. 2014. “arima: an applied time series forecasting model for the bovespa stock index.” applied mathematics, 5 (21): 3383-3391. stanković, jelena, ivana marković, and ognjen radović. 2015. “predviđanje trenda belex15 indeksa i njegovih konstituenata pomoću ls-svm metoda.” anali ekonomskog fakulteta u subotici, 52 (34/2015): 251-264. wadi al s., mohammad almasarweh, and ahmed atallah alsaraireh. 2018. “predicting closed price time series data using arima model.” modern applied science, 12 (11): 181-185. belgrade stock exchange. 2022. historical data of belex15 and belexline values. https://www.belex.rs/trgovanje/indeksi/svi/indeksi (accessed 03/04/2022) article history: received: may 20, 2022 revised: july 3, 2022 accepted: july 7, 2022 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp95-108 original scientific paper impact of economic freedom on total factor productivity in former socialist countries zoran borović1* | dragan gligorić1 | jelena trivić1 1 university of banja luka, faculty of economics abstract total factor productivity (tfp) is the portion of the country's output not explained by the amount of inputs used in production. the main goal of the present paper is to estimate the total factor productivity levels and then determine the long-term impact of economic freedom on the tfp in ten former socialistic countries, which are full eu members since 2000. to estimate the tfp we have applied the fixed effect panel on standard cobb-douglas production function in per capita terms. in the second iteration we have used pmg ardl model to estimate the long-term impact of economic freedom on the tfp. this research has proven that higher level of economic freedom, which is used as a proxy of the quality of the institutions and institutional framework, caused higher level of total factor productivity in the period 2000-2018 in the case of ten former socialistic countries which are full eu members since 2000. the obtained results enable us an insight in policies which are important for efficiency increase and economic performance. our finding could be very useful for policymakers, stressing which policies are contributing to efficiency, and which are not. so that policymakers could intervene in the way to increase the quality of institutional framework and economic institutions. many other studies investigate the tfp and growth, or growth and institutional framework for the countries of central and east europe. our survey is among the first to investigate the long-term impact of the institutional framework and economic institutions on the countries efficiency for this countries. our survey enables us an insight into the mechanism through which the institutions can positively impact the tfp through increasing the predictability and reducing the uncertainty for ce countries. key words: growth, total factor productivity, economic freedom, institutional framework, cobb‐ douglas production function jel classification: o30, o38, f20 introduction intense and ruthless competition is the main characteristic of modern capitalism. the technological development, which leads to increased efficiency, represents the concrete foundation of sustainable growth in the environment which is characterized by fierce competition. the neo-classical model of economic growth specifies that technological progress is exogenous. on the other hand, the endogenous growth theory suggests that technological development is created within the economic system, and it is affected by economic decisions. the quality of institutions and institutional framework, and their impact on efficiency has been in the focus of recent growth literature. one of the main questions in economic literature regards * corresponding author, e-mail: zoran.borovic@ef.unibl.org 96 economic analysis (2020, vol. 53, no. 2, 95-108) the differences in life quality between rich and poor countries. many authors, like hall and jones (1999) and acemoglu, johnson and robinson (2008), claims that these differences in wellbeing can be explained by differences in quality of institutions and institutional framework. this study relies on the so-called today “new institutional economics and development literature”. the incentives of the key economic actors are shaped and influenced by economic institutions. the production organization, investment in human and physical capital, decisions between investments and savings, technological progress, are all shaped by economic institutions. in our survey, we use the economic freedom as a proxy of the quality of the institutions and institutional framework. there are two economic freedom indexes which have been used in economic literature to measure the quality of institutions and institutional framework. the economic freedom index (efi) represents the first attempt to quantify the quality level of institutions and institutional framework., and it is reported annually by the fraiser institute in the report called economic freedom of the world. the fraiser institute started the freedom of the world project with milton rose and friedman in 1986. the index of economic freedom (here and after ief) is published by the heritage foundation in cooperation with the wall street journal. as berggren states, ``economic freedom is a composite that attempts to characterize the degree to which an economy is a market economy—that is, the degree to which it entails the possibility of entering into voluntary contracts within the framework of a stable and predictable rule of law that upholds contracts and protects private property, with a limited degree of interventionism in the form of government ownership, regulations, and taxes`` (berggren, 2003. p 194). total factor productivity (here and after tfp) is the portion of output not explained by the amount of inputs used in production (comin, 2008). regarding the tfp, our position is close to the "conventional view", in according which, changes in tfp measure the rate of technical change (law, krugman, young). in our paper, we use the tfp as the best expression of the efficiency of economic production. many studies conducted by solow (1957), hall and jones (1999), and more recently, caselli (2005) and jorgenson and vu (2010), have proven the hypothesis that the tfp represents an important channel, through which economic freedom impacts the gdp per employee. in this survey we investigate tfp determinants by focusing on economic freedom. we conduct our analysis on ten former socialist countries which are a full european union members since 2004 (bulgaria, czech republic, estonia, hungary, latvia, lithuania, poland, romania, slovak republic and slovenia). they were all a part of socialist economic system with central planning. these countries have changed their economic system and shifted from socialism to capitalism. our survey cover the time period between 2000 and 2018. this study is organized as follows. after this introduction, in the second section, we present a critical review of the existing literature regarding economic freedom and tfp. in the third section, we provide the model specification and used methodology. empirical results and discussion are presented in the fourth section, while the fifth section concludes the paper. literature review there are numerous studies which focus on the impact of economic freedom on the economic growth (ayal and karras, 1998; gwartney et al., 1999; heckelman, 2000; de haan and sturm, 2000; dawson, 1998). in all these studies, the researchers came to the same conclusion, that economic freedom does have a positive and statistically significant impact on the economic growth. economic freedom is guaranteed by an institutional structure. this means that liberal market economy creates an environment that is both augmenting growth and accelerating development (ulosoy and tas, 2017). even though there is a consensus regarding positive impact of economic freedom on the economic growth, many researchers have find that subcomponents of both economic freedom indexes can have positive or negative impact on economic growth. zoran borović, dragan gligorić, jelena trivić 97 acemoglu (acemoglu et al., 2004) states that quality institutions are of great importance for the productivity and economic growth. according to henry (henry, 2003) economic freedom have a positive impact on the physical capital. the mechanism is very simple, the higher the economic freedom is, the more will economic actors save and invest, thus, increasing the physical capital. high level of economic freedom means free international trade. according to cagetti and denardi (2006), removing the restrictions on capital movements between countries will increases the supply of venture capital, which may lead huge increase in innovation. impact of the fdi on the tfp, both in the host and in the home country has been investigated by a number of authors. there are two channels through which the fdi inflow can positively affect the tfp in the host country (griffith, et al. 2003). on one hand, the fdi inflow can lead to the increase in the competition, which might result in speeding up domestic innovative outcomes. on the other hand, as the result of the fdi inflow, the host country is expected to benefit from the technology transfer (keller, 2004). these positive effects of the fdi inflow are much more important for less developed economies, because of their larger distance to the international technological frontier. according to aitken and harrison (aitken and harrison, 1999), the developing countries might be unable to utilize the benefits of fdi inflow due to their weak absorptive capacity. analogously, if the knowledge-base synergies are strong enough to flow from the host to the source country, the home country will benefit from productivity increase. the positive effect on tfp growth rate can be achieved through the openness in international trade (alcalá and ciccone 2004; coe and helpman 1995; greenaway and kneller 2007; wagner 2007). trade flows of goods and services, similarly as in the case of fdi, might lead to an increased competition of domestic sectors. bjørnskov and foss (2010) have stressed that high level of regulation, sound money, judicial system, security of property rights, openness to international trade and investments, all have a positive impact on tfp. on the other hand, high taxes and large government can have both, positive and negative impact on the tfp. the institutions with high level of economic freedom can positively impact the tfp through reduction of transaction costs, increasing the predictability and reducing the uncertainty. this positive impact is direct result of the favorable environment for the entrepreneurial experimentation that lead to productivity-enhancing innovations in products, processes and ways of organizing productive activities (bjørnskov and foss, 2010). model specification and methodology our analysis is split in two iterations. in the first iteration, we will estimate the tfp levels over time and across countries. in the second iteration, we will investigate the impact of economic freedom on the tfp. to estimate the tfp, we will apply the cobb-douglas production function. our analysis is based on the assumption that all analyzed countries are very homogenous in relation to structural and institutional factors affecting productivity. the standard cobb-douglas production function can be written as: 𝑌 𝐴𝐾 𝐿 (1) , where y represents output or real gdp, the k stands for the economy-wide capital stock, l represents employment and α is the elasticity of output to capital. the a is interpreted as the tfp. with some rearrangement, the standard cobb-douglas production function is transformed into a log-log model: ∆ log 𝑌 ∆ log 𝐴 𝛼∆ log 𝐾 1 𝛼 ∆ log 𝐿 (2) 98 economic analysis (2020, vol. 53, no. 2, 95-108) the modern economic literature is rich with empirical approaches for tfp evaluation (see. welfe (ed.) 2007; severgnini and burda, 2010, pp. 447–466; gehringer et al., 2014). the tfp estimation is also split into two iterations. our analysis is based on the approach proposed by tokarski (tokarski, 2008) and later, used by balcerzak and pietrzak (balcerzak and pietrzak 2015a; 2015b, 2016). firstly, the cobb-douglas production function is estimated in per capita terms: log 𝑦 𝑐 𝑔𝑡 𝛼𝑙𝑜𝑔𝑘 (3) , where y is gdp per employee, k stands for capital per employee, g is the rate of technological progress in the sense of hicks, α is the elasticity of labor productivity to the capital to labor ratio, and it is time trend. the classification of technical progress was presented by sir john hicks in his theory of wages (1932). the technical progress, in per employee production function, is said to be hicks-neutral if, at any constant value of the capital-labour ratio (k/l), the ratio of the marginal product of capital to the marginal product of labour remains constant. hicks-neutral progres implies that the ratio of rental rate of capital to the wage rate is constant. and thus, the ratio of relative shares of labour and capital income in national income is constant. in other words, the hicks-neutral technical progress indicates the economy’s growth rate, assuming that capital investments and the employment are kept constant. the fixed parameter α has been applied in the tfp calculation for all countries, with different output per employee, and with different capital per employee. after estimation of parameter α from equation (3), we can estimate the tfp in the second iteration, by applying parameter α in the following equation (tokarski, 2008, pp. 38–53): 𝑇𝐹𝑃 (4) with some rearrangements, we can rewrite equation (4) in log terms (balcerzak and pietrzak, 2016): log 𝑇𝐹𝑃 log 𝑦 𝛼 log 𝑘 (5) the data on the capital volume is very often published by the official statistics offices. the problem is that the data on the capital volume published by official statistical offices from different countries are very likely obtained by applying different methods. therefore, the additional calculation is necessary in order to obtain the tfp. the researchers have used the perpetual inventory method in many studies for assessment of the capital stock. the perpetual inventory method can be described with the following equation: 𝐾 𝐼 1 𝛿 𝐾 (6) where δ represents the depreciation rate and i stands for investments. the subscript t stands for the beginning of the time period t and t-1 represent the previous time period. the assessment of capital stock requires the calculation of the anchor capital volume. in many studies, the researchers have used the first year in the sample as an anchor year. in the steadystate, the anchor capital volume is characterized by constant growth rate g. assuming the steady-state of the economy, we can calculate the anchor capital volume with the following equation: 𝐾 (7) where k0 is the initial capital stock, i0 are investments in the anchor period. the steady-state assumes that output and capital grew at the same rate (harberger, 1988). therefore, we can use zoran borović, dragan gligorić, jelena trivić 99 the growth rate of output smoothed using an hp filter with λ = 100, to evaluate the steady-state growth rate. the last piece of a puzzle needed for evaluation of the capital stock in the initial period, and for estimation capital volume from time to time, is the depreciation rate. in our survey, we will set the depreciation rate at 0.05, with the assumption that the depreciation rate is constant over the period and across countries. many authors and researchers set the depreciation rate between 0.04 and 0.1 (vanags and bems 2005; griliches, 1980; nehru and dhareshwar, 1993; romer, 1988; kamps, 2006; rapacki and prochniak, 2009; berlemann and wesselhöft, 2014; harberger, 1988; nadiri and prucha, 1996). there are many surveys where the depreciation rate is set at 0.05 (de la fuente and doménech, 2006; hernandez and mauleon, 2003; cororaton, 2002; and felipe, 1997). once we estimate the tfp levels over time and across countries, we will investigate the existence of co-integration relationship between tfp and economic freedom. here, we will estimate the models which is described with following equatuion: log 𝑡𝑓𝑝 𝑐 log 𝑒𝑓𝑖 log 𝑀 𝜀 (8) , where efi represents the composite index of economic freedom, and vector m holds the control variables: openness, fdi and human capital, and ɛ represents the error term. a similar vector of control variables was used by borovic, rebic & tomas (2020) in order to capture the tfp drivers for the fourteen eu countries. data and results we will conduct our analysis on ten former socialist countries which are a full european union members since 2004. for the period 2000-2018 (bulgaria-bul, czech republic-cze, estonia-est, hungary-hun, latvia-lat, lithuania-lit, poland-pol, romania-rom, slovak republic-slv and slovenia-slo). variables, their definition and sources are presented in table (1). table 1. variables description variable description source y gdp (constant 2010 us$) world bank national accounts data, and oecd national accounts data files. i gross fixed capital formation (constant 2010 us$) world bank national accounts data, and oecd national accounts data files. k capital stock authors calculation l number of persons engaged (in millions) penn world table y gdp per employee authors calculation k capital per employee authors calculation tfp total factor productivity authors calculation efi index of economic freedom heritage foundation open calculated as a sum of export and import as a percentage of gdp world bank national accounts data, and oecd national accounts data files. fdi foreign direct investment, net inflows (% of gdp) world bank national accounts data, and oecd national accounts data files. h human capital investment rate -as proxied by secondary enrolment rate world bank national accounts data, and oecd national accounts data files. source: authors some observation for the fdi were negative, se we had to transform them using the following procedure (busse and hefeker, 2007; ren, et al, 2012). 100 economic analysis (2020, vol. 53, no. 2, 95-108) 𝑌 log 𝑥 √𝑥 1 (9) the data on gdp per employee are presented on graph (1). 3.8 4.0 4.2 4.4 4.6 4.8 00 02 04 06 08 10 12 14 16 y_bul y_cze y_est y_hun y_lat y_lit y_pol y_rom y_slo y_slv graph 1. gdp per employee (in logs) source: authors most of the countries converge around the same level of average productivity over the time period, and with similar growth rates of average productivity. three countries have an average productivity below the general level, but with tendency to catch up with the rest of the sample. the data on capital per worker are presented on graph (2). 4.0 4.4 4.8 5.2 5.6 00 02 04 06 08 10 12 14 16 k_bul k_cze k_est k_hun k_lat k_lit k_pol k_rom k_slo k_slv graph 2. capital per worker (in logs) source: authors most of the countries converge between 4.4 and 5.0. the countries below the average level tend to catch up, because of higher growth rates of the capital per worker, relative to the countries above average. we start econometrics estimation by estimating cobb-douglas production function in per capita terms (equation (3). the authors which have used the equation (3) to estimate the parameter α, they did not test the series for stationarity, instead, they used a panel with fixed zoran borović, dragan gligorić, jelena trivić 101 effects, i.e. classic ols (tokarski, 2008, balcerzak and pietrzak 2016а, 2016b). the estimation of parameter α was carried out by applying the classic ols on panel data with fixed effects. in addition to the classic ols estimation, we have checked for robustness. the estimation of parameters for equation (3) is presented in table (2). the parameters α and g are statistically significant at 5% level of significance. the results of estimation are presented in table (2). table 2. estimation of elasticity of labor productivity to the capital to labor ratio (α) parameter estimate robust std. err. p value α 0.392412 0.000 0.000 g 0.011323 0.011 0.011 constant 1.959962 0.006 0.006 r-sq 0.44 source: authors calculation the technological progress in the sense of hicks (parameter g) is estimated at 0.011323, which means, that under assumption of constant level of capital and labor, the selected countries are characterized with rate 1.1323% of production growth. once we have estimated the parameter α, we will calculate the tfp by applying the α on equation (5). the descriptive statistics for tfp, efi, h, fdi, and openness are presented in table (3). table 3. descriptive statistics for tfp, efi, h, fdi, and openness tfp efi fdi h open mean 2.54 65.98 11.47 98.99 119.36 median 2.56 66.10 7.80 98.17 122.96 maximum 2.75 79.10 109.75 117.52 190.68 minimum 2.32 47.30 0.032 79.78 48.52 std. dev. 0.10 6.13 14.66 7.65 33.68 observations 178 178 178 178 178 source: authors calculation the tfp on a country level is presented in graph (3). 2.3 2.4 2.5 2.6 2.7 2.8 00 02 04 06 08 10 12 14 16 tfp_bul tfp_cze tfp_est tfp_hun tfp_lat tfp_lit tfp_pol tfp_rom tfp_slo tfp_slv graph 2: evolution of the tfp on country level (in logs) source: authors calculation 102 economic analysis (2020, vol. 53, no. 2, 95-108) regarding the tfp, we have three groups of countries. the first group of countries converges around the same level of the tfp (2.5): poland, czech republic, estonia, hungary, and slovakia. also, they have almost the same growth rate of the tfp. the second group of countries is characterized by the lowest tfp rate: bulgaria, latvia, and romania. since 2010. their growth rates of the tfp accelerates and tend to catch up with the first group. the third group has the highest tfp level, and the growth rates of the tfp are much higher than the rest of the sample. members of this group are slovenia and lithuania. our data are not affected by the problem of multicollinearity. the correlation matrix is presented in table (4). table 4. correlation matrix tfp efi fdi h open tfp 1 efi 0.4682 1 fdi -0.1236 -0.0160 1 h 0.2796 0.5365 -0.1975 1 open 0.5767 0.5960 -0.0829 0.3796 1 source: authors calculation in the present paper, we have used a cross-section dependence test (pesaran cd test) to test the null hypothesis that there is no cross-section dependence (correlation) in the time-series, cd ~ n(0,1). ignoring a cross-section dependency in panel analysis will result in substantial bias in estimations. the results of a cross-section dependence test are presented in table (5). table 5. cross-section dependance test variable cd test p value tfp 22.717 0.000 fdi 10.308 0.000 efi 12.999 0.000 h 14.663 0.000 opp 25.764 0.000 source: authors calculation the results of cross-section dependence test showed that change in tfp, fdi, h, and opp that occurred in any of the observed countries affected other countries as well. we have used the second generation of unit root test (cips cross-section im, pesaran, and shin) in order to test our series for stationarity. the results are presented in table (6). table 6. unit root test series stationarity tfp i (1) efi i (1) h i (0) open i (0) fdi i (0) source: authors calculation our main goal is to determine the long-term impact of economic freedom on the tfp. we have used human capital, fdi, and country openness to capture their impact on the tfp. our series do zoran borović, dragan gligorić, jelena trivić 103 not have the same level of integration, in which case standard co-integration tests such as pedroni, kao and fisher johansen test are not allowed. instead, we will use relatively new pmg ardl (autoregressive distributed lag) model proposed by pesaran (1997) and pesaran and shin (1999) which will enable us an effective estimation of both long and short-term effects, on the basis of panel data series with a different level of integration, but lower than i(2). we have fixed the number of lags of both dependent and independent variables to 1. the form of the dynamic ardl (p, q) model was defined by paseran and shin (1997): y ∑ λ y , ∑ δ x , μ ε 10 , where i represents the number of observation units i 1,2,....,n; t represents the number of time instances t 1,2,....,t; xit is vector of independent variables of dimension k 1; ij is coefficient of lagged dependent variable; i is parameter that determines the specific effects of the group or observation unit. a similar cointegration technique was carried out by gligoric, borovic & vujanic (2017) for the commonwealth of the independent states, which are also former socialist countries. we have estimated five different models, and the best model is chosen based on loglikelihood, akaike, and bayesian information criterion. the results of our analisys for the pmg estimator are presented in table (7). table 7. results of the pmg ardl estimation variable model 1 model 2 model 3 model 4 model 5 short-run coeff. ect -0.174*** -0.142* -0.104*** -0.153*** -0.125*** (0.056) (0.085) (0.029) (0.051) (0.043) δ efi 0.016 -0.054* 0.125*** 0.023 0.015 (0.035) (0.030) (0.045) (0.029) (0.026) δ fdi -0.001 0.004 0.001 0.002 (0.001) (0.003) (0.001) (0.002) δ h 0.009 0.019 0.029 (0.069) (0.051) (0.088) δ opp 0.044** 0.045** 0.063*** (0.017) (0.020) (0.015) long-run coeff. efi 0.244*** 0.627*** -0.765*** 0.307*** 0.392*** (0.060) (0.079) (0.255) (0.079) (0.075) fdi 0.054*** 0.006 0.060*** 0.063*** (0.007) (0.004) (0.008) (0.008) h -0.027 0.449** 0.087 (0.093) (0.186) (0.074) opp 0.091*** 0.074*** 0.018 (0.031) (0.015) (0.047) constant 0.196*** -0.058* 0.374*** 0.114*** 0.102*** (0.059) (0.035) (0.106) (0.033) (0.029) obs. 168 170 168 168 170 log lik 601.5 584.3 584.2 567.8 566.7 aic -1183 -1153 -1152 -1120 -1121 bic -1152 -1127 -1127 -1095 -1103 standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1 source: authors calculation 104 economic analysis (2020, vol. 53, no. 2, 95-108) according to log-likelihood, akaike, and bayesian information criterion, the best pmg ardl estimator is model 1, therefore, our conclusion will be based on the pmg estimation of model 1. the existence of a long-run relationship among the variables of interest requires that the coefficient on the error–correction term (ect) has to be negative and not lower than -2. in our model, error correction term is statistically significant at 1% level and negative, which means that variables in our model have long rung equilibrium. except human capital, all variables are statistically significant at 1% level. our variable of particulas interest, economic freedom index (efi) is statistically significant a 1% level and positive, which is expected. we can conclude that high economic freedom led to the higher total factor productivity in the selected former socialistic countries. other two variables which have statistically significant impact on total factor productivity also have expected positive impact on total factor productivity. higher openness to foreign trade and foreign direct investment growth cause higher total factor productivity growth. in assessing the effects of economic freedom on total factor productivity growth, one important concern is the possibility of reverse causality, namely that countries with higher total factor productivity have higher degree of economic freedom. we test directly for reverse causality by conducting pairwise dumitrescu-hurlin test. table 8. dumitrescu-hurlin causality test null hypothesis zbar‐stat p value efi does not homogeneously cause tfp 0.0912 0.0365 tfp does not homogeneously cause efi 1.2919 0.3160 source: authors calculation the results of dumitrescu-hurlin test indicate that we can accept hypothesis that total factor productivity does not granger-cause economic freedom, i.e. we have no problem with reverse causality. also, we cannot accept the hypothesis that economic freedom does not granger cause total factor productivity. conclusion this research has proven that higher level of economic freedom, which is used as a proxy of the quality of the institutions and institutional framework, caused higher level of total factor productivity in the period 2000-2018 in the case of ten former socialistic countries which are full eu members since 2000. the presence of cointegration between the total factor productivity and composite index of economic freedom are observed using pmg ardl model while dumitrescu-hurlin test has indicated that reverse causality between this two variables does not exist. also, foreign direct investment and openness rate have positive and significant impact on economic growth in observed countries. half of our sample converge around the same level of tfp (2.5), and their growth rate of tfp tends to decelerate after the crisis. two countries with the highest level and highest growth rate of the tfp are slovenia and lithuania. the lowest tfp is a characteristic of bulgaria, latvia, and romania. but, since 2010. their growth rates of the tfp are accelerating and they tend to catch up with the rest of the sample. the results of our research are in line with those of ulosoy and tas, acemoglu, henry, and bjørnskov and foss. the conclusion is same, the economic actors will invest more and produce more in environment which characterize higher level of economic freedom. quality institutions and institutional framework are of great importance for the productivity and economic growth in former socialistic countries. the obtained results enable us an insight in policies which are important for efficiency increase and economic performance. our finding could be very useful for policymakers, stressing which policies are contributing to efficiency, and zoran borović, dragan gligorić, jelena trivić 105 which are not. to boost productivity and economic growth, policymakers should intervene to increase the quality of institutional framework and economic institutions. many other studies investigate the tfp and growth, or growth and institutional framework for the countries of central and east europe. our survey is among the first to investigate the long term impact of the institutional framework and economic institutions on the countries efficiency for this countries. our survey enables us an insight into the mechanism through which the institutions can positively impact the tfp through increasing the 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(2007). gospodarka oparta na wiedzy [knowledge-based economy]. warszawa: pwe 108 economic analysis (2020, vol. 53, no. 2, 95-108) appendix table 5. unit root tets results variable exogenous variables second generation of unit root test cips test statistics number of opservations tfp individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -2.326 170 efi individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -2.064 170 h individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -1.576** 158 fdi individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -3.597*** 170 openenes no constant nor trend cips cross-section im, pesaran, and shin -1.862** 170 *** p<0.01, ** p<0.05, * p<0.1 source: authors calculation article history: received: october 31, 2020 accepted: december 3, 2020 ea_2014_3-4 udc: 005.334:336.77 005.22 jel: g22 cobiss.sr-id 21178164 original scientific paper credit spread modeling: macro-financial versus hoc approach dudaković sanja1, franklin university switzerland abstract – the aim of this paper is to throw light on the relationship between credit spread changes and past changes of u.s. macro-financial variables when invariants do not have gaussian distribution. the first part presents the empirical analysis which is based on 10-year aaa corporate bond yields and 10-year treasury bond yields. explanatory variables include lagged u.s. leading index, russell 2000 returns, bbb bond price changes interest rate swaps, exchange rates eur/ usd, repo rates, s& p 500 returns and s&p 500 volatility, treasury bill changes, liquidity index-trsw, libor rates, moody’s default rates; credit spread volatility and treasury bills volatility. the proposed dynamical model explains 73% of the u.s. credit spread variance for the period 1999:072013:07. the second part of the article introduces the parameter estimation method based on higher order cumulants. it is demonstrated empirically that much of the information about variability of credit spread can be extracted from higher order cumulant function (85%). key words: credit spread modeling, arma parameter estimation, higher order cumulants, non gaussian arma models, dynamic regression introduction the predictability of credit spread has been assuming a new importance since both fixed income investors and financial managers need reliable predictions to make more money. for the past fifteen years, the source of the greatest variance between investment objectives and payoffs has been credit risk. there are two opposed micro-financial approaches to credit spread modeling, used in literature so far: the “structural” approach versus the “reduced” approach. however they have a common characteristic, which is the assumption that the main explanatory component of credit spread is a default risk. the market pricing of default risk can be analyzed using the “structural approach”, (merton, 1974), which is based on black and scholes option pricing model. the “reduced approach” to the pricing of default risk assumes that investors require excess return in order to cover the risk. in this context the pricing requires a measure of corporate default probability and the associated recovery rates. although conceptually very elegant, the structural models have had limited success in matching with empirical data. 1 address: via ponte tresa 29, lugano, switzerland, e-mail: sdudukovic@fus.edu economic analysis (2014, vol. 47, no. 3-4, 53-68) 54 elton, gruber and mann [2001] found that expected default losses are insufficient to explain the great part of the variability of credit spreads. using a reduced form model, they showed that the expected default loss can explain only up to 25% of credit spread. huang and huang (2003) used a structural model too, and verified that for investment grade bonds (baa and higher rating) only 20% of the spread is explained by the default risk. both models used historical default frequencies produced by moody’s and standard and poor’s. alternative estimates of default probabilities are provided by lando and skodeberg (2002) who used a continuous time analysis of rating transitions to improve the estimate of the default risk. collin-dufresne, golden and martin (2001) examined a firm level related risk as determinants of credit spread changes, spot rate changes, changes in the slope of the yield curve, changes in a firm leverage, changes in volatility, changes in the probability and magnitude of a large negative jumps. they concluded that the monthly changes in firm specific factors are not a driving force in credit spread changes. besides merton (1974), krishman, ritchken and thompson (2003), showed that the predictability of credit spread, based on the credit slope, largely depends on the maturity of the corporate bonds. zhang, zhou and zhu (2005), argued that the unsatisfactory performance of structural models may be in part attributed to the fact that the impact of volatility and jump risks are not treated seriously. they found strong volatility and jumps effects, which predict another 16% of credit spread. in this paper, it is first investigated how credit spread changes are explained by the changes of macro-financial variables such as: lagged changes russell 2000 returns, bbb bond price changes, u.s. leading index, interest rate swaps, exchange rates eur/usd, repo rates, s& p 500 returns and s&p 500 volatility, treasury bill changes and their volatility, liquidity index and moody’s default index (section 1). empirical dynamic regression model is discussed in section two. statistically speaking, credit spreads time series is non gaussian which means that its autocorrelation function does not provide sufficient statistics for arima-garch parameter estimation. cumulants (in frequency domain called polyspectra) have received the attention of the statistics and signal processing and wireless communications (zou, zhong & jiang ,2013). gianninakis (1990) derived cumulant based arima order determination method for communication signals, because second order cumulants for non gaussian signals vanish, higher order cumulants are generally nonsymmetrical functions of their arguments, and as such carry phase information about arma parameters. the section three of this article discusses some of the theory behind higher-order statistics, particularly as it applies to non gaussian signals arma parameter estimation. it then in details describes the steps taken towards constructing such an estimator. these steps are aimed to determine the credit spread arma model order which is necessary to provide accurate cumulant estimates using mathlab software, to examine the performance of a cumulant based arma parameter estimation for a non-gaussian credit spread time series, and to examine the ability of the cumulant based model to outperform the classical regression model. conclusion is given in section four. duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 55 the problem and the methodology it is well known that a credit spread represents the difference between the yield of a risky security (corporate bond) and that of a risk-free security of the same or similar maturity. the predictability of a credit spread is of paramount importance for both fixed income investors and financial managers. if prediction shows that the future credit spread will widen, the trader would sell the portfolio of corporate bonds and vice versa. on the other side, corporate finance managers would be able to lower the firm’s cost of capital by timing debt issuance. as pointed out by harvey (1999), if prediction is that credit spread will tighten, managers will support short term debt operations, will lock in interest rates today and wait until the spread really tightens to issue long term debt. the static multiple regression model for credit spread, as used almost everywhere, is not considered. instead, multiple integrated autoregressive ia –garch model is used.the rational for this choice is quite simple: the classical multiple regression model reflects instantaneous relationship. thus, even when the coefficient of determination is high, this model is of little use for forecasting whether statistically significant predictions of explanatory variables are not available. almost all explanatory variables used in literature so far, after being stationarized by making their first differences, have quickly vanishing autocorrelations which contain a marginal amount of information useful for their forecasting. let xit and yt be jointly stationary gaussian processes with finite first and second moments that can be treated as outputs from the linear autoregresssive integrated moving average ( arima) filters, whose inputs are white noise signals: uti and vt respectively: a1(z)* dxti= b1(z)* uit , i=1,2…k a2(z)* dyt= b2(z)* vt , where z is a backward shift operator: yt-1=zyt , yt-k =zkyt ; a(z) = 1-a1z-a2z2 …apzp and b(z) = 1-b1z-b2z2 …bqzq are ar and ma filters of orders p and q respectively, d is the first difference filter, dyt = yt yt-1 , i is the index of independent variable, k is the number of independent variables. the model of credit spread we use has iar-grach general form, as defined by box-jenkins (1976) and by bollerslev (1986), as a generalization of engle (1982). iar model has the form: k pi q dyt =σ σαij *xti-j + σβm *εt-m , (1) j=1 m=1 i=1,2...pi, j=1,2…k, m=1,2…q , economic analysis (2014, vol. 47, no. 3-4, 53-68) 56 while garch model is : ht =ω + γhτ−1ε2t-1 + δht-1 (2) where pi is the ar order or the series i, i is the index of independent variables and t is the residual white noise associated with yt, q is the ma order of the {εt} residuals and {ht} is volatility of the residuals. dynamic macro-financial model the corporate credit spread, or just the credit spread crsp, is usually measured as the difference between the yields of a defaultable corporate bond and of a u.s. government bond of comparable time to maturity. in this article, the credit spread is the difference between yields of 10 year aaa bonds and 10-year treasury bonds. its chart is presented in figure 1, for the period 1999:01-2014:07. a statistical description for aaa yields, 10-year treasury yields and the credit spread, are presented in table 1. table 1. descriptive statistics for credit spread dcrsp aaa tre10y mean -0.000402 7.080172 5.781264 median 0 7.17 5.81 maximum 0.41 9.01 8.28 minimum -0.64 4.96 3.33 std.dev. 0.116715 0.960916 1.1809 skewness -0.405155 -0.232654 0.06616 kurtosis 8.569198 2.456881 2.156968 observations 174 174 174 figure 1. credit spread chart the credit spread appears to be non -stationary, which is demonstrated by using the unit root test results: crsp duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 57 adf test statistic -2.20972 1% critical value* -3.47 5% critical value -2.878 10% critical value -2.576 *mackinnon critical values for rejection of hypothesis of a unit root. the first difference of the credit spread has autocorrelations (ac) and partial autocorrelations (pac) different from zero, as presented in table 2. table 2. autocorrelations (ac) and partial autocorrelations (pac) lags 1 2 3 4 5 6 7 8 9 10 ac 0.348 -0.06 -0.125 -0.184 -0.128 -0.009 0.007 0.03 -0.014 -0.061 pac 0.348 -0.21 -0.033 -0.157 -0.029 0.008 -0.043 0.01 -0.066 -0.042 the best time series model obtained by using aic criterion is arima (2,1,0) with coefficients presented in table 3. as it can be seen from the table, this model explains only 16.25% of the credit spread variance. table 3. arima model dependent variable: d(crsp) included observations: 172 variable coefficientstd. error t-statistic prob. ar(1) 0.42333 0.074555 5.67813 0 ar(2) -0.2072 0.07458 -2.7778 0.0061 r-squared 0.16245 mean dependent var 0.0003 explanatory variables as mentioned above , the following explanatory variables are used : s&p 500 composite index returns and its volatility, three months treasury bill rate and corresponding volatility, libor rate, repo rate, swap rate, russell 2000 index, eur/usd exchange rate, liquidity index and u.s. leading index. their meanings are explained bellow. by using the unit root test, it is shown in table 4, with 99% confidence, that all the variables are non stationary, whilst s&p 500 returns, russell 2000 returns and u.s. leading index are stationary time series. the s&p 500 is one of the most commonly used benchmarks for the overall u.s. stock market. it is a market-value weighted index, which means each stock's weight in the index is proportionate to its market value. s&p 500 returns are calculated as usually: sp500rt= (sp(t)-sp(t-1)) /sp(t-1) (3) economic analysis (2014, vol. 47, no. 3-4, 53-68) 58 table 4. unit root test augmented dickey-fuller test results variable adf test statistic 1% critical value* -3.472 5% critical value -2.880 10% critical value -2.576 sp500r -6.527 tre3m -1.905 swap5 -2.194 swap10 -2.042 uslead -4.762 russel2000 -7.253 euro -1.489 default rate -1.791 libor6m -1.881 trsw -1.868 reporate -2.132 prime rate -1.959 *mackinnon critical values for rejection of hypothesis of a unit root. stock market returns are expected to be negatively correlated with bond market returns. the best arma model is arma (1,1) whose coefficients are presented in table 5. table 5. arma (1,1) dependent variable: sp500r included observations: 164 variable coefficientstd. error t-statistic prob. c 0.0080 0.0033 2.4567 0.0151 ar(1) -0.6321 0.2498 -2.5301 0.0124 ma(1) 0.6760 0.2454 2.7545 0.0066 r-squared 0.0346 mean dependent var 0.0081 three months treasury bill rate, t bills. by definition, this rate is a debt obligation issued by the u.s. government and backed by its full faith and credit, having a maturity of one year or less. treasury bills are considered the safest securities available to the u.s. investor, and so the yield of these securities is considered risk-free. these securities do not pay a coupon, and the interest earned is estimated by taking the difference between the par value and the purchase price of the bond, with time adjustments. in this analysis the t-bills with 3 months maturities are the only t bills that are significant for credit spread variations. their best arima model is presented in table 6. as it can be seen from the table the series has significant volatility of the garch (1,1) residuals. interest rate swaps can provide forward indication of credit spread direction. interest rate swaps are used to hedge interest rate risks as well as to take on interest rate risks. if a treasurer is of the view that interest rates will be falling in the future, he may convert his fixed interest liability into floating interest liability; and also his floating rate assets into fixed duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 59 rate assets. if he expects the interest rates to go up in the future, he may do vice versa (the floating side of the swap would usually be linked to another interest rate, often the libor). in an interest rate swap, the principal amount is never exchanged; it is just a notional principal amount. in a word, interest rate swaps are financial tools that potentially can help issuers to lower the amount of debt service. we use two swap indexes, which are significant for the credit spread changes: a 5-year swap and 10-year swap index, taken from bloomberg. table 6. arima model dependent variable: d(tre3m) coefficientstd. error z-statisticprob. ar(1) 0,9074 0,046431 19,543 0 ma(1) -0,6521 0,08504 -7,6682 0 variance equation c 0,00428 0,001808 2,36827 0,0179 arch(1) 0,2094 0,059513 3,51855 0,0004 garch(1) 0,65998 0,082713 7,97914 0 r-squared 0,24012 mean dependent var-0,0164 the best arma-garch model coefficients for the series swap5 and swap10 are presented in tables 7 and 8 respectively. as it can be seen from the tables, self predictive power or arima models is fairly low for both series. a liquidity index is consider to be an estimate of changes in the difference between yields of the 10-year swap index and 10-year treasuries, trsw, as suggested by collin-dufresne, goldstein and martin (2001).the best arima model is given in table 7. table 7. arma-garch model coefficients for the series swap5 table 8. arma-garch model coefficients for the series swap10 dependent variable: d(swap5) included observations: 173 coefficient std. error z-statistic prob. ar(1) -0.415908 0.263282 -1.579707 0.1142 ma(1) 0.58401 0.262362 2.225973 0.026 variance equation c 0.090758 0.046474 1.952889 0.0508 arch(1) -0.102324 0.04004 -2.555525 0.0106 garch(1) 0.152989 0.485436 0.315159 0.7526 r-squared 0.033673 mean dependent var -0.0217 dependent variable: d(swap10) included observations: 173 coefficient std. error z-statistic prob. ar(1) -0.69404 0.194109 -3.575512 0.0003 ma(1) 0.808037 0.1549 5.216516 0 variance equation c 0.028355 0.054337 0.521849 0.6018 arch(1) -0.036194 0.049834 -0.726295 0.4677 garch(1) 0.690456 0.645622 1.069443 0.2849 r-squared 0.01843 mean dependent var -0.0228 eur/usd exchange rate was the only shorter time series used in this article. the missing values are obtained by using a weighted average of the foreign exchange value of the u.s. dollar against a subset of the g7 index currencies that circulate widely outside the country of issue, issued by the board of governors of the federal reserve system for the period 19911999.its arma –garch model parameters are presented in table 10. economic analysis (2014, vol. 47, no. 3-4, 53-68) 60 it is not unusual that instead of eur/usd exchange rate, researchers use ted spread, or treasury rate – eur/usd exchange rate (harvey 1999). since the credit spread already contains treasury rate yields, we prefer to use the exchange rate itself. table 9. arma-garch model table 10. arma –garch model parameters dependent variable: d(trsw) method: ml arch (marquardt) sample included observations: 172 coefficient std.error z-statistic prob. ar(2) 0,7312 0,1241 5,8926 0,0000 ma(1) -0,7426 0,0538 -13,7959 0,0000 ma(2) -0,8315 0,0925 -8,9858 0,0000 ma(3) 0,6565 0,0893 7,3553 0,0000 variance equation c 0,0019 0,0003 6,7920 0,0000 arch(1) -0,0776 0,0034 -22,8489 0,0000 garch(1) 1,0186 0,0089 115,0676 0,0000 r-squared 0,2884 dependent variable: d(eur/us) date: 03/09/14 time: 12:00 included observations: 174 after adjusting endpoints coefficient std. error z-statistic prob. ma(1) 0,464845 0,088904 5,22861 0 ma(2) 0,004959 0,072703 0,068205 0,0094 variance equation garch(1) -0,128229 0,014563 -8,805107 0 1,025287 0,017666 58,03805 0 r-squared 0,165566 mean dependent var -0,0009 the u.s. leading index, as issued by the conference board, is a composite average of ten components: average weekly hours (weight .189), average weekly initial claims for unemployment insurance (.026), manufacturers' new orders, consumer goods and materials (.049), vendor performance, slower deliveries diffusion index (.027), manufacturers' new orders, non-defense capital goods (.012), building permits, new private housing units (.018), stock prices, 500 common stocks (.033), money supply, m2 (.306), interest rate spread, 10year treasury bonds less federal funds income ratio (.323), index of consumer expectations (.017). dudukovic (2005) demonstrated the causality between the credit spread and the u.s. leading composite index returns and showed that leading index explained up to 30% of credit spread changes. arma-garch model for uslead percent changes, usleadr, is presented in table 11. repo rate as explanatory variable are suggested by lando (2002). it is well known that the market for repurchase agreements involving treasury securities (known as the repo market) plays a central role in the federal reserve’s implementation of monetary policy. transactions involving repurchase agreements (known as repos and reverses) are used to manage the quantity of reserves in the banking system on a short term basis. by undertaking such transactions with primary dealers, the federal reserve bank, through the actions of the open market desk, can temporarily increase or decrease bank reserves. by definition, repo rate is the rate of return that can be obtained from selling a debt instrument future contract and simultaneously buying a bond or note deliverable against that future contract with borrowed funds. the best arima-garch model for those rates is given in table 12. duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 61 table 11. usleadr table 12. the best arima-garch model dependent variable: usleadr100 included observations: 173 coefficient std. error z-statistic prob. ar(2) 0.939386 0.034147 27.51011 0 ma(2) -0.772158 0.077257 -9.994679 0 variance equation c 0.356773 0.069682 5.120015 0 arch(1) 0.108312 0.051191 2.115844 0.0344 garch(1) -0.814267 0.256766 -3.171236 0.0015 r-squared -0.004185 mean dependent var 0.0032 dependent variable: d(repo3) included observations: 169 after adjusting endpoints coefficient std. error z-statistic prob. ar(1) 0.855709 0.077274 11.0737 0 ma(1) -0.606855 0.112583 -5.390271 0 variance equation c 0.019547 0.011925 1.639159 0.1012 arch(1) -0.034796 0.002004 -17.36755 0 garch(1) 0.548244 0.282948 1.93761 0.0527 r-squared 0.225874 mean dependent var -0.0124 the russell 2000 index measures the performance of the smallest 2000 companies in the russell 3000. it is published by the frank russell company. the index itself is considered to be the benchmark for all small-cap mutual funds. the best arma-garch model is presented in table 13. default rate. we use moody’s monthly default rates for all corporate u.s. issuers (available on bloomberg and, discontinued in 2002). a significant positive relationship between the credit spread and default rates is reported in by huan and hong, 2003, where the standard regression analysis is used to explain credit spread changes.the best arima-garch for default moody’s default rates is presented in table 14. table 13. default rate table 14. moody’s default rates dependent variable: r2000r included observations: 173 after adjusting endpoints coefficient std. error z-statistic prob. ar(1) 0,375244 0,278737 1,346228 0,1782 ma(1) -0,267793 0,295763 -0,905432 0,3652 variance equation c 5,52e-05 6,70e-05 0,824652 0,409 arch(1) 0,058571 0,056084 1,044343 0,0296 garch(1) 0,92554 0,067004 13,81327 0 r-squared 0,022226 mean dependent var 0,0097 dependent variable: d(mdefaultr) included observations: 136 coefficientstd. error z-statisticprob. ar(1) 0,82976 0,087785 9,45222 0 ma(1) -0,5206 0,141277 -3,6852 0,0002 variance equation c 0,00042 0,000245 1,72445 0,0846 arch(1) 0,03117 0,035966 0,86661 0,3862 garch(1) 0,91387 0,049796 18,3525 0 r-squared 0,21959 mean dependent var -0,0017 dynamic model empirical results the proposed dynamic regression model , is tested by using e-views software. different model equations are used, with different lags for independent variables. the resulting model is chosen as one for which all the variables were statistically significant, according to t-values and p values. according to table 15, credit spread determinants are proven to be: u.s. leading index, russell 2000 returns, interest rate swaps, s& p 500 returns, treasury bill changes, liquidity index and moody’s default rates. economic analysis (2014, vol. 47, no. 3-4, 53-68) 62 table 15. macro-financial crsp model dependent variable: d(crsp) date: 03/09/14 time: 12:00 included observations: 135 variable coefficient std.error t-statistic prob. usleadr100(-1) -0.04 0.01 -3.27 0.00 usleadr100(-3) 0.03 0.01 3.03 0.00 d(swap5(-2)) 0.04 0.02 1.89 0.12 d(swap10(-1)) -0.28 0.03 -9.27 0.00 d(tre3m(-2)) -0.14 0.04 -3.95 0.00 d(crsp(-1)) 0.33 0.06 5.34 0.00 d(tre3m(-1)) 0.15 0.03 4.30 0.00 sp500r(-1) 0.21 0.12 1.72 0.11 r2000r(-1) -0.28 0.11 -2.54 0.01 d(mdefr(-1)) -0.08 0.04 -2.04 0.11 d(mdefr(-2)) 0.11 0.05 2.20 0.03 d(trsw(-1)) -0.30 0.04 -7.61 0.00 variance equation c 0.00 0.00 1.79 0.07 arch(1) -0.06 0.07 -0.91 0.36 garch(1) 0.70 0.17 4.18 0.00 r-squared 0.729435 mean dependent var0.002 surprisingly, the volatilities of s&p 500, the volatility of credit spread and the volatility of treasury bills are neither significant for credit spread changes, nor for the change of rsquared. this could be seen from table 16, which has to be read as the bottom part of table 15. the same holds for repo rates, libor and us&eur exchange rate .this contradicts huang and kong, 2003 and lando 2005. the real credit spread and its iar-garch model are presented in figure 2. table 16. dependent variable: d(crsp) variable coefficient std.errort-statistic prob. crspvol 0,667885 0,86558 0,771606 0,442 spvol 0,218875 5,63366 0,038851 0,969 tbill3mvol -0,322887 0,30795 -1,04851 0,297 repo3(-1) 0,001459 0,00684 0,213343 0,831 duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 63 figure 2. real credit spread differences and its iar-grach model. the residual volatility obtained by using garch model is presented in figure 3. figure 3. credit spread volatility hoc approach to credit spread modeling the new approach to the credit spread forecasting, suggested in this paper, is based on arimagarch model (engel -boleslev1996). the model building, as usually, consists of three steps: model identification (order determination using akaike's information criterion – aic), parameter estimation and model testing. the main premises in this methodology is that each stationary time series is treated as the output of ar(p), ma(q) or arima filter, which has as the input uncorrelated non gaussian shocks known as "white noise" :a(z)* dyt= b2(z)* vt ,where vt is a white non gaussian noise , z is a backward shift operator: yt-1=zyt , yt-k =zkyt , a(z) = 1-α1z-α2z2 -αpzp and b(z) = 1-β1z-β2z2 …βqzq are ar and ma filters of orders p and q respectively, d is the first difference filter, dyt = yt yt-1 , dkyt=yt yt-k as for volatility its model is given by engle (1982) : p q h t =α 0 +∑α i r 2 t-i + ∑β j h t-j (4) i=1 j=1 in which pt represents stock prices, {rt} represent random returns, ht is the conditional volatility, αi is autoregressive, and βj is the moving average parameter as related to the squared stock market index residuals. -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 1999-2013 d(crsp): real and model monthly data crsp crsp-model 0 0.001 0.002 0.003 0.004 0.005 0.006 0.007 1 31 61 91 121 151 d (c r s p ) v o la til ity months garch variance garch variance economic analysis (2014, vol. 47, no. 3-4, 53-68) 64 an equivalent arma representation of the garch (p, q) model is given by: p q e t 2 = α 0 +∑(αi+β i )e 2 t-i +ν t ∑β j ν t-j (5) i=1 j=1 where t = et2 ht and, by definition, it has the characteristics of (i.i.d) white noise. in other words, the garch (p, q) volatility model is an autoregressive moving average (arma) model in et2 driven by white noise t .the rt2 is stationary if ( i+ i)t 1   the aim of this paper is to take a new direction which leads back to the essence of time series analysis. namely, it is argued that the sufficient statistics for credit spread is defined in terms of the higher order cumulant (hoc) function. it is hypothesized that the hoc model extracts the information about the credit spread , better if arma parameters are calculated by using both second, third and fourth order cumulant functions. a new method of parameter estimation for non gaussian processes is based on the higher order cumulants. the third c3y and the fourth order cumulants c4y are defined by gianninakis (1990): c3y(τ1,τ2)= (∑(y(t)y(t+τ1)y(t+τ2))/n, c4y(τ1,τ2)= (∑(y(t)y(t+τ1)y(t+τ2) y(t+τ3))/n, oyet a. (2000, pg 4) and zou at all.(2013) proved that efficient arma parameters can be obtained by using a modified set of yule walker equations where autocorrelations are replaced by third or fourth order cumulants: p ∑ αi c3(k-i,k-l) = c3(k,k-l) , k≥l≥q+1 (6) 1=1 p ∑ αi c4(k-i,k-l, k-m) = c4(k,k-l, k-m) , k≥l≥ m≥q+1 (7) 1=1 swami (1989) developed the matlab routine arest which enable ar parameter estimation using both the second and the third order cumulants . once the ar residuals are calculated, the ma parameters can be calculated by using the routine maest which uses the least squares set of equations: q q ∑βi c3(n-i,n-i)-∑β i2c2(n-i) =c2(n) , n= -q…,2q (8) 1 1 where both second and third order cumulants are used. duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 65 with the above theory in mind, the higher order cumulants are used for credit spread arima modeling. the forth order crsp cumulants are presented in figure 4.the different factors discussed here were investigated using matlab and its higher-order spectral analysis (hosa) toolbox. matlab was used to calculate estimates of the data's third-order cumulants, as well as to estimate arma model parameters. further residuals analysis is done using e-views. the obtained cumulants based model parameters are presented in table 18. the model and the real credit spread data are presented in figure 5. figure 4. third order cumulants for credit spread first difference figure 5. cumulant based credit spread model -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 1 22 43 64 85 106 127 148 169 1999:10-2013:07 credit spread -cumulant based model crsp crsphos economic analysis (2014, vol. 47, no. 3-4, 53-68) 66 table 18. cumulant based arima estimates dependent variable: dcrsp method: cumulant based least squares date: 12/02/07 time: 18:57 sample(adjusted): 4 174 included observations: 171 after adjusting endpoints convergence achieved after 30 iterations backcast: 1 3 variable coefficientstd. error t-statistic prob. ar(1) 0,939886 0,152151 6,177341 0 ar(2) 0,668867 0,217999 3,068214 0,0025 ar(3) -0,71802 0,114241 -6,28511 0 ma(1) -0,1833 0,103085 -1,77816 0,2911 ma(2) -0,35279 0,167842 -2,10191 0,0371 ma(3) 0,166202 0,08135 2,043051 0,1616 r-squared 0,857758 mean dependent var 0,0075 concluding remarks the credit spread predictability, defined as the difference between aaa corporate bond yields and 10 year treasury bond yields, has assumed a new importance since both investor managers as well as corporate finance managers need credit spread predictions to make more money. the multiple lagged iar-garch model for the u.s. credit spread is made in this paper for the period 199:01 to 2013:07. as explanatory macro-financial variables we investigated: u.s. leading index, russell 2000 returns, interest rate swaps, s&p500 returns, treasury bill changes, liquidity index and moody’s default rates, s&p 500 volatility, credit spread volatility, treasury bill volatility, exchange rates eur/usd, repo rates and libor rates. all the volatilities, repo rates, libor rate and exchange rates were not found to be causally related to credit spread changes. however, credit spread determinants are proven to be the following macro variables: u.s. leading index, russell 2000 returns, interest rate swaps, s& p 500 returns, treasury bill changes, liquidity index and moody’s default rates. the obtained macro model significantly improves predictability of credit spread changes. structured models based on micro independent variables, default rate and recovery rate, have explanatory power which varies from 20% to 50%.the proposed model explains 73% of the credit spread variability. the advantage of the lagged model over the classical instantaneous multiple regression models like (huang and kong, 2003) is that our model enables prediction, since the model relates future credit spread change and the current and past values of the explanatory variables or their changes. the second part of the paper introduces the estimation method based on higher order cumulants.namely, it is argued that the sufficient statistics for credit spread is defined in terms of the higher order cumulant (hoc) function. it is hypothesized that the hoc model duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 67 extracts the information about the credit spread, better if arma parameters are calculated by using both second, third and fourth order cumulant functions. a comparison with a dynamical regression model is also provided. ultimately, it is demonstrated that much of the information about the variability of the credit spread can be extracted from higher order cumulants. in fact the coefficient of determination obtained by regression for credit spread data is .729 while the coefficient of determination obtained by using the third order cumulants and applying hos method appears to be .857. this demonstrates the fact that the hos based arma estimation achieves statistically higher coefficient 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creditnog spreda macro-finansijskom metodom i metodom kvr rezime – cilj ovog rada je da objasni promene kreditnog spreda u zavisnosti od promena macro-finansijskih variabli koje nemaju gausovsku raspodelu. prvi deo rada predstavlja empirisku analizu baziranu na spredu između prinosa desetogodišnjih korporativnih aaa obveznica i državnih zapisa sa desetogodišnjim rokom dospeća (10ytb). makrofinansijske variajable uključuju indekse kao što su vodeći indeks rasta (us leading index), stock market indeksi russel 2000 i s&p500, s&p volatilitet, kurs eur/usd, repo interesna stope, promene cena bbb korporativnih obveznica, promena cena državnih ili trezorskih zapisa (tbills), indeks likviditeta, referentna kamatna stopa libor, moody stopa otpisivanja, volatilitet kreditnog spreda i volatilitet trezorskih zapisa. predloženi diniamicki regressioni model objasnjava 73% varianse kreditnog spreda u sad-u. drugi deo rada uvodi estimaciju parametara arma model kreditnog spreda, baziranu na kumulantima višeg reda kvr. demonstrirano je empiriski da uvedeni metod estimacije ekstrahuje 85% informacije o varijansi kreditnog spreada. ključne reči: modeliranje kreditnog spreda, ocena arma parametara, kumulanti višeg reda, ne-gausivi arma modeli, dinamička regresija article history: received: 30 july 2014 accepted: 2 november 2014 doi: 10.28934/ea.22.55.2.pp79-90 first online: december 15, 2022 preliminary report key features and challenges of the china-western balkan countries merchandise trade development elena jovičić18f* | danijela stojanović1 1 institute of economic sciences, belgrade, serbia abstract the western balkan countries’ economic growth and development largely depend on the integration of national economies into international trade flows. bearing in mind the expanding presence of china in the western balkans and the considerable increase in bilateral trade over the previous decade, it is of great importance to focus on the strategies for overcoming main challenges and fostering more balanced trade in the forthcoming period. regarding that, the main aim of the research was to analyze trade flows and patterns and investigate the trade intensity between the western balkan countries and china. furthermore, the research attempted to determine the main challenges and to consider the strategic approach to their overwhelming, including better exploiting the opportunities provided by trade cooperation with china in the rapidly changing global environment. the paper used desk research a descriptive analysis of data on merchandise trade between six western balkans countries (albania, bosnia and herzegovina, montenegro, croatia, north macedonia, and serbia) and china. the analysis was based on the data available in the un comtrade, trade map, and wto statistical databases for the period 2016-2021. in addition, the trade intensity index (tti) was also used in the paper in order to discover how intensively the western balkan countries were trading with china. however, despite the rapid trade growth with china, its share in the wb countries' total trade remains at a relatively low level of about 8%. the trade deficit also increased significantly, indicating a deepening of the asymmetry in the economic relations of the observed countries. although the trade intensity index (tii) also confirms the deepening of trade relations, the tii value of 0.24 in 2021 indicates that trade between the western balkans and china is not developed at a desirable level, and there is considerable room for improvement. keywords: china, western balkan countries, merchandise trade, exports, imports, challenges jel classification: f1, f5 introduction being almost non-affected after the 2008 financial crisis, china has continued its “go global” approach, which led to the increase of various chinese actors’ presence around the world (shambaugh, 2013). since 2008, chinese outward foreign direct investments have grown significantly (dong et al., 2011; jin et al., 2016), while china became the world’s leading exporter and second-major importer of merchandise goods in 2012 (gurría, 2014). * corresponding author, e-mail: elena.jovicic@ien.bg.ac.rs 80 economic analysis (2022, vol. 55, no. 2, 79-90) along with the intensification of china's economic presence worldwide, and especially in the region of central and eastern europe, the previous decade was marked by the dynamic development of relations with the countries of the western balkans (wb) in the field of economic and other aspects of bilateral and multilateral cooperation. china committed itself to expanding economic and political ties with central and eastern europe (cee), including the western balkan countries, by initiating the so-called china-cee mechanism (formerly known as the “16+1” and later as the “17+1” mechanism or platform). namely, the cee-china mechanism was founded in 2012 in warsaw as an initiative that will gather countries from cee and china with the aim of enhancing mutual economic, political and cultural relations (zakić & radišić, 2019). since 2015, china has been deeply engaging the wb countries to an unprecedented degree and has had a profound impact on this region in recent years (pavlićević, 2019). trade and investment activity have both been significantly increasing, attracting chinese companies’ interest in different strategically important investments and infrastructure projects in the wb region (vangeli, 2019). intensive economic cooperation between western balkan countries and china continued even during the covid-19 pandemic crisis, and there was a rise in the total trade exchange recorded (the highest growth rate of trade of the western balkans countries was achieved precisely with china). this positive dynamic was primarily the result of the effective realization of measures to prevent the spread of the virus and the role of china in providing assistance to the countries of the western balkans in the fight against the pandemic, primarily as the most important or even the sole supplier of protective and other medical equipment and pharmaceutical products necessary for the treatment of the sick (beraha & jovičić, 2021). although the growing trade and expanding investments are often mentioned in the context of the deepening cooperation between the western balkans and china, it seems that investments still attract much more attention from scholars than trade. trade, again, could play a vital role in the western balkans’ efforts to promote its economic growth and more stable and balanced trade relations with china. in accordance with the above-mentioned, the main aim of the research was to analyze trade flows and patterns and investigate the trade intensity between the western balkan countries and china. in addition, the research attempted to determine the main challenges and to consider the strategic approach to their overwhelming, including discovering the measures for better exploiting the opportunities provided by trade cooperation with china. theoretical background international trade, i.e. exports and imports, is one of the key drivers of economic development (bakari & mabrouki, 2017). the scientific literature extensively discusses the relationship between trade openness and economic growth, and the majority of empirical studies' findings support the idea that trade openness promotes economic growth (çetintaş & barişik, 2009; busse & königer, 2012; huchet et al., 2018; marjanović & domazet, 2018; gurgul and lach, 2014). in addition to promoting faster growth, international trade supports productivity improvement, providing better living standards and lower income inequality (cerdeiro & komaromi, 2017). in terms of international trade significance, an enhancement of exports is of particular importance. eberhard-ruiz and calabrese (2018) claim that a country's level of export competitiveness is crucial for its successful participation in the global economy and international trade but also for managing the eventual deterioration of the trade balance. nguyen (2011) and atkinson (2013) consider exports to support increased specialization in production by more efficient resource allocation, which boosts productivity and consequently promotes more robust economic growth. countries could benefit from export-led economic elena jovičić, danijela stojanović 81 growth because it facilitates foreign exchange inflows, increases production, creates new employment opportunities, and increases the overall commercial volume (temiz dinç & gokmen, 2019). furthermore, export trade diversification is essential since it makes economies more adaptable to changes in demand, enables more effective inclusion of small and mediumsized enterprises, and promotes innovation (songwe, 2019). export-led growth is essential for boosting economic growth in developing countries (hakobyan, 2017). it may be especially significant for small (or relatively small) open economies (like western balkan countries), which rely much more on cooperation with external partners (baranenko & đukić, 2012). this confirms ilahi et al. (2019) claiming that “in the past several years, exports have contributed strongly to growth and economic convergence in many small open countries, aspiring western balkan countries to embark on an export-led growth and convergence path.” although most countries experienced the positive effects of net exports on growth in the post-crisis period, the wb region still lags behind, primarily due to “a lack of openness, reliance on low-value products, and weak structural competitiveness” (ibid). shimbov, et al. (2019), by using an export sophistication index, reveal that export sophistication has a positive and significant impact on the wb countries’ economic performance, while the research outcomes support the idea that greater involvement in global production networks, along with improved institutional environments, promotes the export enhancement and, as a result, accelerates economic growth. on the other side, authors found that this process in the wb countries “is driven more by the sophistication in medium-skill and technology-intensive manufactured goods rather than through sophistication in high-skill goods” (ibid). in this regard, bearing in mind its growing presence in the region, china appears as one of the trade partners that could encourage export growth as well as more effective involvement of the companies from the wb countries in the global value chains (gvcs). however, most of the authors (zakić, 2022; beraha & jovičić, 2021; gigov & poposka, 2022; szunomár et al., 2020; jaklič & svetličič, 2019; jacimovic, et al. 2018; yue, 2018; matura, 2019; and others) generally conclude that despite the intensive development of economic cooperation, the wb countries have not fully benefited from trade with china – trade remains unbalanced, leading to significant trade deficit growth in most countries in the region. data and methodology the paper used desk research a descriptive analysis of data on merchandise trade between six western balkans countries (albania, bosnia and herzegovina, montenegro, croatia, north macedonia, and serbia) and china. for the purpose of the research, the data was retrieved from the un comtrade, trade map, and wto statistical databases for the period 2016-2021. merchandise trade structure was observed at the harmonized commodity description and coding systems (hs) 2-digit level. for the sake of a more coherent approach, the data was collected so that china was observed as a reporting country on merchandise exports and imports (reporter), while the countries of the western balkans were considered partner countries (partner). in addition, the trade intensity index (tti) was also used in the research in order to measure how heavily the western balkan countries were trading with china. tti is defined as “the share of one country’s exports going to a partner divided by the share of world exports going to the partner” (world bank, 2010). the tii approach determines whether the value of trade between two countries exceeds or falls short of what would have been anticipated based on their relative significance in world trade by evaluating bilateral trade status based on both a country's global trade status and its trade partner's economy size (maryam et al., 2018). the mathematical definition of tii is as follows: 82 economic analysis (2022, vol. 55, no. 2, 79-90) tij = (xij/xit)/(xwj/xwt) (1) where xij and xwj are the values of the country i’s exports and of world exports to country j, while xit and xwt are the country’s total exports and total world exports respectively (world bank, 2010). an index with a value greater than one denotes a high level of trade intensity between the two economies. conversely, a lower estimate of the index (if it is less than one) denotes less bilateral trade intensity between the partner countries. results and discussions according to the un comtrade data, the total merchandise trade between the wb countries and china was steadily growing in the period 2016-2021, so the total trade volume amounted to 7.3 billion us dollars in 2021, which represents an almost threefold increase compared to 2016 (figure 1). continuous positive annual growth rates were also recorded on both the wb countries’ imports and exports sides, except for 2016 and 2018, when there was a slight y-o-y decline in total exports. robust import volume growth overshadowed an increase in exports, which resulted in a worsening of the trade balance. namely, the trade deficit significantly widened to around 3.3 billion us dollars in 2021, or it was almost 99% higher compared to 2016. figure 1. the wb-china trade dynamics over the period 2016-2022, in mil. usd source: un comtrade database compared to 2020, the total wb countries’ trade with china saw a remarkable rise of almost 40% in 2021, driven by a sharp increase in exports (87%) and a more moderate increase in imports (27%). the significant export growth contributed to the trade deficit reduction in 2021– the trade deficit increased by only 6% compared to the previous year. such an impressive dynamic determined by high y-o-y growth rates was, among other things, the result of a low base from 2020 caused by a decrease in economic activity as well as trade flows due to the negative impact of the covid-19 pandemic. however, it should be mentioned that a proactive approach enabled china to position itself as an important external participant in the western balkans region during the pandemic and accelerate bilateral trade relations. due to the success in the fight against the covid-19 virus, i.e. the speed with which it managed to restore full production after the complete lockdown of provinces and cities and take advantage of the 4% 16% 14% 15% 23% 39% 0 5 10 15 20 25 30 35 40 45 2016 2017 2018 2019 2020 2021 -4000 -2000 0 2000 4000 6000 8000 exports imports total trade balance yoy growth elena jovičić, danijela stojanović 83 increase in demand, china, for instance, became one of the few countries with which trade growth has been achieved in 2020 (beraha & jovičić, 2021). observed by individual countries, the largest share in the total trade with china in 2021 was achieved by serbia (44%), followed by croatia (32%), while the share of other countries was much more modest: albania 10%, north macedonia 8%, bosnia and herzegovina 4%, and montenegro only 1% (figure 2). in terms of exports, the dominant position of serbia was even more pronounced, with a share of as much as 49%, while the shares of north macedonia, croatia, albania, bosnia and herzegovina, and montenegro were 18%, 17%, 8%, 7%, and 1% respectively. figure 2. the share of individual countries in total trade between the wb countries and china source: un comtrade database during the period 2016-2022, serbia was the only country that recorded a continuous annual increase in total trade (see figure 3), but also in both exports and imports, confirming the fact to be the most important chinese trade partner among the other five countries. however, apart from montenegro, the positive growth rates of total trade in 2021 compared to 2020 were achieved by all countries: north macedonia and serbia’s trade with china saw an increase of 55% and 52%, respectively, followed by bosnia and herzegovina (42%), croatia (36%), and albania (16%), while trade between montenegro and china reduced by 37%. figure 3. the western balkans-china total trade annual growth rates source: un comtrade database 0,44 0,32 0,1 0,08 0,04 0,01 serbia croatia albania north macedonia bosnia and hercegovina montenegro 2016 2017 2018 2019 2020 2021 -60 -40 -20 00 20 40 60 80 100 albania bosnia & herzegovina montenegro croatia north macedonia serbia 84 economic analysis (2022, vol. 55, no. 2, 79-90) based on the analysis of the trade structure, it could be concluded that there were no significant changes during the observed period. the low-value-added goods were the backbone of the western balkan countries’ exports, while the more sophisticated goods were imported from china (table 1). table 1. the western balkans-china exports/imports composition in 2021: key commodity groups* exports imports albania • ores, slag and ash (55%) • iron and steel (24%) • articles of apparel and clothing accessories, not knitted or crocheted (9%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (18%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (12%) • furniture; bedding, mattresses, mattress supports, cushions and similar stuffed furnishings (8%) bosnia & herzegovina • articles of apparel and clothing accessories, not knitted or crocheted (26%) • wood and articles of wood; wood charcoal (26%) • ores, slag and ash (17%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (27%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (14%) • pharmaceutical products (11%) croatia • ships, boats and floating structures (50%) • wood and articles of wood; wood charcoal (16%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (12%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (24%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (15%) • toys, games and sports requisites; parts and accessories thereof (7%) montenegro • ores, slag and ash (56%) • beverages, spirits and vinegar (14%) • optical, photographic, cinematographic, measuring, checking, precision, medical or surgical instruments and apparatus; parts and accessories thereof (13%) • iron and steel (12%) • plastics and articles thereof (11%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (11%) north macedonia • iron and steel (61%) • miscellaneous chemical products (11%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (10%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (26%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (21%) • miscellaneous chemical products (6%) elena jovičić, danijela stojanović 85 exports imports serbia • ores, slag and ash (39%) • copper and articles thereof (31%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (10%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (34%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (21%) • articles of iron or steel (7%) * the percentage share of major commodity groups in wb countries’ imports from/exports to china source: authors’ based on the trade map data in terms of imports, there was a remarkable average annual growth rate over the previous five years in imports of pharmaceutical products in all wb countries except albania and croatia: montenegro had a 938% increase, bosnia with 210%, serbia with 138%, and north macedonia with 120%. on the export side, serbia had a record average annual growth rate of copper exports of 809%, while albanian iron and steel exports increased by 248% on average. despite these positive tendencies, the share of the wb countries’ goods in total chinese imports is still negligible, with about 3% in 2021. observed by the individual countries, it is even less. if taking a look at the sum of the main three export commodity groups in each country, not one country reached even 1% in the imports of china. for instance, even the sum of the 3 top commodity groups (ores, slag and ash + copper and articles thereof + electrical machinery and equipment and parts thereof, etc.) of exports of serbia (that otherwise has a leading position among other wb countries) was less than 1% of total imports of china in 2021. trade intensity index development it was chosen to employ the trade intensity index (tti) approach in the study to carry out a more thorough analysis of trade relations between western balkans and china. as already mentioned in the methodology part, this approach enables the assessment of the bilateral trade intensity level based on the country’s status in international trade and its trade partner’s economy size (jovičić et al., 2020). as can be seen in table 2, although the tti value has been rising over the last six years, reflecting the fact that the trade relations between the wb countries and china have been strengthened, the tii value of 0.24 in 2021 indicates that trade between given partners is “under-represented.” this implies that there is undoubtedly considerable room for improvement. table 2. trade intensity index of the wb region and china 2016 2017 2018 2019 2020 2021 0.14 0.16 0.12 0.15 0.18 0.24 source: authors’ calculations based on un comtrade and wto databases the evaluation of tti between the individual wb countries and china gives a more complicated picture (table 3). namely, the value of tti has been changing across the countries during the period 2016-2022. albania and montenegro were the only two countries that closed (albania) or surpassed (montenegro) the value of tti numerically equal to one in some particular years. trade between the rest four countries (bosnia & herzegovina, croatia, north macedonia, and serbia) and china has been underrepresented. meanwhile, the value of tti has been increasing in the last few years. 86 economic analysis (2022, vol. 55, no. 2, 79-90) table 3. trade intensity index of the wb individual countries and china albania bosnia & herzegovina montenegro croatia north macedonia serbia 2016 0.66 0.08 0.93 0.12 0.10 0.11 2017 0.82 0.09 1.72 0.11 0.15 0.12 2018 0.34 0.10 0.97 0.11 0.06 0.11 2019 0.35 0.11 0.96 0.08 0.19 0.17 2020 0.28 0.10 1.34 0.07 0.29 0.22 2021 0.42 0.13 0.22 0.12 0.34 0.32 source: authors’ calculations based on un comtrade and wto databases main challenges hampering the trade relations enhancement regardless of the deepening economic relations with china, which was, among other things, reflected in an increase in the trade volume, the wb countries still face many challenges and issues that should be overwhelmed. one of the main challenges is the fact that despite the intensive dynamic of trade relations development with china, its share in the wb countries’ total trade still remains at a rather modest level of around 8%. in 2021, china's participation in total imports of the wb was 11%, and in exports only 3%, while the eu appeared as the most important foreign trade partner of the countries of the western balkans with a share of 81% in exports and 58% in imports (eurostat, 2022). another issue is the fact that the trade is strongly in favor of china, which means that the countries of the wb record a continuous deficit. this fact in itself would not be so worrying because china generally has a positive balance with most countries around the world, but the challenge is that when it comes to the wb region, the trade deficit with china has been steadily deepening over the last few years, and this is particularly relating to serbia, croatia and albania (figure 4). figure 4. the western balkans-china trade balance, in bln. usd source: un comtrade database one of the key obstacles that remain is poorly diversified exports, which applies to all western balkans countries. namely, the backbone of exports in the previous period comprised 2016 2017 2018 2019 2020 2021 -002 -002 -001 -001 -001 -001 -001 000 000 000 000 000 albania bosnia & herzegovina montenegro croatia north macedonia serbia elena jovičić, danijela stojanović 87 ores, iron and steel, coppers, wood and wood products, as well as construction materials such as sand and concrete. all these products represent products with low added value, which means a very unfavorable position for the wb countries compared to china. furthermore, trade cooperation is often slowed down by barriers to market access like subsidies, capital restrictions on foreign investments, lack of transparency, and complicated regulation in china. the delay in the agreements’ implementation, which refers primarily to acquiring export licenses, could also be mentioned in this concern. a challenge that also defines trade cooperation is the absence of a strategic approach and lack of institutional support, which is the problem all six countries continuously face. in addition to that (but in some manner as a consequence of the lack of a strategic approach), “insufficient access to information, language and cultural barriers, mistrust and risk of fraud” appear as serious obstacles as well (gigov & poposka, 2022). the global market situation should also be considered in the context of the key obstacles. namely, the trade flows, as well as global value chains, had barely recovered after the disruptions caused by the covid-19 pandemic when the ukraine-russian federation conflict and consequent energy crisis took over the role of the major blow to the global economy. the growing geopolitical tensions and economic turbulences have already had a negative impact on the gvcs and global trade flows, which means the new disruptions in the trade relations between china and other countries worldwide, including the wb region, could also be expected in the forthcoming period. recommendations for the overwhelming of key obstacles considering the above-discussed key challenges, one can get the impression that the prospects for the development of trade relations in the upcoming period are not very promising. however, it should be borne in mind that there is still a significant potential that, with an appropriate strategic approach, the wb countries can use to improve the current situation. regarding the opportunities, the size of the market should be taken into account, as well as the growth of the purchasing power of chinese consumers, which means that there is definitely room for more intensive promotion of domestic companies to enter the chinese market. with full appreciation of china's economic superiority, the countries of the western balkans have certain comparative advantages on which the further development of trade relations with china should be based. this primarily refers to the price competitiveness of highly educated human resources in the field of advanced technologies and potential in the field of agricultural production and processing food (beraha & jovičić, 2021). it is necessary to encourage the attraction of investments in strategically important sectors that could produce greater added-value products. in this regard, work should be done to promote the inclusion of the countries of the western balkans in the global value chains of chinese producers and, in this way, also contribute to increasing exports of higher value-added products and helping productivity gains and income growth. having in mind similar trade patterns of the western balkan countries and close economic and trade cooperation inside the region, it is worth considering the development of a joint tactical approach to exports enhancement, the removal of trade barriers, and to the better positioning of the domestic companies on the chinese market. moreover, the cooperation in this context should be deepened not only among the wb but also with other countries of the cee region since most of them are participating in the china-cee mechanism. the authors completely agree with the crucial recommendations offered by gigov and poposka (2022) regarding the fact that “all wb countries, except serbia, have a limited understanding of china in terms of its goals, opportunities, politics and public policies”, which appears as one of the major challenges that should be overwhelmed. namely, gigov and poposka (2022), in this context, conclude that it is necessary to acquire expertise and knowledge and 88 economic analysis (2022, vol. 55, no. 2, 79-90) create a strategy that will enable policymakers to make decisions based on current and adequate information. along with attracting chinese investments, western balkan policymakers should be more proactive in initiating negotiations to improve trade relations and promote exports to maximize national interests. it should be mentioned in this regard that serbia was the first country in the wb region to take an important step on the path of the development of the strategic approach towards trade relations encouragement with china by the announcement of the free trade agreement conclusion that should be signed by the end of 2022. currently, it is difficult to predict all benefits and risks the fta will bring since all details and obligations are yet to be specified. nevertheless, it is expected that the fta would further strengthen the economic relations between serbia and china by delivering enhanced investment and trade opportunities. conclusion involvement in international trade flows contributes to the improvement of competitiveness and encourages economic growth and development of national economies. international trade is of special importance for developing countries since it, among other things, enables the realization of the effects of economies of scale, a higher degree of capacity utilization, attracting foreign direct investments, increasing employment, and technological advancement. trade undoubtedly represents a very important aspect of economic cooperation between the countries of the western balkans and china, and the deepening of relations during the past decade has resulted in the continuous growth of bilateral trade. whereby the intensification of trade cooperation and the acceleration of foreign trade occurred, especially after the accession of the countries of the western balkans to the belt and road initiative, i.e. the china-cee mechanism, which is an integral part of the belt and road initiative aimed at the development of china's economic relations with central and eastern europe. regardless of the deepening economic relations with china, which was, among other things, reflected in an increase in the trade volume, the wb countries still face many challenges that should be overcome. primarily, it refers to the deepening trade deficits, poorly diversified exports, lack of the appropriate strategic approach and support to the domestic companies willing to enter the chinese market, and, finally, the situation on the global market. in the forthcoming period, efforts should be made to attract chinese investments in strategically important sectors as well as to promote the inclusion of domestic companies in the gvcs of chinese producers in order to enable greater production of higher added value products and as well as contribute to export diversification. of great importance also is the development of comprehensive strategies and more proactive western balkan policymakers’ approach to export promotion and initiating negotiations that would lead to the enhancement of economic relations with china based on better 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(2017). excess reserves and monetary policy implementation. review of economics dynamics, 23, 212-235. arrata, w., nguyen, b., rahmouni-rousseau, i., & vari, m. (2020). the scarcity effect of qe on repo rates: evidence from the euro area. journal of financial economics, 137(3), 837-856. bartolini, l., hilton, s., sundaresan, s., & tonetti, c. (2011). collateral values by asset class: evidence from primary securities dealers. the review of financial studies, 24(1), 248–278. bekaert, g., hodrick, r. j., & marshall, d. a. (1997). on biases in tests of the expectations hypothesis of the term structure of interest rates. journal of financial economics, 44(3), 309-348. boissel, c., derrien, f., ors, e., & thesmar, d. (2017). systemic risk in clearing houses: evidence from the european repo market.” journal of financial economics, 125(3), 511-536. bottazzi, j. m., luque, j., & páscoa, m. (2012). securities market theory: possession, repo and rehypothecation. journal of economic theory, 147(2), 477–500. d’amico, s., fan, r., & kitsul, y. (2018). the scarcity value of treasury collateral: repo-market effects of security-specific supply and demand factors. journal of financial and quantitative analysis, 53(5), 2103-2129. longstaff, f. a. (2000). the term structure of very short-term rates: new evidence for the expectations hypothesis. journal of financial economics, 58(3), 397-415. covid-19 and serbian stock market response: a panel data approach bojan đorđević1 | sunčica stanković14f* introduction literature review research methodology research methods results of econometric tests conclusion references the quest towards obtaining a competitive advantage in organizations through managing the human capital nikaela wilson1* | iva vuksanović herceg25f* introduction the concept of human capital, elements and approaches for achieving competitive advantage in organizations human capital elements for achieving competitive advantage in organizations employees’ natural and personal skills employees’ commitment employees’ knowledge employees’ innovative skills intellectual capital and competitive advantage the two common types of competitive advantage the resource base perspective to achieve competitive advantage approaches based on the theory of human capital competitive advantage and managing human capital industry 4.0 and human capital in achieving competitive advantage concluding comments does the increase in the number of registered patents affect economic growth? evidence from romania and bulgaria ivana domazet16f* | darko marjanović1 | deniz ahmetagić2 | marija antonijević1 introduction literature review data analysis and findings conclusion acknowledgements references business process innovation of serbian entrepreneurial firms mihailo paunović1 | marija lazarević-moravčević1 | marija mosurović ružičić17f* introduction theoretical background data and methodology results and discussion conclusion acknowledgements references key features and challenges of the china-western balkan countries merchandise trade development elena jovičić18f* | danijela stojanović1 introduction theoretical background results and discussions trade intensity index development main challenges hampering the trade relations enhancement recommendations for the overwhelming of key obstacles conclusion acknowledgements references sedmi aa1* | bb2 | vv3 osmi aa1* | bb2 | vv3 deveti aa1* | bb2 | vv3 deseti aa1* | bb2 | vv3 microsoft word 2009_1_2.doc world economy crisis and the possible impacts it might have on bosnia and herzegovina adnan rovčanin, faculty of economics, university of sarajevo, sarajevo, b&h amra kožarić, faculty of economics, university of tuzla, tuzla, b&h key words: instability of global economy, emerging crisis, global economic recession, bosnia and herzegovina jel: f01, f33. abstract – at the end of 20th and the beginning of 21st century, the international community, through various forms of action plans and ambitious steps, has engaged itself to solve problems of the birth and wide increase of instability of global economy, that many countries stages of development and transitional economy have faced. nevertheless, the results of this have not been very impressive. the concern still exists that the new and even worse global recessions will take place as well as the wide spread of global instabilities on the international markets. as far as it looks, situation is more serious than the governments are ready to admit. the economists and world leaders are greatly presenting pessimism because of those issues. the uncertainties on the markets, globally looked at, are staying very great. in conditions like those, discussions will be focused on what steps should be taken to soften the risks at the financial markets and how the instability, that describe the world economy in the 21st century, could decrease. hence the first part of this paper is discussed the current situation as well as the modern problems that the global economy faces, where the combinations are made from available information about modern discussions about international economic relations, global economy and crisis, so that all the actors of the global financial system are ready to asses the global future options and their possible impact on their lives. special focus in this research, as the second part of the paper, is put on bosnia and herzegovina, a transitional country in development stage, that lies in very poor economic state and which is threatened by a big blow of world instabilities and crisis. introduction the modern international economic relations are presenting the fact that things arenʹt looking great on the international financial markets. the overwhelming and accelerated liberalization of international movement of capital, frequent speculative blows on the international monetary system and national financial systems, the birth and development of financial abnormalities and global financial crisis, inadequate determined regimes of foreign currencies are just some of the global prevalent financial problems that came with the last decade. the characteristics mentioned above are intensifying parallel with the problems of increased scope of international financial transactions and intense transfer of financial instruments, the integration of international financial markets (especially the euro currency market, the international bonds market and the foreign currency market), the inconsistencies in the foreign currency politics with macroeconomic performances, the problems in creating a stable currency configuration, increased system risks as well as the problems in keeping up the international liquidity. economic analysis 1-2 (2009) 65-78 66 despite the fact that current coordination of macroeconomic politics is on the global level, the biggest monetary problems that the world economies are facing, especially the economies of the countries in developing phases, have made the impression the global economy is more unstable today, than it was in the past decades. the inadequate, decelerated, and unsatisfactory activities of international financial institutions, especially imf, in the solving of international financial crisis (before in the case of mexico, brazil, russia and eastern asia, and now in the case of usa and the whole europe), and supporting development of developing countries are presenting more serious problems inside the global economy. this is all generally usurping the world financial scene and greatly impacts the deepening of unbalances and financial crises in the global economic arrangement up to several years. unfulfilling the criteria of efficiency in the world financial systems is causing the appearance of great fluctuations that are quickly dispersing throughout the whole world. the instabilities and economic unbalances have become global and systematic, and the attempts of certain countries to come over this excessive and crisis are simply not enough. concerning with that, question is what kind are those global problems that are facing the industrially developed countries and developing countries, that have consequently caused the need, or raison dʹetre for timely action and reform of global economic arrangement, global economy, and the need to redefine the direction of activities of international financial institutions in the context of solving of all the mentioned financial instabilities, (economic and financial) crisis, and recessions? according to, and regarding to our determined aforesaid topic in this paper, we set up next hypothesis: instabilities on the international financial markets, and amending on the international monetary market, inflation movements and global riots in the global financial system, essential affect on the new economic system which lead global economy to the serious crisis state. respecting the beforehand fitted topic and hypothesis, we will set up objectives of the research: identification global and actual problems of global economy and identification and analyzed rate of concern from global economic recession, and in finally implications of these world instability trends on the weak, insufficiently developed, transition economy of bosnia and herzegovina. before we look at the factual state in which the world economy is in, we will make few references: since this is a very complex and extensive theme, we will give our best to present the most important trends and describe them abbreviated and sublimation, everyone is slightly interested to spot trends as well as the impact on the personal state in the countries, but everything is based on predictions. economic situation in the world today can be presented in four key determinants: • new global economic system: in the past 30 years or so, dramatic changes had occur as: affirmation and appearance of eu, strong of japan, asia and phenomena that are chine and india; • (predicted) economic indexes of the situation and growth (gdp, interest rate, inflation, foreign currencies, deficit of the balance of payment); • e n e r g y g e n e r a t i n g p r o d u c t (crude oil, gas, coil), food (wheat, rice, corn, soy) and minerals (iron, aluminum, copper, colored metals), bio e n e r g y g e n e r a t i n g p r o d u c t –one billion people are living with less than a $1 daily, 400 million people are living with less that $2 daily, or 1,5 billion people are living on $1-2 a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 67 daily. there is famine, and in over 90 countries, the threats of protests because of food prices are inevitable. the price increase in the past (2008.) year is one of the greatest in history; • the credit crisis–huge losses for the banks because of the wrong full investments in bonds, based on mortgages, increase in the real estate values have made the markets too hot, the transformation of credits into stock products like derivatives, bonds. because of this transformation of credits into stocks, the risks have been fogged and the market has been brought to delusion. certain banks have lost up to $100 billions, and the total losses are about $1 trillion. the effects of this crises are expanding to eu, australia and canada. current condition and the main problems of world economy the question that will start the discussion is an obvious one, a question if the continuance of the modern global economy is anticipated, the economy that was typical by huge increase and change during the 90ʹs of the 20th century? the fact remains that the global unbalance has spread rapidly in the past few years and reached a point for which most are saying that it is a climax, and that itʹs leading to global concern. in addition to that, the adequate tendencies are not existence yet, the ones that could correct the imbalances. if those kind of indicators are not implemented and if it is proven and assessed that the current situation is unstable (or better said, if the current worrying situation has proven to be true), the result could be the crisis. which form could be expected from such crisis? well, the closest form would be the world recession. because of that, most of the leading world economists are showing great concern of the birth of the potential global world economic recession that would come from the distance between the industrial and developing countries, and as the main problems of world economy would inflation and rapid drop of dollar value comparing to the euro and the pound of sterling. considering the rebalance on the world monetary market, the crises on the real estate marked (mortgage market), not just in the mostly developed countries such as usa, but in the developed world, this inflation movements are followed by great unemployment, increase in liabilities, the payable balance imbalance, the deficits in the budgets and the mess in the global financial system, all brought to the fact that the global economy is in a very serious state. the important fact is that the world crises could lose at the financial markets, and as many are saying, this is one of the hardest economic crises since the great depression and the end of the wwii. it is hard to predict how much deeper the real estate prices will drop in the usa and how long the crises at the mortgage loans market is going to last, but itʹs very important to emphasis that this thatʹs happening in the world economy is the new thing for the economic politics, and that the economy doesnʹt have great experience in this department. this fact is supported by the research of the two american economists paul krugman and ex boss of the feb alan greenspan, who made a statement that this is one of the worst crises yet. even martin wolf has written for the financial times that the capital dream of a free market has long been woken up, a the reason why the economists and the financial experts cannot agree on the character of the crisis is explained as follows: “one reason is the complexity of the crises, and the other is the fact that this crises is something brand new...“, and then he adds: “this crises is extremely complicated, it involves the economic analysis 1-2 (2009) 65-78 68 macroeconomic elements that are creating deficit on the world monetary market, and the feb politics is very questionable. to continue, there are inflation movements and finally, mess in the sole of the global financial system. the news is that the financial system today is different than the one of the past. real estate price drop in the usa was unheard of. attachment of this fact to the world economy, is without a president. this is brand new, and we do not have much experience with that.“1 the main reason which effect global economy, martin wolf assume the mortgage credits and real estates in usa: “we donʹt know how many people will have losses, we donʹt know the proportion of these losses, and also we donʹt know the government’s instrument for resolving this problems. i am assured that global recession is c o m i n g i n t o e x i s t e n c e , and because of that, global economy, global financial system and usa economy is need to be heal. off course it could be my guesses, and it could show that i was wrong. economic, financial crises attack developing countries”.2 c o n s e q u e n t l y , those countries reach the recession, protectionism, inflation, higher oil prices, interest rates, volatility of exchange rates, etc. all in all, financial and economic experts think that the basic characteristic of future will be the occur of the international financial crises, the international financial institutions (imf, world bank, wto) are completely unready to deal with them. because of the number of international financial crises, today developed countries organize numerous world economic forums (wef). especially, we emphasize the forum in davos (january of 28th – february of 02nd 2009) where the basic topic was usa crisis, new global financial system and its possible reform, expanding the crisis in other regions (europe, asia, africa), the reform of the international monetary fund (imf) and the world bank, and decreasing the protectionism, poverty, investments in energy sector, climates changing, etc. anyway, todayʹs crises wonʹt be resolved in nearly future. the new era of crisis management and global recession seek for more sophisticated dimensions and political tools. that new era should introduce the new discipline-crisis prevention and crisis resolution, and to put in the first place the role and the power of the international financial institutions (imf, the world bank). that institutions should be prepared to manage with global economy. hence, today is deadline for any other comments and for starting public discussions, we donʹt have time for promises, we need cooperation between developing and developed countries, we need to solve this chaos in global financial system right now!. destiny of the global economic: world economic crises which was the basic characteristic of the world economy in past year (2008)? because of finance worldwide ferment which was begin since more of two years, the global economy is confront with big imbalance how between certain countries, that’s like inside certain national economy. in the process of economic recovery it is necessary to relief and/or elimination of that imbalance. it is hard to tell with what speed or successful it will happen. the fact that the parts of the global economy are in different level of business circles it can have a twosided influence on the next trend of economic growth. it can act like dynamic and stability performance for preserving the global growth, which required strong worldwide 1available: [http://www.poslovni.hr/32169.aspx], (3.4. 2008.) 2ibidem. a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 69 coordination and cooperation, but also can contribute the consolidation of the worldwide protectionism. because of that the consolidation of the international integration and the step up of international assets flows for whose bring the economic protocol, it will make a new challenge. currently, the countries who was affected with global finance crises and recession are gradually recovering, but their recover is not enough for now. next progression will depend of the future structural reforms in that economy. [greenspan a., (2007), 8.] the crises of the global economy and that’s issue are present the main discussion. as the awake about changes broad the world, the discussion about international relations and crises are opening the question which gain the new and exhausted discussion. in the beginning of the 21st century it is said the most about the features of the new century. discussion about the possible global changes was got the frenetic extension of field, and it was abetment with the growth hope that’s the peace between the people and the growth of prosperity during the 21st century years in the future will stay. many people are kept the breath on that promises of the stabile future of the world. however, our era doesnʹt have its name or define character. we are living in the period of which passed a few different wars. these e t i q u e t t e donʹt talk enough about transition time of world history. we left all behind us, but still we donʹt believe in the future. the world got into new century. but, how we can think about global future, when currently the global financial system is threaten by financial collapse?. * * * from day to day, somehow we had a few ideas that couldnʹt get off our mind, and all information which we got and read form our thinking, lead us to conclude that destiny of the global economic is world economic crises. why we think so? namely, almost the whole world production is based on oil, and as we expect that barrel will amount $200, surely in future there will be higher prices of foodstuff and (non) foodstuff. forward, we also emphasize higher prices in energy sector, service sector [salvatore d., (2006), 794.] … and for rapid changing of alternative form of energy there is no time, from day to day us dollar is decreasing, even today it achieve the lowest rate with regard to euro, and when us dollar is very low, that means that “something doesnʹt respond well“. there are also, a huge credit crisis, a huge fear from recession, inflation cycle... usa is b e l l w e t h e r of the world, and every adventure in state is reflection on the rest of the world. how the land lies, usa has a unlikely future, unfortunately, the same destiny is prescribe for the rest of the world. but, price of oil isnʹt just a main reason for our panic. one of the basic fears is so called; domino effect, caused by the recognition of kosovo, where will be tense political situation for short period of time, and where will economic circumstances make worse or more difficult. also, we emphasize that, global heating will cause less yield in agrarian sector, and hereby the famine of the basic food stuffs. economic behold, with the increasing the demand, the price will be higher, which means that it could effect global economy. list of the factor that could effect on global economy is a p p r e c i a b l e . take just banal example of the protest against price increasing and oil across the world. politicians care, but they donʹt know how to deal with the current situation. inadequate passed dimensions didnʹt solve the economic diseases! economic analysis 1-2 (2009) 65-78 70 do we have a reason to get worried...? generally speaking, yes! not paying attention to the measures that are currently being taken, with the goal to avoid financial crisis of greater volume, many countries in europe and usa believe in the economy worsening in year 2009. most of the population of the four european countries and usa believed that the economy situation in 2008 was getting worse in comparing to the situation in the past year (2007). this was shown in the financial times research that presented that 61% of great britain, 55% of france, 54% of spain, 57% of italy and 54% of usa population believed in worse economy in the current year. the population poll on this something differs in germany where 33% of the population believe in the economy to worsen, while 47% think that the situation will pretty much stay the same. nevertheless, the research was done from january of 10th to 21st of this year through the internet, and it was done on a sample of 6676 adults ranging from 16 to 64 years of age, in france, germany, great britain and usa, as well as the adults ranging from 18 to 64 years of age in italy. most pessimism was presented through the economy outlook of every particular country. having said that, when we are talking about the situation in the personal finances department in 2008, people tend to be more optimistic. also, 44% of italy, 43% of great britain, 41% of american, 38% of germany and the same amount of spain population see their personal finances staying the same in this year. (diagram 1.) d i a g r a m 1 . p r o g n o s i s o f g l o b a l e c o n o m y s i t u a t i o n i n 2 0 0 8 3 0 10 20 30 40 50 60 70 great britain france italy spain germany usa do you think economy will be better or worse in 2008.? (%) better niether better nor worse worse pessimism is greatly dispersed in the countries of europe and usa. global dispersion pessimism is shown in the new research by the financial times (2008) that showed that 80% of italians, 67% of french, 52% of americans and 41% of great britain population seem to think that the situation in their countries are bad. german and spanish are divided as far as this goes, meaning that 36% think that situation in germany is going worse, and that opinion has 38% of the spanish. also, 28% of germans and 30% of spanish believe that the situation is good. the research has also showed that pessimism is not only concerning the current state, but it is present when its talked about the near future. 65% of italians, 59% of 3available: http://www.poslovni.hr/32169.aspx], (3.4. 2008.); http://www.seebiz.eu/bih/analize/najvece-prijetnjesvijetu-recesija,-nafta-i-nedostatak hrane,5961.html, (3.4. 2008.) a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 71 americans, 56% of french, and only 2% of the british believe in that. 49% of germans and 48% of the spanish believe that their country is going in the bad direction. on the other hand, the population of those two countries are showing the greatest optimism, meaning that 39% of germans and 30% of the spanish believe that thing are going in the right direction. the negative feelings are mostly connected to the opinion about economic situation in separate countries. so, 75% of italians, 70% of french, 63% of americans, 52% of spanish and 45% of british believe that the situation is dissatisfactory because of the unsatisfactory economic state. the only ones who believe that their country is standing tall regarding this question, are germans that showed this in 39% of their population. some of the many reasons for such pessimism are poor state in the justice system and unsatisfactory situation as far as employment goes. when itʹs talked about education in a certain country, a great part of the population believe that the situation is going for the better. (diagram 2.) d i a g r a m 2 . p e s s i m i s m i n e u r o p e a n d u s a i n 2 0 0 8 4 0 10 20 30 40 50 60 70 80 great britain france italy spain germany usa how is the situation in your country? (%) good bad besides the intensive world financial magma of the twenty first century, the highest developed countries still believe that the recession could be avoided. ministers of finances of the g-7 countries concluded that the world economy is pretty solid, but it is being threatened to become unstable. thus, countries that are the part of the seven mostly developed countries of the world have concluded that basic indicators of the world development and economy are solid and that the recession, especially in usa, as well as anywhere else could be avoided. at the same time we are warned that instability present on the markets is increasing thanks to the weakening of the american economy, d y s f u n c t i o n of the financial sector, as well as the high prices of oil and merchandise. but, the g-7 countries have shown the readiness to take drastic measures individually and together to secure global stability and market growth. american minister of finances henry paulson has said that todayʹs financial turmoil are serious and he has added that despite the problems, he is anticipating american economy to continue growing and that it will not come to recession, meaning that the percentage of the 4available: http://www.suvremena.hr/5995.aspx,, (3.4. 2008.) economic analysis 1-2 (2009) 65-78 72 increase of economic growth in 2009 will be on the satisfactory level. but, paulson has mentioned that certain market risks are facing this scenario, but he is predicting strong growth of the rapidly growing economies, but it will weaken in the future (diagram 3). very soon, his prediction has been shown as a mistake. d i a g r a m 3 . i m f p r e d i c t i o n s o f e c o n o m i c g r o w t h i n t h e w o r l d i n 2 0 0 9 ( % ) 5 0 1 2 3 4 5 6 7 8 9 10 china india world great britain japan euro zone usa imf predictions of economic growth in the world in 2008. (u%) economic growth the oil prices since the beginning of 2007. have been continuously growing, and their movement presented the threat to the economic growth in 2008 and also will be in 2009. the continued growing changes in the foreign currencies, before all in the currencies between the euros and the dollars, could lead to jolts on the international financial markets, further interest growth on the capital markets and the negative effects on the world economic growth. as we can see in the diagram, analysts believe that the economic growth on the global economy level will decrease. the reasons for this is the volatility in the oil and oil derivative prices due to the growth of demand, decrease of the monetary and fiscal stimulants in most of the countries, growth of interest rates and geopolitical tension. economists of the imf are predicting that the growth of the world economy (that has been growing in the rate of 4,9% last two years, in 2008 was 3,7%), is 2,2% in the current year. imf is cautioning to the risk that decrease of economic growth could be greater, predicting that there is 25% probability of that happening. if the growth of the world economy in the next two years was to be under 3% or less, that would, by the imf criteria, mean world recession. generally speaking through the world regions, after the intermission at the beginning of the 21st century, eu came over the stagnation and met greater growth rates of gdp (2-3,5%) in the period from 2005. to 2007. usa had more consistent growth in the period from 2003. to 2007. with over 3% annually. china all those years has gdp growth over 10% and india about 8%, russia between 6 and 8% and brazil between 5 and 7%. after the beginning of the credit crisis in 2007. the growth has been revised in eu to 5-2%, in usa 1-2%. the interest rates in usa were about 2-3% in the period from 2002. to 2007., where in the six months the discount rate of the federal reserves has been brought down to 2%. the interest rate of the ecb has been 5% for almost a year, the interest rate in china is 7-8%. the inflation in eu 5available: http://www.poslovni.hr/58372.aspx, (3.4. 2008.) a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 73 reaches 3,4% in most of the g-7 countries (the goal is to be under 2%), in usa about 3,5%. china and russia have inflation close to 10%. [imf, (2007), 9-12.] besides this, the world bank has in its «world economic predictions for 2008.», predicted also slowing down of the global economy growth down to 3,3% form last yearʹs 3,6%. considering «world economic predictions for 2008.» global growth will come up to 3,6% in the future. in 2007, global growth has been decreased to 3,6% after it was documented in the year before to be at 3,9%. world bank is starting that the activity deceleration in 2007. has been due to weaker growth in the countries of high gdp, but the developing countries have softened greater deceleration for the global growth thanks to strong growth of 7,4%, that almost stayed the same comparing the year before. the authors of this report have highlighted increased uncertainty of the current period, as well as few serious risks that have contributed to global growth deceleration. the inter demand for products of the developing countries could significant weaken, and the m e r c h a n d i s e prices could drop since the weakened real estate market in the usa and the new jolts to the financial markets will push american economy into recession. in the upcoming years of the bank, recovery of the global economic activities is anticipated as well as the economic growth of the developing countries. the growth of real gdp is anticipated also with about 7,1 %, while the countries with high gdps should achieve modest growth of about 2,2%. [world bank, (2008), 1-2.] the beginning of deeper crises of bosnia and herzegovina economy kemal kozaric, b&h central bank the governor has stated that the only way out of the possible crises in b&h can be seen only in domestic production. imf is concerned that in this country, due to inflation pressure on the food prices (the predicted inflation rate for 2008 is 2,6%) and e n e r g y g e n e r a t i n g p r o d u c t prices, and devaluation would considering many experts predictions in this area, be a punishments for all b&h residents. but despite those problems b&h imf office will be shut down. the cause of this is not the obvious one, that everything in b&h is great and there no need for them anymore, but it is not that the state in b&h is desperate, so they are leaving us (the inner restructuring of imf is in progress because it was necessary to decrease staff numbers due to decreased budget, and due to the same problem it was necessary to shut down resident offices in the countries that don’t have program with the fund). well, the governor kozaric said that this international organization is leaving due to decreased imf administration, but it still will be present in b&h through regular discussion and cooperation. with that is important to explain the reason for their living the right way. it is the same case for all the countries in the region that don’t have to stand by arrangement, and the stronger relationship with imf. they have played an important role in the period after war in b&h, have helped in the making of the central bank and have given technical help, but the greatest concern for the fund are three determinants, such as: they are aware of economic growth, there is progress that the inflation is under control, but they are expecting the fiscal board of b&h to start functioning, and they want to see them in action, and the recently accepted fiscal board code, creating such board and long-term solution to the profit division question and as it is predicted, the payroll code will bring more order in this area in the institutions. but they are still concerned over the inflation pressure prices of food and e n e r g y g e n e r a t i n g p r o d u c t . this is familiar to the bh public as well, so they are concerned too, especially over the consumption economic analysis 1-2 (2009) 65-78 74 increase in the federation of bh. the fund is satisfied because bh will sign the agreement about stabilization and joining the eu and it is anticipating positive effects to have on bh. but, bh authorities are doing next to nothing to soften the price increase blows, or to stop the oil crisis. for example, serious countries are already using own instruments to increase or initiate food production. bh governments should find or create funds to initiate domestic food production. last year bh spent about a billion km for import of foods that it already has. governments must stimulate domestic manufacturers or diminish some of their liabilities in order to help them. there is a lot of untouched agricultural ground, also, this country has a great climate and people who could work. governments could find some relaxation in the tax department as well, do they need to drop the vat rate or introduce “swimming axis” to gas, but they are the ones to decide. when oil comes to question, it’s too bad that oil refinery in bosanski brod still hasn’t started working because there aren’t any domestic crude oil refineries. no matter what the situation in bosnia looks like, there will not be currency devaluation, because it would be a punishment for its residents. for example, all credits would devaluate. that would be a shock and such measure that would shake everything bh worked on so far. they will definitely not take that adventure. the world economy crisis will not worsen bh stability. bh currency is stable and it has a 100% coverage, and amount 400 million km in free reserves as a “security” for domestic currency. bh analysts are conscious of the fact that crises is coming, but world banks, that were exposed on the american mortgage market, are not active in the region, so the first crises wave would avoid bh. we just need to watch what will happen next. according to information of eminent magazine «dnevni avaz» (june of 17th 2008.) population of bosnia and herzegovina have been very interested in this subject. namely, this magazine asked a question to population of bosnia and herzegovina (which were selected with s t o c h a s t i c example): «do you support the attitude of the central bank of bosnia and herzegovina, to not to devaluate km (convertible money), because this action (devaluation) would not effect on moderation of inflation in bosnia and herzegovina? here are the results of voting population of this country: diagram 4. the population against the devaluation of km the population of bosnia and herzegovina against the devaluation of km 71% 20% 9% yes no i don't know as you can see from presented diagram, most of the population support the attitudes of the central bank of bosnia and herzegovina, considering that this is adequately instrument for struggle against the currently state (not to use devaluation as a monetary instrument). a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 75 we should be prepared for the next crises and that’s why financial stability is important, which depends on all the segments of the financial sector. commercial banks have announced increase in interest rates, but central bank shouldn’t expect a big increase in that department. interest rate formation is free on bh market, but it’s inevitable that commercial banks are selectively choosing clients with good credit history and the ones who can finance their liabilities, so that significant increase of interest rates isn’t expected. interest rates in bh are on the average as in croatia, somewhat less in serbia, but somewhat greater in slovenia, meaning that bh is in the regional frames. it should be highlighted when saa starts being used, much food will come from eu that will be cheaper and if bh authorities do not react, domestic production would not be compatible again. but, it’s obvious that such strategy is not existence, no one takes concern over it. the e n e r g y g e n e r a t i n g p r o d u c t could be used because there is power shortage in the world, so bh should throw itself into energy production for which we posses the potential to export as well as to compensate for the oil we need to import. anyway, we shouldn’t be fooled, because significant world crises could shake the groundwork of bh economy. we are reminded that imf analysts have warned us that bh is in the group of especially threatened countries of the southeast europe. we highlighted that bh liabilities are high, because with export we are barely covering half of the import, so we should be afraid of foreign investments on the bh markets. the current shakes on the world financial market could disrupt the owing balance consumption and debt repayment in bh. it is explained that banks in every crisis are covering themselves first and their businesses in the mother countries. that’s why they are ready to write off daughters abroad, decrease the credits or completely withdraw from some markets. in such case, bh could be left without new loans. it is highlighted that we should watch the happening on the world market as well as the serious warning that are coming out way. the key question is if the current shakes of the world market will impact bh economy and how will they impact. we should find the answer to that as fast as possible so that we could get ready for what’s expected in the future. it is looking like, it is going to be tough for bh where it will depend on outer factors, with huge outer owning, deficit in merchandise trade, dependence of he whole economy on the service sector, credit liabilities or residents with long term housing credits, high ratio between the dependants and the on the employed…in this whole situation “the bright points” could be seen from the perspective that europe, eu actually, has a chance to become more powerful that usa, where they will not blindly listen to usa commands and where possibly, by entering eu, bh could be better then if it didn’t come into eu. and finally, bh could achieve greater economic growth rates only if it lessens public spending and fiscal deficit, and increases business surrounding. potential growth of gdp in bh is around 6,2% now. so, for a faster growth economic reforms are necessary, smaller role of the government and smaller fiscal deficit, faster privatization, increase of business surroundings, more efficient b u r e a u c r a c y , bigger flexibility on the labor market and the judicial reforms. further limitations of public expenses are still staying as a key question, because they would decrease the deficit of the current account of payment balance and the total liabilities of the country. but the increase in the public spending in bh is making imf concerned. before the bh government lies great homework, like stopping the inflation increase and deficit of the current account. general manager of the imf, straus kahn, has economic analysis 1-2 (2009) 65-78 76 stated that before the bh government lies great homework, the one stated above, but he added in the final solution to the inner liability question, with the goal to keep the fiscal stability and remove possible risks associated to everything mentioned above. until when will the price growth of the necessary basic articles keep up in bh, and does that mean that it’s just the beginning of the deeper crisis of its economy? when and will the crisis end soon…? prognosis of all the financial experts are correct, until they are shown as wrong. the same thing is happening in global crisis predictions that shook the world of finances after the breakdown of mortgage market in the usa and while some, few months ago, were saying that the worst is over, now there are many more who are predicting the end of the crisis. as the time passes by, their prediction are for the longer time period. many analysts are sure that the crises will last for another year and a half, but majority using their authority is warning us that the worst period still hasn’t passed and there still will be market shakes global banks are on the great quest for partners to recapitalize them, while best european banks are calmly observing. the happenings with big groups. the question is, how long will they be able to calmly observe the neighborhood. for the first time we are faced with the fact that crises came from the west, and not the east. for the first time the undeveloped east wasn’t too greedy in the race to achieve the greatest profit, growth possible. the banking market in the eastern europe is almost untouched, because the old countries of eu are tampon zone towards eastern europe since it was them. that were financially attached to usa, where the crises aborted, so the crises actually did come from the west countries and not developing market. the cause of the crisis is found in banks and their refinancing trough complex financial instruments such as derivatives. simply put the banks where buying bad and breakable assets since we should find something good in everything that’s bad, the banks in eastern europe will have less available money on the international capital market that will decrease already huge credit owning in the population, but not to make everything so bright, the same thing could happen in the b&h credit economy whose growth depends on foreign investments for now. the end result could be their decrease in growth, which is exactly what is happening. although b&h is not connected to american economy, b&h still has biggest trade with the countries of eu. that also shore be hit whit this, so we should hope that this crisis will pass by and the great shakes will not happen because the whole world is connected, and so that includes b&h as well. but, looking of the researches of many analysts, they are saying the financial crisis will continue hitting the world economy for an certain period of time, even until 2012 (average 24 years). the fact is the one we can’t escape from, that the crises come from the west. banking market of the southeastern and eastern europe should overcame the crisis but the question pending is how hit will the real economies be. economic declaration in the usa in the future will lead to new credit problems begins in the area of mortgages, the consumer credits auto loans, is still unpredictable. the liquidity shortage in the financial system that was brought up by credit crisis will surely loot for few more years. financial institutions from the whole world, such a city group on a ubs, have last over $300 billion in last value and credit trough out the credit crisis that has stored the collapse of the commercial mortgage market, but many are saying that the worst part of the crisis is over ever since in march of 2008 bear a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 77 sterns was rescued with help of federal reserved. the worst is over but the crises isn’t over yet. it is clear that the american economy will decrease grown in the next period, but the recession is not likely unless the hand of price increased of oil and product continues. if the price increase continues with the same speed, recession in the usa will be unavoidable. the dramatic oil price growth on the american market has increased concerns over inflation and the consumer buying power. usa shocks have collapsed after record growth in oil prices and government confession that the unemployment financial crises isn’t over yet, and it is safe to expect more market shocks, and we still question if the worst is over yet. conclusion we came in the 21st century with faith that the global unbalance and crises will diminish. we looked at this century as a new epoch with evened out economic growth and balanced working and living conditions. but, unfortunately, every time period brings its own traps. it looks like that the good macroeconomic politics, reliable institutions, real regulatory frame, timely reactions, and a good intentions do not have a alternative. world economy is in the unusual period and bosnia and herzegovina can’t impact new resource findings or world food prices, but in the frame of its limits it can do more then it is already doing. at the beginning of 21st century, significant orderly relations and more balanced economy growth has been anticipated, but food shortages come pong, with the enormous jump of prices of the basic food articles in the world, and the sole existence of great amount of people is in question. everything that made the groundwork of the world economy is brought to question, and the crises of mortgage is bringing in to question the stability of the financial system. solution of the world economy crises is in the macroeconomic management, and that eu and usa should start working together as far as the dollar currency goes, payment deficit, and to soften the credit crises but, should be high lighted that b&h is not in the first arrangement of countries that are impacted by the happenings in the world economy, but also that it is not able to stored a good position in the circle in which its economy works. changes around that country are much faster then in it, and that’s the only problem that we can impact, the other things are objection. the only was for bit to smoothen dimmer relations is trough the interests of economy that could be part of the regional story. the world crises was caused by poor economic management, usa, the country playing the part of the cradle of liberal capitalism, has a hard time in managing economy and regulation of the outer system, but considering its impact on global economy, those problems are sipping through the other countries of the world. in the world today, the biggest problem is the political instability caused by war and crisis that lessen the business optimism, in the usa before all but in the other countries as well. consequences of financial crisis will be demolishing for usa economy firstly, but will have same impact on the global economy as well. but, it is possible to recover, because is a great deal of free capital so the investments should be focused on manufacturing. although, the feeling of the possible recession should be eliminated, usa and eu have totally different goals. if we continue with friends like, oil price growth, increase of imbalance of food, decrease in dollar value or increase in inflation, recession is unavoidable. economic analysis 1-2 (2009) 65-78 78 references greenspan a., (2007), the age of turbulence, penguin group, washington d.c. http://www.poslovni.hr/32169.aspx http://www.poslovni.hr/32169.aspx http://www.seebiz.eu/bih/analize/najvece-prijetnje-svijetu-recesija,-nafta-i-nedostatak hrane,5961.html http://www.suvremena.hr/5995.aspx http://www.poslovni.hr/58372.aspx imf, (2007), annual report., washington d.c. available: [http://www.imf.org]. salvatore d., (2007), international economics, ninth edition, john wiley & sons, inc., new york. world bank (2008), global development finance: the role of international banking-review, analysis, outlook, washington d.c. available:[siteresources.worldbank.org/intgdf2008/resources/gdf_complete_web-appended6-12.pdf]. doi: 10.28934/ea.22.55.1.pp48-62 original scientific paper effects of consumer ethnocentrism, cosmopolitanism and cultural intelligence on the acceptance of foreign brands stefan zdravković17f* | dragana gašević2 1 univeristy of kragujevac, faculty of economics in kragujevac, department for business economics and management, phd student, kragujevac, serbia 2 high business school, novi sad, department for business economics and management, novi sad, serbia abstract globalization of the market has diminished the importance of national borders, so that an increasing number of companies are internationalizing their business. it is very important that the company’s management investigates the characteristics of the foreign market in which it wants to operate. it is necessary to formulate and implement adequate marketing strategy, which will take into account ethnocentric tendencies and the cultural framework of consumers. consumer ethnocentrism usually comes to the fore during crisis situations and a number of consumers want to strengthen the national economy by purchasing domestic products and services. on the other hand, a number of consumers have developed a high degree of cosmopolitanism and cultural intelligence, which implies preferences for foreign brands over domestic ones. the aim of this scientific paper is to identify some of the most important drivers of consumer ethnocentrism (patriotism, conservatism, dogmatism), and then to examine whether consumer ethnocentrism, cosmopolitanism and cultural intelligence through their basic factors (metacognitive, cognitive, motivational and behavioral factors) influence the formation of consumer attitudes towards foreign brands. it also examines whether the positive attitude of consumers towards foreign brands affects the loyalty of consumers to foreign brands, because it is necessary for companies to move from transactional marketing to customer relationship management, because loyal consumers are a stable source of income and enable long-term profitable business. empirical research was conducted using a survey method in the republic of serbia (belgrade, kragujevac). the results of the research showed that consumer ethnocentrism has a negative statistically significant impact, and consumer cosmopolitanism and cultural intelligence have a positive statistically significant impact on consumer attitudes towards foreign brands, and a positive attitudes implies consumer loyalty to foreign brands. key words: consumer ethnocentrism, consumer cosmopolitanism, cultural intelligence, foreign brands jel classification: a13, m21, m31 introduction due to the process of globalization and liberalization of international trade, an increasing number of companies are internationalizing their business, that is placing their brands on foreign markets (wong, polonsky & garma, 2008). consumer have a large number of alternative brands at their disposal in the purchasing process, so the formulation and implementation of an adequate marketing strategy is a great challenge for marketing managers of multinational companies (dey, alwi, yamoah, agyepong, kizgin & sarma, 2019). some consumers have pronounced ethnocentric tendencies and buy exclusively products and services of domestic origin. this enables the * corresponding author, e-mail: szdravkovic034@yahoo.com stefan zdravković, dragana gašević 49 strengthening of the national economy, increasing the employment of the population and increasing living standards (akbarov, 2022). also, consumers with expressed ethnocentric tendencies consider it their moral and ethical obligation to buy domestic products and services (souiden, ladhari & chang, 2018). one of the most important drivers of consumer ethnocentrism is patriotism, which is defined as a feeling of love, pride, attachment and loyalty to one’s country (sharma & wu, 2015). also, consumers who are conservative, respect traditions, customs, social institutions, norms and rules of conduct, usually have pronounced ethnocentric tendencies (jain & jain, 2013). ethnocentric consumers buy domestic products even in situations when they are inferior to foreign products in terms of quality, reliability and technical performance, which can be explained by dogmatism that represents beliefs and principles to be adhered to, although they don’t have logical explanations and scientific groundedness (shankarmahesh, 2006). on the other hand, the process of globalization has enabled the exchange of ideas, products, services, cultural values, so that a certain number of citizens have expressed cosmopolitanism, which reflects the tendency of these individuals to adapt to foreign cultures (prince, yaprak & palihawadana, 2019). these peoples are characterized by global prudence, a high level of information and monitoring of technological discoveries, a developed global consumer culture, and thus a desire to buy foreign brands (rabelo neto, sousa-filho & carneiro lima, 2022). modern trends show that people want to get to know foreign cultures, history and traditions of other countries, their customs and cultural heritage (yazdanshenas, 2021). traveling abroad has become much more affordable, so that when visiting foreign tourist destinations, people can make contact with the local population, exchange ideas and opinions and thus gain new authentic experiences and develop their cultural intelligence (bhardwaj, 2021). marketers points out that the very concept of cultural intelligence consists of a group of developed abilities. metacognitive and cognitive abilities include the possession of intercultural knowledge and skills, understanding of cultural differences and knowledge of norms, customs, legal systems of other countries. motivational abilities imply investing energy and a high degree of self-confidence in intercultural communication, while behavioral abilities imply adequate verbal and nonverbal behavior when communicating with people from other cultures (liu, wu, xu & chen, 2021). consumer decision to accept foreign brands is influenced by many factors. a brand is defined as a mark, symbol or any other characteristic that distinguishes the products and services of one seller from its competitors (gammoh, koh & okoroafo, 2020). the subject of this research is the analysis of the drivers of consumer ethnocentrism and its definition as a concept, as well as the definition of the concept of consumer cosmopolitanism and cultural intelligence and the analysis of their impact on consumer decision to accept foreign brands. it is also necessary to analyze whether consumers are ready to make long-term purchases after forming a positive attitude towards a certain foreign brand, because loyal consumers are one of the main goals of every company, because they enable long-term profitable business, and marketers also point out that it is much cheaper existing customer, rather than attract a new one. the research consists of five parts. after the introductory part, the concepts of consumer ethnocentrism, cosmopolitanism and cultural intelligence were defined within the literature review. their most significant drivers, factors, as well as methods and scales used for their measurement and analysis are listed. also, in this part, research hypotheses are conceived and the conceptual model of the study is presented. the third part deals with the research methodology and sample structure. empirical research was conducted on the territory republic of serbia using a survey method. data were analyzed through spss statistical software. from statistical analyzes, reliability analysis was used to determine whether the set research model was relevant, as well as regression analysis in order to test research hypotheses. the fourth part presents the results of these statistical analyzes, while the study concludes with the main implications of research that can be helpful to managers of multinational companies in internationalizing business and formulating an adequate marketing strategy. 50 economic analysis (2022, vol. 55, no. 1, 41-62) literature review ethnocentrism is a sociological concept that represents the tendency of people to see their culture as dominant and the best in relation to the cultures of all other countries (bizumic, 2019). from the basic concept developed consumer ethnocentrism, whose basic principle is the purchase of domestic products and services due to bias towards the home country and implies general care for the protection of the national economy, encouraging employment and can be seen as an ethical dimension related to the fact that the purchase of imported products is unpatriotic behavior (zdravkovic, sapic & filipovic, 2020). the purchase of foreign products and services has economic consequences for the domestic economy, leading to the closure of domestic companies and a decline in living standards (yen, 2018). governments of certain countires conduct marketing campaigns and appeal to citizens to buy domestic products. however, the question arises as to whether it is justified to direct citizens to buy domestic products, which are useally inferior to foreign products in terms of their level of quality, reliability, technical characteristics and performance (marinkovic, 2017). also, the application of protectionist economic policies leads to reciprocal measures of other countires and represents a significant barrier to the development of foreign trade and progressive economic relations with other countries (john & brady, 2011). consumers show ethnocentric tendencies to a significant extent during crisis situations. the covid 19 virus pandemic has caused significant geopolitical tensions and disrupted market supply. despite global appeals to find a common solution and show solidarity, consumers mostly decided to buy domestic products that were generally available on the market, and at the same time to support the domestic economy (he & haris, 2020). also, if there is animosity towards a country due to war or economic conflicts, consumers avoid buying products that originate from that country (lee, lee & li, 2017). for example, western countries imposed sanctions for russia in 2014 over the ukraine crisis, and russia retaliated with reciprocal measures banning the united states, canada, australia and the eu from exporting certain food and agricultural products to russia, such as meat, fish, fruit, vegetables (yormizoev, teuber & li, 2019). the conflict escalated in early 2022 year. due to the process of globalization, there is a decrease in cultural homogeneity, ie an increase in cultural heterogeneity, so that in every culture there is an increasing number of subcultures. in this way, regional ethnocentrism appears, so that, for example, the inhabitants of the autonomous province of catalonia buy only brands originating from catalonia, and refuse to buy foreign brands and even brands from spain, which is their home country, because they demand state independence (abdelwahab, jimenez, san-martin & prodanova, 2020). shankarmahesh (2006) states in his classification that there are four groups of drivers of consumer ethnocentrism: 1. sociopsychological factors (patriotism, conservatism, dogmatism and others) 2. economic factors (capitalism, economic development, living standards, etc.) 3. political factors (political propaganda, political history, manipulations of leaders, etc.) 4. demographic factors (such as gender, age, education). this research will examine whether patriotism, conservatism and dogmatism, as socio-psychological factors, have an impact on consumer ethnocentrism. patriotism represents the feeling of love or concern of an individual for his country, as well as the degree of connection of an individual with his nation and its symbols. patriotism encompasses the instrumental affiliation, of an individual realizes as a member of a certain nation (eg citizenship), while sentimental affiliation implies that personal values that an individual perceives as correct are complementary to national values (pentz, terblanche & boshoff, 2017). previous research has found a positive correlation between patriotism and consumer ethnocentrism (vida & reardon, 2008; marinkovic 2017; pavlovic & savic, 2017). conservatism implies respect for tradition, history, customs, social norms that are characteristic of a nation (zalega, 2017). previous research has found a positive correlation between conservatism and consumer ethnocentrism (javalgi, khare, gross & scherer, 2005; jain & jain, 2013). dogmatism implies beliefs and rules of conduct that must be followed, although they do not have an exact scientific basis (shankarmahesh, 2006). paul, gupta & tyagi (2021) found in their study that dogmatism stefan zdravković, dragana gašević 51 has a positive effect on ethnocentric consumer tendencies. based on the above research, the following research hypotheses can be formulated: h1a: patriotism has a positive statistically significant impact on consumer ethnocentrism. h1b: conservatism has a positive statistically significant impact on consumer ethnocentrism. h1c: dogmatism has a positive statistically significant impact on consumer ethnocentrism. most researchers use the cet scale (consumer ethnocentric tendency scale) created by shimp & sharma (1987), to measure consumer ethnocentrism. this scale contains 17 statements, although in field marketing research a smaller number of statements are generally chosen, which will be the approach in this research as well. the natid scale (the national identity scale) created by keillor & hult (1999), is also used to measure consumer ethnocentrism. this is essentially a scale for measuring national identity, but consumer ethnocentrism is one of its components. there are other scales that are less used in research, such as ceescale (consumer ethnocentrism extended scale) created by siamagka & balbanis (2015), which consists of five dimensions, prosociality, cognition, insecurity, reflexivity and habituation. there is also cesscale (revised consumer ethnocentrism scale) created by sharma (2015), which has three dimensions to measure ethnocentrism, affective reaction, cognitive bias and behavioral preferences. there are numerous studies in the academic literature that have found that consumer ethnocentrism (cet) has a positive effect on consumers’ decision to buy domestic products and services (deb & chaudhuri 2014; marinkovic 2017, pavlovic & savic 2017, sapic, filipovic & dlacic, 2019, zdravkovic, sapic & filipovic, 2020). based on the above, the following research hypothesis in the paper: h2: consumer ethnocentrism has a negative statistically significant impact on consumer attitudes towards foreign brands. cosmopolitanism is a concept that has a sociological genesis and implies a high degree of worldview, openness to other cultures and understanding the differences that exist between them. cosmopolitans differ from the local population because they went to travel beyond national borders and get to know the traditions, history and customs of other countries (srivastava, gupta & rana, 2021). cosmopolitanism has gained in importance due to the process of global integration, political cooperation and the development of international trade. consumer cosmopolitanism has developed from the basic concept, which refers to the economic dimension, ie it represents the preferences of cosmopolitans towards foreign products, services and brands (lee & mazodier, 2015). in his study, sapic (2017) found that consumer cosmopolitanism has a positive impact on consumers’ decision to accept foreign brands and visit foreign fast food restaurants. prince, yaprak & palihawadana (2019) found that consumer cosmopolitanism has a positive impact on consumer attitudes towards foreign brands, as well as on their intention to become loyal to certain foreign brands. from the above studies, the research hypothesis follows: h3: consumer cosmopolitanism has a positive statistically significant impact on consumer attitudes towards foreign brands. cultural intelligence (cq) is defined as a set of competencies that help an individual to adapt to an intercultural environment and to have a high degree of self-confidence when communicating with people from other cultures (presbitero, 2017). due to the global integration, there has been a significant increase in the number of business and tourist trips in the world, so that people improve their level of cultural intelligence by learning about the values of other cultures, their history, visiting cultural monuments, and landmarks, communicating with locals and learn a foreign language (zdravkovic & pekovic, 2021b). cultural intelligence has implications in the academic world, ie an increasing number of students believe that studying abroad is a valuable experience, because it allows, in addition to obtaining a degree, to get to know other cultures (bernadette & diane, 2016). also, cultural intelligence has implications in the business world, because employees in multinational companies come from different cultures, so it is very important that the leader and all members of project teams have developed a high level of cultural 52 economic analysis (2022, vol. 55, no. 1, 41-62) intelligence, which helps them achieve high business performance and thereby enabling business owners to meet the level of profit (chen, liu & portnoy, 2012). also, strategic partners come from culturally diverse backgrounds and need to have a developed level of cultural intelligence that allows them to know the legal and economic systems of other cultures, religious values, and they need this information for successful cooperation (cui, liu, xia & cheng, 2019). the most well-known way to measure cultural intelligence is the method of self-assessment and it involves individuals giving answers to 20 statements, which are used to determine their level of cultural intelligence (ang et al., 2007). also, an observer’s report is often used, where experts and supervisors summaraize their perceptions of one’s cultural intelligence (van dyne, ang & koh, 2008). ang, rockstuhl, & ng (2014) presented a cultural situation assessment test that measures cultural intelligence. respondents are shown pictures and given some time to think and then explain how they perceive the situation, and their non-verbal behavior is analyzed (views, facial expressions). ang, rockstuhl & tan (2015) have proposed combining different methods for measuring cultural intelligence, as they provide complementary information so as to increase the relevance and reliability of the results obtained. earley & ang (2003) state that there are four basic factors of cultural intelligence: metacognitive, cognitive, motivational and behavioral. metacognitive processes refer to understanding the cultural differences that exist between different nations (zdravkovic, 2021). in their study, ang & van dyne (2015) state that metacognitive cultural intelligence influences, among other things, consumer preferences for foreign product. cognitive cultural intelligence implies knowledge of the functioning of foreign social systems, institutions, knowledge of laws, norms and rules of conduct (yazdanshenas, 2021). the cognitive factor of cultural intelligence affects the ability of marketing managers in terms of recognizing positive signals from the market, proactively reacting and making good decisions in conditions of market uncertainty and incomplete information of economic actors. also, the cognitive factor influences the decision of consumers to buy foreign products and services (lorenz, ramsey & glenn richey, 2018). motivational cultural intelligence means investing energy and showing enthusiasm for getting to know other cultures, their values systems and communicating with the local population (pratono & arli, 2020). consumers with a high degree of motivational cultural intelligence visit foreign tourist destinations and buy foreign brands (frias-jamilena, sabiote-ortiz, martin-santana & beerli-palacio, 2018). behavioral cultural intelligence implies the application of certain verbal and non-verbal competencies that enable and individual to change the strength of tone, accent, facial expressions, body language and to better adapt to the intercultural situation (rahman, abdel fattah, hussain & hossain, 2021). zdravkovic & pekovic (2021a) found that behavioral cultural intelligence has a positive impact on consumers’ decision to buy foreign brands. based on the mentioned studies, the following research hypotheses can be formulated: h4a: the metacognitive factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. h4b: the cognitive factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. h4c: the motivational factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. h4d: the behavioral factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. it is very important that marketing managers formulate and implement a good marketing strategy that will influence consumers to form positive attitudes towards the brands of a given company and to achieve a certain degree of satisfaction when using the brand. however, it is not enough for a consumer to make one purchase, but the first purchase needs to be the beginning of a transition process whose end result is consumer loyalty (liu, li, mizerski & soh, 2012). it is necessary for companies to move from transactional marketing to customer relationship stefan zdravković, dragana gašević 53 management, ie to build a partnership with their clients, because a large number of loyal clients enables the company to continuously operate successfully and achieve all set goals, especially profits (anisimova, weiss & mavondo, 2019). based on the above, the following research hypothesis can be formulated: h5: the formed positive attitude of consumers towards a foreign brand has a positive statistically significant impact on consumer loyalty to a foreign brand. in order to facilitate the monitoring of the structure of the paper, research variables are presented through a conceptual model, as well as research hypotheses through which their interdependence will be analyzed (figure 1). figure 1. conceptual model source: authors research methodology empirical research was conducted on the territory of the republic of serbia (belgrade, kragujevac) at the end of 2021 year. the research was conducted by the method of a simple random sample, the questionnaire was distributed personally and electronically to the respondents, who evaluated the statements from the questionnaire using the likert scale with grades from 1 to 7 (1-absolutely disagree with the statement; 7-absolutely agree with the statement). the total sample consists of 305 respondents, who are segmented according to certain demographic characteristics (gender, age, education, status). an overview of the demographic structure of the respondents is given in table 1. the statements from the questionnaire are taken from relevant scientific papers in the field of marketing and management, which is a regular approach in field research. within the results of the research, all the statements that were used are listed, and by applying certain statistical analyzes, it was determined that they are internally 54 economic analysis (2022, vol. 55, no. 1, 41-62) consistent and can be grouped into factors, ie research variables. data were analyzed through statistical software spss, and from statistical analyzes, factor analysis and reliability analysis were applied to determine whether the statements used were internally consistent and whether the research model was relevant and reliable, while regression analysis was applied to test research hypotheses. table 1. demographic structure of respondents number of respondents percentage of respondents gender females 147 48.2 % male 158 51.8 % total 305 100 % age up to 20 years 41 13.4 % 21-30 years 118 38.7 % 31-40 years 52 17.0 % 41-50 years 56 18.4 % 51 years and older 38 12.5 % total 305 100 % education primary school 25 8.2% high school 143 46.9% college 137 44.9% total 305 100 % status unemployed 47 15.4% employed 98 32.1% student 118 38.7% retired 42 13.8% total 305 100% source: authors in the total sample of respondents, there are 147 women and 158 men. the largest number of respondents is between the ages of 21 and 30. most respondents have completed high school or college. when it comes to status, the largest number of respondents in the sample are students, followed by employees, and the number of unemployed and pensioners is approximate. research results the statements used in questionnaire were taken from relevant papers in the field of marketing. by applying factor analysis, statements are grouped into factors, ie into research variables (table 2). consumer ethnocentrism, consumer cosmopolitanism, attitude towards a foreign brands, loyalty to a foreign brand were measured by three statements. drivers of consumer ethnocentrism (patriotism, conservatism, dogmatism) and factors of cultural intelligence (metacognitve, cognitive, motivational and behavioral factor) were measured by two statements, because the questionnaire is quite extensive, ie to take less time from respondents when filling out the questionnaire. however, the results of factor analysis and reliability analysis show that the stated approach is correct, al obtained values are stable, research variables are measured through adequate statements and the research model is relevant and reliable. stefan zdravković, dragana gašević 55 table 2. research variables and corresponding statements research variables statements factor saturation adapted to the source patriotism 1. i am proud to be a citizen of the republic of serbia. 0.81 marinković (2017) 2. i am proud to see the flag of the republic of serbia waving. 0.77 conservatism 1. i respect the customs and traditions of serbian culture. 0.82 pentz, terblanche & boshoff (2017) 2. i support the work of social institutions in the republic of serbia. 0.78 dogmatism 1. i think that it is only right to buy products and services that originate from the republic of serbia. 0.83 shankarmahesh (2006) 2. i always buy serbian products and i do not need special reasons and explanations for such a decision. 0.82 consumer ethnocentrism (cet) 1. we need to buy products from the republic of serbia and strengthen the national economy. 0.79 zdravkovic, sapić & filipović (2020) 2. imports of goods cause economic consequences and reduce the employment of population. 0.78 3. i prefer exclusively the purchase of products and services originating from serbia. 0.75 consumer cosmopolitanism 1. i want to get to know the traditions and culture of other countries and to try foreign gastronomic specialites. 0.87 sapić (2017) 2. i believe that foreign products have a high degree of quality. 0.83 3. i am innovative and i want to buy foreign brands, because they have excellent performance. 0.81 cultural intelligence (cq) a) metacognitive factor b) cognitive factor c) motivational factor d) behavioral factor 1a) i try to improve my cultural knowledge by interacting with people from other countries. 0.83 ang et al. (2007) 2a) cultural knowledge helps me to adapt in a foreign environment. 0.81 1b) i know the social systems of other countries. 0.90 2b) i know the art and cultural heritage of other countries. 0.88 1c) i enjoy communicating with people from other cultures. 0.75 2c) i have confidence in intercultural communication. 0.73 1d) in intercultural situations, i apply appropriate verbal behavior (accent, tone). 0.76 2d) during intercultural communication i adjust my non-verbal behavior (body language, facial expression). 0.71 attitude towards a foreign brand 1. i prefer to buy foreign products. 0.91 son, jin & george (2013) 2. foreign brands have a high degree of quality. 0.87 3. foreign brands provide prestige in society. 0.85 loyalty to a foreign brand 1. i will continue to buy foreign brands in the future. 0.83 moller jensen & hansen (2006) 56 economic analysis (2022, vol. 55, no. 1, 41-62) research variables statements factor saturation adapted to the source 2. i am ready to recommend foreign brands to my family members. 0.81 3. i recommended foreign brands to my friends. 0.77 source: authors all assumptions for the application of factor analysis are justified. all statements were measured using an interval scale. the total number of respondents in the sample is 305, and the number of statements in the questionnaire is 26, and the condition for applying factor analysis is that in this ratio there are least 10 times more respondents in the sample than the findings in the questionnaire (jovetić, 2015). based on the factor analysis, statements are grouped into 11 main factor (patriotism, conservatism, dogmatism, consumer ethnocentrism, consumer cosmopolitanism, metacognitve, cognitive, motivational and behavioral factor of cultural intelligence, attitude and loyalty of consumer towards foreign brand). in the case of tests relating to the justification of the application of factor analysis, satisfactory results have also been obtained (table 3). table 3. kmo and bartlett’s test kaiser-meyer-olkin measure of sampling adequacy 0.765 bartlett’s test of sphericity approx. chi-square 548.068 df 10 sig. 0.000 source: authors the value of kaiser-meyer-olkin coefficient 0.765 is greater than the threshold of 0.60, which indicates that the conditions for conducting factor analysis are met (pallant, 2005). also, the value of the bartlett’s test shows statistical significance (χ2=548.068, sig=0.000), ie it confirms that there is a statistically significant correlation and internal consistency between the statements through which the research factor (variables) are measured. reliability analysis is also applied in the research, in order to examine the internal consistency between the used statements and to examine the relevance of the set research model. the results are presented in table 4. table 4. reliability analysis research variables cronbach’s alpha coefficient patriotism 0.78 conservatism 0.79 dogmatism 0.80 consumer ethnocentrism 0.80 consumer cosmopolitanism 0.84 metacognitive factor of cultural intelligence 0.81 cognitive factor of cultural intelligence 0.88 motivational factor of cultural intelligence 0.71 behavioral factor of cultural intelligence 0.72 attitude towards a foreign brand 0.88 loyalty to a foreign brand 0.80 source: authors stefan zdravković, dragana gašević 57 in order for the used statements to be internally consistent and for the research model to be relevant, it is necessary for the value of the cronbach’s alpha coefficient to be greater than 0.70 (nunnally, 1978), and such a result was obtained for all used research variables. multiple regression analysis was applied to examine the influence of patriotism, conservatism and dogmatism on consumer ethnocentrism (table 5). table 5. multiple regression analysis (dependent variable: consumer ethnocentrism) independent variables beta coefficient t test sig value vif coefficient patriotism 0.154* 1.990 0.057 2.282 conservatism 0.128* 1.701 0.090 2.160 dogmatism 0.263** 4.370 0.000 1.379 source: authors note: **-level of significance 0.01; *-level of significance 0.1 r2 = 0.458 the coefficient of determination is r2 = 0.458, which means that 45.8 % of the variability of the dependent variable consumer ethnocentrism is explained by a given regression model. the value of vif coefficient is less than the limit values 5, so there is no problem of multicollinearity (field, 2000). variables patriotism (β=0.154; sig=0.057), conservatism (β=0.128; sig=0.090) and dogmatism (β=0.263; sig=0.000) have a positive statistically significant impact on consumer ethnocentrism, so that research hypotheses h1a, h1b and h1c have been confirmed. multiple regression analysis was applied to examine the influence of consumer ethnocentrism, consumer cosmopolitanism and cultural intelligence (metacognitive, cognitive, motivational and behavioral factor) on attitude consumers towards a foreign brands. the results are presented in table 6. table 6. multiple regression analysis (dependent variable: attitude towards a foreign brand) independent variables beta coefficient t test sig value vif coefficient consumer ethnocentrism -0.296** -2.826 0.005 4.984 consumer cosmopolitanism 0.438** 6.737 0.000 2.308 cultural intelligence metacognitive factor 0.088 0.371 0.465 4.489 cognitive factor 0.240** 4.205 0.000 1.782 motivational factor 0.179** 3.650 0.000 1.318 behavioral factor 0.174** 3.514 0.002 4.480 source: authors note: **-level of significance 0.01; r2 = 0.675 the coefficient of determination is r2 = 0.675, which means that 67.5 % of the variability of the dependent variable attitude towards a foreign brand is explained by a given regression model. the value of vif coefficient is less than the limit values 5, so there is no problem of multicollinearity (field, 2000). variable consumer ethnocentrism (β= -0.296; sig=0.005) has a negative statistically significant impact on attitude towards a foreign brand, while on the other hand variable consumer cosmopolitanism (β=0.438; sig=0.000) has a positive statistically significant impact on attitude towards a foreign brand, so that research hypotheses h2 and h3 have been confirmed. cognitive factor (β=0.240; sig=0.000), motivational factor (β=0.179; sig=0.000), and behavioral factor (β=0.174; sig=0.002) of cultural intelligence have a positive statistically significant impact on attitude towards a foreign brand, while the influence of the 58 economic analysis (2022, vol. 55, no. 1, 41-62) metacognitive factor (β=0.088; sig=0.465) of cultural intelligence is not statistically significant, so that research hypothesis h4a has not been confirmed, while research hypothesis h4b, h4c and h4d have been confirmed. when the consumers forms a positive attitude towards a foreign brand, they perform the buying process. however, there is a lot of competition in today’s world market, so the goal of companies is to make the consumer loyal to their brands. the goal of every company is to move from transactional marketing to customer relationship management (crm), because loyal consumers are a source of long-term profitable business. due to the above, by applying a simple regression analysis, it examines whether the formed positive attitude of consumers towards a certain foreign brand, affects consumer loyalty (table 7). table 7. simple regression analysis (dependent variable: loyalty to a foreign brand) independent variable beta coefficient t test sig value attitude towards a foreign brand 0.606** 13.248 0.000 source: authors note: **-level of significance 0.01; r2 = 0.367 the coefficient of determination is r2=0.367, which means that 36.7 % of the variability of the dependent variable loyalty to a foreign brand is explained by a given regression model. variable attitude towards a foreign brand (β=0.606; sig=0.000) has a positive statistically impact on loyalty to a foreign brand, so that research hypothesis h5 has been confirmed. that is, the formed positive attitude of consumers towards a certain foreign brand has a direct impact on loyalty to the same brand. conclusion the research was conducted to examine whether patriotism, conservatism and dogmatism are the drivers of consumer ethnocentrism, as well as to examine the impact of consumer ethnocentrism, consumer cosmopolitanism and cultural intelligence (metacognitive, cognitive, motivational and behavioral factor) on consumer attitudes towards foreign brands. it was also examined whether the formed positive attitudes of consumers towards foreign brands affect their loyalty to foreign brands. the academic literature examines the individual impact of these determinants on the acceptance of foreign brands, but as the main contribution and originality of this research, we can mention the fact that a holistic and integrative approach was applied, ie the research model is designed to examine the common effect of all these determinants on consumer attitudes and loyalty to foreign brands. theoretical implications are reflected in the expansion of scientific knowledge about the impact of these determinants on consumer decision to accept foreign brands and arise from research hypotheses that become valid scientific knowledge. the results of research confirmed the results of previous studies that patriotism, conservatism and dogmatism have a positive impact on consumer ethnocentrism (pentz, terblanche & boshoff, 2017; marinkovic 2017; pavlovic & savic, 2017; paul, gupta & tyagi, 2021) also, the results show that consumer ethnocentrism has a negative impact on consumer attitudes towards foreign brands, while consumer cosmopolitanism and cultural intelligence (through cognitive, motivational and behavioral factors) have a positive impact on the acceptance of foreign brands, and similar results have been obtained through previous studies (sapic, 2017; zdravkovic, sapic & filipovic, 2020; zdravkovic & pekovic, 2021a, zdravković & pekovic, 2021b) this research didn’t prove that the metacognitive factor of cultural intelligence has a positive impact on consumer attitudes towards foreign brands, which can be explained by the fact that there are many young respondents in the sample, and metacognitive processes in humans develop with age. the formed positive attitude towards a foreign brand also stefan zdravković, dragana gašević 59 affects consumer loyalty, and the same result was obtained in the previous study (anisimova, weiss & mavondo, 2019). managerial implications are based on helping international marketing managers consider the factors that influence consumer’s decisions to accept foreign brands. it is necessary to formulate and implement an adequate marketing strategy that will take into account the ethnocentric tendencies of consumers and their cultural framework. also, it is necessary for companies to form as large a base of loyal consumers as possible, because they are a stable source of income and enable long-term profitable business. the transition from transactional marketing to customer relationship management should be the goal of every successful company. the limitation of research is reflected in the relatively small sample size and the fact that it was conducted on the territory of one country. cross-cultural research provides more comprehensive results because it allows the attitudes and opinions of members of different nations to be compared. in addition, the directions of future research could be based on the analysis of another drivers of consumer ethnocentrism (for example, national identity, animosity, materialism), as well as the inclusion of some more variables in the research model, which could be a significant determinants of foreign brands acceptance (eg country of origin image, consumer xenocentrism). references ang, s., van dyne, l., koh, c., ng, k.y., templer, k. j., tay, c. and chandrasekar, n.a. 2007. 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"consumption in fast-food restaurants in croatia and serbia". british food journal, 121(8): 1715-1729. article history: received: march 20, 2022 revised: april 5, 2022 accepted: may, 30, 2022 doi: 10.28934/ea.21.54.2.pp41-54 preliminary report the impact of the covid-19 crisis on the serbian economy consequences and recovery marija lazarević-moravčević10f* | sandra kamenković2 1 institute of economic sciences, belgrade, serbia 2 university union belgrade, belgrade banking academy, belgrade, serbia abstract the subject of this paper is the analysis of the consequences of the corona crisis on the serbian economy. the focus is on the analysis of the crisis effect, taking into account the sectoral structure of the serbian economy and the distribution of business entities by size. the assumptions are that the crisis did not affect all business sectors equally, as well as that the size of the company is a factor that significantly determines the organization's ability to respond to the crisis. the paper also analyzes the effectiveness of measures taken by economic policy makers in order to mitigate the consequences of a pandemic. desk-research method was used in the paper, primarily analyzing papers and publications from scientific journal and other professional literature, as well as official data, databases and reports of relevant institutions. in conclusion, the authors state that it is extremely difficult to predict the pace at which the serbian economy will recover from the crisis, especially under the assumption that the pandemic may continue. recovery from the crisis is determined by a number of factors: measures that the state will implement in the upcoming period, the company's ability to adapt to new business conditions, the pace of vaccination, the further course of the pandemic, events in the environment. key words: economy, sector, effects, measures, covid crisis, support, small and medium enterprises jel classification: m21, e60 introduction ever since it was registered in china, the covid-19 virus has become a key global threat. the virus is spreading rapidly and intensively, affecting all parts of the world creating pressure on economies. the pandemic have caused immediate economic effects and consequences. the world is facing a recession, whose end is not possible to envisage now. according to certain estimates, „the virus reduced global economic growth in 2020 to an annualized rate of -3.4% to -7.6%, with a recovery of 4.2% to 5.6% projected for 2021. global trade is estimated to have fallen by 5.3% in 2020, but is projected to grow by 8.0% in 2021. major advanced economies, which comprise 60% of global economic activity, are projected to operate below their potential output level through at least 2024” (congressional research service, 2021). the pandemic has prevented or limited the functioning of many economic entities. the most endangered were companies operating in high-contact activities. companies operating in these activities were forced to limit or suspend operations for several months. it is estimated that “93% of the world’s workers were living under some form of workplace restrictions as a result of the global pandemic and that 8.8% of global working hours were lost in 2020 relative to the fourth * corresponding author, e-mail: marija.lazarevi@ien.bg.ac.rs 42 economic analysis (21, vol. 54, no. 2, 41-54) quarter of 2019. losses in working hours in 2020 were approximately four times higher than during the global financial crisis in 2009” (international labour organization, 2021). the covid-19 pandemic has significantly affected the labour market, especially in the united states, and less in central asia and europe. global job losses during 2020 amounted to 114 million jobs, compared to 2019 (international labour organization, 2021). in european economies, there were no major shocks in the labour market thanks to the measures taken in order to protect companies from bankruptcy and to maintain the number of employees. according to the ilo report, during 2020, employees lost their jobs mainly in the services sector, i.e. in activities where it was not possible to organize work from home. thanks to the measures implemented in the segment of fiscal and monetary policy, the economic decline during 2020 was smaller than expected at the global level. in order to prevent the spread of the virus, protect the population and the economy, most countries have reacted in a similar way borders were closed, measures for social distancing are established, support is provided to the most vulnerable segments of society and the economy. despite the fact that the “covid-19 pandemic has been recognized “as a major exogenous shock that has altered the competitive landscape for both small and large firms (wenzel, stanske, lieberman, 2020)”, large firms are significantly more willing to face the crisis. in european countries, the most important, but currently the most sensitive segment of the economy is the sme sector. this segment of the economy represents the "backbone of the european real economy because it employs about two thirds of employees and participates in the creation of more than 55% of total value added in the non-financial business economy" (european investment bank, 2020). the crisis caused by the pandemic covid-19 resulted in the decrease of income and employment levels of many small businesses. a significant number of smes were forced to suspend operations (accommodation and food services, recreation and entertainment) or to operate at reduced capacity (transport, manufacturing, construction). in order to maintain business activities, most eu countries have provided significant support to smes and using various financial tools they covered all or part of the costs incurred due to the closure, suspension or slowdown of operations (international trade centre, 2020). in fact, in most economies rapid solutions were applied to support the sme on the basis of direct funding, tax incentives, financial guarantees, loans with low interest rates and other (grondis, slusarczik, hussain, androniceanu, 2021). due to the great uncertainty related to the future course of the epidemic, the effects of the crisis cannot be precisely determined. according to the forecasts made by the international monetary fund, the world economy will experience a stronger recovery during 2021 and 2022. “global growth is projected at 6% in 2021, moderating to 4.4% in 2022” (imf, 2021). in january 2021, the world bank released its updated economic forecast, which indicated that global economic growth would reach 4.3% in 2020 and 4.0% in 2021, compared with june 2020 projections of -5.2% for 2020 and 4.2% in 2021, but rise by a slower rate of 3.8% in 2022 (world bank group, 2021). both reports state that the speed of recovery of individual countries will be different. the intensity of overcoming the crisis will be determined by the pace at which vaccination is carried out and the support measures that will be taken by the states. the covid-19 pandemic has caused general recession, including the serbian economy (fic, 2020). despite the fact that the crisis has caused a decrease in gdp, exports and foreign demand, total production (especially industrial), a decrease in the growth rate, the impression has been gained that its impact is milder compared to other economies. “the current account deficit was reduced to around 4.3% of gdp in 2020, primarily due to lower outflows of net income of foreign economic entities and, in part, a lower foreign trade deficit (international bank for reconstruction and development, 2021)”. during 2020, the growth of government debt was also recorded. in november 2020, government debt amounted to 56.8% of estimated gdp, compared to 52.0% at the end of 2019 (oecd, 2021). employment did not decline, primarily thanks to state program of marija lazarević-moravčević, sandra kamenković 43 fiscal incentives. on the other hand, the support that helped the economy survive also meant high budget costs (international bank for reconstruction and development, 2021). in order to mitigate the negative effects of the crisis in serbia, a comprehensive package of monetary, fiscal and banking measures has been implemented. interventions carried out by the government and the nbs were primarily aimed at preventing bankruptcy and dismissal during the state of emergency. the goal was to recover the economy from the initial shock. “most measures introduced by the republic of serbia are related to labour and deferral. also, measures related to financial instruments have not been left out either, however they are less intensive comparing to other countries“ (beraha, đuričin, 2021). the implemented measures cannot be effective and sufficient, assuming that the crisis continues and generates long-term changes in market conditions. the lack of a planned approach in resolving the secondary effects of the crisis may undermine the position of companies in serbia and their competitive advantage (united nations, 2020). similar to other economies, the crisis in serbia did not affect all sectors equally. according to some estimates “69% of the sector was immediately affected by the pandemic, while 31% of the sector was left without an immediate negative impact, but with possible indirect and subsequent negative consequences” (fic, 2020). some sectors have managed to adapt to the new situation, such as the it sector, food and beverage production and agriculture, and to hire new employees (privredna komora srbije/usaid, 2020). the long-term effects of the crisis on the serbian economy cannot be accurately estimated. it is possible to assess the consequences of current events and the measures applied in the fight against it. on the other hand, it is difficult to assess secondary and tertiary effects. potential (secondary) effects are a consequence of the primary ones and will occur if the crisis continues. the tertiary effects of the crisis arise as a result of changes in the international market due to the limited movement of people, goods and capital (institute of economic sciences, 2020). also, the economy and overall well-being of serbia are significantly influenced by events in the eu, as the dominant trading partner (united nations, 2020). the paper analyzes the consequences of the crisis on the performance of the serbian economy, observed from the aspect of individual sectors and the most sensitive segments of the economy small and medium enterprises. in addition, the paper chronologically presents the measures taken with the intention to minimize the impact of the crisis, as well as proposals that would make the most sensitive segments of the economy more resilient to the effects of the crisis. sectoral analysis of economic activity in serbia during the pandemic majority of sectors experienced some kind of change during the covid-19 pandemic. while some activities struggled with a large decline, some experienced a large increase in business volume, which implies that the pandemic crisis did not affect all activities uniformly. epidemiological restrictions worldwide had a strong negative impact on activities such as accomodation and food services, the aviation industry, the automotive industry, the non-essential goods manufacturing industry, as well as part of the international logistics industry, due to difficult global transport, complicated administrative procedures and breaking delivery deadlines. on the other hand, restrictions and the health situation made huge impact on pharmaceutical industry, food and other essential food retail, video game industry, online sales, logistics providers related to providing delivery to each individual consumer. it is necessary to mention that the business registers agency of serbia in its annual report publishes the summary results of the sectors according to the classification of activities (kd) 2010. as a result, we have in some way averaged results of the sector, because according to the classification e.g. the manufacturing sector includes the production of pharmaceutical products and medical equipment, which due to a sharp increase in demand recorded a sharp increase in 44 economic analysis (21, vol. 54, no. 2, 41-54) business, but also the production of motor vehicles and furniture, which due to rising risks related to future incomes, recorded decrease in demand and decrease in activity. the data from the annual bulletin of financial statements for 2020 published by the business registers agency are presented in tables 1 and 2 and they confirm these findings. table 1. net business results of serbian companies by sectors of activity net result (in millions of rsd) index 2019 2020 2020/2019 wholesale and retail trade 74.345 134.858 181,4 manufacturing 116.268 130.894 112,6 construction 33.878 58.484 172,6 information and communication 37.551 44.921 119,6 electricity, gas, steam supply 3.973 26.166 658,6 agriculture, forestry and fishing -4.652 9.712 n/a real estate activities 23.709 4.156 17,5 mining 1.163 16.728 7,0 arts, entertainment and recreation 6.491 1.370 21,1 transportation and storage 11.389 -11.539 n/a accommodation and food service activities 1.332 -9.183 n/a source: apr (2020) annual bulletin of financial statements, https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf there are 6 sectors in the group of activities that made higher profits in 2020 compared to 2019. in the wholesale and retail trade sector, the result was 81% better than in 2019, with an increase in the number of employees by over 4.500. the next sector with profit growth is the manufacturing sector, which grew by over 12%, noting that this sector recorded the largest increase in the number of employees of over 17.000. the construction sector recorded a growth of net results of 72% compared to 2019, with an increase in employees by 3.543 workers, while the information and communication sector recorded a growth of profitability of 19%, with an increase in the number of employees by 11.279 workers. the largest increase in profitability was recorded in the electricity supply sector, whose net result after the fall in 2019 compared to 2018 by 45%, in 2020 compared to 2019 increased over 6 times, with a decrease in the number of employees by over 500 workers. higher profits were also made in the agricultural sector, which after a loss in 2019, made a profit in 2020. growth was achieved by sectors where the impact of epidemiological restrictions was minimal, such as construction sector, agricultural, electricity supply sector, and especially those where epidemiological restrictions actually stimulated demand, such as wholesale and retail sector, which includes online trade, food and beverage wholesale, computer equipment wholesale, then manufacturing, where the trade in medical equipment and pharmaceutical products is classified, as well as the information and communication sector, which includes telecommunications, programming and information service activities. sectors that performed positively in 2020, but significantly worse than in 2019, are the real estate sector, the mining sector and the arts, entertainment and recreation sector, which achieved 17.5%, 7% and 21% of the profit realized in the previous year. the crisis has the hardest negative impact on the transport and storage sector, which lost almost 12 billion rsd. this is not surprising given that in some periods during 2020, borders were closed or at least with significant restrictions on moving from one country to another to prevent the spreading of the virus. however, a large loss at the level of 9.2 billion rsd was scored by the sector of accommodation and food services, also for very obvious reasons during the pandemic period. these data more than obviously explain the fact that the measures of the economic policy https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf marija lazarević-moravčević, sandra kamenković 45 of the government of serbia regarding the issue of sectoral assistance were directed especially in these two sectors. it is interesting to point out that in the transport and storage sector the number of employees increased by 70, while in the accommodation and food services sector decreased by 458 workers, which may suggest that despite the sharp decline of activity in these sectors, government measures in the form of subsidies mitigated the decline of employees in the accommodation and food services sectors, i.e. maintained the number of employees at the similar level in the transport sector. table 2. number of companies and number of employees by sectors number of companies number of employees 2018 2019 2020 2018 2019 2020 wholesale and retail trade 34.074 33.044 32.107 219.373 223.116 227.618 manufacturing 17.969 17.735 17.381 367.282 374.840 391.855 construction 8.670 8.984 9.323 72.479 78.003 81.546 transportation and storage 6.639 6.810 6.883 99.228 99.912 101.935 administrative and support service activities 3.991 4.108 4.139 76.413 83.165 83.122 other sectors 34.512 35.352 36.278 306.458 315.326 331.878 source: apr (2020) annual bulletin of financial statements, https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf impact of the pandemic on performance sme sector in serbia the crisis caused by the covid-19 pandemic has affected all economic entities small and large organizations. it also confirmed the fact that the size of the company is a factor that significantly determines the ability to resolve crisis situations. large companies were better prepared to deal with the crisis, while the micro and small business segment was hit hard. their excessive sensitivity can be explained by the fact that this is the segment of the economy that is the least liquid and has the lowest credit rating (ien, 2021). in addition, these companies mainly operate in the most affected sectors. they are financially constrained and have little opportunity to diversify their business (ceves, 2020). on the other hand, their flexibility is responsible for the relatively successful resistance to the pressures caused by the crisis. it is known that smaller organizations have the ability to quickly adapt to new circumstances and market needs. unlike large companies, which are characterized by sluggishness, small companies can more easily reorient themselves to new market demands (kamenković, lazarević-moravčević, 2018). seen in the context of the sme sector, it is expected that the organizations that belong to the category of medium-sized enterprises show the greatest resistance to the crisis. the explanation can be found in the fact that these companies have the characteristics of both small and large systems. organizations that belong to the category of medium-sized enterprises have not lost their flexibility, and on the other hand, they have certain similarities with large systems (capacities, resources and structure) that allow them to attract financial resources and more easily overcome the crisis. in fact, medium-sized companies are “closest to the ideal combination of capital and flexibility, which enables them to successfully deal with the crisis caused by the covid-19 pandemic (ceves, 2020)”. despite the fact that the crisis affects all the important segments of business (plans for investment, liquidity, ability to collect receivables, negative trends in demand, supply chains) can be concluded that companies in serbia demonstrated a certain level of resistance and readiness to adapt to new market conditions (usaid, 2020). in the initial stages of the crisis, most companies managed to keep their workers, thanks to savings, loans and financial support provided by the state (united nations, 2020). in spite of the expectation that mass layoffs will be one of the key consequences of the crisis, official statistics indicate opposite trends. https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf 46 economic analysis (21, vol. 54, no. 2, 41-54) based on the data presented in the table 3, it can be concluded that the growth trend in number of economic entities belonging to the category of medium-sized enterprises has continued. also, in these companies a positive trend in the number of employees has been identified. on the other hand, decrease in the number of employees was recorded in the category of small enterprises. an interesting observation is that despite the reduction in the number of micro enterprises in 2020, the number of employees in this segment of the economy has grown. table 3. number of enterprises and employees in the sme sector (2018-2020) number of enterprises number of employees medium enterprises 2018 1.387 232.991 2019 1.497 253.876 2020 1.815 273.115 small enterprises 2018 10.387 313.435 2019 11.036 321.391 2020 11.617 316.247 micro enterprises 2018 93.689 236.575 2019 93.085 236.639 2020 92.257 237.035 source: apr (2020) annual bulletin of financial statements, https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf during the crisis maintaining employment levels is not recognized as a problem facing the sme sector in serbia. problems can be identified in the area of maintaining revenue and net profit levels. "the crisis has negatively affected the company's income, so the business reality is significantly worse than expected (ceves, 2020)", especially in the segment of micro companies. compared to 2019, the segment of small enterprises achieved total revenue decrease by 5%, while reducing total expenses by 6%. in this segment of the economy was also observed reducing the number of employees (5.144). small companies achieved the most dynamic growth of a positive net result of 34.2%. growth was achieved primarily under the influence of business activity of companies in the wholesale and retail trade sector (serbian business registers agency, 2021). figure 1. small businesses revenue and expenditure trends (2017-2020) source: based on data from the annual bulletin of financial statements 2018, 2019, 2020, https://www.apr.gov.rs/ 2500000000 2600000000 2700000000 2800000000 2900000000 3000000000 3100000000 2017 2018 2019 2020 total income total expenses https://www.apr.gov.rs/ marija lazarević-moravčević, sandra kamenković 47 a negative tendency in the movement of total revenues was also noted in the segment of micro enterprises. this is the most numerous segment of the economy that achieved a decline in total business activity with a negative result, as well as a significantly impaired financial position. during 2020, micro enterprises recorded a decrease in total revenues by 13%, with an almost identical decrease in total expenditures. compared to 2019 the number of micro enterprises decreased by 828 (serbian business registers agency, 2020). micro enterprises were the only ones to operate with a loss of 13,310 million dinars, which is 16.4% less compared to 2019 (serbian business registers agency, 2021). figure 2. micro enterprises revenue and expenditure trends (2017-2020) source: based on data from the annual bulletin of financial statements for 2019 and 2020, https://www.apr.gov.rs/ a negative tendency in the movement of total revenues, especially in the field of microenterprises, is a result of reduced business activity. micro, as well as a significant number of small companies mainly operate in labour-intensive activities, i.e. in sectors where personal contact is extremely important. during a pandemic these organizations were often exposed to business interruptions. however, the total revenues and expenditures within the sme sector are certainly affected by the change in the number of economic entities. it can be stated that the largest contribution to the growth of overall profitability was given by medium and small enterprises. medium-sized companies are the only segment of the economy that has recorded growth in total revenues and total expenditures. also, these companies are recognized as the most financially stable part of the economy. on the other hand, negative impact of the crisis is the largest in the segment of micro enterprises. during 2020 the financial position of these companies was significantly impaired (serbian business registers agency, 2020). according to a survey conducted by usaid in cooperation with the serbian chamber of commerce on a sample of 1.000 companies, the crisis has disrupted certain plans and activities of many smes in serbia. forecasts of businessmen in serbia are becoming less optimistic in terms of plans, future income, and volume of activities and employment of new workers. on the other hand, they believe in ability to retain current employment level. companies are planning to continue their activities (usaid, 2020) and most of them do not intend to introduce permanent changes in their business, due to the pandemic (ceves, 2020). the biggest problem for smes in serbia remains the lack of access to various sources of funding (usaid, 2020; ceves, 2020). despite the fact they are still the most dominant source of financing, the share of own funds in business financing during 2020 is declining. on the other hand, businessmen in serbia do not find alternative solutions in bank loans or professional investors. in addition, the following problems 1250000000 1300000000 1350000000 1400000000 1450000000 1500000000 2017 2018 2019 2020 total income total expenses https://www.apr.gov.rs/ 48 economic analysis (21, vol. 54, no. 2, 41-54) have been identified: unfair competition, legal uncertainty due to unclear regulations and lack of transparency in the adoption of regulations, lack of investment options, and unavailability of qualified human resources. according to the results of the mentioned research, businessmen in serbia positively evaluate certain aspects of the regulatory environment procedures and regulations related to inspection supervision, vat refund procedures. on the other hand, they negatively assess the amount of taxes and contributions on salaries, as well as the efficiency of the work of the state administration (usaid, 2020). the crisis that companies are currently facing has given online business a completely new role and meaning. all the benefits of online business have now come to the fore. in the new circumstances, it is realistic to expect a growing number of companies that rely on modern technological solutions in their business. the need to introduce alternative options is also a consequence of changes in the behavior and habits of consumers during the crisis (lazarevićmoravčević, domazet, lazić, 2021). during the crisis, the benefits of internet business have become significant. the number of companies that use the internet as a communication channel is constantly growing, as well as the number of companies that own a website. the website is owned by 84.4% of companies, which is an increase of 0.8% compared to 2019 and an increase of 1.8% compared to 2018 (republic statistical office, 2020). there is a noticeable increase in the number of visits to informative internet portals, as well as an exponential growth of communication on social networks. also, there is an increase in demand for streaming platforms, i.e. for video conferencing and online education (domazet, 2020). figure 3. measures taken or planned in response to the crisis in serbia source: usaid (2020) annual survey of 1.000 serbian businesses, https://saradnja.rs/wpcontent/uploads/2020/11/anketa-1000-preduze%c4%87a-2020..pdf companies are increasingly recognizing the importance of digital solutions for business improvement and see them as the primary response to the crisis (usaid, 2020). in the pandemic business environment, a significant number of smes were forced to adapt to online business. exactly, the best business results achieved companies that operate in sectors where this was possible. adaptation to digital business is also determined by the size of the company. compared to large ones, smaller organizations can more easily focus on online business. the visibility of small businesses, their products and services can be improved by applying certain solutions offered by modern information technology (lazarević-moravčević, 2019), especially in conditions of a pandemic crisis. factors limiting this transformation are the lack of financial and human resources, with state support playing a major role (vidas-bubanja, 2021). 34% 23% 17% 17% 9% opening new advertising channels digital marketing, etc. strengthening existing online business channels changes to the production algorithm or introduction of new product opening of new sales channels (introduction of electronic shops through web shop) opening new billing channels (online billing cards, etc.) marija lazarević-moravčević, sandra kamenković 49 therefore, it can be concluded that the sme sector has been significantly affected by the crisis. however, the consequences are less than expected thanks to the support measures taken by the state in order to maintain a certain level of business activity and employment. in the coming period, the performance of the sme sector will be determined by support measures, but also by the ability of companies to accept modern forms of business and investment. analysis of implemented economic policy measures in serbia during the pandemic since 2014, when fiscal consolidation measures were launched, most macroeconomic indicators in serbia have recorded a positive trend. fiscal consolidation lasted from the end of 2014 to the end of 2017, with the aim of reducing the fiscal deficit, which was 6.2% of gdp, as well as reducing the share of public debt in gdp, which amounted to 67.5%. the trend of reducing the deficit started in 2015, and in 2017 a surplus appeared. the share of public debt in gdp started to decline in 2017, and at the end of 2019, this indicator was at the level of 52.9% (ministry of finance, republic of serbia, public debt administration, quarterly report, december 2019). these reductions are actually very significant, because in the unplanned situation of the pandemic crisis, they gave space to the economic policy makers for the inevitable borrowing in order to mitigate the negative effects of the pandemic crisis. fiscal and monetary measures to mitigate the negative economic effects of the pandemic have been introduced in most countries around the world. in general, they can be grouped in 3 directions, tax policy measures, direct budget incentives measures and liquidity preservation measures. the first package of economic policy measures was adopted in april 2020, and the measures as well as the budget for them are presented in table 4. table 4. measures and budget in the first package of economic policy measures name of the measure amount in billion rsd 1. tax policy measures 161 1.1. postponement of payment of taxes on salaries and contributions for the private sector with the beginning of collection no earlier than 2021 (march-may 2020 or april-june 2020) 140 1.2. postponement of payment of advance income tax in the second quarter of 2020 21 2. direct assistance to companies for employees 97.3 2.1. direct assistance to entrepreneurs who are taxed at a flat rate and who pay real income tax, micro, small and medium enterprises in the private sector in the amount of 3 minimum wages (march-may 2020 or april-june 2020) 92.8 2.2. direct assistance to large companies in the private sector assistance in the amount of 50% of the net minimum wage for employees who are temporarily removed from work 4.5 3. measures for liquidity of the economy 264 3.1. support to the economy through the development fund of the republic of serbia 24 50 economic analysis (21, vol. 54, no. 2, 41-54) name of the measure amount in billion rsd 3.2. guarantee scheme to support the economy through banks 240 of which 25% state guarantee 20 4. other measures 86 4.1. moratorium on dividend payments until the end of the year, except for pes 16 4.2. payment of 100 eur to all adult citizens 70 total measures 608,3 source: ministry of finance of the republic of serbia the total value of economic support measures in the first package was slightly less than 610 billion rsd (which is about 11% of gdp), but it is important to note that the amount includes both public and private funds that are engaged. namely, in the part that refers to credit support to the economy through banks, out of 240 billion rsd, 60 billion rsd refers to state guarantees. when the difference is subtracted, the amount of 430 billion rsd is a burden on public finances, which is slightly less than 8% of gdp. having this in mind, the impact of economic measures is not the same on the budget deficit and public debt, i.e. the impact on public debt is, given the methodology of calculating public debt in serbia, 430 billion rsd, while the impact on the budget deficit is slightly less than 370 billion rsd (fiskalni savet, ocena antikriznog programa ekonomskih mera, 2020). from the first package, tax policy measures had the greatest impact on the budget result, and within them the dominant effect was the postponement of liabilities to the private sector for taxes on salaries and contributions, followed by payment of minimum wages to the private sector and then payment of 100 eur to adult citizens, and at the end the state guaranteed commercial bank loans. companies were allowed to postpone the payment of taxes and contributions on salaries and profit taxes, regardless of the company activity, but with the condition that the number of employees is not reduced by more than 10%, and that they do not pay dividends until the end of 2020. wage allowance included the payment of 100% of the minimum wage from the budget to sole traders and employees in micro, small and medium enterprises, as well as direct aid to large enterprises in the amount of 50% of the minimum wage paid to employees who are temporarily removed from work, but their employment continues after the state of emergency. tax policy measures, as well as direct assistance measures, were largely used and proved to be very expedient, as they prevented the sudden decline in the number of employees that was expected at a time when many activities had to completely stop the work process. the program of financial support to the economy took place through the two channels. the first channel involved loans granted by the state to enterpreneurs directly through the development fund of republic of serbia. the loans were intended for entrepreneurs, micro, small and medium enterprises and agricultural farms, and were approved for a period of 36 months with a grace period of one year. the maximum loan amount depended on the size of the company and ranged from 5 million rsd for entrepreneurs and micro companies, 25 million rsd for small companies, to 50 million rsd for medium-sized companies. the second channel involved lending to companies through commercial banks with a state guarantee for these loans. the same group of companies, entrepreneurs, micro, small and medium enterprises had the right to apply, with the maximum allowed loan amount of 350 million rsd. the purpose of the previously listed measures was to preserve production capacities and employment in the private sector, predominantly in the part of small and medium enterprises, and it can be stated that this purpose was achieved with the first package. marija lazarević-moravčević, sandra kamenković 51 in addition to the measures on the supply side, the state also envisaged a measure on the demand side, which included the payment of 100 eur to each adult citizen. the purpose of this measure was a fiscal stimulus to increase domestic demand. although 70 billion rsd were planned, considering the number of registered citizens, the implementation of this measure in the end cost 72 billion rsd, or about 610 million eur. since there were no funds available in the budget of serbia for this measure, it was financed by government borrowing. this measure was quite questioned, as it was non-selective, which was not the practice in other countries that implemented a similar measure. also, one of the arguments against this measure is that the problem with aggregate demand in serbia is not a consequence of lower purchasing power, but a consequence of the impossibility of population movement and thus the purchase of goods and services. also, another aspect of stimulating growth by increasing the income of citizens is emphasized in serbia, which is a small and open economy, the dominant part of the increase in income spills over to imported goods, leading to an increase in trade deficit, lower foreign exchange supply and foreign exchange market pressure. the second package of economic policy measures was adopted in july 2020 and included the postponement of the payment of taxes on salaries and contributions for the private sector for august 2020, then direct assistance to entrepreneurs who are taxed at a flat rate and who pay taxes on real income, micro, small and medium-sized enterprises in the private sector in the amount of 60% of the minimum wage (august-september 2020), as well as direct assistance to large enterprises in the private sector assistance in the amount of 50% of the net minimum wage for employees who are temporarily removed from work. the total value of this package was 66 billion rsd, or about 1.2% of gdp. bearing in mind that during july, and partly in august, the health situation deteriorated considerably, economic activity decreased, and these measures have a positive impact on maintaining production capacity and preventing the growth of unemployment, it can be stated that the measures in this package were completely justified. the third package of measures was actually a sectoral package, which was formulated in the form of subsidies to companies operating in the tourism industry. the package was in the form of two public calls and had a value of 1.6 billion rsd, or 0.03% of gdp. the first public call included grants to hotels in the amount of 350 eur per individual bed and 150 eur per accommodation unit, for all hotels in the private sector. the application deadline was september 15, 2020. the condition was that in the period until the end of 2020, the number of employees will not be reduced by more than 10%. the second call was intended for travel agencies, only to those who have a license, and the application deadline was december 4, 2020. according to the ministry of trade, tourism and telecommunications (2020), the third package was used by 312 hotels and 90 travel agencies. it can be stated that these sectoral measures were adequate because the sectoral analysis shows that the tourism sector was indeed the most endangered in terms of declining activity. these measures made it possible that, despite the sharp decline in activity, the decline in number of employees was not so sudden, which was the purpose of the measure. the fourth package of economic policy measures was adopted in february 2021. the package includes direct assistance in the form of payment of 50% of the minimum wage for 3 months (march-may 2021), for entrepreneurs, micro, small, medium, but this time also large companies. considering that it includes about 1.4-1.5 million employees in the private sector, the amount of 69.8 billion rsd is planned for the measure. in addition to this assistance, the food service and tourism sector, tourist guides and car rental agencies are provided with support in the amount of another entire minimum wage, for which 2 billion rsd are intended. sectoral assistance also includes the repetition of the measure from the previous package, a non-refundable aid for hotels in the amount of 350 eur per bed and 150 eur per accommodation unit, for which 1.7 billion rsd are allocated. this package also envisages support to the sector of passenger transport and road traffic, considering that according to the data from the annual report of the agency for business registers, this sector recorded the largest decline in net results 52 economic analysis (21, vol. 54, no. 2, 41-54) in 2020. the assistance includes the payment of 600 eur per month for each bus in a period of 6 months, and the total value of the measure is around 2.6 billion rsd. the measure of aid for 1.7 million pensioners of 50 eur costs 10 billion rsd, while all adult citizens will receive 30 euros twice, one payment was in may 2021, and the other is expected in november 2021. considering that in the previous package, about 6.2 million citizens applied for the measure of non-refundable aid, it is estimated that this measure will be worth about 43 billion rsd. in the sum these two measures, the one-time non-refundable aid costs over 50 billion rsd, or around 440 million eur. according to the statements from the ministry of finance, the packages of adopted measures are worth a total of 953 billion rsd, or about 8 billion eur. the measures implemented since the beginning of the pandemic can be declared as adequate. they were focused predominantly on the sme sector, which, as all analyzes show, was really the most endangered. if we analyze the sectoral assistance, the measures were also adequate in the sense that additional assistance was provided to the tourist trade, food service and transportation sectors, which, according to the business registers agency of republic of serbia, suffered the largest decline in activity and were therefore the most vulnerable sectors. the most contested measure is the one of one-time assistance to all adult citizens in the amount of 100 eur in 2020 and 60 eur in 2021, as well as one-time assistance to pensioners in the amount of 5000 rsd in 2020 and 50 eur in 2021. considering that borrowing is necessary for this measure, the position is that the measure of assistance to adult citizens should have been selective, in the sense that it should have been directed to socially endangered categories, who most needed help. also, in order to reduce additional government borrowing, it was possible to abandon some projects envisaged in the budget for 2021, which are not a priority at the moment, such as increased equipment of the security sector, financing the airport in trebinje, certain subsidies, and redirect that money in the envisaged economic measures. the main objection to the adopted measures is their non-selectivity. assistance to companies was the same for all companies, regardless of the achieved business results and the sector in which they operate, even though all data indicate that the sectors are affected differently. the nonselectivity of this measure has been partially corrected by additional assistance to particularly vulnerable sectors such as tourism and transport. the measure of the so-called helicopter money is especially non-selective, since all citizens received the same amount of money, although it is clear that it did not mean the same to everyone and that selective assistance to the most endangered categories would be significantly better. conclusion the covid-19 pandemic has brought radical changes to the lives of every individual and organization. many activities are stopped or restricted. a large number of organizations are forced to suspend or reduce business. the globally recession is certain, but the question remains how long it will take and how to mitigate the effects of the crisis. the crisis did not affect all activities and economic entities equally. data from the annual report of the business registers agency of the republic of serbia clearly show that the sectors of wholesale and retail, manufacturing, construction, information and communication, electricity, gas, steam supply and agriculture in 2020 in serbia performed significantly better than in 2019. on the other hand, the sectors that have suffered the largest decline in economic activity are transportation and storage, and accommodation and food service activities. it has also been proven that the size of a company determines its readiness to face a crisis. compared to large and medium-sized, small and micro companies showed greater sensitivity. their excessive sensitivity can be explained by the fact that this is the segment of the economy that is the least liquid and has the lowest credit rating. in addition, these companies mainly marija lazarević-moravčević, sandra kamenković 53 operate in the most affected sectors. they are financially constrained and have little opportunity to diversify their business. having in mind the previous fact, the economic measures adopted in serbia seem to be adequate. they were mostly intended for the sme sector, which proved to be the most vulnerable part of the economy. the measures included assistance through tax deferral, grants in the form of minimum wages and measures through more favourable lending in order to overcome the problem of illiquidity. also, measures that included additional assistance to certain sectors were also targeted towards the most affected sectors of transportation and accommodation and food service activities. another proof that the measures were adequate is the fact that despite a significant decline in activity, there was no significant decline in the number of employees in the serbian economy. the measures taken by the state can be considered effective because they have given immediate results. however, if we take into account the fact that the support implied high budget spending, the question arises whether the measures are justified and sustainable, especially assuming that the crisis can continue and generate long-term changes in market conditions. further recovery of the economy, especially the sme sector, will not be determined solely by the measures that the state plans to implement, but also by the ability of companies to adapt to the new business conditions. the paper also points out the fact that in the crisis period, all the benefits of online business have become significant. modern information and communication technologies have been recognized as one of the key factors for overcoming the difficulties faced by smaller organizations during the crisis. references agencija 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(2020). “strategic responses to crisis”. strategic management journal, 41:7-18. article history: received: july 29, 2021 accepted: october 5, 2021 https://www.ien.bg.ac.rs/sr/black-swan-in-the-world-economy-2020/ https://documents1.worldbank.org/curated/en/965271619455150688/pdf/subdued-recovery-serbia-country-note.pdf https://documents1.worldbank.org/curated/en/965271619455150688/pdf/subdued-recovery-serbia-country-note.pdf https://www.intracen.org/uploadedfiles/intracenorg/content/publications/itcsmeco2020.pdf https://www.intracen.org/uploadedfiles/intracenorg/content/publications/itcsmeco2020.pdf https://www.imf.org/en/publications/weo/issues/2021/03/23/world-economic-outlook-april-2021 https://www.imf.org/en/publications/weo/issues/2021/03/23/world-economic-outlook-april-2021 https://www.ilo.org/wcmsp5/groups/public/---dgreports/---dcomm/documents/briefingnote/wcms_767028.pdf https://www.ilo.org/wcmsp5/groups/public/---dgreports/---dcomm/documents/briefingnote/wcms_767028.pdf http://www.javnidug.gov.rs/default.asp?p=128&menuitem= https://www.oecd.org/south-east-europe/covid-19-crisis-in-serbia.pdf https://www.oecd.org/south-east-europe/covid-19-crisis-in-serbia.pdf https://saradnja.rs/wp-content/uploads/2020/07/zajedno-kroz-krizu_pks-usaid-anketa-iii-faza.pdf https://saradnja.rs/wp-content/uploads/2020/07/zajedno-kroz-krizu_pks-usaid-anketa-iii-faza.pdf http://publikacije.stat.gov.rs/g2020/pdf/g202016015.pdf https://serbia.un.org/sites/default/files/2020-09/seia_report%20%281%29.pdf https://saradnja.rs/wp-content/uploads/2020/11/anketa-1000-preduze%c4%87a-2020..pdf https://saradnja.rs/wp-content/uploads/2020/11/anketa-1000-preduze%c4%87a-2020..pdf https://openknowledge.worldbank.org/bitstream/handle/10986/35647/9781464816659.pdf https://openknowledge.worldbank.org/bitstream/handle/10986/35647/9781464816659.pdf marija lazarević-moravčević, sandra kamenković 55 the impact of the covid-19 crisis on the serbian economy consequences and recovery marija lazarević-moravčević10f* | sandra kamenković2 introduction sectoral analysis of economic activity in serbia during the pandemic impact of the pandemic on performance sme sector in serbia analysis of implemented economic policy measures in serbia during the pandemic conclusion references ea_2014_1-2 udc: 004.738.5:339 ; 366.12(497-15) jel: l81 id: 207712780 professional paper determinants of customers behavior in online group buying markets of the western balkans countries zahirović suhonjić anida1, university of tuzla, tuzla, bosnia and herzegovina abstract – the field of this research is a specific part of electronic commerce called group buying on the internet or online group buying in terms of theoretical assumptions and key determinants of customers behavior in online group buying. the basic theoretical concepts of customers decision making in online group buying are analyzed: social exchange theory, equity theory and heuristic model. the basic characteristics of competitive environment are established and customer behavior in online group buying is analyzed in terms of website performance and heuristic factors of customer decision making within national markets of selected countries of the western balkans. key words: online group buying, customer behavior, heuristic model, western balkans introduction given that the group buying on the internet or online group buying (ogb for short) is primarily a sales and marketing business model, for its success are especially important determinants of the market, such as customer behavior in group buying and market performances of suppliers and online group buying services in the context of a specific terms of competitive environment. ogb is a specific form of electronic commerce where the products or services can be purchased with a significant discounts in the case that the offer reached a sufficient number of interested buyers. although it seems like a simple business model, the nature, content and processes in the online group buying require a complex analysis of the competitive environment and the different aspects and relations between participants in online group buying. every business model produces a variety of specific customer behavior. the model of ogb uses different factors to influence customer behavior on the website, which offers services and products. the successful offers on the website must reach the required minimum number of customers. ogb business model designers should understand the factors that determine the decision to purchase and use it to influence social intelligence about position of their offers. social buying (and ogb) uses social intelligence (the ability to understand and manage the buyers) in order to create profitable opportunities for business (erik eliason, yohanes frezgi and fatima khan, 2010). 1 inžinjerijske brigade 3 5/10, tuzla, bosna and herzegovina, e-mail: zahirovic.suhonjic@gmail.com economic analysis (2014, vol. 47, no. 1-2, 175-192) 176 in a significant number of cases, it is a first time that customers are confronted with a certain company (supplier, vendor) on the website of ogb service. values and discounts determine the attraction level to consumers, although it affects the perception of the supplier’s product/service. usually, consumers will first collect information about the supplier before they decide to buy, therefore it is crucial to have satisfied consumers that give positive feedback and comments. with better grades and comments about supplier's product/service, the brand of the supplier becomes stronger, and the ogb service becomes less needed. goal of each offer on the online group buying website is to attract the customer, who will eventually come back and purchase the product/service at full price in official market. (alex cohen, 2012) for research on consumer behavior in ogb the most important questions are: • what theoretical concept of customer decision making can be applied to ogb? • how the customer accepts this form of shopping? • why does the customer accepts this form of shopping? • what are the main reasons for making a decision to purchase? • besides economic, what psychological determinants are important (group effect, motives, expectations, security of transactions, etc.)? • how competitive environment influences the behavior of customers? • how much does the seller and online service impact the purchase? • is the ogb business model compliant to theoretical models? etc. therefore, the subject of the study relates to the role, structure and intensity of the key determinants of customer behavior in a business model of ogb in the context of competitive environment and ogb service management in order to achieve long-term profitability to suppliers and ogb service, and to satisfy customers’ needs and desires. the purpose of the research is to identify and explain the competitive environment and key determinants of customer behavior in a business model of ogb. the purpose is also to determine the characteristics of the applied business model of group buying in terms of website performances and decision making factors of the customers within the national markets of selected countries of western balkans: serbia, croatia and bosnia and herzegovina. basic theoretical concepts of customers decision making applied to online group buying taking into account the specifics of e-commerce and ogb business model, customer behavior in group buying has characteristics of individual and group behavior in shopping. due to this interaction, research and identification of patterns in customer behavior in ogb is more complex compared to traditional shopping. main motive for customers to participate in ogb is usually intent to save money, however, the studies have shown, motives tend to change and develop into more dimensions over time. those changes were influenced by the development of online social networks and competition among online group buying services as well. with development of social networks the perception of information exchange, interaction and knowledge sharing among customers has changed. customers have a feeling that they benefit from sharing and zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 177 exchanging the information (wen-lung shiau and margaret m. luo, 2012). therefore, customer satisfaction can be managed through ogb business model, so it is necessary to present different theoretical approaches and empirical results on decision making and customer behavior in group buying. in the literature, we can find three dominant theoretical concepts, as analyzed below. theory of a social exchange in the research (shiau and luo, 2012) the factors that impact the intention of the customers to participate in group buying were studied. the level of reciprocity and reputation of social exchange, trust and creativity of a supplier that impact on customer satisfaction and intent to shop online were studied as well. the concept of the research was based on the theory of social exchange in terms of online group buying by applying factors such as reciprocity, reputation, trust and satisfaction. these factors were identified as very important in online and offline shopping. theory of the social exchange is a concept based on: expectations (prize, contribution and social association) and anticipation (unpredicted prizes and reciprocal relation). motives for knowledge exchange were identified as egoistic and altruistic. egoistic motives imply that certain behavior is a result of the economical reward, while altruistic motives imply that one is willing to increase the welfare of all, not expecting anything in return. this research used knowledge exchange factors (reciprocity, reputation and trust) in order to define factors that influence the intention of individual to participate in online group buying, but altruistic motives were omitted with assumption that participation in online group buying does not include motives to increase welfare of other customers, and it only includes motives for personal gain. however, online group buying participants share their knowledge and expect feedback from other participants, because of mutual benefits. reciprocity, reputation and trust affect the perception of social prize. results of the study show that intention of a customer to enroll into ogb can be predicted based on their satisfaction, trust and creativity of the ogb service. satisfaction of the customer in the online group buying inicialy is predicted by the trust customer is showing, then by the customer reciprocity. theory of equity by the use of theory of equity as conceptual basis in the research (tracy l. tuten & christy ashley, 2011), it is studied how the customers evaluate the offers and how this value exceeds into future positive outcomes for suppliers, including the intention to purchase again and positive “word-of-mouth” marketing. the subject of the research is also how small companies can make the most of ogb market. the theory of equity suggests measuring costs of participation of customer compared to achieved benefits which results in estimated value. in the context of group buying, perception of the transaction value is connected to three benefits: • practical perception of monetary benefit • hedonistic perception of research benefit economic analysis (2014, vol. 47, no. 1-2, 175-192) 178 • symbolic perception of social benefit. this research has shown that small companies have to find a way to increase the perception of the transaction value. that can be achieved by noticeable price difference (discounts), by increasing the perception of research and social aspects of the offer. other recommendations for small businesses that want to exploit the benefits of online group buying, to increase the transactions, and to build awareness about their offers and brand are following: • make sure that group buying market at particular geographical region matches the target market; • create product/service offer that assures brand promotion regardless of the customer demand; • plan the initial offer so the costs of attracting new customers does not exceed the revenue from the offer or has negative impact on transactions with current customers; • encourage satisfied customers to share their positive experience with friends, family etc.; • measure the success rate of the offer by counting sold offers and return of customers attracted by the offer on group buying website, and based on that, crate future offers; • collect information about customer satisfaction and accept their suggestions in order to create better offers (emphasize that customer privacy is assured). heuristic model of customer decision making this customer decision making model has six dimensions: popularity, authority, reciprocity, affiliation, consistency and scarcity. this model is used in case study (eliason, frezgi and khan, 2010) of group buying and all six dimensions were taken into account. this approach provides useful frame to influence positive decision making of the customers under the psychological pressure. in the context of ogb the each of these six dimensions is explained. popularity: popularity is powerful tactic that impacts customer behavior. the popularity principle implies that group affects the individual. traditional e-commerce websites do not show how many products have been sold or the popularity of certain offer, while ogb websites transparently give these information and use them to attract even more customers. group buying websites also allow comments and questions from the customers relevant to the offer or supplier. usually, comments are positive. another successful tactic that increases popularity of the offer or supplier is sharing information on facebook, twitter or some other social network. authority: when it comes to decision making people often ask experts for their opinion. experts with their knowledge reduce the users’ time needed for decision making. these decisions are affected by news reports, politicians or comments on social networks. online group buying services apply relevance tactic by showing articles and news reports published by relevant media. they publish users’ comments from other websites, like yelp and opentable (in usa) where these users were given a title of “local experts”. actually, group zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 179 buying services create their own relevance through branding and claim that they are experts for offers, local businesses and things that people should visit or try out. reciprocity: reciprocity principle is applied to group buying through different methods, such as exclusive approach. reciprocity represents certain procedure of individual or company, believing that other side will compensate their initiative. customers usually believe that supplier rewarded them with discounts through online group buying. scarcity: online group buying services apply the principle of scarcity in order to encourage certain customer behavior. it is well known that products become even more attractive when they are less available. in practice this principle is constructed so it seems to customers that products or services are exclusive. compared to popularity principle where it is what people gain by shopping, scarcity principle is based on what people lose by not buying. on group buying websites this principle is applied by creating time and quantity limitations on the offers. affiliation: affiliation principle shows the behavior where customers follow other customers, brands or products they like. this principle represents believe that customers like people, brands and products they are familiar with or similar to. group buying services use this principle in order to increase quaintness and mutual interest among customers in same cities. consistency: when customers find their position, usually they tend to keep it. offer published on group buying website contains information about the offer, terms, supplier, and about the customer as well. customers want to be identified by the content of the offer and supplier activities. for example, fitness, sauna and gym offers usually attract trendy customers who live healthy life. customers behave consistent and stay consistent to their actions from the past. key determinants of customers behavior in online group buying because group buying happens online, it has to be mentioned that the internet has made major changes in customers behavior. in ogb model customers behavior factors are: (1) individual factors of customers behavior in ogb, (2) group behavior factors, (3) social factors and (4) e-commerce factors. individual factors of customers behavior in ogb individual factors of customer behavior in group buying, besides the usual factors in theory of customer behavior, are ability to use the internet, sensitivity to price and discount perception, and trust in the supplier and online service. most common factors used in research of customer behavior are: consumer resources and economic status, gender, age, education, profession, life style, psychological characteristics such as: motives, emotions, character, memory, knowledge, attitudes, preferences, habits, loyalty, shopping flow, impulsive shopping tendency etc. examples are groupon and livingsocial, leading online group buying services in usa with over a million customers and subscribers. research has shown that average user of ogb service is a woman at age of 28, with college degree and household revenue over $100k a year (eliason, frezgi and khan, 2010). economic analysis (2014, vol. 47, no. 1-2, 175-192) 180 in 2012. there was a research in croatian gfk (gfk croatia market research center, 2012) on subject of online group buying. research showed that 64% of online users are members of group buying and that they receive newsletter from 2-3 ogb services. more women (73%) than men (54%) receive newsletter. around 50% of online users (80% members) have made at least one purchase through a group buying service. although women are more often to be members of a group buying service, research has shown that men are more often to realize the purchase (88%:75%). these purchases were usually related to cosmetic services (haircuts, pedicure, manicure, and other treatments around 24%). purchases related to specific products and travel bookings come second (around 20% each), then gastronomic offers (around 20%), followed by purchases related to clothes, footwear and accessories (around 10%) (gfk croatia market research center, 2012). buying “invisible” goods, payment terms, shipping cost and time or service execution, and after sale services (complaint, service and maintenance) are important factors in making an attitude about online transaction. although online group buying service communicates with customer and is considered as mediator, supplier is usually responsible for product/service quality and other terms of transaction in online group buying. ogb is based on discounts (at least 50% off) and according to the author (dragutin gutić, 2006) customers perceive those discounts as shown in the following table 1. theoretically, discounts can cause positive and negative reactions among customers. in the group buying the effects are similar, so discount perception can be a very important factor in purchase decision making. table 1. customer product/service discount perception negative perception positive perception • if the product was any good, it would be sold by now. • obviously they have sales problems. • probably product's expiration date is closing up, so they want to get rid of it as soon as possible. • probably there is a brand new similar product. • suppliers made their commissions too high and now they are lowering them. • supplier is facing bankruptcy, so he made stock clearance. • it was about time they lower the prices. • obviously they want to increase transactions. • that is my chance to buy that product. • it is expected since it is seasonal product. other elements can also cause a negative perception of the customer, such as the time limit of the offer. offers on the ogb websites usually have time limit, and sometimes the offer is active only for one day. this practice is good because otherwise it could lead to counter effect and questions from customers like (robert j. kauffman, hsiangchu lai & chao-tsung ho, 2010): zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 181 • what is the real price of a product or a service if it is offered for a long time with a significant discount? • why is it so hard to sell a specific product or a service, and why can it only be sold on the ogb market? the decision to purchase products and services, in general, can occur in two ways: (1) mostly planned, especially if it is a product for daily use or products with brand, where customers behave routinely, and (2) impulsive or unplanned. given the specifics of the ogb model and mostly unsegmented approach to the customers, their behavior in this model is very similar to the characteristics of customers who purchase in impulsively rationally manner. impulsively rationally purchase is based on rational criteria. it means that the subject of purchase is not currently needed, but it is purchased because it is on sale and it is a special offer. ogb model exactly meets the characteristics of this way of purchasing. of course with this type of purchase the other factors must also be taken in consideration, such as tendency to e-commerce, experimentation and innovation in purchasing, satisfaction of participating in group buying, satisfaction with the award (lower price and other benefits), the impact of the group, etc. the study (irem eren erdogmus and mesut cicek, 2011) based on the survey results explained the motives, behavior and perceptions of customers in online group buying in turkey. although the ogb expects customer satisfaction, loyalty and „word-of-mouth“ marketing, this study has shown that it often leads to a disappointment of customers due to price sensitivity and transactional orientation. this study showed that discount rates are the main motive for participating in online group buying. however, searching for news, exploring and learning have also proved to be important factors for participation in ogb. customers mostly perceive ogb as a way to enrich their experience and discounts enable them to buy something they wouldn't otherwise buy. in addition to the discount rates, the decision to purchase is usually affected by the location of provider of products or services, and the perceived value of the product/service. the influence of groups and social factors on the behavior of customers in online group buying group factors of customer behavior in ogb are specific compared to the traditional approach to influences of group factors on behavior. in addition to groups, group status, group interaction, group norms, the role of leaders and followers is a little more specific in this purchasing model. in the ogb model the relevant and reference group have important influence on customer behavior (the principle of popularity), as well as aspects of social acceptability of some purchases. the relevant or reference group includes a set of individuals who contact each other in a given period and who have common needs and goals (stevan vasiljev and ljubomir trufunović, 2006). the group in the ogb business model is a set of individuals gathered in order to buy a particular product or service at a discounted price, which have indirect contact with each other through the ogb service. these individuals don't need to know each other. among these individuals there are some who are committed to promoting and economic analysis (2014, vol. 47, no. 1-2, 175-192) 182 attracting new customers because they are expecting additional bonuses. this principle where customers follow other customers in ogb is called the principle od similarity. customers generally value opinions of other people, friends, family and other formal and informal groups, and that is usually based on the principle of popularity and similarity. the presence of groups in the purchasing situation encourages customers to behave in a way that benefits ogb. social factors that are important for e-business, and thus for online group buying include legal and political environment, the state of the economy, demographics, but the most important for ogb are the it culture of the population and technical infrastructure. the following factors are crucial for the development of e-business market: computer literacy, adequate telecommunication networks, hardware and software support, the regulations for the use of internet services and economic status of the participants as a prerequisite for the purchase of necessary equipment. e-marketing and customer behavior in online group buying e-marketing factors are used to directly impact and effect customer behavior. those factors include the basic elements of the marketing mix 4p and 7p, online infrastructure, platforms and websites of ogb services. different tactics and techniques of e-marketing and social media can be used for the implementation of business strategies. tactics are generally associated with a marketing mix, while e-marketing techniques used in the ogb business model are (božidar radenković, marijana despotović-zrakić and zorica bogdanović, 2011b): e-mail marketing, permission marketing, viral marketing, affiliate marketing, referral marketing, one-to-one marketing, etc. social media are online media for social interaction and they include social networks, online communities, creating groups, internet forums, message boards, blogs, and every kind of sharing photos, audio and video clips. for example, the power of social applications in groupon's business model consists of the following (vinny wu, 2010): integration with the facebook account, so there is no need for additional registration, location-based business, every city has an independent twitter or facebook account, $10 bonus for a recommendation to a friend, subscription to a newsletter, rss, and api. as the additional marketing methods groupon uses: blog (one of the ways to communicate with customers and suppliers), groupon says/ live off, reward system for referrals and personalized service in order to increase trust and reduce the emotional distance and barriers. „word-of-mouth“ marketing is especially important in online group buying, the key purpose of marketing is to manage demand, level of demand and timing (philip kotler, 2003). ogb marketing usually integrates all the factors that influence the decision to buy on the group buying website. in the study (erdogmus and cicek, 2011) that analyzed turkish market of online group buying, it is established that ogb is suited for companies that offer products or services and whose buyers are reluctant in traditional shopping. this study has shown that buyers are more interested in different services, like recreational activities, than products. when ogb service is posting a new offer, they should make sure that their target market, who lives nearby, hears about the offer, goes to a website and makes a purchase. the offer should also zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 183 contain the information about the supplier of products/services and it should be presented as a reliable, reputable and high quality so that buyers reduce perceived risks. ogb service should publish guarantee and compensation schemes for the buyers. as such, ogb service can gain the trust and loyalty of customers and competitive advantage on the market. personalization and creating a consumer value in online group buying personalization allows customers to personalize the content that is presented to them on the website based on their preferences (božidar radenković, marijana despotović-zrakić and zorica bogdanović, 2011a). in online group buying it means that two users can be on the same website at the same time and see completely different offers. personalization is implemented by using different technologies that enable web server to collect information about buyers and based on that to present relevant offers to a particular buyer. there are three key elements in the process of personalization: 1. the mechanism responsible for personalization 2. the criteria for personalization 3. what exactly adjusts to user – content, design, functionality of a website, etc. personalization is usually realized by forming groups of users. groups are formed based on different criteria, such as common demographic, geographic and other characteristics. modern web technologies enable automatic collection of data on each web user. the users can voluntarily leave information about themselves by filling out different questionnaires and forms on the website. once the web server collects enough information about the user, it puts user in a particular group and displays the content intended for that particular group of users. it is necessary to clearly define which requirements a user must meet to be classified into the group. depending on the size of a group, there may be different levels of personalization. once the groups of buyers are identified, it must be defined what exactly on the website will adjust to what group of users. ogb service collects information about customers that can be divided into: • information that customer voluntarily submits during registration or by filling out the form or questionnaire • buyer evaluates and ranks different offers, and based on that ogb service understands buyers preferences • information on previous purchases (type of offer, how often they buy, how much they spend, etc.) • information about buyers behavior on the website (clickstream, which offers they watch, etc.) group buying services use personalization to create a suitable situation for all participants in online group buying. customers are satisfied because they have a personalized shopping experience, and they can see the offers they are most interested in. suppliers are satisfied because they have the opportunity to approach the most relevant customers, while ogb service benefits when it effectively and efficiently meets the needs of customers. by doing this, ogb service builds a better relationship with customers and it encourages them to return to the website. economic analysis (2014, vol. 47, no. 1-2, 175-192) 184 in the framework of personalization in online group buying it is important to give the customers the option to review offers, suppliers, products and services offered on the group buying website. empirical research of the competitive environment and customers decision making model in online group buying market of the western balkans competitive environment of the ogb business model represents the segment of the external environment (industry), which includes all ogb services that offer products or services by the principles of online group buying and the market where ogb services sell these products or services. the industry of ogb is characterized by products and services sold by the ogb service and customers who purchase these products or services. in addition to technical characteristics, the content of a website can have a positive impact on customer decision making about participating in online group buying. ogb services create and present content on the website in the way that customers are often under psychological pressure to buy and social media is used for the same reason on ogb websites. therefore, the adequacy of information presented on a website influences the intention of customers to participate in ogb, to say „yes“ under psychological pressure and social media are all crucial factors of the ogb website. these factors can be considered in the context of a theory, such as the theory of social exchange or theory of six heuristic factors. this second theory provides a suitable framework for determining the adequacy of the information presented on a website. compliance of the information that influence customers decision making can be explained based on the indicators of a website content on the premise of six heuristic factors. theoretical concept of empirical research the theoretical concept of empirical research is based on the premise that the characteristics of the competitive environment are important for understanding the customers behavior in ogb model. important characteristics of the competitive environment in the ogb market are as follows: number of significant ogb services, ogb website rank, the dynamics of change in rank, market structure, spatial aspect of the market, strategic groups, etc. in addition to the competitive environment and the characteristics of the offer, the content of websites is an important factor in customers decision making about participating in ogb. the adequacy of information can be examined based on the website content and how it influences the intention of customers to participate in online group buying, which is the goal of heuristic model of ogb customer behavior. heuristic factors (variables) of customers decision making are identified based on the indicators of website content and related social media, including: • popularity: information on the number of sold offers, the popularity of a particular offer, the option to comment and ask questions about the offer or supplier, the option to share offer on facebook, twitter and other social networks, review of products or services; zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 185 • authority: displaying articles or reports published by authoritative media, user reviews from other websites (e.g. in usa yelp or opentable), branding, claiming they are experts for offers, local activities and things to do and see in the city; • reciprocity: exclusive access, the belief that customers are already awarder in the form of discount; • scarcity: it is not about what customers gain if they make a purchase, it is about what they lose if they don't buy a particular offer, offers on the ogb websites can be limited by time and sometimes quantity; • affiliation: interest among buyers in the same geographical area, offering products or services to a large groups of customers; • consistency: personalization, information about suppliers and products/services from the buyers' perspective. performances of the ogb websites are identified in the context of heuristic model and they are divided into four groups of indicators, which is presented in table 2. table 2. performances of the ogb websites indicators of the market and offers e-metrics social media indicators mobile application indicators • number of cities • rewards for buyers • prize games • payment methods • reviews • personalization • average website load time • average time spent on a website • google pagerank • facebook likes • google +1 • twitter followers • youtube views • rss • blog • android • ios methodology of empirical research the research covered the industry of online group buying in selected countries of the western balkans: serbia, croatia and bosnia and herzegovina. the time coverage referred to the second half of the year 2012. there are no registers of ogb services on the observed markets, rather the data on the basic set (the list of ogb service on the selected market), their presence and performance were obtained from various sources. significant presence on the market of group buying was found for the following services: in serbia 37, in croatia 31 and in bosnia and herzegovina 5 services of ogb. on the selected market a sample of five best rated sites of online group buying for each country were taken from the site (alexa.com) and the sites of services (for bosnia and herzegovina). gathering the data was made by primary and secondary research. the primary data were gathered by the method of observation applying the analysis of the content from web pages, while the secondary data on research units were taken from their websites and the site economic analysis (2014, vol. 47, no. 1-2, 175-192) 186 (alexa.com) about buyers. groupon – a website and business model of the most successful online service was used as a benchmark for websites in the sample. the instrument for gathering primary data was a form for observation of websites of the selected ogb services which was used to gather the data on the presence or absence of various types of website performances, such as: system of rewards, prize games, comments on the offer and seller, personalization, review and so on. the rest of the data from websites are secondary ascertainments and they refer to: features of the offer (category, discount, savings, duration, efficacy), amount of sold offers, sharing information on social media, opinions and reviews of the media and buyers, savings for buyers, restrictions of the offer and offer category. analysis of competitive environment on the markets of group buying in the western balkans countries analysis of competitive situation in the branch of group buying in the countries of the western balkans was conducted by determining the key features of competitive environment, which is presented in table 2. table 3. key features of competitive environment of the observed countries features of competitive environment bosnia and herzegovina croatia serbia number of more significant services of ogb 5 31 37 services of ogb according to the rank of the site 1 to the rank of 300 4 above the rank of 500 1 to the rank of 100 5 to the rank of 500 1 to the rank of 100 7 to the rank of 500 dynamics of changes growth with undeveloped market participants growth stagnation of fall market structure monopoly to oligopoly oligopoly oligopoly spatial aspect of the market mostly national markets number of cities from 1 to 6 mostly national markets families of services regionally present number of cities from 6 to 23 mostly national markets families of the services regionally present number of cities from 2 do 20 strategic groups identified market leader and lower group identified market leader, corporative innovators and corporative followers identified market leader, corporative followers and low group to differentiation dreamers zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 187 development of competitive environment in a branch of group buying may be evaluated on the basis of the number of ogb services. it is obvious that the branch of ogb in croatia and serbia is on a such institutional level that it enables the development of this branch (in croatia 31 significant service was identified, and in serbia 37), while this branch in bosnia and herzegovina is undeveloped (identified 5 significant services). if we take into account the criterion of positioning the ogb service according to the rank of a site it can be noted that all three markets are not the most popular with respect to electronic markets. in serbia and croatia only 1 service is among the first 100, while in bosnia and herzegovina the most popular service is of the rank 201-300. also a small number of ogb sites is among the first 500 sites, so that in serbia there are 7 of those, in croatia 5, and in bosnia and herzegovina merely 1. if we observe the dynamics of changing the sites of ogb service it can be noted that both in croatia and serbia the market leaders strengthened their market position and improved their rank, while in croatia the rest of the sites improved their rank, and in serbia the sites of services mainly stagnated or considerably worsened their rank. in bosnia and herzegovina, which has an undeveloped market structure, the market leader has significantly improved his rank, and the follower has also improved his rank, however, other sites have significantly decreased their ranks. the markets of group buying in the selected countries converge to approximately oligopoly structure (five competitors together have at least 75% of market participation), which is acceptable taking into consideration the level of development of these countries and development of the market of e-commerce. oligopoly structure is characterized by the branch of ogb of croatia and serbia, while in bosnia and herzegovina prevails monopoly to oligopoly structure of the group buying market on the internet. on the market of group buying in croatia and serbia this process is currently ongoing, while in bosnia and herzegovina the existing and new online services that will create stable oligopoly structure are yet to be recognized. services of ogb are mainly oriented towards national markets in all three countries. it has been noticed that certain families of services of ogb are present on the regional market. when it comes to strategic groups a classification was made for services in the following five groups: market leader (have many or enough resources and a large market participation), corporative innovators/differentiators (have enough resources and despite the low market participation, they try to differentiate, which puts them on a promising position), corporative followers (have enough resources, but low market participation and low level of differentiation), differentiation dreamers (have very restricted resources, low market participation, but an average or high level of differentiation) and low group (low level of differentiation and focus, low market participation, as well as resources and possibilities). seven significant competitors of group buying were identified in serbia (by the popularity of website), which can be classified in the following strategic groups: market leader, four corporative followers and two services in low group to differentiation dreamers. five significant competitors were identified on croatian ogb market, which can be classified in the following strategic groups: market leader, three corporative innovators/differentiators and one corporative follower. economic analysis (2014, vol. 47, no. 1-2, 175-192) 188 bosnian and herzegovinian ogb market is undeveloped, so that the leader on the market does not have the features of a true market leader, but is closer to the features of corporative follower in the sense of following the basic business model of group buying. implementation of heuristic model of decision making of web users on the participation in group buying under the application of heuristic model for identification of factors of decision making of web users for group buying that refer to website ogb service features, an analysis was conducted for the content of websites of all services from the aspect of heuristic factors and indicators they are measured by. tables 4 to 9 show the similarities and differences between the ogb services in the context of heuristic models in the selected countries of the western balkans: serbia, croatia and bosnia and herzegovina. table 4. similarities and differences of ogb sites with respect to popularity variable similarities differences • all sites have prominent number of offers • presence on social networks (facebook and twitter) • they have the ability of sharing information on social networks • they have the ability of commenting offers and asking questions • most of the services do not have android and ios applications • smaller number of services in serbia do not have the ability of commenting • larger number of services in croatia do not have the ability of commenting • smaller number of services in croatia do not have the possibility of sharing offers on social networks when it comes to popularity only a small number of services do not satisfy the criteria defined by the indicators. mainly all sites have prominent number of offers and possibility of sharing offers on social networks. the sites also have the possibility of commenting offers and asking questions. average time spent on the site in serbia is from 2:52 minutes to 11:15 minutes, while all the sites have below-average value of google page rank, on the level 4, with respect to the most popular sites with the value 10. in croatia the average time spent on an ogb site is from 3:05 minutes to 6:30 minutes. in croatia one site has an average value of google page rank 5, while the rest of the sites have below-average value. for bosnian and herzegovinian ogb market it is in effect that the average time spent on a site is from 2:05 minutes, to 3:32 minutes. all sites of group buying in bosnia and herzegovina have low value of google page rank (from 1 to 3). all of the services on the observed markets are present on facebook and twitter with different number of likes and followers. zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 189 table 5. similarities and differences of ogb sites with respect to the variable of authority similarities differences • mainly do not show articles and reviews published by competent media • mainly do not show reviews of the users on concrete offers, sellers, products and services • services mainly do not give the possibility of review • in croatia and serbia strong branding of ogb services and suppliers • in bosnia and herzegovina branding is inadequate since there are unsuccessful offers • in serbia there are services that give the possibility of review the criterion of authority is not met by the vast majority of services. a small number of ogb services contain a link to reviews of diverse media related to that service. the users are partially enabled to value and write their opinion on concrete offers, sellers and services. table 6. similarities and differences of ogb sites with respect to the variable of reciprocity similarities differences • savings are mainly emphasized • only participation in group buying means a prize in the form of discount • system of prizes and prize games is present but not dominant • in croatia and bosnia and herzegovina the savings are mainly shown monetarily or in percentage • in serbia there are services which only show the savings in percentage reciprocity as a factor of decision making is on a satisfactory level with all services. some services practice expressing savings for buyers in money and percentage, while some have decided for expressing only the percentage. table 7. similarities and differences of ogb sites with respect to the variable of scarcity similarities differences • offers mainly have temporal and/or quantitative restrictions • products or services look like exclusive (mainly successful offers) • in serbia offers are present without temporal or quantitative restrictions • in croatia and bosnia and herzegovina most of the services restricted the offers temporally and quantitatively by coupons per person (buyer) • in bosnia and herzegovina nonexclusivity is present due to unsuccessful offers even though scarcity is one of more important factors effecting the behavior of buyers on a site of online buying, ogb services have not fully used the influence of this factor. some of the services have not clearly restricted the offers neither temporally, nor quantitatively, while some also restrict offers by total amount and amount of coupons per person. economic analysis (2014, vol. 47, no. 1-2, 175-192) 190 table 8. similarities and differences of ogb sites with respect to the variable of affiliation similarities differences • most of the services do not build mutual interest between buyers in same cities • for the success of offer mostly needed small number of coupons • most of the services have offers that succeed only with one sold coupon • in serbia an average affiliation (more than 5 sold coupons) • in croatia there is no, or it is a weak feature of affiliation (up to 4 sold coupons) • in bosnia and herzegovina mainly weak affiliation (up to 2 sold coupons) services in the region have not used the influences the factor of affiliation has on buyers in the best way, so that there are considerable lags in implementation of this criterion. with respect to the system of reward and prize games, ogb services that apply them have similar approaches, most frequently a prize of a buyer when a friend to whom the buyer recommended the offer makes the purchase. table 9. similarities and differences of ogb sites with respect to the variable of consistency similarities differences • all have presented content on seller and offer from the aspect of buyer • personalization is present, but not dominant • same means of payment (cards, ebanking and deposit slips) • in croatia with smaller number of services the detailed content on the seller and offer is not present from the above stated it can be concluded that consistency as a factor of decision making with buyers is on a satisfactory level with all ogb services in the observed countries, except from personalization as a form of personalized offers that are shown on a site and personalized offers in newsletters, which is not adequately present on websites of services in the region. conclusive considerations behavior of a buyer in group buying is an important market determinant of business model in group buying. this market determinant is important both for supplier, and for the ogb service. systematization and analysis of factors in behavior with buyers by the system of group buying have determined various aspects, structure and intensity of governing determinants of their behavior. theoretical concepts for analysis of buyers decision in the system of ogb are identified and clearly given. theories of social exchange, theory of equity and heuristic model of buyers decision making are specially analyzed. zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 191 particular factors of buyers behavior in group buying are analyzed in the context of perception of price reduction, behavior in a group and under the influence of e-marketing factors and personalization. in the empirical part of the work it has been affirmed that market structure of group buying in serbia and croatia has oligopoly features, while in bosnia and herzegovina it is monopoly to oligopoly. the market of group buying in the period of observation in serbia had stagnation or a fall, in croatia growth, while in bosnia and herzegovina the growth of market was emphasized, but with undeveloped market participants both on the side of offers and the side of demand. markets of group buying in the selected countries converge to approximately oligopoly structure that is acceptable concerning the level of development of these countries and the development of e-commerce. the market of group buying in bosnia and herzegovina is on a low level of development, with respect to the number of present ogb services, observed needs of sellers for group buying, as well as education of buyers and encouragement of satisfaction of their needs with participation in group buying. structure of heuristic model buyers decision making implemented in group buying was analyzed. indicators were identified that can measure each of these dimensions. heuristic model is implemented in the ogb market of the countries of the western balkans. it has been determined that ogb services in the region have not used the influences that some of the factors from heuristic model have in adjusting their sites to the principle of their implementation, so that there is a lot of space for enhancement of functions and design of websites in the context of this model. references alexa – the web information company, www.alexa.com cohen, a. 2012. “the ultimate guide to group buying sites” 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(2003). kako kreirati, ovladati i dominirati tržištem, novi sad: translation, adizes. economic analysis (2014, vol. 47, no. 1-2, 175-192) 192 radenković, b., despotović-zrakić, m., and bogdanović, z. (2011a). “elektronsko poslovanje: stanje i perspektive” teaching material, www.myelab.net. radenković, b., despotović-zrakić, m., bogdanović, z. (2011b). “internet marketing: strategije, taktike i tehnike internet marketinga” teaching material, www.myelab.net. shiau, w. l. and luo, m. (2012). “factors affecting online group buying intention and satisfaction: a social exchange theory perspective” computers in human behavior, 28: 24312444. tuten l. t. and ashley c. (2011). “promotional strategies for small businesses: group buying deals” small business institute journal, 7(2): 15-29. vasiljev, stevan, and trufunović ljubomir. (2006). marketing. bijeljina: fakultet spoljne trgovine. wu, v. (2010). “groupon – collective buying & social marketing,” http://www.slideshare.net/vnnw/groupon-2nd#btnnext (last visited: 02.10.2013.). determinante ponašanja grupe internet kupaca na tržištima zemalja zapadnog balkana rezime – područje istraživanja u radu je specifičan dio elektronske trgovine nazvan grupna kupovina na internetu ili onlajn grupna kupovina s aspekta teorijskih postavki i ključnih determinanti ponašanja kupaca grupne kupovine. analizirani su osnovni teorijski koncepti odlučivanja kupaca primenjeni na onlajn grupnu kupovinu: teorija društvene razmene, teorija pravičnosti i heuristički model. utvrđene su osnovne karakteristike konkurentskog okruženja i ponašanje kupaca u grupnoj kupovini s aspekta performansi veb sajtova servisa i heurističkih faktora odlučivanja kupaca grupne kupovine unutar nacionalnih tržišta odabranih zemalja zapadnog balkana. ključne reči: onlajn grupna kupovina, ponašanje kupaca, heuristički model, zapadni balkan article history: received: 13 november 2013 accepted: 20 november 2013 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp42-58 original scientific paper housing, inequality and economic growth: evidence from a sample of brazilian states vittoria manzoli1 | antónio portugal duarte2 | marta simões2* 1 faculty of economics, university of coimbra, coimbra, portugal 2 ceber and faculty of economics, university of coimbra, coimbra, portugal abstract this paper investigates the inequality-growth nexus using state-level data for brazil from 2005 to 2013 and considers that the housing deficit better reflects inequality in the brazilian economy, a highly unequal country. we estimate a growth regression where the housing deficit is the main explanatory variable taken alongside other control variables. the findings point to the existence of a negative linear association between the housing deficit and the growth rate of real gpd per capita across the 27 brazilian states, with a higher explanatory power relative to the regressions that use the gini index. the association is also stronger for the sample of richer states. other statistically significant regressors include initial income and human capital/education. our findings endorse investing in housing as a potential important means for fighting inequality and promoting faster economic growth in brazil. attention should also be given to broadening access to higher quality utilities such as electricity and sanitation. the promotion of universal access to education as a means to increase the human capital stock is also a path to achieve faster growth in brazil. key words: housing inequality, economic growth, brazilian states, panel data jel classification: c23, o18, o40 introduction brazil is a country with high contrasts in terms of income distribution, as evidenced in the united nations human development report (hdr), which identified the country as the ninth most unequal country in the world in 2017, a position based on the gini index that recorded a value of 0.549 in 2017. on the other hand, over the period 2000-2015, brazil's real gdp per capita recorded an average annual growth rate of 1.7%, according to oecd statistics. in this study we investigate whether brazil could have grown faster if not for the high level of inequality. according to the literature, the relationship between inequality and economic growth can be either negative or positive. neves and silva (2014) argue that there is no universal sign that applies to all countries at all times for the relationship between inequality and economic growth and so researchers and policymakers must take into account the specificities of each country or region. in any case, the sign of the effect of inequality on growth in less developed countries is in general negative and more intense and so policies aimed at reducing inequality in developing countries such as brazil will likely have a positive impact on economic growth. * corresponding author, e-mail: mcsimoes@fe.uc.pt vittoria manzoli, antónio portugal duarte, marta simões 43 one of the clearest expressions of inequality in the brazilian case is access to housing, and so this study will focus on the relationship between the housing deficit and economic growth to gain a better understanding of the role of inequality on economic growth in this particular situation. access to housing of adequate quality is essential to guaranteee the well-being of inidividuals. lack of or inadequate housing can thus have repercussions in terms of labour force reproduction or the supply of goods and services, mainly because housing represents shelter, protection, and security. the debate on housing access in brazil is necessary to understand and deal with inequalities that affect a large proportion of the population. a significant proportion of the brazilian population sets as a main goal to own a house, because housing is seen as performing a social function, as a means to provide shelter for the family and assist in its development, besides being associated with success and social position. this paper investigates the inequality-growth nexus using state-level data for brazil from 2005 to 2013, retrieved from different sources, such as the institute for applied economic research (ipea) and the brazilian institute of geography and statistics (ibge) that make available census and national accounts data for the different states. we consider that the housing deficit, computed by fundação joão pinheiro (fpj), better reflects inequality in the brazilian economy, a highly unequal country. albeit over the past decade targeted income and social inclusion policies managed to achieve a reduction in inequality, it remains high and so it is important to assess the potential growth benefits from inequality reduction using indicators that enable the design of more precise and effective policies. the empirical formulation adopted corresponds to a growth regression where the housing deficit is the main explanatory variable taken alongside other control variables. this indicator measures housing shortages at the state level relative to the total population of a state. in its calculation, the housing deficit considers any housing in which one of the following occurs: precarious housing; different families’ cohabitation; excessive rent burden; or excessive number of dwellers in rented housing. the remainder of the paper is organized as follows. in the next section we carry out a brief review of the literature on the relationship between income inequality and economic growth. section 3 presents the empirical model and the estimation methodology. the variables selected and a brief descriptive analysis of the data are presented in section 4. section 5 presents and discusses the results and policy implications. section 6 concludes. literature overview how does inequality affect a country's economic growth performance? the relationship between inequality and economic growth can be either positive or negative and the results from the vast empirical literature on the subject to date, such as barro (2000), also show considerable ambiguity. several researchers have analysed the relationship between inequality and economic growth taking into account different transmission channels in order to gain a better understanding on the sign, as reviewed by neves and silva (2014) and neves, afonso and silva (2016). while the aggregate savings and the r&d channels predict a positive impact of inequality on growth, other transmission channels point to a negative relationship, including: (i) credit constraints and associated barriers to the accumulation of human and physical capital; (ii) socio-political instability; (iii) redistribution and associated high tax burdens; and (iv) joint education and fertility decisions. some of the possible explanations for the negative effects are: (a) in the presence of strong credit constraints, the poorest population will not be able to invest in physical and human capital, mainly because they have few (if any) guarantees to give as collateral for obtaining credit (barro, 2000); (b) inequality may increase the risk of political instability, with negative investment outcomes. for instance, when inequality is accompanied by low rates of social mobility, people may be attracted to criminal practices rather than formal work or education, and high crime rates may lead to lower investment as the enforcement of 44 economic analysis (2020, vol. 53, no. 1, 42-58) property rights is weakened and since they create uncertainty (gründler and scheuermeyer, 2018); (c) income redistribution policies, if common in more unequal countries, may lead to the need to increase the tax burden and the transfer of resources from the richest to the poorest, possibly discouraging labour supply and effort and investment by firms; and (d) finally, gründler and scheuermeyer (2018) suggest that the most unequal societies tend to have high fertility rates and low levels of education because the poorest cannot afford to invest in their children's education and they regard children as a chance to increase family income. by contrast, richer families are willing to have fewer children and invest more in their education. as for the possible positive effect of inequality on economic growth through aggregate savings, according to gründler and scheuermeyer (2018), kaldor (1955) argued that inequality stimulates growth as the marginal propensity to save increases with the income level and so the richest save a higher fraction of their income, increasing investment and in this way growth. the positive effect of inequality on economic growth is also revealed through the demand side. more unequal income distributions increase the demand for high quality products such as luxury goods and high-tech products, and not just for basic needs, for a given price increase. when the price effects outweigh market size effects, innovative companies are favoured by the presence of those that are willing to pay higher prices for new products, and thus inequality can stimulate r&d, a main driver of economic growth (halter et al., 2014). identifying the impact of inequality on economic growth is thus an empirical issue, which has been the subject of extensive research. at the empirical level it is possible to find studies that obtain a negative effect of inequality on growth, results that are in turn contradicted by a significant number of other studies that arrive at a positive effect. neves and silva (2014) suggested, based on a comprehensive survey of this literature, that differences in estimation methods, the quality of the data collected and sample coverage may influence the relationship between inequality and growth obtained by different empirical studies. neves, afonso and silva (2016) conducted a meta-analysis of the empirical literature that estimates the relationship between inequality and growth based on a reduced form regression, i.e. studies that seek to identify the direct impact of inequality on growth. the main results and conclusions drawn support different impacts of inequality on growth, highlighting that: (i) the impact is negative and stronger in developing countries relative to richer countries; (ii) inequality in wealth distribution has a stronger negative impact on growth than inequality in income distribution, possibly due to the fact that the relevant transmission channels in action in the two types of distribution are not the same, and therefore policies focusing on reducing inequality in developing countries will be more likely to have a positive impact on growth. income inequality refers to the discrepancy in income distribution among holders of productive factors or between individuals and is mainly due to unemployment, low paid jobs or a high wage pay gap, common in developing countries. inequality in the distribution of wealth is measured based on the distribution of productive factors, human capital, physical capital, or on the distribution of real and financial assets (castelló and doménech, 2008). in the presence of wealth inequality, the less favoured will be less likely to make investments in productive factors, such as human and physical capital, and will prefer direct income transfers over investment. this scenario possibly leads the government to increase taxation so that infrastructure and other productive public investments can be carried out, for example. for the brazilian case, two recent empirical studies on the relationship between inequality and growth are cruz et al. (2015) and bessaria et al. (2018). cruz et al. (2015) investigate the link based on data for the 27 brazilian states over the period 1995-2009. by focusing on brazil at the state level it is possible to overcome some of the data comparability issues involved in crosscountry studies, especially as far as inequality is concerned. the growth regression estimated by the authors considers a non-linear relationship between inequality and growth by including both a linear and a quadratic term of the gini index of income distribution, alongside other control variables such as initial income per capita, the crime rate, schooling, fertility, life expectancy, openness and state intervention. the results using the system-gmm estimator point to a positive relationship between inequality and growth in the richer states and the opposite vittoria manzoli, antónio portugal duarte, marta simões 45 applies in the poorer states. another important growth determinant in the case of the brazilian states according to the authors is educational attainment. in bessaria et al. (2018) the main explanatory factors of output growth rate differences across brazilian states are income inequality and education. using state level data for the period 1990-2014 to estimate a growth regression, the authors conclude that additional years of education positively affect economic growth and, by contrast, income inequality, measured by the gini index, has a negative growth impact. the data used, besides real gdp per capita and the gini index, included investment (capital expenditure), political instability (homicides rate), openness and regional dummies. bessaria et al. (2018) also show that, during this period, there was a reduction in income inequality at the national level and, following the trend of the brazilian economy, all of its macroregions (recorded a reduction in income inequality, higher in the southern regions. the authors additionally carried out cointegration tests in a panel data context and concluded that there is a long run relationship between real gdp per capita growth, the gini index and educational attainment at the state level. for the specific case of brazil, what the study by bessaria et al. (2018) suggests is that inequality is likely to have a negative impact on economic growth, even though the empirical literature has not reached a consensus on this issue. brazil is characterized by strong social contrasts, high income inequality and a poorly educated population. their paper investigates the inequality-growth nexus at the state level for brazil considering as a proxy for inequality the housing deficit. brazil is frequently in the spotlight for the lack of domestic security and the large number of “favelas” where violent episodes frequently occur. the choice of the housing deficit as a proxy for inequality in brazil is due to the importance of housing in terms of providing individuals with better living conditions, thus improving other important factors for the wellbeing of people, such as health and educational outcomes. the big inequality levels in the country resulted in the exclusion of the poor, who are deprived of some basic rights, such as access to decent quality housing and consequently greater security. access to decent housing is a right of every citizen inscribed in the brazilian constitution and, in addition, housing investment is able to deliver benefits not only to the low-income population but also to the country as a whole, if it is able to promote economic growth. empirical strategy and data to investigate the link between inequality and economic growth in brazil we use data for the 27 states that compose this country. limited time coverage for our explanatory variable of interest, the housing deficit, for some states implied that the analysis concentrates on the period 2005-2013. in this way we have data for the 27 states observed over two 4-years sub-periods (2005-2009 and 2009-2013) in order to overcome to some extent business cycle effects, as is usual in empirical studies of economic growth. the panel is balanced with 2 observations for each of the 27 states, which gives a total of 54 observations. the baseline empirical model is given by equation (1): 𝐺𝑟𝐺𝐷𝑃 𝑝𝑐 𝛼 𝛽 𝑙𝑛𝐺𝐷𝑃𝑝𝑐 ; 𝛽 _ ; ; + 𝛽 𝑆𝑐ℎ𝑜𝑜𝑙 ; 𝛽 𝐼𝑛𝑣 +𝛽 𝐺𝑟𝑃𝑜𝑝 𝜀 (1) according to equation (1), economic growth depends on initial output, the accumulation of factors of production, physical and human capital, the population growth rate and inequality. the control variables included in the empirical model were selected taking into account the predictions of the augmented solow model (mankiw, romer and weil, 1992) and previous empirical studies on the relationship between inequality and growth (forbes, 2000). the dependent variable, grgdppc, is the annual average growth rate of real gdp per capita, our measure of economic growth. initial income, lngdppc measured at the beginning of each subperiod, intends to capture the possibility of convergence among the brazilian states due to the 46 economic analysis (2020, vol. 53, no. 1, 42-58) diminishing marginal returns assumption of exogenous growth models, according to which initially poorer states will grow faster and converge to the income levels of the richer states. the estimated coefficient on initial income per capita is thus expected to be negative. also according the augmented solow model, higher rates of accumulation of physical and human capital, measured respectively as the investment rate (inv) and as the average years of schooling of the population aged 25 and above (school) are expected to lead to faster growth and so the respective estimated coefficients are expected to be positive. finally, as far as control variables are concerned, faster population growth (grpop) saps growth since the same amount of inputs has to be distributed across a higher number of workers and so the respective estimated coefficient is expected to be negative. our explanatory variable of interest is inequality, proxied by the initial housing deficit per capita, _ . although the literature has not reached a consensus on the sign of the link between inequality and growth, the prevailing evidence for developing countries is that the relationship is negative and so we expect that the respective estimated coefficient is negative for brazil, classified by the world bank as an upper middle income country. 𝑎 is the constant terms and 𝜀 the error term. table 1 contains a description of the variables used and respective sources. table 1. variables and sources notation description source grgdppc annual average growth rate of real gdp per capita for each 4-years sub-period ipea lngdppc log of real gdp per capita at the beginning of each 4years sub-period. ipea hous_def pop shortage or inadequate housing per capita at the beginning of each 4-years sub-period. fundação joão pinheiro and ibge school average years of schooling of the population aged 25 and above at the beginning of each 4-years subperiod ipea inv annual average investment rate for each 4-years subperiod. due to limited data availability at the state level the proxy used corresponds to public capital expenditure as a percentage of gdp. brazilian ministry of finance (ministério da fazenda) grpop annual average growth rate of the population for each 4-years sub-period. ibge gini gini index of the distribution of personal income at the beginning of each 4-years sub-period. ipea concerning the data used, it is important to look in some detail at the indicator chosen to measure inequality in brazil, the housing deficit, calculated annually by foundation joão pinheiro (fjp), in a partnership with the ministry of cities, the inter-american bank for development bank (idb) and the united nations development program (undp). the protocol signed between the fjp and the federal government is relatively recent, 1995, and the main objective is to calculate the brazilian housing deficit and improving its calculation methodology. but it was from 2003 onwards, with the creation of the ministry of cities, that the computation and analysis of such indicator gained more importance. based on the calculations of the housing deficit, the central government makes decisions on housing policies, housing subsidies, sanitation and urban transport (fjp, 2014). indeed, the main objective of the housing deficit indicator is to guide those responsible for the implementation of public policies and programs reduce this deficit. this indicator can measure and track the development and progress of vittoria manzoli, antónio portugal duarte, marta simões 47 housing policies adopted by the government, and inform policy makers on the need for government action. the indicator of the housing deficit that will be used in this work is directly related to housing shortages. the housing deficit can be understood in two ways: the deficit due to the need for an increase in the stock of housing and the deficit due to the need to replace the depreciation of the existing stock. the first component is due to lack of housing and the second component is due to the need to replace existing decaying housing. the calculation of the housing deficit is the result of the sum of four elements: precarious housing, family cohabitation, excessive rent burden and excessive density. these elements are presented in table 2 below. the calculation methodology used by the fjp ensures that double counting does not occur. table 2. components of the housing deficit 1. precarious housing 1.1. improvised housing usually located in a building that was not built exclusively for housing, as well as places considered unsuitable for housing which are occupied for this purpose. 1.2. rustic housing housing not made of masonry or paired wood. the dominant material is usually uncoated mud, reused wood, etc. 2. family cohabitation 2.1. rooms according to the ibge “rooms are private housing consisting of one or more rooms located in a casa de cômodo, cortiço, cabeça-de-porco, etc.” 2.2. cohabiting families families living in the same house, with the intention of constituting their own / separate home. 3. excessive rental burden rent is considered excessive when the household spends 30% or more of its income to pay for the rental of housing. (households with incomes above three minimum wages are not included in this indicator). 4. excessive density in rented households excessive density occurs when permanent private rented housing has more than three inhabitants per room. source: based on information from ibge and fundação joão pinheiro. table a.1 in the appendix contains descriptive statistics for real gdp per capita for the 27 brazilian states between 2005 and 2013. the highest real per capita gdp recorded was that of the federal district in 2013, corresponding to a value of 63.05 thousand reais (the brazilian currency). in contrast, the lowest real gdp per capita recorded during this period was in the state of piauí in 2005 (5.63 thousand reais), located in the northeast region of brazil. for the total sample (27 states) the average real gdp per capita was 17 thousand reais. table a.2 in the appendix contains descriptive statistics for the annual average growth rate of real gdp per capita for the two sub-periods under analysis, 2005-2009 and 2009-2013. the state of pará, located in the north part of brazil, recorded the lowest growth rate, 0.86% in 20052009. the state of paraná, located in the south part of brazil, recorded the highest growth rate, 12.81%, 2009-2013. as far as the explanatory variable of interest is concerned, figures 1 and 2 in the appendix show that over the period 2000-2015, for five brazilian regions and for brazil as a whole, respectively, although the housing deficit is still considerable it recorded a slight improvement 48 economic analysis (2020, vol. 53, no. 1, 42-58) during this period. the total brazilian housing deficit went from 7,222,644 in 2000 to 6,355,743 in 2015, a reduction of about 12%. as shown in table a.3 in the appendix, the state with the largest housing deficit in this period was são paulo (1510463 units in 2005). the fact that this number is so high for são paulo is associated with the fact that são paulo is the most populous state over the period. são paulo was the only state that in 2015 recorded a housing deficit that exceeds one million houses (1.337 million), and of the total housing deficit for this specific year, 48% (639 thousand houses) is located in the metropolitan region of são paulo. also for the year 2015, minas gerais recorded the second largest housing deficit, 575 thousand units, followed by bahia, with a deficit of 461 thousand units. throughout the sample period, the state with the lowest total housing deficit was roraima, with 13799 units in 2008. results we first applied three diagnostics tests, the f-test, the breusch-pagan test and the hausman test, to choose between pooled ols, fixed effects or random effects estimation methodologies. pooled ols assumes that the units under analysis behave in exactly the same way and so the constant term and the estimated coefficients in equation (1) are common to all the 27 states over the 2 sub-periods for which they are observed. if this assumption is not correct and the model suffers from ommitted variable bias then the results are not robust. fixed effects considers that the behaviour of real gdp per capita can differ across the 27 states due to specific features that remain constant over time, which is translated in a different intercept for each cross section unit. with random effects these specific characteristics of each cross-section unit are also taken into account, but are not considered constant over time (they are random), so heterogeneity is included in the error term. table 3 presents the results of the three diagnostic tests based on the estimation of equation (1). the f-test considers as the null hypothesis that pooled ols is the adequate estimation procedure against fixed effects. the breusch-pagan test considers as the null hypothesis that pooled ols is the adequate estimation procedure against random effects. finally, the hausman test considers as the null hypothesis that fixed effects is the adequate estimation procedure against random effects. according to the results presented in table 3, the p-value for the f-test does not allow us to reject pooled ols as the adequate estimation procedure at the usual significance levels since it is higher than 10%. on the other hand, the hausman test tell us that we cannot reject fixed effects as the most adequate estimation procedure relative to random effects. in this case, it is thus not necessary to perform the breusch-pagan test since transitivity of results from the former two tests implies that pooled ols is the most adequate estimation procedure relative to fixed effects and random effects. we thus proceeded with the estimation of our empirical model using pooled ols. table 3. results of the diagnostics tests to select the appropriate panel estimation procedure test statistic p‐value f f(26, 22) = 1.5925 0.1355 breusch-pagan ---- hausman h = 73.4513 1.95744e-014 source: authors’ computations using the econometric package gretl. table 4 contains the results of the estimation of the baseline regression given by equation (1) using pooled ols. as can be seen in column (1), the housing deficit adjusted for population size presents a negative and statistically significant coefficient at the 1% significance level. this result confirms, at least in qualitative terms, the results observed in neves, afonso and silva (2016), which concluded that the effect of inequality on output growth is negative in developing countries. the signs of the estimated coefficients for most of the control variables also confirm the theoretical predictions. initial real per capita gdp presents a negative contribution to real vittoria manzoli, antónio portugal duarte, marta simões 49 per capita gdp growth, which suggests conditional convergence between the brazilian states. the estimated coefficient for the level of education is positive and statistically significant as expected. in the case of the population growth rate, the estimated coefficient is negative as expected, but not statistically significant. in the case of the investment rate, the estimated coefficient is negative, contrary to theoretical predictions, but it is not statistically significant, suggesting that the accumulation of physical capital is not a relevant source of growth for the brazilian states, contrary to what happens with the accumulation of human capital. next we carried out a sensitivity analysis of the results to the consideration of the standard measure of inequality, the gini index of income distribution. again the diagnostic tests results point to pooled ols as the most adequate estimation procedure (results available from the authors). table (4), column (2), contains the results using the gini index. as can be seen, the estimated coefficient for the gini index is also negative, although not statistically significant. it is also important to note that the explanatory power of the model is now smaller: the adjusted r2 decrease to around 22% and the value of the akaike information criterion is higher, when the best model is the one that minimizes this value. in summary, the results using the housing deficit are more robust than the results using the gini index. these results are in accordance with those reported in neves, afonso and silva (2016), according to which the negative growth impact of an unequal distribution of wealth is stronger than the negative growth impact of an unequal income distribution. we can think of the housing deficit as closer to a measure of inequality in the distribution of wealth, while the gini index used is a measure of inequality in the distribution of income. table 4, columns (3) and (4), presents the results of accommodating the possibility of a nonlinear relationship between inequality and economic growth in the form of an inverted u so that an increase in inequality may increase the pace of economic growth up to a certain level beyond which additional increases in inequality become detrimental to growth. to capture this effect, a quadratic term of the inequality measure was introduced, in addition to the linear term. table 4, columns (3) and (4), contain the estimation results by alternatively considering the housing deficit or the gini index as measures of inequality and again using the pooled ols method. as can be seen, the estimated coefficients of both linear and quadratic inequality terms are not statistically significant, regardless of the inequality measure considered, thus not confirming the existence of a nonlinear relationship. note that the explanatory power of the models also seems to decrease based on the lower adjusted r2 value, while the information criteria values are higher than for the linear models. to overcome, to some extent, the possibility of omitted variable bias we further estimated our empirical model with the inclusion of regional dummies. the dummies correspond to the five brazilian macro-regions: north, northeast, midwest, southeast and south. the dummies allow us to capture specific regional effects, which may have been ignored before, such as effects of differences in violence, culture, regional institutions, among others. the regression includes only four of the dummies (regions), north, northeast, southeast, and midwest, due to the obvious linear dependency problems that the inclusion of a fifth dummy would cause. the results show that only the dummy for the north region presents a negative estimated coefficient, as can be seen in table 4, columns (5) and (6). moreover, none of the dummies revealed a statistically significant coefficient. 50 economic analysis (2020, vol. 53, no. 1, 42-58) table 4. results for the whole sample (pooled ols) (1) (2) (3) (4) (5) (6) const 0.0987*** (0.0306) 0.1205 (0.0798) 0.0983*** (0.0334) −0.2852 (0.8873) 0.1018 (0.0477) 0.1655 (0.0813) lngdppc -0.095*** (0.0223) -0.093*** (0.0244) −0.0951*** (0.0225) −0.0912*** (0.0251) -0.1149*** (0.0275) -0.1063*** (0.0313) school 0.0379*** (0.0102) 0.0408*** (0.0112) 0.0379*** (0.0104) 0.0407*** (0.0113) 0.0449 (0.0105)*** 0.0472 (0.0115)*** inv -0.0283 (0.0364) -0.0442 (0.0395) −0.0284 (0.0372) −0.0470 (0.0403) -0.0152 (0.0363) -0.0320 (0.0396) grpop 0.1449 (0.4966) -0.1109 (0.5382) 0.1442 (0.5023) −0.071 (0.5497) 0.3262 (0.5319) 0.0412 (0.5926) def_house -0.993*** (0.2959) −0.9643 (0.9375) -1.0389 (0.2974) def_house2 −0.3407 (10.394) gini -0.1476 (0.1271) 1.325 (3.209) -0.2626 (0.1600) gini2 −1.3463 (2.9322) dum_north -0.0169 (0.0185) -0.0116 (0.0228) dum_northeast 0.0059 (0.0204) 0.0178 (0.0276) dum_southeast 0.0075 (0.0153) 0.0111 (0.0176) dum_centre-west 0.0149 (0.0163) 0.0178 (0.0196) r2 0.4092 0.2905 0.4093 0.2937 0.4879 0.3835 adjusted r2 0.3477 0.2166 0.3339 0.2036 0.3830 0.2574 fstats (p-value) 0.000089 0.0045 0.00025 0.0092 0.000233 0.0065 akaike -223.6166 -213.729 −221.618 −211.971 -223.3215 -213.3138 bic -211.6827 -201.796 −207.7 −198.05 -203.432 -193.424 hannan-quinn -219.0142 -209.127 −216.248 −206.602 -215.6508 -205.6430 notes: standard errors in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. source: authors’ computations using the econometric package gretl. we also analysed the sensitivity of the results obtained to the division of the sample according to the value of real gdp per capita in the year 2005, in accordance with the study by brueckner and lederman (2018), who concluded that the relationship between inequality and growth depends on initial income. the results of brueckner and lederman (2018) provide support for the assumption that income inequality is conducive to faster growth in poor countries, but is detrimental to growth in high to middle income economies. regression with panel data was thus performed for two distinct samples: high and low income states. the sample was split based on the average real gdp per capita in 2005, equivalent to 12037 reais. the first sub-sample, which comprises the high income states, those with values of income per capita in 2005 above the average, contains 13 states (amazonas, federal district, espírito santo, goiás, mato grosso, mato grosso do sul, minas gerais, paraná, rio de janeiro , rio grande do sul, roraima, sao paulo, santa catarina); the second sub-sample comprises the low-income states, those with below vittoria manzoli, antónio portugal duarte, marta simões 51 average intial income per capita, and contains 14 states (acre, alagoas, amapá, bahia, ceara, maranhão, para, paraiba, pernambuco, piaui, rio grande do norte, rondonia, sergipe, tocantins). the results obtained with the splitting of the sample are shown in table 5. the three diagnostics tests were also applied and pointed to pooled ols as the most adequate estimation procedure when using the housing deficit, columns (1) and (2), also for the high-income states of column (4) when using the gini index, while for the low-income states when using the gini index, column (3), the adequate estimation procedure is fixed effects. these results are available from the authors. the main take away from these results is that the housing deficit has a stronger negative association with growth in the initially richer states. of course this result could be the consequence of reverse causality since richer states attract more people, which in turn results probably in a higher housing deficit. the other results remain basically unchanged. table 5. results with the two sub-samples, 14 richest states and 13 poorest states (pooled ols/fixed effects) (1) 14 richest states (2) 13 poorest states (3) 14 richest states (4) 13 poorest states const 0.1266 (0.0501) 0.1534 (0.0898) -0.3607 (0.7096) -0.0157 (0.1605) lngdppc -0.1086*** (0.0346) -0.1210** (0.0501) 0.0142 (0.2552) -0.0741 (0.0742) school 0.0433*** (0.0146) 0.0370** (0.0141) 0.0846* (0.0369) 0.0372** (0.0155) inv -0.0313 (0.0595) -0.0110 (0.0519) 0.7487* (0.3254) -0.0383 (0.0543) grpop 1.4364 (0.7185) -0.0051 (0.7469) 1.0334 1.0869 -0.3079 (0.7885) def_house -2.1733*** (0.5218) -0.8629* (0.4475) gini -0.5439 (0.5125) 0.0637 (0.2363) r2 0.6519 0.3593 0.4256 0.2535 adjusted r2 0.5649 0.2137 0.2820 0.0838 f-stat. (p-value) 0.00042 0.0641 0.0367 0.2321 akaike -112.7503 -110.8854 -99.7273 -106.6045 bic -105.2017 -102.8921 -92.1787 -98.6112 hannan-quinn -110.5765 -108.4417 -97.5536 -104.1608 notes: standard errors in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. source: authors’ computations using the econometric package gretl. overall our results point to the housing deficit as an important policy instrument for public decision makers. since public resources are scarce, it is very important to define priorities and accurate indicators are of paramount importance in order to avoid waisting scarce resources. in such an unequal context as is the case of brazil, it is probably not efficient nor effective to 52 economic analysis (2020, vol. 53, no. 1, 42-58) implement the same public housing policies across the states, with different income levels, as shown by the results presented in table 5. the construction of new residential units seems of utmost importance to foster growth. a possible measure in this regard would be the financing of housing investments in a longer time horizon, thereby promoting access by low income households. financing is essential for building new houses and also for maintaining the existing ones, as highlighted by maricato (2017), p. 57, "production because it is the immobilization of significant capital over a long period of time, and consumption because housing is a special, high-priced commodity that requires credit for its purchase." improving brazil's housing situation should not only be concerned with building new housing units, but also with helping the poorest people maintaining the existing ones. stimulus packages for taking advantage of empty houses could also be used by the government, given the large number of empty houses because owners cannot find people who can pay the rent demanded or simply do not want to rent their houses. policies that facilitate and encourage the renting market may also help to reduce brazil's housing deficit and in this way promote growth. conclusion in this paper we investigated the relationship between inequality and economic growth for brazil using state-level data for the period 2005-2013 and focusing on the housing deficit as an indicator of inequality of opportunities, instead of the most often used gini index of income distribution. according to the literature, inequality can have a negative growth effect through three main channles: it generates socio-political instability that reduces investment, increases the demand for redistribution which hurts incentives and in a context of credit market imperfections prevents the poor from investing. but a positive impact can also emerge if higher inequality creates incentives to work harder and with higher effort, innovate and if the rich have a higher propensity to save and there are investment indivisilities. for developing countries such as brazil previous evidence points predominantly to a negative impact. the housing deficit can be seen as an indicator of wealth inequality, which previous literature as argued can be more important for the explanation of economic growth than income inequality since, quoting islam & mcgillivray (2019), pp.1-2 “(…) a negative growth effect of wealth inequality may be more noticeable than that of income inequality as wealth accumulates over time by generating its own income in terms of interests, dividends, rents, and capital gain and passing on between generations.” it could also be the case that when national wealth is highly concentrated in a few elites there will be an increase in political rent-seeking, resulting in less productive investment decisions and barriers to the entry of new investors which will also slow down growth (morck et al. (2000)). for instance, deininger & olinto (2000) find evidence that land inequality, a proxy for wealth inequality, has a relatively large significant negative effect on growth in a sample of 60 countries over the period 1960-1990, while income inequality reveals to have only a tenuous growth effect and in some cases with a positive sign. also, the authors findings indicate that a highly unequal distribution of assets reduces the effectiveness of educational interventions. our findings also revealed that the housing deficit is more strongly associated with the dynamics of real gdp per capita for the sample of brazilian states over the period under analysis than the gini index. the evidence found of a growth-reducing impact of the housing deficit is of policy relevance in a number of aspects, supporting housing policy as a means to promote social inclusion, provide more equal chances to every citizen and stimulate economic growth. housing policies should be designed to ensure adequate housing for all citizens and promote growth so that improving people's access to quality housing should become a priority. in brazil, recent efforts in this direction have been made, for instance with the minha casa minha vida (my house my life) program, which introduced financial subsidies through public banks for the purchase of the first house. however, little has been done by the government to subsidize the maintenance and depreciation of housing, which directly impacts the quality of the flow of services derived from vittoria manzoli, antónio portugal duarte, marta simões 53 existing housing. in addition to facilitating people's access to funds to maintain their capital stock (housing), the government could set as a priority, whithin an economic growth agenda, the extension to the whole country of basic services, such as sanitation and electricity. additionally, these policies can have spillover effects on human capital, another important determinant of the growth of real gdp per capita in our sample of brazilian states according to our findings. access to housing and of better quality can be an important determinant of the quality of the education received (learning outcomes) and the health status of the population. especially at early stages of economic development, quality housing is highly correlated with the population's health conditions and even the quality of education. therefore, policies aimed at expanding access to and the quality of housing should be a priority, not withstanding the need for other more direct measures aimed at reducing inequality in the wealth and income distributions, such as increasing the minimum wage, encourage higher savings rates among the poorer (e.g. through compulsory retirement plans), provide access to low-cost financial services (that can also facilitate home ownership) or investments in education. the evidence presented in this paper should in any case be interpreted with some caution since it is based on a rather short period of time, which additionally did not allow us to control in a more precise way for the possibility of reverse causality. as more data on the housing deficit becomes available, in particular covering a longer time period, it will be possible to deal with these limitations. references barro, r. 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(2017). “does inequality benefit growth? new evidence using a panel var approach.” universidade federal do pernambuco. vittoria manzoli, antónio portugal duarte, marta simões 55 appendix table a.1. summary statistics for real gdp per capita, thousands of reais, 27 states, 2005-2013, constant 2002 prices states average std. dev. min. max. acre 11,41 1,70 9,40 14,78 alagoas 8,18 1,76 6,61 11,29 amapá 12,91 2,22 10,82 17,37 amazonas 17,33 2,20 15,33 21,81 bahia 10,73 1,54 9,27 13,62 ceará 9,20 1,67 7,35 12,42 distrito federal 56,64 4,16 51,12 63,05 espírito santo 23,80 4,98 18,13 32,66 goiás 16,83 3,71 13,47 23,52 maranhão 7,21 1,39 5,81 9,96 mato grosso 20,54 3,91 16,26 28,04 mato grosso do sul 18,52 4,32 14,41 26,75 minas gerais 18,05 3,00 15,13 23,70 pará 10,98 2,03 9,30 15,15 paraíba 8,57 1,76 6,89 11,85 paraná 21,11 4,57 17,18 30,32 pernambuco 10,98 2,31 8,76 15,33 piauí 7,11 1,44 5,63 9,82 rio de janeiro 27,02 5,81 22,15 38,38 rio grande do norte 10,87 2,30 8,98 15,27 rio grande do sul 23,04 3,34 19,12 29,76 rondônia 14,59 2,74 11,31 18,94 roraima 14,18 2,04 12,04 18,46 santa catarina 25,29 3,52 22,04 32,33 são paulo 30,04 5,10 24,36 39,28 sergipe 11,97 2,29 9,75 16,09 tocantins 12,09 2,09 9,73 16,10 total 17,01 10,43 5,63 63,05 source: authors based on data from ipea. 56 economic analysis (2020, vol. 53, no. 1, 42-58) table a.2. annual average growth rate of real gdp per capita, 2005-09 and 2009-13 states period annual average growth rate rondônia 2005-2009 4,60% 2009-2013 5,88% acre 2005-2009 3,54% 2009-2013 6,72% amazonas 2005-2009 0,90% 2009-2013 7,23% roraima 2005-2009 2,80% 2009-2013 6,91% pará 2005-2009 0,86% 2009-2013 11,25% amapá 2005-2009 2,59% 2009-2013 8,43% tocantins 2005-2009 4,03% 2009-2013 7,56% maranhão 2005-2009 2,52% 2009-2013 10,48% piauí 2005-2009 3,90% 2009-2013 9,19% ceará 2005-2009 2,95% 2009-2013 9,44% rio grande do norte 2005-2009 1,85% 2009-2013 11,13% paraíba 2005-2009 2,31% 2009-2013 10,83% pernambuco 2005-2009 2,90% 2009-2013 10,56% alagoas 2005-2009 2,07% 2009-2013 10,97% sergipe 2005-2009 3,09% 2009-2013 8,61% bahia 2005-2009 1,33% 2009-2013 7,54% minas gerais 2005-2009 1,28% 2009-2013 9,43% espírito santo 2005-2009 2,82% 2009-2013 9,53% rio de janeiro 2005-2009 1,98% 2009-2013 11,53% são paulo 2005-2009 2,93% 2009-2013 8,13% paraná 2005-2009 1,52% 2009-2013 12,81% santa catarina 2005-2009 1,45% 2009-2013 7,35% rio grande do sul 2005-2009 2,69% 2009-2013 7,45% mato grosso do sul 2005-2009 3,05% 2009-2013 12,21% goiás 2005-2009 2,48% 2009-2013 11,07% mato grosso 2005-2009 2,07% 2009-2013 9,26% distrito federal 2005-2009 1,57% 2009-2013 2,87% source: authors based on data from ipea. vittoria manzoli, antónio portugal duarte, marta simões 57 table a.3: summary statistics for the housing deficit, units, 2005-2013 states average std. dev. min. max. acre 25641.78 5011.24 18804.00 34054.00 alagoas 104768.67 17064.99 84377.00 131963.00 amapá 23451.78 6625.82 15546.00 35419.00 amazonas 166549.89 26223.29 131574.00 212487.00 bahia 477590.67 78827.16 379160.00 657555.00 ceará 292796.33 55367.58 245951.00 424321.00 distrito federal 114963.33 10039.00 98269.00 126169.00 espírito santo 99232.89 15100.09 77033.00 125412.00 goiás 184292.11 27276.73 145678.00 229488.00 maranhão 430812.78 70407.48 274930.00 539571.00 mato grosso 90276.89 19653.12 66866.00 118889.00 mato grosso do sul 78738.67 6855.49 65024.00 87182.00 minas gerais 528256.00 85922.57 431049.00 682432.00 pará 316086.56 60371.95 256212.00 427327.00 paraíba 121643.00 15083.21 101315.00 153320.00 paraná 253781.67 43691.66 199633.00 325681.00 pernambuco 286144.89 60138.47 236658.00 427923.00 piauí 120979.78 21460.24 93316.00 165177.00 rio de janeiro 454335.89 87469.45 368098.00 596207.00 rio grande do norte 116039.33 13126.68 97647.00 143319.00 rio grande do sul 257215.11 57141.10 191189.00 368233.00 rondônia 49683.22 12380.29 30579.00 71281.00 roraima 19504.44 4309.01 13799.00 25237.00 santa catarina 156419.78 24458.30 128464.00 195947.00 são paulo 1254420.11 181327.02 1032999.00 1510463.00 sergipe 76520.33 10209.60 66445.00 99998.00 tocantins 59464.00 11305.17 42706.00 82111.00 total 228133.70 253411.64 13799.00 1510463.00 source: authors based on data from foudation joão pinheiro. 58 economic analysis (2020, vol. 53, no. 1, 42-58) figure 1. housing deficit in 5 brazilian regions, units, 2000-2015 source: authors based on data from foundation joão pinheiro figure 2. housing deficit in brazil, units, 2000-2015 source: authors based on data from foundation joão pinheiro article history: received: november 13, 2019 accepted: december 22, 2019 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp23-35 original scientific paper comparative analysis of insurance premiums in serbia and bosnia and herzegovina ‐ multiple linear regression analysis model tijana kaličanin1* | sandra kamenković1 | ivana simeunović1 1 university union, belgrade banking academy ‐ faculty of banking, insurance and finance, belgrade, serbia abstract in the last few years, the global insurance market has shown a trend of concentration growth, which was conditioned by the processes of mergers and acquisitions in insurance. the aim of this paper is to make a comparative analysis of insurance premiums in serbia and bosnia and herzegovina. dynamic analysis of market concentration indicators calculated on the basis of absolute amounts of premiums indicates that the insurance market in bosnia and herzegovina is characterized by low concentrated supply, i.e. there is greater equality of market share in relation to high inequality and high concentration among market participants in the insurance sector of the republic of serbia. having applied the multi‐linear regression model in order to analyze the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐2017, it can be concluded that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had the average net salary, households and final consumption expenditure and gross domestic income. key words: insurance premiums, insurance sector, multiple linear regression analysis model jel classification: c30, g22, l19 introduction in the last two decades, countries of central and east europe have experienced tremendous changes in the political, cultural, social and economic environment. central and east european financial system has been rapidly developing during the last couple of years, contemporary regulations have been introduced and new financial institutions have been established contributing to the maintenance of macroeconomic stability in the region. nonetheless, the macroeconomic sector in the region, underdeveloped even before the recession took place, has been a highly risky place for investments and unstable in comparison with western europe (kaličanin & hanić 2016a). the insurance market in the western balkans is characterized by significant changes caused by different economic growth pace. countries preparing to become members of the european union are carrying out faster reforms, and there is also a significant inflow of foreign capital due to a reduction of financial and political risks (novović‐burić et al. 2017). in this paper, the insurance sectors were analyzed in the republic of serbia and bosnia and herzegovina. in addition to the transition process in both countries, these countries have * corresponding author, e‐mail: tijana.kalicanin@bba.edu.rs 24 economic analysis (2019, vol. 52, no. 1, 23‐35) undergone similar political and economic changes in the past decade. both insurance markets have passed through the process of integration and internationalisation. in addition to many similarities characteristic for these two markets, there are substantial differences that are reflected in the number of residents, the number of insurance companies, the market structure, the participation of the market leader, and the number of companies with foreign capital. the market of a country is as developed as its competition is able to function on it. competition has to be constantly stimulated and protected by mechanisms in line with the european integration processes and policy focused on market economy development. competition as such has been a particularly sensitive issue in transitional countries such as serbia and countries in the region. changing the number of insurance companies on the market influenced significantly the formation of a group of leaders in the insurance market as well as strengthening the position and increasing the individual market share of the leader (kaličanin & lazić, 2018). initial structural changes raised an issue and brought about the need for a higher competitiveness in serbia. every country aspiring to join the eu and integration processes ought to develop legal norms and apply the eu regulations (kaličanin & hanić 2016a). in recent years, the insurance sector has become a significant factor in the development of the overall financial and economic system. in the first part of the paper, insurance markets and level of competitiveness were analyzed. competitiveness in the market has led to changes in the balance sheet structure of the entire financial sector as well as the position of individual insurance companies in previous years. the insurance sector is extremely important for the economy of a country, not only from the point of view of security and protection from different types of risks but also from the point of view of the overall economic development and improvements in the functioning of the financial market. in the second part of the paper, the focus is on the analysis of insurance premiums and the impact of selected macroeconomic indicators on premiums using the multi‐linear regression model. literature review there are many analyses which deal with insurance premiums and economic growth. outreville (1990), zhi (1998), beck and webb (2003), webb et al. (2002) have shown a very strong interaction between insurance premiums and gdp despite different periods and country patterns. analyses mainly suggest that higher gdp growth rates have an impact on economic activity growth, which leads to assumptions about a positive correlation between gdp growth rate and demand for insurance. haiss and sumegi presented very extensive research in 2008, which led to the conclusion that there is a correlation between insurance and gdp growth in eu‐15 countries with developed financial markets as well as short‐term linkages between gdp and non‐life premiums on a sample of cee countries. serbia and bosnia and herzegovina are selected for this research because very few authors have analyzed this region from the insurance aspect. novovic‐buric et al. (2017) explored the influence of certain factors on the purchase of insurance products through a panel analysis. western balkan countries were analyzed in the period from 2005 to 2015, and the results show that most of the economic factors affect total life premiums. the demand for life insurance has a significant and positive impact on gdp and wages, while the influence of unemployment and interest rates is negative. dragos (2014) used the fixed and random effects model in the analysis, which entailed 17 countries in asia and central eastern europe. the aim was to compare emerging markets in europe characterised by market economies and emerging markets in asia, which are predominantly planned economies in terms of the impact of economic performance on life and non‐life insurance. it has been noted that the differences certainly exist. the results concerning the cee, taking into consideration the countries which are analyzed in this research have shown tijana kaličanin, sandra kamenković, ivana simeunović 25 that income and education have a positive impact on the insurance demand, while urbanisation has shown a significant impact on non‐life insurance. on the other hand, income distribution negatively influences the demand for insurance. kjosevski (2012) analysed the determinants of life insurance demand in central and southeastern europe by using fixed‐effect panel models in the period 1998‐2010. the results show that in terms of life insurance, the most significant predictors are the following: high gdp per capita, inflation, health expenditure, level of education and the rule of law. mitra (2017) analysed the impact of economic, demographic and cultural factors on life insurance consumption in 28 eu countries. the focus was on the emerging east european economies, given that in the analysed period 2009‐2014, there were significant reforms of the insurance sector in these countries. the results show that the higher gdp is an indicator of higher wages and higher levels of economic activity, the more positive impact on insurance demand. ward and zurbruegg (2002) analysed 37 countries in the period 1987 ‐ 1998 with the intention to point to the links between insurance premiums and various legal and political factors, as well as economic and social factors. the analysis has shown that the consumption of life insurance products is under stronger influence of gdp in asia than in oecd countries, which is an expected result given that in the oecd countries there is a considerably higher average income level and that ‘s curves’ suggest that at higher levels of income the demand for insurance is less susceptible to the revenue growth. bianchi et al. (2011) analysed the insurance market in central, eastern and southeastern europe and both countries which were analyzed in this research are contained in the sample. they used panel regression (a cross section with fixed effects) to examine the impact of gdp growth on insurance premium growth. the results suggest that economic development and catching‐up processes mainly condition premium growth, and that in unstable periods, it shows increased volatility. comparative analysis of the insurance market figure 1 shows the total number of insurance companies operating in the insurance market in serbia as well as in bosnia and herzegovina in the last ten years. the largest number of insurance companies in serbia was present in the period 2011‐2013 when there were 28 companies, followed by the decline in the number of insurance companies, ranging from 25 in 2014 to 21 at the end of 2017. figure 1. number of insurance companies, 2007‐2017 with the number of insurance companies in the market in bosnia and herzegovina, fewer oscillations can be noted in the observed period, ranging from 24 to 27. the largest number of 0 10 20 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 20 24 26 26 28 28 28 25 24 23 21 25 26 26 26 25 25 25 24 24 27 27 number of insurance companies ‐ serbia number of insurance companies ‐ bih 26 economic analysis (2019, vol. 52, no. 1, 23‐35) insurance companies at the b&h market operated in the last two years of the observed period, i.e. 2016‐2017 with a total of 27 companies. in addition to the banking sector with the largest share of the balance sheet total in the total financial sector ‐ about 90%, the balance sheets of the leasing companies, pension funds and insurance companies are included. figure 2 shows a fall in the share of the insurance sector's balance sheet total in the total financial sector, which is notable in both markets in the period 2005‐2008. after 2008, the share of the insurance sector balance sheet total in serbia rose from 4.2% in 2008 to 6.3% in 2017. the same trend is present in the insurance market of bosnia and herzegovina, where the growth of the balance sheet total in the total financial sector increased in the same period for the same percentage ‐ 2.1%, from 3.45% to 5.57% in 2017. figure 2. contribution of the balance sheet total of the insurance sector to the overall financial sector, 2005‐2017 figures 3 and 4 show the ratio of the total number of insurance companies and foreign companies in the period 2007‐2017. it can be concluded that the number of foreign insurance companies in serbia has changed proportionally with the total number of companies present in the market. the number of foreign companies in the insurance market of b&h did not change significantly in the observed period. there were 10 foreign insurance companies in the period 2008‐2014, after which this number increased to 11 and 12 in 2015, 2016 and 2017, respectively. figure 3. relationship between the total number of insurance companies and foreign companies, 2007‐2017, serbia 4,42 3,75 3,46 3,45 3,72 3,86 4,43 4,77 4,86 5,19 5,38 5,57 5,57 5,3 4,3 4,1 4,3 4,2 4,2 4,4 4,5 4,8 5,2 5,8 6,1 6,3 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih serbia 20 24 26 26 28 28 28 25 24 23 21 13 17 19 19 21 21 21 19 18 17 15 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign tijana kaličanin, sandra kamenković, ivana simeunović 27 figure 4. relationship between the total number of insurance companies and foreign companies, 2007‐2017, b&h given that the subject matter of the analysis is the amount of income earned by insurance companies, the companies’ market shares are calculated on the basis of the amount of total premiums at the end of the year taken from the balance sheet of insurance companies. figure 5 shows a comparative analysis of the concentration of the largest companies in b&h and serbia according to the criterion of the total balance sheet. dunav insurance company was the market leader in serbia according to the mentioned criterion and has absorbed about one‐quarter of the entire market in the observed period. by the end of 2015, sarajevo insurance was the market leader in b&h according to the criterion of the total premium. for the next two years of the observed period, uniqa insurance achieved the largest amount of total premiums. the concentration of leader ratio in b&h is much lower than in serbia, so the leader in this market has a share of about one‐tenth of the entire market. figure 5. cr1 according to the criterion of the total premium, 2007‐2017 the number of companies involved in the calculation of this indicator is determined by government agencies that are monitoring the degree of bid concentration in that particular country, provided that this coefficient is used as an official indicator (martin, 2002). cr 1, cr3 and cr5 are most frequently accrued in the reports of the responsible insurance institutions, according to the criterion of total premiums, total non‐life insurance premiums and total life 25 26 26 26 25 25 25 24 24 27 27 9 10 10 10 10 10 10 10 11 11 12 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign 013 012 012 012 013 013 012 011 010 009 008 031 025 028 026 027 029 027 025 027 026 027 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 28 economic analysis (2019, vol. 52, no. 1, 23‐35) assurance premiums. figure 6 shows the concentration ratio of the top five insurance companies with the highest total premium. although there is a mild tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. (as can be seen in lorenz curves 8 and 9). cr5 had fallen from 84.16% in 2007 to 77.19% in 2017. the mentioned concentration ratio in b&h dropped from 45.97% to 39.21%, from 2007 to 2017. figure 6. cr5 according to the criterion of the total premium, 2007‐2017 figure 7 shows the dynamic analysis of the herfindahl‐hirschman index in the period 2007‐ 2017 for both markets. the significance of the index is reflected in the fact that although it respects the individual market share of all companies in the branch it particularly responds to the presence of companies with large market participations, which significantly increase its value (lipczynski & wilson, 2001) given the above and taking into account the high cr5 concentration ratio on the insurance market of the republic of serbia, high values of the herfindahl‐hirschman index are not surprising. figure 7. herfindahl‐hirschman index according to the criterion of the total premium, 2007‐017 with the increase in the number of insurance companies in serbia, this index has declined, so the highly concentrated bid with the index of 2050 in 2007 reached the level of a medium concentrated bid (it is considered thin the market is medium concentrated if the hhi index value 046 045 045 046 046 045 046 045 042 041 039 084 082 079 077 077 077 076 077 076 075 077 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 2050 1820 1654 1520 1551 1595 1495 1496 1558 1495 1543 655 623 622 643 636 640 636 610 585 555 534 0 500 1000 1500 2000 2500 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 serbia bih tijana kaličanin, sandra kamenković, ivana simeunović 29 ranges from 1000 to 1800). it can be concluded that from 2008 until today, the insurance market in serbia is medium concentrated. herfindahl‐hirschman index according to the criterion of the total premium differs significantly in the market of bosnia and herzegovina, where the permanent low‐concentration bid is present in the observed period. although the hhi index fell from 655 to 534, from 2007 to 2017, it can be concluded that the insurance market in b&h is inconsistent, i.e. that there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. figure 8 shows lorenz curves based on the amount of total premiums for the initial and the last year of the observed period, i.e. 2007 and 2017. first, insurance market leaders have reduced their market share, i.e. the top 20% of insurance companies in 2007 had a cumulative 80% of the total market share measured by the total premium, while the same percentage of leaders in 2017 had less than 60%. with the exception of market leaders (the first four companies) of 18 companies in 2007, 14 companies shared 18.85% of the total market, while in the year 2017 some 15 companies shared 18.69%, which suggests that the number of companies increased in the market with smaller market share, primarily due to the appearance of new companies in the market. this finding contributes to the value of the herfindahl‐hirschman index as well as the value of cr5. figure 8. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, serbia constructing lorenz's curve in terms of the degree of concentration of supply in the relevant market, the distribution of the entire market between business entities can be clearly seen. (kaličanin & hanić 2016b). lorenz curves for the insurance market of bosnia and herzegovina constructed based on the premiums shown in figure 9 differ considerably from those presented in figure 8. the distribution of the market share of insurance companies in the stipulated market is characterised by greater equality, which can be inferred from the lorenz curve distance from the equal’s curves (in case of equal distribution of market share among all participants in the market). fewer companies have been able to increase their market share over the observed period, while market leaders reduced their cumulative market share. 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz 30 economic analysis (2019, vol. 52, no. 1, 23‐35) figure 9. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, b&h in 2017 in bosnia and herzegovina, there were 27 companies, i.e. 6 companies more than in the republic of serbia. in addition to the difference in the number of companies, there is greater inequality in the distribution of market shares in the serbian insurance market as well as greater concentration on the supply side compared to the low concentration of the insurance market of bosnia and herzegovina. methodology as emphasised before, the aim of this paper is to analyse the insurance market in serbia and bosnia and herzegovina with reference to certain macroeconomic indicators that play a key role in the development of insurance. in this respect, we investigated the mutual influence of individual variables on the movement of total premium income earned in these countries. in this analysis, a time series is used for the period 2000‐2017, i.e. for a period of 18 years. for the mentioned period, the following independent variables were analysed:  – average net salary (current, rsd/km)  – unemployment, total (% of tthe otal labor force)  – gross domestic income (constant lcu)  ‐ gdp per capita (current us$)  ‐ wage and salaried workers, total (% of total employment)  ‐ households and npishs final consumption expenditure (current us$) while the dependent variable was – total premium (current rsd/km). for this research, multiple regression analysis was carried out using the spss statistical software. the choice of independent variables is based on empirical fundaments that relate to the studied variable, as well as on the information contained in the relevant literature. six independent variables were included in the analysis to identify those that could explain the major part of the variability of the studied (dependent) variables. a model involving variables whose calculated regression coefficient is significant at 5% level is selected. empirical research and discussion usually, the first part of the study contains basic indicators of descriptive statistics. since all variables included in the analysis were measured on the ratio scale, the values of arithmetic mean and standard deviations are presented as indicators of a descriptive statistic (table 1 and table 2). 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz tijana kaličanin, sandra kamenković, ivana simeunović 31 table 1: descriptive statistics for different variables – serbia mean std. deviation n total premium 49372718.5000 24831359.35237 18 average net salary 345729.3333 183811.84680 18 unemployment, total (% of total labor force) 17.6239 3.61340 18 gross domestic income (constant lcu) 2855342777777.7780 458570337497.97485 18 gdp per capita (current us$) 4614.9873 1798.25314 18 wage and salaried workers, total (% of total employment) 69.4582 1.98410 18 households and npishs final consumption expenditure (current us$) 25301236558.1667 9670960437.31504 18 source: authors using spss table 2: descriptive statistics for different variables – bih mean std. deviation n total premium 430206288.0000 141434498.99548 18 average net salary 1035.7778 262.30260 18 unemployment, total (% of total labor force) 27.3079 2.00943 18 gross domestic income (constant lcu) 24073220032.1667 3036558289.97812 18 gdp per capita (current us$) 3848.6667 1366.86275 18 wage and salaried workers, total (% of total employment) 66.5221 6.48730 18 households and npishs final consumption expenditure (current us$) 12811176132.8333 2684992943.38614 18 source: authors using spss below is an output that refers to the multiple regression model which was implemented on the data obtained for both countries involved in the analysis. table 3: model summary along with the values of r and r square – serbia model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .962a .925 .920 7023512.91992 .925 196.491 1 16 .000 2 .981b .962 .957 5152189.94256 .037 14.733 1 15 .002 3 .992c .983 .980 3548389.97989 .021 17.624 1 14 .001 4 .996d .993 .990 2444365.32992 .009 16.502 1 13 .001 a. predictors: (constant), average net salary b. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$) c. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu) d. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu), unemployment, total (% of total labor force) source: authors using spss 32 economic analysis (2019, vol. 52, no. 1, 23‐35) in the case of variables describing the insurance market in the republic of serbia, four models were generated, where the last model was selected having the highest value of the coefficient . the value in this case shows that 99.3% variations in total premium can be explained by selected four variables and this model can be considered appropriate to develop the regression equation. the independent variables selected by the above mentioned model are as follows: average net salary, households and npishs final consumption expenditure, gross domestic income and unemployment, total (table 3). the following table shows the unstandardized and standardised regression coefficients for all models. in the last model, t‐values for all the two regression coefficients are significant as their significance values (p‐values) are less than 0.05. therefore, it can be concluded that the previously selected 4 independent variables significantly explain the variations in the total premium. table 4: regression coefficients of selected variables in different models along with their ‐ values and partial ccorrelations – serbia model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) 4460520.406 3606405.932 1.237 .234 average net salary 129.906 9.267 .962 14.018 .000 .962 .962 .962 2 (constant) 14150355.208 3656718.281 3.870 .002 average net salary 178.058 14.268 1.318 12.479 .000 .962 .955 .628 households and npishs final consumption expenditure ‐.001 .000 ‐.405 ‐3.838 .002 .753 ‐.704 ‐.193 3 (constant) ‐66019515.273 19262250.240 ‐3.427 .004 average net salary 102.779 20.448 .761 5.026 .000 .962 .802 .174 households and npishs final consumption expenditure ‐.002 .000 ‐.640 ‐6.977 .000 .753 ‐.881 ‐.242 gross domestic income 4.254e‐5 .000 .786 4.198 .001 .934 .747 .145 4 (constant) ‐49098413.472 13907538.352 ‐3.530 .004 average net salary 107.565 14.135 .796 7.610 .000 .962 .904 .182 households and npishs final consumption expenditure ‐.001 .000 ‐.550 ‐8.200 .000 .753 ‐.915 ‐.196 gross domestic income 3.880e‐5 .000 .717 5.512 .000 .934 .837 .132 unemployment, total (% of total labor force) ‐783350.327 192833.041 ‐.114 ‐4.062 .001 .250 ‐.748 ‐.097 a. dependent variable: total premium source: authors using spss using the values of the unstandardized regression coefficients of the last model presented in table 4, the following regression model can be shown: 49098413.472 107.565 0.001 0.0000388 783350.327 tijana kaličanin, sandra kamenković, ivana simeunović 33 concerning the same analysis carried out for the data from bosnia and herzegovina, two models were generated, where the second one was selected for which the value of 0.983 was assigned for the determination coefficient (table 5). in this way, a multiple hierarchy model was formulated which combines two independent variables as follows: gross domestic income and wage and salaried workers, total. since the f‐value for this model is highly significant, the model is reliable. also, the regression coefficients in the stipulated model are statistically significant, and it is considered that the selected variables have a great predictive significance in estimating the value of the total premium. table 5: model summary along with the values of r and r square ‐ bih model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .975a .951 .948 32128444.21790 .951 313.443 1 16 .000 2 .992b .983 .981 19491967.96979 .032 28.470 1 15 .000 a. predictors: (constant), gross domestic income (constant lcu) b. predictors: (constant), gross domestic income (constant lcu), wage and salaried workers, total (% of total employment) source: authors using spss the last table contains the values of the regression coefficients for the previously selected model. table 6: regression coefficients of selected variables in different models along with their ‐ values and partial correlations ‐ bih model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) ‐663490820.738 62238137.572 ‐10.661 .000 gross domestic income .045 .003 .975 17.704 .000 .975 .975 .975 2 (constant) ‐827546449.311 48694106.929 ‐16.995 .000 gross domestic income .035 .002 .759 14.452 .000 .975 .966 .483 wage and salaried workers, total (% of total employment) 6110923.803 1145287.155 .280 5.336 .000 .866 .809 .178 a. dependent variable: total premium source: authors using spss regression equation, which can explain the variability of the observed total premium variable analysing trends in selected independent variables goes as follows: 827546449.311 0.035 gross domestic income 6110923.803 wage and salaried workers 34 economic analysis (2019, vol. 52, no. 1, 23‐35) conclusion after 2008, the share of the insurance sector balance sheet total in serbia and bosnia and herzegovina increased in the same period for the same percentage – 2.1%. the number of insurance companies with foreign equity in serbia has changed proportionally with the total number of companies present in the market whereas the number of the foreign insurance companies in bosnia and herzegovina remained almost the same although the total number of the insurance companies increased. the concentration of leader ratio (cr1) in bosnia and herzegovina is much lower than in serbia, so the leader in this market has a share of about 10% of the entire market while in serbia it is about 27%. although there is a moderate tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. it can be concluded that in the last decade the insurance market in serbia is medium concentrated according to herfindahl‐hirschman index calculated by total premium and it differs significantly in the market of bosnia and herzegovina, where permanent low‐concentration bid is present in the observed period ‐ there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. in this paper, the multi‐linear regression model was applied in order to analyse the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐ 2017. we can conclude that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had average net salary, households and final consumption expenditure and gross domestic income. therefore, there is a positive correlation between household income (including salary and other income) and premiums. also, in the periods when household expenditure was higher, the amount of total insurance premium was also higher. both of the selected economies have undergone changes in the financial sector, particularly in terms of recent regulatory reforms. this paper provides information on the determinants of insurance demand in the republic of serbia and bosnia and herzegovina. this research is limited to a macro level analysis of the insurance demand. further, detailed analysis can be performed on individual life insurance products, which may result in more reliable findings. the period 2000‐2017 was analysed, so future studies can further segregate the cee region into developed and developing economies and make a detailed time series analysis incorporating both pre‐crisis and post‐crisis period. acknowledgements this paper is a result of research projects under the code 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonisation with eu requirements) financed by the ministry of science and technological development of the republic of serbia. references beck, t. & webb, i. 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(1998). die nachfrage nach lebensversicherungen: eine empirische analyse für china, mannheimer manuskripte zu risikotheorie, portfolio management und versicherungswirtschaft 112, universität mannheim. www.nbs.rs www.azobih.gov.ba www.data.worldbank.org article history: received: april 1, 2019 accepted: may 29, 2019 doi: 10.28934/ea.19.52.12.pp56-68 scientific review the impact of globalization on entrepreneurship mirjana radović-marković1 | zvonko brnjas1 | vladimir simović1* 1 institute of economic sciences, belgrade, serbia abstract this paper aims to explore the importance of globalisation for the development of entrepreneurship. changes in the global business environment require new business strategies. small business owners are expected to be able to develop the resiliency of their businesses so that they can face severe external conditions. their sustainability depends on resilience but also on the perspectives of longterm business operations. therefore, small and medium-sized enterprises must demonstrate their ability to anticipate changes in the market, react to them, and initiate them. this implies the improvement of basic processes, learning new skills and closer cooperation with external and internal partners. small enterprises need to redefine their goals and use their resources more effectively as a necessary condition for expanding maneuvering space for growth and for achieving sustainable development. finally, it is concluded that organisations must establish the right balance between the challenges and benefits of globalization and the four basic areas for achieving the right balance are adequate cost, human resources and risk management, as well as the formulation of a strategy that follows the requirements of the global market game. key words: globalization, entrepreneurship, global index of entrepreneurship, organization, competitiveness, resilience jel classification: m13, f690, m15 introduction the analysis of the implications of globalisation for the development of entrepreneurship is of particular importance, bearing in mind the overall significance of entrepreneurship. however, this impact varies depending on the level of economic development of a country and the degree of its integration into the global business environment. therefore, it has long been assumed that highly developed and globally integrated countries have a developed entrepreneurial sector, measured by the global index of entrepreneurship. it determines the impact of globalisation on the development of entrepreneurship at the level of individual countries. it is also an indicator of the quality of entrepreneurship, especially related to the effects of entrepreneurship and innovation, which are conditioned by individual and institutional factors. in addition to the differences in the global index of entrepreneurship, what is common to most countries is the fact that with the growth of globalisation, the number of start-up companies and new jobs are growing; there is an increase in innovation and effective and rapid absorption of technological progress. globalisation influences following the strategy of the company more than before, which in today's terms implies multifunctional teams. this is also an explanation of why globalisation can never be tied only to business with one region or market. accordingly, * corresponding author, e-mail: vladimir.simovic@ien.bg.ac.rs vladimir simović, mirjana radović-marković, zvonko brnjas 57 global companies differ in their ability to serve a large number of markets, but also in their possibility to take advantage of all market opportunities and increase their competitiveness. the method of analysis is primarily based on a review of the latest literature on this topic. the theoretical framework presented in this paper provides a starting point for the study and analysis of the relationship between the level of globalisation and the level of entrepreneurship. literature review literature abounds mainly with papers dealing with the effects of globalisation on the business and performance of large multinational corporations (drucker 2001; mazlish, 2012; haller, 2016; button, 2018), while there is a lack of equivalent studies that explore these effects on the example of small and medium-sized enterprises. drucker (2001) states that multinational companies are more knowledge-oriented, while hierarchies are less important within the organisation. they are particularly characterized by a high level of professionalism (employees are rather professionals than just executives), independence (employees have decision-making rights, flexibility in the activities they perform, access to continuous training and education) and they identify with company values. the last decade of the 20th century became a testament of the market power, benefits of integration processes and globalisation (pesakovic,2017). globalisation has also affected small and medium-sized enterprises in the fact that they have changed their role, first of all, in national economies. namely, globalisation represents new challenges for small and medium enterprises, leading them to integrate the idea of global changes into their business strategies. in this way, by changing their business strategy in global terms, they would become less sensitive to internal and external shocks and raise the index of resilience (radovic-markovic, 2019). to what extent the economies deal with shocks depends on various factors, including the political environment, the depth of economic and financial diversification, and especially the quality of institutions and the economic structure of the economy. in addition, countries that have well-developed business plans and action plans in case of disaster risk, as well as programs for assessing the resilience of enterprises, showed a higher index of resilience than those who did not have it (radovic-markovic, 2018). the study found that the index of resilience is highly correlated with gdp per capita, suggesting that economic resilience is associated with economic success. namely, despite the high exposure to external shocks, a large number of small countries manage to maintain economic growth and continue their development, given their relatively high gdp per capita (radovic-markovic, 2019). since the influence of many factors arising from globalisation is different for small and medium enterprises in relation to multinational companies, it is necessary to identify the most important factors and to determine their effect. one group of researchers identified the two most important factors of globalisation that directly affect small and medium enterprises (deo, 2013): 1. growth of cheap communications and transport (with the improvement of information technology and cheaper transport, new opportunities have opened up for many companies, especially for small and medium ones). 2. internationalisation of businesses depending on financial and economic integration. also, research has shown that there is no correlation between the big market and the success of large businesses. in other words, globalisation rewards companies that are innovative and competitive, regardless of the size of the organization and the country of origin (radovicmarkovic and tomas, 2019). in addition, employee competencies play a major role in achieving success in the global market (radovic-markovic, 2011). there is great agreement among researchers that e-skills are becoming increasingly important for improving competitiveness, productivity and innovation, as well as for hiring a workforce and its professionalism. in this sense, the need to provide the knowledge, skills and competencies of managers and it specialists in this field, as well as the users, is very evident in order to influence the fulfilment of 58 economic analysis (2019, vol. 52, no. 1, 56-68) the highest global standards, which are continuously improved through the process of effective lifelong learning. the researchers also put entrepreneurial orientations, behavior of entrepreneurs, their personality traits, leadership styles, the influence of entrepreneurial education on the success of entrepreneurial business, and the cultural aspects of entrepreneurship in the global context (lee, lim & pathak, 2009, lepoutre et al. al., 2010, ryan, tipu & zeffane, 2011, radovicmarkovic & tomas, 2019). it was found that various exogenous factors, such as cultural specifics and experience, had implications for the development and types of businesses, as well as the background of family businesses and emotional intelligence of entrepreneurs (pradhan & nath, 2012). namely, the conditions leading to entrepreneurial activities range from personal, cultural and institutional, and are influenced by the levels of business innovation, variety of offers (products and services) and individual entrepreneurial efforts (wennekers, thurik, 1999). having in mind the various approaches to the research of entrepreneurship, it can be concluded that entrepreneurship has become a point of interest among many researchers. in the first place, all the schools of entrepreneurship can be classified into special categories (radovicmarkovic, 2009): a. psychological schools those examining personal qualities of entrepreneurs and their psychological characteristics b. traditional schools those based on recognizing the new opportunities in entrepreneurship c. management-based schools those dealing with the management and leading of entrepreneurial activities in recent years, the schools that can also be added are those that focus on the development of entrepreneurship in the global business environment by examining its legal (parker, 2007; loza, 2011), socio-cultural (valdez & richardson, 2013; nagayya & tirumala 2013; ghiat, 2014; and economic aspects (kropp, lindsay, & shoham, a., 2008; singh, garg, & deshmukh, 2010; radovic-markovic & tomas, 2019). the two-sided impact of globalization on small and medium-sized enterprises (smes) the impact of the phenomenon of globalisation today has become comprehensible and has affected all areas of life. of particular importance is its impact on the economy, and here we are interested in the impact on one very important segment of the economy: small and mediumsized enterprises (smes), as one of the key agents of the development of entrepreneurship and innovation. the impact of globalisation on smes, like in other areas of life, is twofold. on the one hand, it opens up the unobserved opportunities for developing smes, primarily through the opening of new markets that were completely inaccessible to them in the past. by their nature and in accordance with their resources and general capacities, smes are targeted at local markets. the main drivers of globalization in today's conditions, primarily the development of information technology and traffic, annul the basic handicaps of small and medium-sized enterprises that are related to the inability to communicate effectively with the distant markets, how to get information about customers and suppliers, and how to send information about them in the other direction. thanks to the availability of the market in terms of simple and efficient communication and information exchange with its stakeholders, as well as increasingly easy and cheaper ways to overcome spatial and other geographical barriers, smes are becoming more and more able to become equal participants in economic activities in the most distant international markets. on the other hand, these same factors allow real and potential sme competitors from international markets to suddenly appear on local markets that are considered to be their safe "protected zone" until recently and dramatically threaten existing positions and relationships. vladimir simović, mirjana radović-marković, zvonko brnjas 59 the characteristics of smes competitive models in a global environment according to the namiki model (mckinnon, 2003); small and medium-sized enterprises in the competitive struggle on the global market have available four of the following strategic forms of competitiveness: • becoming competitive by pricing. this model or strategy implies that smes, due to their flexibility, lower administrative costs, knowledge of the local labour market and in general procurement, are able to offer their products at lower costs than large local companies and most international competitors; • competing by unique capabilities in production (reliance on a unique, innovative product, a wide range of products, and so on) .this model is based on the production capabilities that enable smes to offer products that will more fully meet the expectations and needs of customers compared to competitors. this type of sme can supply end-users, but also very often are contractually linked to large corporations that supply certain inputs on a long-term basis. • competing by technological superiority. this type of competitiveness model refers to smes that have emerged and are developed under the influence of factors such as genuine innovative-technological solutions, inventions or expertise, which give them a superior position in relation to existing standard technological solutions used by competitors. this advantage in technology gives companies possessing it a significant market advantage over competitors. • competing by high quality of services and/or products. finally, smes can differentiate themselves from competitors with the high quality of their services and products. in addition to the technology that is especially distinguished in the previous model, this type of competitive advantage can also be based on superior market knowledge, some specific segments of clients, and the ability to satisfy their needs in the best possible way. if a company can combine these models, i.e. to achieve a competitive advantage based on several factors, insofar as this will more favorably affect its market position. for example, if at the same time it can offer a technologically superior product at lower prices and to a greater degree adjusted to the needs of its clients, then it can count on a superior market position over the long term, with the expected continued stable financial results. essentially the described strategies are reduced to the differentiation strategy in specific market segments, which is achieved by the specialization and high quality of products and services. the limitation of resources as a general characteristic of smes necessarily directs them to strategies based on entrepreneurship and innovation, which means to specialization, i.e. focusing on narrower market segments where they can be imposed as superior competitors and thus differentiate in relation to their competitors. this strategy allows them to avoid direct conflicts with large corporations in which, due to limited resources in the long run, they have no chance. it also allows them to occupy specific niches in which they can satisfy the needs of clients, including large corporations with whom they can establish cooperative relationships, instead of entering, for them into a very uncertain relationship of competitive conflicts. competitiveness factors for smes in the global market the global environment is characterized by its growing complexity and uncertainty. the theorists of strategy and strategic behaviors believe that such an environment necessarily requires companies, both large and smes, to provide an entrepreneurial strategic response (covin, & lumpkin, 2011). when defining a strategy, it is no longer enough to merely make rational decisions that take into account the existing market situation, relations between competitors and similar; but rather it is necessary to make entrepreneurial decisions that create new relationships in the market and establish new "rules of the game" in a competitive bid. 60 economic analysis (2019, vol. 52, no. 1, 56-68) the key factor for adapting to the complex global environment and successful internationalisation of business is the ability of smes to develop new technologies and to be competitive in the launch of advanced technological solutions and procedures (gagnon, sicotte and posada, 2000). in this domain, certain limitations of smes have been observed, which are primarily reflected in their often insufficient administrative capacity and the establishment of robust operational procedures that are a prerequisite for the efficient management of complex production and technological systems necessary for the development and continuous production of new products. the importance of technological development for smes has been observed in both developed and developing areas (almubaraki & aruna, 2013). research has shown that market and site clustering can significantly improve the performance of smes and help them empower their strategic position (requier-desjardins, boucher, & cerdan, 2003). such groupings, due to their geographical proximity, significantly facilitate communication between these companies and lower transport costs, thus enabling synergetic effects in their operational functioning. these effects are manifested when there is direct production-business cooperation between these companies, but often in an indirect way, through the facilitated exchange of knowledge and experience. globalisation very often has a direct positive impact on the grouping of companies, including smes and their clustering. many countries, as well as regions and local governments, today bring a series of measures that encourage companies to be located on their territories. for this purpose pre-arranged and specially equipped locations are specially offered under very favourable conditions (industrial zones, business centres, innovative centres, etc.) so that they group the companies of similar or related activities. organizational forms of entrepreneurs in a global environment the global environment, as already mentioned, exposes standard business and entrepreneurial practices to many challenges that are multiplying and becoming more and more complex. on the other hand, it opens up many new opportunities and chances: in many activities, today there are completely new forms of doing business activities in general, especially entrepreneurial activities. further, some of the previously existing forms of activities are gaining new content and are becoming increasingly important. according to the global entrepreneurship monitor (gem, 2018/2019 global report), in the modern conditions at the global level, the following four forms of entrepreneurial activities are especially distinguished: • "solo" entrepreneur • entrepreneurial employee activity • family entrepreneurship • "gig" entrepreneurship or entrepreneurship based on internet platforms the "solo" entrepreneur. entrepreneurial activities usually relate to an individual who appears as a leader of a smaller or larger team. he is the driver of an entrepreneurial initiative, and often at later stages of company development, and organizer and manager of operational processes. the emerging phenomenon is that a growing number of entrepreneurs decide to start, but also to continue to perform all business and entrepreneurial activities on their own, that is, to act as a "soloist", without associates, partners and employees. the reasons for this phenomenon can be found first in technological changes that allow certain activities to be completely transferred to, in a word, machines. for this reason, in some situations, instead of employing associates, they can rely on technology, especially for the purpose of performing less complex, technical tasks. these possibilities are at the same time based on changes in work habits and preferences of individuals: there are more and more people who are unwilling to submit themselves to rigid corporate procedures, externally imposed discipline, specific value systems but prefer autonomy and independence in their work. vladimir simović, mirjana radović-marković, zvonko brnjas 61 the percentages of entrepreneurial activities carried out in this way are becoming more and more important. according to gem report from 2018 in the netherlands, about 23% of entrepreneurial firms are entrepreneurs "soloists"; in spain, great britain, italy, germany and sweden, over 15%. this trend is also very pronounced in less developed countries. brazil is one of the countries in which this form of entrepreneurship becomes dominant: according to the same report in this country, where the enterprise becomes characteristic of this phenomenon, as many as 53% of entrepreneurs operate alone. the next country in which solo entrepreneurs are highly represented is madagascar (over 30%). the entrepreneurial employee activity. entrepreneurship is most often viewed and studied as the activity of autonomous, independent individuals (owners and managers of newlylaunched and already existing entrepreneurial businesses, as well as already mentioned “solo” entrepreneurs). in recent years, more and more attention has been paid to entrepreneurial activities driven by people who are employed in already existing companies. this phenomenon denotes entrepreneurial behaviour within an existing company in which employees take the immediate responsibility to turn an innovative idea into a profitable business. it is often referred to in the literature as "entrepreneurial activity of employees"1, and also often the term intrapreneurship, which was first introduced at the end of the last century, is often used (pinchot, 1984). interestingly, the entrepreneurial employee activity (or eeas) in some countries viewed by the participation in overall entrepreneurial activities is equally important as independent entrepreneurship. this is the case in sweden, germany and cyprus, while in the netherlands and canada, this form of entrepreneurship has somewhat less participation, albeit with it, its movement closely correlates with the trends of independent entrepreneurship (gem, 2018/2019 global report). the research of these two forms of entrepreneurship has shown that, according to some key parameters between their bearers (the two types of entrepreneurs: independent and employed in companies), there are essentially no major differences (nyström, 2012). it turned out that both groups perceive in the same way, i.e. highly value entrepreneurship in terms of three indicators, namely as a good choice regarding the development of one's own career, according to the social status that they can have as successful entrepreneurs and the attention given to them by the media. however, the difference is seen in perceiving the opportunities for entrepreneurship and having the knowledge and skills to start a new business. employed entrepreneurs, namely, as well as those independent, consider that the chances of starting entrepreneurial activities are good, but unlike independent ones, they feel that they do not have enough knowledge and skills to start a new business on their own. family entrepreneurship family business, especially within smes, is a phenomenon whose significance has been observed for a long time, and as such has been the subject of numerous research, as well as specific measures of active economic policy. what is more specifically indicated to in recent times is family entrepreneurship. family entrepreneurship is defined as an entrepreneurial business involving more members of one family. a family entrepreneurial company is distinguished in which members of one family jointly own and/or actively participate in the management of a company from a company in which ownership and management is not shared among family members, but they are only part of the collective (family members are employed by the company without managerial and proprietary rights). according to the gem definition, the first form is said to be the complete form of family entrepreneurship, and the second the partial form of family entrepreneurship (gem, 2018/2019 global report). family entrepreneurship is particularly pronounced in start-ups. namely, entrepreneurs turn to the family most often during the first stages of starting their businesses. this phenomenon is 1 entrepreneurial employee activity (eea) 62 economic analysis (2019, vol. 52, no. 1, 56-68) particularly pronounced in asia; thus, for example, in china and thailand, every fourth started business involves more members of one family. in europe and north america, this trend ranges between medium and highly present: in switzerland and bulgaria, for example, about 30% of newly-established companies have characteristics of family entrepreneurship. countries with this characteristic are least visible in poland and the uk. in examining the development of family businesses in serbia, grozdanic and radovic-markovic (2015) emphasize that resource-limited family businesses must use internationalisation as a strategy to address current resource requirements. they also state that economic policymakers in the country need to improve general business parameters so that business internationalization can become faster, and resources can be easily transmitted across borders. "gig" entrepreneurship or entrepreneurship based on internet platforms. the development of information technology and the process of globalisation, which alongside it is causative, have initiated the development of a phenomenon that can in many respects be considered the beginning of some completely new forms of entrepreneurship and forms of work in general. they have the potential to make a real revolution in the organisation of work at the micro level (level of the individual workplace), but also at the macro level in terms of the way companies organize their operational processes. it is an economy based on internet platforms for which a completely new term is crafted: the "gig" the economy. "gig" economy denotes a situation in which individuals offer their services to small and large companies on the basis of individual contracts. the business operations are therefore not performed on the basis of employment of people with certain skills, qualifications, etc. but an agreement is being made to provide a specific service. this type of work is suitable for service providers (the so-called "freelancers") because it provides them with flexibility and autonomy; on the other hand, for companies, this form of human resources security is cheaper and gives them also considerable flexibility in conducting operational activities. the "gig" economy formally represents a form of work that has long been present in the practice of employment: technically, it is temporary work. what, however, in contemporary conditions of globalisation gives a completely different dimension to this form of work is the inclusion of it technology which opens to both sides (service providers and companies) unprecedented opportunities in terms of market capacities and potentials. special internet platforms have been developed (such as "99 designs", "airtasker", airbnb and others) that link service seekers (companies), on the one hand, and service providers ("freelancers"), on the other hand on a global level. thanks to information technology, locations of both companies and freelancers become irrelevant, so partners in these forms of work can be from completely different parts of the globe. due to the role of the internet in these processes, the "gig" -the economy is also called an economy based on internet platforms, a sharing economy or a network economy (frenken & schor, 2017). given that this is a new phenomenon, there is still no comprehensive statistics on the number and share of this type of economy in total economies. some individual assessments, however, indicate a high share of this kind of work in the total number of employees and a very dynamic trend of its further growth. thus, it is estimated that in south korea, every fifth adult resident participates in a "gig" economy; high participation of this phenomenon is also registered in israel, ireland and the united states (gem, 2018/2019 global report). the analysts of this phenomenon especially point to another potentially very positive effect of the "gig" of the economy. "freelancers" and all others engaged in the "gig" economy represent a significant reservoir of future entrepreneurs. namely, "gig" entrepreneurs are only a step away from the other forms of entrepreneurship described above, especially from soloentrepreneurship. the extent to which people that perform certain economic activity through individual contracts will be devoted to establishing a separate firm and starting their own entrepreneurial business depends on the environment. in this regard, economic policymakers vladimir simović, mirjana radović-marković, zvonko brnjas 63 are suggested to pay special attention to this (potential) entrepreneurial population by creating a special set of incentive measures for them. it should be pointed out, however, that in addition to all of the above mentioned positive effects, the "gig" economy also brings certain risks and controversies (kobie, 2018). they are mainly related to limiting the rights of employees: companies in these relationships often, in the effort to reduce costs, do not pay ordinary employment benefits (health and pension insurance, etc.). therefore, as part of the above-mentioned incentive measures for the "gig" economy and "gig" entrepreneurs, it is necessary to pay attention to ensuring fair working conditions in which employees in this form will have all forms of social protection, identical or similar to those obtained in other forms of employment. it is significant that countries will simultaneously provide fiscal support for this type of work, which has a growth trend in the future. gender aspects of entrepreneurship in the last two decades, there are first studies that focus on gender aspects of entrepreneurship. in many countries, their need to realize themselves in their work through the realization of their business ideas has not been properly understood and recognized for a long time (radovic-markovic, 2012). for these reasons, there was no longer a significant period of significant research. even in the late 1980s and early 1990s, literature was concerned only with male entrepreneurs (loza, 2011). therefore, only in the late 1990s papers appeared in the literature citing the importance of the special study of women as entrepreneurs (wortman, 1987, devine, 1994; coleman, 1998). they mostly deal with women in business only as an economic and social phenomenon. however, recent studies on women entrepreneurship expand the scope of their research, focusing on five thematic areas (radovic-markovic, 2007): 1. studies dealing with the motivation factors of women who decide to establish their businesses 2. studies dealing with the constraints faced by women who want to engage in entrepreneurial activities 3. studies dealing with models of female entrepreneurship 4. studies examining the "entrepreneurial culture" of entrepreneurial women 5. studies examining the types of businesses that women are dealing with also, there are more and more studies dealing with the economic potentials of women, which put their research into a global context (karnani, 2007; minniti, 2010; radovic-markovic, 2007, 2011, 2019). information technologies and entrepreneurship the development of information technology, the internationalization of businesses, globalization and other processes whose influence on the development of entrepreneurship is analyzed in the previous part of this paper are inextricably linked to the development of the internet as a global medium, which by its occurrence has drastically changed the way companies conduct their business operations, led to the emergence of new business models and the creation of a new, unique virtual market. according to data from relevant agencies (internet world stats, 2019) in march 2019, the number of internet users in the world was around 4.38 billion, or about 56.8% of the world's population. in developed regions of the world (north america and europe) penetration of internet users is between 86% and 89%, which is a huge, highly payable virtual market. this fact, together with all the other advantages of internet business, is one of the main reasons for the expansion of internet-based entrepreneurship in recent years. 64 economic analysis (2019, vol. 52, no. 1, 56-68) with its occurrence, the internet has led to the emergence of new business models, many of which could not even be imagined before the emergence of the internet. by using and combining different business models, contemporary entrepreneurs create new value by using their distinctive advantages and market dynamics (tallman et al., 2017). below are some of the most common business models of internet business systematized: 1. business models based on commission (commission based model). the essence of this model is in a business that provides a dedicated service for a fee (commission) (lumpkin, dess, 2004). an internet business that applies this business model in its business usually has the role of intermediary between, on the one hand, customers and, on the other hand, sellers. by facilitating transactions between buyers and sellers, the broker earns from the commission he charges, usually to the seller. there are many variations of this business model that have surfaced over time on the internet, such as services that connect consumers and sellers of fast food (donesi.com), services that connect buyers and sellers to auctions (limundo.com), services that link owners of apartments and travelers (booking.com) and the like. 2. business models based on advertising (advertisement based model). the essence of this business model is the free provision of content and services to visitors who are subsequently monetized through the payment of advertisements. the best-known example of a service that has monetized its popularity globally through the advertisingbased model is google. google has created two parallel services that monetize its enormous popularity. the first is called google adwords and is intended for business owners who in this way, want to advertise their service using google's platform. the second service is google adsense and is intended for owners of popular sites who, by connecting to this service, give google some part of the ad space to advertise advertisements from other advertisers. in addition to google, the second largest online platform that monetized its enormous popularity through a business-based advertising model is facebook. google and facebook are certainly gigantic internet entrepreneurs, but a large number of other, smaller service-providers offering different, usually free content to their users, later monetize their popularity through a business-based advertising model. 3. merchant business model. it is a business model that has its foundation in a real environment and classical trade, regardless of whether it is a wholesale or retail sale. this type of business model is equally represented in both the click and mortar companies and virtual companies, that is, with companies that normally operate in a real environment that use the internet to expand its market boundaries and reduce costs and companies operating exclusively on the internet. the essence of this business model is to obtain cheaper and sell more expensive, using the advantages that the internet carries with it in terms of significantly lower operating costs and greater geographic reach. examples of large and successful companies that apply this business model in their business are numerous and varied. some examples are amazon and aliexpress, but the internet market is full of many other successful internet businesses that apply this business model in their business. 4. manufacturing business model. as the title suggests, it is a business model in which the entrepreneurial idea is based on production based on the use of available raw materials and intermediate goods. two basic categories of advantages that the internet has contributed to by its appearance, and in the context of this business model, are considerably lower marketing costs and the ability to produce personalised product versions, which has a very beneficial impact on consumer loyalty (lumpkin, dess, 2004). a company that is a representative example of the successful implementation of this business model is dell. vladimir simović, mirjana radović-marković, zvonko brnjas 65 5. affiliate business model. the basic assumption of this business model is in rewarding business associates for traffic (visitors) who come from their websites to the merchant website that has launched an affiliate business model with the aim of undertaking some concrete action: purchasing, registering, application to mailing lists etc. for any action taken by the visitor who came from the affiliate's website on the merchant's site, the affiliate receives a certain fee. in this way, the market reach significantly increases and reduces the costs of marketing. an example of a company that owes its initial market success precisely to the business model of the associate is amazon. 6. subscription-based business model. the essence of this business model of modern entrepreneurs is to charge subscriptions at a monthly and/or annual level in the name of providing a kind of service or content that is made available to users. companies that provide hosting services to users are an example of this business model. content creators such as netflix are also examples of internet companies that base their business models on the subscription model. 7. software as a service business model (saas). progress in cloud computing has led to the emergence of a variation of this technology called software as a service. the essence of this technology is that software is placed on remote servers and thus made available to users instead of a traditional approach that involved purchasing a software license and installing software on a local machine. some providers, using this business model, do not charge any fees to users (for example, google's drive service). this business logic is conditioned by monetization through another business model, in the case of google's advertising. 8. the fee for service model. the essence of this model is that providers charge content or other types of resources that they make available to their users according to actual consumption or the degree of use that the client has in a given period. for example, eproject.com provides its clients with a virtual work environment equipped with collaboration tools and charges them with the degree of utilization of these resources during the month. these business models of modern entrepreneurs represent only a copy of those models that over time, have been clearly differentiated and demonstrated that they have significant potential for purposeful business use. in addition to the above, there are a number of other business models in the modern business practice, whose number practically has no limits, since the business model settings that will be applied in internet business are limited only by the imagination and the entrepreneurial imagination. one of the most important features of modern entrepreneurs is flexibility. in this regard, the selected business models of successful internet businesses often involve a combination of several different business models. competent managers, who are at the forefront of innovative entrepreneurial ventures, should use a wide range of new, technologically-supported options in formulating their strategies in order to respond to changes, rather than just reacting to them (radovic-markovic et al., 2018). the combination of innovative business models is one of the good examples of such a practice. educating entrepreneurs also plays a very important role in this process (simovic, radovic-markovic, 2018). as suggested by fjeldstad and snow (2018), the business model choice is directly related to organisational design and performance. the goal of combining different business models is to provide a competitive advantage and more potential revenue sources for the entrepreneurial enterprise (revenue streams). conclusion this paper presents a systematic effort to perceive, through the analysis of relevant literature in the field of entrepreneurship, processes that have a dominant influence on the development of entrepreneurship in the 21st century. although entrepreneurship as a practical activity appears 66 economic analysis (2019, vol. 52, no. 1, 56-68) in antiquity, the creation of a scientific-theoretical framework has been implemented only since the mid-18th century. given that each country has its history and vision regarding its integration into global business flows, it is necessary to take into account their size and their diversity; variations in their inclusion in international trade; their geographical, ethnic and cultural differences; and differences in the degree of their economic development. the opinions in regards to the effects of globalisation on the development of small and medium enterprises are different in scientific circles. on the one hand, it is claimed that the turnover of the global market would improve the access of smes to foreign inputs and international finance, while on the other hand it would be considered that globalisation could only intensify restrictions for smes and jeopardise their ability to survive in global business frameworks. despite the fact that many researchers believe that small and medium-sized enterprises are endangered in the global business environment due to limited size and resources, they play an important role in this type of internationalization (radovic-markovic & tomas, 2019). besides many differences, what is common to most entrepreneurship theorists is the fact that smes can succeed in global processes if they can increase economic competitiveness and innovation. consequently, this paper provides integrated insight into the models and factors of competitiveness of smes in the global business environment. the organisational forms of entrepreneurship in the global environment have been thoroughly analyzed, and the current views of the scientific community on this issue are presented. examples of leading smes around the world emphasise that specific information and communication technologies, then innovations and the implementation of strategic risk management and risk management in small businesses are becoming more and more important for their survival and development. therefore, a special segment of the paper deals with the analysis of the relationship between the internet and modern entrepreneurship. in this segment of the paper, business models of modern entrepreneurial ventures on the internet were analyzed, and the importance of combining business models was pointed out with which modern entrepreneurs resort to the goal of achieving competitive advantage. speaking about the future of the entrepreneurial sector, a large number of researchers in the world believe that 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"institutional determinants of macro-level entrepreneurship." entrepreneurship theory and practice, 37(5): 1149-1175. wennekers, s. & thurik, r. (1999). linking entrepreneurship and economic growth. small business economics, 13(1) pp. 27-55. 15. wortman, m. (1987). entrepreneurship: an integrated typology and evaluation of empirical research in the field, 13 j. mgmt. stud. 259-79 (1987)) article history: received: may 16, 2019 accepted: june 4, 2019 international editorial board local editorial board india post. (2016). post office network. http://www.indiapost.gov.in/our_network.aspx, retrieved on april 29, 2016. owens, j. (2015). eight trends that will impact financial inclusion in 2015. afi, http://blogs.afiglobal.org/2015/01/20/eight-trends-that-will-impact-financial-inclusion-in-2015/ retrieved on april 9, 2016. pmjdy. (2016). progress-report pradhan mantri jan dhan yojana as on april 20, 2016, http://www.pmjdy.gov.in/account, retrieved on april 29, 2016. doi: 10.28934/ea.20.53.1.pp133-148 scientific review what drives private equity and venture capital in central and eastern europe countries: focus on serbia isidora ljumović1* | ivana lečovski milojkić2 | vladimir obradović3 1 institute of economic sciences, belgrade, serbia 2 university of belgrade, faculty of organizational sciences, serbia abstract the paper examines the main drivers of private equity (pe) and venture capital (vc) capital into the central and eastern european (cee) market with focus on serbia. also, this article analyses the current trends in the industry. although most of cee economies remain far behind eu-15 countries in the amounts invested trough pe and vc industry, the region is becoming increasingly attractive. poland, hungary, slovakia, romania, and the czech republic currently attract the majority of pe/vc investors. investment activities in cee observed by sector, show that the largest total investments are made in the sector of consumer goods and services, in the sector of information and communication technology and in life sciences. cee private equity market remained dominant in buyouts, where vc as a proportion of total investment activity remained relatively low. main drivers of the region are increased economic activity, favorable tax rates, tax incentives for investors and high quality of labour with low costs. according to swot analysis, serbia has many advantages in terms of attracting pe/vc investments, with the most important factors such as geographical position, well educated and qualified labor with relatively low cost of labour and advantages related to the tax treatment, free trade agreements, but also the efforts made in recent years such as reforms, improvement of fiscal discipline, and introduction of numerous incentives in order to attract investments. key words: private equity, venture capital, investments, central and eastern europe, serbia, country attractiveness jel classification: e50, g00 introduction the phenomenon of private equity, i.e., investing in order to buy a stake in a potentially successful business venture or company, is a concept as old as business itself. examples of entrepreneurs who are receiving money from private investors for their business ventures and in return giving a share of their business are part of everyday life, but also, they are a historical constant. private equity (pe), as defined by evca (european association of venture capital funds) is a form of equity investment into private companies not listed on the stock exchange; medium to long-term investment, characterised by active ownership which builds better business by strengthening management expertise, delivering operational improvements and helping companies to access new markets and outsize their returns. pe investors are not interested in regular dividends, but rather in an exit strategy from the investment in a period of * corresponding author, e-mail: isidora.ljumovic@ien.bg.ac.rs 134 economic analysis (2020, vol. 53, no. 1, 133-148) usually 3-6 years (ptacek, kaderabkova, 2014). on the other hand, venture capital (vc) is a subtype of private equity focused on start-up companies with innovative ideas for a product or service who need investment and expert help in achieving growth. rao&jain (2002) highlight that vc funds invest in start-ups and early-stage businesses, as well as businesses in ‘turn around’ situations. vc funds invest mainly in small and medium-sized enterprises, which are not listed on the stock exchange and have high growth potential (ramadani, 2014). thus, they are an important catalyst for nurturing start-up firms with high-growth potential to undertake innovative endeavours that contribute to national wealth (pradhan et al., 2017). it is considered that firms backed up by vc are more innovative (cao et al. 2015) so the industry has given rise to many successful enterprises, some of which have produced major innovations (tykvova, 2017). this paper aims to explore factors that determine pe/vc investments in cee, with the focus on the serbian market. sistematization of the countries included in cee region is taken from invest europe, since they have the most comprehensive data bases on pe and vc. for this purpose, we analysed available data on pe/vc investments in period 2007-2016. according to the analysis, the most attractive countries for pe and vc were poland, the czech republic, hungary and slovakia, and that countries received the largest amounts of investments. some of the factors that drove pe/vc in these countries are accelerated economic activity, favourable tax regime, and qualified working force. the most unattractive countries in the analysis include bosnia & herzegovina, north macedonia, moldova and montenegro who received sporadic investemnts of low amounts. these markets are still perceived as small and too risky. theoretical background literature review investment of pe or vc funds provides capital to a private company, getting a stake in the company in return, to sell the company when its value increases and therefore generate significant capital gains. the choice of investment is preceded by a detailed analysis of socioeconomic factors that have an impact on the performance of the investment itself. therefore, it is important to take into account a large number of socio-economic factors that will influence the outcome of a potential investment. according to global pe watch worldwide, total pe investments amounted us$391b in 2016, down 4% from 2015 or 50% from 2007, when pe investments reached us$740b. in cee, fundraising peaked in 2008, but under the delayed influence of financial crises, pe investments decreased by about 50% by 2010. the strong private equity market is a cornerstone for commercialization and innovation in a globalized world (groh, 2009). private equity industry has a significant role in the modern economy since it can contribute to the growth by nurturing new enterprises and reenergizing existing ones (european commission, 2011). vc helps the development of innovations, economic growth, and job creation and has a lasting positive effect on the economy because it mobilizes long-term investments (ljumovic et al. 2015). empirical studies confirm that private equitybacked firms are less likely to fail (goncalves-raposo&lehmann, 2019). pe investors allocate their funds to companies with high growth potential, from innovative start-ups needing capital to grow or mid-cap companies with the ambition to take the next level in their development, but also to large business, with the capacity to become the leader on the market. related to that, moritz et al. (2016) found that younger, more innovative and with higher growth expectations are more likely to access equity from vc or pe investors. suppliers of capital estimate the demand for pe and vc with one to two year horizon, make their allocations accordingly and judge the individual countries’ attractiveness, which is determined primarily by expectations about the ability of local pe and vc funds to perform a sufficient number of transactions with satisfactory risk and return ratios (groh, liechtenstein&lieser, 2008). pe and vc industry contributes to the value-creating process, meaning that they add value to companies to make them worth more. however, in evaluating the potential market, they take into account numerous factors. according to oberli (2014, p.47), these factors are: capital markets, macroeconomic, fiscal/legal environment, government intervention, culture-related issues; while variables include past returns to investors (in countries with enough information on track records), initial isidora ljumović, ivana lečovski milojkić, vladimir obradović 135 public offerings (ipos), recent investment activity, growth of gross domestic product, (short term) interest rates, gross domestic savings volume, capital gains taxation, the legal system, fairness, protection of property rights, liberal bankruptcy laws, investment regulations, labour market policies, the maturity of the private equity market and its size, technological opportunities, risk capital culture, and managerial talent. some of these factor will be analysed in this paper. costs of equity finance are depending on macroeconomic conditions and credit supply in the country. according to the masiak et al. (2017) most important macroeconomic determinants are the inflation rate, inflation volatility, unemployment rate, tax rates, gdp per capita and gdp growth rates. pe and vc investments in emerging economies are riskier than that of developed countries because of firm characteristics that are combined with high risk and volatile political environments (johan and zhang, 2016). however, high economic growth and lowering of state intervention in those markets are making them interesting for pe and vc industry on one side (leeds and sunderland, 2003), but challenging on the other since they are still relatively immature, under-developed, with substantial regulatory restrictions and corporate governance weaknesses (bruton and ahlstrom, 2003) and usually high level of corruption that has negative effect on the cost of doing business (fisman and miguel, 2007). however, hain et al. (2015) that market-driven corruption may actually have a positive impact on vc investments into a country, but generally corruption should have a negative impact. a research from cherif and gazdar (2011), shows that gdp growth is a significant indicator for venture capital investments, but also, research and development expenditures and lack of corruption have positive impact on vc investments. they have not found statistical significance for variables such as divestments by ipo, trade sale, or write-offs. institutional and cultural differences matter, nahata et al. (2014) found a positive influence on venture capital investment success when there is cultural distance between the country of the venture capitalist and the portfolio company. they also discovered positive relation between developed stock market and vc performance. in order to analyze the attractiveness of the national equity market, several methodologies and publications are used. however, they all use similar methodologies and input parameters to determine the attractiveness. venture capital and private equity country attractiveness index, which was initiated by iese business school barcelona is used most often by researchers and professionals. it measures the attractiveness of 125 countries for investors in the vc and pe asset classes, by monitoring national pe and vc markets, taking into account specific factors. they consider that “key drivers,” which potential investors focus on when making investment decisions, are economic activity; depth of capital market; taxation; investor protection and corporate governance; human and social environment and entrepreneurial culture and deal opportunities. overview of the industry since the whole investment process in the pe/vc industry is geographically biased, it is reasonable to expect that the largest, most prominent and most active institutional investors in the pe/vc asset class are located in the us, which contributes to the dominant role of the us vc and pe market (groh et al., 2010). according to the venture capital and private equity country attractiveness index, in 2018, top ten ranked countries are: the usa (score 100.00), the uk (94.40), canada (92.60), hong kong (91.20), japan (91.20), singapore (90.70), australia (90.20), germany (87.70), new zealand (87.20) and denmark (84.30). total pe investments in cee between 2007 and 2016 were around 16,7 billion eur, and the largest total investments were made in 2007 (3,01 billion eur), but they had a negative trend up to 2013. there has been a trend of growth until 2016, but the investments didn’t reach the maximum level achieved in 2013 (figure 1). 136 economic analysis (2020, vol. 53, no. 1, 133-148) figure 1. total investments in cee between 2007 and 2016 source: authors own calculation based on data from invest europe on the other hand, if we look only at the specific countries of the cee region, this index shows that the most attractive country in 2018 for pe/vc investors is poland, which took 26th place (globally), with 72.40 score. serbia is ranked 88th out of 125 countries (figure 2). most of cee countries remain far behind eu-15 in areas such as economic activity, entrepreneurial opportunities and depth of capital markets (stefanova, 2015, pp. 51-52), as a result of significant changes that took place in the 1990s – the collapse of the communist centrally-planned system in the cee countries or the self-management system in the former yugoslav countries and transformation to a market based economies. today, pe and vc are part of the common framework at eu level in the process of further integration of eu capital markets, but since its appearance, they have gone through several phases in the cee. the first phase occurred during the early and mid-1990s, where pe/vc investments played a significant role in the process of transition. in this period investments came mainly from global funds and also from specific country-focused funds (relatively small investments, up to 50 million eur). the second phase, which from the late 90s to the mid-2000s, was characterized by the emergence of regional funds with a portfolio of eur 200-250 million and by the first gains on initial pe investments occurred in the first phase. figure 2. cee countries scores for 2018 based on the vc and pe country attractiveness ranking source: the venture capital and private equity country attractiveness index 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00 isidora ljumović, ivana lečovski milojkić, vladimir obradović 137 most private equity investments, around 85%, are into small and medium enterprises (smes), that have high potential to grow and develop. (oecd, 2017). smes are the dominant form of business organization in both developed and developing economies (harvie et al., 2013), but in eu smes are largely financed by bank loans (over 80% of attracted funds) and only 2% by venture funds, while in the us about 15% of investments in the sme sector are vc (oecd, 2017). according to stefanova (2015) the lack of sufficient investments in start-up phase of smes in eu is due to the comparatively low returns of these investments (the rate of return on 10-year investments from all forms of venture capital in eu amounts to about 6.3% while in the us, it is 26%, respectively). serbian economy is also dominated by smes (table 1), where almost 65% of the labour force is employed and smes are accounted for 56% of total gross value added and 44.8% of total exports in 2014 (oecd, 2017). table 1: distribution of firms in serbia, 2014, by firm size (enterpreneurs are included under micro enterprises) firm size (employees) no. firms percent no. employees percent all enterprises 324 766 100.0 1 174 947 100.0 smes (0-249) 324 272 99.8 761 539 64.8 micro (0-9) 312 943 96.4 355 389 30.2 small (10-49) 9 198 2.8 185 206 15.8 medium (50-249) 2 131 0.7 220944 18.8 large (250+) 494 0.2 413 408 35.2 source: oecd, 2017 investments by sector investment activities in cee observed by sector between 2007 and 2016 (table 1) shows that the largest total investments are made in the consumer goods and services, total eur3,81 billion; in the sector of information and communication technology eur3,41 billion and in life sciences eur2,04 billion. table 2. investments by sector in cee between 2007 and 2016 amounts in 000 € 2007 2008 2009 2010 2011 sector focus amount % amount % amount % amount % amount % agriculture 11251 0.4 4300 0.2 82 0.0 43794 3.4 6721 0.5 business products and services 356195 11.9 218963 9.0 67156 2.7 118778 9.2 149866 12.0 chemicals and materials 227637 7.6 53041 2.2 6882 0.3 21822 1.7 10688 0.9 ict (information and communication technology) 719842 24.0 495803 20.1 535664 21.9 164387 12.7 272364 21.8 computer and consumer electronics 163297 5.4 54218 2.2 173598 7.1 97448 7.5 61005 4.9 construction 65871 2.2 43883 1.8 16849 0.7 15211 1.2 25301 2.0 consumer goods and services 319871 10.6 362863 14.8 888890 36.3 418620 32.4 362054 29.1 energy and environment 127495 4.2 91106 3.7 248377 10.2 93962 7.3 50842 4.1 financial and insurance activities 318767 10.7 308356 12.5 249536 10.2 107487 8.3 97994 7.9 life sciences 300770 10.0 616522 25.1 210591 8.6 158838 12.3 12 9.5 real estate 91634 3.0 5068 0.2 45555 1.9 4258 0.3 0.0 138 economic analysis (2020, vol. 53, no. 1, 133-148) amounts in 000 € 2007 2008 2009 2010 2011 transportation 301621 10.0 184476 7.5 0.0 47351 3.7 91436 7.3 other 875 0.0 17011 0.7 3858 0.1 0.0 213 0.0 total 3005126 100 2455610 100 2447036 100 1291685 100 1246901 100 table 1 (continued). investments by sector in cee between 2007 and 2016 amounts in 000 € 2012 2013 2014 2015 2016 sector focus amount % amount % amount % amount % amount % agriculture 8638 0.9 20345 0.9 56269 4.3 37905 2.4 11548 0.7 business products and services 90375 9.0 95848 12.1 81051 6.2 113609 7.2 100113 6.3 chemicals and materials 8719 0.9 12564 1.6 973 0.1 1254 0.1 27486 1.7 ict (information and communication technology) 109075 10.8 133487 16.9 492213 37.5 136999 8.7 344680 21.6 computer and consumer electronics 67885 6.7 26008 3.3 245957 18.8 0 0.0 0 0 construction 11552 1.2 48299 6.1 687 0.1 688 0.0 46239 2.9 consumer goods and services 243311 24.2 141891 18.0 193620 14.7 511214 32.3 365674 22.9 energy and environment 86057 8.5 76627 9.7 119062 9.1 489414 30.9 192490 12.1 financial and insurance activities 115283 11.4 23657 3.0 16551 1.3 88538 5.6 149023 9.3 life sciences 259074 25.7 31999 4.1 85758 6.5 135399 8.6 240318 15.1 real estate 0.0 99413 12.6 1158 0.1 7389 0.5 113 0.0 transportation 7046 0.7 77333 9.8 17616 1.3 59257 3.7 101193 6.3 other 0.0 1230 0.2 0.0 0.0 16863 1.1 total 1007015 100 788702 100 1310914 100 1581664 100 1595740 100 source: authors own calculation based on data from invest europe pe investments by stage focus. in period 2007-2016, european private equity market remained dominant in buyouts, which accounted for 52.5-78.8% of total investments by value; cee market followed europe in terms of total investments by stage focus. however, in cee total buyouts were relatively higher, up to 40% of total value invested, which is consistent with the growth orientation of the cee economies. vc as a proportion of total investment activity in europe remained relatively low, 9.3% on average, and in cee it was even lower in this period (5.3% on average). even though the regulatory framework for vc is still not in place in the republic of serbia, there are some sporadic investments of vc and equity funds established abroad (oecd, 2017). in serbia, in 2007, only 0.6% of investments were vc, while buyouts dominated with almost 53%. isidora ljumović, ivana lečovski milojkić, vladimir obradović 139 table 3. type of investment in cee by stage focus 2007-2016 source: invest europe note: other consists of bosnia & herzegovina, north macedonia, moldova and montenegro. 140 economic analysis (2020, vol. 53, no. 1, 133-148) data analysis and results so far, we examined pe/vc investments in cee, in total amount, as well as a percentage of gdp. we compared the results with the european average in period 2007-2016 but also presented pe/vc investments in total value by stage focus. as investors in pe/vc funds have an objective to get access to activities with satisfying risk and return ratios, they are taking into account many factors to evaluate their investment opportunities. as already mentioned, venture capital and private equity country attractiveness index, which was initiated by iese business school barcelona is used most often by researchers and professionals to analyze the attractiveness of the national equity market. the most important factors according to iese are: economic activity (gdp, inflation, unemployment rate); size and liquidity of capital markets; taxation; investor protection and corporate governance; the human and social environment (human capital, labour market policies and crime); and entrepreneurial culture and opportunities (including innovation capacity, the ease of doing business and the development of high-tech industries)(groh et al, 2008). macroeconomic indicators economic size and growth, employment level and entrepreneurial activity are important criteria for pe/vc country attractiveness and their stable and predictable trend is desirable. investors follow indicators such as gdp, inflation and unemployment rate to evaluate their investment opportunities. table 2 presents total pe investments as a percentage of gdp (as a determinant of a country’s economic performance) in cee countries in period 2007-2016. the results show that in europe as in cee, the highest level of investments as a percentage of gdp was in 2007, but the european market has experienced a sharp decline in 2008. this fall came as a consequence of the global economic crisis. after this period pe investments remained relatively stable until 2016. in cee, there has been an increase in 2009, but the trend turned negative until 2014. majority of cee countries (except estonia, moldova, serbia, and slovakia) have reached their maximum of investments as a percentage of gdp between 2007 and 2009. significant investments in relation to gdp in serbia occurred in 2007 (0.548%) when it was above the cee average. however, the level of investment reached a maximum level of 0.7% of gdp in 2014. observed in relation to cee average investments, hungary was the most successful, by 6 out of 10 observed years with above-average investments. table 2 shows that unfortunately, we cannot determine a a stable trend on pe investments in any of the observed countires. rather, it seems that pe the investments in these markets happen ad hoc, as and individual initiatives when the investor sees a chance to buy a specific companies. table 4. pe investment as a percentage of gdp country 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 bosniaherzegovina 0.007 0.034 0.052 0.000 0.000 0.000 0.000 0.000 n/a n/a bulgaria 1.923 0.265 0.530 0.228 0.019 0.211 0.027 0.006 0.100 0.049 croatia 0.046 0.213 0.061 0.027 0.035 0.073 0.044 0.097 0.010 0.090 czech republic 0.133 0.297 1.010 0.133 0.092 0.069 0.085 0.193 0.020 0.096 estonia 0.332 0.088 0.033 0.176 0.041 0.109 0.147 0.204 0.090 0.361 hungary 0.487 0.423 0.223 0.068 0.194 0.103 0.056 0.164 0.150 0.078 latvia 0.793 0.274 0.005 0.029 0.100 0.017 0.066 0.141 0.150 0.103 lithuania 0.567 n/a 0.004 0.006 0.086 0.023 0.064 0.107 n/a n/a macedonia 0.177 n/a 0.217 0.000 0.000 0.000 0.094 0.000 n/a n/a isidora ljumović, ivana lečovski milojkić, vladimir obradović 141 country 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 moldova n/a n/a 0.000 0.000 0.019 0.000 0.035 0.000 n/a n/a montenegro n/a 0.582 0.000 0.000 0.000 0.000 0.000 0.000 n/a n/a poland 0.222 0.165 0.089 0.192 0.183 0.125 0.096 0.061 0.210 0.172 romania 0.392 0.198 0.187 0.101 0.049 0.020 0.049 0.052 0.090 0.087 serbia 0.548 0.025 0.000 0.104 0.000 0.014 0.047 0.986 0.700 0.142 slovakia 0.043 0.046 0.003 0.022 0.013 0.137 0.003 0.015 0.020 0.016 slovenia 0.139 0.010 0.224 0.019 0.039 0.010 0.012 0.037 0.030 0.183 ukraine / 0.247 0.045 0.085 0.053 0.033 0.015 0.004 0.020 0.013 total cee 0.325 0.209 0.241 0.119 0.104 0.082 0.062 0.104 0.130 0.120 total europe 0.570 0.404 0.186 0.314 0.328 0.260 0.249 0.277 0.300 0.329 source: authors own calculation based on data from the invest europe capital market the depth of capital market, its development, liquidity, capitalisation, number of listed companies and ipo activity, m&a market, presence of financial institutions such as investment banks are crucial for pe/vc activity. black&gilson (1998) state that well-developed stock markets, which allows general partners to exit investments via ipos, are crucial for the establishment of vibrant vc/pe markets. bank-centered capital markets are less able to produce an efficient infrastructure of institutions that support vc/pe. according to oberli (2014), exit opportunities and the amount of credit provided by the banking sector are strong determinants of new funds raised overall. annual fundraising volume is dependent on the previous year’s market liquidity (balboa&marti, 2003). cee companies face small capitalisation of local markets, limited liquidity and poor effectiveness of legal systems, all of which can have detrimental effects on stock pricing (korczak&bohl, 2005). serbian capital market is categorized into a group of frontier markets (very small and illiquid emerging stock markets), where privatization significantly influenced on the features and volatility. although the number of companies listed on the belgrade stock exchange is extremely high, this does not reflect the developed capital market, since the level of market capitalization is extremely low. a large number of companies listed on the belgrade stock exchange are a direct consequence of the selected model of privatization of the economy and forced involvement in the stock market (ljumović et al. 2015). secondary capital market is underdeveloped, and although formally there are conditions for initial and secondary public offer, in practice this is extremely rare. however, similar effects of privatization were noticed in other transition economies (minović&vuković, 2013). stock markets in cee countries significantly collapsed during the financial crisis of 2008 (kizys&pierdzioch, 2011). taxation tax system influences on the decision to invest, since the return from pe/vc investments is realised in the form of capital gain, dividends or interest income that are subjected to taxation. corporate income tax is one of the key elements that investors are considering when making decisions about investing in a particular country. other tax items also relevant for pe/vc, according to invest europe (2018) are vat on management fees charged to the fund; withholding taxes on dividends; tax exemptions available for dividend income and capital gains; the availability of special fund regimes; stamp duties or financial transaction taxes. cee countries have a lower corporate income tax rates compared to the developed countries, where the goal of maintaining such low tax rates is to create a favourable investment climate and thus economic growth in order to create new job opportunities. in the cee region, the highest 142 economic analysis (2020, vol. 53, no. 1, 133-148) corporate tax rate is in slovakia (21%), while montenegro and hungary have the lowest corporate tax rate at the level of 9%. bosnia-herzegovina, bulgaria, and macedonia have a 10% rate, and together with montenegro and hungary, according to this criterion, they are the most attractive for investing. serbia’s corporate tax rate of 15% is among the lowest in europe, and a special rate of 10% is applied for sole traders. non-residents are taxed only based on their income generated in serbia. serbian vat rates are also among the most competitive in cee – a standard rate of 20% for most taxable supplies and reduced rate of 10% for basic foodstuff, newspaper etc. (table 3). even though this looks good on the first glance, para-fiscal charges (such as social security contribution etc.) represent a heavy burden for the local economy in serbia. table 5. tax rates in cee relevant for pe/vc investing country corporate tax rate (%) withholding tax on dividends (%) vat (%) social security contribution (%) personal income tax (%) standard reduced employer employee bosniaherzegovina 10 5 17 10.50 31.00 10 bulgaria 10 0/5 20 9 18.9219.62 13.78 10 croatia 18 12 25 13 17.20 20.00 12-36 czech republic 19 15/35 21 15 34.00 11.00 15 estonia 20 0 20 9 33.80 1.60-3.60 20 hungary 9 0 27 5/18 19.50 18.50 15 latvia 20 0/20 21 5/12 24.09 11.00 23-31.4 lithuania 15 0/15 21 5 9 31.18 9.00 15 macedonia 10 10 18 5 10.00 27.00 10 moldova 12 6 20 8 27.50 10.50 7-18 montenegro 9 9 21 7 10.70 24.00 9 poland 15-19 19 23 5/8 21.00 22.71 18-32 romania 16 5 19 5/9 2.75 35.00 10 serbia 15 20/25 20 10 17.90 19.90 10 slovakia 21 0/35 20 10 35.20 13.40 19 25 slovenia 19 15 22 9.50 16.10 22.10 16-50 ukraine 18 15 20 7 22.00 18 source: deloitte (www2.deloitte.com) investor protection and corporate governance investor protection and corporate governance in terms of country’s legal environment is an important factor that investors consider when making pe/vc investing decisions, and it is concerned with the agency problem, as a result of the weaker legal protection of shareholders. a country’s institutional framework (both legal system and capital markets) is important for the success of privately held companies and, in turn, for promoting entrepreneurship and the vc industry (rajarishi et. al, 2014). to measure a level of shareholder protection against expropriation by corporate insiders, djankov et al. (2008) developed “anti-self-dealing index”, which is calculated for 72 countries based on legal rules in 2003. their results show that high shareholder protection is positively related to measures of stock market development, such as market cap to gdp, number of listed companies per million inhabitants and ipos. la porta et al. isidora ljumović, ivana lečovski milojkić, vladimir obradović 143 (2002) found that shareholder protection is empirically associated with the higher valuation of corporate assets. other important factors that determine the attractiveness of a particular market are accounting standards and property rights protection. pe financing improves corporate governance in companies by involvement of a pe fund manager in the early stages of company development or in existing companies, who sets a certain level of corporate discipline and improves shareholder protection because pe investors are actively involved in portfolio firms by monitoring and supporting managers with value-adding services (croce&marti, 2016). human and social environment human and social environment is very important for pe/vc activity because human capital is the key for company performance and success. vcs, expecting cultural differences, make a more careful job screening potential investments before investing in their portfolio companies (rajarishi et. al, 2014). family firms can suffer from nepotism, lack of professionalism, and rigidity in adapting to new challenges (poutziouris, 2001; croce&marti, 2016). at the other side, chakrabarti et al. (2009) and rajarishi et al. (2014) state that greater cultural distance between lead vc investor and portfolio company increases the likelihood of vc success, instead of reducing it. one of the most important business performance drivers in cee is high qualified labour force, which requires minimum training to adapt to the international business environment. this represents good value for money for investors because of relatively low labour costs and incentives for creating new job positions. pe/vc market in serbia during the process of transition, serbia started the transformation process into an open market economy with a goal of creating a favourable climate for foreign investments leaving the domination of social property as a basic ownership form. in recent years, the serbian government has made efforts to improve investment climate conducting macroeconomic reforms, greater political and financial stability and improved fiscal discipline. eu accession process that provides the impetus for legal changes that improve the abusiveness environment contributed to the process. one of priority of the serbian government is promotion on the world bank’s doing business list. currently, serbia is ranked 48th globally in terms of ease of doing business (april 2019). to analyze the factors that influenced and shaped the current pe/vc market in serbia, we conducted a swot analysis. taking into account all the factors that determine pe/vc investments, we summarize all strengths, weaknesses, opportunities, and threats of cee economies with swot analysis in table 4. the main barriers for the development of pe and vc operations, either foreign investments or local initiatives, are market size, since the market is too small and immature, lack of entrepreneurial culture and venture friendly environment, political and economic factors (low market competitiveness, corruption, lack of strategies and legal framework, bureaucratic delays and administrative burdens, etc.), and lack of access to finance. however, serbia’s main advantages are favourable geographical position, cheap and well-educated workforce, low corporate tax rate, free trade agreements. smes engaging in professional, scientific, technical and innovative activities represent 11.69% of all businesses in the serbian economy, and 11.71% of the entire sme sector (đuričin&beraha, 2016). 144 economic analysis (2020, vol. 53, no. 1, 133-148) table 6. swot analysis of serbia in terms of attracting pe/vc investments strengths weaknesses well educated and highly qualified labour relatively low labour costs (total costs about 50% of labour cost in eu countries from cee) competitive operating costs: corporate income tax rate (15%) vat standard 20%, reduced 10% tax on dividends 20% personal income tax 10% availability of tax incentives for foreign investments customs-free imports of raw materials and semifinished goods, machinery and equipment for foreign investors free zones (many municipalities offer the possibility to operate within industrial zones with favourable geographic location and infrastructure, and some of these zones are free from the vat, customs and clearance) consumer spending growth fast registration of companies with founding capital small market lack of entrepreneurial culture corruption practices and insufficiently developed anti/corruption strategies and legal framework bureaucratic delays, low efficiency of public administration smes reliance primarily on bank credits and loans from family and friends unresolved problems with state-owned enterprises serbian capital market is categorized into a group of frontier markets very small and illiquid emerging stock markets opportunities threats the possibility of developing certain business activities thanks to a favourable climate and natural resources strategic geographical position macroeconomic reforms, greater political and financial stability improve the business environment the ambition to access to eu forces countries to maintain fiscal discipline free trade arrangements with key markets (countries of south eastern europe and russia) mechansims for investor protection developing infrastructure demographic crisis and aging of population new technologies global economic crisis and slow down global competition growth source: authors own research regional vc and pe attractiveness landscape shows that eastern europe countries have taxation as the main drive to pe and vc investors and the weakness in the depth of capital market, and in investor protection and corporate governance; human and social environment and entrepreneurial culture and deal opportunities relative to other regions (groh et al. 2018). ten years ago, serbian economy was characterized by the low level of capital, old technology, lack of know-how management, but on the other hand, a country with a great opportunity for investing, taking into account the natural resources, qualified and cheap workforce and its central position in the balkan peninsula (makojević, 2009). during the 2009-2011 period when the serbian economy was hit severely by the world economic and financial crisis, private equity backed companies have increased their total assets from eur 814 million in 2009 to eur 882 million in 2011, which is an 8.25% increase (trbovich, et al., 2014). isidora ljumović, ivana lečovski milojkić, vladimir obradović 145 table 7. type of investment in serbia by stage focus 2008-2018 (amounts in 000 eur) year seed startup growth later-stage venture buyout total 2008 7102 1300 8402 2009 2010 13208 2011 2012 4350 4350 2013 16076 16076 2014 326100 326100 2015 425 228657 229082 2016 2050 2050 2017 300 1200 1500 2018 400 3465 3765 source: authors own research based on data from the invest europe according to the results published by the invest europe, the dominant type of pe investment in serbia between 2008 and 2010, was growth capital (which is usually a minority investment); between 2012 and 2015 the investment focus shifts to buyouts, although in 2015, for the first time startup investments are emerging, accounting for only 0.2% of total investments, while in 2017 startup investments dominated with 80%, as in 2018 with as much as 92%. serbia stands to benefit both from entrepreneurial private ventures, as well as important regional initiatives supported by european union such as the western balkan enterprise development and innovation facility (wb edif) and the new eu programme for the competitiveness of enterprises and smes (cosme), which will also stimulate the supply of venture capital, with a particular focus on the expansion and growth phase of smes (trbovich, et al., 2014). conclusion private equity and venture capital industry is not a solution for macro-economic underperformance and poor competitiveness, but it can make an important contribution to the revitalization of the economy. having in mind economic and historical heritage of the cee counties, especially in the collapse of communist/socialist central-planning systems and transition into open market economy, pe and vc can play an important role in developing and promoting high-growth innovative companies that can contribute to fast economic growth and development. although most of cee economies remain far behind eu-15, as a result of significant changes that took place in the 1990s, countries as poland, hungary, slovakia, romania, and the czech republic are growing fast now, and they are very attractive for investors in pe/vc funds. there are many factors that drive pe/vc in cee, like economic activity, because in core cee countries gdp is growing faster than gdp in developed countries; taxation and favorable tax rates which are relatively low, and what is more important – presence of numerous tax incentives for investors and high quality of labor with low costs. total cee investments were dominant in the form of buyouts in analyzed period, at their highest level in 2007, and after decline which lasts for six years, they started to recover from 2013. the private equity fund managers present in cee mostly operate on a regional basis, and although being ready and resourced to complete transactions, they commit their exposure only when the deals have foreseeable exit horizons. fund managers assess exit strategies rigorously before deciding on an investment. the goal is to ultimately exit investments before the pe partnership is terminated. exits through ipos may be 146 economic analysis (2020, vol. 53, no. 1, 133-148) problematic, even for successful investments. several reasons contribute to this outcome including small and illiquid local exchanges. according to swot analysis, serbia has many advantages in terms of attracting pe/vc investments, with the most important factors such as geographical position, well-educated and qualified labor with relatively low cost of labour and advantages related to the tax treatment, free trade agreements, but also the efforts made in recent years such as reforms, improvement of fiscal discipline, and introduction of numerous incentives in order to attract investments. however, financing through pe/vc is almost negligible. no equity or venture fund has been established in serbia yet, but this is not an obstacle for investing. a fund can be geographically located anywhere in the world and invest in serbia. the main reason for the low level of equity and venture capital investments is the poor socio-economic environment, immature and small market. also, the unwillingness of companies for equity investments is one of the reasons for the low level of investments. they have a climate of so called "hostility" towards investors in capital, because the owners are not ready to give up part of the ownership and interfering with the process of decision-making. however, serbia is putting a lot of efforts in to in attracting the investors. recently, the new law on alternative investment funds was introduced, that will start to apply in april 2020. acknowledgements this paper is a part of the results within research on project 179001 financed by the ministry of education and science of the republic of serbia references balboa, m., martí, j. 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(2014). “the role of venture capital in economic transition in serbia. ekonomika preduzeća. 62.99-115. tykvova, t. (2017). “when and why do venture-capital-backed companies obtain venture lending?” journal of financing and quantitative analysis. vol.52, no. 3. 1049-1080. veselinović, p., makojević, n. (2011). “venture capital and private equity investing in western balkan region”. industrija. 4/2011. 71-87. article history: received: may 14, 2019 accepted: june 30, 2019 http://dx.doi.org/10.1787/fin_sme_ent-2017-en what drives private equity and venture capital in central and eastern europe countries: focus on serbia isidora ljumović125f* | ivana lečovski milojkić2 | vladimir obradović3 investments by sector pe investments by stage focus. data analysis and results macroeconomic indicators capital market taxation investor protection and corporate governance human and social environment pe/vc market in serbia conclusion acknowledgements references doi: 10.28934/ea.22.55.2.pp91-106 first online: december 23, 2022 original scientific paper influence of green transformational leadership on the workplace pro-environment behavior: a case study of a large energy company in thailand patarawadee tongsoongnern1 | wing shing lee29f* 1 imba program, college of management, i-shou university, kaohsiung, taiwan 2 department of international business administration, international college, i-shou university, kaohsiung, taiwan abstract today, environmental problems are worsening, greenhouse gas emissions are increasing, and natural resources are depleting. solving these problems requires the efforts of everyone in the organization. this study aims to analyze the impact of green transformational leadership on proenvironmental behavior in the workplace. specifically, the main hypothesis is that green transformational leadership positively influences workplace pro-environment behavior. two other pathways are also proposed. the relationship can be mediated through green mindfulness and green self-efficacy. the method used in this study is a questionnaire, and data were collected from 163 respondents who work for the electricity generation authority of thailand. an integrated model containing the hypothesized structure was then tested with structural equation modeling. the results showed that green transformational leadership positively impacted workplace proenvironment behaviors and that this relationship was mediated by green mindfulness. however, green self-efficacy did not mediate between green transformational leadership and workplace proenvironment behavior as there was no relationship between self-efficacy and workplace proenvironment behavior. rather, green self-efficacy influences workplace pro-environment behavior through green mindfulness. the revised model provides some practical implications for corporations that intend to promote workplace pro-environment behavior. first, green transformational leadership serves as an important factor as it has both direct and indirect impacts on workplace proenvironment behavior. second, green mindfulness is an important mediator for two indirect effects upon workplace pro-environment behavior. these two factors are key in motivating staff members to work environmentally keywords: green transformational leadership, workplace pro-environment behavior, green selfefficacy, green mindfulness jel classification: m10, m14 introduction today, environmental protection has become a major concern of many societies in both developing and developed countries. according to the emissions gap report 2022 (unep, 2022), little progress has been made towards meeting the temperature goal of the paris agreement since the 26th united nations conference of the parties to climate change (cop26) in 2021. to achieve this goal in 2030, annual global greenhouse gas emissions must be reduced * corresponding author, e-mail: joelee@isu.edu.tw 92 economic analysis (2022, vol. 55, no. 2, 91-106) by 45% compared to emissions projected under current policies. thailand was among the top 10 countries that were most affected by climate change from 2000 to 2019, according to germanwatch, an environmental ngo. the prime minister of thailand attended cop26 and emphasized that thailand attaches great importance to solving the problem of climate change. thus, “going green” becomes inevitable for both individuals and organizations. the term "going green” involves people making conscious and sustainable choices. frequently referred to as the three r's (reduce, reuse, and recycle) for the workplace, going green not only helps an organization conserve resources, but also helps create a socially responsible image. in some parts of the world, customers are concerned about how businesses have an impact on the environment, such as their contribution to sustainable production and green consumption (lin & niu, 2018; souri, sajjadian, sheikh, & sana, 2018). in organizations, green innovation has become a powerful and positive tool due to the increasing preference of customers for environmentally friendly products in the market (chen & chang, 2013; sheu, 2014). this phenomenon arises because the world has experienced issues such as climate change and global warming that are harming human beings. therefore, in this era, enterprises should strive to promote knowledge and innovations in the green domain. green transformation leadership becomes a key element of this process. still, most companies in thailand fall behind the global trend of going green. according to a report issued by the bank of thailand (bot, 2022), in 2021, only 16 companies announced their intention to achieve net zero emissions. however, this is about to change, as the same report states that if companies fail to commit to net zero emissions, they may find it harder to raise capital internationally. due to the importance of going green and the lack of research in thailand on how to transition companies to green outcomes, this study aims to fill the gap. specifically, this study aims to investigate how green transformational leadership, directly and indirectly, influences proenvironmental behavior in the workplace as the latter affects greenhouse gas emissions. currently, little research on green transformational leadership has been conducted in thailand, although some studies have been published on transformational leadership and human resource issues (phungsoonthorn & charoensukmongkol, 2018; promchart & potipiroon, 2020). green transformational leadership stems from transformational leadership. ackoff (1999) defines transformational leadership as a leader who guides, encourages, and facilitates followers to change. similarly, green transformational leadership provides employees with a clear vision, inspiration and motivation and supports their developmental needs to achieve their goals in a green organizational environment (chen & chang, 2013; mittal & dhar, 2016). this paper proposes that green transformational leadership can enhance followers' workplace proenvironment behavior in two ways. the first is through green mindfulness, and the second is through green self-efficacy. the results may boost the organization's green profile and help it capture business opportunities (mittal & dhar, 2016). the research questions of this paper are then specified as follows: (1) does green transformational leadership have a direct effect on workplace proenvironment behavior and an indirect effect through green mindfulness? (2) does green transformational leadership have a direct effect on workplace proenvironment behavior and an indirect effect through green self-efficacy? the structure of the rest of the paper is as follows. the second part, a literature review, will discuss recent literature on green transformational leadership, workplace pro-environmental behaviors, green self-efficacy, and green mindfulness. hypotheses are then developed. the third part is data and methodology. here, the samples, measures, data analysis, and results of the structural equation modeling are presented. the fourth part includes the discussion of results and follows the conclusion. patarawadee tongsoongnern, wing shing lee 93 literature review green transformational leadership transformational leaders inspire their followers to strive for performance that exceeds expectations. they instill confidence in their subordinates, improving their inner motivation and outer performance. transformational leadership has four elements: idealized influence, inspirational motivation, intellectual stimulation, and individual consideration (commonly referred to as the "four is"). idealized influence enables a leader to build respect and trust among team members, to become their role model, and to make followers feel proud to be part of the team. leaders must have very high standards of ethical conduct. inspirational motivation is when a leader sees a vision and inspires others by executing and challenging the work of followers. intellectual stimulation describes how leaders work with followers to find innovative ways to deal with organizational problems. individualized consideration allows leaders to focus on the needs of their followers and act as a coach or an advisor for their personal achievement and growth. green transformational leadership stems from transformational leadership. it motivates employees to acquire new knowledge (han, seo, yoon, & yoon, 2016; le & lei, 2018) and engages them in activities related to green products and process innovation. this will help companies to introduce green products and/or market services (andriopoulos & lewis, 2010) and improve their environmental performance (martinez-conesa, soto-acosta, & carayannis, 2017). through inspiration from the leaders, followers work toward environmental goals, strive to generate fresh ideas for the environment (mittal & dhar, 2016), and try to attain performance that exceeds expectations. previous research has found that green transformational leadership is associated with many green outcomes. several studies have shown a positive relationship between green transformational leadership and green performance (chen & lai, 2014; gustiah & nurhayati, 2022; zafar, nisar, shoukat, & ikram, 2017). other studies have found that transformational leadership has a positive impact on green creativity or innovation (li et al., 2020; singh, del giudice, chierici, & graziano, 2020; zhang, xu, & wang, 2020). huang, ting, and li (2021) have shown that green transformational leadership of ceos positively impacted green work engagement and environmentally proactive strategies. çop, olorunsola, and alola (2021) also have reported similar results. green work engagement and green team resilience are also positively related to green transformational leadership. workplace pro-environmental behavior one of the three types of environmental behavior proposed by stern (2000) is environmentalism in the private sphere, which is the focus of this paper. of particular interest to us is behavioral choice (clayton & myers, 2015), which involves decisions that are less harmful to nature, such as the three rs (reduce, reuse, and recycle), buying organic, and taking public transportation. such behaviors are important because they are performed voluntarily and privately by employees. in general, however, environmental behavior in the workplace helps organizations protect natural resources and the environment (anderson & bateman, 2000), as well as promote corporate social responsibility (jones, 1996). recent research has identified some determinants of work pro-environmental behavior. they include the status and power of a leader (arsanti, sugiarto, pasharibu, & wijayanto, 2021), coworkers’ relationships (videras, owen, conover, & wu, 2012), social norms (banwo & du, 2019; czajkowski, hanley, & nyborg, 2017), moral motivation, private costs or efforts (czajkowski et al., 2017), perceived behavior control, intention to act, and environmental attitude (banwo and du 2019). 94 economic analysis (2022, vol. 55, no. 2, 91-106) green mindfulness kabat-zinn and hanh (2009) and bishop et al. (2004) define mindfulness as the awareness of experiences in a non-identifying, unbiased, open, and accepting manner. this definition includes two aspects: awareness and acceptance (rau & williams, 2016). sometimes it also refers to one's ability to respond to change one's focus, or one's willingness to consider alternatives (chandwani, agrawal, & kedia, 2016). green mindfulness is considered a condition for an individual's awareness of environmental context, knowledge, and information (blok, 2018). green mindfulness activities depend on the shared vision of the organization. without a shared vision, mistrust and doubt can breed, and promoting mindfulness activities can become challenging (uchihira, 2019). therefore, leaders who can instill a shared vision among members of an organization are key to building green mindfulness among them. geiger, otto, and schrader (2018) found that increased mindful awareness of momentary experiences had a positive impact on healthy lifestyles, which in turn had positive effects on ecological behaviour. amel, manning, and scott (2009) also showed that mindfulness is positively associated with sustainable behavior. on the other hand, arslan et al. (2022) considered green mindfulness as a moderator variable. they have found that green mindfulness moderated the relationship between energy efficiency and green creativity. green self-efficacy according to schwoerer, may, hollensbe, and mencl (2005), general self-efficacy refers to an individual's belief in one's ability to complete different tasks successfully. similarly, bandura (1994) believes that self-efficacy is a person's judgment of one's ability to organize and perform certain actions to achieve a certain level of performance. people who are high in self-efficacy tend to be more engaged and persistent (bandura, freeman, & lightsey, 1999; schunk, 1995). they perform better and are more committed to their goals (bandura, 1994). they are also confident in their ability to generate new ideas (hmieleski & baron, 2008). green self-efficacy is a specific mechanism related to environmental motivation. it can be referred to as one's belief in organizing and working towards environmental goals. green self-efficacy was found to have a positive impact on green buying intentions (sharma & dayal, 2016) and pro-environmental behaviour (abraham, pane, & chairiyani, 2015). it also served as a moderator in the relationship between green servant leadership and proenvironment behavior (faraz, ahmed, ying, & mehmood, 2021). farooq, zhang, talwar, and dhir (2022) have found that green self-efficacy mediated the relationship between green human resource management and green creativity. hypotheses development the first hypothesis concerns the relationship between green transformational leadership and workplace pro-environment behaviour. the idealized influence, one of the components of transformational leadership, is likely to be the driving force in this relationship. idealized influence means the leaders can build trust with followers and make followers become valued team members. leaders themselves are role models for followers. previous studies have found that green transformational leadership has a positive impact on social aspects such as green work engagement (gustiah & nurhayati, 2022) and green team resilience (çop et al., 2021). social norms and relationships are key determinants of workplace pro-environment behaviour (banwo & du, 2019; czajkowski et al., 2017). in addition, by using a focus group, arsanti et al. (2021) have found that the position, status, and power of a leader positively influence subordinates’ pro-environment bheavior. therefore, the first hypothesis is: h1: a positive relationship exists between green transformational leadership and workplace pro-environment behavior. patarawadee tongsoongnern, wing shing lee 95 on the other hand, green transformational leadership can also have a positive impact on green mindfulness. mindfulness is considered to be a condition for an individual's awareness of environmental context and information (blok, 2018). furthermore, green mindfulness activities depend on the shared vision of the organization. here, it is proposed that green transformational leadership can increase followers' environmental awareness through a shared vision initiated by the leader. the inspirational motivation factor of transformational leadership helps to introduce new ideas by conveying inspiration, rational motivation and image (mumford, 2000). an inspiring vision presents an impressive picture of future goal achievement and motivates followers to achieve the goal (arendt, 2009). followers will then be able to view their work in a mindful context (gioia & chittipeddi, 1991; vogus & sutcliffe, 2012), and contextual awareness is a major component of green mindfulness. therefore, transformational leadership is likely to have a positive influence on mindfulness (madsen, desai, roberts, & wong, 2006). previous studies (chen & lai, 2014; zafar et al., 2017) did find a positive correlation between green transformational leadership and green mindfulness through questionnaire surveys. accordingly, the following hypothesis is proposed: h2: a positive relationship exists between green transformational leadership and green mindfulness. mindfulness includes five elements: openness to novelty, sensitivity to different contexts, alertness to distinction, orientation to the present moment, and awareness of multiple perspectives (langer, 2016). these five elements can significantly promote workplace proenvironment behaviors (langer, 2016). for example, openness to novelty may help employees to adopt new procedures to reduce waste. other elements, such as attention to new stimuli, sensitive interpretation of different contexts, appreciation for a different perspective, and extended scanning (fiol and o'connor, 2003) may be associated with pro-environment behaviors in the workplace. once followers understand their work in a more important context through different perspectives, they become fully committed to their work, and this engagement benefits environmental behavior in the workplace (friedman & förster, 2001). moreover, mindfulness may enhance employees’ problem-solving and communication skills, as well as maintain their concentration. all of these qualities may also contribute to enhancing environmental behavior (davis, 1993). therefore, green mindfulness can positively contribute to workplace pro-environment behavior (friedman & förster, 2001). empirical evidence provides support that mindfulness can lead to certain green outcomes. geiger et al. (2018) have found an indirect relationship between mindful awareness and ecological behavior. amel et al. (2009) reported a positive relationship between mindfulness and sustainable behaviour. thus, the third hypothesis is: h3: a positive relationship exists between green mindfulness and workplace pro-environment behavior. workplace pro-environment behavior depends on employees' ability to take responsibility and support decision-making (fiol & o'connor, 2003). green mindfulness can help reduce the complexity of the decision-making process by focusing on the present moment and awareness of multiple perspectives. previous research has shown that mindfulness can positively impact creative thinking and learning (langer, 2016), as it can help build open-mindedness, commitment, and resilience in workplace pro-environment behaviors (kirkpatrick & locke, 1996). therefore, green mindfulness may mediate between green transformational leadership and workplace pro-environment behaviors. in other words, workplace pro-environment behavior is not only directly influenced by green transformational leadership, but also indirectly through green mindfulness as the mediator. the fourth hypothesis is proposed as follows: h4: green transformational leadership has an indirect effect on workplace pro-environment behavior through green mindfulness as the mediator. 96 economic analysis (2022, vol. 55, no. 2, 91-106) next, a positive relationship between green transformational leadership and green selfefficacy is proposed. in general, self-efficacy is referred to as the effectiveness of performing specific behaviors and actions to achieve goals (chen, chang, yeh, & cheng, 2015). transformational leaders are good at inspiring others to pursue the vision (ackoff, 1999). they actively communicate with their followers, trust them, and guide them to achieve their goals. furthermore, transformational leaders can bring out ideas and trust so followers can successfully overcome challenges (bass, 1998). transformational leadership, through positive perceptions and communications, influences followers' self-efficacy (kirkpatrick and locke, 1996; bandura et al., 1999), making them believe in their ability to achieve their goals. previous studies (chen & lai, 2014; zafar et al., 2017) did find a positive correlation between green transformational leadership and green self-efficacy through questionnaire survey methods. the fifth hypothesis is thus formed as follows: h5: a positive relationship exists between green transformational leadership and green selfefficacy. self-efficacy refers to people’s beliefs about their ability to achieve a specified level of performance (bandura et al., 1999). individuals who are high in self-efficacy are more engaged, persistent, and committed to achieving their goals (bandura, 1994; bandura et al., 1999; schunk, 1995). they tend to think positively, set effective goals, and regulate themselves skillfully (bandura et al., 1999; zimmerman & bandura, 1994). they are also confident in their ability to create new ideas. past research has reported a positive relationship between self-efficacy and workplace behavior (hsiao, tu, chang, & chen, 2011; kumar & uzkurt, 2011; mumford, 2000). sharma and dayal (2016) found through a survey method that green self-efficacy is positively correlated with green purchase intentions, which in turn are related to workplace proenvironment behavior. therefore, the sixth hypothesis is: h6: a positive relationship exists between green self-efficacy and workplace pro-environment behavior. by combining h5 and h6, green self-efficacy mediates between green transformational leadership and workplace pro-environment behavior. by sharing vision, inspiring confidence, and building trust with followers, green transformational leadership increases followers' selfefficacy. as followers increase their self-efficacy, they will become more engaged and committed to environmental behaviors in the workplace. a study has found that self-efficacy is positively associated with ethical behavior, such as responsible purchases and dispositions (song & kim, 2018). therefore, the final hypothesis is: h7: green transformational leadership has an indirect effect on workplace pro-environment behavior through green self-efficacy as the mediator all hypotheses are now summarized in figure 1. data and methodology sample collection the questionnaire was distributed to the employees of the electricity authority of thailand. respondents evaluated the statements from the questionnaire using the 5-point likert scale (1 strongly disagree; 5 – strongly agree). the total sample consists of 163 respondents. an overview of the demographic structure of the respondents is presented in table 1. patarawadee tongsoongnern, wing shing lee 97 figure 1: framework of the hypotheses source: authors table 1. demographic structure of respondents number of respondents percentage of respondents gender male 81 49.7 female 82 50.3 total 163 100.0 age less than 20 6 3.7 21-30 57 35.0 31-40 37 22.7 41-50 27 16.6 above 50 36 22.0 total 163 100.0 education high school/diploma 7 4.3 bachelor 99 60.7 postgraduate 57 35.0 total 163 100.0 working experience less than 2 years 35 21.5 more than 2 years 128 78.5 total 163 100.0 position officer 100 61.3 senior manager 47 28.9 director 16 9.8 total 163 100.0 source: authors participants in this study included 163 employees (82 women; 81 men) from the electricity authority of thailand. their positions ranged from junior officers (100) to senior managers (47) and directors (16). their education backgrounds include 35% postgraduates, 60% graduates, and the rest own a diploma or high-school qualifications. about 80% of them worked for more than two years, and the rest for less than two years. measures green transformational leadership the six-items scale developed by chen and chang (2013) was adopted here. a sample question included “the leader of the green innovation project provides a clear environmental green self-efficacy h5 h6 workplace proenvironment behavior h1 h3 green transformational leadership green mindfulness h2 h4 h7 98 economic analysis (2022, vol. 55, no. 2, 91-106) vision for the project members to follow”. the measurement for the latent variable of green transformational leadership is: 𝐺𝐺𝑇𝑇𝐺𝐺𝑚𝑚 = 𝜆𝜆𝑚𝑚1𝐺𝐺𝑇𝑇𝐺𝐺 + 𝛿𝛿𝑚𝑚1 (1) where 𝐺𝐺𝑇𝑇𝐺𝐺𝑚𝑚 are the six items of measurement (i = 1,…,6) of the latent variable green transformational leadership (𝐺𝐺𝑇𝑇𝐺𝐺), 𝜆𝜆𝑚𝑚1 are the factor loadings and 𝛿𝛿𝑚𝑚1 are the errors of measurement. workplace pro-environment behavior three items of the daily task-related pro-environment behavior from bissing-olson, iyer, fielding, and zacher (2013) were used. an example is, “today, i fulfilled responsibilities specified in my job description in environmental protection at work.” the measurement for the latent variable of workplace pro-environment behavior is: 𝑊𝑊𝑊𝑊𝑊𝑊𝑚𝑚 = 𝜆𝜆𝑚𝑚4𝑊𝑊𝑊𝑊𝑊𝑊 + 𝜀𝜀𝑚𝑚4 (2) where 𝑊𝑊𝑊𝑊𝑊𝑊𝑚𝑚 are the three items of measurement (i = 1,…,3) of the latent variable workplace pro-environment behavior (𝑊𝑊𝑊𝑊𝑊𝑊), 𝜆𝜆𝑚𝑚4 are the factor loadings, and 𝜀𝜀𝑚𝑚4 are the errors of measurement. green mindfulness green mindfulness is referred to the scale used by chen et al. (2015). the scale has five items. a sample question included “the members of the green innovation project feel free to discuss environmental issues and problems”. the measurement for the latent variable of green mindfulness is: 𝐺𝐺𝐺𝐺𝑚𝑚 = 𝜆𝜆𝑚𝑚3𝐺𝐺𝐺𝐺 + 𝜀𝜀𝑚𝑚3 (3) where 𝐺𝐺𝐺𝐺𝑚𝑚 are the five items of measurement (i = 1,…,5) of the latent variable green mindfulness (𝐺𝐺𝐺𝐺), 𝜆𝜆𝑚𝑚3 are the factor loadings, and 𝜀𝜀𝑚𝑚3 are the errors of measurement. green self-efficacy this measure is also adopted from chen et al. (2015). there are six items. a sample item states: “we feel competent to deal effectively with environmental tasks”. the measurement for the latent variable of green self-efficacy is: 𝐺𝐺𝑆𝑆𝑚𝑚 = 𝜆𝜆𝑚𝑚2𝐺𝐺𝑆𝑆 + 𝜀𝜀𝑚𝑚2 (4) where 𝐺𝐺𝑆𝑆𝑚𝑚 are the six items of measurement (i = 1,…,6) of the latent variable green self-efficacy (𝐺𝐺𝑆𝑆), 𝜆𝜆𝑚𝑚2 are the factor loadings, and 𝜀𝜀𝑚𝑚2 are the errors of measurement. data analysis empirical research was conducted by survey method. reliability analysis was applied to measure the internal consistency between the items of measurement and cronbach’s alpha patarawadee tongsoongnern, wing shing lee 99 coefficient was used. the measurement model combines the four equations (1) – (4) above. the structural model includes the following regressions: 𝑊𝑊𝑊𝑊𝑊𝑊 = 𝛽𝛽43𝐺𝐺𝐺𝐺 + 𝛽𝛽42𝐺𝐺𝑆𝑆 + 𝛾𝛾41𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁1 𝐺𝐺𝑆𝑆 = 𝛾𝛾21𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁2 𝐺𝐺𝐺𝐺 = 𝛾𝛾31𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁3 where 𝛾𝛾𝑠𝑠 and 𝛽𝛽𝑠𝑠are regression paths, and 𝜁𝜁𝑠𝑠 are residual errors. structural equation modeling (using lavaan package in rstudio v.1.2.1335) was used to analyze both the measurement model and the structure model. measurement model was evaluated by reliability, discriminant validity and convergent validity. structural model was evaluated by multiple fitness indicators. results and discussion the measurement model the correlations between the four latent variables and their means and standard deviations are shown in table 2. positive correlations were found between all four latent variables. table 2. means, standard deviations and correlations of the latent variables. latent variables mean s.d. a. b. c. a green transformational leadership (gtl) 1.626 0.439 b workplace pro-environment behaviour (wpb) 1.888 0.584 0.53** c green mindfulness (gm) 1.724 0.443 0.54** 0.54** d green self-efficacy (gs) 1.687 0.485 0.53** 0.45** 0.66** note: ** p < 0.01 source: authors table 3 describes the results of the measurement model. all factor loadings of the latent variables are significant. cronbach's alpha coefficients are all above the minimum requirement of 0.7, which indicates the reliability of the measurements is acceptable. discriminant and convergent validity are then tested. discriminant validity was satisfied by comparing the correlations between the latent variables and the square roots of average variance extracted (ave). the former should be smaller than the latter. table 2 shows that the aves for the constructs ranged from 0.728 to 0.733, greater than all correlations shown in table 1 (ranging from 0.45 to 0.66). therefore, discriminant validity is acceptable. second, the convergent validity was also satisfactory, as the aves for all four constructs were higher than 0.5. 100 economic analysis (2022, vol. 55, no. 2, 91-106) table 3. the items’ factor loadings (λ), the reliability, and the average variance extracted (ave) latent variables items factor loading (λ) reliability (cronbach’s αlpha) ave √𝑨𝑨𝑨𝑨𝑨𝑨 green transformational leadership (gtl) gtl1 0.641 0.87 0.535 0.731 gtl2 0.712 ** gtl3 0.747 ** gtl4 0.758 ** gtl5 0.763 ** gtl6 0.738 ** workplace pro-environment behavior (wpb) wpb1 0.650 0.78 0.537 0.733 wpb2 0.777 ** wpb3 0.780 ** green mindfulness (gm) gm1 0.724 0.87 0.533 0.730 gm2 0.808 ** gm3 0.762 ** gm4 0.688 ** gm5 0.675 ** gm6 0.719 ** green self-efficacy (gs) gs1 0.701 0.87 0.530 0.728 gs2 0.753 ** gs3 0.667 ** gs4 0.762 ** gs5 0.744 ** gs6 0.740 ** source: authors the structural model the structural model was then tested. table 4 shows the results and figure 2 shows the path diagram. the overall fitness of the model is acceptable (χ2 (184) = 324.38, p < .01; cfi = 0.917; rmsea = 0.068; srmr = 0.085). the only path that is not significant is the one between green self-efficacy and workplace pro-environment behavior. it means all the hypotheses are supported except the two related to green self-efficacy, namely h6 and h7. nonetheless, it is found that the fitness of the model could be improved by making some alterations to the framework. a path to connecting green self-efficacy to green mindfulness was added and the improvement in fitness is significant. (χ2 (183) = 283.27, p < .01; cfi = 0.941; rmsea = 0.058; srmr = 0.051). the revised structural model includes the following regressions: 𝑊𝑊𝑊𝑊𝑊𝑊 = 𝛽𝛽43𝐺𝐺𝐺𝐺 + 𝛾𝛾41𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁1 𝐺𝐺𝑆𝑆 = 𝛾𝛾21𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁2 𝐺𝐺𝐺𝐺 = 𝛾𝛾31𝐺𝐺𝑇𝑇𝐺𝐺 + 𝛽𝛽32𝐺𝐺𝑆𝑆 + 𝜁𝜁3 where 𝛾𝛾𝑠𝑠 and 𝛽𝛽𝑠𝑠are regression paths, and 𝜁𝜁𝑠𝑠 are residual errors. table 5 shows the results and figure 3 shows the path diagram of the revised framework. overall, the revised framework shows that green transformational leadership directly influenced workplace pro-environment behavior. moreover, it also indirectly influenced the latter through green mindfulness. in addition, green transformational leadership has a direct impact on both green mindfulness and green efficacy. patarawadee tongsoongnern, wing shing lee 101 table 4. the results of structural equation modeling for the proposed framework regression path coefficient z-value sig value standardized path estimate wpb -> gm 0.483 3.242 0.001 0.389 ** gs 0.059 0.484 0.628 0.053 gtl 0.550 2.473 0.013 0.368* gm -> gtl 0.813 6.145 0.000 0.676** gs -> gtl 0.897 5.990 0.000 0.666** goodness of fit statistics chi-square χ2 (184) = 324.38, p < .01 comparative fit index (cfi) 0.917 rmsea 0.068 srmr 0.085 note: ** level of significance 0.01; * level of significance 0.05 source: authors figure 2. path diagram for the proposed framework source: authors table 5. the results of structural equation modeling for the revised framework regression path coefficient z-value sig value standardized path estimate wpb -> gm 0.550 3.874 0.000 0.444 ** gtl 0.547 3.244 0.001 0.367** gm -> gs 0.543 5.531 0.000 0.605** gtl 0.305 2.750 0.006 0.254** gs -> gtl 0.821 5.683 0.000 0.614** goodness of fit statistics chi-square χ2 (184) = 283.27, p < .01 comparative fit index (cfi) 0.941 rmsea 0.058 srmr 0.051 note: ** level of significance 0.01; source: authors 0.368* 0.676** 0.389** 0.053 0.666** workplace proenvironment behavior green mindfulness green transformational leadership green self-efficacy 102 economic analysis (2022, vol. 55, no. 2, 91-106) figure 3. path diagram for the revised framework source: authors discussion regarding the first research question on whether transformational leadership has a direct effect on workplace pro-environment behavior and an indirect effect through green mindfulness, the results are affirmative. for the second question, the results did not support the indirect effect of self-efficacy. rather, their relationship is more complex. there is no direct relationship between green self-efficacy and workplace pro-environment behavior. the only effect on green self-efficacy is that it is positively related to green mindfulness. according to the results, green transformational leadership is a pivotal factor in influencing workplace pro-environment behavior. green transformation leadership not only had a direct impact on the latter but also indirectly through green mindfulness. it is a surprise that green self-efficacy is not significantly related to workplace pro-environment behavior. conversely, green self-efficacy directly affected green mindfulness, which in turn affected workplace proenvironment behavior positively. in other words, green self-efficacy has an indirect relationship with workplace pro-environment through green mindfulness as the mediator. in fact, this finding is quite plausible. without mindfulness, even individuals with high green self-efficacy may not be aware of whether their actions are pro-environment or not. nonetheless, this relationship suggests that awareness and acceptance of the environment also depend on beliefs about one's own ability to deal with green-related issues in summary, the findings suggest that green transformational leaders can influence followers’ workplace pro-environment behavior through different pathways. first, green transformational leadership has a direct and positive impact on workplace pro-environment behavior. this is probably due to the idealizing influence of transformational leadership. leaders serve as role models for others to follow. second, green transformational leaders can also indirectly influence work pro-environment behavior by raising employees' green awareness. green mindfulness may be enhanced due to the inspiring motivation and intellectual stimulation of transformational leaders. here, leaders constantly challenge followers and constantly work with them. third, green transformational leaders act as advisors to help followers grow, thereby increasing their green self-efficacy, which further strengthens their green mindfulness. practical implications first, the findings suggest that green transformational leadership does have a direct and indirect impact on individuals' workplace pro-environment behavior. this means that green transformational leaders are able to motivate followers to adopt green behaviors at work, including actions to reduce, reuse and recycle. as noted in the revised framework, green mindfulness is also another key factor in green behavior at work. if the individual is more aware 0.254** 0.444** green mindfulness workplace proenvironment behavior green transformational leadership green self-efficacy 0.614** 0.605** 0.367** patarawadee tongsoongnern, wing shing lee 103 of the issue or embraces environmental protection, then the individual's work will be more proenvironment. since green mindfulness is also related to the shared vision of the organization, an approach that clearly communicates the vision is recommended. therefore, if organizations want to motivate their employees to work green, they should first consider the feasibility of green transformational leadership. second, they should also contemplate the enhancement of green mindfulness among staff. conclusion this study supports the argument that green transformational leadership directly and indirectly affects workplace pro-environment behavior, whereas the indirect effect comes from green mindfulness. on the other hand, contrary to the initial predictions, green self-efficacy did not serve such a mediating role. in fact, green self-efficacy and workplace pro-environment behavior have no direct relationship. rather, the relationship is mediated through green mindfulness. this highlights the importance of green mindfulness in workplace proenvironment behavior. in other words, an individual's behavior will be pro-environment only when the individual is mindful of the environment. overall, this study shows that green transformational leadership and green mindfulness are two critical forces in contributing to workplace pro-environment behavior. a limitation of this study is that the sample was limited to one organization in thailand. nonetheless, it contributes to the literature as research on green transformational leadership in thailand is rare. in addition, companies in thailand are under pressure to engage in environmental activities to secure overseas capital. this study could serve as a starting point for future research. 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(2012). securities market theory: possession, repo and rehypothecation. journal of economic theory, 147(2), 477–500. d’amico, s., fan, r., & kitsul, y. (2018). the scarcity value of treasury collateral: repo-market effects of security-specific supply and demand factors. journal of financial and quantitative analysis, 53(5), 2103-2129. longstaff, f. a. (2000). the term structure of very short-term rates: new evidence for the expectations hypothesis. journal of financial economics, 58(3), 397-415. covid-19 and serbian stock market response: a panel data approach bojan đorđević1 | sunčica stanković14f* introduction literature review research methodology research methods results of econometric tests conclusion references the quest towards obtaining a competitive advantage in organizations through managing the human capital nikaela wilson1* | iva vuksanović herceg25f* introduction the concept of human capital, elements and approaches for achieving competitive advantage in organizations human capital elements for achieving competitive advantage in organizations employees’ natural and personal skills employees’ commitment employees’ knowledge employees’ innovative skills intellectual capital and competitive advantage the two common types of competitive advantage the resource base perspective to achieve competitive advantage approaches based on the theory of human capital competitive advantage and managing human capital industry 4.0 and human capital in achieving competitive advantage concluding comments does the increase in the number of registered patents affect economic growth? evidence from romania and bulgaria ivana domazet16f* | darko marjanović1 | deniz ahmetagić2 | marija antonijević1 introduction literature review data analysis and findings conclusion acknowledgements references business process innovation of serbian entrepreneurial firms mihailo paunović1 | marija lazarević-moravčević1 | marija mosurović ružičić17f* introduction theoretical background data and methodology results and discussion conclusion acknowledgements references key features and challenges of the china-western balkan countries merchandise trade development elena jovičić18f* | danijela stojanović1 introduction theoretical background results and discussions trade intensity index development main challenges hampering the trade relations enhancement recommendations for the overwhelming of key obstacles conclusion acknowledgements references influence of green transformational leadership on the workplace pro-environment behavior: a case study of a large energy company in thailand patarawadee tongsoongnern1 | wing shing lee29f* introduction literature review green transformational leadership workplace pro-environmental behavior green mindfulness green self-efficacy hypotheses development data and methodology sample collection measures green transformational leadership workplace pro-environment behavior green mindfulness green self-efficacy data analysis results and discussion the measurement model the structural model discussion practical implications conclusion references doi: 10.28934/ea.23.56.1.pp69-84 first online: june 13, 2023 original scientific paper impact of continuing education on stable employment and wages of men and women in serbia kosovka ognjenović5 f*1 1 institute of economic sciences, welfare economics department, belgrade, serbia abstract this paper examines whether continuing education and training contribute to overall job security and to narrowing the gender wage gap, thereby mitigating the potential effects of employer discrimination. data from the serbian survey on income and living conditions are used, focusing on 2020 and estimating wage regressions. the main results show that participation in continuing education and training has a positive effect on wages and contributes to reducing the wage gap, especially for individuals who were previously unemployed and participated in some form of additional training. this paper contributes to understanding the importance of training and its impact on employment stability and workers' wages in the post-transition economy. the findings presented in this paper are advisory to both policymakers and management. in general, it can be stated that trained employees are better suited to do tasks and, especially if they are satisfied with the knowledge acquired in the company, contribute to a stable environment that makes it easier for them to meet the demands of competition. on the other hand, this implies the empirically confirmed assumption that competition may be negatively correlated with employer discrimination. however, employee participation in continuing education and training in serbia is still below the optimal level. keywords: employees, employment, serbia, training, wage differences jel classification: j31, m53 introduction the extent and structure of gender discrepancies in the labor market are usually studied in terms of paid work in the main job. analysis of this practice is important in the modern organizational environment because it can have far-reaching economic and social consequences for the formation of the overall labor supply and active inclusion. although there is a general trend toward wage convergence, owing to the better observed characteristics of women, gender differences in wages remain substantial. one of the explanations is based on the finding that, in parallel with the improvement in observed characteristics (including educational attainment and years of work experience), women have also improved their unobserved characteristics (blau and kahn, 2003). this claim is due to the fact that wage models do not account for investments in improving personal qualifications and skills. in other words, due to the limitations of available microdata, relevant explanatory variables that measure investment in personal development over working life cannot be accounted for in the empirical model (brown, moon and zoloth, 1980). a low female employment rate is positively correlated with the gender wage gap (fortin, bell and * e-mail: kosovka.ognjenovic@ien.bg.ac.rs 70 economic analysis (2023, vol. 56, no. 1, 69-84) böhm, 2017). moreover, the higher the proportion of female employees in the firm, the lower the wage gap is (fanfani, 2022). existing trends in the serbian labor market speak to the need for such an analysis. the unexplained gender wage gap persists in the serbian labor market (vladisavljević, avlijaš and vujić, 2015), although it is smaller than in most european countries (hedija, 2017). greater flexibility led to an increase in non-standard forms of employment and further contributed to widening wage gaps in the labor market, with fixed-term contracts predominating (albanese and gallo, 2020). moreover, gender gaps in employment have remained constant over the years, reflecting a slow absolute increase in female employment. investment in education and training remains moderate, resulting in low relative workforce participation in lifelong learning. considering the increasingly demanding global demand for skills (european commission, 2022), the participation rate of the adult population of serbia in some form of education or training is significantly lower compared to the eu-27 average 19.8% versus 45.1% (statistical office of the republic of serbia, 2018). regarding the intention of enterprises to carry out some form of continuing vocational education and training, the difference between serbia and the eu-27 is much smaller. in serbia, 49.2% of companies carry out some form of continuing vocational training, compared to 67.4% in the eu-27 (statistical office of the republic of serbia, 2022b). the strategic framework for employment policy in serbia for the period 2021-2026 is based on improving the position of women in the labor market, reducing gender inequalities, and strengthening the educational structure of the workforce (government of the republic of serbia, 2021). in addition, it is suggested that global indicators of the quality of human capital and the quality of employment should be included in monitoring the achievement of the goals of this strategy (ognjenović, kuzmanov and pavlović, 2021). to illustrate, the gender employment gap has widened to 15.2 percentage points, while the gap between male and female labor force participation rates increased to 15.9 percentage points in 2021. this slight widening of the gender gap in the labor market can be partly attributed to the impact of the covid-19 pandemic. at the same time, the gender gap in employment and labor force participation in the eu-27 was 11.5% and 12.1%, respectively, in 2021, but decreased slightly compared to 2020. according to the 2018 structure of earnings survey, the gender pay gap in serbia and the eu-27 was 9.6% and 14.4%, respectively (statistical office of the republic of serbia, 2020; eurostat, 2022). analyses of european labor markets show that training programs are an effective tool that contributes significantly to overall employment stability (zweimüller and winter-ebmer, 1996; doerr, fitzenberger, kruppe, paul and strittmatter, 2017). on the other hand, international experience often shows ambiguous results. social support measures for women (e.g., parental leave) may lead to greater participation of women in on-the-job training after their return to work. on the other hand, they may also discourage employers from investing in on-the-job training for women, thereby promoting discrimination against women (blau and kahn, 2003). those who have higher educational attainment, who are more committed to fulfilling job tasks, and younger employees have a higher probability of entering a firm-provided training as evidenced in numerous studies (picchio and van ours, 2013; filippetti and iammarino 2019; barrenecheaméndez, ortín-ángel and rodes, 2022). thus, the main research question in this paper is whether continuing education and training (cet) contribute to mainstream job security and reduce the gender wage gap, thereby mitigating the potential effects of employer discrimination. this hypothesis is examined using data from the survey on income and living conditions (silc), focusing on the year 2020. this year was also chosen because the survey microdata includes a variable that measures monthly wages (independent of total annual income from work). the remainder of the paper is organized as follows. the next section contains a current literature review on the topic studied in this paper. this is followed by a section of the paper that discusses the methodology and explains the data. the main findings are presented in a separate section, followed by discussions and conclusions of the paper. kosovka ognjenović 71 literature review the empirical literature suggests that there is a positive relationship between employment stability (including workers' wages) and the provision of training. this training can be provided by firms or initiated by workers through the offering of training providers outside the firm. the literature addressing workplace learning does not clearly delineate the terms used to explain motivation to learn and participate in training, making it difficult to measure their effects and interdependencies in empirical studies (kochoian et al., 2022). continuing education cannot be studied separately from digitization. the effects of digitization on the labor market are usually studied from a global perspective. they do not differ significantly when observed only in an isolated labor market, such as a post-transition economy. janeska and lozanoska (2021) found that the impact of digitization on the north macedonian labor market can be observed against the background of the changing employment structure. that is, the changes in the labor market are reflected in the economic sectors, occupations, job profiles and qualifications. when examining the impact of digitalization on the serbian labor market, bradić-martinović and banović (2018) found that women need to improve their digital skills to catch up with their counterparts. in different contexts and countries, there is empirical evidence of the positive effects of jobrelated training on employability, job retention, wages, and career advancement. table 1 provides an overview of the selected literature on this topic. gender wage differentials may be due to monopsonistic characteristics or the tight structure of the labor market, but also to women's preference for more flexible working conditions. this is evident from a study published by fanfani (2022), which examined taste-based discrimination among manufacturing employers in an italian industrial region. examining wage differentials in the two european countries and canada, fortin et al. (2017) found that the increase in wages in the top percentile of the wage distribution may be associated with the increase in the unexplained portion of the gender wage gap. differences in students' propensity to compete while still in education may be related to later gender differences in labor market outcomes (blázquez et al., 2018; lüthi and wolter, 2021) and women's aspirations for top corporate positions (hoyer et al., 2020). similarly, the adoption of professional values during the education of young practitioners early in their careers may be reflected in their subsequent success in the labor market (jackson et al., 2022). participation in job-related training and employment stability are positively related, and this relationship may also contribute to sustained wage growth. it is also important to note that higher levels of education trigger further participation in all types of continuing education. kramer and tamm (2018) have empirically confirmed a positive relationship between education and continuing training on german data of adults over the life course. on-the-job training can be used as a companion strategy in recruiting workers by offering the same level of training for the same job and then using trainees' skills for selection purposes (barrenechea-méndez et al., 2022). cairó and cajner (2018) also show that complementarity between education level and job-related training can lower separation rates, but has no effect on job matching rates. however, studies can be found that show that job-related training or another type of training can significantly improve employability and job stability (mamaqi et al., 2012; picchio and van ours, 2013). studies using spatial or sector-specific data may show some degree of inconsistency with the original hypothesis with respect to several other socioeconomic factors (filippetti et al., 2019). 72 economic analysis (2023, vol. 56, no. 1, 69-84) , table 1. summary of relevant literature author state method results barrenechea-méndez et al. (2022) spain cross-sectional data; ols and ordered probit (+) relationship between on-the-job training and selection blázquez et al. (2018) 15 eu countries and japan cross-sectional data; multinomial logit and ols (+) relationship between cognitive competencies of university students and wages cairó & cajner (2018) u.s. cross-sectional data; search and matching model education and job-related training reduce unemployment duration and employment volatility (labor market volatility) doerr (2022) germany the german federal employment agency’s data on training vouchers provided to job returners; propensity score matching (+) relationship between training vouchers and (re)employment and wages of women returning to work fanfani (2022) italy matched employeremployee data; 2-way fe regression (+) relationship between the gender gap in firms' wage policies and tastebased discrimination filippetti et al. (2019) italy panel data from the survey on labor participation and unemployment; probit and 2-step control function (+) relationship between training and employment stability, the differences by region fortin et al. (2017) canada, sweden, and the uk administrative data on wages and lfs; counterfactual analysis using reweighting estimator and oaxaca-blinder an increase in top wages reveals a growing share of the unexplained gender gap gay & borus (1980) u.s. longitudinal data from four employment and training programmes; limited dependent variable models and maximum likelihood insignificant relationship between participation in sponsored training and job placement in the long-run hoyer et al. (2020) the netherlands self-administered 3-round experiments with university students; probit and ols the importance of gender differences in competitiveness is reflected in the lower participation of women in top positions jackson et al. (2022) australia self-administered survey of owners and business and hr managers; analysis of variance (anova) job-related training strongly correlates with young trainees' adoption of job-related values and employment stability kramer & tamm (2018) germany national education panel study; ols and instrumental variable estimator (+) relationship between education and participation in training lüthi & wolter (2021) switzerland matched survey data of students with administrative records of gender differences in competitive behaviour in class are significantly kosovka ognjenović 73 author state method results apprentices; binary and multinomial probit associated with later outcomes in real life and the labor market mamaqi et al. (2012) spain cross-sectional data; binary logit model (+) relationship between employment stability and continuing training picchio & van ours (2013) the netherlands longitudinal data from the european community household panel (echp); dynamic unobserved effects probit (+) relationship between on-the-job training and employability schmidt (2009) u.s. and canada the job training and job satisfaction survey; analysis of variance (anova) temporary workers' satisfaction with on-the-job training differs by type of job, status, and tenure zweimüller & winterebmer (1996) austria administrative data on unemployed, men; bivariate probit (+) relationship between participation in training programmes and employment stability source: the author based on collected papers. empirical studies pointing to the importance of training for the unemployed also cannot be ignored, whether it is training in the context of european labor market policy (zweimüller and winter-ebmer, 1996) or institutionally supported training in the us labor market (gay and borus, 1980), whose role is to contribute to reduced volatility in the labor market or to facilitate job placement. using the austrian labor market as an example, doerr (2022) has shown that training can improve the reemployment and wages of women returning to work. considering that temporary workers also play an important role in the functioning of companies, it is important for hr departments hiring these workers to obtain feedback on their satisfaction with on-the-job training (schmidt, 2009). statistical facts prior to the pandemic covid-19, serbia was well on its way to reducing the gender wage gap, and a legal framework was adopted that made this possible (ognjenović, 2021). however, the wage gap remains significant (table 2). according to eurostat's methodologically standardised structure of earnings survey, the unadjusted gender wage gap in serbia increased slightly before the covid-19 pandemic (statistical office of the republic of serbia, 2020). this may be influenced to some extent by a slight increase in the gap between men's and women's wages in the private sector, a redistribution of working hours in favour of more working hours for men, and the type of employment contract. although the gender wage gap in serbia is smaller than the eu-27 average of 14.4% in 2018, it is still larger than in some former transition countries in central and eastern europe (cee) (eurostat, 2022). table 2. the gender wage gap in serbia, in % country | year 2014 2018 serbia 8.7 9.6 note: this table depicts the unadjusted gender wage gap extracted from eurostat’s structure of earnings survey that excludes public administration, defence, and compulsory social security and includes full-time and part-time jobs. source: eurostat, 2022. 74 economic analysis (2023, vol. 56, no. 1, 69-84) as figure 1 shows, the largest wage gaps between men and women remain in the two former baltic transition countries (estonia and latvia), the two former cee transition countries (the czech republic and slovakia), and the two old eu member states (austria and germany). these differences are due not only to the institutional framework, which is uniform across the eu, but also to sociocultural factors, which vary from country to country, and most importantly, full-time and part-time jobs are included. women working part-time usually have lower wages, contributing to a wider pay gap. for example, austria and germany, where one of the largest unadjusted gender wage gaps is identified, have more women engaged in part-time jobs. figure 1 depicts the gender wage gap for both full-time and part-time employees. any further analysis of the unadjusted gender wage gap across eu countries would require taking into account the differences in the distribution of working hours of employees. however, data on the gender wage gap by working hours are not available for all countries. figure 1. the unadjusted gender wage gap, in %, in europe according to the eurostat’s structure of earnings survey source: eurostat, 2022. source: eurostat, 2022. the gender wage gap is widest in serbia compared to other countries in the process of accession, but at the same time, it is smaller than in some neighboring countries that are already members of the eu. according to the share of part-time employees, serbia is more similar to countries, such as montenegro and macedonia, with which it is compared. when only salaried workers are considered, the differences among employees according to the share of part-time jobs are small. the share of part-time employees in serbia does not exceed four percent and is more than twice as high as in these two countries. the unadjusted gender wage gap for serbia, shown 0 5 10 15 20 25 30 eu -2 7 es to ni a a us tr ia cz ec hi a g er m an y sl ov ak ia la tv ia fi nl an d fr an ce n et he rl an ds d en m ar k h un ga ry li th ua ni a b ul ga ri a m al ta sw ed en sp ai n cr oa ti a ir el an d cy pr us g re ec e sl ov en ia po rt ug al po la nd b el gi um it al y r om an ia lu xe m bo ur g m on te ne gr o n . m ac ed on ia a lb an ia se rb ia 2014 2018 kosovka ognjenović 75 in table 2, is more in line with the pay gap of full-time employees, which was 9.9% in 2018 (eurostat, 2022). when low-skilled women drop out of the labor force or engage in part-time employment or employment with reduced benefits, this further increases their financial vulnerability (doerr, 2022). this has practical implications for public policy, which may be reflected in women's subsequent position in the labor market or their recognition by the pension and social security systems as potential benefit recipients. measures to support the most affected sectors of the economy, including those in which women are overrepresented, aim to maintain balanced employment and prevent job loss due to a greater risk of contagion. previous findings show that the gender wage gap is likely to be correlated with the economic sector (hedija, 2017; fanfani, 2022), while education forms a negative relationship with the gender wage gap (ognjenović, 2021). narrowing down the discriminatory patterns in wage determination requires further attention. this will be explored in the following sections. data and methodology additional variables will expand the human capital portion (𝑥𝑥′𝛽𝛽) of the wage model (1) to perform this empirical exercise and assess its impact on reducing gender inequality in the labor market. thus, the first set of variables includes age (age and age squared), education (education dummies), and work experience (experience and experience squared), the second set (𝑧𝑧′𝛾𝛾) includes all other socioeconomic (marital status, number of preschool children, health status) and work-related characteristics (permanent contract, managerial position, region, ownership, industry), while (𝑤𝑤′𝛿𝛿) includes dichotomous variables, such as female and continuing education dummies, and their interaction term 𝜀𝜀 represents an error term in the wage regression. the mathematical notation of the wage model can be expressed in the following form: 𝑦𝑦 = 𝛼𝛼 + 𝑥𝑥′𝛽𝛽 + 𝑧𝑧′𝛾𝛾 + 𝑤𝑤′𝛿𝛿 + 𝜀𝜀 (1) in applying this methodological approach, we first need to examine whether the variable “continuing education and training” has a statistically significant effect on the gender wage gap by estimating the wage model (1), which includes a female dummy as a proxy for the gender wage gap. this variable refers to employees pursuing further education and participating in training while working without specifying the form of this training. to examine whether training affects employment stability, we may compare the employment tenure of those who participated in training and those who did not, as well as total work experience. however, only the total work experience variable is available in the data sample. the high correlation between earnings and work experience of those previously unemployed and who participated in additional training may indicate the validity of this relationship. in conducting this experiment based on the silc data, it is important to keep in mind that the percentage of participants in additional education and training is significantly lower than when analysing data from the continuing vocational training survey for the simple reason that the research is conducted on other sample units. this survey refers to professional development training that companies provide to their employees (statistical office of the republic of serbia, 2022b). these variables indicate whether someone found a job and was previously unemployed and whether they participated in additional education and training. according to the proposed strategy for empirical estimation, it can be assumed that further education and training are observable characteristics that can affect gender inequalities in wages and contribute to employment security. the latest data from the survey on income and living conditions in serbia (statistical office of the republic of serbia, 2022a) are used to empirically explain the theoretical relationship in the estimated model and draw valid conclusions for policy recommendations. the sample includes the population older than 17 years. the sample includes 4,168 observations, of which 45.2% are women. the dependent variable is the average monthly net wage divided by the number of hours worked in the same month. a 76 economic analysis (2023, vol. 56, no. 1, 69-84) logarithmic transformation was applied to the average hourly wage thus obtained so that the dependent variable can be expressed in terms of hourly wage rates. the average hourly wage rate of men is 5.550, while the standard deviation (sd) is 0.420, and that of women is 5.446 (sd =0.391). the dispersion of the average hourly wage rate of women is smaller than that of men. the interquartile rank of the average hourly wage rate of women is 0.511, and that of men is 0.542. the descriptive statistics, including mean, standard deviation, minimum and maximum values, of the dependent and explanatory variables included in the empirical wage model are presented in table 3. except for average hourly wage, age, and working experience are continuous variables, while all other variables are dichotomous variables. for the categorical variables of education level, urbanization level, business size, and economic sector, the categories of low education level, sparsely populated area, microenterprise, and macro sector of agriculture were excluded from the econometric modelling. the average work experience is 16 years (17 for men and 15 for women), while the average respondent is 41 years old (about the same age for both sexes). this indicates that in serbia, on average, a person does not enter the labor force until after the age of 25. given that only 19.7% of respondents have a university degree, this would be more consistent with the finding that nonstandard forms of employment, especially among young people, or late entry into employment, are represented to a significant extent. table 3. descriptive statistics of the sample variable mean s.d. min. max. socioeconomic characteristics average hourly net wage in log 5.512 0.409 3.904 8.286 age in years 41.407 11.491 18 77 experience in years 16.220 11.114 0 45 education low educated 0.075 0.264 0 1 medium educated 0.727 0.445 0 1 high educated 0.197 0.197 0 1 marital status and children marriage 0.635 0.481 0 1 presence of children 0.223 0.417 0 1 gender female 0.452 0.498 0 1 health status poor health 0.019 0.136 0 1 job-related characteristics type of employment permanently employed 0.802 0.398 0 1 responsibility level managerial position 0.143 0.350 0 1 region serbia-north region 0.453 0.498 0 1 degree of urbanization thinly populated area 0.312 0.464 0 1 intermediate populated area 0.295 0.456 0 1 densely populated area 0.393 0.488 0 1 firm size micro firms 0.327 0.469 0 1 small-sized companies 0.472 0.499 0 1 medium and large-sized companies 0.201 0.401 0 1 ownership privately owned 0.635 0.481 0 1 kosovka ognjenović 77 variable mean s.d. min. max. economic sector agricultural sector 0.015 0.123 0 1 manufacturing & construction sector 0.025 0.025 0 1 services sector 0.956 0.205 0 1 continuing education continuing education and training 0.015 0.122 0 1 previous employment status unemployed 0.075 0.264 0 1 no. of observations 4168 source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). the proportion of workers who participated in additional education and training is low only 1.5%, as estimated from a complete sample. however, the participation rates for men and women differ, showing that women are more likely to participate in training than men. the participation rate for the latter is 1.3%. and for the former 1.7%. to some extent, this may be related to the larger proportion of women who were previously unemployed and found a job in the last twelve months. the data show that the corresponding rates for women and men are 8.1% and 7.1%. some other studies show that women are more likely to participate in continuing education than men, and this is not only a characteristic of the serbian labor market. in the eu countries, women with high education, those employed in the services sector, and those who occupy positions in the public sector are more inclined toward participation in continuing education (picchio and van ours, 2013; doerr, 2022). when it comes to mothers with small children and part-time workers, picchio and van ours (2013) found a low probability of their participation in further education, explaining this result by the fact that income from work is a less significant source of their total income. results and discussion the gender wage gap is positively correlated with labor force participation and unemployment rates, as shown in numerous empirical studies for advanced economies (blau and kahn, 2003; fortin, bell and böhm, 2017). low employment is the trigger for the existence of the wage gap. the labor force participation and employment rates of men and women in serbia have not changed significantly in recent years. the only slight widening of the gap can be partly attributed to the impact of the pandemic. according to the labor force survey of the statistical office of the republic of serbia for 2021, the labor force participation rates for the population aged 15 and older were 62.9% and 47.0%, and the employment rates were 56.5% and 41.3% for men and women, respectively. many observable and unobservable factors can cause gender gaps to widen for men and women. some of these differences relate to participation in additional education and training and observing their impact on employment stability and potential discrepancies in wages between men and women. table 4 provides the main characteristics of participants in additional education and training and nonparticipants for comparison. as can be seen, those who practice participation in continuing education are younger (the average age of participants is almost 28 years, while that of nonparticipants is 42 years). the average age difference between the participants and those who did not participate in continuing education is almost 14 years and is statistically significant (p<0.001). accordingly, participants are less experienced (they have an average of four years of professional experience) and are better educated (25.4% of participants with a high level of education compared to 19.7% of nonparticipants), while people with a low level of education have almost no chance of participating in additional education and training, according to silc data. this is consistent with previous findings indicating a high correlation between educational attainment and participation in cet (kramer and tamm, 2018). the participation rate of women is 78 economic analysis (2023, vol. 56, no. 1, 69-84) predominant among participants (52.4%), while there is no obvious difference in participation in cet depending on previous employment status. however, the revealed differences are not statistically significant at conventional levels. table 4. characteristics of wage earners by participation in cet variable nonparticipants participants difference age in years 41.614 27.905 13.709*** experience in years 16.406 4.127 12.279*** education low educated 0.076 medium educated 0.727 0.746 -0.019 high educated 0.197 0.254 -0.057 previous employment status unemployed 0.075 0.079 -0.004 gender female 0.450 0.524 -0.074 no. of observations 4105 63 note: p < 0.001 ***; p < 0.01 **; p < 0.05 *; p < 0.10 ‡. differences between means of categorical variables are tested using z-test. source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). table 5 shows the distribution of actual values of average hourly wages, measured in log units, as a function of socioeconomic characteristics for the entire sample of men and women and for those who were previously unemployed and found a job within the last twelve months. table 5. log values of the average hourly net wage for men and women by main personal characteristics variable all unemployed men women differ. men women differ. age age [18-29] 5.458 5.427 0.031 5.354 5.349 0.005 age [30-54] 5.573 5.465 0.108*** 5.410 5.290 0.120‡ age 55 and more 5.575 5.524 0.051 5.244 5.444 -0.200 experience experience [0-5] 5.450 5.421 0.029 5.354 5.322 0.032 experience [6-15] 5.540 5.422 0.118*** 5.460 5.326 0.134 experience [16-25] 5.588 5.522 0.066** 5.154 5.443 -0.289 experience [26-35] 5.609 5.521 0.088** 5.377 5.196 0.181 experience [36-45] 5.606 5.504 0.102‡ 5.682 education low educated 5.390 5.197 0.193*** 5.161 5.220 -0.059 medium educated 5.506 5.372 0.134*** 5.358 5.279 0.079‡ high educated 5.837 5.813 0.024 5.614 5.619 -0.005 no. of observations 2286 1882 162 152 note: p < 0.001 ***; p < 0.01 **; p < 0.05 *; p < 0.10 ‡. source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). comparing the average hourly wages of young workers at the beginning of their careers (ages 18-29), prime-age workers (ages 30-54), and workers over age 55 for the entire sample and for those who were previously unemployed, both distributions show that the wages of those who kosovka ognjenović 79 remain employed (employees who have not experienced a break in employment in the last year) are higher on average. men also earn higher wages than their female counterparts, with the only exception being older workers who have recently found a job, which shows that women earn higher wages on average. however, this result may be due to a small number of sampling units, which translates into low dispersion in the data. total work experience in the sample ranges from zero to 45 years. the distribution of work experience includes the newly employed (with no previous work experience) up to five years of total work experience and continuously shows the intervals within the range of ten years between the lower and upper limits of the interval. for the entire sample, men have higher wages than women on average across all intervals of work experience. the wage gap is smallest for workers with fewer years of work experience. it increases proportionally as they reach higher levels of work experience, confirming the statistical significance of revealed differences. however, for workers who have replaced their current employment status with their previous unemployment status, the difference in actual wages is smaller, and for a given level of work experience (between 16 and 25 years), women earn higher wages on average. the resulting difference in wages is not statistically significant. in the distribution of wages by educational attainment for the entire sample, women cannot match the wages earned by men with similar educational attainment. however, this difference is smallest for those with high levels of education, but it is not statistically significant. women with low levels of education who were previously unemployed can achieve higher wage premiums than men. the wage gap between men and women who were previously unemployed is also much smaller for individuals with a medium level of education. in contrast, highly educated women are at a slight advantage since they are paid more relative to men. however, the revealed difference in pay is not statistically significant. table 6 summarizes the results of estimating the wage models. the modeling strategy was to estimate the models to a full sample of workers and to those who left unemployment within the last twelve months. the main research hypothesis is to examine the impact of participation in continuing education and training on wages and, indirectly, how the presence of this variable in the wage model affects wage differentials between men and women. the importance of the gender wage gap in the wage model is captured by the dichotomous variable that measures the proportion of women in the sample of employees. table 6. the estimates of the regression model variable all unemployed estimate std. error estimate std. error socioeconomic characteristics age 0.006 0.005 0.020 0.013 age^2 -0.000** 0.000 -0.000 0.000 experience 0.009*** 0.002 0.008 0.008 experience^2 -0.000 0.000 -0.000 0.000 education medium educated 0.106*** 0.022 0.108‡ 0.066 high educated 0.411*** 0.026 0.392*** 0.108 marital status and children marriage 0.010 0.013 -0.052 0.051 presence of children 0.012 0.014 0.005 0.059 gender female -0.095*** 0.011 -0.042 0.043 health status poor health -0.127*** 0.040 -0.190 0.123 job-related characteristics type of employment 80 economic analysis (2023, vol. 56, no. 1, 69-84) variable all unemployed estimate std. error estimate std. error permanently employed 0.032** 0.015 0.007 0.045 responsibility level managerial position 0.192*** 0.017 0.180 0.205 region serbia-north 0.125*** 0.011 0.098** 0.048 degree of urbanization intermediate populated area -0.031** 0.014 0.078 0.065 densely populated area -0.029** 0.013 0.078 0.053 firm size small-sized companies 0.106*** 0.013 0.102* 0.052 medium and large-sized companies 0.139*** 0.014 0.175*** 0.050 ownership privately owned -0.111*** 0.012 -0.030 0.055 economic sector manufacturing & construction sector 0.375*** 0.052 1.005* 0.491 services sector 0.150*** 0.040 0.205* 0.089 continuing education continuing education and training 0.184*** 0.057 0.236*** 0.069 intercept 4.995*** 0.097 4.489*** 0.254 model fit statistics f-statistics (p) 92.12 (0.00) 5.14 (0.00) r2 0.309 0.208 no. of observations 4168 314 note: p < 0.001 ***; p < 0.01 **; p < 0.05 *; p < 0.10 ‡. excluded categories are low education, sparsely populated area, microenterprise, and macro sector of agriculture. source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). the variables capturing the level of human capital development significantly determine the wage distribution implying further that those are the leading factors in explaining the gender wage gap as it is previously proved in empirical studies (vladisavljević, avlijaš and vujić, 2015; ognjenović, 2021). both the wage-age and wage-experience profiles emerge, as theoretically expected, as indicative of the depreciation of human capital due to aging. it is well known that age is a proxy for total work experience when the data do not include a variable on work experience because of a lack of continuity in work experience due to a high rate of undeclared work or termination of employment for other reasons. therefore, these two variables may be highly correlated. however, estimating the empirical model with alternate inclusion of the two variables does not affect the precision of estimates of other variables in the model, so both variables are retained. education, especially that acquired at institutions of higher learning, generates a high wage premium. for those who have been unemployed, prior work experience does not make a significant difference in the wage premium, while an educational degree still makes a significant wage premium. other personal characteristics of workers have very small effects on wages and are not statistically significant. previous research shows that family situation has a strong influence on a person's decision to actively participate in the labor market (vladisavljević, avlijaš and vujić, 2015). marriage can also have a positive impact on wages; in particular, it has been empirically confirmed that men earn a significant wage premium if they have a wife or partner (ognjenović, 2021). workers living in families with preschool-aged children can expect positive effects on wages, but the results are mixed and do not always show statistically significant wage gains. kosovka ognjenović 81 similar results, showing no significant impact on wages, are obtained for a subsample of previously unemployed individuals. when job-related characteristics are the focus of analysis, permanent employment has the largest and statistically significant impact on wages, although the share of atypical forms of employment is increasing. the responsibility level associated with a managerial position in a firm has a statistically significant impact on wages. the leadership position rejects nearly one-fifth of higher wages, both for all employees and those employed in the last twelve months. it is interesting to note, however, that the percentage of wage growth that comes with a position of responsibility in the company accounts for only half of the potential wage growth of employees with higher education. this finding does not change when only previously unemployed individuals are considered. health problems lead to a 13% decline in average hourly wages, while for those who have been employed in the past 12 months, poor health lowers hourly wages by 19% on average; however, these effects are not statistically significant at conventional levels. employer characteristics are an important factor in examining the gender wage gap as workers' human capital characteristics are. for example, fanfani (2022) examined gender discrimination in the workplace based on employer tastes in an industrial sector of a highly developed area in europe. the author found that employer discrimination and women's preference for a more flexible form of employment were significant determinants of gender wage differentials in large manufacturing firms. results were derived from combining data on employee and employer characteristics. workers, both the entire sample and those who were previously unemployed, in firms in the northern areas of serbia can expect higher wages on average than workers in the rest of serbia. in addition, medium and large firms, as well as small firms, paid higher wages than micro firms, so workers in these firms can expect significant wage increases regardless of whether they were affected by unemployment in the past year. despite the fact that wages in the service sector are higher on average than in other sectors of the economy, it is an interesting finding that private firms operating in manufacturing and construction have higher wage gains. this result is not so surprising if it is related to the fact that the regional distribution, ownership, and size of the company significantly determine the level of the average wage in the sample of data analyzed. the estimate of the dichotomous variable manufacturing and construction may be inaccurate because it is based on a small fraction of the sample of previously unemployed individuals. regression estimates did not change significantly when this variable was excluded. the research hypothesis investigating the impact of continuing education and training on workers' wages was tested and confirmed using the estimated models. indeed, all workers in the sample can expect slightly less than one-fifth higher average hourly wages if they continue their education (𝜹𝜹� = 0.184; p<0.001), while those who were previously unemployed earn more than one-fifth higher average hourly wages (𝜹𝜹� = 0.236; p<0.001). it is just not known whether it is general training or training for a specific job. it is certainly an encouraging result that additional training generally has a positive effect on average wages, but it has an even more pronounced effect on the wages of workers who were unemployed in the previous period. the increase in wages is indirectly related to the stability of employment. thus, through the relationship between participation in additional education and training and wages, the effect on employment security can be confirmed and mediated. when analysing the wage model, it is also important to consider that self-selection into employment may play an important role in calculating the value of the coefficients. the aim of this study was to show the positive role of additional education and training on workers' wages, and any further study on this topic would require a more precise definition of the variable "continuing education and training". all estimates of the tobit model are available on request from the author. the inclusion of a dichotomous variable corresponding to the proportion of women in the sample shows that this part of the labor force earns on average 0.095 lower log hourly wages than their male counterparts, while the estimated wage gap is twice as small in the sample of previously unemployed individuals; however, the estimate is not statistically significant. although women 82 economic analysis (2023, vol. 56, no. 1, 69-84) make up less than half of the sample of formerly unemployed individuals, the inclusion of the interaction term between the dummy variable "female" and "continuing education and training" suggests an additional positive effect of further education on women's wages. this means that a significant part of the total effect of the variable "continuing education and training" is due to the increase in women's wages due to participation in education. conclusion this paper examines whether continuing education and training contribute to overall job security and to narrowing the gender wage gap, thereby mitigating the potential effects of employer discrimination. data from the serbian survey on income and living conditions are used, focusing on 2020 and estimating wage regressions. the main results show that participation in continuing education and training positively impacts wages and contributes to reducing the wage gap, especially for individuals who were previously unemployed and participated in some form of additional training. it was shown that all workers in the sample could expect to earn slightly less than one-fifth of a higher average hourly wage if they continued their education, while those previously unemployed make more than one-fifth of a higher average hourly wage. furthermore, some specific results also show that each additional month of participation in training increases women's wages in a way that contributes to narrowing the gender wage gap, with an estimated contribution of 0.08 percentage points. ognjenović (2021) further found that the difference in educational attainment by gender helps reduce the gender wage gap by almost four percent. vladisavljević, avlijaš and vujić (2015) previously reached similar conclusions for a different country sample. the gender wage gap is calculated using the wage model as the difference in the adjusted values of men's and women's hourly net wages. again, this leads to a generalized conclusion because it is not known what type of additional education is involved, as this is not apparent from the silc data. it can only be assumed that it is job-related training. therefore, it is necessary to consider the results concerning the level of education, which will still be the subject of future research. any further examination of the impact of participation in continuing education and training on the gender wage gap would require additional analysis, including a more significant sample of participants. since their share in the data used for the analysis in this paper is small, it remains for future research. this will provide the answer to the question of why the companies provide training and how they select employees to be trained. this paper contributes to understanding the importance of training and its impact on employment stability and workers' wages in the post-transition economy. empirical evidence shows that the effects of additional education and training on employment and earnings are positive, as seen in the work of zweimüller and winter-ebmer (1996), doerr et al. (2017), cairó and cajner (2018), doerr (2022) and others. the results presented in this paper are relevant for both policymakers and management. in general, it can be stated that trained employees are better suited to work tasks and, especially if they are satisfied with the knowledge acquired in the company, contribute to a stable environment that makes it easier for them to meet the demands of competition. on the other hand, this implies the empirically confirmed assumption that competition may be negatively correlated with employer discrimination. however, employee participation in training is still below optimal levels, as all data sources used in this study indicate the below-average involvement of employees in serbia in additional education and training. acknowledgements the research presented in this paper was funded by the ministry of science, technological development and innovation of the republic of serbia under contract number 451-03-47/202301/200005. note: the author dedicates this work to her cat mićko (2007-2022). kosovka ognjenović 83 references albanese, a., & gallo, g. 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(1996). manpower training programmes and employment stability. economica, 63(249), 113–130. https://doi.org/10.2307/2554637 article history: received: 29.4.2023 revised: 29.5.2023 accepted: 5.6.2023. https://doi.org/10.1016/j.labeco.2020.101815 https://doi.org/10.1016/j.ijme.2022.100692 https://doi.org/10.28934/ea.21.54.1.pp24-40 https://doi.org/10.28934/ea.21.54.1.pp24-40 https://doi.org/10.1007/978-3-030-89582-2_4 https://doi.org/10.1016/j.econedurev.2017.11.004 https://doi.org/10.2298/stnv2102123o https://doi.org/10.1016/j.econedurev.2012.08.004 https://doi.org/10.1080/13678860902982082 https://doi.org/10.1057/9781137460981_10 https://doi.org/10.2307/2554637 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp71-91 original scientitic paper corporate governance of the companies listed on the belgrade stock exchange: metadata analysis based on the results of the methodology g20/oecd questionnaires ivana ljutić1* 1 university union belgrade, belgrade banking academy abstract the present article addresses the ex-post metadata statistical analysis of the corporate governance questionnaire of the listed companies at belgrade stock exchange. the period is 2013-2020, with 50 reports filed as public information at the official website of the exchange. methodology is based on the standardized approach promulgated on the ifc technical support to the exchange. it reflects fully the g20/oecd corporate governance principles and corporate governance assessment quality based on this method. the statistics consisted of handling of large and voluminous data with 50 questions, while the question no. 3 was included as a number but not as a question in the reports. statistical calculation allowed us to make some conclusions and recommendations. at the same time, we are aware that those reports were not assured or audited internally within the companies, externally by the auditors or by the stock exchange itself. the main goal of our analysis was to give a standard and harmonized overview on the quality of corporate governance of issuers at the belgrade stock exchange, which in turn could be compared with the relevant exchanges worldwide, also to be used for policy makers, regulators and issuers to make practical steps to further improve the quality of corporate governance key words: corporate governance, listed companies, belgrade stock exchange, balanced scorecard, g20/oecd/ifc jel classification: o16, g3, g34, m41, m42 introduction as any other deep and profound economic crisis this one shall have a dire consequence on the business performance of the companies. it is at the same time a chance for the positive changes that companies in serbia could and should embrace the culture of corporate transformation. stakeholders in the corporation existing and the potential as new investors shall have more sharp focus on the corporate governance, corporate social responsibility and overall business and financial performance. the economic crisis shall certainly have negative impact on the quality of corporate governance and social democratic values. regulatory bodies and agencies should be aware of that fact and take into the account of their regulatory actions to countermeasure the before mentioned negative effects. companies could react twofold. to behave fully reactively and resist change, or to embrace it, seeing their long-term strategic goals. the overall global economic and social landscape is going faster and faster into a direction of drastically * e-mail: ivana.ljutic@bba.edu.rs 72 economic analysis (2021, vol. 54, no. 1, 71-91) environmentally and socially conscious and accountable doing business. if the companies and serbian national economy shall not opt to go into this and the only perspective and real direction that will pave the way to peril for the serbian companies, economic growth, no doubt. the shift waiting serbian companies and the need for change in the sphere of corporate governance is opportunity to embrace change, to adjust, to harmonize, to be socially responsible and sustainable, since this is the only way out. we are in front of the long-term changes in the pattern of work. work from home and distance working regardless of the conservative management negative reaction shall turn into a “new normal “whenever the costs are at stake, and the costs shall be even more at stake from now on. consequently, the effective corporate governance shall become more important than ever since the investors and stakeholders are more interested in the going concern of the business and in the sustainability. it becomes even more important not only “what “the companies do but rather “how “they do it. ifc as a member of the world bank group is representing in serbia and globally the biggest development institution. its activities were focused to promote the private sector in the serbian transitional economy. expanding and growing listed companies are promoting employment and standard of living, economic growth and social stability, while attracting and productively mobilizing the inflow of capital into businesses. in order to ensure sustainable development and growth in serbia joint stock companies have been assisted in the time span extending over few recent decades, helping them to attract the capacity for investments, for which is the only solid foundation the highest quality of corporate governance and social responsibility. the equally important aspect on this strategic footstep orientation is to inform the general public while increasing the public awareness on the role and significance of the quality of corporate governance. good corporate governance is a model for the issuers to attract the domestic and foreign investors in the private sector, and shall be even more and increasingly important in the forthcoming economic crisis 2021 onwards. serbian issuers which follow the international standards of good corporate governance principles founded by the g20/oecd shall improve corporate economic efficiency, performance of the top management, board of directors, protect the interest of shareholders, stakeholders and the public interest as well. this study with its preliminary results is aiming to instigate and stimulate the management board to clearly define objectives and goals at the interest of shareholders and stakeholders, while at the same time increasing the efficient use of the scarce resources. the broader goal is also to spread this attitude and orientation towards increasing quality of corporate governance to all private and public companies also in serbia. oecd principles of corporate governance as a foundation of the scorecard analysis one of the leading, respected and influential think-thank is the organization of economic cooperation and development – oecd, as a pioneer in this field. they have published the first set of corporate governance principles in 1999 (oecd, 1999) and revised version in 2004 (oecd, 2004). the so-called oecd principles are focused on the legal and regulatory frameworks for the corporate governance and the level of national jurisdiction (compliance online, 2020). oecd principles are promoting the following key aspects:  creating effective and efficient regulatory framework for the corporate governance;  protecting the shareholders and keyholders rights;  treatment of shareholders on an equitable base;  ensuring the position and interest of other stakeholders in the regulatory framework;  information disclosure and reporting transparency;  duties and responsibilities of the management board. ivana ljutić 73 corporate governance as a pillar of equity investments supported by the strong an efficient capital markets, rule of law, clearly defined and separated responsibilities of the complex system of the regulatory and supervisory bodies and institutions, as well as the strong legal and regulatory enforcement authorities. principle of corporate governance are one of the central pillars of the globalization, while the corporate law evolves via domestic mechanisms, so it is very important for serbia to follow the international trends. corporate governance mechanisms also become a vital part of the international agreements. this fact is enabling serbia to harmonize with the unwritten international standards and regulation, also to be a part of the positive development by producing the real changes in the quality of corporate governance. (sachs, 2019). basic shareholder rights could be grouped into the following:  secure registration of ownership rights;  secure transfer and convey of shares;  availability of the timely and relevant information about the company;  right of shareholders to participate and vote in the general shareholders meetings;  share in the company’s profits. the equitable treatment of shareholders including the minority and foreign shareholders is rather complex requirement to be implemented in countries like serbia, since the legal profession does not fully grasp the economic ratio and context. from the regulatory point of view the rights of minority shareholders have not been addressed adequately, taking into the account that the renewed national stock market is rather small, slow, and not with so many issuers and investors. closely with that the role of stakeholders should be readdressed. issuers should have a better sense and communication with minority shareholders and stakeholders in general (the world bank, 2020). the reaction of the serbian regulatory community has been strengthening minority investor protection, but the outcome could not be assessed right now, as the market is slowing down. further studies should clarify the level of good intentions turn into a positive practice of protecting minority shareholders. the topic of adequate and timely and accurate disclosure is material in corporate reporting in every sense. the external audit function is not well understood, accepted and the role of its influence on the quality and transparency of the national financial reporting system and in the national economy as a whole (the world bank, 2016). the effective monitoring and control of the operations of the board, with a focus on the accountability, especially in the view that the forthcoming reforms in eu and in uk in 2021., and onwards shall directly define the responsibility of the top management for the materiality in corporate reporting (jones, 2021). the foreseeable future is that the company directors shall be considered personally liable for the accuracy of financial statements and very soon for the whole framework of non-financial information reporting, as reflected in the forthcoming eu regulation (legislative, 2021). eu has been firmly determined to review and update the non-financial reporting directive before the april 2021. the balanced scorecard for corporate governance (bscg) could be portrayed twofold as important guidelines for the domestic issuers but also very relevant for all savvy and conscious corporate governance and corporate socially responsible companies in serbia. peković, zdravković & pavlović (2020: 121-132), (raičević, et al., 2018: 92-102) focused on the model to explain the role of balanced scorecard in assessment of the performance of board of directors, one of the most important feed-back mechanism of corporate results. equally important is that the information from the bscg is a beacon and orientation for the corporate strategies and the impact of the corporate sector in the national, regional and global economy. the advantage of this approach is in its simplicity, understandability and efficient application in the corporate practice, as well as important information for the financial 74 economic analysis (2021, vol. 54, no. 1, 71-91) institution like the belex and national and international regulatory bodies (belex, serbian sec, national bank of serbia, ministry of finance of serbia) (seskar, 2014: 2). research methodology the balance scorecard methodology promoted by the ifc, based on the globally standardized, widespread and accepted methodology created and continuously curated by g20/oecd, has been introduced at the belgrade stock exchange (belex) by the ifc. this global financial institution has created the set of two toolkits which distils practical experience of 17 developed and developing countries. these toolkits are offering practical advice on building corporate organizations that are educating and training company directors on the best practices of corporate governance (ifc, 2003, 2005). ifc assisted belex and issuers in obtaining know-how, training, implementation and subsequently it has been introduced at the official public website of the belex. joint stock companies (companies) listed at the primary and secondary securities listings where the companies are filing and publicizing the questionnaires. we have covered the period 2013-2020, accessing the individual filed questionnaires from the different issuers, various years. for some issuers there were more than one, but all without any regularity. the statistical metadata analysis has been consistently applied to all 50 questionnaires. it has been applied consistently g20/oecd balanced scorecard methodology of questionnaires to report on the level of overall quality of corporate governance. the questionnaires were not enlisted in a structured data base, but at the random public access register. the names of the companies are not relevant for the overall conclusion on the level of the quality of corporate governance of issuers at belex. this metadata analysis could be helpful for further research as it is a standardized methodology which is offering full consistency and compliance with the similar studies and research globally, since all stock exchanges and issuers are strictly following the methodological and reporting guidelines envisaged by the ifc based on the g02/oecd methodology. orderly regulation of the national capital markets is a crucial to strengthen the national economy (gurria, 2019: 1). globalization trends increases the integration of capital markets, business, interdependence of investors and issuers. different legal, regulatory systems, economic and social systems, cultural traditions are also a solid foundation for the harmonization of the regulation and practice of corporate governance. g20/oecd methodology is improving and “standardizing” the so-called global language of corporate governance, improving the regulatory and operational framework (oecd, 2017). in turn this is the best guidance for the belex, investors, stakeholders, issuers and the general public in serbia. as improved quality of the corporate governance is ensured and the long-term sources of capital are increasing to inflow to the companies as investors are increasing confidence in the corporate performance and from now on even more of the agility and integrity of issuers. g20/oecd principles of corporate governance help policy makers in serbia to evaluate and improve the legal, regulatory and institutional framework. this in turn is supporting the economic efficiency, sustainable growth and financial stability of the transition economy as serbia is. principles developed by the oecd corporate governance committee in cooperation with the world bank are very useful for the policy makers in serbia since they are offering in practice clear clarifications what is going in that so called “harvard black-box” of corporate governance of issuers at belex. methodology is backed by the belgrade stock exchange belex code, and the serbian chamber of commerce and industry relevant codes ccis code, and practice of corporate governance in serbia (zivkovski, 2020), with the full backing of the serbian securities and exchange commission (seskar, 2014: 1-2) (ebrdm, 2016: 1). according to seskar, methodology was mainly the mirror image of the german approach with the full support and backing of the global corporate governance forum sponsored and supported by the world bank/ifc (global, ivana ljutić 75 2016: 1,12), but in earnest this is ifc implementation of the g20/oecd approach. mirror image of this methodological approach is governance scorecard for institutional investors globally (institutional, 2019). corporate governance is the key ingredient and the solid foundation of the stock markets expansion, investment and economic growth. the need of entrepreneurs in serbia to raise financing to fuel the corporate growth is moving from the debt towards the equity market (isaksson, 2017: 5-6). those market/s should be attractive to investors, transparent to stakeholders, protecting the rights of minority shareholders and preserving the corporate social responsibility (ifc, 2016: 31). controlling the majority shareholders could be only effectively implemented and addressed through the real and potential mechanisms to address the corporate governance issues stemming from the such uncontrolled power of the majority shareholders and top management teams (nenova, 2005: 181-222), (ljutić, 2013). it promotes the private sector, stabilize the national economy and the financial and banking system. countries with strong corporate governance and financial systems even if some are the emerging economies like serbia could be attractive to foreign investments. what is worrisome in serbia is the instability and the lack of motivation of the institutions like belex, serbian sec, central bank, not wholeheartedly to support the need for continuous process of improvement of the quality of corporate governance. adoption of the code, improvement and continuous work on is a positive strategic option, but the real value of scorecard is practical opportunity to measure something until now almost unmeasured but more than important to attract the domestic and foreign investors (oicv-iosco, 2016). in essence the application and practice of corporate governance looks like the “bridge too far.“ in the transition economies like serbia with a relatively weak analytical community and rather low demand for such information there is no real push for improvement. quality of corporate governance gives companies wide opportunity for benchmarking, aiming to improve the quality of the corporate governance performance, while the costs are kept at minimum. the common component building blocks of the corporate governance scorecard are logical and complementary leading to a final scoring. on the other hand, we are facing with the objective obstacle that the issuing companies are somehow reluctant to “open up the heart and mind, “since the picture portrayed is rather a wide-angle landscape photo which reveals a lot between the lines. as we know the best remedy for viruses and bacteria is the sunlight, and also for investments the full information of the public about the corporate governance and social responsibility of the issuer. logical starting assumption is that the issuers are attracted to the idea to lure equity investors. at the same time the importance of application of the eocd corporate governance code and guidelines is at the top of priorities of the securities regulation at the national level (gobiernocorporativoarg, 2019). the structure of the balanced scorecard of corporate governance of issuers in serbia the scorecard methodology is consisted of six broad conceptual areas: i ensuring an effective implementation of the corporate governance principles including the aspect of corporate social responsibility ii equitable treatment of shareholders (e.g., shareholders' meetings) iii management model – responsibilities and functioning of the board iv corporate executive bodies and secretary of the company v supervision, control and independent external audits vi transparency and disclosure to each broader group of related and consistent questions it has been allocated adequate weighted ponder expressed in percent. these ponders are expression on the relevancy of each area, and all in all are leading to the total maximum score of 100%, e.g., reflecting the full 76 economic analysis (2021, vol. 54, no. 1, 71-91) compliance expressed in the answers given by the issuers, but not audited or in any other way reviewed by the belex either/or external auditors. serbian promulgation of the bscg at the beginning has been a pilot and test study. in focus were the companies from financial and banking sector, later on manufacturing and services. at the start the whole project was based on the voluntary and confidential base, as it was logical then. the reviewers additionally organized pilot on site visits, with the adequate representations on both sides (belex, scci, ifc with company representatives: executive board members, cfos, secretaries). the primary focus was on the legal compliance followed by selected advices, recommendations, suggestions, swot approach. initial assessment by the founding team at belex was that the key benefits of the introduction and application of the bscg (seskar, 2014: 2) were:  better understanding, valuation and assessment of the corporate governance practice of issuers in serbia;  tracing of the map for better and continuously improving quality of corporate governance and social responsibility (virijević-jovanović, at al., 2020: 105-1117);  principles of corporate governance at the belex in serbia are supporting investment and generating growth, while the operational efficacy and quality is the critical factor for the quality assessment. the impact on the domestic corporate and financing laws is immensely positive, and located problems and neuralgic spots should be solved and dismantled, in order to create a common new framework of reference of the quality of corporate governance of issuers (siems, 2017: 1);  harmonization with the leading international practice, as the balance scorecard in essence is very useful proven in practice management tool.  capacity to review the standards as minimum requirements looking into the future how to raise the bar of continuous improvement. the change and the reform of corporate reporting from the mainly financial towards nonfinancial with an emphasis on the integrated, reporting, environment-social responsibilitygovernance (esg), sustainability, green, is leading towards the creation of the unified global standards. this trend is now evolving under the auspices of the ifac/iasb with the full support of all other voluntary bodies and organization. based on the preliminary information and hints the new robust standards will cover the aspects of management responsibility for the overall reporting, while there will be introduced new mechanisms for the review, auditing and external assurance of the corporate governance and social responsibility as significant pillars of the expected new forms of non-financial reporting. the open question is the level of assurance and verifiability of the corporate governance and social responsibly information issued by the companies (ifac, 2020). survey of the standardized ifc/g20/oecd questionnaires of the quality of corporate governance of issuers at belgrade stock exchange the methodological approach we have adopted is based on the standardized widely acclaimed and approved methodology introduced, developed continuously and applied in practice by the ifc in almost all the member countries. the main purpose of this reporting by the issuers in the period 2013-2020, was to give an overview insight into the practice with a goal the external users of information could determine the level and quality of corporate governance, to identify the problems and to solve them proactively in order to make companies issuers more productive. the methodology based on the balanced scorecard approach is giving an excellent inroad to analyse the interaction in practice of the norms and real performance, based only on the reports of issuers, for which in turn issuers are legally and regulatory liable. this approach has given us the opportunity to obtain a deeper insight into: ivana ljutić 77  the current and in the prolonged period the quality of corporate governance practice in joint stock companies and banks at the listing of belex;  the level and quality of compliance of issuers with the pertinent serbian corporate and related legislation and with the national and international codes of corporate governance;  to further locate and pinpoint the bottlenecks and problems in practice. applied statistical metadata methodology in this research we have focused and covered all the published corporate governance questionnaires of issuers at belex, period 2013-2020. all in all, all the publicized 50 reports by various issuers for the covered period, with 50 standardized questions (note: question number 3 does not exist, but that was not a problem for the proper analysis), which in turn is a stable approach to handle and include all the publicly available data reports. we were not able to conduct individual interviews with the representatives of issuers, as this was not the goal of this initial study. we have statistically covered the final data and then we have processing, statistically summarizing, and presenting the analysis of the results we have obtained. the issuers and respondents are legally liable for the truthfulness of the data, and as the data has been publicized at the official website of the belex, as it is public information revealed, not more than that. our role and goal of research was clearly not to critically overview and objectively deeper assess the value of data, although we stress that we do not express negative opinion on that either. the answers were on three levels or types with grades, yes (1), partly (0, 5), no (0). timeframe of the survey the surveys were conducted by the issuers and reported by belex in the period from 2013 until 2020. survey coverage in the survey we have covered all 50 questionnaires supplied by the issuers, whose questionnaires we were able to locate at the official website of belex. 78 economic analysis (2021, vol. 54, no. 1, 71-91) summary of quality of corporate governance survey of issuers at belgrade stock exchange figure 1. scorecard for the corporate governance code in serbia: overview of results and the final grade (total score) source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. the flowchart (figure 1) is representing the balanced scorecard with the accompanying (figure 2), is showing that the commitment to the corporate governance principles and corporate governance social responsibility is 100%, assembly and shareholders 75%, board of directors 85%. while it is full 100% for the executive directors, 92.5% for the supervision and control activities, transparency and publicity 87.50%. the overall score of the quality of corporate governance is rather high with 89.25% out of the maximum based on the scorecard standard 100% (figure 3). standard standard 10% 15% 100,00% 10,00% 100,00% 15,00% standard standard 15% 20% 75,00% 11,25% 100% 89,25% 92,50% 18,50% standard standard 20% 20% 85,00% 17,00% 87,50% 17,50% weight factor: weight factor: individual grade: individual grade: weight factor: weight factor: individual grade: individual grade: board of directors transparency and publicity standard individual grade commitment to corporate governance principles and social responsibility executive directors weight factor: weight factor: individual grade: individual grade: assembly and shareholders final grade supervision and control ivana ljutić 79 figure 2. scorecard for the corporate governance code in serbia source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. figure 3. final score per group of questions source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. commitment to corporate governance principles and social responsibility assembly and shareholders board of directors executive directors supervision and control transparency and publicity 100,00% 75,00% 85,00% 100,00% 92,50% 87,50% 10,00% 11,25% 17,00% 15,00% 18,50% 17,50% commitment to corporate governance principles and social responsibility assembly and shareholders board of directors executive directors 80 economic analysis (2021, vol. 54, no. 1, 71-91) figure 4. final grade source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. table 1. i connitment to corporate governance principles and social responsibility (10%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 1. has the company adopted its own code of corporate governance or has it applied another organisation's code of corporate governance? 1 33% 33,00% 2. have applicable corporate governance principles been incorporated into the company acts and are they easily available to all stakeholders? 1 33% 33,00% 4. does the company publish in its annual reports the information on its business operations' compliance with the corporate governance principles or provide explanations for any departure from the principles, in line with article 368 of the law on commercial entities? 1 34% 34,00% 100% 100,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021. all the companies on the sample have responded positively on all the three criteria of commitment to corporate governance principles and corporate social responsibility. they all have adopted their own code of corporate governance, applied the principles, incorporated in the company internal regulation, with easily accessible information to stakeholders. annual reports and related information were publicized jointly with the compliance of the principles of corporate governance, that is easy, but in essence formal and necessary first inroad step into the right direction. on the following figure 5, is portrayed that compared to the balanced scorecard grade criteria, issuers have achieved full compliance, that is excellent itself. 82% 84% 86% 88% 90% 92% 94% 96% 98% 100% 1 100% 89,25% standard individual grade ivana ljutić 81 figure 5. commitment to corporate governance principles and social responsibility source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. table 2. ii assembly and shareholders (15%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 5. does an invitation for meeting of the shareholders assembly include all the prescribed elements and information, including the shareholders day details and information on shareholders' rights to participate in the activities of the shareholders assembly and propose items of the agenda, with timeframe for exercising these rights, as well as the description of voting procedures, either by proxy, absentee ballot or electronically? 1 8,33% 8,33% 6. is the invitation for meeting of the shareholders assembly, with all relevant explanations and information submitted to the stock exchange for the purpose of publishing in the regulated market, i.e., mtp belex, immediately after its sending (publishing) to shareholders? 1 8,33% 8,33% 7. are the materials for the meeting of the shareholders assembly available on the company website? 1 8,33% 8,33% 8. has the company established some of legally prescribed options for online participation in the assembly activities, and if so, in which manner? 0,5 8,33% 4,17% 9. does the company publish adopted decisions and minutes of the meetings, immediately, i.e., within prescribed deadlines, after the meeting? 1 8,33% 8,33% 10. what materials, decisions and other relevant documents related to the shareholders' assembly, if any, are also prepared and published in english? 1 8,33% 8,33% 11. has the company adopted the shareholders' assembly rules of procedure and does this or other company act set forth rules and procedures which ensure that shareholders are provided with timely answers to all relevant questions concerning the assembly? 1 8,33% 8,33% 12. has the company clearly defined its dividend policy and the procedures and deadlines for its distribution? 1 8,33% 8,33% 13. has the company issued shares in the previous year with restriction on shareholders' option to buy new emissions of the company shares? 0 8,33% 0,00% 32% 33% 33% 33% 33% 33% 34% 34% 34% question 1 question 2 question 4 standarni weight factor score 82 economic analysis (2021, vol. 54, no. 1, 71-91) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 14. has the company established its mechanism for prevention and settlement of possible conflicts between its shareholders and the company? 1 8,33% 0,00% 15. is comprehensive information on the proposed nominees available to the shareholders' assembly when selecting board members, particularly the information on any relations to the company, affiliated parties, competitors and main business partners of the company? 1 8,33% 8,33% 16. are shareholders enabled to exercise their rights to unrestricted participation in the shareholders' assembly activities and decision-making? 0,5 8,33% 4,17% 100% 75,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021. aspects of the assembly and shareholders relationship covered the wide criteria, from the invitation to the shareholder assembly (regular annual, other), invitation, supplied materials and related information available on the company website. issuers have partly established some form of the legal prescribed options for online participation at the assembly activities (question 8). all other aspects like publication decisions and meetings minutes, dissemination of relevant information and documents, adopted rules of procedure for shareholders’ assembly are handled on a timely bases with prompt responses, transparent dividend policy. it is evident that the companies have not issued shares in the previous year (question 13). it is significant the positive response of issuers on the company which has established its mechanism for prevention of settlement of possible conflicts between its shareholders and the company. the process of selection of the board members, revealing the information on any relations to the company (e.g., related party transactions) has a positive response, while the shareholders was only partly enabled to exercise their rights to participate in the activities of the shareholders’ assembly, which a fact which should attract attention in the further subsequent research. figure 6. assembly and shareholders source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. 0,00% 1,00% 2,00% 3,00% 4,00% 5,00% 6,00% 7,00% 8,00% 9,00% standarni weight factor score ivana ljutić 83 table 3. iii boards of directors (20%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 17. which governance system has the company set up? 1 10% 10,00% 18. do the company acts define in more detail the competence of the board of directors, i.e., the company's supervisory board? 1 20% 20,00% 19. do the company acts define criteria for required expert and professional knowledge and experience, as well as other conditions for appointment of board members? 0,5 10% 5,00% 20. does the board of directors prepare analyses and assessments of the quality and efficiency of its activities minimum once per year, and propose measures and activities for their improvement, notifying shareholders of the above measures? 1 10% 10,00% 21. are independent directors, i.e., independent members of the supervisory board under any obligation to inform the company and its shareholders of all changes which may affect their status in terms of independence? 1 10% 10,00% 22. has the company adopted a transparent and publicly available remunerations policy for the board of directors members and is the remuneration amount dependent on their contribution to attaining corporate financial and nonfinancial results and business goals? 1 20% 20,00% 23. has the company's board, apart from the law-prescribed audit commission, formed any other commissions as well, specifically other expert advisory bodies? 0,5 10% 5,00% 24. are the remunerations which are paid to the company's commission members included in the remunerations policy for the company's commission members, i.e., determined within the framework defined by the company's assembly? 0,5 10% 5,00% 100% 85,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021. the composition of the board of directors, adopted governance system, the important role of external independent directors and also the composition and functioning of the supervisory board is more than important and positive response also for the transparent and publicly available remunerations policy for the board of directors and members (e.g., measured contribution to financial and non-financial performance. on the other hand, the partly implementation of the law request to establish the audit board (commission) and other expert advisory bodies is the reflection of the not full and adequate understanding of the important and more than useful role of this control mechanism. this is also a clear indication that also remuneration for these bodies is not adequately regulated, since the companies are probably reluctant to use the full possibility of potential full contribution while at the same time to pay those external experts adequately. the neuralgic spots could be observed in the following figure 7, on the response to the questions 19, 23 and 24. 84 economic analysis (2021, vol. 54, no. 1, 71-91) figure 7. board of directors (20%) source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. table 4. iv executive directors (15%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 25. do the company's acts clearly define the authorizations and responsibilities of the executive directors? 1 20% 20,00% 26. do the company acts set the criteria which define the required expert and professional knowledge and experience, as well as other requirements that a person must meet to be appointed an executive director? 1 20% 20,00% 27. has the process of work evaluation of executive directors by the non-executive directors of the board of directors, or by supervisory board, been established and is applied, in case of a two-tier system? 1 20% 20,00% 28. do the remunerations for the executive board members comprise the fixed and variable parts (bonuses, motivation, etc.) depending on their performance in achieving financial and nonfinancial results and the company’s business objectives? 1 10% 10,00% 29. does the company have efficient mechanisms to provide the accurate, timely, comprehensive, and egalitarian reporting to the company's board members by the executive directors, specifically, which procedure is applied when reporting to the nonexecutive directors and/or members of the supervisory board on all issues relevant to business operations, financial status, and potential risks to the company's assets? 1 10% 10,00% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% question 17 question 18 question 19 question 20 question 21 question 22 question 23 question 24 standarni weight factor score ivana ljutić 85 criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 30. do the executive directors report to the company's board on the issues under art. 416 of the law on commercial entities, specifically in terms of giving qualitative opinion and analysis of important issues which significantly impacted company's operations in the reporting period, including the view and analysis of significant company's business risks and future long and short-term perspectives of the company? 1 10% 10,00% 31. does the company have the function of the corporate secretary and, if yes, specify the assigned duties and responsibilities. 1 10% 10,00% 100% 100,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021 board of the executive directors, as it would be expected has been well approached as a top management body and that is reflected in corporate practice. the issuers have clearly defined their authorization and responsibilities, set up the clear criteria for the expert advice (requirements of the appointment of the executive director/s). that follows the process of work evaluation of executive directors by the non-executive directors or by the supervisory board. also are important aspects of management reporting, opinions, analysis, strategic perspectives of the company, the significant role of the company secretary. all responding questions got positive response from all the companies included in the sample, see figure 8 below. figure 8. executive directors source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% question 25 question 26 question 27 question 28 question 29 question 30 question 31 standarni weight factor score 86 economic analysis (2021, vol. 54, no. 1, 71-91) table 5. supervision and control (20%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 32. is there the audit commission in the company? 1 15% 15,00% 33. are there any bodies and/or persons appointed for the activity of internal audit? 1 15% 15,00% 34. do the company acts more specifically regulate the issues under article 452 of the law on commercial entities? 1 15% 15,00% 35. are there any mechanisms and rules for performing supervision and control established at the company level, as well as the activity indicators that should suggest to the internal audit that the preventive audit and control need to be performed? 1 10% 10,00% 36. do the systems of internal audit include the insider information affairs? 0,5 15% 7,50% 37. does the external auditor of the company inform the audit commission on the issues under art. 453 of the law on commercial entities? 1 10% 10,00% 38. does the external auditor prepare a separate internal document for the company's board (letter for management), comprising key shortfalls identified during the procedures of control, company’s accounting and operative procedures, including the suggestions for their improvement? 1 10% 10,00% 39. does the external auditor attend the meetings of the shareholders assembly where the reports on performed audits and company's financial reports are reviewed? 1 10% 10,00% 100% 92,50% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021 supervision and control are narrowly focusing on the important aspects of the introduction of the audit committee or commission, internal audit function and department, at the corporate level, as the usage of key performance indicators (kpi), as well as on the effective functioning of the internal audit on the preventive manner and as a control mechanism. all those criteria (questions 32. to 35.) are having a full positive response. the companies have been somewhat not so disciplined following the pattern that the internal audit assure the quality of internal information. the cooperation between the external audit function and company’s audit commission is positive. the external auditors prepare a separate internal communication to the audit commission, e.g., informing them on the quality of internal control system, and what is very valuable positive outcome is the attendance of external auditor to the meetings of shareholders assembly (figure 9). ivana ljutić 87 figure 9. supervision and control source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021 table 6. vi transparency and publicity criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 40. does the company have a clearly defined and publicly accessible disclosure policy which defines principles, rules and procedures of reporting to shareholders, relevant authorities, public, and other interested parties? 1 10% 10,00% 41. does the company publish its business reports including the report of the external auditor in compliance with the laws, by-laws, and regulations of the stock-exchange? 1 5% 5,00% 42. do the company’s business reports include all law-prescribed elements, notably elements prescribed under art. 289 of the law on commercial entities and art. 50 of the law on capital market? 1 10% 10,00% 43. apart from information defined in the law on capital market, does the company establish and immediately publish the data which may impact the price of shares of the company and the shareholders' status? 1 10% 10,00% 44. are the updated data on the company's insiders publicly accessible, including data on the number of company's shares/ratio of shares owned by them? 1 10% 10,00% 45. does the company publicly announce the biographies data of the members of the company board, members of the audit commission, and person responsible for internal supervision of business? 0,5 5% 2,50% 46. does the company publicly announce the data on transactions with affiliated persons and deals with persons having special authorizations in the company, and their affiliated persons? 0,5 10% 5,00% 0% 2% 4% 6% 8% 10% 12% 14% 16% standarni weight factor score 88 economic analysis (2021, vol. 54, no. 1, 71-91) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 47. does the company report to the public on individually paid remunerations and other financial and non-financial rules and benefits gained by the holders of coordination, management and supervision functions in the company, as well as by the company’s board’s commissions members? 0,5 10% 5,00% 48. does the company use its own internet page to publish all relevant information? 1 10% 10,00% 49. is the company's internet page organized in the manner as to enable a simple access to information relevant to investors? 1 10% 10,00% 50. are all relevant investment information published in the english language as well? 1 10% 10,00% 100% 87,50% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021 aspects of transparency and publication of the relevant information are covered in the last segment of this questionnaire (questions 40 to 50). it has included starting from the public free access of information, publication, business reports and of the insider information. somehow companies are not so willing to publicize the full biographical information of the members of the board and on the transactions with affiliated persons (questions 45 and 46). also, companies are somehow not fully opened up and transparent in revealing information on individually paid remunerations (e.g., financial and non-financial rules and remunerations of the members of the top management and supervisory board (question 47). aspects of the internet webpage for the publication of the company relevant information, pages simple to be accessed supplied with information relevant to investors, stakeholder and general public, have being covered fully. it is very positive that all that information has been published also in english language for this segment see the following figure 10, on the transparency and publicity. figure 10. vi transparency and publicity source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021 0% 2% 4% 6% 8% 10% standarni weight factor score ivana ljutić 89 conclusion in the article we have analyzed the practical implementation of the g20/oecd principles of corporate governance of the issuers at the belex, period 2013-2020. as this is rather a prolonged period, with no so many issuers, even with the change of the structure of reporting companies we have selected in the statistical sample of all 50 filed questionnaires of the corporate governance we have obtained. the standard methodology is founded on the original principles envisaged by the organization for economic cooperation and development (oecd) in 1999 (original principles), the last third version 2014-2015, as a result of the active involvement of the group of the largest developed countries (g20) as was adopted at antalya summit, turkey, november 2015. the current economic crisis from 2020 and afterwards has not been reflected in the principles since the crisis is in its early starting stages, but also strongly present and very deep with the negative consequences on the investments, sustainability and economic growth. this article is pointing out to the drastic and urgent need to improve the quality of corporate governance, to think creatively based on the results of this analysis how to implement much needed recommendations based on the oecd principles. unresolved issues and goals should be stressed not mainly from the aspects of quantitative analysis but from the point of view of qualitative improvements. this study is showing evidently that the stress and focus is on the formal implementation, from the transparency, standardized high quality disclosure of financial and increasingly stressing from now on even more the importance of non-financial disclosure, increased social responsibility as a key to open the doors to investors to finance the future economic growth and social stability. acknowledgements i express my sincere thanks to mr. nikola m. stajić, master, ba 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(2020). “corporate governance in serbia.“ https://www.ceelegalmatters.com/serbia/12586-corporate-governance-in-serbia. article history: received: march 7, 2021 accepted: april 9, 2021 doi: 10.28934/ea.22.55.1.pp105-127 original scientific paper economic activity and employment in the non-financial sector of bulgaria under conditions of covid-19 crisis. sectoral vulnerability assessment stoyan shalamanov122f* 1 sofia university “st. kliment ohridski”, faculty of economics and business administration, department of economics, sofia, bulgaria abstract this article examines the economic consequences in the non-financial sector of bulgaria as a result of the covid-19 pandemic. the development of the pandemic in bulgaria is analyzed from a medical point of view and it is concluded that the country will need periodic lockdowns (restrictions by the government and health authorities) of some economic sectors for at least a few more years. the analysis of the data from bulgaria and around the world shows that the lockdowns have general economic consequences, but mainly affect certain sectors. the main goal of the article is to identify the most vulnerable to social distancing industries in the bulgarian economy. to this end, the article develops a methodology based on a set of criteria for assessing sectoral vulnerability to lockdowns. the methodology includes an assessment of sectoral vulnerability to automation, percentage of selfemployed in the sectors, lockdown index, home-office index, teamwork, and customer-facing. we have found that the most vulnerable sectors in bulgaria is the hotel and restaurant business sector, and air transport. key words: covid-19, pandemic, non-financial sector, sectoral vulnerability, lockdown jel classification: e24, e32, j21, j23 introduction what is specific about the covid-19 pandemic is that it is an exogenous factor of economic growth. the specificity of addressing the health consequences of the virus requires imposing restrictions mainly on the mobility and social life of people. on the one hand, there are no purely economic and financial factors for the crisis. on the other hand, addressing the health aspect of the crisis concerns some sectors differently if compared to others. some sectors, such as health, land transport and construction, even turn out to be favored, their growth is stimulated both by the created situation with covid-19 and the support that is not precisely targeted according to the needs of the sectors. if the covid-19 crisis lasts longer, it would be useful for economic policy to identify the most vulnerable sectors in order to make support more targeted, rather than supporting sectors and businesses that do not need support, which only creates inflation. this is the purpose of the present study. the object is non-financial enterprises in bulgaria by sectors. the subject of research is the economic consequences of the pandemic on non-financial enterprises. * e-mail: shalamanov@feb.uni-sofia.bg 106 economic analysis (22, vol. 55, no. 1, 105-127) methodologically, a literary, comparative, and descriptive graphical analysis at sectoral level will be used to achieve the purpose. chapter one collects and analyzes data on the development of the pandemic. by analogy with the world trends in the spread of the virus and the introduced restrictions on social contacts, a forecast is made for the development of the pandemic in bulgaria. chapter two applies to the classification and comparison of the consequences of the pandemic in bulgaria and around the world. the third chapter summarizes data from various international studies on the effects of the pandemic on the non-financial sector of economies. the fourth chapter with the help of graphical, descriptive analysis presents the effects of the pandemic on the nonfinancial sector of the economy in bulgaria. we create a tabular model for assessing the vulnerability of the non-financial sectors in bulgaria in the fifth chapter, compare and classify the results. the methodology includes an assessment of sectoral vulnerability to automation, percentage of self-employed in the sectors, lockdown index, home-office index, teamwork, and customer-facing. the article will first describe the development of the pandemic from a medical point of view. this is an important component of the analysis because, as mentioned above, it is an exogenous crisis, which in this case is directly dependent on the development of the health factor, including: the rate and fluctuations in the spread of the infection, the approaches to dealing with it that have economic consequences, i.e. those that directly restrict certain economic sectors. second, the general economic consequences for the world, as well as for individual countries and regions, including bulgaria, will be discussed. third, the impact of the pandemic in the non-financial sectors of some countries will be analyzed as an introduction to getting acquainted with the consequences in the non-financial sector of bulgaria until the first quarter of 2021. in the last section of the analysis, based on various indicators and indices developed in scientific literature, a cumulative method for assessing sectoral vulnerability in bulgaria will be developed. this method will be used to analyze the sensitivity of the various non-financial sectors of the bulgarian economy to the consequences and restrictions associated with the pandemic and draw conclusions on the future support policy. general health consequences in the world and in bulgaria for 2020 and early 2021. the covid-19 virus occurred in wuhan city of central china at the end of 2019. it was identified when in december people developed pneumonia of unknown cause that did not respond to the known methods of treatment. it has rapidly widespread and on march 11, 2020, the world health organization (who) has declared the novel coronavirus (covid-19) outbreak a global pandemic. by the end of july 2021, there were already more than 198 million confirmed cases of people infected with the virus worldwide, of which over 4 million deaths, and nearly 15 million active cases (worldometer, 2021). figure 1. shows the dynamics of spread of the virus around the world from the beginning of the pandemic in the spring of 2020 to july 2021. both charts show a trend of increasing the cases in recent weeks; the world is on the verge of a fourth wave of covid-19. stoyan shalamanov 107 figure 1. daily new cases around the world source: worldometer. 2021. bulgaria reported the first confirmed case of coronavirus disease (covid-19) on march 8, 2020. since then, the statistics of prevalence and mortality has been following the global trends with a slight delay of several weeks, which can be seen in figure 2. as of the end of july 2021 bulgaria has already reported over 424 thousand officially registered cases of infected, of which over 18 thousand death cases, nearly 400 thousand recovered cases and over 8 thousand active cases (unified information portal, 2021). figure 2. daily new cases in bulgaria source: worldometer. 2021. towards the end of july, the origination of the fourth wave in bulgaria is not clearly visible graphically, but the cases are increasing and the logic of the first two waves suggests that we will probably continue to follow the negative trends in global statistics. this conclusion is also supported by the low vaccination rate in bulgaria compared to the rest of the world. as of september 2021, the fully vaccinated population in bulgaria is 15% compared to 30% on average for the world. on the one hand, the positive aspect in the fight against the pandemic are vaccines that reduce mortality; on the other hand, the negative aspect are new mutations of the virus such as delta variant, which so far do not allow a permanent reduction in the number of infected. these covid108 economic analysis (22, vol. 55, no. 1, 105-127) 19 mutations either multiply and spread more rapidly or are more resistant to vaccines. this means that the need for restrictions in social life and some economic activities will remain. social distancing measures are different types with different scope and stringency and can be categorized as partial and full. in the case of full measures, a quarantine blockade of entire regions or countries is required. in the strictest form, the entire population is forbidden to leave their homes, unless it is absolutely necessary. physical contact is allowed only between members of the same household. only basic essential organizations, such as grocery stores, pharmacies, and hospitals, operate. the full restrictive measures are imposed for a more limited period of time (fiscal council of bulgaria, 2020). the partial measures restrict activities related to mass events and crowing of people, and can be (covid 19 healthdata, 2021.): • closure of schools and educational institutions at all levels of education (primary, secondary and higher education), introduction of distance learning; • suspension of insignificant activities, closure stadiums, cinemas, shopping malls, museums and playgrounds, bars and restaurants (they can offer home deliveries), closure of retail stores and services such as beauty salons and hairdressing salons. only suppliers of basic goods and services work. fines are imposed on offenders. • restrictions on travel. movement between settlements is prohibited. only those who provide basic services and returning residents isolated in foreign territories are admitted. travel in private cars is limited only for the purposes of access to work and basic services. public transport is stopped. • gatherings are limited. restrictions can be applied both to public and private gatherings (a definite of people in one place). • businesses are temporarily closed. these restrictions do not apply to all companies but may include a particular group such as bars and restaurants. • contact persons are tracked and quarantined. • remote forms of employment are encouraged. • a mask is used, and distance is observed in contact with people outside the household. • information campaigns for prevention and vaccination. • mass testing policy. • promoting vaccination against covid-19 by different approaches – incentive and prohibitive. the measures applied by the health authorities differ not only in their type and stringency, but also in the timeliness and speed of their application. in general, they cause, in addition to the negative economic consequences, resistance and boycott by a part of the society. the gradual combination of different partial measures allows a large part of the economy to continue to operate. another approach is to alternate full measures with partial measures (in the form of ‘dance’). in any case, there is a risk of early or excessive loosening of the measures. figure 3 shows how the measures to restrict social contacts, applied by the government since the start of the pandemic, affect the mobility of people compared to the usual levels for bulgaria. stoyan shalamanov 109 figure 3. social distancing source: covid 19 healthdata. 2021. mobility should change with the application or easing of the measures for social distancing, so data should give us an idea of the extent to which the restrictive measures of the government have actually led to an increase in social distancing. individual decisions for mobility restriction, despite the government restrictions, also have an impact on the model because ‘mobility’ in the model is based on anonymous mobile phone tracking data provided by technology companies to combat covid-19. all other conditions being equal, it is accepted that mobility is an indicator of greater potential for personal contact that can contribute to the spread of the disease. when mobility is high, the risk of spreading covid-19 is also considered to be high. however, taking precautions, such as keeping distance between individuals during gatherings, wearing face masks in public areas and washing hands regularly, can significantly reduce the risk of transmitting the disease. the model also provides three forecast scenarios for the development of the situation (covid 19 healthdata, 2021.): • continuation of the trend (average reference scenario) under equal other conditions. • worsening of the situation (unfavourable scenario), in which new coronavirus mutations begin to spread more rapidly and/ or the use of masks among vaccinated persons begins to decrease exponentially one month after the end of the vaccination course. • the ‘mask’ scenario (favourable scenario) is based on the same assumptions as the reference scenario, but also assumes that 95% of the people wear masks in public areas. it is stated that the use of masks at this level can reduce the transmission of the virus by more than 30%. in the unfavourable scenario and the average reference scenario, the forecast from the model is that mobility in bulgaria will have to be significantly limited by october. only in case of over 95% wearing masks we can rely on maintaining the current mobility, but such a percentage in bulgaria is unattainable. currently, such a level of wearing masks is found only in singapore. based on this chart, it can be concluded that social distancing must also be maintained in the coming months in order to limit the spread of covid-19. at the same time, the measures for social distancing have a detrimental effect on the economy, but there is no alternative at this stage, because there is still not enough clarity about the effectiveness of vaccines against new mutations of covid-19. the conclusions from the above analysis at the time of writing this article are that the pandemic has not subsided at all, either in the world or in bulgaria. in connection with the emergence of newer mutations of the virus, which are more resistant to vaccines, precise forecasts cannot be 110 economic analysis (22, vol. 55, no. 1, 105-127) made for the development of the situation and the recovery of social and economic life. economies must be prepared for a long regime of opening and closing, and people for a long regime of social distancing. some studies have found that the application of strict protocols to several sectors is generally preferable to the application of softer protocols to a larger number of sectors both in terms of health and economic benefits. (janiak, machado & turén, 2021.) it would be useful for the economic management of the crisis to get to know in more detail the economic consequences of the pandemic both in the world and in bulgaria, as well as to identify the most vulnerable (most affected by closures) economic sectors in order to refine the economic support policy in bulgaria. general economic consequences of the pandemic for the world and bulgaria the onset of the covid-19 pandemic and the restrictive measures imposed to address its health consequences have led to a sharp contraction of economic activity in all major economies. the covid-19 pandemic has raised the global index of uncertainty to historic levels – fig. 4. uncertainty was declining relatively rapidly as early as the end of march 2020 (altig & others, 2020.), with the peak of the negative economic effects of the restrictive measures observed around may 2020. data from international trade confirm that the negative effects of covid-19 in exporting countries persist until august 2020, but their scale decreases over time. (hayakawa & mukunoki, 2021). the relatively rapid recovery of confidence and economic activity, especially in some large economies such as china, has allowed the overall global economic decline for 2020 to be limited to just 3.3%. the chinese economy even managed to report growth of 2.3% for the year, the decline for the united states was 3.5%, great britain – 9.9%, germany – 4.9%, france – 8.2%, russia – 3.1%. (world economic outlook, 2021.) figure 4. global index of uncertainty source: international monetary fund, through murginski, 2021. the global economy is expected to expand by about 6% in 2021, the fastest pace in 80 years, mainly due to the strong recovery of several major economies. however, many emerging markets and developing economies continue to struggle with the covid-19 pandemic and its aftermath. the world production will be about 2% below pre-pandemic forecasts at the end of 2021. among low-income economies, where vaccination is lagging behind, the effects of the pandemic are stoyan shalamanov 111 reducing the achievements in poverty reduction. these forecasts are included in the june issue of the world bank’s report on global economic prospects (global economic prospects, 2021). it should be noted, however, that these economic forecasts do not reflect the purely medical aspect of the problem that we have already addressed in chapter 1. uncertainty about the emergence of new mutations in the virus that are resistant to vaccines and new waves of the pandemic remains high. in the pre-pandemic year of 2019, the gross domestic product of bulgaria increased in real terms by 3.4%, exceeding 3% for five consecutive years. the leading factor of growth is final consumption, which increased by 5.7% compared to 2018. since mid-2019, there has been a slight slowdown in the real growth of gdp to 3.2% and 3.1%, due to the slowdown in the global economy that has already begun. the crisis caused by the global pandemic dramatically changed the dynamics of economic activity in the bulgarian economy. (institute for market economics, 2020). with the introduction of the state of emergency in bulgaria on march 13, 2020, strong restrictions on social and economic activities were imposed. hotels, restaurants, bars, beauty salons, tourist offices, cinemas, theatres, malls, retail stores, etc. completely closed. some manufacturing companies ceased their operations due to disruptions in the international supply chains. travelling was restricted, checkpoints were established at the exits of the regional centres, the mandatory fourteen-day quarantine of bulgarian and foreign citizens arriving in bulgaria was introduced. (petranov, zlatinov, velushev & karaivanov, 2020). the shock on transport is evident from the following statistics: • the number of trucks passing through the main border checkpoints of the country reduced by 30% 40%; • the bulgarian airlines association announced that the expected losses only in the months of march, april and may would amount to eur 34 million (customs agency, 2020); • only in march, the revenues of the sofia-based companies ‘metropolitan’, ‘stolichen avtotransport’ and ‘stolichen elektrotransport’ shrank by eur 3.3 million. the gross domestic product decreased by 8,5% in real terms compared to the second quarter of 2019 and by 10% compared to the first quarter of 2020. according to data of the employment agency, in the six weeks after the introduction of the state of emergency in the country, more than 105 thousand new unemployed people have been registered in the employment offices and only 16 thousand have started working for the same period. the number of registered unemployed reached the highest value of 295,5 thousand people in may or by over 112 thousand more compared to same month of 2019. (institute for market economics, 2020). the easing of restrictive measures and the opening of businesses in may – june 2020 have led to a resumption of the activity in july. the confidence of the business and consumers was increasing; the industrial production was beginning to recover. however, activity in the services and retail trade sectors has been hampered by the loss of consumer incomes, the increase in savings and the continued restrictions on some activities. (oecd economic reviews – bulgaria, 2021). in the end, the bulgarian economy contracted by 4.2% in the crisis year of 2020 to bgn 118.6 billion at current prices, according to preliminary data of the national statistical institute (nsi), as the decline was below the eu and euro area average. according to eurostat, the decline in the eu economy is 6.2% and the gross domestic product of the euro area countries is minus 6.6% in 2020. despite the severity of the pandemic and economic crisis, in 2020 the unemployment rate increased by only 0.9 percentage points, compared to 2019, and reached 5,1%, respectively 5,4% for men and 4,8% for women. the number of unemployed reached 168,6 thousand by the end of 2020, according to nsi data from march this year. the reported increase in unemployment is much less negative that during the previous global economic crisis of 2008-2010. (bulletin for macroeconomic development, 2021). 112 economic analysis (22, vol. 55, no. 1, 105-127) dynamics in the non-financial sectors of different countries at the moment of completion on this article, there is no available data regarding other countries that are more similar (in terms of size and economic development) to bulgaria. initially, with the introduction of the restrictive measures, the production and sale of vehicles and spare parts, as well as their service maintenance, were among the most affected economic activities because some manufacturers were forced to close their factories in a number of countries. transport was also strongly affected due to the closure of borders, introduction of quarantine blockades and decline in tourism. in air transport, already requested and paid reservations were cancelled. in the first week of april alone, there was a drop of over 90% in the scheduled flights to countries such as the united kingdom and germany (fiscal council of bulgaria, 2020). the introduction of quarantine blockades, the restrictions on mass events, the distance working of employees, etc. significantly reduced the passenger flow in the public urban transport. in retail trade, a number of companies faced difficulties and delayed the payment of their rents, the large shopping centres closed due to the ban on crowding of people. some of the catering establishments restaurants and cafes temporarily relied only on home deliveries of food, thus compensating at least a small part of the decline in their income. (fiscal council of bulgaria, 2020). some researchers have found that countries with a better virus control strategy, healthcare opportunities and relatively higher share of employment in the primary sector have suffered lower losses (goswami &, 2021). it can be argued that labour-intensive industries are more vulnerable, with the footwear industry suffering a decline until august 2020, the production of transport equipment showing a decline especially in april and may 2020. in other industries, such as those offering medical products or digital consumer services, software and computer services, electronic entertainment, positive effects of covid-19 have been observed. (hayakawa & mukunoki, 2021). another research claims that the sectors with high contact and higher vulnerability to infection are the wholesale and retail, hotels and restaurants, entertainment and personal services, transport, education, healthcare, and construction. all other sectors can be determined as sectors with low-contact and lower risk of infection (world economic outlook, 2021). in general, most sectors have been affected in some way the primary and secondary industries are suffering due to poor logistics and supply chain problems, the wholesale and retail due to the need to speed up their online services, and the tourism sector is the most affected sector. (lu & others, 2021). the greater vulnerability of some industries may depend on the share of self-employed in a given sector; such persons in a given economy are very often not insured or are insured on a minimum income and therefore cannot benefit from business and employment preservation programs. statistics on the sectoral distribution of this vulnerable employment in pakistan shows that the lowest percentage of self-employed is observed in the financial sector, supply of utilities (water, electricity and gas), mining and education, while in the agricultural sector, wholesale, retail and real estate they are at most over 60 % for each. (sohail, 2019). if such microenterprises and self-employed are left without state support, they could not survive for a long time. data from a study in pakistan show that most small and micro-enterprises would not survive for more than 5 weeks, if restrictive measures are introduced in a new wave of covid-19. tourism and entertainment industry are the economic sectors that have most been affected by covid-19 in the world. they report a decline of usd 2,86 trillion for 2020 or more than 50% loss of revenue. (abbas, & others, 2021) in fig. 5, the percentage change in the number of international tourist trips by geographical regions can be seen for january may 2019, compared to the same period of 2018, and for january may 2020, compared to the same period of 2019. for example, australia’s inbound tourism industry is expected to reach a decline of usd 39 to 42 billion in the gross domestic product for 2020. the results show direct losses of 152 000 jobs in tourism, which together with indirect losses, including related industries in the production chain, reach a total of stoyan shalamanov 113 about 450 000 jobs. (pham, 2021). the negative effects of covid-19 extend beyond the direct impacts on tourism-related industries. figure 5. change in the number of international tourist trips by geographical regions source: world tourism organisation, through: abbas, j., and others. 2021 the long-term economic consequences for the tourism industry will affect any household, directly or indirectly related to the sector. the pandemic has literally stopped tourism in some periods of 2020 and 2021. usually, when crises such as natural disasters, epidemics, wars, civil unrest, etc. affect a region, travellers are flexible and move from the destination affected by the crisis to another. tourism has the ability to attract consumers (visitors) from around the world. in this global pandemic of covid-19, however, all these alternative plans lose their meaning because the pandemic affects any type of tourism, whether summer, winter, cultural, pilgrimage, health and rehabilitation or otherwise. in addition, the covid-19 pandemic will have a lasting impact on the tourism industry, as tourists are not expected to regain their previous level of mobility even after its end (singh & others, 2021). covid-19 has made life very difficult for the poorer people of society working in tourism. these people have no other choice but turn to new professions, which will also have lasting consequences for the sector. apart from tourism, employment in developed economies is declining most sharply in the wholesale and retail, transport, catering, and arts and entertainment sectors. the difference with previous recessions in the last 50 years is that during such recessions the manufacturing and construction sectors were usually most affected. it is also interesting that covid-19 accelerates the existing structural trends to reduce employment in sectors that are more vulnerable to automation (fig. 6). sectors are classified as more vulnerable to automation, if more than half of their employment is in professions classified as routine (carrillo-tudela & others, 2016). in these sectors there is a gradual decrease in the share of employees with lower qualifications. most employees working remotely are in sectors that are classified as less vulnerable to automation, which means that covid-19 also creates a tendency to switch to teleworking. however, there are some exceptions, for example – sectors that are less vulnerable to automation, but cannot work remotely, including utilities, culture and entertainment, as well as sectors that can work remotely, but are more vulnerable to automation, including administrative services. there are indications that the shock of covid-19 is accelerating the existing trends, with employment declining in sectors and occupations that are more vulnerable to automation. this is also observed in the movement of labour flows during past recessions, although now the specific sectors most affected are different – wholesale and retail, accommodation and catering. (world economic outlook, 2021). 114 economic analysis (22, vol. 55, no. 1, 105-127) figure 6. sectors vulnerable to automation source: choi and others (2018), through: world economic outlook. 2021. in general, the effects of covid-19 on global employment affect young people, low-skilled and women to a greater extent. (world economic outlook, 2021). the shock of covid-19 is likely to have some lasting effects, accelerating the reduction of employment that is more vulnerable to automation and that cannot switch to teleworking. changes in economic activity and employment in bulgaria by main economic sectors. the growth by economic sectors of the bulgarian economy in pre-pandemic 2019 is defined as sustainable, because the industry sector has the highest contribution. at the same time, fundamental sectors such as trade, transport, hotel business, it and telecommunications are reducing their contribution to the overall growth (yotsov, zlatinov, & others, 2020). with the advent of covid-19, the government’s anti-crisis measures, including physical distancing, have had different effects on different sectors of the economy. when applying partial restrictions, the negative effects are focused on some sectors, but are subsequently extended to the related ones and ultimately to the whole economy. in the second quarter of 2020, when the crisis was most pronounced, compared to the same quarter of the previous year, the largest decline was reported – by 17,7% in the sectors of trade, repair of motor vehicles and motorcycles; transport, warehousing and post offices; hotel and restaurant business and by 4,7% in the sectors of culture, sports and entertainment. the number of persons employed in the second quarter of 2020 was lower by about 123 thousand than in the same quarter of 2019. the contraction is almost entirely due to the reduced employment in the sectors of trade, hotel and restaurant business (by over 72 thousand) and industry (by over 36 thousand), whereas, regardless of the crisis, in the sector of creation and distribution of it and creative products and telecommunications, employment increased by over 7 thousand people on an annual basis. growth is also reported in healthcare and social activities (institute for market economics, 2020). stoyan shalamanov 115 the pandemic has had an extremely negative impact on international tourism. in pre-pandemic year of 2019 the ‘hotel and restaurant business’ and ‘travel agency and operator activity’ sectors formed directly about 4.7% of the employment in the country; in 2019 the revenues from export of tourist services amounted to about 6.3% of the gdp (chobanov & others, 2020). with the onset of the pandemic, in june 2020 the total number of foreigners visiting bulgaria decreased by 75,2%, compared to their number in june of 2019, and the number of those coming for a vacation or excursion was lower by 94,6%. the university of oxford has developed a stringency index of government measures. it varies in the range from 0 to 100 points, as the higher value corresponds to tightening of restrictions. for bulgaria, the index registered a peak of 73.15 points at the end of march 2020 and from may a gradual easing of restrictive measures began as a result of the control of the first wave of the pandemic. bulgaria was among the eu states with the least restrictions at the end of the second and the beginning of the third quarter of 2020 (institute for market economics, 2020). this explains the relatively low rate of decline in economic activity and employment (fig. 7.1, 7.2. and 7.3) in most sectors during this period, compared to the other member states. figure 7.1. industry and services* figure 7.2. construction and transport* figure 7.3. hotel and restaurant business* sources: infostat, 2021, and own calculations (appendix table) * on the left scale, employment in the given sector is measured, and on the right scale – the value of stringency index. 0 10 20 30 40 50 60 70 460000 480000 500000 520000 540000 560000 580000 q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 stringency index industry services 0 10 20 30 40 50 60 70 115000 120000 125000 130000 135000 140000 145000 q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 stringency index construction transport 0 10 20 30 40 50 60 70 0 20000 40000 60000 80000 100000 120000 q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 stringency index hotel and restaurant business 116 economic analysis (22, vol. 55, no. 1, 105-127) the stringency index is calculated using policy indicators c1 c8 and h1. the value of the index for each day is the mean value of these nine indicators relating to individual policies, each with a value between 0 and 100. the indicators c1 to c7 and h1 have an additional coefficient corresponding to whether the policy is applied locally (in specific areas/cases) or as a whole throughout the country (covid-19 government response tracker, 2021). с – containment and closure policies: с1 – school and university closing; с2 – workplace closing; с3 – cancellation of public events; с4 – restrictions on gatherings; с5 – closure of public transport; с6 – stay-at-home requirements; с7 – restrictions on the internal movements between cities/ regions. н – health system policies: н1 – public information campaigns. in figure 7.3 we see, albeit in the opposite direction, the symmetrical development of stringency index, which is measured on the right scale, and employment, which is measured on the left scale, in the hotel and restaurant business sector for the first, third and fourth quarter of 2020, as well as employment in the services and industry sectors for the whole of 2020. interestingly, in all observed sectors there is growth in the first quarter of 2021, despite the increased stringency index. this can be explained by the adaptation of the business to some extent to the conditions of the pandemic and the restrictions associated with it. the results and analyses of 2020 presented above show that the government’s restrictive measures have a different impact on the non-financial sectors of the economy and the policies to support them need to be refined. the unnecessary support of some sectors has shown that it can put inflationary pressures on the economy, while the insufficient support of others can lead to lasting negative effects in some sectors, restructuring employment and thus increasing poverty and inequality, the latter being particularly strong in 2020. it would be useful to try to analyse the vulnerability of the main non-financial sectors of the economy with regard to the pandemicrelated closure. this knowledge can be used not only for the current crisis, but also for subsequent similar trials that bulgaria and humanity as a whole may face in the future. in pre-pandemic year of 2019, the industry sector was the basis of economic growth. subsequently, it was affected by the first wave of the pandemic and reported a strong decline in the months of march, april and may 2020, after which it began to recover in june 2020. both in the world and in bulgaria, the industry is coping relatively well with the crisis, is recovering quickly, and by june 2021 in bulgaria it is moving around the norm for the season with an index of 108,3 for 2019, the index for 2021 is 109,6 (fig. 8)(infostat, 2021). stoyan shalamanov 117 figure 8. industrial production indices, calendar adjusted data. source: infostat. 2021. clothing production has been permanently affected, for example with an index of 88,3 in june 2019 it fell to 75 in june 2020 and 73,5 in june 2021. this negative trend can easily be explained by the reduced demand for clothing in the conditions of severely limited mobility and social activity of the population both in bulgaria and around the world under pandemic conditions. the production of medicinal products and substances is at the other pole, with the production index reporting high values of over 130 in march, april and november 2020, and march 2021 (infostat, 2021). these values correspond to the three waves of covid-19 in bulgaria, which have been observed so far. despite the strong economic performance in 2019, employment in the industry sector has shown a trend of gradual decline since the beginning of the pre-pandemic year. from 574 477 persons employed in the first quarter of 2019, they reached 557 697 in the fourth quarter, with a sharp decline at the start of the pandemic in the second quarter of 2020, when 535 856 persons employed were reported. we can talk about recovery only in 2021, when for the first quarter the first for the period growth of 544 255 persons employed was reported (infostat, 2021). the trade sector, although more moderately than industry, also contributed to the economic growth prior to the crisis. after the initial lockdown in march and april 2020, similarly to international trade, the sector began to recover in the third quarter of 2020. it is noteworthy that companies and consumers were adapting relatively quickly to the new conditions and were largely switching to online forms of trading, which helped the rapid recovery of the sector as a whole. until the end of 2020 the tendency of wholesale in non-food consumer goods to move around and above pre-pandemic levels remained. employment in the sector was stable in 2019, showing over 390 thousand persons employed every quarter. however, the decline began already in the first quarter of 2020, when the number of persons employed was 389 thousand, compared to 396 thousand in the last quarter of 2019. in the next second quarter, which generally affected the economy most strongly, there was a smaller decrease by less than 3 thousand persons employed. employment remained below 390 thousand in the next quarters until the first quarter of 2021 inclusive (infostat, 2021). the construction sector, like the trade sector, is rapidly recovering after the initial shock. construction is one of the sectors with a smaller contribution to growth in 2019. fluctuations in housing construction and civil/ engineering construction are symmetrical, as all three more serious declines coincide with the three waves of coronavirus in 2020 and the spring of 2021 (fig. 9). it is noteworthy that the levels of housing construction, despite the growth of housing prices, are still below those of 2019, in contrast to civil/ engineering construction, which has a tendency to growth even above the levels of 2019. employment in the construction sector, similar to the trade sector, also began to decline in the first quarter of 2020, when nearly 124 thousand persons 118 economic analysis (22, vol. 55, no. 1, 105-127) employed were reported, compared to over 128 thousand persons employed in the first and last quarter of 2019. employment in the sector has recovered to the pre-pandemic levels of 128 thousand persons employed only in the first quarter of 2021 (infostat, 2021). figure 9. construction production. calendar adjusted data. source: infostat, 2021. the transport sector also contributed moderately to the economic growth in pre-pandemic year of 2019. all modes of transport were affected in the first months of the pandemic, falling in the second quarter of 2020. land transport can be said to have recovered, as its index for the first quarter of 2021 is even slightly higher than that for the first quarter of 2019 122.7 compared to 121.2. air transport is, however, still severely affected, including at an international level. the collapse is most noticeable in the third quarter of 2020, when the index is 56,5 compared to 229,2 for the third quarter of 2019. the first quarter of 2021 has an index of 37.1 compared to 49.4 for the first quarter of 2019; the decline seems less pronounced, but this is not a vacation period of the year. employment in the transport sector decreased by about 3000 people in the second quarter of 2020, recovering to the pre-pandemic levels of over 140 thousand persons employed in the first quarter of 2021 (infostat, 2021). sector services, excluding transport, hotels and restaurants: at the start of the pandemic not a small part of the activities for service provision were limited. however, some activities remained unaffected and others even managed to increase their production. postal and courier activities have been showing almost a continuous growth since the beginning of the pandemic, including in the second quarter of 2020 until the first quarter of 2021, when the index reached 174.8, with an index of 128.0 for the first quarter of 2019. the same can also be said for telecommunications, which reported a decline in the index only in the first quarter of 2021. information technologies can also be said not to have been affected by the pandemic; for information technologies, even no conclusion can be drawn for a significant impact of the pandemic in any direction. security activities are marking a slight increase, which is typical for the sector during crises. catastrophic is the situation with travel agency activity; it is indicative that the index is 7,8 for the second quarter of 2020, which will probably remain in history as the historically lowest value of a production index in bulgaria. for the same quarter of 2019 the index is 141.9. employment in sector services has been developing dynamically since 2019. in the second quarter it reached its highest value of 561 162 persons employed; since then it has started to fall steadily, reaching 506 954 during the highly crisis second quarter of 2020. in the following months, the fluctuations are stoyan shalamanov 119 various, as we can talk about signs of the beginning of recovery only in the first quarter of 2021, when the persons employed exceed 510 thousand (infostat, 2021). sector hotel and restaurant business: in general, tourism is the most affected sector by the pandemic. only for january may 2020, compared to the same period of 2019, tourist travel in eastern europe marked a decline by 54%. immediately after the introduction of the state of emergency in bulgaria, the sector collapsed and is still very far from its normal levels (fig. 10). figure 10. turnover indices in sector hotel and restaurant business at current prices. calendar adjusted data. source: infostat, 2021. in the hotel business, the negative dynamics is more pronounced. for the strongest third quarter of 2020 the index is 143.4, compared to 279.4 for the same quarter of 2019. for restaurants, restrictions were lifted several times and reintroduced, which put the sector in great uncertainty, as some of the restaurants closed permanently. it is noteworthy that for the strongest third quarter of 2020 the index of the restaurant business reached 170.5, almost equal to that for the same quarter of 2019 (177.4). for the other periods, however, the decline is significantly larger; it reached 79.7 for the first quarter of 2021, compared to 128.1 for the first quarter of 2019. employment in the sector is characterized by high seasonal dependence, which is also observed from the data for 2019, which range from 107 thousand in the winter months from the beginning of the year to over 137 thousand in the summer season; the trend of crisis decline can already be seen in the last quarter of 2019, when employment fell to 103 thousand, and in the first quarter of 2020 to 82 thousand. surprisingly, the second quarter of 2020 reported an increase to nearly 89 thousand persons employed, which can probably be explained by the beginning of the summer season in june, when the covid-19 cases decreased. however, the negative trends in the severely affected sector continued to be observed until the end of 2020 – there were 77 thousand persons employed in the last quarter, and 2021 began its first quarter with only 80 thousand, compared to 107 thousand for the first quarter of 2019 (infostat, 2021). sector it and telecommunications is traditionally among the strongly performing ones in bulgaria. in 2018, it had a strong contribution to the economic growth of the country. the whole year of 2019 also elapsed in growth of the sector from an index of 138.6 in the first quarter it reached 187.0 in the fourth quarter. in 2020, the sector started with an index of 151,2 in the first quarter and 150.5 in the second quarter, after which the index increased to 187.8 in the last 120 economic analysis (22, vol. 55, no. 1, 105-127) quarter. the new year of 2021 started with an index of 175.1 in the first quarter, compared to 138.6 and 151.2 for the same quarter of 2019 and 2020, respectively. as a whole, the sector has not been affected by the pandemic; even it can be said that it has been promoted by the fact that the increase in remote forms of work have lead to an increase in the demand for it products. this is also confirmed by the dynamics of employment in the sector, in which the trend of growth of the persons employed in 2019 continued in 2020, except for the second quarter, in which there was a slight decline by about a thousand people. the year of 2021 started strongly, with 105 917 persons employed in the first quarter, compared to 98 821 and 90343 for the same quarter of 2020 and 2019, respectively. vulnerability assessment of non-financial sectors in bulgaria under pandemic conditions in general, it can be argued that from the beginning of 2021 economic recovery is under way, but uncertainty remains high. from chapter 1 in the present study and on the basis of fig. 3 (social distancing), we concluded that social distancing should be maintained in the coming months in order to limit the spread of constantly mutating covid-19. the unique thing in this situation is that the human factor vulnerability is at the basis of economic difficulties. sectors in the economy, where living workforce is dominant and direct contact between a serving party and a served party is required, are more affected (national and international tourism, transport, healthcare, culture, sports). other sectors manage to readjust quickly and do not experience significant problems (part of the services, administration, education). some activities and productions will benefit (pharmacy, it sector, trade in goods of first necessity, production of protective clothing and protective equipment) (yotsov, zlatinov & others, 2020). for the management of the economy, it is important not only to assess the most affected sectors in bulgaria, but also to identify the most vulnerable sectors to lockdowns (restrictions related to social distancing) in general. if the support policies are not precisely targeted by sectors, we take the risk of creating inflation instead of supporting those that are in real need. to this end, we have developed a compilation method for assessing sectors. in it, each sector is assessed according to 8 criteria: • decline in production indices – number of quarters compared to the previous one, starting from the first quarter of 2020 and reaching to the first quarter of 2021. this indicator will show us how many quarters of the crisis period the companies in the sector have been vulnerable to closure. • decline in employment – number of quarters compared to the previous one, from the first quarter of 2020 to the first quarter of 2021 inclusive. this indicator will show us how many quarters of the crisis period the persons employed in the sector have been vulnerable to closure. • sectoral vulnerability to automation. we explained above (fig. 6) that the shock of covid19 accelerates the reduction of employment in sectors and occupations that are more vulnerable to automation. these sectors will, therefore, need stronger employment protection during the pandemic in order to limit the employment rate. • percentage of self-employed in the sectors. we explained above that the greater vulnerability of some sectors can be characterized by the percentage of self-employed in the sector. self-employed in an economy are very often not insured at all or are insured at a minimum income and, accordingly, cannot benefit from business and employment preservation programs. • lockdown index. • home-office index. • teamwork. stoyan shalamanov 121 • customer-facing. the last four indices will be discussed in the text below. we have already discussed in chapter 1 that, in order to respond to the spread of the covid19 pandemic, governments are implementing lockdown policies aimed at creating physical distance between people. these policies largely affect the workplace. many activities are closed or their capacity is seriously limited during the peaks of the pandemic. some jobs are more affected than others, in part because, by their nature, they cannot avoid physical closeness between people in the work process. in addition, some major activities are excluded from lockdown policy due to their crucial importance, such as healthcare, social care and public administration, and they remain unrestricted. there is a strong heterogeneity in the lockdown of different industries. these differences are captured in an indicator called lockdown index. according to a study conducted in switzerland, large industries, such as the hotel business, construction and education, are most affected by the lockdown. more than 56% of their workers and employees are limited by the lockdowns. in contrast, agriculture, financial services, it sector and communications are relatively unaffected, with less than 23% of the workers having to work close to other people (faber & others, 2020). the home-office index (work-from-home index) accounts for the proportion of workers and employees in a profession who can work from home. the calculation is based on a number of characteristics from the area of work, through the socio-demographic characteristics and whether a profession requires daily outdoor work, use of vehicles, mechanical devices or equipment. if so, such professions are classified as unsuitable for home office (work from home). the resulting indicator is defined as a home-office index, varying between 0 and 1, with 1 meaning that all workers in this group can work from home (dingel & neiman, 2020). in social distancing interventions, the businesses that rely heavily on face-to-face communication where everyone is in direct contact with each other are particularly vulnerable. data on the dependence of the american business on human interaction show that before the advent of the pandemic 43 million employees worked in professions that relied heavily on faceto-face communication or required physical closeness. many of these employees lost their jobs in the conditions of covid-19. indices measuring how intense the communication is in a job can help quantify the economic costs of social distancing. such indices are teamwork for measuring internal communication with colleagues and customer-facing for measuring external communication with customers. in order to be accounted for in the indices, face-to-face communication is required to occur at least several times a week, because face-to-face meetings can often be replaced by remote communication. the professions that work intensively in a team or with customers, where both e-mails and other electronic forms of communication are rarer, are included. (koren & pető, 2020). the teamwork index takes into account: • face-to-face discussions at least several times a week and predominantly before the use of emails and other remote forms. • teamwork. • provision of consultations and advice to colleagues. • coordinating the work and activity of employees. • management, guidance and motivation of subordinates. • team development and building. the customer-facing index takes into account: • face-to-face discussions at least several times a week and predominantly before the use of emails and other remote forms. 122 economic analysis (22, vol. 55, no. 1, 105-127) • working with external customers. • performing for or working directly with the public. • helping and servicing customers (patients). • providing consultations and advice to customers. • establishing and maintaining interpersonal relations. usually, the retail and accommodation and catering services, the arts, entertainment and recreation have the highest share of employees with intensive communication, exceeding 35%. the it, transport, scientific and technical services, as well as the agricultural industry are less dependent on face-to-face communication (koren & pető, 2020). table 1 shows the results of the assessment of the main non-financial sectors according to the above 8 criteria. the it and telecommunications sector is the least vulnerable sector by the pandemic, with the least (totally four) quarters of decline in production and employment. the sector is not assessed with a risk of automation and has the lowest percentage of self-employed. relatively low is also the lockdown index, which in turn means a low sensitivity to the permanent restrictions on economic life imposed by governments. finally, the sector is characterized by the highest home-office index, which means that it is highly adaptable to the conditions of social isolation. table 1. sectoral vulnerability assessment sources: *1faber & others. 2020; *2 dingel & neiman, 2020; *3 world economic outlook, 2021; *4koren & pető, 2020; infostat, 2021, and own calculations. the hotel and restaurant business sector is at the other pole. in the sector, there are totally six quarters of decline in production and employment. there is no risk of automation, but there is a relatively high percentage of self-employed. this sector is traditionally characterized by the lowest average income in the economy, which a consequence of the large-scale formal conclusion of part-time and minimum wage employment contracts with workers. in this regard, the sector is particularly vulnerable. it is also rated with the highest lockdown index and the lowest homeoffice index. 8% of those working in the sector are exposed to intensive communication with se ct or s\ in d ic at or s d ec li n e in p ro d u ct io n , n u m be r of q u ar te rs d ec li n e in e m p lo ym en t, n u m be r of q u ar te rs v u ln er ab il it y to au to m at io n *3 se lf -e m p lo ye d ( % ) lo ck d ow n in d ex *1 h om eof fi ce in d ex *2 t ea m w or k (% ) *4 cu st om er – fa ci n g (% ) *4 industry 3 4 1 7,37 0,27-0,47 0,17-0,45 7 5 trade 3 4 1 22,19 0,08-0,37 0,24-0,60 08-13 12-66 construction 4 2 1 19,73 0,56 0,16 transport 3 2 0 22,19 0,36 0,40 8 8 services 2 3 0 29,89 0,35-0,53 0,18-0,46 5-12 10-30 hotel and restaurant business 4 2 0 22,19 0,60 0,11 8 50 it and telecommunic. 3 1 0 5,92 0,23 0,77 stoyan shalamanov 123 colleagues and as much as 50% to intensive communication with customers, the latter being one of the highest values among the industries. the services and transport sectors have similar vulnerability characteristics a moderate total number of quarters of decline in production and employment – five quarters each, not a small percentage of self-employed – between 20-30%, average lockdown index and home-office index – between 0.35 and 0.53 and between 0.18 and 0.40, respectively. the teamwork index and customer-facing index also have average values – between 5 and 12% and between 8 and 30%, respectively. for the services sector, these variations in the indicators are accounted for due to the heterogeneity of the sector. in general, both sectors can be classified as moderately vulnerable. this assessment is also valid for the trade sector. what is special about it is that there are relatively more quarters of decline in production and employment as many as seven. there is also a risk of automation and a relatively high percentage of self-employed 22.19. on the other hand, some types of trade are characterized by a low lockdown index (0.08) and a high homeoffice index (0.60). online trading is characterized by such signs, which has intensified especially since the beginning of the pandemic. there are also serious differences between wholesale and retail. for example, in wholesale the intensive communication with customers is rated at 12%, while in retail it is as high as 66%. the industry and construction sectors each also have seven quarters of decline in production and employment. the sectors are also characterized by a risk of automation. in the construction sector, there is a large percentage of self-employed (19.73), a high lockdown index (0.56) and a very poor opportunity to work from home. it can be concluded that all data point to a high vulnerability of the sector to the pandemic-related restrictions, but such vulnerability does not seem to be socially significant; it is probably compensated to some extent by the strong rise in prices and demand for housing since the beginning of 2021, as well as by the traditional workforce deficit in the sector. in the industry sector, the percentage of self-employed is the lowest after that in the it and telecommunications sector only 7.37%. heterogeneity in the sector determines the variations in the lockdown index (0.27-0.47) and home-office index (0.17-0.45), as within these limits no conclusion of particularly high vulnerability can be drawn. the indicators for the intensity of communication in a team and with customers are also not very high 7% and 5%, respectively. conclusion the analysis of the development of the pandemic in bulgaria from a medical point of view leads to the conclusion that the health factor for the crisis will not be overcome soon. the mutations of the virus and the fluctuating rates of vaccination in bulgaria are likely to put the country in need of periodic lockdowns (restrictions) of some economic sectors for at least a few more years. a typical situation for pandemics is for governments and society as a whole to face the dilemma of choosing between the health and well-being of the population. in order to mitigate the effects of restrictions on social contacts, mobility and part of the economic activity, the government of bulgaria has introduced fiscal stimulus measures amounting to about 6% of the gross domestic product. these measures mitigate the shock effect of the pandemic by limiting the loss of jobs, easing the financial conditions for the most affected companies and households, and strengthening healthcare. the measure 60/40 for employment support is specifically targeted at the effects of the crisis. the state pays 60% of the costs for salaries and social security of workers in enterprises with reduced activity. according to data of the national social security institute (nssi), from the beginning of the pandemic until august 2020 more than 170 thousand, and by january 2021 more than 265 thousand employees to nearly 12,000 employers, were included in it. most of the supported enterprises are in the manufacturing and hotels and restaurants business sectors. 124 economic analysis (22, vol. 55, no. 1, 105-127) it is particularly important to identify the most vulnerable to the pandemic sectors to provide more targeted and regular support, commensurate with the available relief budgets and antiinflationary policies. based on the net government debt for 2020 (difference between gross debt and fiscal reserve), the cost of the crisis for public finance can be assessed. from the beginning to the end of 2020, the net debt increased by over bgn 5.5 billion (chobanov & others, 2020). all these funds would be in vain, if they lead to an acceleration of the inflation (for now forecasts for 2021 are for an inflation of over 3%), without supporting the most affected and vulnerable sectors of the economy. in the present study, we have found that the most vulnerable sector in bulgaria is the hotel and restaurant business sector. the negative consequences in it are expected to persist in long term. this sector is traditionally characterized by a relatively high share of selfemployment and seasonality, as well the lowest average income in the economy, which is a consequence of the large-scale grey sector practices such as: formal conclusion of part-time and minimum wage employment contracts with workers. for these reasons, government support in this sector is difficult. the fact that under the 60/40 program the state pays 60% of the costs for salaries and social security of employees in enterprises with reduced activity will not help much in the hotel and restaurant business sector. at the same time, this sector is fundamental for employment and sustainable economic growth of bulgaria. in these hard times, it needs specifically targeted strengthening. air transport remains directly related to tourism and seriously affected. the possible range of specifically designed government supported measures for strengthening of sectors hotel and restaurant business and air transport can be explored in a further study. it is most certain that they can only be saved by gradually easing the international travel restrictions. the right step in this direction are vaccination passports (certificates), but in order to validate their use and for people to start returning to the pre-pandemic levels of mobility, more decisive action will be needed at european union level. it is necessary to adopt the same (unified) requirements for issuing certificates and rules for mobility between countries. in this way, certificate holders will be able to return to a more normal life and mobility. acknowledgements this paper is a result of a research project under the code 80-10-107/25.03.2021 (the bulgarian economy in the first year of the covid-19 pandemic – sectoral analyses and macroeconomic impact) financed by the sofia university „st. kliment ohridski“. references abbas, j., and others. 2021. exploring the impact of covid-19 on tourism: transformational potential and implications for a sustainable recovery of the travel and leisure industry, current research in behavioral sciences, 2. altig, d., and others. 2020. economic uncertainty before and during the covid-19 pandemic, journal of public economics, 191. bulletin for macroeconomic development, 2021, bulgarian development bank, https://bbr.bg/en/ (accessed september 10, 2021). chobanov, p., and others. 2020. the economics of 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https://www.worldbank.org/bg/news/press-release/2021/06/08/world-bank-global-economic-prospects-2021 https://www.worldbank.org/bg/news/press-release/2021/06/08/world-bank-global-economic-prospects-2021 https://www.nsi.bg/en https://doi.org/10.1371/journal.pone.0239113 http://www.ime.bg/ http://ikm.mk/ojs/index.php/kij/article/view/5488 https://www.oecd-ilibrary.org/economics/oecd-economic-surveys-bulgaria-2021_1fe2940d-en https://www.oecd-ilibrary.org/economics/oecd-economic-surveys-bulgaria-2021_1fe2940d-en https://coronavirus.bg/bg/ https://www.imf.org/en/home https://www.worldometers.info/coronavirus/ 126 economic analysis (22, vol. 55, no. 1, 105-127) yotsov, v., zlatinov, d., and others. 2020. economic development and policies in bulgaria: assessments and expectations, annual report 2020, economic research institute at bas, sofia. zlatinov, d., atanasov il. 2021. “absolute and conditional convergence: a story about convergence clubs and divergence in the eu”, economic studies journal 2, issn :0205-3292. stoyan shalamanov 127 appendix table. dynamics of employment in non-financial sectors and stringency index for bulgaria quarters q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 industry 557697 553860 535856 535485 534606 544255 construction 128096 123772 125336 125272 124985 128443 trade 396317 389231 386459 385707 387187 383564 services 520018 509842 506954 509850 494949 510436 transport 138911 140073 136979 137076 136108 140387 hotel and restaurant business 102684 81864 88891 89664 76904 80355 it and telecommunications 93480 98821 97386 99031 99765 105917 stringency index 0 18,98 57,69 37,91 46,78 54,34 article history: received: november 2, 2021 revised: july 7, 2022 accepted: july 11, 2022 crowdfunding response to the covid-19 pandemic: evidence from kickstarter isidora ljumović10f* | aida hanić1 | slavica stevanović1 introduction literature review methods variables results discussion conclusion references state and perspectives of agricultural land acquisitions ana budak11f* introduction data and methodology data methodology the general trends and causes of agricultural land acquisitions the crucial causes of agricultural land acquisitions and their relation to the growing world population the dynamics of agricultural land acquisitions conclusion references just-in-time strategy implementation challenges and the organizational structure dimensions jelena erić nielsen1 | vesna stojanović aleksić1 | ana todorović spasenić16f* introduction literature review challenges of jit strategy implementation organizational structure as a factor of the successful implementation of the jit strategy research design and results methodology and sample discussion of research results theoretical/practical implications and further directions of research conclusion references effects of consumer ethnocentrism, cosmopolitanism and cultural intelligence on the acceptance of foreign brands stefan zdravković17f* | dragana gašević2 introduction literature review research methodology research results conclusion references stock markets integration between western europe and central and south-eastern europe: latest trends jelena minović18f* | irena janković2 | vlado kovačević3 introduction literature review methodology and data data multivariate garch model: the bekk model results and discussion acknowledgements references appendix an evaluation of the short-term skills trainings targeting the roma ethnic minority lara lebedinski110f* introduction literature review sample overview and descriptive statistics sample overview descriptive statistics impact analysis assessment of matching quality impact estimates conclusion acknowledgements references forecast of belex15 and belexline movement using arima model aleksandra živković121f* introduction literature review methodology belex15 and belexline – empirical data and forecast of index values by using arima model discussion of results conclusion references economic activity and employment in the non-financial sector of bulgaria under conditions of covid-19 crisis. sectoral vulnerability assessment stoyan shalamanov122f* introduction general health consequences in the world and in bulgaria for 2020 and early 2021. general economic consequences of the pandemic for the world and bulgaria dynamics in the non-financial sectors of different countries changes in economic activity and employment in bulgaria by main economic sectors. vulnerability assessment of non-financial sectors in bulgaria under pandemic conditions conclusion acknowledgements references ea_2019_2 doi: 10.28934/ea.19.52.2.pp43-63 original scientific paper the offer of financial derivatives in the banking sector of the republic of serbia mina kobilarev1* | branko živanović2 1 glasgow caledonian university 2 union university belgrade, belgrade banking academy faculty for banking, insurance and finance, department for economic and finance, belgrade, serbia abstract the paper examines the results of the research conducted in the serbian banking sector considered the only counterparty to companies in the derivative otc market given that serbia’s financial system is bank-based. the primary objective is to assess the total level of derivative instruments demand in serbia and types of derivatives offered by banks. besides, we also aim to determine the reasons that limit the most the development of the domestic derivatives market and that impact bank activities aimed at attracting derivative business and its development phases. in addition, we explored the expertise of banking sector employees in the financial derivatives field, most often in the treasury department. we endeavoured to ascertain the number of staff working in departments in charge of derivatives trading, their professional skills and expertise, qualifications, training and certificates. we have analysed the reasons that most severely restrict the development of the domestic derivatives market and possibilities and limitations of introducing the derivatives market as an unregulated segment on the belgrade stock exchange. this paper also gives a comparative overview of the use of derivatives from the banks’ viewpoint between the banking sectors in serbia and bosnia and herzegovina (bih) so as to determine the level of derivative instruments demand, types of derivatives offered by the banking sector and possibilities and limitations of introducing the derivatives market as a market segment on stock exchanges in serbia and bosnia and herzegovina. key words: risk management, banking sector, financial derivatives, corporate finance, hedging jel classification: g21, g32 introduction serbia is an economy in transition which records elevated instability as to its exchange rate, inflation and other main macroeconomic indicators. in addition, financial derivatives as hedging instruments are not frequently used in the country (djenić et al. 2012). the main precondition for the use of financial derivatives are developed financial markets. the degree of development is seen in the level of financial infrastructure, the range of financial instruments and human know-how. in view of the poor profitability of the economy, inappropriate savings habits, soaring interest rates, dented confidence in the financial system, unclear ownership rules, no expert human resources and high inflation, the degree of development of serbia’s stock exchange is inappropriate. grubišić, kamenković and duran (2013) analysed the weakness of * corresponding author, e-mail: minakobilarev@gmail.com 44 economic analysis (2019, vol. 52, no. 2, 43-63) the financial market of serbia, when an attempt was made to apply the concept of a contemporary portfolio theory to the serbian capital market, but there were a number of restrictions. the market of financial derivatives in serbia is in the initial phases of development. the concept of a stock exchange emerged in serbia as early as 1830, but the belgrade stock exchange (bse) was established in 1894. shares, bonds, commodities and foreign currency were traded on this combined stock exchange. it was suspended in 1941, and officially wound down in 1953. it was set up again in december 1989 as the yugoslav capital market – belgrade. since 1992, it has been working as the belgrade stock exchange. it trades mainly in short-term securities. the initiative to establish the stock exchange came from government authorities which wanted to have as an institution with the main role in the transition process. still, the former reputation of the bse was not renewed. the first financial derivative is about to be admitted to the organised market (marinković and skakavac, 2010). the currency forward agreement was the first derivative traded in modern serbia (djenić et al., 2012). a forward is in fact an otc contract. the first cash market that carried a forward component was the foreign exchange market. currency derivatives, e.g. currency forwards in serbia are carried out in the financial market via banks. thus, serbia’s fx market is the only market where financial derivatives are truly traded. for instance, as suggested by shiu, moles and shin (2010), in the case of taiwan, interest rate and foreign exchange derivatives were launched only in 1998 on the taiwan futures exchange. the serbian legal framework allowing the use of financial derivatives was established in 2006 pursuant to the foreign exchange law (the fx law), and the law on securities market and other financial instruments, which envisaged for the first time the concept of financial derivatives. by-laws were adopted in mid-2007, though the practice began only in 2009–2010. even then, these instruments were used highly infrequently. users were usually large multinationals companies already working with these instruments. smes were either not interested or did not have expertise concerning currency hedging. they were hesitant mainly due to the lack of knowledge. generally, all financial derivatives are carried out through banks given that serbia’s financial sector is bank-based – the share of banks in its total assets equals 92.6 per cent. on 1 december 2011, the nbs adopted the decision on performance on financial derivative transactions (rs official gazette, no. 85/2011), which superseded the decision on the terms of performing financial derivative transactions by banks, residents and nonresidents (rs official gazette, no. 80/2007). this decision prescribes the conditions under which and the manner in which banks, residents and non-residents may make payments, collections and transfer in respect of trading in financial derivatives. this decision also defines netting and reporting obligations on transactions in regard to financial derivatives trading. the valid legal framework defines only derivative products. secondary legislation governing this field has still not been adopted. such steps must be taken so that the forward market can be established, and in order to define the limits of what is permitted. also, the above decisions of the national bank enable residents to trade in derivative products on foreign stock exchanges and have contractual relations with foreign clearing houses, but such trading in the territory of serbia is not stipulated. in april 2009 the national bank of serbia (nbs) introduced fx swaps as part of a special package of facilities for supporting the country’s financial stability. the main goal was to improve the liquidity of national commercial banks (both in euros and dinars, the local currency) through swap auctions or as a bilateral agreement between commercial bank and the nbs according to živanović b. and a jolović (2012). barjaktarović m. et al., (2017) concluded that commercial banks and monetary regulators should continue in the direction of creating a good climate for further development of financial derivatives market. potential corporate users of the derivatives, on the other hand, are to recognize their interest in these instruments and expend their knowledge of them. emerging economies, including serbia, introduced financial derivatives as entirely new instruments, with many companies still not recognising the importance of their use and methods mina kobilarev, branko živanović 45 of financial risk exposure management. this paper analyses the development of financial derivatives markets in serbia, with a focus on the use of financial derivatives for risk management objectives of non-financial firms from banks’ viewpoint given that the serbian banking sector is considered the only counterparty to companies in the derivative otc market, bearing in mind the bank-based position of serbia’s financial system. in order to achieve the research objectives, authors gathered data on the derivatives market structure, usage and types of derivative instrument traded, with a focus on commercial banks. given the above, in order to conduct relevant analyses, two scientific hypothesis have been formulated, i.e. h1: types of the derivatives offer by the banking sector is sufficient in regard to the derivatives usage by non-financial companies in serbia. h2: knowledge about and focus on the effect of derivatives use. according to literature, limited knowledge affects companies’ use of derivatives (bodnar et al. 1998; børsum and ødegaard 2005). it is suggested that companies’ focus on derivatives, their importance and the extent of use. this paper explores whether knowledge affects the derivative usage from banks’ perspective given that banks are considered the only counterparty to companies in the derivative otc market bearing in mind the bank-centric nature of serbia’s financial system, as already mentioned. literature review travica (2010) explored the use of currency derivatives, namely forward derivatives as a possible solution for currency-induced credit risk. she also identified non-performing loans on the basis of foreign exchange rate regression model, using the sample of 123 serbian nonfinancial companies. she investigated the most important factors which affect hedging and the relationship between non-performing loans and the exchange rate. she claims that managers perceive currency-induced credit risk, but are not aware of the potential of forwards as hedging instruments. she ascertained that variables which affect the currency-induced credit risk (nonperforming loans npls) are statistically significant at a pretty high confidence level and are economically important for the prediction of further trends in non-performing loans. besides, research has shown that managers are not familiar with the protection offered by forwards in case of a volatile exchange rate. the research found several key conclusions and observations: • there is currency-induced credit risk and forwards as hedging instruments are not recognised as instruments which hedge against foreign exchange risk. as a result, it is not used to the degree possible because of the lack of understanding of such financial instrument and its benefits. • besides, the lack of corporate management in domestic companies is a serious gap. it enables managers to pursue unhedging policy and thus avoid responsibility for foreign exchange losses. there is also the fear of job loss because foreign exchange losses arising from hedging may lead to a change in financial managers. the research also showed that most of the management failed to employ forwards as hedging instruments for repaying of foreign currency-denominated loans, while the majority of companies carry that kind of liability in their balance sheets. managers in the sample observed do not frequently involve in use of derivatives (fx forwards) because of possible regret due to loss, lack of understanding of determinants of foreign exchange rate and lack of corporate governance and fear. • the research also identified the new cause of negligible hedging presence in the serbian market, this being the interest rate differential. forward thus becomes too expensive. namely, if the number of companies (forward users) increases, banks would be able to 46 economic analysis (2019, vol. 52, no. 2, 43-63) offer better pricing of forward which may increase hedging. also, if the dinarisation takes hold, there would be less need for hedging loans. still, successful de-euroisation may last many years. • thus, the relationship between npls and the exchange rate should be closely followed. the research shows the basic model and also explains npls and foreign exchange relationship. this confirmed the second hypothesis that “there was strong correlation between non-performing loans and foreign exchange rate on serbian market in the period december, 2008 – august 2011” • also, hedging a loan at the time of dinar’s depreciation could save money to the company’s owners and ensure a more predictable business environment. besides, a company would have the same level of predictability provided the dinar appreciates, but in that case foreign currency loss would be recorded. in either way, this would affect the company’s profitability and its repayment capacity, which corresponds to the third hypothesis. • additionally, this research opened new avenues for future research. one point would be to establish a model so as to hedge companies against foreign exchange risk. furthermore, future research should explore the difference between spot and forward rates as an important factor against hedging, and should encompass a larger number of observations of npls, available over a longer period. travica (2010) finally argued that the recommendation for all market participants such as the serbian banking association, the national bank of serbia and commercial banks is to act jointly in promoting hedging instruments and in educating stakeholders about benefits and cost of hedging instruments. the degree of development of the serbian forward market in serbia was explored by djenic, popovic-avric and bajraktarović (2012), who also analysed the presence and use of forward contracts. despite volatility, this hedging instrument is not frequently used. the research began from the legal framework analysis regarding forward contracts, including the analysis of the degree of forward market development. the aim was to determine why local companies still do not understand their benefits deriving from this instrument in their everyday operations. another aim was to assess the use of forward contracts in serbia, including the main economic and legal issues pertaining to their successful implementation. the findings show that even though currency forward contracts do hedge against fx risk, they do not increase with greater exchange rate volatility. the principal reason is the fact that forward contracts are implemented by big companies, i.e. companies which have high risk management awareness. such companies implement forward contracts constantly, regardless of trends in the exchange rate. they implement these contracts in accordance with their foreign currency ins and outs (i.e. liabilities). as a result, for bigger companies, the most important determinant for the use of financial derivatives is the business cycle. other companies still complain about foreign exchange flexibility and expect from national bank of serbia to eliminate the risk of foreign exchange rate changes, instead to hedge it through forward contracts. thus, greater exchange rate volatility is not an important determinant of demand for forward contracts for the majority of serbian companies. the unclear regulatory framework and the ensuing restrictions only to hedging transactions because of limited legal regulations, including inadequately developed companies` awareness of the necessity to hedge against risks, are the main reasons for the lack of use of forward contracts and other financial derivatives in serbia. other reasons include the neglecting of exchange rate volatility, as well as ignoring risks and expecting from the government and the central bank to stabilise the exchange rate. namely, the government and central bank are responsible for ensuring a macroeconomic environment that will create stable conditions for doing business and, therefore, they are responsible for systemic risk factors, including currency risk. mina kobilarev, branko živanović 47 nonetheless, according to the current monetary policy, the main objective of the national bank of serbia is price stability (low and predictable inflation), and not exchange rate targeting. thus, it unjustified for local companies to rely on the central bank and the state, in regard to foreign exchange rate and risk elimination. besides, the poorly developed entrepreneurial spirit and no understanding of business risks, including improper education, are only some of the reasons why local companies do not use forwards. in addition, there is no disputing that many entrepreneurs already hedge – not by sophisticated instruments, but only by building their selling prices at the exchange rate. a probable reason is also reflected in the impossibility to agree forward contracts with long maturities which would serve as hedging of long-term liabilities denominated in foreign currency in a company’s balance sheet liabilities. in conclusion, the paper presents many upsides of financial derivatives as modern financial instruments. but, given the potential risks of financial derivatives because of undefined legal norms and at the time of the world economic crisis, they offer scope for abuse. future research will analyse the use of other financial derivatives in the serbian market. marinković and skakavac (2010) analysed the evolution of derivatives trading in the serbian financial market and its prospects. the first part of their paper includes some of their analytical observations of the current situation in the domestic economy, as well as the questionnairebased survey, conducted in the banking industry. they concluded that most banks try to answer to the increasing need for derivatives. banks with the highest market shares recently began to offer less sophisticated risk management products to clients. those were, at the first place, currency forward agreements. as the matter of fact, the core of the banking industry aimed to respond to the increasing need for derivatives. some banks already offered risk management products, primarily currency forwards and swaps. besides, there is a forecast of future trends, prepared based on observed facts. the authors identified the factors constraining the development of derivatives markets. namely, banks considered market leaders did not show a clear interest. the competition from other financial institutions which break the monopoly of customary intermediaries (banks) is rather fruitless. the domestic financial industry is underpinned by financial conglomerates which leave little space for independent financial service providers. although some banks offer currency-risk related products, this takes place only on an ad hoc basis, and there are no efforts to make twosided continuous trade at a fair price, without discriminatory terms and conditions. those seriously affected by currency and interest rate risk (households and corporates) are not knowledgeable about the derivatives business. the third main stakeholder is the local financial exchange. there is no initiative in the financial exchange field to diversify business by offering a new range of products, which can be partly put down to the bad timing. cash trading also loses its momentum. therefore, it will probably take a lot of time for the first derivatives to be traded on the exchange. the paper by kozarević, kesetović, kokorović and čivić (2012) analyses the derivatives use in financial risk management by companies in bosnia and herzegovina (bih) on two samples: banks and companies. in general and based on information provided by banks, financial derivative users and export/import companies, the authors concluded that the main reasons for the weak use of derivative instruments are the lack of information about procedures of the derivatives usage and the lack of knowledge about possible benefits of these instruments when it comes to risk management. this is true not only for company employees, but for bank employees as well. moreover, a significant restriction to a greater derivatives usage is the small number of business operations implemented by bih companies in the foreign market, and no major trends on the bih currency market given the central bank’s currency board (i.e. fixed exchange rate of the bosnian convertible mark against the euro and, in turn, a low degree of currency risk that companies face, excluding bam/usd). risk factors against which bih 48 economic analysis (2019, vol. 52, no. 2, 43-63) companies hedge by means of financial derivatives are revenue and cash flow volatility, and the safeguarding of balance sheet positions. the reasons why bih companies do not use derivatives in order to hedge relate to the company size (in terms of annual turnover), and the intention to restrict cash flow or revenue volatility or to safeguard financial ratios. bih companies decide against derivatives is the lack of knowledge and higher costs of derivatives portfolio maintenance; costs associated with financial risks are not a likely reason. however, the derivative products offer in bih is substantial, and bih companies plan to introduce additional products such as interest rate swaps. besides, a lot of companies decide to use current and new financial derivatives instruments in their future business. however, if they wish to improve their financial risk management practices, given higher costs (arising mainly from banks’ provisions and targeted profit rates) and irrespective of their positive experience, bih companies should apply exchange-traded derivatives of developed countries rather than derivatives on the local otc market. conversely, f. sajjad, u. noreen and zaman k. (2013) analysed risk concerning the financial services sector (fss) and the adequacy of risk management derivatives in pakistan. with the aim of developing the derivatives market in pakistan, the financial derivatives business regulations (fdbr) have been designed in the implementation of power by the state bank of pakistan pursuant to the banking companies ordinance 1962 and foreign exchange regulations act 1947, to allow, regulate and supervise financial institutions that conclude derivative transactions. relying on literature and sbp/fdbr publications, the study arrives at the conclusion that derivatives products are appropriate for managing fss risk exposures. the development of the pakistani derivatives market is needed to improve liquidity and employ the necessary capital for economic growth. f. sajjad, u. noreen and zaman k. (2013) gave the following recommendations to encourage vibrant growth of the derivatives market in pakistan: • there are several causes of concern concerning exchange-traded equity derivatives in pakistan. namely, there are major gaps in the scope of actively traded derivative products. when it comes to equity derivatives, merely a single stock of deliverable futures is transacted, making up close to 100% of the overall volume of derivatives traded on the stock exchange. depleted market liquidity may be ascribed to poor derivatives trading. the key challenge to sbp is to facilitate proper trading and prudent supervision of derivatives transactions. therefore, sbp should regulate and conduct monitoring of participants in the pakistani derivatives market so that market guidelines are complied with. • it is advisable that the exchange should initiate new programmes for the education of dealers, traders, brokers and market staff. competent institutions must dedicate more resources to enhance operational processes and improve the derivatives-trading technology. • reforms aimed at market development will step up the growth of these markets. public institutions such as the old age benefit fund and national investment trust should be supported to take part in the operational derivatives market. this will, in turn, enhance liquidity volumes. metodology data about serbian commercial banks were collected from two main sources: the survey and interview. we relied on questionnaire data more than on the interview given that the survey data were supported by interviews results. mina kobilarev, branko živanović 49 questionnaire in order to assess the overall level of derivative instruments demand in serbia and types of derivatives offered by the banking sector, kobilarev (2014) conducted a research amongst commercial banks operating in serbia in early june 2013. for this purpose, a particular questionnaire was designed and delivered to all banks in serbia that offer hedging instruments. the sample included 17 commercial banks, according to the data from the national bank of serbia (nbs). the methodological framework of the questionnaire was primarily based on elaborative and simultaneous development of research questions, theory and analysis, which aim to explore the types of derivatives offered in the serbian banking sector in order to hedge fx, ir and pr exposures. another aim was to assess the level of usage by serbian companies as the banking counterparty, and to provide proposals and outline the limitations for the development of the derivatives markets in serbia. the questionnaire was structured into six major parts. research questions were addressed to explore: 1. the first section aims to evaluate the source of information that the banking sector uses in regard to the financial derivatives use. 2. the second section aims to assess the overall level of the financial derivatives demand in serbia, to explore the types of derivatives offered by the banking sector, and to assess their importance. 3. the third section analyses banking activities taken to attract derivative business. it also analyses whether banks intend to establish a special department for financial derivatives management in the near future, to introduce or have already introduced new derivatives lines. 4. the fourth section steams from the third section but with more emphasis on bank staff in the financial derivatives field, usually in the treasury department – the intention is to understand how many staff were employed in the department in charge of derivatives trading, including their professional skills and expertise, qualifications gained, adequate training and certificates obtained. 5. the fourth section explores the reasons that most severely constrain the development of the domestic derivatives market and possibilities and limitations of introducing the derivatives market as an organised segment on the belgrade stock exchange. 6. the last section aims to collect the company profile details, the field of industry, when the company was founded, the number of employees, respondents’ personal data, including their gender, age group, years of professional experience, profession, academic and professional qualifications, position and the department where they work. judging by the data collected from official websites of the nbs and association of serbian banks and questionnaire, out of 31 commercial banks, 17 of them offer derivatives products. the remaining 14 banks do not offer derivative instruments. thus, these 14 banks were not included in further research. out of 17 banks with derivative instruments, 11 banks returned the questionnaire, which was 65 per cent of all responses. additionally, a part of the questionnaire concerned those banks that do not offer derivatives instruments at all so as to determine if they tend to introduce them in a near future. three banks returned the questionnaire, which resulted in the total response rate of 82 per cent – this is considered an adequate response rate compared to other studies (e.g. the response rate in the 2012 bih survey called “the usage of derivatives in financial risk management by companies in bosnia and herzegovina, from the banks perspective”, as reported in kozarević et al. (2012) was 80 per cent). the questionnaire consisted of 28 questions. out of 11 respondent banks that offer derivative products, only one is state-owned, while ten are foreign-owned. therefore, it may be concluded that foreign-owned banks will probably offer derivatives products. 50 economic analysis (2019, vol. 52, no. 2, 43-63) a similar response rate was observed in the neighbouring country. according to kozarević, kesetović, kokorović and čivić (2012), in bih out of 29 commercial banks, ten of them offer derivatives. the remaining 19 do not offer derivative instruments. therefore, these 19 banks were not taken out from further research. out of ten banks offering derivative instruments, eight banks returned the questionnaire, which was 80 per cent of all responses. the primary data in the serbian banking sector were collected through the questionnaire – a semi-structured questionnaire was delivered to the bank’s deputy executive director or if there is no such position, to the deputy head or head of sales of the banks’ treasury departments. it was implicitly assumed that these persons would most probably have the relevant information. the methodological framework of the questionnaire implied primarily the elaborative and concurrent development of research questions, theory and analysis, with a view to analysing the types of derivatives offered in the serbian banking sector for the purpose of hedging fx, ir and pr exposures. another objective was to assess the degree of usage by serbian companies as the banking counterparty, and to give proposals and define the constraints for the development of the derivatives markets in serbia. in order to evaluate the degree of derivative instruments demand in serbia and types of derivatives offered by the banking sector we used a descriptive statistical analysis excel. the main limitation of the present study lies in the fact that only one research has been carried out in the region. it concerns bosnia and herzegovina, which is why we compared our results with this country only. in this context, the present article contains the first empirical evidence of the derivatives offer in the serbian banking sector, which is particularly significant for the corporate sector given that it contains all necessary information concerning this field. the survey also contains considerable evidence enabling international comparison, which is certainly an advantage. the study can also be carried out in other see countries. the findings presented in this article may be used as the starting point for further research of the derivatives use in financial risk management from the perspective of banks. interviews for this concrete research, the semi-structured interview was applied as the suitable method to elicit subjective answers from respondents. therefore, semi-structured interviews were carried out with serbian directors of treasury departments of the banking sector. according to bernard (1998), a semi-structured interview is more suitable as the interviewer oversees the process of obtaining information from the interviewee but is free to explore new ideas as they appear. besides, primary data in the banking sector were gathered not only through the semistructured questionnaire, but also through the semi-structured interview with serbian experts from treasury departments. as soon as the directors or heads of sales from treasury departments filled out the questionnaire, they were invited to an interview. the response rate was high – 82 per cent, the same rate as in the questionnaire; 82 per cent of contacted treasury directors spoke of their willingness to participate. we obtained information from 14 treasury directors and managers from the serbian banking sector. the main aim of the interview was to supplement and reinforce the qualitative semistructured questionnaire earlier conducted among the banking sector. the interview contains several main questions concerning the areas covered by the research. the interview contains 38 open-ended and probing questions. seven semi-structured interviews were carried out with banks’ treasures. each interview spanned for around 40–60 minutes. the interviews were recorded in order to ensure accurate information for the research and to ensure a careful analysis of respondents’ answers. most respondents agreed to audio recording. we took notes in the case of those interviewees who refused the recording. mina kobilarev, branko živanović 51 the following stage of the study implied the analysis of collected data. each interview question is to ascertain a particular issue not fully explained by the answers in the questionnaire. thus, to examine interview data, the interpretive analysis approach was introduced. data interpretation implies explicating insights, making deductions, giving appropriate relevance, enabling understanding, and arriving at appropriate conclusions. the application of the same principles in other places in different circumstances is reasonable as well (patton, 2002). results and discussions the serbian banking sector has 31 banks (nbs, 2013). foreign-owned banks are dominant in the market – they account for 75 per cent of total assets, 74 per cent of total capital and 72 per cent of total banking sector employment and record a profit of around rsd 17 bn (nbs, 2012). foreign-owned banks operating in serbia are members of banking groups from 11 countries. when it comes to their share in total banking sector assets, the most important are italian banks (23 per cent), followed by austrian (15 per cent), greek (15 per cent) and french (10 per cent) banks. banks from other countries accounted for a 12 per cent share in total banking sector assets (nbs, 2012).1 based on banks’ answers, kobilarev (2014) concluded that, besides a poor supply of derivatives in the banking sector (54.8 per cent), the otc derivatives market in serbia is relatively “young” and it has been operation for the last six years only. there is no formally organised derivatives market as a derivatives exchange. respondent 1 noted the following: “we are still a bank-based financial market, we have no alternative financial market, banks are the main markets for capital movements. banks in serbia are traditionally dominant financial mediators, so it is understandable to say that the serbian financial sector is bank-based. this is confirmed even by the data that banks indirectly manage more than 90 per cent of financial sector’s assets. except this, banks are majority owners of non-bank financial institutions. banks are certainly major players on such a financially focused market from the demand and supply sides. the importance of banks for the serbian financial markets is confirmed by the fact that the two biggest markets – foreign exchange market and money market – are organised as standard interbank markets. on the capital market, banks are also leading investors, as the largest government bonds buyers.” respondent 2 said the following: “the capital market does not exist. serbia’s capital market is banks. the capital market is when you, as a firm, think about how to obtain money, to finance something. you have the option to issue shares, bonds, to take a loan. and then you weigh up the pros and cons. in serbia, all that is more expensive by 3-4 per cent, and you take a loan. cash flow is clear for a bond. you pay a coupon, or you do not have a coupon and you pay the bill of exchange. in case of a share, you pay nothing apart from the dividend. there is a return to the investor of the share the price of your share perhaps goes up, and he sells it at a higher price than he bought your share, or through the dividend payment he periodically recovers a part of his money. only nis in serbia and a few other companies pay out dividends; rising shares are a dream and it doesn’t happen, those are mostly some speculators. based on banks’ answers, kozarević et al. (2012) came to the conclusion that, besides a weak supply of derivatives in the banking sector (34.48 per cent), the otc derivatives market in bih is still nascent given that it has operated for merely six years already. there is official derivatives market as a derivative exchange, which is also the case with the serbian banking sector. still, despite the weak derivatives supply in both countries, it is possible to conclude that the supply of derivatives in the serbian banking sector is by 20.32 per cent (total 54.8 per cent) higher than in the bih banking sector, even though both derivatives markets are still young and nascent. 1 banking sector in serbia – first quarter report 2013. 52 economic analysis (2019, vol. 52, no. 2, 43-63) sources of information of derivative usage in banking sector we first analysed the source of information that the banking sector relies on in terms of the financial derivatives usage. the survey shows that 64 per cent of respondents have a very positive attitude and that 36 per cent of respondents have a positive attitude towards derivative instruments. graph 1. attitude towards derivative instruments source: author’s data in addition, 82 per cent of respondents are fully informed about the role and characteristics of derivatives instruments, while only 18 per cent are merely informed. no respondent stated that he/she is not informed or merely uniformed or gave no answer. in general, it is possible to conclude that most bankers from treasury departments have a very positive attitude in regard to derivatives and the majority are fully informed about their usage. judging by to survey results, the dominant source of information about financial derivatives is literature with 100 per cent, followed by seminars and courses with 73 per cent and the internet with 64 per cent. bankers infrequently attend conferences for the purpose of informing themselves about derivatives (36 per cent) and are not used to being informed through regulatory authorities such as the nbs and sec (36 per cent). besides these sources of information, one bank stated its head office as the source of information about derivatives. as a part of a large international network, this bank puts significant effort in educating and training its employees in serbia in the field of derivatives trading. graph 2. source of information about financial derivative instruments source: author’s data mina kobilarev, branko živanović 53 in the interviews, kobilarev (2014) ascertained the main reason why subsidiaries often do not inform themselves through their parent banks. “our head office provides us with all the necessary information about the use of financial derivatives since it is in their interest that we sell more financial derivatives. but i do not think that all head offices are doing so. nor are they always ideally organised, and do not have time to deal with the education of their daughter banks. but generally it is a good backup”, said respondent 3. the response of this particular interviewee mirrors the general feeling stated by most interviewed banks. it can therefore be said that the link between the parent bank and its branches in terms of information is good, but banks generally try not to burden their parent banks and therefore rely more on information available, mainly literature and the internet. they also educate themselves by attending seminars, courses and trainings about the use of derivatives. in case of dilemmas, they often contact their parent banks. the second section of the questionnaire analyses the overall level of the financial derivatives demand in serbia, examines the types of derivatives offered by the banking sector, and ascertains their importance. the research showed that the offer of derivative instruments in serbia is insufficient. commercial banks usually offer only five types of derivatives, which are used predominantly for foreign exchange risk, interest-rate risk and price risk hedging: the most frequent are currency forwards with 100 per cent, followed by currency swaps with 73 per cent, and interest rate swaps. on the other hand, currency options (18.2 per cent), otc commodity options (18.2 per cent) and otc interest rate options (9.1 per cent) are the least present in the banks’ offer. the structure of derivatives offered in the otc market in serbia is presented in graph 3. six banks in serbia (54.5 per cent) offer financial instruments for hedging against currency risk only (see figure 5.4). all of them offer currency forwards (100 per cent) and only three of them currency swaps (27.3 per cent). merely three out of 11 banks covered by the survey (27.7 per cent) offer derivative instruments for hedging both against currency and interest rate risk. they offer currency forwards, currency swaps and interest rate swaps (27.3 per cent for each). graph 2. source of information about financial derivative instruments source: author’s data the two biggest surveyed banks offer a broader range of financial derivatives. they offered financial instruments for hedging against all three types of financial risks: currency, interest and price risk (see table 1). conversely, banks in bih have in their offer only three types of derivatives, generally used for foreign exchange risk and credit risk hedging: currency forwards, currency swaps, and interest rate swaps. according to the research, all three types of derivatives are contained in the offer of 54 economic analysis (2019, vol. 52, no. 2, 43-63) 12.5% of the surveyed banks, currency forward and currency swaps are in the offer of 50% of the banks, and 37.5% of the banks have only currency forwards (kozarević et al. (2012)). table 1. overview of derivatives by the type of financial risks in the otc market in serbia types of derivative number and % of banks offering only fx derivatives 6 (54.5%) number and % of banks offering fx and ir risk derivatives 3 (27.3%) number and % of banks offering fx, ir and commodities derivatives 2 (18.2%) currency forward (%) 6 (54.55%) 3 (27.3%) 2 (18.2%) currency swap (%) 3 (27.3%) 3 (27.3%) 2 (18.2%) interest rate swap (%) 3 (27.3%) 2 (18.2%) otc interest rate option (%) 1 (9.1%) otc commodity option (%) 2 (18.2%) otc currency option (0%) 2 (18.2%) source: author’s data according to the interviews conducted in the serbian banking sector, derivative instruments, notably commodities and interest derivatives, are transacted with clients through parent banks. the primarily reason why transactions do not take place in the domestic market is insufficient knowledge among banking professionals about these products. fx derivatives, namely fx forwards and fx swaps are still the most prevalently traded derivatives in serbia, while ir and price risk derivatives are underdeveloped. as suggested by the questionnaire results, banks which offer financial instruments to hedge against price risk do not publish such information on their websites. respondent 4 said the following: “the demand for derivatives is very small, which is why we do need to inform our clients of them on our website. commodities derivatives are highly costly and the corporate sector’s demand for them is extremely low. all treasury directors interviewed concurred that “there are around 40–50 companies in our market at most which use financial derivatives for hedging, usually against currency risk: 99 per cent are currency forwards, of which 80 per cent are covered or quasi forwards. in terms of interest rate hedging, mere two interest rate swaps are traded in serbia, according to their knowledge. there is no knowledge about interest and price risk, while the knowledge of fx risk is low. there are no options because they are expensive. in general, we can offer all instruments envisaged by law, but no one will use them except for the said three types of instruments. options are costly. of course, a bank must have a small margin and when it gives an option to a client, it is much costlier than a forward agreement, which is the reason these options are not used. a bank can calculate an option, this poses no problem, but it will also deliver a price, which will be rather high. companies are not inclined to paying anything in advance. banks offer options at expensive terms, which is why companies use them infrequently.” the demand for derivative instruments in serbian and bih banks is also very weak. in the questionnaire serbian banks graded the demand for financial derivatives on the one to five scale (from very low to highest intensity). it transpired that 36.4 per cent of the respondent banks assessed demand for financial derivatives with very low intensity of one, while 45.45 per cent of banks scored demand with the low intensity grade of two. only 18.2 per cent (two surveyed banks) graded the derivatives demand with a medium intensity grade of three (see graph 4). mina kobilarev, branko živanović 55 when it comes to the demand of bank corporate clients for financial derivatives, it can be noted that it did not increase compared to last year in the case of 72.72 per cent of surveyed banks. only in three banks (27.3 per cent of the surveyed banks), the demand for financial instruments went up compared to 2012. graph 4. assessment of derivatives demand in the banking sector source: author’s data in addition, information obtained in interviews with deputy heads of sales in treasury divisions showed that the major reasons for the weak usage of derivative instruments are the absence of information about the procedure of the derivatives use and no knowledge about potential benefits of these instruments in the field of risk management. information given by derivatives users (via informal communication) in the bih banking sector showed that the main reasons for weak usage of these instruments are the same as those in serbian banks. besides, the key limiting factor of a stronger derivatives use both in serbia and bih can be put down to the small number of business operations of the companies on the foreign market. judging by the interviews in serbian banking sector, it can be concluded that the main derivatives users are companies producing and distributing oil and oil derivatives, including wholesale and retail companies, gas trading and supplying companies, construction companies, communication and it companies. rather similar results are found in bih where the main users of derivatives, in addition to the above mentioned, are also furniture production and trade companies (especially trade companies importing from china), including gas trading and supplying companies. serbian banks were asked questions about the practical use of derivatives by the corporate sector, with a view to exploring the practical usage of derivatives in the banking sector. asked if they ever concluded forward contracts with the corporate sector, 100 per cent of banks gave a positive answer. in terms of the contracts category, 100 per cent of banks stated that they use forwards, while 36.36 per cent of them concluded swap contracts. the underlining asset for derivative contracts is currency with 100 per cent, and interest sensitive assets with merely 18.18 per cent. all institutional agreements are concluded in the otc market. according to the survey results of kozarevic and al. (2012), the clients of bih banks show the strongest interest in currency forwards, with the average grade of 2.33, currency swaps (2.20) and finally interest rate swaps (2.00)2. currency risk derivatives the questionnaire also examines the banking sector’s offer of derivative instruments as a currency risk management tool (see table 2). 2 the surveyed banks were asked to assess demand for derivative instruments through the grading system, where 1 meant “there is no demand”, 2 “low demand”, 3 “moderate demand”, 4 “high demand”, and 5 “very high demand”. 56 economic analysis (2019, vol. 52, no. 2, 43-63) table 2. banks’ offer of financial derivatives as a currency risk management tool instrument percent of banks that offer the instrument importance 1-3 (1 less important, 2 important, 3 very important) 1= less important 2= important 3= very important 1. currency forward 100 9 2 2. covered or “quasi” forward 91 1 7 2 3. currency futures 0 4. currency swap 72.73 3 3 2 5. stock-exchange currency option 0 6. otc (over-the-counter) currency option 18.18 2 7. structured derivatives (e.g. currency swaption) 0 source: author’s data the table shows that currency forwards are the most dominant and are offered by all surveyed banks. nine out of 11 surveyed banks consider them an important currency risk management tool, while two of them give them the highest score (of three), i.e. consider them very important. currency swaps with 72.73 per cent are the second most common currency hedging instrument. in contrast to currency forwards with high importance, only two banks assessed currency swaps as very important, three banks as important and three as less important. in line with the interview, otc currency options are the least commonplace in the offer and were graded as less important by two out of 11 surveyed banks. as the matter of fact, options are still rather costly financial instruments for the corporate sector. banks were also asked to state the total number and the type of currency forward contracts that they entered into with their corporate clients for hedging purposes, in 2011 and 2012, and the average value of contracts in the national currency. six banks considered this question a business secret, which is why we did not obtain these data. for the reasons already mentioned, the following data were prepared on the sample of five banks. data about three banks are contained in table below, while two other banks will be examined further in the text. the data in table 3 show that three banks concluded only 115 currency forward contracts in 2011 with an average value of eur 310,000 and 106 currency forward contracts in 2012 with an average value of eur 316,666. the most commonly used were the so-called “quasi” forwards. there were 801 of them in 2011, with the average value of eur 550,000. table 3. total number of fx derivatives contracted with the serbian companies 2012 total number of contracts 2012 average value of contracts in din or eur 2011 total number of contracts 2011 average value of contract din or eur currency forward 106 eur 316,666 115 eur 310,000 covered or “quasi” forward 880 eur 550,000 810 eur 550,000 currency swap 40 eur 750,000 30 eur 750,000 currency option 3 eur 225,000 5 eur 225,000 source: author’s data since the start of their derivatives trading in 2009, two banks entered in only six currency forwards with the average value of eur 790,000, and only had a forward agreement with the average value of eur 120,000. according to research results, the derivatives market in serbia is mina kobilarev, branko živanović 57 in its early stages of development, which indicates a low derivatives market potential in serbia. furthermore, živanović et al. (2018) concluded that 65.9 per cent of slovenian companies covered by the sample employ financial derivatives, vs. 43 per cent in croatia, and in serbia only 40.32 per cent of companies use financial derivatives, implying that the serbian corporate sector has the lowest percentage of derivatives usage in the region. kozarević et al. (2012) assessed the demand for derivatives in bih as extremely low. according to data, one bank which is the largest supplier of derivatives, closed merely 10 contracts for derivatives with an average value of bam 750,000.00 (cc. eur 383,600.00) since august 2008. all other banks together concluded only four contracts for derivatives. a suggested by research results, the derivatives market in bih is in the early stage of development, which indicates a low derivatives market potential in bih. the research results suggest that serbian banks concluded 106 currency forwards in only one year (2012) with an average value of 316,666 eur, which implies 98 more closed currency forwards than the bih sector has ever contracted. for the sake of comparison, the serbian banking sector concluded more types of derivative contracts than the bih banking sector. it is possible to conclude that the serbian derivatives market has a higher potential than the bih derivatives market though both markets are still in development phases. the situation is similar in montenegro, although the montenegrin economy is to an extent better developed. the main reason for the low visibility of forwards in the local financial market is the absence of currency risk exposure, as the legal tender of montenegro is the euro, in all transactions since march 2002. (živanovic et al., 2012). interest rate derivatives foreign exchange derivatives are the most frequently traded of all risk categories in serbia, whereas interest rate derivatives remain underdeveloped according to the survey results. when the question was asked about the types of interest rate derivatives on offer and their importance (1 = less important; 2 = important; 3 = very important), five surveyed banks (45.45 per cent) said that they offer interest rate swaps, while only two banks offer otc interest-rate options (see table 4.). in terms of interest rate swaps, three out of five surveyed banks assessed them as a less important interest-rate risk management tool, giving them the lowest score of 1, while two banks consider them an important ir tool (the score of 2). the overall activity in interest rate derivatives in serbia, however, remains extremely low. otc interest rate options were assessed by two banks as less important, with the score of 1. on the sample of five surveyed banks, the questionnaire results suggest that since ir derivatives were introduced to the serbian market only four contracts have been entered into with the average notional amount of eur 10 million, while otc interest rate options are not traded. table 4. banks’ offer of interest rate hedging products instrument percent of banks that offer the instrument importance 1-3 (1 less important, 2 important, 3 very important) 1= less important 2= important 3= very important 1. interest rate forward 0 2. interest rate futures 0 3. interest rate swap 45.45 3 2 0 4. stock-exchange interest rate option 0 5. otc (over-the-counter) interest rate option 18.18 2 0 0 6. structured derivatives (e.g. cap, floor, collar, corridor or swaption) 0 source: author’s data 58 economic analysis (2019, vol. 52, no. 2, 43-63) with the aim of assessing, on the one hand, the opinion of serbian deputy heads of treasury divisions about this matter, as well as to increase the reliability of the results obtained from the questionnaire, the following question was asked at the interviews: what are the instruments that the banking sector offers to corporate clients to hedge them against interest rate risk and what is the perspective of the further development of ir derivatives. a general opinion of heads of treasury divisions can be summed up in the following answer given by respondent 5: “i can assure you that among interest derivatives, only the interest rate swap is used in serbia. interest rate swaps are at a disposal, but i believe that the advantage of an interest rate swap is that at the beginning there is no payment, i.e. no exchange of cash, while in case of interest options the premium must be paid in the start. it is the same as an insurance policy. this doesn’t exist with swaps. interest swaps will be popular now because euribor is expected to rise. this will certainly happen as interest rates have hit the bottom. you already see the information that the european economy is recovering and exiting from recession. as the economy is recovering, there is fear of inflation, key interest rates are rising, everyone is raising interest rates, euribor is soaring. i therefore believe that companies will start to use more interest rate swaps in hedging their risks. interest rate options imply advance premium payment. very few clients are ready to give you cash in advance. commodity options would be more popular. i believe they are more liquid, especially oil and wheat; commodity derivatives will be generally more popular here than interest rate ones.” as confirmed by survey results, interest rate derivatives are not used by the corporate sector to a significant extent in the serbian otc market. in terms of ir derivatives, only ir swaps are traded, but have a very low importance. nevertheless, it is expected that the interest in ir derivatives, i.e. swaps, will go up in the future given the high variability of interest rates (e.g. euribor) and in parallel with the increase in economic activity of the serbian corporate sector, primarily growth in exports and imports, and the development of the domestic financial market. commodity derivatives when it comes to price risk management solutions, banks’ offer of commodity derivatives is very poor according to the survey results. merely two out of 11 surveyed banks offer otc commodity options (18.18 per cent), rating them with the score of 1 as less important (1 = less important; 2 = important; 3 = very important). judging by information obtained from the interviews, all bankers believe that commodity derivatives in serbia are still in their infancy. respondent 6 noted: “regulations were recently amended. the nbs allowed what was recently forbidden by the decision on performance of financial derivative transactions – the contracting between a domestic legal person and a foreign bank of a commodity non-deliverable derivative (ndf). a domestic company can now conclude with a foreign bank a derivative which is not executed in goods, but in the difference, and now they are launching first commodity derivatives, then they will analyse the situation and will see what are possible impacts on the financial systems, they will be letting interest rates go up etc. by changing the provision, it is possible to deliver nondeliverable derivatives between residents and non-residents. we expect higher interest in this instrument in the future, but it should be emphasised that the lack of corporate culture of serbian enterprises is what generally impedes the development of derivative instruments in general.” in view of the above research results (see table 2; 3; 4), it is possible to accept our research hypothesis that types of derivative offer by banking sector are sufficient relative to the derivative usage by non-financial companies in serbia. mina kobilarev, branko živanović 59 prospects for the further development of derivatives usage when asked about the activities they undertake to attract derivative business, all 11 banks stated that they are working all the time to improve staff education in derivatives trading, while six surveyed banks carry out strategic planning activities so as to attract their corporate clients. a downside is reflected in the fact that all surveyed banks do not have the intention to establish separate departments for financial derivatives management in the near future. at the time of data collection, no bank surveyed was planning to set up departments for derivatives trading in the near future, which is understandable given the lack of substantial demand for derivatives. this will, ceteris paribus, hinder further development of financial and derivatives markets in serbia. the same research results were observed in the bih banking sector, as suggested by kozarevic et al. (2012), with a positive fact that the surveyed banks pay considerable attention to basic financial instruments that are available and have therefore organized separate departments (such as trading and asset departments), with staff trained for this type of transactions. a positive aspect relating to operations in the otc derivatives market is that 54.5 per cent of the surveyed banks engage employees with appropriate knowledge and international certificates for financial instruments trading (e.g. aci dealing certificate, cfa), while other banks engage staff with relevant brokerage certificates (27.27 per cent) and investment advisor certificates (9.1 per cent) issued by the republic of serbia securities commission. as indicated by the survey, there are on average three employees in charge of financial derivatives. when interviewed about the type of necessary education, most respondents referred to the aci dealing certificate exam, as well as basic education and training in all fields of business operations with derivatives. education is indispensable not only for staff employed in the front desk, but also for those engaged in other departments and dealing with derivative transactions, such as the financial department, trading department, credit department, etc. a downside of operations on the bih otc derivatives market is that merely 25% of the surveyed banks engaged specialized persons with now-how and international certificates for financial instruments trading (e.g. aci dealing certificate), while other banks meet legal requirements and take on staff with adequate brokerage certificates and investment advisors certificates issued by the securities commissions in the federation bih and republic of srpska. when surveyed the type of education needed in the serbian banking sector, the majority of the surveyed subjects referred to the aci dealing certificate exam, and the need for basic education and trainings in all aspects of derivatives operations. education is indispensable not only for those engaged in a front desk, but also for those working in other departments and dealing with derivative transactions, such as financial department, trading department, credit department, etc. it is noteworthy that all banks, both in serbia and bih, express the need for further education of their staff in the area of derivatives trading as the tool for managing (i.e. hedging) risks. this made us conclude that the main reason for the weak level of derivatives supply and demand is the lack of information and education of banking staff in derivatives contracting, as well as banks’ caution in terms of legal risk. nine banks or 81.82 per cent of banks in the serbian banking sector did not introduce any new derivative product recently, with only two banks introducing them. when it comes to widening the derivatives offer, 54.5 per cent (six) of the surveyed banks intend to offer new derivative instruments, 27.27 per cent (three) do not have such plan, while 18.18 per cent (two) did not give a clear answer to this question. as for the broadening of types of derivative products, 75% of the banks surveyed in bih intend to offer new derivative instruments, 12.5% do not have such plans, while 12.5% did not provide a clear answer to this question. the banks that gave a positive answer to the question concerning the broadening of their derivative offer, they intend to offer non-deliverable forward, currency swap, interest rate swap 60 economic analysis (2019, vol. 52, no. 2, 43-63) and otc commodity options. a thorough structure of the derivative offer development in serbia is presented in graph 5.5. in bih, the banks that gave a positive answer to the questions concerning the broadening of their derivatives offer, stated they will offer interest rate swaps, currency swaps, and credit options. in regard to the need to set up a regulated derivatives market, the situation with the surveyed banks is as follows: 36 per cent state that establishing the derivatives market will contribute to the development of the financial market in serbia in general, while 64 per cent think that there is no need for that yet. those stating there is no need for an organised derivatives market believe that bilateral cooperation among banks would suffice. as stated by respondent 7: “financial markets demand volume and market participants. in our country, bilateral cooperation between banks would be sufficient. first you need to regulate the interbank (otc) market properly because it has many disadvantages and should be regulated in the first place. in our banking system, there is still no spot market or forward rate quotations. our financial market is still in infancy, while the corresponding volume and demand for financial derivatives are at a very low level. where there is no market environment there cannot be a real financial market. where there are no basic financial instruments, derivatives cannot be contracted and traded. the prerequisite for this is the existence of an adequate market depth.” when it comes to the need to organise a derivatives market as a segment within the sarajevo stock exchange (sase) or banja luka stock exchange (blse), the situation among the surveyed banks is the following: 50% of them believe the establishing of the derivatives market will incite the development of the financial market in bih in general, while 50 per cent believe there is still no such need. graph 5. the (intended) structure of derivative offer development in serbia source: author’s data when surveyed about the reasons that most seriously constrain the development of the domestic derivatives market, all 11 surveyed banks (100 per cent) stated that this is due to the uninformed client base and valid legislation regulating derivatives. in addition, the absence of interest in banks (36.36 per cent) and no experienced staff in banks (18.18 per cent) are less important reasons. as banks were also provided the possibility to state another reason which we may not have specified in the question, 80 per cent of them said the main reason hindering the development of the domestic derivatives market is our shallow financial market. we also asked banks to provide the most important reasons/limitations for the derivatives use by the corporate sector (companies). as suggested by the survey, the most significant conditions and/or obstacles to derivatives purchases by companies the following: • the absence of corporate culture in the corporate non-financial sector, as highlighted by all eleven surveyed banks (clients are still not informed of how hedging instruments can improve the security of their financial operation) mina kobilarev, branko živanović 61 • costly derivative instruments and still insufficiently elaborate legal regulations regulating derivatives in serbia • need to have deposits on a special bank account to cover forward transactions • high level of required collateral (depending on clients’ creditworthiness) and • substantial need to purchase different currencies. kobilarev (2014) asked the same question in the interview, aiming to obtain a more elaborate explanation of the expression “the lack of corporate culture”, stated by serbian bankers as the primarily reason hindering the use of derivatives by the corporate sector. respondent 8 stated that “one of the obstacles to the use of hedging instruments is the lack of corporate culture because of the unwillingness of entrepreneurs, especially smes, to inform, educate and engage in new transactions. the trend of using hedging in the future will depend on the willingness and desire of banks to refer clients to these possibilities and to assist them in understanding the rules of the financial derivatives usage.” we learned the following from the interview: “in the corporate sector there are generally financial directors who do not want to hedge against financial risks; if the dinar strengthens, the director is a bigwig, if the dinar weakens he will ascribe it to force majeure, no one will tell him that he is a bad financial director. this is the main reason – poor corporate governance. unfortunately, this is the hardest factor for investigation, but this will not be settled until the economy is transformed, before the governance structure in enterprises is established under a western model. not all is the best in the west, this financial crisis showed that everything was not in order”, claimed respondent 8. it is therefore possible to accept our research hypothesis according to which knowledge and focus on derivatives impact their use. according to research results of kozarević et al (2012) in bih, as evident from the information provided by derivatives users (via informal communication), the principal reasons for the low usage of derivative instruments are the lack of information about the derivatives use procedure and the absence of knowledge about possible benefits of these instruments for risk management purposes. besides, the main factor constraining a more substantial derivatives usage can be put down to a relatively low number of business operations of bih companies on the international market. the most important conditions and/or constraints for derivatives purchases by bih companies are as follows: • need to have a deposit on a special bank account to cover forward transactions (usually 10% of transaction value), • value of turnover of the client with the bank, • substantial need to buy different currencies, and • degree of collateral (depending on clients’ credit worthiness). conclusion based on the research carried out in the serbian banking sector, currently 17 out of 33 banks in serbia offer different hedging instruments. banks are considered the only counterparty to companies in the derivatives otc market given that serbia’s financial system is bank-based. as suggested by research results in the banking sector, in addition to a weak supply of derivatives in the banking sector (54.8 per cent), serbia’s otc derivatives market is nascent given that it has existed over the past seven years only (m. kobilarev, 2014). in terms the types of derivatives used, serbian companies generally employ otc derivatives, which are more expensive compared to exchange-traded derivatives, since there is no regional market for exchange-traded derivatives. as suggested by survey results, foreign exchange derivatives are the most traded of 62 economic analysis (2019, vol. 52, no. 2, 43-63) all risk categories in serbia, whereas interest and commodity rate derivatives are still underdeveloped. the research showed that currency forwards are the most commonplace and are contained in the offer of all surveyed banks, with currency swaps being the second most dominant currency hedging instrument. the research results confirm that interest rate derivatives are not employed by the corporate sector to a high degree in the serbian otc market. in terms of ir derivatives, only trading in ir swaps takes place, but their importance is very low. as stated by all the banks, the reasons that most seriously hinder the development of the serbian derivatives market are the lack of information in the corporate sector and the absence of appropriate legislation governing derivatives transactions. as banks could also state other reasons, most of them referred to serbia’s shallow financial market. as indicated by the survey, the most important restrictions for the derivatives purchase by companies are the lack of corporate culture in the company sector and costly derivative instruments, including the still insufficient regulations regulating derivatives operation in serbia. taking into account the above, both of our research hypotheses can be accepted. the first hypothesis suggests that types of the derivative offer by the banking sector are sufficient in regard to the derivatives usage by non-financial companies in serbia. furthermore, we concluded that knowledge and focus on derivatives influence their use, wherefore our second hypothesis can be accepted as well. this article offers the first empirical evidence of the derivatives offer in the serbian banking sector, which is highly important for the corporate sector as it provides all necessary information relating to this field. additionally, the survey contains ample evidence allowing international comparison, which is undoubtedly an advantage. the study can also be implemented in other see countries. the findings given in this article may serve as the starting point for future research of the derivative usage in financial risk management from banks’ perspective. references barjaktarović m., d. karić and r. zečević (2017). currency options in function of currency risk hedging and speculating, economic analysis, institut ekonomskih nauka, vol. 44, no. 1-2, pp. 38–46. bernard, h. r. (1988). research methods in cultural anthropology, newbury park, california: sage. bodnar, g.m., g.s. hayt and r.c. marston (1998). wharton survey of derivatives usage by us non-financial firms, financial management, 27(4), pp. 70-91. børsum, ø.g., and b.a. ødegaard (2005). currency hedging in norwegian non-financial firms, norges bank economic bulletin 1, pp. 29-40. grubišić z., kamenković s., duran e., (2013). modern portfolio theory on the capital market in serbia, ekonomske teme br. 4/2013, ekonomski fakultet, univerzitet u nišu, niš, br. 4 (2013), pp. 671-683. marinković, s and a. skakavac (2010). derivatives market in serbia, economics and organization, 7(1), pp. 47–59. djenić, m, s. popovčić-avrić and l. barjaktarević (2012). importance of forward contracts in the financial crisis journal of central banking theory and practice, 2(1), pp. 75-96. kobilarev, m. (2014). hedging as a risk management approach in a transitional country: the case of serbia, phd thesis, glasgow caledonian university, glasgow. kozarević, e., i. kestović, m. kokorovic-jukan and b. čivić (2012). the usage of derivatives in financial risk management by companies in bosnia and hercegovina, economic review – journal of economics and business, 10(2), pp. 59-72. patton, m. q. (2002). qualitative research & evaluation methods, 3rd ed., thousand oaks: sage publications. mina kobilarev, branko živanović 63 sajjad f., u. noreen and k. zaman (2013). impact of derivatives on financial services sector and risk management middle-east journal of scientific research 18(6), pp. 748-758. saunders n.k., a. thornhill and p. lewis (2009). research methods for business students 5th ed, prentice hall: harlow. shiu y.m., p. moles and y.c. shin (2010). what motivates banks to use derivatives: evidence from taiwan, the journal of derivatives 17(4), 67-78. travica, m. (2010). forward as a possible solution for currency induced credit risk identified in non-performing loans-foreign exchange rate regression model. mba thesis. belgrade: london school of business and finance. živanović, b. and m. kobilarev (2017). the usage of financial derivatives in financial risk management by non-financial companies in serbia, industry: institute of economic sciences, 45(3), pp. 65-82 živanović, b., a. cvejić and m. kosanović (2000). perspectives of managing corporate currency exposure using forward products in the serbian commercial banking industry, published in the conference proceedings: new economic policy reforms, belgrade banking academy faculty for banking, insurance and finance, pp. 298–316. živanović b. and a jolović (2012). the evolution of serbian forex through nbs swaps, economic analysis, institut ekonomskih nauka, vol. 45, no. 3/4, pp. 12–26. article history: received: june 15, 2019 accepted: july 23, 2019 ea_2019_2 doi: 10.28934/ea.19.52.2.pp1-11 original scientific paper a comparative study of minimum wage and employment in china and in the united states duanxiang fu1 | jianfeng yao2* 1 research center for energy economics, school of business administration, henan polytechnic university, jiaozuo 454000, china 2 college of business and economics north carolina agricultural and technical state university, 1601 east market street, greensboro nc 27411, usa abstract in this paper, we use regression models to analyze and compare the effect of a change in real minimum wage on employment rate both in china (the largest emerging market) and in the united states (the largest developed country). the longitudinal data we use is from 2000 to 2016 published by both countries. after controlling for unobserved heterogeneities by using the fixed effect estimations, the results show a significant and negative correlation between real minimum wage and employment rate in both countries, with a smaller and weaker effect of real minimum wage in china. it indicates that employment in china is less responsive to a change in minimum wage because of its unique economic system. in addition, we find that the effect of minimum wage on employment rate turns into insignificant in recent years in china since 2008, which is the opposite of and different from the situation in the u.s. key words: minimum wages, employment rate, comparative analysis jel classification: j31, d23 introduction motivation the minimum wage system is a basic wage and social security system that has been utilized by governments to directly intervene in the wages of labor market. in order to meet the demand of the developing market economy and to protect the basic living needs and lawful rights of working individuals and their families, former department of labor of china initiated in november 1993 “minimum wage regulations for enterprises” (labor department, 1993) and officially piloted the minimum wage system and the minimum wage standard in 1994.the minimum wage system has now been implemented in all provinces in china. the united states is one of the earliest countries to implement the minimum wage system. in 1938, the united states enacted the national minimum wage act – ‘fair labor standards act’ (united states congress, 1938) and set up the federal minimum wage standard in order to ensure the daily life of the poor. as such, the minimum wage system is carried out across the country and is widely used (jiao d. 2014). the vast majority of the american people who receive minimum wage are young people ranged from 16 to 24 years old. * corresponding author, e-mail: jyao@ncat.edu 2 economic analysis (2019, vol. 52, no. 2, 1-11) china’s minimum wage has risen sharply in the past decade amid an imperfect social security system and labor market. the us government is cautious about raising the minimum wage. with the rise in cpi and the advent of the information technology revolution, the adjustment of the us federal minimum wage is characterized by a small increment at slow pace. so, should the minimum wage continue to rise? what effect will a higher minimum wage have on employment rate? how do we achieve an effective combination of a rational level of minimum wage and the promotion of employment? the effect of minimum wage on employment has attracted extensive attention in academic circles, and its conclusions have always been controversial. the comparative analysis of the effect of the minimum wage on employment in both china and the us has produced few results. in this study, we use a relatively comprehensive panel data to conduct a comparative analysis over the impact of minimum wage on employment rate in both countries, and to seek the difference of the impact and the reasons behind the difference. this study is to perfect the minimum wage system, to improve the quality of employment and the effectiveness of the minimum wage, and to improve the coordination between minimum wage and employment rate. it is believed the study possesses both theoretical significance and practical values. historical background as economy develops and living expenses rises, minimum wage increases gradually. in china, minimum wage has entered a period of rapid and frequent increase since 2004. from 2000 to 2016, the average annual growth rate of the minimum wage in china was 11.3%, and the average wage increased by 13.2%. the minimum wage adjustment in the united states appears to be small and slow; however, the federal minimum wage has risen from $0.25 per hour in 1938 to the current $7.25 an hour. from 2001 to 2017, the average annual growth rate of the minimum wage in the us was 2.3%, and the average wage increased by 2.5%. research question what impact will the increase of minimum wage have on employment? what is the difference, between china and america, of the impact of minimum wage increase on employment? what are the reasons for their difference? the study of those questions is the main content of this paper. this paper is organized in six sections. section one is about the background and significance of the study. section two is a literature review which provides the research basis for our study. the third and fourth sections use the panel data from both china and the united states (2000-2016) to evaluate the employment effect of the minimum wage in china and in the united states by using a regression method. the fifth section is the comparative analysis that explains the research results and the reasons for any differences between the two countries. section six concludes and puts forward policy suggestions. literature review researchers have long put forward different opinions on the implementation of the minimum wage system and studied the adjustment and evaluation of minimum wage and its economic effects on employment. they proposed some relative theoretical models and used them to explain how the minimum wage affects employment. at the same time, different evaluation methods were used from a variety of perspectives to empirically test the effect of minimum wage on employment. in china, leping yuan and gongfei li (2007) used a model of labor supply and demand to study the increase in minimum wage and concluded that it not only increased the income of the workers, but also reduced the unemployment rate. guangxin wang and xianguo yao (2014) used the 2000-2010 panel data of 30 autonomous regions in china and took the contracted duanxiang fu, jianfeng yao 3 employees from various companies as their research object to study the impact of the minimum wage increase. they found a negative effect on the employment of those employees by using generalized least square method. you wu (2014) used a differential gmm (generalized method of moments) method to conduct an empirical study using panel data from 26 regions of china from 1998 to 2012. the results showed that the effect on national employment was negative, but the negative impact on employment could be offset by economic growth. the increase of minimum wage has a significantly inhibitory effect on employment in the north-eastern and eastern regions, while the employment impact in the central and western regions is not significant. abowd, francis & margolis (2000) found that the overall employment effect of the minimum wage is negative, but there are differences in the degree of employment impact on workers of different genders. every 1% increase in the minimum wage reduces the employment of american male and female workers by 0.4% and 1.6% respectively. sabia & joseph (2014) studied the employment effect of minimum wage on low-skilled workers in different economic cycles of a country, and the impact of national productivity and spatial heterogeneity on low-skilled sectors. it turns out that the increase in the minimum wage between 1989 and 2012 reduced employment for low-skilled workers more during the recession than that during economic expansion. the employment flexibility range of the national minimum wage is 0-0.2 in the economic expansion, but as high as -0.3 in the trough of the economic cycle. the study by neumark and wascher (1992) found that the minimum wage had a significant negative impact on employment, especially for low-income workers. the increase of the minimum wage by 10% increased the unemployment of american teenagers by 1%-2%, and increased the unemployment of young adults by 1.5%-2%, that is, the increase of the minimum wage reduced the employment of young people. kalenkoski and lacombe (2013) used spatial econometric techniques and the annual average data from 1990 to 2004 collected by the us bureau of labor statistics to check the youths’ employment effect of minimum wage. the results showed that youth employment has been affected. the minimum wage increased by 10% in real terms, the youth employment fell 2.1%. neglecting the spatial correlation will underestimate the impact of minimum wage on youth employment. slonimczyk and skot (2012) conducted a regression analysis on the relative impact of the minimum wage on employment and concluded that the reduction of the minimum wage in the united states may lead to the decrease of employment and the deterioration of the relative wage of low-skilled workers. it is evident that the research on minimum wage has achieved great outcomes in the past decades. different data and different methods have been used to study the employment effect of the minimum wage. there is a large amount of studies over the employment effect in china that is created by the minimum wage, but they are mainly on chinese migrant workers and employment in different regions. studies on the impact of minimum wage on american youth employment, different gender workers and employment in different states are relatively focused in america. but comparative analysis of the impact of the minimum wage on employment in different countries is rarely fruitful, which provides a research space for this study. this study uses relevant governments’ annual statistical data for the period of 2000 and 2016 and uses the regression analysis to analyze the employment effect of the minimum wage increase in both china and the united states. through comparison of the results we try to explore the differences between the two countries and the reasons for the differences. 4 economic analysis (2019, vol. 52, no. 2, 1-11) data data sources the chinese data adopted in this study comes from chinese official statistics including the national bureau of statistics of the people's republic of china, the ministry of human resources and social security and the national federation of trade unions and other departments, such as “the statistical yearbook of china (2004-2016)”, “the labor statistical yearbook of china (2004-2016)”, “the statistics bulletin of the national economy and social development of china (2003-2016)”, as well as the relative annual statistical yearbooks from different provinces, autonomous regions and municipalities directly under the central government and labor law and so on. the u.s. data are mainly from the statistical data and the investigation reports released on the website of the bureau of labor statistics by the department of labor. those data include the minimum wages and average wages, employment, gdp (gross national product), relevant data such as the consumer price index and foreign direct investment. the data are all collected from official agencies, with authenticity and reliability. variable selection there are many factors that can affect employment, such as the economic development speed, wage level, labor supply and demand, and changes in the international economic environment. this study mainly analyzes the effect of the increase of the minimum wage on employment. in the process of econometric analysis, the analysis variables mainly include employment-topopulation ratio as a measure of employment rate, minimum wage, average wage, and gdp per capita. the minimum wage, average wage and gdp are then converted into monthly minimum wage, monthly average salary and monthly gdp per capita. in china, minimum wage level is difference across different provinces, and we use the province level monthly minimum wage documented by the national bureau of statistics of china. the american state minimum wage standard form is usually an hourly minimum wage standard, so the hourly minimum wage standard is converted into monthly minimum wage (calculated by using 40 hours a week, 52 weeks in a year, or 12 months in a year) in the process of econometric analysis. in order to ensure the comparability of the panel data, the minimum wage, average wage, and gdp per capita and so on are converted into the real value by applying the consumer price index with the base year of 2009. in order to eliminate possible heteroscedasticity between variables, the annual time series such as the minimum wages and average wages and gdp per capita are transformed into the natural logarithm. summary statistics table 1 and table 2 show the descriptive statistics for both china and u.s. between 2008 and 2016.as we can see from table 1, the employment rate in china is slightly higher than the rate in the u.s.; monthly nominal minimum wage, average wage and gdp per capita are in u.s. dollar values and converted into real values by using the consumer price index with the base year 2009 equal to 100. the real values of wages and gdp per capita is substantially low for china compared to the ones for the u.s. table 2 allows us the observe the trend of growth of minimum wages, average wages and gdp per capita both in china and u.s.; column 2 and 3 in table 2 reports the statics of china before and after year 2008. column 4 and 5 include the information for the u.s.; with respect to the employment rate and minimum wages ( in terms nominal and real values), we observed a large increase in minimum wages in china, which is associated with slight increase of labor employment rate. yet in the u.s., the trend is the opposite, an increase in the minimum wages is accompanied by a decrease in the labor employment rate. these trends duanxiang fu, jianfeng yao 5 suggest that the effect of minimum wage on employment in china may not be as sensitive as the effect in the u.s. in an expected direction. as a result, this merits a more detailed regression and comparative analysis. other variables such as average wages, gdp per capita and consumer price index all keep increasing over time in both countries as we expected. econometric specification in this paper, our objective is to estimate the effect of minimum wage on employment indicated by the labor participation rate. in order to accurately measure such effects and given the longitudinal structure of our data, we use the fixed-effect estimation models to control for the unobserved time-invariant heterogeneities. the model specification is as follows: ln���� � = c + c� ln� ��� � + c� ln����� � + c� ln����� � + c�� + c� ln� ��� � ∗ ln����� � + �� + ��� where employment-to-population ratio or employment rate, ��� , is the dependent variable of the province i or state i in year t. we aim to estimate, c�, the captures the effect of minimum wage on employment. in the specification above, �� is a province-specific effect that stays constant across time and ��� is an idiosyncratic error term. �� may include factors such as working cultural or confidence in the economic and political system such as communism that does not vary much with time. fixed effect estimate models remove the effect of those unobserved time-invariant characteristics so we can assess the net and unbiased effect of the predictors on the outcome variable. ��� represents the monthly real minimum wage of the province or state i in year t. we assume that the time variant minimum wage in each province is exogenously determined by the local governments in both countries. we converted minimum wages to monthly values in both countries to for the purpose of consistency and performance of comparative analysis. ���� is the monthly real average wage of a province or state, and it is also time variant and reflects the degree of average income of workers in a certain area and time. it also captures individuals’ incentive to work and the average number of jobs employers are willing to offer. ���� is the explanatory variable that reflects the monthly real gdp of a province or state. the growth of the real gdp indicates the economic growth a country or region and the development of an industry that may eventually determine the employment or the labor participation. other control variables include the interaction term the between real minimum wage and real average wage and time trend. the effect of real minimum wage on employment varies with the real average wage. the time trend is used to illustrate growth in production or industry earnings which also influence the employment or the labor participation. results table 3 shows the fixed effect estimation results for china and u.s. between 2000 and 2016. as we may observe, minimum wage has significant negative effects on the employment rate or employment-to-population ratio for both countries. however, the effect is significantly smaller for china than it is for the u.s.; more specifically, from the estimate coefficients, we can say that the marginal effect of log real minimum wage is -1.249 in china, which is smaller than the marginal effect of log real minimum wage in the u.s., -3.524. as a result, china's labor force and employment is less sensitive to a change in the minimum wage. also, by comparing the coefficients of log real gdp per capita, we may conclude that china's employment is more sensitive to a change in gdp than it is for the u.s. table 4 describes the estimations result in different time periods for china and u.s. respectively. we use the estimations in different time periods to examine how the effect of minimum wage on employment changes over time. for china, an interesting observation is that the effect is significantly negative before 2008 and then turns into insignificant and weak after 6 economic analysis (2019, vol. 52, no. 2, 1-11) 2008. it indicates that the employment is not quite sensitive to an increase of minimum wage in china in recent years probably due to the change of exogenous policies or economic environments. however, in the u.s. we have a different situation, that is, the effect of minimum wage on the labor participation tends to be stronger and bigger in recent years. in table 5, we perform the estimations at a different range of minimum wage. the effects are estimated on the upper 50th percentile of the minimum wage. we do this in order to see if there is any change of the effect when minimum wage becomes relative higher. from the table, we find that, in china, at the upper range of the minimum wage, the effect of such wage on labor employment does not persists, which may indicate that as the minimum wage increases, the relationship between minimum and employment tends to become weak and insignificant. again, in the u.s., we have a more stable and consistent situation, the effect of minimum wage is still negatively significant at higher levels of such wage. table 6 shows the estimation results in different areas for china. we mainly look at the coastal areas and inner areas of china. coastal areas are in general more developed than inner area. by comparing the coefficients of the minimum wage, we observe that labor employment is more sensitive to the change of minimum wage in coastal areas where there are more private and foreign invested companies. labor market and market of goods and services are also relatively mature and open in coastal areas. the effects of other variables such as average wage, gdp per capital and time trend are also significantly bigger in coastal areas. table 7 captures the fact that the effect of minimum wage on employment also depends on foreign direct investment (fdi) in china. fdi is associated with the private industries and companies that are not owned and operated by the government. foreign invested companies in china are sensitive to the change of minimum wage because of the characteristics of cheap labor intensive industries in which most of these companies are involved. on the other hand, stateowned domestic industries are less responsive to the change of minimum wage because they are not sensitive to the cost variations thanks to the government subsidies. the evidence that stateowned industries and foreign invested companies behave differently and that fdi reinforces the negative effect of minimum wage can be found in the estimation results. as the table 7 shows, when the effect of minimum wage is significant between 2000 and 2016, especially before 2008, the interaction term minimum wage and fdi are also significantly negative, which demonstrates the fact that, as the minimum wage increases, its negative effect is further amplified the value of fdi and the number of foreign invested industries. conclusion this paper studies the effect of minimum wage on employment measure by the employmentto-population ratio. the analysis over the panel data from 2000 to 2016 shows that the minimum wage is significantly correlated to the employment rate both in china and in the united states. in capitalist economy, raising minimum wage may lead to a decline in employment rate due to the fact that employers are reluctant to hire or keep labor because of the increased cost of labor, which is consistent with the results of our data analysis. however, the magnitude of such effect is different between china and u.s. because their different economic and political systems. from our analysis, a dollar increase in minimum wage in china would reduce employment rate lower than it does in the u.s.; this indicates that the increase of minimum wage in china has a smaller impact on the decline of employment rate, which may be because china’s demographic structure, national system and enterprise structure are different from those in the united states. this shows that china’s employment may not be sensitive to raising the minimum wage. one explanation could be that china has a large number of stateowned enterprises or companies that are subsidized by the government, and when the cost of employing people increases, these companies are not quite responsive due to the government subsidies. when we divide china into inland and coastal regions, the significant negative duanxiang fu, jianfeng yao 7 correlation still exist between the minimum wage and employment rate in the both regions. however, coastal regions are more responsive to the change of minimum wage, which may indicate different portions of the state-owned companies in these areas. when we divide the time into two periods, before 2008 and after 2008, there is an interesting observation in china: before 2008, an increase of the minimum wage significantly reduces the employment rate, but after 2008, an increase in the minimum wage did not significantly lower the employment rate. this may indicated that, after 2008, due to policy uncertainties in china, there may be the withdrawal of foreign invested enterprises or the enterprises relying on cheap labor, or it may because of the upgrades of domestic industries. some domestic enterprises in china may no longer rely on the labor intensive operations that pay the minimum wage. for the united states, the economy is relatively more stable, and the increase of minimum wage before and after 2008 is always significantly associated with the decrease of employment rate. in addition, for china, after the minimum wage exceeds a certain level, such as 50th percentile, the increase of the minimum wage has no significant impact on the employment rate. it may be because that an increase in the minimum wage has led to an exodus of foreign firms or firms that heavily rely on cheap labor. the remaining firms are less sensitive to the minimum wage. after we introduce the interaction term between foreign direct investment and minimum wage, we also find the effect of raising minimum wage on the employment rate is dependent on and reinforced by the foreign direct investment (fdi) before 2008. however, raising the minimum wage after 2008 had no such significant effect on the employment rate. our estimation would be more accurate if the data for the employment rate of foreign enterprises or domestic enterprises are available. in the future, if we could get county level or individual level data, we would be able to perform more comprehensive analysis. research project key research projects of universities in henan province (no. 18a790019), science and technology project of henan province (no. 172102310710), soft science research project of henan province (no. 192400410200). table 1. summary statistics for china and u.s. 2008-2016 china 2008-2016 u.s. 2008-2016 employment rate 0.661 0.654 (0.361) (0.068) monthly nominal minimum wage 103.420 1176.854 (58.398) (242.712) monthly nominal average wage 375.572 3487.108 (241.017) (593.755) monthly nominal gdp per capita 346.868 3958.465 (272.323) (987.243) monthly real minimum wage 83.224 1183.582 (38.119) (170.007) monthly real average wage 300.829 3477.129 (166.198) (467.893) monthly real gdp per capita 279.592 3978.900 (203.341) (775.008) consumer price index (2009 dollar) 118.436 98.962 (16.076) (11.537) observations 510 504 8 economic analysis (2019, vol. 52, no. 2, 1-11) table 2. summary statistics for china and u.s. before and after 2008 china 2000-2007 china 2008-2016 u.s. 2000-2007 u.s. 2008-2016 employment rate 0.610 0.707 0.668 0.644 (0.389) (0.329) (0.064) (0.069) monthly nominal minimum wage 55.855 145.699 978.575 1335.478 (17.779) (48.573) (158.975) (170.846) monthly nominal average wage 183.188 546.580 3049.328 3793.554 (79.160) (204.877) (392.845) (513.289) monthly nominal gdp per capita 167.408 506.388 3408.004 4398.833 (126.938) (267.831) (776.037) (915.377) monthly real minimum wage 53.425 109.712 1110.457 1242.082 (15.762) (32.128) (171.528) (144.440) monthly real average wage 174.836 412.824 3398.805 3532.236 (71.901) (144.639) (462.507) (464.597) monthly real gdp per capita 160.127 385.784 3851.122 4081.121 (119.929) (203.487) (771.320) (764.038) consumer price index (2009 dollar) 103.933 131.327 88.215 107.560 (4.634) (10.745) (6.094) (6.583) observations 240 270 224 280 table 3. fixed effect estimation for china and u.s. 2000-2016 china u.s. employment log real minimum wage -1.249*** (0.190) -3.524*** (0.700) log real average wage -1.999*** (0.144) -3.234*** (0.625) log real gdp per capita 0.465*** (0.056) 0.229*** (0.023) time trend 0.054*** (0.012) -0.003*** (0.000) interaction between real minimum and average wage 0.249*** (0.032) 0.430*** (0.086) constant -102.671*** (23.596) 30.533*** (5.141) observations 510 476 standard errors in parentheses *p< 0.05, **p< 0.01, ***p< 0.001 duanxiang fu, jianfeng yao 9 table 4. fixed effect estimations for china and u.s. before and after 2008 china<2008 china>=2008 u.s.<2008 u.s.>=2008 employment log real minimum wage -1.514*** (0.508) -0.175 (0.390) -1.382* (0.795) -4.136*** (0.886) log real average wage -2.113*** (0.441) -0.557* (0.306) -1.361* (0.706) -3.839*** (0.788) log real gdp per capita 0.582*** (0.218) 0.252*** (0.051) 0.240*** (0.023) 0.235*** (0.038) time trend 0.002 (0.033) 0.023 (0.014) -0.005*** (0.000) 0.001** (0.000) interaction between real minimum and average wage 0.324*** (0.099) 0.069 (0.066) 0.166* (0.098) 0.508*** (0.109) constant 1.731 (64.704) -46.865* (27.885) 17.697*** (5.784) 26.228*** (6.602) observations 240 270 196 280 standard errors in parentheses *p< 0.1, **p< 0.05, ***p< 0.01 table 5. fixed effect estimation for china and u.s. china median u.s. median employment log real minimum wage 0.298 (0.435) -5.584*** (1.301) log real average wage -0.812** (0.357) -5.139*** (1.132) log real gdp per capita 0.299*** (0.052) 0.232*** (0.028) time trend 0.079*** (0.013) -0.002*** (0.000) interaction between real minimum and average wage -0.021 (0.071) 0.679*** (0.158) constant -159.426*** (26.219) 43.487*** (9.405) observations 258 347 standard errors in parentheses *p< 0.1, **p< 0.05, ***p< 0.01 10 economic analysis (2019, vol. 52, no. 2, 1-11) table 6. fixed effect estimation for coastal and inner provinces all areas coastal areas inner areas employment log real minimum wage -1.249*** (0.190) -1.177** (0.460) -1.011*** (0.215) log real average wage -1.999*** (0.144) -2.429*** (0.349) -1.586*** (0.165) log real gdp per capita 0.465*** (0.056) 0.607*** (0.156) 0.382*** (0.060) time trend 0.054*** (0.012) 0.098*** (0.026) 0.015 (0.014) interaction between real minimum and average wage 0.249*** (0.032) 0.236*** (0.080) 0.229*** (0.036) constant -102.671*** (23.596) -188.518*** (52.063) -26.656 (27.723) observations 510 102 408 standard errors in parentheses *p< 0.1, **p< 0.05, ***p< 0.01 table 7. fixed effect estimation after the control of foreign direct investment 2000-2016 2000-2007 2008-2016 employment log real minimum wage -1.443*** (0.193) -2.636*** (0.500) 0.688 (0.510) log real average wage -2.270*** (0.167) -3.736*** (0.521) 0.442 (0.489) log real gdp per capita 0.417*** (0.053) -0.031 (0.201) 0.234*** (0.051) log real fdi 0.301*** (0.068) 1.100*** (0.171) -0.334*** (0.123) time trend 0.048*** (0.011) 0.042 (0.029) 0.024* (0.014) interaction between real minimum and average wage 0.321*** (0.042) 0.780*** (0.127) -0.157 (0.108) interaction between real minimum wage and fdi -0.039** (0.016) -0.221*** (0.044) -0.078*** (0.029) constant -91.592*** (22.509) -74.800 (56.391) -54.198* (28.299) observations 510 240 270 standard errors in parentheses *p< 0.1, **p< 0.05, ***p< 0.01 reference abowd j.m., kramarz f., margolis d.n., philippon. (2000). the tail of two countries: minimum wages and employment in france and the united states. iza discussion paper no. 203. bureau of labor statistics, united sates department of labor. duanxiang fu, jianfeng yao 11 bureau of population and employment statistics of the national bureau of statistics. china labor statistical yearbook (2004-2016). fabián slonimczyk, peter skott. (2012). “employment and distribution effects of the minimum wage.” journal of economic behavior & organization, 84(1): 245–264. jiao d. (2014). minimum wage in foreign counties. beijing: china labor and social security press. kalenkoski, charlene m, lacombe, donald j. (2013). “minimum wages and teen employment: a spatial panel approach.” papers in regional science, 92 (2): 407-417. labor department. (1993). minimum wage regulations for enterprises. neumark d, w wascher. (1992). “employment effects of minimum and subminimum wages: panel data on state minimum wage laws.” industrial and labor relations review, 46(1): 155181. sabia, joseph. (2014). “the effects of minimum wages over the business cycle.” journal of labor research, 35(3): 227-245. united states congress. fair labor standards act. 1938. wang gx, yao xg. (2014). “the impact of minimum wage on employment in china.” economic theory and business management, 11:16-30. wu, y. (2014). the empirical study of china’s minimum wage employment effect. hangzhou: zhejiang university of finance and economics. yuan lp, li gf. (2007). “the impact of minimum wage system on unemployment rate in china’s labor market.” journal of hunan financial and economic college, 23(109):126-128. article history: received: june 20, 2019 accepted: september 19, 2019 microsoft word 2011_3_4_finalna ver.doc original research paper    studying the effect of foreign direct investment  on economic growth in greater and   traditional middle east countries   behname mehdi*, department of economics of the university of shiraz, iran   udc: 330.322(5‐19);(61)    jel: f21; f43     studija efekta stranih direktnih investicija na ekonomski rast  velikog i tradicionalnog bliskog istoka        abstract  –  this  article  tries  to  study  whether  foreign  investment  in  the  greater  and  traditional middle east leads to economic growth. we have selected 21 countries of this zone for the  time period 1980‐2008. due to lack of endogenous relationship between variables, the two equations  have been estimated separately. fdi affects economic growth directly and  indirectly. indirect effect  means interaction term. infrastructures and economic stability have a special significance in foreign  investment  attraction.  furthermore,  oil  extraction  has  a  positive  effect  on  foreign  investment  attraction and economic growth while technology gap has a negative effect on fdi and gdp variables.    key words: foreign direct investment, economic growth, greater and traditional middle east;  panel data  introduction   after  1980’s,  developing  countries  practiced  some  policies  for  fdi  attraction;  policies  such as giving subsides, decreasing tax, economic stabilization, etc... neoclassical economics  believes that increase of fdi leads to increase of gdp growth per capita. therefore, due to  importance of this criterion, most countries seek to attract fdi today. in the past, foreign  investors were willing to give some advantages for establishing a site in host countries. but  nowadays, everything has changed and it is the host countries which give advantages for  fdi. however, while many studies indicate the positive effect of fdi on gdp, some other  studies prove otherwise. therefore, it seems necessary to conduct this test for the greater  and  traditional  middle  east  countries  in  order  to  find  which  hypothesis  is  true  for  the  middle east.   in this study, effect of fdi on economic growth of the greater and traditional middle  east countries has been studied. the difference of  this study with other studies  is  in  the  statistical sample (greater and traditional middle east) and study of oil extraction effect on  gdp and fdi. oil exporting countries have been considered as dummy variables. the other                                                         * e‐mail: mehdi_behname@yahoo.com; tel‐fax: 00987116276371    economic analysis (2011, vol. 45, no. 3‐4, 35‐43)   36 distinction of this study is its taking into consideration the indirect effect of human capital on  gdp and fdi.   in a recent study of the literature, hanson (2001) concludes that evidence that foreign  direct  investment  generates  positive  spillovers  for  host  countries  is  weak.  aitken  and  harrison’s (1999) in venezuela do not support the positive spillovers hypothesis.  in a review  of  micro  data  on  spillovers  from  foreign‐owned  to  domestically  owned  firms,  gorg  and  greenwood (2002) argued that the effects are mostly negative. borensztein, de gregorio, lee  (1998)  and  xu.,  b.,  (2000)  show  that  foreign  direct  investment  brings  technology,  which  translates into higher growth only when the host country has a minimum threshold of stock  of  human  capital.  lipsey  (2002)  takes  a  more  favorable  view  from  reviewing  the  micro  literature and argues that there is evidence of positive effects.  theoretical issues  until commencement of the globalization process in 1980’s, the developing countries did  not have a positive belief on foreign investment and mostly believed that they had dropped  out the imperialistic from the door but this policy (foreign investment) was trying to enter  from the window. but from 1980’s on, due to abundant advantages of foreign investment in  economy, most of  these countries not only changed  their mind but also sought  to attract  foreign investment by offering attraction policies.   economic growth is one of the indexes very important to all countries of the world and  for growth of which the countries devise many special plans and policies since increase of  economic growth indicates increase of social welfare and increase of the country’s economic  development in long term. in economics, many variables are effective on economic growth;  for instance technology, physical capital, human capital, etc..     meanwhile,  foreign capital  is one of  the variables which bring  the  mentioned growth  under its effect.   foreign  investment  may  affect  economic  growth  in  two  direct  and  indirect  ways.  its  direct effect is that foreign investment increase the level of production, employment, added  value and export. these factors directly increase gdp; for instance, employment increases  the individual’s income and this income increment is directly calculated in gdp. likewise is  for added value and export. on the other hand, foreign investment increases gdp indirectly  as well; for  instance, transition of technology, knowledge and know‐how through  license,  imitation  and  job  training.    besides,  externalities,  technology  spillover,  human  capital  formation,  efficiency  and  productivity  are  the  factors  which  indirectly  increase  gdp  in  economic growth.   in  regard  to  the  relationship  between  fdi  and  economic  growth,  it  is  believed  in  neoclassical economics that fdi only have effects on the level of gdp per capita yt/popt and  not on the rate of economic growth yt – y 1−t  /y 1−t . it means that fdi is not the economic  growth  engine  in  long  term.  in  contrast,  in  the  modern  theory  of  economic  growth  it  is  believed  that fdi affect the  level of production per capita and economic growth (nuzhai  falki, 2008).   although  many of  the  theories  indicate  that fdi  results  in  economic growth  through  some  factors  such  as  transition  of  technology,  technology  spillover  and  increase  of       behname m., studying the effect of fdi, ea (2011, vol. 45, no, 3‐4, 35‐43)   37 productivity, there are other theories which take opposite position. the later theories forecast  that fdi is harmful to resource allocation at presence of preexisting trade, price and other  financial disorders and it decreases economic growth (boyd and smith, 1992). this case is  mostly observed in developing countries. but the main problem of such countries may be in  their weak economic structure; for instance, improper infrastructures, weak human capital,  traditional  and  old  technology,  etc.,  which  does  not  provide  the  capability  required  for  attracting advanced technology and knowledge.   methodology  heterogeneous unit root test     to conduct co‐integration test for the panel data like time series data it is necessary to  perform stationarity test. of course, it should be taken into consideration that panel unit root  test has higher power than time series unit root test.  in order to consider unit root in panel data, the following autoregressive model can be  used:  yit = ρ i yit‐1 + δi xit + ε it                  (1)  where i = 1, 2, …, n indicates the countries and t = 1, 2, …, t stands for time. xit indicate the  exogenous variables,  ρ i indicates autoregressive coefficient, and ε i is the error term. if �pi�  ≤ 1,  ∀ i, the considered series is stationary , and if �pi�= 1, yi has unit root. llc, brt and  hardi unit root tests suppose that  ρ i =  ρ ,∀ i. in this scenario, yit‐1 coefficient is used for all  homogeneous  cross  ‐section.  but  ips  and  fisher  tests  are  conducted  with  supposition  of  heterogeneous coefficient meaning ρ i (costantini, martini, 2010).   since the economic structures of the greater middle east countries are independent from  each other, we use ips test.   im, pesaran test for every sample of cross‐ section data is as follow:   it p j jitijitiiit i yyy ερβα +δ++=δ ∑ = −− 1 1             (2)  where ρ i is the number of lags in adf regression.    the zero and alternative hypotheses are as follow:                                                                  (3)    model   the  model  selected  for  studying  the  effect  of  fdi  on  economic  growth  is  the  model  developed by alfaro et al., (2004), durham, (2007), which is   ⎩ ⎨ ⎧ = ∀= ioneleastatfor sisomefor h h i i ii 0 '0 : ,0: 1 0 pβ β β    economic analysis (2011, vol. 45, no. 3‐4, 35‐43)   38 itititititit xhumfdiyy εβββββ +++++= − 432110  (1)         (4)  where i  is the country’s index, t  is the time index, y in the logarithm of real gdp per capita,  fdi is foreign direct investment, hum is human capital and x is the vector of other variables  which have effect on economic growth  including  inflation,  infrastructure  (telephone  line),  capital formation, population growth, technology gap, dummy variables or interactions.    technology  gap is gapit = yimax – yit / yit where gdp per capita of iran country has been  considered as the maximum gdp. inflation can be a proxy for economic stability (barro and  sala‐i‐marin, 2004, p.520). number of telephone lines has been used as infrastructure proxy.  the coefficients of human capital, infrastructure, and fixed capital formation are expected to  be positive since these variables attract foreign investment.     since we consider the model to be endogenous, the following equation indicates the  effect of growth on fdi:  itititititit xhumfdiyfdi μααααα +++++= − 432110         (5)  results and data  data  the data set includes 21 countries of greater and traditional middle east throughout the  period 1980‐2008.   the data required for fdi has been collected from unctad, imf and world investment  report. the national accounts data such as growth per capita and inflation has been collected  from growth data resources. number of telephone lines, human capital, population, etc.,  have been collected from undata, wdi, undata and the world bank group.   the  reason  why  we  have  selected  the  middle  east  countries  as  samples  is  that  the  economic  structure  of  such  countries  is  almost  similar  and  they  are  among  developing  countries. the mentioned time period has been selected because of accessibility to data. to  study the effect of oil extraction on attraction of foreign investment and economic growth,  we consider two groups of dummy variables: first, oil exporting countries member of the  middle east and the non oil exporter countries. if a country is included in the oil exporting  group,  the  dummy  variable  is  equal  to  one  for  this  country  and  equal  to  zero  for  other  countries.  empirical results  having  conducted  durbin‐wu‐hausman  endogenous  test  (augmented  regression  test  which is referred to as dwh), we came to the conclusion that the data related to the time  period 1980‐2008 had not been endogenous; but fdi and gdp variables were endogenous  for the time period 1983‐2008; it is why we have selected the first period as the time period,  but with the single equation.       behname m., studying the effect of fdi, ea (2011, vol. 45, no, 3‐4, 35‐43)   39 unit root  before  estimating  panel  data  model,  unit  root  test  is  to  be  performed  for  variables’  stationarity and avoiding spurious regression. in this study, we use im, pesaran, shin test for  unit root, the results of which have been presented in table (1).     table 1. unit root test of panel data(1980‐2008)    gdp  growth  fdi  inflow  pop  growth  inflation  rate  telephone  line  hum  capital  cap  growth  gap  technology  ‐2.99*  ‐8.13*  ‐4.32*  ‐3.81* ‐2.39* ‐4.32* 3.13*  5.13*  * the variables are stationary at the 5% confidence level    the results indicate that all variables are stationary at the 5% confidence level and we are  not led to spurious regression. hausman test is used for selecting fixed effects and random  effects model and indicates that random effects model is acceptable.   the  results  related  to  equation  (1)  have  been  presented  in  table  (2).  column  1  has  considered all variables except fdi. all variables’ sign accord with the theory. increase of  physical and human capital leads to increase of economic growth. technology gap causes  decrease  of  national  production.  coefficients  of  inflation  and  telephone  variables  are  not   significant. negative coefficient of population indicates that gdp per capita is decreased by  population increase.   in  the  second  column,  we  also  add  fdi  to  the  model.  results  indicate  that  fdi  has  positive effects on economic growth. in column 3, we enter dummy variables which indicate  the  effects  of  oil  on  gdp.  oil  export  increases  economic  growth.  in  column  4,  we  have  entered  the  interaction  of fdi  ×human  capital which  indicates  the  positive  effect of  this  variable on economic growth.    table 2. gdp growth is dependent variable (1980‐2008)    (1)  (2)  (3)  (4)  constant  4.2  3.13  5.13  11.21  (1.3 1)  (1.12)  (0.37)  (2.01)**  population growth  ‐0.29  ‐0.36  ‐0.38  ‐0.42  (‐2.32)**  (‐1.12)  (‐2.11)**  (‐2.13)**  capital growth   0.31  0.21  0.51  0.72  (8.21)***  (4.21)***  (4.44)***  (5.32)***  human capital    1.21  0.29  0.49  0.33  (2.32)***  (6.31)***  (5.49)***  (3.92)***  telephone line  0.53  0.36  0.42  0.51  (0 .32)  (0.71)  (2.04)**  (0.72)  inflation  0.32  0.41  0.37  0.21  (0.18)  (0.19)  (2.09)**  (0.13)  technology gap   ‐0.19  ‐0.34  ‐0.37  ‐0.12  (2.14)**  (‐3.71)***  (‐3.90)***  (‐0.12)  fdi     0.071  0.18  0.03     economic analysis (2011, vol. 45, no. 3‐4, 35‐43)   40   (4 .37)***  (5.31)***  (2.01)**  oil exporting dummy      0.35  0.32      (2.29)**  (0.71)  non oil exporting dummy      0.41  0.51      (0.35)  (0.32)  fdi x human capital         0.51        (2.01)**        ** significant at the 5% level;         *** significant at the 5% level       values in parentheses are t‐statistics    table  3  presents  the  results  of  the  second  equation.  gdp  growth  has  a  positive  and  significant effect on fdi since foreign investors seek a high purchase power for selling their  products. inflation rate and technology gap have negative effects on fdi flow. availability of  human capital is considered to be a positive factor for foreign investors. likewise it is for the  interaction of gdp and human capital. equation estimation indicates that availability of oil is  a proper motivation for doing investment.    table 3. fdi inflow is dependent variable (1980‐2008)    (1) (2) (3) constant  ‐3.27 ‐6.39 ‐9.25 (‐3.21)*** (‐4.21)*** (‐4.37)*** gdp growth  0.012 0.09 0.71 (4.37)*** (4.55)** (3.35)*** human capital    0.04 0.15 0.21 (2.01)** (2.22)** (3.35)*** inflation  ‐0.12 ‐0.17 ‐0.35 (‐2.12)** (‐1.2) (‐2.01)** telephone line  0.32 0.53 0.81 (2.01) (2.90)*** (3.39)*** technology gap   ‐0.39 ‐0.55 ‐0.77 (‐0.25) (‐2.08)** (‐0.35) oil exporting dummy  0.71 0.82 (5.31)*** (4.51)*** non oil exporting dummy  0.02 0.02 (0.21) (0.22) fdi x human capital   0.35 (2.55)**                    ** significant at the 5% level                     *** significant at the 1% level                    values in parentheses are t‐statistics       behname m., studying the effect of fdi, ea (2011, vol. 45, no, 3‐4, 35‐43)   41 conclusion  in this research we studied the effects of fdi on economic growth for the greater and  traditional middle east countries during the period 1980‐2008. the test results indicate that  the  two  variables  gdp  and  fdi  are  endogenous  only  for  the  period  from  1993  to  2008.  therefore, we have used two equations separately for the entire sample. this study indicates  that  there  is  a  strong  complementary  relationship  between  gdp  and  its  interaction  with  human capital and fdi. likewise  is  for  interaction of fdi with human capital and gdp.  effects of technology gap and inflation on fdi attraction are negative, meaning the investors  select  those  countries  for  investment  which  have  higher  technologies  and  more  stable  economy.  oil  exploitation  has  positive  effects  on  gdp  and  foreign  investment  attraction  since investors can easily reach an important raw material.   policymakers  should  make  clear  policies  with  regard  to  the  variables  important  for  investors. policymakers have to pay special attention to economic stability due to the fact  that  economic  instability  is  a  negative  criterion  for  an  investor.  due  to  the  positive  relationship between gdp and fdi as well as the relationship between fdi and technology  and infrastructures, the increase of the later variables’ level should be taken into account in  host countries because promotion of technology and improvement of infrastructures attract  foreign investment, and the fdi itself leads to increase of gdp and social welfare, a criterion  sought by all economists.   *  the  greater  middle  east  is  a  political  term  coined  by  the  bush  administration  to  englobe  together  various  countries,  pertaining  to  the  muslim  world.  the  countries  are  turkey, bahrain, kuwait, oman, qatar, saudi, united arab emirates, iraq, jordan, lebanon,  syria, iran, egypt, pakistan, algeria, mauritania, libya, morocco, tunisia, sudan, somalia.  references  aghion, p., d. comin, and p. howitt.,  (2006). “when does domestic saving matter  for economic  growth?”, nber working paper 12275.  agosin, mr., and ricardo mayer., (2000)“foreign investment in developing countries: does it crowd  in domestic investment?”, unctad discussion paper no 146, geneva: unctad.  ahmad  m.h.,  alam  s.  and  butt  m.s.,  (2003)“foreign  direct  investment,  exports,  and  domestic  output in pakistan”, the pakistan development review 42:4 pp. 715‐723  aitken, b. j., and a. harrison., (1999) “do domestic firms benefit from direct foreign investment?  evidence from venezuela”, american economic review 89: 605‐618.  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shabbir t., and mahmood a., (1992)”the effects of foreign private investment on economic growth  in pakistan”, the pakistan development review 31:4 pp.831‐841  tallman, s., (1988) “home country political risk and foreign direct investment in the united states”,  journal of international business studies, 19(2): 219‐233.  the world bank group., www.worldbankgroup.org  the world bank., www.data.worldbank.org  unctad., www.unctad.org  weil, d., (2004), economic growth. boston: addison‐wesley.  wheeler,  d.  and  a.  mody.,  (1992)  “international  investment  location  decisions:  the  case  of  us  firms”, journal of international economics 33: 57‐76.  xu,  b.,  (2000)  “multinational  enterprises,  technology  diffusion,  and  host  country  productivity  growth”, journal of development economics 62, 477‐493.        apstrakt  ‐  ovaj  rad  pokušava  da  pruči  da  li  strane  direktne  investicije  u  velikom  i  tradicionalnom bliskom istoku dovode do ekonomskog rasta. u radu su analizirane 21 zemlje u ovoj  zoni u periodu od 1980‐2008. godine. zbog nedostatka endogenih veza između varijabli, dve jednačine  su  procenjivane  odvojeno.  uticaj  sdi  na  ekonomski  rast  direktno  i  indirektno.  indirektni  efekat  podrazumeva    interakciju  uslova.  infrastuktura  i  ekonomski  stabilnost  imaju  poseban  značaj  za  privlačenje stranih  investicija. osim toga, ekstrakcija ulja  i ekonomski rast  imaju takođe pozitivan  efekat na privlačenje stranih investicija dok tehnološki nedostatak ima negativne efekte na sdi i gdp  varijable.  ključne  reči:  strane  direktne  investicije,  ekonomski  rast,  velika  britanija  i  tradicionalni  bliski istok, panel podataka        article history:  received:  21 november 2011  accepted:  12 december 2011          microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp13-23 original scientific paper intentions to smoking cessation in the time of covid-19: evidence from serbia jovan zubović1* | aleksandar zdravković1 | olivera jovanović1 1 institute of economic sciences, belgrade, serbia abstract in this study, we examine whether the outbreak of pandemic has given incentive to smoking cessation and which factors are associated with such intentions, emphasizing change of economic conditions and smoking habits in the time of covid-19. data were collected through a telephone survey among a representative sample of the serbian adult population aged less than 65 years (n=1,002) from 11 to 19 may 2020. the current smokers reported whether the covid-19 pandemic had changed their tobacco products consumption, disposable income and intentions to cease smoking. among the current smokers, 26.3% reported that the covid-19 pandemic triggered intentions to cease smoking. on the other hand, 42.4% of smokers reported a decrease in income, while 22.7% of smokers reported increased smoking during the covid-19 pandemic. logistic regression reveals that occasional smokers are the most likely to stop smoking (or 4.17; ci: 2.18 7.99), while the majority of other factors (socio-demographic, economic, smoking habits) do not influence the odds of smoking cessation. lack of association between intentions to cease smoking and pandemic-related worsening of economic well-being might result from low cigarette prices in serbia. consequently, higher taxation of tobacco products is recommended to policymakers. keywords: smoking cessation, smoking habits, covid-19, serbia jel classification: e20, h20, c13 introduction the outbreak of the covid-19 pandemic and the follow-up containment measures have had severe outcomes on the population's mental health. a harsh impact of the epidemic on the population's mental health has been evidenced even before the outbreak of the covid-19 pandemic in studies examining the effects of the sars 2002-2004 epidemic (schäfer et al. 2020). an early covid-19 meta-analysis reveals that participants in the studies on threats posed by the pandemic frequently reported anxiety and depression (16%-28%) and stress (8%) as common psychological reactions to pandemic (rajkumar, 2020). the latter cross-country systematic overview of the effects of the pandemic on the general population reported high rates of symptoms of anxiety (6.33%-50.9%), depression (14.6%-48.3%), post-traumatic stress disorder (7%-53.8%), psychological distress (34.43%-38%), and stress (8.1%81.9%) (xiong et al. 2020). in addition to the pandemic's health-related concerns, the containment measures posed a serious threat to the population's economic well-being, following a sharp decline in economic activity. a downfall in economic activity reduced demand for working hours; for instance, estimated total working-hour losses in the second quarter of 2020 equals 495 million full-time jobs (ilo, 2020), endangering prospective long-term employment preservation. besides, the * corresponding author, e-mail: jovan.zubovic@ien.bg.ac.rs 14 economic analysis (2021, vol. 54, no. 1, 13-23) estimated loss of labour income during the first three quarters of 2020 amounts to us$3.5 trillion (ilo, 2020). smoking cessation under the threat of covid-19 is beneficial, as the evidence suggests that smoking cessation for four weeks or more is likely to reduce the risk of developing covid-19 and respective severe covid-19 complications (eisenberg & eisenberg, 2020). empirical research on the impact of covid-19 outcomes on smoking habits is still in progress; results are mixed and vary across countries:  france: the number of smokers who increased tobacco consumption (27%) exceeded the number of smokers who reduced smoking (19%). the increase in consumption is associated with participants 25-34-year-old (41%) and those who work at home (37%) (santé, 2020).  italy: smokers reported a reduction in tobacco consumption (especially those who smoke 5-10 cigarettes per day), while 3.3% of them quit smoking (di renzo et al, 2020). however, this survey was not implemented on a representative sample (76.1% females), so the results' reliability is limited.  the netherlands: stress appears to be associated with smokers who reported an increase (18.9%) and a decrease (14.1%) in tobacco consumption. also, the number of smokers who believe that during pandemic smoking cessation has got more difficult (24.7%) considerably exceeds the number of those who believe opposite (6.4%) (bommelé et al, 2020).  spain: the number of smokers, especially during the first week of lockdown, was reduced by four percentage points (from 13.9% to 9.9%). the health concern was the main reason for smokers to quit (lópez-bueno et al, 2020). however, the survey was not representative (the average age of participants in the sample is lower than in the population), so the results should be interpreted carefully.  poland: almost every second smoker reported an increase in smoking intensity after the pandemic declaration (45.2%), while 40% of them did not change smoking intensity. the results also showed the absence of the relationship between demographic characteristics and the changes in smoking intensity during pandemics (sidor & rzymski, 2020). like others, this survey was not representative (95% of respondents were women).  united states: most smokers (both manufactured and electronic cigarette) reported an increase in motivation to quit smoking (35.6% and 37.6%, respectively). the main reason was health concerns. however, significantly lower numbers reported an attempt to quit (22.9% of manufactured cigarettes and 21.2% of electronic cigarette smokers). on the other hand, tobacco use changes were similar across smokers and positively correlated (30.3% of manufactured cigarette smokers and 29.1% of electronic cigarette users reported increased tobacco consumption) (klemperer et all, 2020).  pakistan: since covid-19 pandemic, 14% of smokers (n=2,062) reported quitting. among other respondents who continue to smoke, 68% reduced, while 18% increased tobacco consumption. smokers were motivated to quit smoking more during the pandemic than before (41% of those who continue to smoke), while 21% were less motivated to quit. the survey was not representative, and it represents a longitudinal study on the same respondents covering the period before the pandemic start (september 2019, february 2020) and the period after (may 2020) (siddiqi et al, 2020).  turkey: results suggest that the covid-19 outbreak effectively reduced the smoking prevalence of the patients admitted to the smoking cessation clinic; 46.2% of patients who started smoking again or never stopped smoking quitted smoking in fear of covid19 (tetik et al, 2020). jovan zubović, aleksandar zdravković, olivera jovanović 15 regarding the high prevalence of tobacco use in serbia (37.9% in 2019), we recognized the need to research smoking habits during the pandemic caused by the covid-19 virus. in this study, we examine whether an outbreak of pandemic and follow-up containment measures have given incentive to smoking cessation and which factors are associated with such intentions, with particular emphasis on change of economic conditions and smokers' smoking habits in the time of covid-19. methods survey this survey is an extension of a national representative survey of tobacco products consumption in southeastern europe in serbia (lawless, 2015), which was implemented within the regional project "accelerating progress on effective tobacco tax policies in low-and middleincome countries" in cooperation with the university of illinois chicago and bloomberg foundation. it was motivated by the urgent need to maintain continuous records of the smoking habits under the changed health and economic circumstances posed by the pandemic, so the original questionnaire was adjusted to include several questions related to the pandemic. we conducted a telephone survey among a representative sample of the serbian adult population aged less than 65 years (n=1,002), including both smokers and non-smokers. the survey was conducted from 11 to 19 may 2020, 5 days since the government of serbia has declared an end of the state of emergency and abrogated all containment measures. variables the questionnaire used in the survey collected information on: (1) socio-demographic variables, including gender, age, education, and settlement characteristics. level of education is measured using official educational grading, but for research, it was categorized into three groups: primary (up to eight years of schooling), secondary (up to 12 years of schooling) and tertiary (15 or more years of schooling). similarly, age was grouped into four categories: 18-24, 25-34, 35-44, 45-65. variable type of settlement reflects whether the respondent's residence location is located in an urban or rural area. (2) economic variables, which depict the financial security of respondents. in particular, two variables are used: employment status and change of income since the outbreak of the pandemic. employment status reflects the overall financial security. it is measured by the official ilo classification of employment status, which is reclassified for research into three categories: full-time (ft) employed, non-ft employed and unemployed. prior expectations are that the unemployed are the most vulnerable to pandemic economic impact and, therefore, the most encouraged to quit smoking. change of income reflects whether financial security had improved or worsened due to implemented containment measures. the three options measure it: increased, did not change and decreased; the first two options are merged, following the aim of research to test expectations that worsening of financial security, in particular, stimulate intentions to cease smoking. (3) general smoking habits, i.e., whether a person is a smoker and if so, how frequently and what type of tobacco product consumes. a variable "smoking frequency" is defined to make a distinction between frequent and occasional smokers, whereby a smoker is regarded as a regular if consumes some tobacco product every day or occasional if does not consume it on an everyday basis. it is reasonable to assume that occasional smokers are more likely to cease smoking under severe circumstances. tobacco products used by smokers are classified into manufactured cigarettes, rolled cigarettes, and others. 16 economic analysis (2021, vol. 54, no. 1, 13-23) the category of other tobacco products encompasses predominantly vaping products such as e-cigarettes and heated tobacco. there are no prior expectations on the impact of this variable on intentions to quit smoking. still, the expensiveness of the manufactured cigarettes might be considered as an incentive to stop smoking. (4) impact of pandemic and related containment measures on current tobacco consumption and intentions to quit smoking. accordingly, three variables are specified in respect of pandemic outbreak: change in tobacco products consumption, switch to less expensive tobacco brands/products and intention to cease smoking. the questionnaire offers three options for response to tobacco product consumption changes: smoke more, same or less. the same or fewer options are merged since we were particularly interested in testing expectations that increased level of tobacco products consumption raises health concerns and stimulates smoking cessation. to assess whether economic worsening motivated smokers to spend less money on tobacco products, participants were asked if they have switched to less expensive tobacco brands or products. eventually, three options were available to smokers to state whether pandemic makes them think about smoking cessation: yes, no and already ceased but started again. similarly, the last two options are merged as they both reflect respondents' unwillingness to quit smoking. the level of significance was set at p≤0.05. descriptive statistics were used for presenting the socio-demographic and economic characteristics and smoking habits of the survey participants who are current smokers. differences in intentions to cease smoking (since pandemic outbreak) across different categories of smokers were assessed using the chi-squared test. a multinomial logistic regression model was fitted to evaluate associations of smokers' characteristics and smoking habits (predictors) and their intentions to quit smoking (dependent). the logistic regression results are presented as odds ratios (or) with 95% confidence intervals (ci). a p-value <0.05 indicates statistical significance. the analysis was performed using stata version 13.0. results the current smokers make up 40.9% of the total sample (n=410). the share of female smokers (53%) slightly exceeds the share of male smokers. almost half of the current smokers (47.3%) are aged 45-65 years. most of the smokers are secondary educated (57.6%) and live in urban areas (71%). also, smokers are predominantly full-time employed (51%). gender, age, employment, and type of settlement structures of current smokers subsample corresponds to respective structures of the full sample, whereas education structure is slightly different – the share of smokers with primary or secondary education is somewhat higher. most smokers consume tobacco products on an everyday basis (84.6%). manufactured cigarettes are the most frequently consumed type of tobacco products (81.7%). overall, 42.4% of the current smokers reported a decrease in income during the covid-19 state of emergency. around 23% of smokers reported an increase in the consumption of tobacco products since the pandemic outbreak. only 5.5% of smokers switched to less expensive tobacco brands or products. eventually, the pandemic made 26.3% of smokers think about quit smoking (table 1). jovan zubović, aleksandar zdravković, olivera jovanović 17 table 1. characteristics of serbian smokers (n=410) variables n (%)* socio-demographic gender female 217 (52.9) male 193 (47.1) age 18-24 45 (10.9) 25-34 81 (19.8) 35-44 90 (22) 45-65 194 (47.3) education primary 18 (4.4) secondary 236 (57.6) tertiary 156 (38.1) type of settlement rural 119 (29) urban 291 (71) economic employment status ft employed 205 (50.9) non-ft employed 43 (10.7) unemployed 155 (38.5) income change since covid19 pandemic higher or same 235 (57.6) lower 173 (42.4) smoking habits smoking frequency regular 347 (84.6) occasional 63 (15.4) tobacco product consumed cigarettes 335 (81.7) tobacco (cut) 57 (13.9) other 18 (4.4) the intensity of smoking since the covid-19 pandemic less than before 48 (11.7) same than before 268 (65.5) more than before 93 (22.7) switch to less expensive tobacco brands/products no 361 (94.5) yes 21 (5.5) intention to cease smoking no 302 (73.7) yes 108 (26.3) * missing values not counted. the chi-squared analysis shows no significant difference between those smokers who have started to think about quit smoking during the pandemic and those who have not, concerning variables expected to have predictive power: socio-demographic and economic characteristics and smoking habits. the only two exemptions are associations of intentions to cease smoking with gender and smoking frequency, as indicated by the significance of the chi-squared test at the 5% level (table 2). table 2. association between smokers' characteristics and smoking habits with intentions to cease smoking. variables intention to cease no yes chi-sq socio-demographic gender female 43.9 9.0 20.51* (0.00) male 29.8 17.3 age 18-24 8.5 2.4 3.52 (0.32) 25-34 13.7 6.1 35-44 17.6 4.4 45-65 33.9 13.4 18 economic analysis (2021, vol. 54, no. 1, 13-23) variables intention to cease no yes chi-sq education primary 3.7 0.7 4.23 (0.12) secondary 40.2 17.3 tertiary 29.8 8.3 type of settlement rural (ref) 20.5 8.5 0.81 (0.37) urban 53.2 17.8 economic employment status ft employed 37.7 13.2 0.35 (0.84) non-ft employed 7.4 3.2 unemployed 28.3 10.2 income change since covid-19 pandemic higher or same 42.9 14.7 0.25 (0.62) lower 30.6 11.8 smoking habits smoking frequency regular 65.6 19.0 17.37* (0.00) occasional 8.1 7.3 tobacco product consumed cigarettes 59.5 22.2 1.08 (0.58) tobacco (cut) 10.5 3.4 other 3.7 0.7 the intensity of smoking since the covid-19 pandemic less or same than before 58.1 19.3 1.45 (0.23) more than before 15.6 7.1 * p<0.05 multinomial logistic regression analysis confirms the results of chi-squared test results that intentions to cease smoking during the pandemic have been associated only with gender and smoking frequency. regression results show that male smokers have three-time higher probability to start thinking about quit smoking relative to female smokers (or=3.10; 95% ci: 1.91 5.04, p<0.001). the smokers who reported occasional consumption of tobacco products are even more likely to stop smoking during the pandemic (or=4.17; 95% ci: 2.18 7.99, p<0.001) compared with regular smokers (table 3). table 3. results of logistic regression variables indicator or (95% ci) socio-demographic gender female (ref) male 3.10* (1.91 5.04) age 18-24 (ref) 25-34 1.39 (0.55 -3.51) 35-44 0.96 (0.36 2.58) 45-65 1.45 (0.59 3.53) education primary (ref) secondary 1.88 (0.54 6.57) tertiary 1.09 (0.30 3.97) type of settlement rural (ref) urban 0.91 (0.55 1.50) economic employment status ft employed (ref) non-ft employed 1.35 (0.59 3.08) unemployed 1.04 (0.61 1.78) income change since covid19 pandemic higher or same (ref) lower 1.12 (0.68 1.84) smoking habits jovan zubović, aleksandar zdravković, olivera jovanović 19 variables indicator or (95% ci) smoking frequency regular (ref) occasional 4.17* (2.18 7.99) tobacco product consumed cigarettes (ref) tobacco (cut) 0.74 (0.37 1.47) other 0.37 (0.08 1.57) the intensity of smoking since the covid-19 pandemic less or same than before (ref) more than before 1.15 (0.66 – 1.99) note: dependent variable is: intention to cease smoking since the pandemic outbreak. * p<0.05 discussion theoretical expectations about the impact of pandemic outcomes on smoking habits depend on which dimension is considered: stress or economic well-being. a strong positive association between level of stress and nicotine withdrawal (lawless et al, 2015; kassel et al, 2003; stubbs et al, 2017; siegel et al 2017) or ptsd and smoking (lande, 2018) has been observed, while depressed smokers reported greater difficulty in quitting tobacco consumption (siegel et al, 2017; ho et al, 2019). consequently, issues with stress posed by the pandemic can be considered an incentive for smokers to increase smoking levels. on the side of economic well-being, loss of jobs and reduced incomes should work in the opposite direction toward a decline in smoking prevalence since the positive association between smoking and income is well documented in numerous studies on tobacco products' income elasticity (john, 2005; peng & ross, 2009; yürekli et al, 2010; tarantilis et al, 2013; zubović et al, 2018; jovanović et al, 2018, gjika et al, 2020). however, loss of income and uncertainty about future financial well-being is also a stress booster that can outrun financial incentives to decrease or quit smoking if the population perceives the loss of income as a temporary and short-term outcome of containment measures. the overview of the previous studies on the changes in smoking preferences and motivation to cease smoking since the covid-19 pandemic outbreak shows mixed findings across countries. for instance, smokers in countries heavily affected by the fast-spreading of covid disease, especially at the beginning of the pandemic, reported a reduction in smoking prevalence, like in italy (di renzo et al, 2020) and spain (lópez-bueno et al, 2020), or increased motivation to quit smoking like in united states (klemperer et al, 2020) and turkey (tetik et al, 2020). additionally, in such countries, covid-related health concerns appear as an important factor in reducing smoking prevalence (lópez-bueno et al, 2020; klemperer et al, 2020). the opposite case is poland, where containment measures successfully suppressed the initial spreading of disease, so the reported increase in smoking is likely the effect of quarantine-related stress (sidor & rzymski, 2020). most of the existing studies about the effects of the covid-19 pandemic on smoking habits examined associations with standard socio-demographic characteristics, health-related concerns, and individuals' motives. nevertheless, such studies neglect that smoking prevalence is not driven only by health concerns but also by economic concerns. the present study relies on our previous research on tobacco control policies in serbia, which indicates the association of smoking prevalence with smokers' income (vladisavljević et al, 2019). serbia was among the countries wherein very harsh containment measures with full lockdowns were applied after the pandemic outbreak. the measures effectively preserved public health (low number of diseases and deaths) but at a high price in lost income. indeed, 42.4% of smokers reported a decrease in income during the pandemic. the fear of pandemic outcomes also posed stress to individuals, being a likely cause of increased smoking, as reported by almost a quarter of current smokers (22.7%). the cross-country differences in findings on impact that pandemic has had on smoking prevalence are likely subjected to the cross-country differences in severity of pandemic effects 20 economic analysis (2021, vol. 54, no. 1, 13-23) (number of covid-19 decease and death cases), whereas mixed results on reactions of individual smokers to pandemic within a single country make identification of predictors more challenging. the survey results reveal that the covid-19 pandemic has motivated smokers in serbia to stop smoking. among the current smokers, 26.3% reported that the pandemic outbreak triggered intentions to cease smoking. opposite to our prior beliefs, logistic regression analysis did not confirm the association of intentions to cease smoking with a change in income (a proxy for financial well-being; or=1.12; 95% ci: 0.68 1.84; p=0.638) or change in intensity of smoking (a proxy for individual exposure to stress; or=1.15; 95% ci: 0.66 – 1.99; p=0.602). furthermore, logistic regression analysis reveals that occasional smokers are the most likely to stop smoking (or 4.17; ci: 2.18 7.99; p<0.001), while most socio-demographic factors (apart from gender) do not influence the probability of smoking cessation. this is expected since occasional smokers are less addicted to nicotine and typically smoke on occasions of social gatherings that were banned during the lockdown. gender is the only socio-demographic predictor found to be significant, as male smokers appeared to be more motivated to quit smoking (or=3.10; 95% ci: 1.91 5.04, p<0.001), which is in line with findings from previous empirical research on smoking cessation (lawless et al, 2015; siegel et al, 2017). lack of predictive power of socio-demographic characteristics in explaining variations of smoking habits during the pandemic is also observed in poland (sydor & rzymski, 2020), wherein the epidemic situation was like in serbia. the lack of association between intentions to cease smoking and stress-related increase in smoking is intriguing but not surprising as the previous research also shows that stress posed by the covid-19 pandemic has a mixed effect on motivation to quit smoking (bommelé et al, 2020). lack of association between intentions to cease smoking and worsening of financial well-being might be the consequence of the fact that prices of tobacco products are among the lowest in europe: the average weighted price in serbia in 2018 stood at €2.05 per pack, compared with the eu-28 average of €4.8. (vladisavljević et al, 2020). as reads in table 1, only 5.5% of smokers switched to less expensive tobacco brands and products, although 42.4% of smokers reported a fall in income. such results impose important policy recommendations that serbia's tobacco products need to be more heavily taxed, regardless of the pandemic. this is particularly important, as an increase in tobacco products' price in 2020 was among the lowest in the last 20 years (zubović et al, 2020). the survey's timing is a research limitation since the survey was conducted a couple of days after the termination of harsh containment measures when most of the population perceived that the pandemic is about to over and everything will get back to normal. bearing in mind that a new wave of the pandemic in europe has emerged since autumn 2020, we plan to conduct a new round of the survey after pandemic stabilization. conclusion covid-19 pandemic and respective containment measures severely affected public health and economic well-being and boosted current smokers' intentions to cease smoking. lower nicotine dependence appears as the most significant factor of the intentions to quit smoking during a pandemic. female smokers are less likely to quit smoking, in line with general findings that smoking cessation is gender sensitive. research results suggest that as much as 26.3% of all smokers showed intentions to quit smoking as result of pandemic outbreak. this is not a result of reduced income and increased stress, but rather of other factors, like health awareness. more prone to quitting are occasional smokers, mostly due to lower exposure to addiction. lack of association between intentions to cease smoking and pandemic-related worsening of economic well-being might result from low cigarette prices in serbia. jovan zubović, aleksandar zdravković, olivera jovanović 21 using different non-price measures, policymakers can inform smokers and non-smokers about harmful effects of all tobacco products. special attention should be dedicated to heated tobacco products and narghiles. policymakers in serbia should strengthen the control the implementation of law on tobacco during the time of the pandemic. increased intention of smokers to quit should be used as a signal that there is a need to promote tobacco control measures. consequently, higher taxation of tobacco products is recommended to policymakers as a tool that has been proven as most effective single control measure (vladisavljević et al, 2020; zubović et al, 2020). policy of higher taxation and subsequent drop in affordability of tobacco products will most likely restore expected significance of relationship between variations in income and smoking cessation preferences of individuals. acknowledgements this paper is a result of the research financed by the ministry of education, science and technological development of the republic of serbia. references bommelé, j., hopman, p., walters, b. h., geboers, c., croes, e., fong, g., quah, a., & willemsen, m. 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(2010). the economics of tobacco and tobacco taxation in turkey. https://www.who.int/tobacco/en_tfi_turkey_report_feb2011.pdf. uploaded september 2010. accessed december 10, 2020. jovan zubović, aleksandar zdravković, olivera jovanović 23 zubović j, ljumović i, jovanović o, bodroža d, domazet i, vladisavljević m, et al. (2018) economics of tobacco and tobacco taxation. regional study albania, bosnia-herzegovina, croatia, kosovo, macedonia, montenegro, and serbia. http://tobaccotaxation.org/cms_upload/pages/files/192_regional_study_see_2018.pdf. published december 2018. accessed december 10, 2020. zubović, j., jovanović, o., đukić, m., jolović, n., & vladisavljević, m. (2019). adult tobacco consumption in serbia. retrieved december 10, 2020, from http://tobaccotaxation.org/cms_upload/pages/files/201_srb_report.pdf zubović, j., đukić, m., & jovanović, o. (2020). ekonomski aspekti kontrole duvana i empirijski nalazi u srbiji [economic aspects of tobacco control and empirical evidence from serbia]. institute of economic sciences, belgrade. article history: received: may 13, 2021 accepted: may 24, 2021 microsoft word 2009_1_2.doc book preview: modern management concepts and topical issues (revised and adopted book for indian market) by prof. m. a. omolaja & prof. m. radović-marković publisher for us market: aardvark global publishing, salt lake city, ut, october, 2008, isbn -13: 978-1-4276-3508-2 publisher for indian market: himalaya publishing house pvt. ltd., mumbai, india publication date: april, 2009 pages: 596 in 21st century, globalization, privatization and liberalization process ignoring political boundaries has made the world into one village socio-economically and technically. either wto regime or regional organization regime pleads trade liberalization and multilateral trade regime for increasing share of developing countries in the global economic growth and income. however, giant multinational companies have been emerging in the world trade. in the labor market, good, efficient, and skill management and management students are in the great demand. in this context, this book, modern management: concepts and topical issues written by management gurus, prof. m. a. omolaja & prof. m. radovic-markovic is very relevant and urgent essential as a basic hand book. each of the 14 chapters provided a thorough explanations of managerial concepts supported by case studies and (or) figures to give clarity or visual representation. the collection of concepts will serve as a historical lens that managers can use to guide managerial practices, and researchers can use to guide studies. key terminologies and roles were introduced to refine the context. the context reinforced by beliefs that managerial skills are as essential as leadership skills. the context that centered on motivation gave me a better understanding of behaviors, approaches, perspectives, and positions of graduate learners who experience difficulties completing their dissertations. omolaja and radovic-markovic should be commended for applying the holistic approach, which various cultures and subcultures will appreciate. as a basic hand book of management guru mantra (key formulas), it insights minutely each and every core subject and issue of management and its relevancy in the simple layman’s language for uniform attraction and attention towards the book and also for making highly utility product to all (manager, administrator, students, etc). this adequately focuses on the principles and practice of management in the contemporary industrial and even governmental settings with a great deal of details. this is systematically presented into economic analysis 1-2 (2009) 79-80 8 the fourteen chapters arranged by chapter i nature of management, chapter ii management function, chapter iii organization in modern management, chapter iv specialized management technique, chapter v control in modern management, chapter vi corporate policy, chapter vii corporate strategy, chapter viii operational environment, chapter ix corporate objectives, chapter x managing employee at work, chapter xi organizational behavior, chapter xii employee’s motivation, chapter xiii basic tool of management and chapter xiv communication theory. they can be rearranged into four major parts: • part i-management chapters, part ii-organizational chapters, part iii-corporate body and • part iv-communication theory. if all relevant chapters are rearranged, it will get extreme excel and continuity. objectives of the book are to provide basic skills to all personnel engaging in multinational companies, corporate office and companies etc. in this, the authors are successful to justify it. theoretically, its presentation, structure, style and writing are interestingly motivated to me. i wish it would be effective to all readers, despite its lengthy chapters. however, in my notice, the authors have ignored practical sides of management for supplementing theoretical discussion and presentation. besides it, it doesn’t cover evolutionary part of management and trend of the world with out which the book seems to be incomplete. thus, unlink ages with market and real world that may be counter product when in market competition may erode quality and standard of the book because the reader needs completeness, real world picture and practical paradigm. despite these digestible shortcomings, its reflection is marvelous for basic foundation and skill of management. therefore, its usefulness to common people as well as academic and professional will be significantly noticeable and worthwhile. dr raghu bir bista, assistant professor, tribhuvan university, nepal and akamai university, usa microsoft word ea_2020_1_final.docx economic analysis (2020, vol. 53, no. 1, 187) 187 doi: 10.28934/ea.20.53.1.pp187 corrigendum doi https://doi.org/10.28934/ea.20.53.1.pp187 corrigendum: tersoo iorngurum, gauging the effects of modern payment technologies adoption on the demand for money in nigeria. economic analysis: applied research in emerging markets 2019, vol. 52, no. 2, pp. 12-27. https://doi.org/10.28934/ea.19.52.2.pp12-27 the author of the article: tersoo iorngurum, gauging the effects of modern payment technologies adoption on the demand for money in nigeria. economic analysis: applied research in emerging markets 2019, vol. 52, no. 2, pp. 12-27, have informed the editorial office of the error in the published text. because of the technical omission of the author, economic analysis journal has to add the second author: godwin chukwudum nwaobi professor of economics veritas university abuja. the authors have requested for this error to be corrected. the authors of this paper are: tersoo iorngurum veritas university abuja, nigeria and godwin chukwudum nwaobi, veritas university abuja. link to the corrected article https://doi.org/10.28934/ea.19.52.2.pp12-27 microsoft word 2011_1-2 review  book review serbia and the european union: economic lessons from the new member states    edited by  mirjana radović‐marković, srdjan redžepagić, et al.      the “serbia and the european union: economics lessons from  the  new  member  states“  proceedings    is  a  result  of  the  cooperation between the institute of economic sciences and the  belgrade banking academy and  the faculty of economics of  the university of coimbra. the editors of these proceedings are  the honoured professors of the institute of economic sciences:  prof. dr mirjana radović‐marković and dr srdjan redžepagić,  as well as the honoured professors of the faculty of economics,  coimbra: professor joao sausa andrade and professor paulino  teixeira.  the  reviewers  of  these  proceedings  containing  25  papers were the professors of the coimbra university: prof. dr  anonio portugal duarte, prof. dr marta c.n. simoes and prof.  dr carlos carriera.    the major goal of the book „serbia and european union: economic lessons from the new  member  states“  is  to  provide  an  accessible  presentation  of  the  facts,  theories  and  controversies that are necessary to understand this process. this book covers the essential  aspects  of  integration,  institution,  laws,  politics  and  policies.  the  book  does  not  only  contribute to our understanding of the explanations of the enlargement through community  rules  and  norms,  but  also  provides  a  strong  theoretical  contribution  to  the  analysis  of  international institutions as well as tries to extract some  general lessons that can be learned  from  the history of eu admission of  the member countries.   the different aspects of  the  integration process are presented in different chapters of the book.   the book consists of  three parts:  • the first section examines the modern european economy and integration.   • the second section examines the regional policy, agriculture and the eu accession  • the third section examines the role of policy  in sme development and the eu  accession.   one  of  the  basic  problems  of  the  transition  countries,  among  them  serbia,  in  their  endeavours to integrate into the eu are mirrored   in the lack of foreign capital, in serious  indebtedness, in the budget deficit, as well as  in the adjustment of financial systems. it is  these  issues  that  the  authors  of  the  publication  dealt  with,  offering  proposals  and     jaško, a., book review, ea (2011, vol. 44, no. 1‐2, 100‐103)     101 recommendations  for  improving  the  critical  points  in  the  economic,  social  and  political  sphere in the integration processes domain.  the first section consists of 10 chapters the aim of which is to get the answers to some  economic,  financing,  monetary  and  cultural  issues  as  the  major  curcumastances    for  the  process of integration. the integrataion is connected to the poltical and normative conditions  and thus considers the  establishmant of the system of functioning market economy. due to  the  integration  process  in  europe  and  the  european  union,  the  authors  of  the  papers  concentrate  in  a  special  way  on  the  economic  integration   proccess  and  describe  the  atratctivness  of  some  balkan  countries  for  foreign  direct  investments  as  esential  to  the  dynamic economic and social development of the countries. special attention is paid to the  financial system in serbia and other countries because it has been subject to major structural  changes in the past decade.   some authors stress the importance of the cultural dimension in the process of individual  countries’ accession   to the eu, because europe  is often seen as economically prosperous,  with  high  standards  of  living  and  monetary  investments  that  could  stimulate  economic  development, and the fact is that to join europe requires many written and unwritten rules  and laws as mental adjustments to the new value system and behaviouroul models that are  different from the old habits. in case of serbia, joining the european union means not only  the  access  to  the  funds  and  a  higher  standard  of  living  but  also  changing  the  „mental  models“ under the influence of the requests that would be made when serbia has joined.   a group of authors point out that one problem of the transition countries, among them  serbia, is the credibility problem, since prominent risks of the transition countries reduce the  credit  worthiness  of  these  countries,  thus  directly  increasing  the  prce  of  capital  and  consequently  reducing  the  national  and  international  competitiveness  of  their  entire  economies.  also,  the  performance  of  the  current  monetry  regime  in  serbia  and  other  countries is not satisfactory. in serbia, like in most developing countries, the predictions for  adopting  inflation  targeting are not present yet. the credibility problem  is still unsolved.  this problem is emphasized by the lack of trusting in the national currency and its exchange  rate.   the  experiences  of  other  countries,  such  as  greece  and  portugal,  in  constituting  the  consumption model can serve as a good example to serbia in its efforts to solve the problems  of debts and high interest rates. the experiences of slovakia in resolving the monetary policy  problems  certainly  serve  as  a  good  example  for  a  further  analysis  and  benchmarking  of  similar problems in serbia.   the second part of the proceedings explores the issues regarding the regional policy and  agriculture in view of the accessionto the eu. the selection of regional policies of a country is  largely conditioned by the regional differences in its development and the specific features of  its  economic  structure.  the  inequalities  in  economic  growth  certainly  is  an  important  problem of the developing countries, among them portugal, the authors dealing with this  phenomenon stress. the financial policy of development and of the  assets from the republic  and institutions’ funds cannot ensure the results that are necessary to accomplish in a short‐ term and the medium‐term periods. it is for these reasons that one solution to an acellerated  development of serbia  is  to make use of  the european  funds earmarked  for  the regional  development. the importance and potential support of these funds for serbia is visiable in     economic analysis (2011, vol. 44, no. 1‐2, 100‐103)   102 the fact that the european union’s financial capacity for the purpose of the equal regional  development is more than ten times higher than the serbian annual gdp. one of the basic  preresquisities for a stable and continuous social and economic development   is the equal  regional growth of all the regions of the country and as one of the basic european values this  should contribute  to planning and application of  the development policy.   as a potential  candidate, the republic of serbia  has made great efforts in conducting legal and technical  preparations  for  an  access  to  these  funds.  in  that  sense,  regionalization  may  be  a  good  preparatory activity. by the time it attains the status of a candidate country, serbia could do  more on the cooperation play with nehgbouring countries and by doing so it would receive  more resources from the eu funds.   since  agriculture  is  the  prevailing  activity  ina  majority  of  the  most  underdeveloped  regions  of  the  eu,  as  well  as  of  serbia,  it  is  evident  that  a  large  number  of  the  serbian  regional development policies  may be related to the eu policy.  a large number of authors  highlight the importance of agriculture as a key factor of a country’s  economic growth. the  authors that deal with the agriculture problems in this section of the proceedings point out  that agriculture is an important determinant of a country’s economic growth. the agriculture  sector  in  serbia  has  a  highly  important  role  in  the  employment  of  the  population.  the  development of agriculture should become a corner stone of a general policy of development  in serbia and should be allocated far larger financial assets from the budget compared to the  previous period. in order that the competitivness of agriculture sector should be improved it  is necessarry that a system solution to  its financing be worked out. this requires that the  agricultural budget and policy be known for the period of at least five years, as well as that a  transparent mechanism of cost control and the control of the efficiency of measures financed  from the agricultural budget be established.   the third section of the proceedings deals with the area of policies in the context of the  small and the medium‐size enterprise development   as well as creating conditions for the  accession to the eu. the authirs stress that small and medium‐size enterprises make a key  issue in the economic development of any country, and the basic source of economic growth  and flexibility.  it is for this reason that they stress the importance of formulating adequate  policies  and  legislature  in  this  area.  the  policymakers  are  conclusive  in  their  attempt  to  promote  a  more  dynamic  development  of  the  sme  sector  by  creating  policies  and  consistently implementing the basic principles contained in the european charter for small  enterprises.  the  further  course  of  the  serbian  integration  to  european  union  will  be  a  primary determinant of  the sme  sector.  the realization of smes growth  potential  in  the  future requires an advanced approach orientied towards promoting enterpreneurship and  creating a friendlier environment for small businesses.   it should be noted that an important point in bringing together the small and medium‐ size businessas and entrepreneurship is the company’s socially responsible business doing  that is one way of achieving sustainable growth.  the countries such as serbia, which strive  to become the eu members, should base their socio‐economic development on the good eu  practices. the role of the academia, the civil sector and the business associations is crucial for  the achievement of this goal. the state has a partcular role in stimulating the csr through  rewarding  the  socially  responsible  behaviour  and  through  public‐private  partnerships  in  addressing the needs of the society.      jaško, a., book review, ea (2011, vol. 44, no. 1‐2, 100‐103)     103 having in mind the importance of the above‐mentioned areas in the process of serbia’s  accession to the european union, this proceedings addresses the key issues and problems  the  transition  countries  are  faced  with.  sharing  the  experiences  of  the  countries  such  as  portugal, greece, slovakia,  we gain the economic, financial and monetary knoeldege which  may be of use to serbia in the process of its accession to the eu. this is where the importance  of this proceedings lies – in the efforts of each of its authors to contribute with their works to  the european integrations.   ana jaško  institute of economic sciences, belgrade    microsoft word 2011_1-2 original scientific paper    precision cotton agriculture and strategic commercial  policies: an analysis in terms of duopoly by quality   baldin claire*, université de nice‐ sophia antipolis, france   udc: 338.44, 339.5    jel: f13, f18, h22, q00, q55, q17, q18        abstract – we study a hotelling’s duopoly in world cotton market to examine the effects of  precision agriculture’s (pa) adoption  in term of strategic  international trade between the united‐ states and central and west africa (cwa). we prove that us producers should be well advised to  adopt  pa  to  offer  “environmental  quality”  cotton  whereas  cwa  producers  have  a  natural  comparative advantage that allows them to offer a “product quality” cotton. we also argue that if the  usa subsidizes pa in order to protect environment, this measure can be considered as a strategic  international policy. we determine a critical subsidy  level, which ousts cwa producers  from  the  cotton market. at this subsidy level, us policy can be thought of unfair even if this policy enables  them to improve the environment    key  words:  strategic  commercial  policy, precision  farming,  hotelling’s  duopoly,  quality’s  differentiation, environment, welfare, cournot, nash equilibrium, subsidies  introduction  the adoption of precision agriculture (pa) is now considered an essential objective for  sustainable  agriculture,  as  has  been  shown  by  the  many  programs  implemented  by  governments.  in  fact,  pa  decreases  pollution  (lambert  and  lowenberg‐deboer  2000,  schumacher  et  al.,  2000,  whitley  et  al.,  2000,  lowenberg‐deboer,  2004)  while  increasing  productivity gains (bronson et al., 2003, yu et al., 2000, and yu et al., 1999).  moreover,  pa  is  an  issue  for  international  trade  because  it  enables  the  countries  that  adopt it to differentiate their products qualitatively as is the case for the cotton sector. pa  enables the production of cotton that  is of a better environmental quality than traditional  cotton. however, the impact of pa on the quality of the cotton fibres remains uncertain so it  may  be  beneficial  for  countries  with  a  natural  advantage  in  terms  of  fibre  quality  to  differentiate their product without necessarily adopting it (yu et al. 1999).  in  this context, pa may be a support  to  the  implementation of strategic  international  trade policies based on granting subsidies for its adoption. recent studies show that, in the  united states, pa has caused a double impact on international cotton exchanges (pan et al.,  2004; world cotton model from pan, malaga and kulkarni, 2008). first of all, we have seen a  decrease  in  world  cotton  prices  and  secondly,  an  increase  in  american  exports  and  in  decrease in exports from central and western african countries (cwa) that are unable to                                                         * université de nice sophia‐antipolis, gredeg‐demos unité mixte de recherche du cnrs n°6227,  e‐mail: claire.baldin@gredeg.cnrs.fr     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     79 adopt pa (oberthür et al. 2006). such policies are even more easily justifiable since, from an  environmental  point  of  view,  pa  enables  a  decrease  in  pollution.  with  respect  to  international trade,  it  looks as  if certain states should switch traditional trade policies for  strategic environmental policies which cannot easily be condemned by the wto although  they have exactly the same effects. in fact, restrictions imposed by the gatt or the wto on  traditional  trade policies have  led many governments  to  increase strategic environmental  policies  to  promote  their  exports  and  protect  their  agricultural sectors  from  international  competition (bureau and mougeot, 2004, bouët, 1992, 1998, 1999, 2001, ulph, 1996, barrett,  1992) without any risk of being condemned for these actions.  the purpose of this article is to evaluate international trade issues of pa in the cotton  sector by analyzing united states (us) policies as opposed to cwa1 countries. two reasons  justify this problem. the first resides in the united states’, the world’s main cotton producer,  role of “price‐maker” on the market (parmentier, 2006). the second involves cwa countries  for which the cotton sector in the main source of agricultural riches (perrin and lagandre,  2005) while there is very little chance that pa will be developed in these countries because of  its cost and the technical knowledge necessary for its implementation (oberthür et al., 2006).  therefore, the states that are unable to adopt pa are at risk of losing their natural advantage.  in order to answer this question, we will develop a horizontal differentiation model “à la  hotelling” between us cotton and cwa cotton, in order to evaluate the strategic effects on  international  trade  that  result  from  the  adoption  of  pa.  we  will  show  under  which  conditions cwa countries can or cannot retain a portion of their revenues from international  trade if the us agent produce cotton of a high environmental quality by using pa. we will  considerer the fact that american and african cottons possess both qualities: environmental  and fibre. the us produces cotton that is of a high environmental quality, because they use  pa, and low fibre quality while the cwa countries offer cotton with high fibre quality that  results from their natural advantage.  our analysis is based around three sections. the first describes the model by explaining  the  demand  for  cotton  (1.1),  the  behaviour  of  growers  (1.2)  and  the  architecture  of  the  proposed issues between the us and the cwa countries (1.3). the second part shows how  cotton consumers are spread over the international market according to whether they prefer  “environmental”  quality  or  “fibre”  quality  (2.1).  we  will  determine  the  nash‐hotelling  balance for “environmental quality” (2.2) and  for “fibre quality” (2.3) which allows cwa  countries to remain competitive when us cotton producers develop pa. we will evaluate the  level of welfare on the international cotton market (2.4). in the third part, we infer that the  us  implements  a  commercial  subsidy  policy  for  pa  so  that  their  growers  will  produce  “environmental quality” cotton. we will determine the levels of “environmental quality” and  “fibre quality” of the cotton that results from this type of policy (3.1). the results show an  improvement in “fibre quality” in us cotton with relation to “fibre quality” of cotton from  cwa countries so that cotton fibre consumers do not care if they use cotton fibre from the  us  or  cotton  fibre  from  cwa.  the  competitive  advantage  of  cwa  countries  is  thus  decreased. we will  then demonstrate  that  this policy  improves  the welfare of  the united  states and cwa countries, but, over a certain level of subsidy, the us trade policy is unfair                                                         1 the main countries involved here are benin, burkina faso, mali and tchad.    economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   80 because  the  cwa  countries  are  at  risk  of  being  crowded  out  of  the  international  cotton  market (3.2).  the model    we  look  at  two  countries,  the  us  and  cwa  countries,  as  a  duopoly  on  the  international cotton market that competes for quality on the third market. we look at the fact  that the competition  is supported by the qualities of the cottons offered knowing that the  cotton has two characteristics: one “environmental” and the other “fibre”. the us produces  cotton  with  high  “environmental  quality”,  noted  as  qe,e ,  due  to  pa.  this  qualitative  characteristic is justified by the fact that pa induces strong environmental benefits. us cotton  also has “fibre quality” of lower quality than the cotton produced in cwa countries. manual  cotton production allows them to produce cotton with a high “fibre quality”, noted as  qa, p .  cwa cotton fibre is qualitatively superior to american cotton.   • hypothesis 1: pa  is adopted  by all of  the american cotton growers but not by  cwa countries.  • hypothesis 2: since the “environmental quality” of cwa cotton is stable because  they  do  not  possess  adapted  technology,  it  is  not  considered  as  an  exogenous  variable noted as  qa,e = q .  demand for cotton  we  infer a heterogeneous demand composed of  two categories of consumers. on one  hand, consumers who are concerned with preserving the environment and who maximise a  utility  function,  noted  as μe ,  and  who  only  use  cotton  characterized  by  a  high  “environmental quality” qe . on the other hand, consumers who maximise a utility function,  noted as μa , who only use “fibre quality” cotton qp .  there  is a continuum of mass  l consumers distributed according  to a  linear hotelling  model on a segment representing the possible cotton qualities where us growers are situated  in  0  and  cwa  growers  are  situated  in  1.  consumers  go  to  american  or  african  cotton  growers  depending  on  whether  they  prefer  cotton  with  high  “fibre  quality”  or  high  “environment quality”. “environmental quality” and “fibre quality” cotton consumers are  noted  as  ne and  na   respectively,  with ne + na = 1.  we  admit  that  american  and  african  growers sell at world cotton prices, supposedly fixed and noted as p = p. we use an  x  to  indicate the location of an agent according to his preferences for one or the other quality of  cotton such as: x ∈ 0;1[ ]. we define the mass of consumers who prefer high “environmental  quality” cotton as  ne ∈ 0; x[ [  and the mass of consumers who prefer cotton with high “fibre  quality” as  na ∈ x;1] ]. the utility functions are noted as follows:  ux = μe = r + qe,e + qe, p − tx − p μa = r + q + qa, p − t 1− x( ) − p ⎧ ⎨ ⎪ ⎩⎪               (1)  in the previous expression,  r  (r > 0) represents the utility of each consumer no matter  what the quality of the cotton. the consumers choose one quality or the other so that the     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     81 entire market  is covered,  in order that  in the balance, all the consumers obtain a positive  utility no matter what type of cotton they buy. the expression  tx  (resp.  t 1− x( )) represents  the disutility of consumers when they want to acquire the cotton  qe  (resp. qp ). the term  x   (resp. 1− x( )  represents the market segment covered by “environmental quality” us cotton  qe   (resp.  cwa  “fibre  quality”  cotton qp ).  the  parameter  t  represents  the  cost  of  transportation traditionally used to formalise the differentiation between the two types of  product.  it  is  linear  and  represents  the  cost  for  a  consumer  to  purchase  environmental  quality or fibre quality cotton.  profit functions    the term  qe,e (resp. qe, p ) represents the “environmental quality” (resp. “fibre quality) of  american cotton with:  qe,e > qe, p > 01. the term  qa, p  represents the “fibre quality” level of  african  cotton  with  qa, p > q > 0 2.  american  growers  (resp.  africans)  determine  the  “environmental quality” of cotton  (resp.  the “fibre quality”) which maximises their profit  function.  we  note  as  ce   and  ca   the  cost  functions,  which  are  supposedly  quadratic,  of  american and african cotton as:   ce = 1 2 qe, p 2 + ne × qe,e   and ca = 1 2 q 2 + na × qa, p   the profit functions of us and cwa growers are then noted as follows:  πqe ,qp = π e = ne ⋅ p − 1 2 qe, p 2 − ne ⋅qe,e = ne p − qe,e( ) − 12 qe, p 2 π a = na ⋅ p − 1 2 q 2 − na ⋅qa, p = na qa, p − p( ) − 12 q 2 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪         (2)  eπ represents the profit function of the us while the adoption of pa allows them to produce  “high  environmental  quality”  cotton,  and  aπ represents  the  profit  function  of  cwa  countries that, being unable to adopt pa, produce “high fibre quality” cotton.  in order to evaluate how pa modifies the terms of competition between american and  african growers, and determine under what conditions the african growers maintain their  competitive advantage despite the diffusion of pa, we will resolve the following issue using  backwards induction.  the architecture of the issue  the  objective  of  the  model  is  to  explain  how  the  adoption  of  pa  by  the  us  can  be  profitable  from  the  point  of  view  of  international  trade  to  both  american  growers  and  growers  in cwa countries,  therefore resulting  in qualitative environmental gains. this  is  how  we  justify  optimal  quality  research  strategies  when  growers  maximize  their  profits.  their objective is to corner the demand of consumers who are concerned with one quality of  cotton or the other. the issue includes four steps:                                                         1, 2 this relation is justified by the specialization in the cotton quality.    economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   82 figure 1. sequence of issue          • in t0 the price of cotton is fixed by the world market as  p = pa = pe . american  and african growers decide whether or not to produce.  • in t1 american and african growers fix the “fibre quality” qp .  • in  t2  american  growers  fix  their  “environmental  quality” qe,e .  the  “environmental quality” of supposedly exogenous cwa cotton  is noted as q   such as  q ≤ p  • in t3 us producers adopt pa. american and african producers determine their  profits and market shares.  resolution of the issue: determine the balances in optimal qualities  the issue is resolved using fait par backward induction. we successively determine the  market shares for growers, the “fibre quality” and “environmental quality” of the american  cotton and the “fibre quality” of the cwa cotton.  determining narket shares between the united states and the cwa countries  in t3 we determine how the two categories of consumers are divided along the  0;1[ ] axis.  we infer that a representative consumer, indifferent as to  qe  cotton and qp cotton situated at  point x̂ verifying μe = μa  such as:  r + qe, p + qe,e − tx̂ − p = r + qa, p + q − t 1− x̂( ) − p  after resolving the previous expression with relation to  x̂ , we obtain:  x̂ = t + δe + δ p 2t   (3)  where  δe = qe,e − q and δ p = qe, p − qa, p  if 0 < x̂ < 1, there is a consumer who is indifferent to the two qualities of cotton available.  consumers belonging to the  0 < x < x̂  range want  qe cotton grown by the us. consumers  belonging to the  x̂ < 1− x( ) < 1 range prefer  qp cotton grown by the cwa countries.  condition 1a: the cotton market is totally covered if r is big enough. in this case, consumers  have  the  choice  between  one  or  the  other  qualities  of  cotton  which  implies  that:  r + qe,e + qe, p − tx̂ − p > 0 and/or that: r + q + qa, p − t 1− x̂( ) − p > 0 .   condition 1b: the model which supposes a configuration of the market such as x̂ ∈ 0;1] [,  t  must  satisfy the following necessary and sufficient condition: t > δe + δ p. this condition ensures a balance  in which us and cwa growers are faced with positive demands.  t0  t1  t2 t3 tstep 1  step 2 step 3 step 4 us and cwa  growers decide to  us and cwa  growers determine qp us and cw  growers determine repartition of the  cotton market    baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     83 condition 1c: the previous condition implies that the degree of horizontal differentiation between  the two types of cotton is high enough for us and cwa cotton growers to coexist on the market. in  other words, it is necessary for:  qe,e > q and  qa, p > qe, p  by  hypothesis,  condition  (1b)  is  satisfactory  because  consumer  preferences  are  evenly  distributed on the market. consumers situated to the left of  x̂ prefer “high environmental  quality” while consumers situated to the right of  x̂ prefer “high fibre quality”. condition (1c)  is  equally  satisfactory  because  cotton  growers  are  differentiated  by  the  competitive  advantage that they possess.       from (3), we can write the functions of demand that are addressed to each grower:  ne = x̂ = t + δe + δ p 2t na = 1− x̂ = t − δe − δ p 2t ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                   (4)  by replacing (4) in (2), we obtain the following us and cwa profits:  πqe ,qa = π e = p − qe,e( ) 2t δe + δ p( ) + p − qe,e( ) 2 − 1 2 qe, p 2 π a = qa, p − p( ) 2t δe + δ p( ) + qa, p − p( ) 2 − 1 2 qe, p 2 + p − 1 2 q 2 − qa, p ⎧ ⎨ ⎪ ⎪ ⎩ ⎪ ⎪ (5)  determination of the “environmental quality” balance  by t2, us cotton growers define the optimal “high environmental quality” of their cotton  by maximising their profit function (first rate conditions)2:  max qe ,e π e = ∂π e ∂qe,e = 0 ⇔ p 2t − qe,e t + q 2t − δ p 2t − 1 2 = 0           (6)  after  resolving  equation  (6),  we  obtain  the  level  of  “high  environmental  quality” qe,e *   produced by the us:  qe,e * = 1 2 p + q + qa, p − qe, p − t( )            (7)  the  “environmental  quality”  level  proposed  to  the  us  depends  negatively  on  t.  therefore, when t decreases, the differentiation with cwa cotton is accentuated. the reverse  observation  can  be  proposed  if  t  increases.  likewise,  if  t  increases,  * ,eeq decreases,  with  induced a decrease in us profits. the effect on the profits is reversed with t decreases.  for cwa growers, the “environmental quality” of their cotton was exogenous qa,e * = q .   the  balance  noted  (ee)  in  terms  of  “environmental  quality”  on  the  cotton  market  is  determined by the following expression:  ee = qe,e * = 1 2 p + q + qa, p − qe, p − t( ); qa,e* = q⎧⎨ ⎩ ⎫ ⎬ ⎭    (8)                                                         2 we verified that at the balance the second order conditions are verified: ∂ 2π e ∂2qe,e = − 1 t < 0 .    economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   84 determining the optimal “fibre qualities” on the cotton market  in  t1,  the  african  and  american  producers  define  the  level  of  “fibre  quality”  of  their  cotton  which  maximizes  their  profits.  the  derivatives  of  the  profit  function  (first  order  condition)3 are expressed in the following way:  max qe , p ,qa, p π = max qe , p π e = ∂π e ∂qe, p = 0 max qa, p π a = ∂π a ∂qa, p = 0 ⎧ ⎨ ⎪ ⎪ ⎩ ⎪ ⎪ ⇔ p 2t − qe,e 2t − qe, p = 0 p 2t + qe,e 2t + qe, p 2t − qa, p 2t − q 2t − 1 2 = 0 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪      (9)  the reaction functions in terms of “fibre quality” of us and cwa growers are written  respectively:  qe, p = 1 2t p − qe,e( ) qa, p = 1 2 p + qe,e + qe, p − q − t( ) ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                 (10)  after the resolution of the equation system (10), we obtain a balance of us and cwa  “fibre qualities” which are noted respectively * , peq and qa, p * such as:  qe, p * = 1 2t p − qe,e( ) qa, p * = 1 2 p 1+ 1 2t ⎛ ⎝⎜ ⎞ ⎠⎟ + qe,e 1− 1 2t ⎛ ⎝⎜ ⎞ ⎠⎟ − q − t ⎡ ⎣ ⎢ ⎤ ⎦ ⎥ ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪ 11.a 11.b            (11)  we notice, as previously  for relation  (7),  that  the “fibre quality”  level of cwa cotton  depends negatively on  t. the utility of  the consumer  preferring “fibre quality”  improves  particularly as t decreases like cwa profits which depend positively on  qa, p * . the effects are  reversed if t increases.   determining “environment” and “fibre” qualities on the cotton narket  in t0, the growers must decide of they grow, in view of the balance qualities determined  in (8) and (11) at the world price p . by replacing (11) in (7), we obtain the “environmental  quality” level that us growers propose:  qe,e ** = p + 2tq − 6t 2 6t −1                   (12)  likewise, by replacing (12) in (11.b) we obtain the optimal “fibre quality” level for cwa  cotton produced in the balance:                                                         3 by considering 1.b the second order conditions are respected if: ∂ 2π e ∂2qe, p = −1 < 0 and ∂2π a ∂2qa, p = − 1 t < 0.    baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     85 qa, p ** = p + t 2 − 2q( ) − 6t 2 6t −1                  (13)  finally,  by replacing  (12)  in  (11.a), we obtain  the optimal “fibre quality”  level  for us  cotton:  qe, p ** = 3t − q 6t −1                     (14)   the optimal level of demand ne ** (resp. na **), for us growers (resp. cwa) is obtained by  replacing (12), (13) and (14) in (4). or after calculation:  ne ** = x̂** = 3t − q 6t −1 na ** = 1− x̂** = 3t − q −1 6t −1 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                   (15)   proposition 1: the growers undertake their production if the level of qualities (environment and  fibre) is positive or nul.     this proposition is verified if the following conditions are realized:  • qe,e ** = p + 1 6t −1 2tq − 6t 2( ) ≥ 0 which implies that: p ≥ 2tq − 6t 2( ) 6t −1 . since p > 0 we verify that: 2tq − 6t 2 > 0 . we deduct that: ** ,eeq if and only if ⎥⎦ ⎤ ⎢⎣ ⎡∈> qtp 3 1 ;0 • qa, p ∗∗ = p + 2t − 2tq − 6t 2 6t −1 ≥ 0implies that: p > 2t − 2tq − 6t 2 6t −1 . since p > 0 we verify that: t 2 − 2q( ) − 6t 2 > 0 . we deduce that: qe, p** ≥ 0 if and only if p > t ∈ 0; q ≤ 1⎡⎣ ⎤⎦. • qe, p ∗∗ = 3t − q 6t +1 ≥ 0 which implies that: 3t − q ≥ 0 . we deduce that: qe, p ** ≥ 0 if and only if t ≥ 1 3 q . (16) according to condition 1.b and proposition 1, if we want the combined levels of quality  to  be  positive,  we  must  restrict  our  study  to  the  case  where  t  respects  the  following  condition: t ≥ 1 3 q with q < 1 (17.a). proposition 1 also highlights the fact that the world price  verifies the following condition:  p > t  (17.b).  by replacing the optimal demand defined by (15) and the balance qualities defined by the  relations (12), (13) and (14) in the profit functions (4), we obtain, in t0, the following profit  balances:         economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   86 π e ∗∗ = ne ∗∗( p − qe,e ∗∗ ) − 1 2 qe, p ∗∗2 = x̂** p − qe,e **( ) − 1 2 qe, p ∗∗2 π a ** = na ** ( p − qa, p ** ) − 1 2 q 2 = x̂** (qa, p ** − p) − 1 2 q 2 + p − qa, p ** ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪         (18)  the growing decision is not undertaken unless the t0 profits are positive.  proposition 2: according to (18), in order for the profits to be positive, we must be able to verify  that:  p − qe,e ** > 0 and p − qa, p ** > 0   this proposition implies that  p is sufficiently large. therefore:  p ∈ qe,e ** , qa, p **( );+∞⎤⎦ ⎡⎣   (19).  when conditions (17.a), (17.b) and (19) are satisfied, the profits of us and cwa growers  are positive so that both countries share the cotton market.                   in other terms, the previous developments show that if american growers adopt pa and  opt  for  an  “environmental  quality”  strategy  of  cotton  production,  cwa  cotton  growers  remain competitive if they adopt a “fibre quality” cotton development strategy.   it is now necessary to assess the impact of the previous strategies in terms of welfare by  determining, first of all, at what level the welfare is set when all the growers adopt pa and,  secondly, show  that public  intervention,  to ensure the distribution of pa  to all of  the us  growers, can impact quality levels to the detriment of cwa countries.   subsidies for the adoption of pa: a study in terms of welfare  two  scenarios  are  considered.  the  first  consists  in  determining  welfare  when  pa  is  distributed to the us (hypothesis 1). the goal of the second is to determine welfare when pa  is used as a support for an international trade policy of subsidies to assist the adoption of pa  for the us who want to acquire a competitive advantage. two arguments are brought forth  to justify such a policy: the first concerns environmental protection and the second concerns  assistance for innovation. in this case, we show how, first of all, the us obtain international  trade revenue by improving their two cotton qualities, and secondly, how such a policy can  be unfair if it continues to crowd cwa countries out of the cotton market since they have no  way to retaliate.  first scenario: evaluation of the welfare without a strategic subsidy  we note as ase ** the surplus of consumers concerned with environmental protection and  as  asp ** the surplus of  the consumer who prefers “fibre quality”. the surplus of growers  corresponds to the level of profits π e ** andπ a ** previously calculated. we note as  w1 ** welfare  on  the  cotton  market  such  as:w1 ** = ase ** +π e ** + asp ** +π a **.  the  following  expression  determines the level of welfare on the cotton market as t0:  w1 ** = r + qe,e ** + qe, p ** − tx̂ − p( )∂x + r + qa, p** + q − t 1− x̂( ) − p( )∂x +x=x̂** 1 ∫ π e** +π a**x=0 x̂** ∫      baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     87 or,  %x** = 3t − q 6t −1   after calculations we obtain the following expression:  w1 ** = −18t 3 + t 2 10q 2 − 36q +15( ) + t 2q −1( ) − q2 2(6t −1)2 + r + q − 1 2 q 2    (20)  proposition 3: cotton production  is undertaken only  if  the welfare  is positive or nil. for all  values of  t > δe + δ p(1.c), and knowing  that r  is sufficiently  large, we verify  that  w1 **is always  positive for  t ∈ δe + δ p;+∞⎤⎦ ⎡⎣  (21).  if condition (21) is satisfactory the welfare is positive. this expression implies that all the  american cotton growers must adopt pa. it this is not the case, the entire american cotton  production  will  not  benefit  from  the  “high  environmental  quality”  characteristic  which  implies that certain consumers μe will not be satisfied and will see no difference between us  and cwa cotton. in this case, the surplus of consumers  ase ** and the welfare  w1 **decrease  and  a  regulator  is  necessary,  in  this  case  the  american  government,  to  ensure  that  all  american growers adopt pa in order to respect the result (20).   second scenario: the implications in terms of welfare of a public policy for  assistance to the adoption of pa  in this paragraph, we abandon the hypothesis in which all of the us growers adopt pa,  which implies that some growers are unable to produce “high environmental quality” cotton  so that their cotton’s level of “environmental quality” may be noted as qe,e ≤ q . because pa  is a “green”  technology, we  infer  that  the american state decides  to subsidise  it without  running the risk of being liable of illegal subsidy policies. we note as “s” the marginal public  subsidy such as:  ∂ qe,e − s( ) ∂s < 0                 (22)  the  impact  of  such  a  policy  can  be  measured  by  evaluating  its  effect  on  the  level  of  american cotton qualities ** ,eeq  and  ** , peq and on the level of profits. from an economic point  of view, taking into consideration pa subsidies is done at the level of “environmental quality  cotton production costs which can be expressed as follows: )( , sqn eee −× .    in sub‐section 3.2.1, we will evaluate  the  impact of such a policy on  the  levels of  “environmental quality” and “fibre quality” of us and cwa  cotton. we will deduct  the  impact of the levels obtained on the level of profits made. sub‐section 3.2.2 will evaluate the  effects of subsidies on welfare.  subsidy policies to assist the adoption of pa in the us: a study in terms of  competitiveness  we  note  as q( s ) e,e ** , q( s ) e, p ** , q( s ) a, p ** ,π( s ) e **   and  π( s ) a ** respectively,  the  optimal  level  of  “environment” and “fibre” qualities produced by us growers when they are subsidised; the  “fibre” quality offered by cwa growers when us growers are subsidised, and the us and     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   88 cwa  profits  with  subsidies.  after  calculating,  and  applying  the  method  of  backward  induction as was used previously, we obtain the following values:  q( s ) e,e ** = p + 1 6t −1 2tq + s 4t −1( ) − 6t 2⎡⎣ ⎤⎦               (a)  q( s ) e, p ** = 3t + s − q 6t −1                            (b)  q( s ) a, p ** = p + 1 6t −1 −6t 2 − 2tq + 2t + 2st⎡⎣ ⎤⎦             (c)  the  levels of “quality” balance obtained depend differently on the parameter t, which  brings us to make several comments.         comment 1: the balance represented by  the relation showed  that the variation  in the  level of “environmental quality” in us cotton, when the growers are subsidised, depends on  t. the quality also depending on s, both cases can be distinguished to appreciate the impact  of a variation of t on (a).  ‐ case 1:  if   s > 3 2 t  and  t decreases,  then  the  level of “environmental quality” balance  decreases towards q , so that the differentiation with “environmental quality” cwa cotton  decreases and disappears. the disutility related to using cwa cotton decreases.   ‐ case 2: if s < 3 2 t , the scenario is reversed. a decrease of t induces an improvement of  “environmental quality” for us cotton which accentuates the differentiation of the cottons.  the disutility related to using cwa cotton increases.  comment  2:  we  can  compare  the  effects  of  a  t  variation  between  levels  of  quality  between     (b) and (c).  ‐ case 1 bis: if  s > 3t  an increase of t, if q < 1, induces an increase in the level of “fibre  quality” of us and cwa cotton. the improvement is greater for us cotton.  ‐ case 2 bis:  if  s < 3t  an  increase  of  t  improves  the  “fibre  quality”  of  us  cotton  and  decreases that of cwa cotton. the differentiation between the two cottons decreases so that  growers in the cwa countries no longer have as much of their natural advantage. if, to the  contrary, t decreases, the induced effect is reversed to the previous to that the improvement  of “fibre quality” in us cotton induced by pa is lower.  comments 1 and 2 show that a variation of t can cancel the positive effects that subsidies produce on us and cwa cotton’s level of balance qualities. we can also see that a variation of t can minimise the anticipated effects on the qualities of us cotton that result from the adoption of pa. at the balance, the repartition of the demand for each cotton quality of given by: x̂s ** = ns,e ** = 3t + s − q 6t −1 1− x̂s ** = ns, a ** = 3t + q − s −1 6t −1 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                 (23)     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     89 likewise with regards to the profits we obtain:  π( s ),qe ,qa ** = π( s ),e ** = x̂s ** p − 1 2 q( s ) e, p **( )2 − x̂s** q( s )e,e** − s( ) π( s ), a ** = x̂s ** q( s) a, p ** − p( ) − 1 2 q 2 + p − q( s ) a, p ** ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪           (24)  proposition 4: according to expression (24) public policy induced an increase in profits if the  level of subsidies verifies the following condition: q( s ), e,e ** − s ≥ 0 . or if:  0 ≤ s ≤ q + 3p − 3t − p 2t                   (25)  the effects of subsidies for the adoption of pa on optimal “environment” and “fibre”  qualities for us and cwa growers can be expressed as follows:  ∂q( s ) e,e ** ∂s = 4t −1 6t −1 > 0 ;  ∂q( s ) e, p ** ∂s = 1 6t −1( ) > 0 ; ∂q( s ) a, p ** ∂s = 2t 6t −1( ) > 0   proposition  5:  subsidies  to  assist  the  adoption  of  pa  induce  a  positive  effect  on  the  “environmental quality” and “fibre quality” levels of american cotton with a greater positive effect on  “environmental quality”.  the previous results show that when subsidies allow american producers to improve the  “fibre quality” of their cotton, they can compete with the growers in cwa countries, who  then see their market share decrease because consumers of “fibre quality” cotton are may  buy american “fibre quality” cotton which meets, or closely meets, their demand.  the  effects  of  public  policy  on  the  demand  for  american  and  african  cotton  can  be  expressed as follows:  ∂ns,e ** ∂s = 1 6t −1 > 0 ∂ns, a ** ∂s = −1 6t −1 < 0 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪   proposition  6:  subsidies  paid  to  us  growers  for  the  adoption  of  pa  cause  an  increase  in  american demand and a decrease in african demand.  the results stated in proposition 4 confirm those of proposition 5. profits resulting from  pa on the “fibre quality” of american cotton, which can be confirmed by certain empirical  works that explain that pa can induce positive effects on the intrinsic quality of the product,  result in the fact that some consumers who are concerned with this will meet their needs by  buying “fibre quality” cotton from the us and not from cwa countries. the closer the level  of american “fibre quality” cotton is to cwa cotton, the more indifferent consumers are as  to the origin of the cotton.  the profit functions can now be expressed in the following way:     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   90 π e,s ** = 36t 3 + t 2 24s − 24q − 9( )+ t 4s2 − 6s − 8sq + 6q + 4q2( )+ 2qs − s2 − q2 2 6t −1( )2 π a,s ** = 18t 3 + t 2 12q −12s −12( )+ t 2s2 + 4s + 2 + 2q2 − 4q − 4sq( ) 6t −1( )2 + p − 1 2 q 2 ⎧ ⎨ ⎪ ⎪⎪ ⎩ ⎪ ⎪ ⎪   from numerical values that respect the hypotheses defined in the model (r sufficiently  large; p > t ;  t ≥ 1 3 q   ;  q ≤ 1   ; and  0 < s < 3t + q −1, we verify that  π e,s ** > 0 andπ a,s ** > 0 1. the  study on the impact of public policy on profits verifies that:  ∂π e,s ** ∂s = 24t 2 + t 8s − 8q − 6( ) + 2q − 2s 2 6t −1( )2 > 0 ∂π a,s ** ∂s = −12t 2 + 4st + 4t − 4tq 6t −1( )2 > 0 ⎧ ⎨ ⎪ ⎪ ⎩ ⎪ ⎪ 26.a( ) 26.b( ) (26)  the expression (26) shows that, no matter what the level of the subsidy, growers’ profits  increase. the following graphic illustrates our results:    graphic 1. evolution of us and cwa profits according to levels of subsidies        proposition 7: american subsidies have a positive impact of the profits of cotton growers in this  country and those in cwa countries, although the  impact  is greater on american profits. it  is an  optimal subsidy level sm when us profits are greater than cwa profits. this level optimal level of  profits is determined after profit maximisation with regard to s. we obtain it by equalizing equations  (26.a) and (26.b). or:  −12t 2 + 4st + 4t − 4tq 6t −1( )2 = 24t 2 + t(8s − 8q − 6) + 2q − 2s 2 6t −1( )2 ⇔ 2s = 48t 2 − 4tq − 7t + q                                                          1 we verify, using numerical values ( ) that the profits are positive.     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     91 ⇔ sm = 24t 2 + t −4q − 7( )+ q       (27)  therefore,  on  a  profit  level,  for  any  amount  of s ≥ 0 ,us  and  cwa  profits  increase.  however, according to proposition 6, subsidies induce an increase in the us market and a  decrease in cwa market shares. this means that there is a critical level of subsidy, noted  as sc from  where  cwa  growers  are  crowded  out  of  the  market.  this  level  is  defined  as:  na ** = 0 ⇔ 3t + q − s −1 = 0  ⇔ sc = 3t + q −1  for a subsidy amount  that  is greater or equal  to cs we can consider  that  the us  trade  policy becomes unfair, without necessarily being condemnable, in the sense that, under the  pretext of protecting the environment, they contribute to crowding cwa growers out of the  cotton market. graphic 2 explains this eventuality:    graphic 2. evolution of cotton market shares with relation to subsidies in place        what  effects  do  public  subsidies  have  on  overall  “environmental  quality”   qe ** = q( s ) e,e ** + q(s ) a,e ** = q( s ) e,e ** + q and overall “fibre quality” quality” qp ** = q( s ) e, p ** + q( s ) a, p **   ?  these impacts can be evaluated from the following derivatives:  ∂qe ** ∂s = 4t −1 6t −1 > 0   ∂qp ** ∂s = 2t +1 6t −1 > 0   proposition  8:  subsidies  to  assist  with  the  adoption  of  pa  increase  the  total  levels  of  “environmental” and “fibre” qualities. this implies that subsidies to assist the adoption of pa induce  an increase in benefits to all consumers.   in this paragraph we were able to show that the implementation of the american public  policy  of  subsidies  to  assist  the  adoption  of  pa  induces  positive  effects  for  growers  and  consumers. although african growers lose market shares, subsidies induce and increase in  their profits. the results also highlight the fact that such a policy can exclude cwa cotton  growers from the market even though they have a comparative advantage.     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   92 it is now time to evaluate the level of welfare that results from subsidies for the adoption of  pa.  the impact of a subsidy for the adoption of pa in terms of welfare  the objective of this section is to identify the level of subsidy that ensures the complete  circulation of pa. to do so, we will establish under what conditions the profits, qualities and  welfare are at least equal to those obtained in the first scenario.  we  note  as  s = s × ne ** the  amount  of  the  subsidies  paid  by  the  us  government.  total  welfare  is defined as  the surplus amount  from consumers and profits minus  the  level of  subsidies.  the public authorities decide to allocate subsidies so that:  (i) the subsidies have a positive impact for us and cwa growers and for cotton  consumers, which we have highlighted in section 3.2.1.  (ii) the amount of the subsidies s is compensated by the increase in the level of  consumers purchasing us cotton and profits made by us growers. in this case  the new level of welfare be at least equal to the previous level.  we will determine the amount of the subsidies that is necessary to maximize us profits  so that welfare in not inferior to that which was obtained without subsidies.  the  level  of  welfare  with  subsidies  noted  as  **2w is  determined  by  the  following  expression: w2 ** = ase,s ** + asp,s ** +π e,s ** +π a,s ** − s**  ⇔ w2 ** = r + q( s ) e,e ** + q( s ) e, p ** − tx̂ − p( )∂x + r + q(s ) a, p** + q − t(1− x̂( )∂x +x=x̂s** 1 ∫ π e,s** +π a,s** − s ⋅ x̂s**x=0 x̂s ** ∫   with: %xs ** = 3t + s − q 6t −1 ;   π es ** = 3t − q 6t −1 −12t 2 + t 4q − 3( ) + q 2 6t −1( ) ⎡ ⎣ ⎢ ⎢ ⎤ ⎦ ⎥ ⎥ + s;   π a ** = 18t 3 + t 2 12q −12( ) + t 4q2 − 4q + 2( ) 6t −1( )2 − 1 2 q 2 .  after calculation, the value of welfare is given by:  w2 ** = 18t 3 + t 2 36s − 36q + 3( ) + t 10s2 + 2q +10q2 +1− 20sq − 2s( ) + 2qs − s2 − q2 2 6t −1( )2 − 1 2 q 2 + r + q  we verify, by taking relevant numerical values1 that respect our hypotheses (r sufficiently  large;  p > t;  t ∈ 0; 1 3 q⎤ ⎦⎥ ⎡ ⎣⎢ ;  q ≤ 1   ; and  0 < s < 3t + q −1 as the welfare  w2 ** > 0. we also verify                                                         1 for  the profits are positive.     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     93 that **1 ** 2 ww ≥ .  the  impact  of  public  subsidies  for  the  adoption  of  pa  on  the  welfare  is  expressed as follows:  ∂w2 ** ∂s = 36t 2 − 2t + s 20t − 2( ) − 20qt + 2q 2 6t −1( )2   proposition 9: an increase in the value of the marginal subsidy ʺsʺ has a positive impact on the  collective welfare. it this case we verify that:∂w2 ** ∂s > 0   in  this  situation,  the  us  public  authorities  optimize  the  welfare  by  determining  the  optimal level of subsidies such as:  ∂2w2 ** ∂2s = 20t − 2 2 6t −1( )2 > 0   the previous expression signifies that, no matter what the level of subsidy, the welfare is  improved.  the  following  graphic  illustrates  this  conjecture  that  welfare  increases  in  fine:  w2 ** (s) ∈ 0;+∞] [, for all values of  s > 0 .    graphic 3. evolution of welfare according to level of subsidies        in the first case, the policy for subsidies to assist the adoption of pa allows american  growers to decrease their production cost for “environmental quality”. the goal of the public  authorities is to evaluate the optimal subsidy that will be beneficial to all of the us actors.  several conditions must be respected in order to make it so.      ‐ condition (25) must be respected: s** ≤ q + 3p − 3t − p 2t   ‐  the  public  authorities  must  take  into  consideration  the  gains  of  african  growers  because, according to the hypotheses retained, they must not be crowded out of the market  (i).   graphic 2 highlights the fact that there is a level of subsidy where african growers are  crowded out of the market. nevertheless, as by hypothesis, r is large enough so that no actor     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   94 is crowded out of the market, the level of subsidies that are granted must meet the following  condition: q − 1 2 < s** < 3t + q −1                 (28)    there  is a  level of subsidy  that  is optimal and profitable  for all  the actors on  the  market.  its  value,  in  t0,  when  condition  (25)  is  respected,  is  given  by  the  following  expression: s** = q − 1 2 .  for this subsidy amount, the welfare is positive and superior to the welfare when pa  is not subsidised. the strategic policy undertaken by the american government enables an  increase  in american market shares and an  improvement in the qualities of cotton that  is  produced. the american and african growers also remain competitive (proposition 7). in  this  case,  the  public  policy  is  justified  economically  because  the  welfare  is  positive  and  superior  to  w1 **(graphic  4),  and  also  because  it  induces  an  increase  in  american  market  shares.    graphic 4. evolution of welfare according to t with and without pa subsidies        we have shown that public policy to distribute pa to the cotton sector enables in increase  in  welfare  and  an  increase  in  market  shares  for  american  growers.  this  policy  can  be  considered to be a strategic commercial policy combined with an environmental policy for  the  reduction  of  pollutants  caused  by  agriculture.  the  american  cotton  sector  becomes  profitable  without  harming  cwa  growers  who  have  a  natural  advantage  in  this  sector.  however, we have shown that there is a critical subsidy level that causes cwa countries to  be crowded out of the cotton market. this situation would obviously be contrary to the us  commitment regard ding policies to aid development in countries such as those in cwa. we  have finally highlighted the fact that subsidies improve both cotton qualities, which would  place cwa countries at a disadvantage because their natural competitive advantage would  be blurred.       baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     95 conclusion  although the quality of the cotton produced by cwa countries is undeniably superior to  cotton from other countries, distributing pa could reverse this state of affairs. many studies  recognize that pa enables optimal soil management, positively influences cotton quality and  induces a positive impact on the environment (bradow et al., 1999a. and 1999b., johnson et  al.,  2002,  ping  et  al.,  2004).  if  pa  should,  in  the  future,  become  a  support  for  the  implementation of strategic trade policy combined with environmental policies, it would be  clear  that  cwa  countries  would  be  faced  with  a  new  challenge  because  their  competitiveness would be jeopardized (gergely, 2005).  the  previous  model  shows  that  such  a  situation  could  be  considered  under  certain  conditions. the balances obtained (section 3), the result of a subsidy policy for the adoption  of pa, are higher to those determined when the hypothesis is made that us growers have  access to pa but are not subsidized (section 2). in other terms, aid for the adoption of pa  implemented by the us would result in an improvement of welfare of the us and welfare of  cwa  countries.  they  also  analytically  confirm  studies  by  yu  et  al.,  (1999),  yu,  2000,  bongiovanni and lowenberg‐deboer, (2000), whitley et al., (2000), schumacher et al., (2000)  bronson et al.  (2003,) regarding  the use of pa, which confirms an  increase  in yields and  profitability and a decrease in pollutants. they also agree with the studies that highlight the  fact that pa enables the quality of cultivated products to be  improved. (long et al., 1998,  bradow et al., 2000, johnson et al., 2000, ping et al., 2004a). however, we have shown that  there  is  a  critical  level  of  subsidy  that  crowds  out  cwa  countries  from  the  market.  for  subsidy amounts that are greater or equal to this level, a strategic commercial policy can be  considered unfair because cwa countries are unable to react by a trade war.  finally, in as much as american profits and welfare are not susceptible to variations in  cotton  prices,  strategic  trade  policies  implemented  by  the  us  to  support  pa  have  every  reason to be initiated at the risk of harming cwa countries.  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economics  of  precision  agricultural  practices  in  cotton  production”,  beltwide  cotton  conferences proceedings, national cotton counicil, memphis.  yu, m. segarra, e. et nesmith, d. (1999), « spatial utilization of phosphorus : implication for precision  agriculture practices », proceedings of beltwide cotton conferences, pp. 299‐302.        article history:  received:  15 march 2011 accepted:  16 april 2011                  ea_2012_3-4 original scientific paper determinants of brand equity and its causes & consequences a study of automobiles oil from peshawar region pakistan shahzad khan*, university of science & i-t, peshawar pakistan udc: 005.936.43 ; 658.626 jel: m32 id: 195855116 abstract – the word brand equity is known to every marketer and they wish that they have positive brand equity for their brands. the question arises why customers will play extra amount for one particular product? there are many variables which create brand equity. these variables include brand awareness, familiarity, brand image, association, loyalty, preferences and availability. but it is important to find that how each of these variables contribute towards brand equity for auto mobiles oil. to find out which of these variables contribute how much towards brand equity a sample of 100 auto mobile oil users has been contacted from peshawar region. on the basis of their responses a regression and correlation analysis was conducted. findings and results of the study shows that brand loyalty and brand familiarity has more influence on brand equity in case of automobile oil in peshawar pakistan key words: brand equity, brand awareness, brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability introduction positive brand equity is the critical success factor for any company for long term survival and enjoying tremendous profit. the question why a customer will pay additional amount of money for a particular brand? for the very same purpose this research has been conducted. but there are many variables which contribute for brand equity. how ever these variables can vary from brand to brand and segment to segment. this research is focused on determinants of brand equity that what are the factors that create brand equity and how much these variables contribute towards brand equity for automobiles oil in peshawar region. research finds seven variables brand awareness, brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability from previous researches. research is focused on that how these variables are contribution towards the brand equity of automobiles oil in peshawar region pakistan. * lecturer city university of science & i-t, peshawar pakistan, shahzadkhan.lecturer@gmail.com, tel: +92-91-3339405596 shahzad, k., determinants of brend equity, ea (2012, vol. 45, no, 3-4, 60-66) 61 literature review tanmay chattopadhyay, shradha shivani and mahesh krishnan (2009) brand equity is the amount generated by the firm just because of it brand image. but charging this additional amount is not an easy job. the effort behind it is effective marketing mix. there are many ways to aware target market about their product. advertising is one of the major among them to create mass awareness in mind of consumers. according to eda atilgan, safak aksoy and serkan akinci (2005) for brand equity its is important to have brand awareness because without awareness consumers don’t pay extra attention towards brands and even don’t pay as the brand is not exposed to them. according to hamed m. shamma and salah s. hassan (2011) brand familiarity in term of usage or experience is an important factor which can influence consumer towards brand equity. that is just because on the basis of experience consumers can decide either the brand is according to their requirements or not. even the post purchase behavior is also dependent upon the brand familiarity or first time use of product. according to u. thiripurasundari and p. natarajan (2011) brands take years to create its brand image. although there are many reasons that contribute for making their brand image but this is the brand image because of which company can charge extra from their customers. this is the brand image which contributes towards brand equity. emari hossien (2011) brand association in terms of any ways can be a reason for brand equity. maha mourad, christine ennew and wael kortam (2010) that country origin can be a reason for brand association. eda atilgan, safak aksoy and serkan akinci (2005) describes in their study that customer loyalty is based on various brand characteristics like price, product quality and post purchase services. these factors directly responsible for customer loyalty. manoj pandey & dr. j.k. raju (2009) describe that customer loyalty is the major factor which create brand equity. aaker, d.a. (1991) preferring a brand over its competitor means that brand has some features which compels consumers to prefer a brand over its competitors. for brand preference the brand characteristics are primarily responsible. when a brand is preferred over its competition it mean consumer are willing to pay even more for that product. but however it depends upon nature of product and market structure and competition strategies. owais (2000) in his study describe that availability is the realistic factor in consumer purchase decision. companies make it available its products every where in market because it should be convenient for the buyers that not to waste time and energy cost for the purchase of one particular brand. consumer can only pay and buy if the product is available in market. if it is not in reach of consumers they can not allocate its purchase resources for it. theoretical frame work of the study there are two variables discussed in this study, i.e. dependent and independent variables. the below figure shows the brand equity depends upon brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. the theoretical frame work of the study includes all those variables that are identified from literature brand familiarity, brand image, brand association, brand loyalty, brand economic analysis (2012, vol. 45, no. 3-4, 60-66) 62 preferences and brand availability are independent variables of the study. while brand equity is dependent upon mentioned variables. study identified the relationship among above variables. on the basis of these variables a conclusion and recommendations is provided. methodology as this research is focused on the brand equity of automobiles oil. for research purpose the branded automobiles oil consumers of peshawar region are targeted. a sample of 100 was selected for data analysis. the four automobiles companies were taken under considerations i.e zic, shell, total and volvien. the likert scale questionnaire is designed for collecting the data from the mention sample. the number of participants who contacted was 100. for data collection among 100 consumers a research instrument was distributed. the response from respondent was 100% and regression and correlation analysis is conducted on mentioned sample size. reliability of scale the table 1 below shows the reliability of the data collected from respondents. the following table show that the data collected from mentioned sample is reliable and respondents answered accurately. because the variables are exceeding from 70% which is the standard of acceptance for reliability. b r a n d e q u i t y brand awareness brand familiarity brand image brand association brand availability brand preference brand loyalty research framework of the study shahzad, k., determinants of brend equity, ea (2012, vol. 45, no, 3-4, 60-66) 63 table 1. reliability of the scale of the study s.no variables cronbach’s alpha 1 brand equity 0.820 2 brand awareness 0.813 3 brand familiarity/usage 0.799 4 brand image 0.911 5 brand association 0.745 6 brand loyalty 0.760 7 brand preference 0.803 8 brand availability 0.918 the above table calculations suggest that the responses given by respondents of the study are reliable. hypotheses of the study and regression analysis an overview of the hypothesis related to the relationship of brand equity with brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. in order to test the hypothesis of the study eight hypotheses are developed. study shows that there is significant relationship between the brand equity and following hypothesis. objectives hypothesis relationship between brand equity and its determinants. h:1 there is a positive relationship between brand equity and brand awareness. h:2 brand familiarity/usage has an impact on brand equity.. h:3 there is a positive relationship between brand image and brand equity. h:4 brand association has an impact on brand equity h:5 brand loyalty has a significant impact on brand equity. h:6 brand preferences has an influence on brand equity. h:7 brand availability has a relationship with brand equity. table 2 below shows significance relationship between the dependent and independent variables. it explains that the brand equity has a significant relationship with brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. table 2 show that the overall model is highly significant. table 2 below shows significance relationship between brand equity and brand awareness. there is significant relationship exist between brand equity and brand awareness (t-statistic = 27.213 and pvalue= 0.000). there is a significant relationships exist between brand equity and brand familiarity (t-statistic = 33.620 and p-value= 0.000) which mean that brand familiarity has an impact on brand equity. economic analysis (2012, vol. 45, no. 3-4, 60-66) 64 table 2. regression results for variables of the study. determinants of brand equity s. no dependent variables independent variable adjusted r square f b st. error t p. value 1 brand equity brand awareness 0.673 17.107 0.173 0.286 27.213 0.000 2 brand equity brand familiarity 0.792 21.169 0.321 0.212 33.620 0.000 3 brand equity brand image 0.697 18.304 0.401 0.271 17.411 0.000 4 brand equity brand association 0.325 32.453 0.720 0.252 28.841 0.000 5 brand equity brand loyalty 0.894 31.412 0.732 0.293 39.112 0.000 6 brand equity brand preference 0.782 27.987 0.383 0.413 33.230 0.000 7 brand equity brand availability 0.577 13.120 0.297 0.610 17.113 0.000 table 2 above shows that there is a significant relationships exist between brand equity and brand image (t-statistic = 17.411 and p-value= 0.000) which mean brand image has an impact on brand equity. there is significant relationship exist between brand equity and brand association (t-statistic = 28.841 and p-value= 0.000). there is significant relationship exist between brand equity and brand loyalty (t-statistic = 39.112 and p-value= 0.000). there is a significant relationships exist between brand equity and brand preferences (t-statistic = 33.230 and p-value= 0.000) which mean brand preferences has an impact on brand equity. study shows that there is significant relationship between brand equity and brand availability (t-statistic = 17.113 and p-value= 0.000). hence the above result shows that brand equity is dependent upon above mentioned variables. correlation analysis as shown in table 3 below, there is strong association between brand equity and brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. survey demonstrates that there is a strong relationship between brand equity and awareness with correlation coefficient (r = 0.701). table 3. correlation analysis for variables of the study determinants of brand equity s. no dependent variables independent variable r r square 1 brand equity brand awarenes 0.701 0.491 2 brand equity brand familiarity 0.898 0.806 3 brand equity brand image 0.746 0.556 4 brand equity brand association 0.453 0.205 5 brand equity brand loyalty 0.917 0.840 6 brand equity brand preference 0.811 0.657 7 brand equity brand availability 0.521 0.271 shahzad, k., determinants of brend equity, ea (2012, vol. 45, no, 3-4, 60-66) 65 for brand familiarity and brand equity correlation coefficient is (r = .898). which mean that brand familiarity has a strong influence on brand equity. as shown in table 3, there is strong association between brand equity and brand image with correlation coefficient (r = .746). there is a weak relationship exist between brand equity and brand association with correlation coefficient (r = .453) there is a very strong correlation between brand equity and brand loyalty with correlation coefficient (r = .917). which mean that brand equity strongly dependent upon customer loyalty towards automobiles brand. brand equity has a strong relationship with brand preference correlation coefficient (r = .811). which mean that brand preference has strong impact on brand equity. there is a week relationship exist between brand equity and brand availability with correlation coefficient (r = .521). which mean that brand availability can weekly affect brand equity. conclusion research finds that brand equity has a significant relationship with brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. all factors play a vital role in creation of brand equity for automobiles oils. but findings of research show that brand loyalty contribute more with correlation (r = .917) toward brand equity for automobiles oil, in comparison of other variables of study. the second prominent variable is brand familiarity/usage with correlation (r = .898) which contribute more toward the brand equity for branded automobile oil. over all between all variables the vital role is from brand loyalty and familiarity. hence it is concluded that all variables has influence on brand equity but brand loyalty and familiarity has greater influence on brand equity towards automobile oil in peshawar pakistan. references aaker, d.a. 1991. „managing brand equity.“ the free press, new york, ny. chao p. 1998. “impact of country of origin dimensions on product quality and design quality perceptions,” j. bus. res, 42(1): 1-7. eda atilgan, safak aksoy and serkan akinci. 2005. “determinants of brand equity a verification approach in the beverage industry in turkey.” marketing intelligence and planning, 23 (3): 237-248. emari hossien. 2011. “determinants of brand equity: offering a model to chocolate industry” world academy of science, engineering and technology, (59): 1205-1213. hamed m. shamma and salah s. hassan. 2011. “integrating product and corporate brand equity into total brand equity measurement.” international journal of marketing studies, 3 (1): 1120. maha mourad, christine ennew and wael kortam. 2010. “descriptive evidence on the role of corporate brands in marketing higher education services.” service science, 2(3):. 154-166,. manoj pandey & dr. j.k. raju. 2009. „analyzing relationship between brand perception and customer loyalty in life insurance industry.“ the journal contemporary management research, 3 (1). economic analysis (2012, vol. 45, no. 3-4, 60-66) 66 owais mufti, shahzad khan and zafar zaheer. 2011. “impact of rational and emotional factors in creating consumer motivation, a study of policy holders of state life insurance corporation in kpk, pakistan”. european journal of social sciences, 24 (iv): 546-552. tanmay chattopadhyay, shradha shivani and mahesh krishnan. 2009. “determinants of brand equity a blue print for building strong brand: a study of automobile segment in india.” african journal of marketing management, 1(4). 109-121. u. thiripurasundari and p. natarajan. 2011. “determinants of brand equity in indian car manufacturing firms?.“ international journal of trade, economics and finance, 2 (4): 346-350. determinante vrednosti brenda i njegovi uzroci i posledice: studija na primeru automobilskih ulja u peševarskoj regiji pakistan rezime – reč „vrednost brenda“je poznata svakom trgovcu,koji želi da ima dobre trgovačke marke za prodaju.postavlja se pitanje zašto bi kupci suviše plaćati za jedan određen proizvod? postoje mnoge varijable koje odredjuju vrednost trgovačke marke. ove varijable uključuju svesnost o brendu, poznavanje njegovog izgleda, odanost brendu, njegovo preferiranje i dostupnost istog. pored toga, važno je otkriti kako svaka od tih varijabli doprinosi vrednosti brenda automobilskih ulja. da bi se saznalo u kojoj meri neka od ovih varijabli doprinosi vrednosti brenda automobilskih ulja, korišćen je uzorak od 100 korisnika automobilskih u peševarskoj regiji. na temelju njihovih odgovora, uradjena regresiona i korelaciona analiza. nalazi i rezultati istraživanja pokazuju da je lojalnost brendu i poznavanje brenda od najvećeg uticaja na njegovu tržišnu vrednost, kada je reč o automobilskim uljima u peševar, pakistan. klju:ne reči: vrednost brenda, svesnost o brendu, poznavanje trgovačke marke, izgled, odanost brendu, preferiranje brenda, raspoloživost article history: received: 15 july 2012 accepted: 9 august 2012 microsoft word 2009_1_2.doc specificities of online concept in comparision with a classic concept of marketing research hasan hanić, belgrade banking academy, serbia beriz čivić, faculty of economics of the university of tuzla, b&h key words: marketing, researching, decision making, information technology, online research jel: l22,m3,l86 abstarct – generation of quality marketing decisions necessarily anticipates existence of a developed system of marketing research. the paper assesses limits of a classic concept of marketing research and stresses specificities of online concepts. the accent is put to a role of information and communications technology and a process and organization of online concepts of marketing research. the paper also analyzes the comparison of these concepts of marketing research and underlines their complementarities and a possibility to eliminate individual limitations of each of the concepts in order to establish an effective process of marketing research with a function to support the process of generation of marketing decisions. introduction contemporary business practice requires a faster process of making business decisions from managers. it is very important for managers to have business information of good quality. companies have an imposed need to establish a quality system of collection and its management. a special accent should be put on market activities of companies and complexity of marketing decisions making. the question is: ″how marketing managers can realize facts in regard to changeable desires of consumers, new initiatives of competitors, changes in distribution channels, etc.?″ the answer is that management has to develop an adequate system of collection and management of marketing data. the marketing research process enables management to collect data of good quality and it is a basis of generation of quality management decisions. significance of marketing research is especially visible in a possibility to diagnose a specific market position of a company. a diagnosis of the existing situation enables management to structure a management instrument that would enable improvement and strengthening of a market position of a company. many companies lack a sophisticated collecting and management of data and information. experience from local and international business practice show that many companies do not have established market research systems or the systems are reduced only to routine predictions based on empirical cognitions or to analyzing of historical data. in the best cases they are reduced to a partial survey as a way of primary data collection. in regard to an increase of effectiveness of a business process, it is very important to establish a system of collection and management of marketing (and other) data and information of a good quality in order to improve the process of marketing decision making and support improvement and strengthening of a marketing position of a company. economic analysis 1-2 (2009) 43-52 44 we can differ two concepts of marketing research, depending on how much application of marketing research is based on the internet and depending on information technology solutions based on the internet. those are: • classic concept of marketing research, • online concept of marketing research. limitations of classic concept of marketing research the classic concept of marketing research anticipates application of a scientifically approved methodology in realization of marketing research, which was a characteristic of the period until the end of the xx century – before a development of modern information and communications solutions based on the internet. when we talk about the classic concept of marketing research, we need to underline the fact that the internet and data bases available via the internet (but only as a source of secondary data) and various software applications for data processing are used for these marketing researches. however, that is a far lower level of application of information technology in marketing research in comparison with the online concept. the classic concept of marketing research can ensure a valid and reliable information basis for making marketing decisions. however, this concept often requires more time and assets to ensure a continuous maintenance of up to date information basis based on what marketing decisions are made. this is a significant limiting factor in contemporary conditions of business operations, which is characterized with an increasing complexity and a need for a quick decision making. the mentioned imposes a need to establish a system of marketing researches that would be based on the application of contemporary information and communications technologies in order to enable a quick collection of valid and reliable data. these data should be available in time, at a proper place in the decision making system and in a form that enables a decision maker to generate a decision quickly. starting from contemporary conditions of a business activity, managers are generally, and particularly those from the field of marketing decision making, faced with a very dynamic market movements which generate a need to make business decisions quickly so they need a continuous provision of quality information in order to retain and improve their market position. ensuring an up to date information basis can be achieved only if a process of generation of data is established as a continuous and organized process. this process can not in wholeness be based on a support provided by the classic concept of marketing research. hence, there is a need to solve this problem in a systemic way. identified weaknesses of this concept in the process of generation of the information basis in the business practice contributed to it and they are manifested through the following: • information necessary to solve various aspects of marketing problematic are counted. however, due to a lack of time and one system that would continuously ensure collecting and managing of information, decision makers are forced to undertake an non systemic ʺhunt for information when making every decisionʺ; h. hanić, b. čivić / ea 1-2 (2009) 43-52 45 • a consequence of the non systemic approach is that not all relevant information are collected or many information that are collected are late or incomplete; • as a consequence of the fact that there is not any organized process of collecting and managing of information, it often happens that important information are not recorded in an adequate way and form in order to be available at all relevant destinations in a company. often they are jealously kept by individuals who want to use them in certain situations as instruments to improve their positions in the company; • since the process of generation of the information basis is not systematic, questioning of a level of quality of an information is often justified (validity and reliability of the information), and that is a prerequisite for a decision of a good quality. the rest of the paper will focus on specificity of the contemporary approach to the process of marketing research that is named as the online concept of marketing research. this concept enables application of solutions of contemporary information and communications technology in the process of marketing research, which enables researchers to improve a process of collecting, processing and storing of data ensuring anticipation of improvement of the process of generation of business decisions in a company. the online concept of marketing research is based on the implementation of these solutions specificity of online concept of marketing research as previously stressed, one of the key prerequisites of making quality marketing decisions is availability of quality information. application of solutions of the contemporary information and communications technology in the process of marketing research enables researchers to improve the process of collecting, processing and storing of data, also ensuring the prerequisite to improve the process of generation of business decisions in a company. the online concept of marketing research is developed on a basis of the application of these solutions. the online concept of marketing researches means application of a scientifically approved methodology in realization of marketing research using solutions of the contemporary information and communications technology based on the internet in all phases of realization of the research process. in this way certain limitations faced by the researchers in the classic concept of marketing research are eliminated. it is important to be aware of the fact that these two concepts of marketing research do not exclude each other but they are complimentary. it is very important to ensure a continuous updating of information background, which serves as a basis for business decisions making. this can be achieved only if the process of data/information generation is established as a continuous and organized process. this process can not in wholeness be based only on a support provided by the classic concept of marketing research. a role of information and communications technology in the process of marketing research wanting to stress a widely spread use of information and communications technology in contemporary business, many authors use the term digital economics in their works. the economic analysis 1-2 (2009) 43-52 46 potential of the contemporary information and communications technology will be assessed in this paper in regard to a possibility of its application and effects of the application to the process of marketing research. hence, the rest of the text focuses on the online concept of marketing research as a frame that enables the application of the solutions of the contemporary information and communications technology in the process of marketing research (in the process of collecting and analyzing data and presenting obtained results). this concept ensures a possibility to use the internet and solutions of the information and communications technology based on the internet in order to realize a standardized systemic process of collecting, processing and presenting the marketing data. however, we need to be aware of the fact that the application of the online concept in a combination with the classic concept can have far better effects than an isolated application of any of these two concepts of market research. but first of all, we need to take care about information needs of users and of market decisions makers. within the marketing information system, we can realize a combination of the classic and the online concept of marketing research, depending on the nature of the information needs, and in order to realize an effective functioning of the system of collecting, managing and application of the data in order to improve business performances of a company. the previously mentioned is more than enough to motivate management to ensure application of the information and communications technology in order to provide a continuous quality process of generation of marketing data and create necessary prerequisites for improvement of business performances of a company. in regard to the mentioned, a need to connect the information and communications technology with the process of marketing researches in order to make the process effective in finding out needs and requests and enable creating of a better system of their satisfaction is clear. the online marketing research represents a standardized systematic procedure of providing marketing data through the internet and the information and communications technology based on the internet. what is characteristic for the marketing research methodology that is realized in a classic way is also valid for the online marketing research. a difference is in resources and a technique used for collection of primary and secondary data. the internet has been (since its appearance) representing a very important source of secondary data, even within the classic concept of the marketing research. in this case we want to focus on ways of realization of primary data collection using the internet resources and other information and communications solutions. it is important to underline that within the frame of the online concept of marketing research we can realize data collection, both internally and externally, because a working methodology of this concept is the same on the internet and on the intranet. however, if we want to realize an internal primary data collection, it is not essential to realize it only within a frame of the intranet because each employee that should be questioned can use resources from the internet. it is the same with usage of secondary internal data sources. one of important advantages of the realization of marketing research by the concept of the online research is that data can be processed as soon as they are obtained. data from the internet do not require any extra steps of data entry because they already are in electronic form. using appropriate software those data (replies of examinees) can be imported into the h. hanić, b. čivić / ea 1-2 (2009) 43-52 47 software which will do further processing of the data and send them to a working position within the business process where they will be used as an information basis for making business decisions. the internet (or web as its most commonly used form) can be used to access collected data of a company from distanced locations (distanced branches), to process the data and present them on the internet and make them available to all those who are interested. besides data collecting, a very important issue is management of collected data and ensuring their adequate storage and timely availability at all places in an organizational structure where they will be used for certain purposes. a process of online marketing research a process of marketing research based on the internet and information and communications solutions do not differ from the process of the classic marketing research. it means that all elements and their inter-relations that characterize the process of the classic marketing research are valid in the case of the online marketing research. what differs the online marketing research from the classic marketing research are techniques and a form of primary data collection. the reason for application of the online marketing research supervenes, among other, from the fact that application of the internet and the information and communication technologies based on it in the process of primary data collection enable this process to be performed: • with less time consumption, • with less assets consumption, • with less possibility of an error. a possibility to decrease sources of errors in the process of primary data collection within the online concept lies in a part of the process connected to editing and coding of data. namely, this process is automatic with marketing research based on the contemporary information and communication technologies. different from the online concept, in the classic concept of marketing researches these activities directly depend on the researcher who has to edit and code the data manually. if we want to analyze collected data with certain software, it is necessary to enter prepared data manually in the software and to analyze the collected data afterwards. these manual operations are time-consuming and a possibility of error occurrence is significant. in the online concept of marketing research this process is automatic and data entry into the software is supported by an examinee (in a method of questioning an examinee gives answers to questions directly in a certain software environment; in a method of observing an observed situation is directly processed by an appropriate software solution), and then the data are transferred from the examinee to a researcher due to a certain information and communications solution. then the data are automatically imported in the appropriate software and an analysis can start immediately. this eliminates editing and coding phases from the whole process and increases a speed of obtaining desired data but eliminates a possibility of occurrence an error that is connected to the two mentioned activities. since marketing research is often realized using a combination of primary and secondary sources, this approach can successfully be realized with the online concepts of marketing research. economic analysis 1-2 (2009) 43-52 48 the process of the online marketing research, as well as the classic concept of marketing research, is realized through basic phases: planning of a research, data collection, analyzing collected data and presentation of results. however, the online concept puts a stress to the application of the software support wherever the nature of marketing research allows and wherever activities of a researcher can be substituted by solutions of the contemporary information and communications technology. in this way one wants to shorten duration of certain phases in the marketing research process or to eliminate the whole process and release a research from manual activities and minimize possibilities of error occurrence. organization of the online marketing research an issue of organization of marketing research deserves a special attention in the classic and in the online concept of marketing research. namely, a quality of marketing research is, among other, determined by a possibility of ensuring a representative sample. to conduct the online marketing research, one needs to establish and maintain a basis of e-mail addresses of potential examinees in order to invite them to participate in a research, if necessary. experience of professional researchers from agencies [gfk croatia, 2006, page 3] state that it is better to do generation of bases of e-mail addresses of potential examinees with an offline method (a survey via phone or personal questioning) than via the online method (via links, banners or pop-up windows from selected web pages). for example, the basis of the internet addresses possessed by gfk is created offline and it contains several thousands potential examinees. gfk croatia – center for market research conducts its online research on a basis of email addresses that has been created since 2002. persons who have [gfk croatia, 2006, page 6] e-mail addresses and the internet access are registered with classic representative surveys (a telephone survey or personal questioning). one can extract a sample for certain target groups of examinees from the base, according to needs of a certain research. then, from gfk’s online pool, one e-mails a user name and a password to every examinee and the examinee registers on a certain web page and fills in a previously prepared questionnaire (picture 1). picture 1. a way of conducting a research with the gfk’s online pool source: gfk croatia, 2006, page 6 users themselves can be conductors of the online marketing research or they can do it through a certain model of cooperation with specialized organizations that deal in the marketing research process. recruitment internet pool address data base examines www questionnaire server e-mail id-nr. offline recruit users of internet (personal surveys, telephone’s surveys, etc.) h. hanić, b. čivić / ea 1-2 (2009) 43-52 49 a recommendation to users is to engage a specialized organization for these services for the online marketing research. namely, a realization of the online marketing research requires a certain infrastructure of technological nature. a construction of this infrastructure can be ensured through a construction of a marketing information system in a company. however, very often creation of infrastructure settings for realization of the online concept of the market research represents a very huge effort for individual users. the online marketing researches can be organized as: • (one time) ad hoc online research, • occasional (repetitive) online research, • continuous (longitudinal) online research. also, the concept of the online marketing research enables an organization have a researching process in a form of: • online panel research, • online omnibus research, • online focus groups. all mentioned forms of organizing the online marketing research can be implemented within the process of establishing the marketing information system, but it is necessary to assess information needs and, according to them, decide about a form and contents of the organization of the online marketing research and a need to combine them with the classic concept of marketing research. comparision of classic and online concept, of marketing research it is the best to make a comparison of performances of the classic and the online concept of marketing research on some examples from research practice. we will use experience of gfk croatia – centre for market research for this paper. namely, for a successful realization of the online concept one needs to pay attention to a level of usage of the internet by potential target groups. the higher the level of the internet usage by a selected target group is, the more representative a certain type of the online samples is. for example, in cases where a target group consists of older people, or with groups of lower income, application of the online concept of marketing research can give worse results than in case when data are collected in this way from students. in regard to an aspect of consumption of time and assets, the online research (questioning techniques) can be realized in a shorter time period and with less consumption of assets than techniques of questioning in the classic concept. the online researches are especially appropriate in case when information is needed urgently and when a wide geographic coverage is necessary in data collecting. it is especially a case with, for example, testing reactions on promotional solutions, etc. the centre for market research gfk croatia has an interesting experience in regard to duration of the process of data collection. according to their experience [gfk croatia, 2006, page 3], the online survey usually do not last longer than 15 to 20 minutes, but the practice proved that interesting topics and questionnaires designed in a interesting way can last longer. it also turned out that the online methodology actually is the best way to conduct in economic analysis 1-2 (2009) 43-52 50 depth conversations with experts from the field of health care. for example, with pediatricians, gynecologists, surgeons and similar professions who have a lack of time and do not accept the in-depth survey eagerly. in regard to complexness of questions the online concept of market research can also give better results. complex questions can be presented in a better way with an adequate usage of software solutions than via telephone or in a survey via post. advantages of the online concept are stressed in regard to a need to use certain presentation material (samples, pictures, promotional solutions, etc.) in the process of data collection in order to entice reactions of examinees. using a multimedia support within the online concept, all types of audio and video recordings and pictures can be presented. for example, web surveys are the most favorable to represent promotional solutions, design solutions, projection solutions, etc. on the other hand, with personal questioning we can have printed, audio or video material, but they require additional expenses because reproduction of a huger number of quality color prints is expensive. with telephone questioning it is possible to present only audio recordings and it limits a possibility to apply the classic approach to this type of researching. previously we stressed significant advantages of the online concept in regard to the classic concept of marketing researches and in regard to processing of collected data and a possibility to eliminate errors that occur in these phases of the research process. according to previous practice of the gfk group, we can define that examinees answer questions more thoroughly in online surveys than via telephone or similar questioning. a short comparison of the classic and the online concepts is given in table 1. table 1. a comparison of the classic and the online concept of the marketing research criteria of comparison online face to face telephone post target group many, even specific almost all almost all majority duration of survey 10 – 20 min – 60 min 15 – 20 min – 90 min possibility of complex questions medium high low medium presentation material multimedia simple possible, but difficult impossible possible, but with influence of survey conductor none medium low none time of realization short long relatively short relatively long expenses low to medium relatively high medium low to medium source: gfk croatia, 2006, page 7 table 2 can be consulted for possibilities of application and advantages of the online concept of marketing research for researchers h. hanić, b. čivić / ea 1-2 (2009) 43-52 51 table 2. some of characteristics of the online concept of the marketing research assessed requirements possibility of satisfying requirements fast implementation yes favorable price yes multimedia presentation yes without influence of survey conductor yes ʺdifficult ʺ topics are possible yes representativeness of sample yes (with exceptions) target groups many, and very specific regional causing yes topics most topics are possible preliminary results yes, unweighted very difficult questions better not without survey d source: gfk croatia, 2006, page 7 according to the previously mentioned, we can conclude that one necessarily needs to take the online concept of marketing research into consideration in planning a realization of the process of marketing research. this is because of an extraordinary spectrum of possibilities offered by this concept. conclusion ensuring a quality information basis is one of the key prerequisites for generation of quality business decisions. this prerequisite is realized through the marketing research process that can be established in a company in several ways. establishing the marketing research process on a basis of application of the internet and solutions of the contemporary information and communicatory solutions based on the internet can ensure adequate results. it is especially a case if it is assessed from an aspect of fulfillment of requirements of modern business practice in regard to a need for availability of up to date data and information and a need to deliver data at a proper place of an organizational structure and in time in order to be used for improvement of business performances of the company. an organizational platform that enables an effective fulfillment of these requirements is the marketing information system. establishment of the system in a company creates an adequate frame for an effective organization of the marketing research process and the process of generation of marketing decisions. it is important to underline that the two concepts of marketing research that are treated in the paper (the classic and the online concept) do not exclude each other. on the contrary, they are complementary and enable establishment of the market research process on a basis of a combination of these two concepts, which eliminates limitations of each of them. economic analysis 1-2 (2009) 43-52 52 references chinsnall m. p., (2001), marketing research, the mcgraw-hill companies, london cooper d. r., schindler p. s., (2006), business research methods, mcgraw hill international edition čivić b., (2007), modeliranje savremenog sistema marketinških istraživanja, magistarski rad, ekonomski fakultet univerziteta tuzla, tuzla fletcher k., (1995), marketing management and information technology, prentice hall europe, london gfk croatia – centar za istraživanje tržišta, (septembar, 2006), gfk e-solutions – online istraživanja (www.gfk.hr) hanić h., (2004), istraživanje tržišta i marketing informacini sistem, ekonomski fakultet beograd, beograd saskcan pulse trading, (2006), prosoft xp, istraživački projekat, the computerworld honors program, regina, canada 2013_1_2 preliminary report creative cash flow reporting – the motivation and opportunities1 stevanović slavica2, institute of economic sciences, belgrade, serbia belopavlović grozdana, lazarević-moravčević marija, belgrade banking academy, belgrade, serbia udc: 657.05 ; 005.32 jel: g3, l2, m42 id: 198577932 abstract – company's stakeholders make business decisions based on information presented by management. the quality of decisions, among other things, depends on the quality and reliability of information in the financial reports. business practice demonstrates that managers tend to present a false picture of the financial position and profitability of the company, often in cooperation with the owners of the capital. procedures that management and investors take, in order to create a false impression about the performances of the enterprise, the contemporary literature defines as creative financial reporting. presentation of better financial performance than realistic one provides misleading signals about the company, while the users of information are misinformed. the goal of this paper is the analysis of opportunities to implement creative cash flow reporting and the factors that encourage the company’s management and the owners of the capital to wrong and misleading interpretation of performance items. after the presentation of the main motive of creative financial reporting, we shall focus on examples of erroneous classification of cash flows. earnings management and the shaping of cash flows may be realised within and beyond the boundaries of accounting regulations on several ways, but a special review in the paper is dedicate to creative reporting procedures of cash inflow and outflow related to receivables, investments, liabilities, and expenses. consequences of creative reporting on cash flow and other performances could be serious both for stakeholders and for survival of the company, which is discussed in the last part of the paper. key words: creative financial reporting, creative cash flow, classification of cash flows, unsustainable cash flows introduction financial reports are an important resource, especially for the shareholders, and other company’s interest groups, which based on the presented accounting information, assess the company’s performance. financial statements information required for the stakeholders should be relevant, and in the same time free of information risk. multiple cases of financial reporting fraud, in the past two decades have undermined confidence in financial reports 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. 2 institute of economic sciences, zmaj jovina 12, belgrade, serbia; e-mail: slavica.stevanovic@ien.bg.ac.rs stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 29 reliability and managers integrity. the role of managers is to manage company’s assets and capital in the interests of the owners, but all the rights acquired by their agent’s position, create a space to meet their own interests, which are often in conflict with the interests of the shareholders. managers can use their accounting discretion to influence the content of financial reports. final selection of the accounting policy and possible hidden intentions of managers affect the reality of reported performances. manipulation of financial reports is known as a creative financial reporting. the very term of creative is usually associated with something positive and innovative. when it comes to financial reporting that is not the case. creative financial reporting includes procedures that management takes in order to conceive a false impression about the company’s performance. the nature of accounting information based on accrual basis, to great extent facilitate the creative reporting. the choice between alternative methods of evaluating certain assets, income and expenses items, gives managers a chance to express overstated or understated company’s earnings and net assets, in accordance to advance the goals and signals they want to send to the public. the values of the financial reports items resulting accounting estimates may also be subject to fraud, which undermines the reality of the presented company’s financial position and performance. in addition to the personal benefits to the management to accomplish unreal presentation of company’s performance, the owners of the company may also put pressure on management to participate in the financial reporting fraud. the motivation for creative financial reporting the manager’s motives to implement financial reporting fraud may be psychological, egocentric, or ideological, but in most cases the economic benefit is the main motive that encourages illegal activities (dušan milojević, 2006). guide by the desire to achieving personal benefits and pressures of the owners, managers conduct activities that result in false financial reports. the company that under conditions of strong competition is not able to maintain a good position in the market can resort to creative reporting of results and cash flows. in this way, the company is trying to avoid the consequences of public disclosure of reducing demand and sale of its products, loss and low net cash flow. manager's personal benefit in form of bonus payments and other incentives depends on the degree of firm's performance, which enhance the managers with poor integrity to manage profit and cash flows in a way that distorts the reality. increasing the market share price, easier obtaining and a lower cost of capital, lack of expected results in the application of the chosen strategy, and relativism of the present monopoly position (dejan malinić, 2008), may be significant motifs for displaying more favourable company's performance then they really are. strong and stable net operating cash flow is a sign of a high quality earnings that easily can affect the growth of share prices. by fictitious increase in share price, earning per share, maintaining a stable income and on that basis payment of stable or higher dividends, the company wants to make shares attractive to new shareholders. expressed good performance more easily attracts capital of creditors and others, under favourable conditions, which is always a key motivation for the creative accounting presence. the interest rate, the degree of binding constraints, the need for some kind of loan guarantees, among other things, depends on the cash flow performances. economic analysis (2013, vol. 46, no. 1-2, 28-39) 30 activities such as accounting manipulations, results better financial performances displaying in comparison to the companies from the same industry, or in comparison with the previous periods that blur image. sometimes companies attempt to increase artificially earnings and net assets in order to realize prognosis or to make up bad financial indicators. financial benefit in a form of misappropriation of assets by employees is also accompanied by manipulation of the company’s financial reports, with the idea to hide illicit activities by accounting records and supporting documents. literature mentioned three factors, referred as the «fraud triangle», often combine to lead individuals to commit fraud: pressure or an incentive to engage in fraud; a perceived opportunity, and the ability to rationalize fraudulent behaviour (centre for audit quality, 2010). earnings management may be motivated by increasing the accounting information use value for all interest groups or, which is not rare in practice, by distorting reality of reported earnings in order to meet some of the goals set in advance. earning management strategy known as increasing income involves multiplied expression of periodic income attempting to show a more favourable picture of the enterprise achievements. aggressive assets depreciation in the current period in order to present an increase in earnings in the period to come is exercised within the big bath strategies. the income strategy, on the other hand, comprises decreasing income in periods of good success, and its increase during the periods of bad achievements, in attempt to conceal the instable income (john j. wild, k.r. subramanyam, robert f. halsey, 2007). management may seek to influence the amount of the presented profit by implementation of earnings management activities, while the assembly of the shareholders has the final decision about the distribution of the profit. unrealistic reported values of company's assets, liabilities, income, and expenses threaten the quality of reported earnings, while the net cash flows trends does not match such movements. for this reason, the cash flow statement is used as a source of information needed for analysis of income quality. comparing the amount and net income trends with net cash flow may indicate the presence of irregularities and creative financial reporting. analyses of cash flow, used to detect the problem of profit quality, do not mean that there is no possibility of shaping the amount and structure of cash flows. the reason for failing to detect fraud and its resulting effects on profit and net assets of the company, may be deliberately expressing of cash flows by the management. as the earnings could be the subject of management, the management board can exert influence on the reported net cash flow from operating activities. misstatement of cash flows provides misleading signals about the sustainability of financial performance, misleading the users of that information. being aware that report users may detect manipulations with earnings by comparing cash flow and profitability trends, managers can access the erroneous or false reporting of cash flows of the company. there are situations when the high presented net cash flow from operating activities does not prove the quality of operating income, but the inclination of the company’s management to manage net cash flows from operations. aware of the importance that information on cash flows from operating activities has for users of financial reports, managers are prone to manage cash flow. by presenting a good financial performance, companies tend to attract investors, creditors, and others. it is therefore important to know whether the higher inflows than outflows of cash from operating activities are the sign of real ability of the company to stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 31 generate cash from operating sources, or they are result of misclassification and other funds’ manipulations. creative cash flow reporting means that management undertakes the actions in order to create a false impression of the cash flows, primarily, on cash flows from operating activities. to the public they are tending to send signals that the company is able to generate cash and cash equivalents, although sources from operating activities are not, or at least not to that extent sustainable. creative cash flow reporting can be executed within the boundaries of generally accepted accounting principles (gaap) and other accounting regulations or their disruption. actual cash flows and flows presented in the statement of cash flows often do not overlap, which could be due to false reporting by the company’s management. committed manipulations conceal the real picture about the ability of the company to generate cash. expression of unsustainable cash flows should also be considered creative reporting (charles w. mulford and eugene e. comiskey, 2005). some of the opportunities of creative accounting practices, when it comes to reporting cash flows, will be presented in the following. opportunities for creative cash flow the value of cash and cash equivalents to the end of the particular accounting period is presented in the balance sheet and the statement of cash flows. the users of mentioned financial reports assume that the information about the cash balance and changes are reliable. the fact is that the audit of the financial statements provides additional security in the reliability of reported values, but it does not provide an absolute guarantee that the presented information is true and correct. due to the fact that audit procedures are not the same for all parts of the assets, the tendency to fraud and embezzlement by management and employees depends on the nature of the company’s assets. cash is a part of assets verified by an auditor using the independent confirmation addresses to the bank. as confirmation is the external source of audit evidence, it can be concluded that the cash is not often the subject of management’s fraud. cash is in contrast to other balance sheet items exempt from problem of accounting estimates and accounting options.. yet, the possibility of overstating of cash inflows and understating the outflows influences the reality of presented structure of cash flows. management is unlikely to be resorted to deliberately false the presentation of the cash balance, but the cash flows and their elements are an area that management could take advantage of the planned manipulation. the shaping of cash flows from operating activities by the company’s management, with the aim of creating the image of the successful generation of cash from operating activities, is understandable given the importance of the amount and trend of net cash from operations in the process of evaluating investments and the calculating company’s stock price. frauds in the area of cash collection and payments are generally accompanied by manipulation of transactions of sale, purchases, investments, debt payments, and other ones that have resulted in a change of cash. cash transactions do not reflect the actual events in the reporting period in the following situations: paying obligations regarding material procurement that really has not been received, turning out invoices to customers at prices economic analysis (2013, vol. 46, no. 1-2, 28-39) 32 that are lower than the prices defined by business policy, employees are calculated and paid based on greater number of hours of work in relation to the actual spent time, the subsidiaries receive higher interest rates than currently paid, double duties paid by suppliers invoices, etc. (milojević, 2006). receivables and related cash flows. the rule is that an increase in the receivables balance in relation to the previous period, as a result of unpaid claims, leads to a decrease in net cash flow. inversely is with the decrease in the receivables balance, which affects positively the net cash flow from operations. increasing net cash flows are interpreted differently depending on the reason of reducing claims and increasing cash inflows. decrease in receivables could be the result of current billing, or claims deriving from the previous period. the collection of outstanding claims will increase net cash flows from operating activities, but it is important to note that this source of cash is not of sustainable. management frauds incurred by presenting fictitious sales, and on that basis introduction of non-existing customers and fictitious receivables, leads to overstated earnings. cash flow statement can help in the discovery of similar financial fraud, but the fact that the statement of cash flows can be subject to management manipulation, is a disadvantage in detecting the fraud. the more convincing is the presentation of the fictitious customers and sales revenue if it is expressed the collection of fictitious sales and receivables, while the operating profit and operating cash flows are moving in the same direction and does not attract the attention of reports’ users. as an example, we can present a company whose management reported fictitious equipment purchase together with fictitious account receivable from the partners with which it already operates (charles w. mulford and eugene e. comiskey, 2005). based on fraudulent purchases of new equipment are presented outflows from investment activities, while the collection of receivables from non-existent customer, leads to increase of inflow from operating activities. fictitious operating cash inflows and investing cash outflows are equal, so that mentioned transactions have no impact on the cash balance at the end of the period, but have resulted in overstated net operating cash flows. advance payments by customers can be a significant source of cash from operating activities of the company, but the increase in income on this basis does not present a stable source of cash. advances payments by customers as balance sheet item, could be used to overstate net operating cash flows. an example is the company enron, whose management together with overstated income, presented overstated cash flows from operating activities, which, at least for some time, avoided the analysts suspects in reality of the earnings. overstated net operating cash flow is the result of misclassification of inflows based on bank loans. related parties have borrowed from banks and paid in advance to the company enron the oil. the bookkeeping of enron showed the customer deposits, while cash flows were classified as operating cash flows (mulford and comiskey, 2005). the classification of cash inflow arising from financing activities as an inflow from operations is an example of company’s reporting practice beyond the boundaries of generally accepted accounting principles. overstating net operating cash flow for the current year could be the result of presenting inflow based on securitization or sale of receivables as operating cash flows. securitization and sale of receivables results a decline in the receivables balance, which is presented in cash flow statement as an cash inflow provided by operating activities. the accelerated collection stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 33 of account receivable, the future cash inflows from operating activities are reported in the current accounting period. generating cash inflow from operating activities in the artificial way in the current period will be reflected in the next accounting period as a reduction of net operating cash flow (mulford and comiskey, 2005). the fact is that the newly created account receivables will substitute those sold, so it will only increase the amount of receivables beyond the previous sold values, and thus lead to an increase of cash outflows from operating activities. investments in notes receivable create in an enterprise doubts concerning the treatment of cash inflow from their collection. options are the classification of cash flows and changes in the notes receivable balance as operating or investing cash flows. most of the companies classify the cash flows based on notes receivable as cash flows from operating activities. using the other option could be exercised an overstating operating cash flows. in this case, the increase in notes receivable is presented as a reduction of net cash flow from investing activities, and thus, the cash flows from operation is increased for the same amount. management that mentioned financial receivables classify as part of the investing cash flows, could consciously increase the receivable balance. the accumulation of uncollected receivables reduces the net investing, instead of net operating cash flow, and creates a space for creative reporting and overstating net operating cash flow. investments and related cash flows. cash flows from company’s financial assets generally are viewed as cash flow from investing activities. classification of cash flow arising in connection with the purchase and sale of financial assets depends on their classification. when financial assets are classified as held-to-maturity investments, and available-for-sale financial assets, the corresponding cash inflows, and outflows are classified within the investing cash flow section. cash used for buying (provided from selling) of financial assets held for trading, is included in operating cash flows. classification of financial assets by purpose shall be made in accordance with the accounting policy of the company, based on criteria that require international accounting standards. four categories of financial instruments are defined in international accounting standard 39. financial instruments held for trading generally are used with the objective of generating a profit from short-term fluctuations in price or dealer’s margin (ias 39, 2011). by reclassification of available-for-sale financial assets on financial assets held for trading, management of the company can create and send the wrong signal about the cash generating capabilities, demonstrating the cash inflows and outflows in favour of net cash flows from operating activities. if buying and selling of financial assets is not active and frequent, it is not appropriate the classification as financial assets held for trading. after the sale of incorrectly reclassified assets as assets held for trading, there is an increase in net operating cash flows, although their buying decreased net cash flow from investing activities. cash from operating activities, generated due to the incorrect classification of financial assets is not sustainable. unsustainable net operating cash flows should be excluded, in order to create the real picture of cash flows from operating activities. investing in the purchase of some part of assets indicates to investing cash flows, but the classification of cash flows from investing activities depends on the kind and purpose of the assets to be purchased. the rule is that expenditure incurred by purchasing assets allocated for doing business in the longer term, represents a part of investing cash outflows, and economic analysis (2013, vol. 46, no. 1-2, 28-39) 34 potential inflows based on their sale, a part of cash inflows from investing activities. expenditures incurred due to purchase of assets intended to be used for the production of goods (materials) or sell (goods), by its nature, cannot be part of cash flows from investing activities. their purpose will determine the classification of the outflow based on current procurement as cash outflow from operating activities. misclassification of assets and related expenditure has an impact on the structure of the cash flows. treating the current assets as part of fixed assets, or investing instead of displaying operating cash outflows, leads to overstated net operating cash flow. liabilities and related cash flows. management disposes with the possibility to use the flexibility of generally accepted accounting principles when presenting wanted cash flows from operating activities. approved overdraft on cash account opened at the bank, creates the ability to boosting operating cash flow. generally accepted accounting principles are not definitive in the cash-flow classification of overdrafts. overdraft is seen as a short-term loan from the bank, where cash flows from the use of overdrafts and related interest payment are viewed as financing cash flows. classification of overdrafts as cash flows from operating activities is explained by the fact that this type of company's loans is mostly used to settle current liabilities. presenting overdraft as a current liability and thus, its turn into operating section of cash flow statement, could lead to overstated net cash flow from operating activities. cash flow from operations generated by increasing overdraft is unsustainable, which is one more reason not to be taken into account when evaluating the performance of the enterprise. account payable as balance sheet item is the result of temporal mismatch of assets purchase and execution of payments for that. although account payable is a form of financing company from suppliers, the cash flows from payment of these liabilities and change of account payable balance are reported as cash flows from operating activities. management can use extension payments to suppliers as a tool to increase net operating cash flow. it is important to known in which percentage the account payable balance increase presents the source of cash from operating activities, because it is a source that is not sustainable. suppliers may approve the company’s defer payment of current liabilities at the end of the current year, instead of the beginning of the following year. this method does not violate the generally accepted accounting principles, but the ability to generate cash flow for two consecutive accounting periods is misted. time mismatch between the transaction of revenue recognition and the one of receivables paid by customers, among other, can lead to dilemmas in terms of classification of cash inflows. collection of revenues from sale in the period before it is made their recognition affects the expression of inflows in the form of increased liabilities based on advance payment. the fact that is the true source of funding provided by the customers, could lead to the conclusion that the related cash inflow have to be presented within the financial section of cash flow statement. yet, customer deposits are a source of cash flow from operating activities, which is explained by the fact that the company will deliver, on that basis, goods or services to the customer. unrealistic reported net cash flow from operating activities could be a result of a misclassification of customer deposits inflows, or forcing advance payments from customers. stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 35 expenses and related cash flows. operating costs can be one of the areas of fraud, in case of their wrong capitalization. expression of certain expenses as capital expenditures or an increase of value of property, plant and equipment, rather than as expenses in the income statement, results in increase of net income and cash flows from operations. the profit is increased in the absence of expenses that are capitalized. recognition of the incurred expenditures as operating expenses in the income statement, would affect the increase of cash flows from operating activities at the time of their payment. making an incorrect capitalization of costs, the cash expenditures recognized in the balance sheet would be described as part of investing cash outflows, which overstates the net operating cash flow, and understates the net cash flow from investing activities. capitalization of software development costs instead of their treatment as a expenses, is an example of reducing the net investing cash flows, instead of net cash flows from operating activities. unlike expenses that should not be capitalized, the capitalization of development costs is possible within legislation acceptable limits. capitalization of subsequent software development costs is performed at the time of reaching technological feasibility, but concerning the percentage of capitalization, companies can adopt different policies. recognizing the expenditures in terms of software development as periodic expenses will affect the statement of comprehensive income and cash flow statement by showing lower profit and lower net cash flow from operating activities. during the capitalization of these expenditures, cash outflows would be included in the investing section of the statement, having no effects on cash flows from operations, thus, they will be reported unrealistically. incorrectly percentage of capitalization of development costs lead to overstated net cash flows from operating activities, even in the absence of a final capitalization effect on profit. effects on the profit are missing during equalization of amortization of capitalized software development costs in the previous period and the amount of expenses capitalization in the current period. changes of company’s capitalization policy have an impact on reported cash flows from operations. capitalization percentage magnification compared to the previous period has the effect of increasing cash flows from operations, because a larger part of cash outflow is included in investing cash flows. it could be concluded that the capitalization of operating expenses leads to incorrect higher operating profit, and cash flows from operations, because instead of showing cash outflows based on operating expenses within operating section of the statement, the outflows, are presented as investing cash flows. companies of equal capital intensity would have reported different net cash flows from operating activities, if one company purchases equipment through operating leasing, and the other one, the same equipment buys. the company that rents equipment through leasing, the expenditures for leasing presents as cash outflows from operating activities. expenditures for purchased equipment are viewed as capital expenditure, thus, a company that is committed to purchase of equipment would have a decrease in net investing cash flow (white, sondhi and fried, 2003). misrepresentation of outflows from operating leasing as investment, rather than operating cash outflows, lead to overstated net cash flow from operating activities. economic analysis (2013, vol. 46, no. 1-2, 28-39) 36 consequences of creative cash flow reporting positive cash flows represent the aim that owners and management tend to achieve. whether and how the company is able to generate cash from operating activities is the crucial information for users of financial reports. potential investors, creditors and analysts are interested in sources, use and cash flow trends, because on that basis they assess the performance of the company. the company with the positive cash flow, with increasing trends from period to period, has no problems with the financing of necessary investments and repayment of maturing obligations. it is in the situation to invest in new business, relying mostly on internal sources of financing. credit conditions for potential external funding investments are certainly favourable for liquid and solvent companies. the above mentioned can be a stimulus for expression of cash flows higher or lower than the actually achieved cash inflows and outflows. stakeholders' decisions on capital investment, loan approval, initiation and continuation of business relations with the company and employment, based on unreliable and unrealistic accounting information would be erroneous. after a period the effects of manipulation on income, net cash flow from operating activities and the share price will become evident, company’s security violated, and the trust of persons associated with the company shaken. misclassification of cash flows, mostly to net cash flow from operating activities resulting in an overstatement of net cash flow from operations. since in that case the value of net cash flow from investing or financing activities is understated for the same amount, the effects of fraud on the total net cash flow will be absent. the fact that the amount of net cash flow as a whole, is not affected by the activities implemented by company’s management, does not eliminate, nor justify the presence of creative cash flow reporting, especially if taken into account that the value of net cash flow as a whole has the lowest information value. misclassification effects of cash flow presented in the table 1 are an example of aggressive capitalization of expenditure. the consequence of showing cash outflow from investing activities instead of operating cash flow, regardless of being erroneous misclassification due to ignorance or with specific purpose, is the overstated net cash flow from operations. table 1. the impact of erroneous classification of cash flows cash flows realistic unrealistic net cash flow provided from operating activities 350.000 overstated net cash flow used for investing activities (730.000) understated net cash flow provided in financing activities 400.000 unchanged net increase in cash and cash equivalents 20.000 unchanged overstated cash inflow, understated cash outflow, and recorded fictitious transactions affect the quality of the reported net cash flow from operating activities. the example of table 2, indicates the change in cash flows due to false reporting of cash flows. since the adequate decisions making by users of financial statements, among other things depend on reliability and comprehensiveness of information of cash flow trends, the better presented stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 37 cash flows in relation to the real cash flow, create a false impression of the ability to generate cash for operating, investment, and financing activities. table 2. the impact of false reporting of cash flows cash flows realistic unrealistic net cash flow provided from operating activities 350.000 overstated net cash flow used for investing activities (730.000) unchanged net cash flow provided in financing activities 400.000 unchanged net increase in cash and cash equivalents 20.000 overstated decisions made based on unrealistically reported cash flow items, and items of other financial reports, resulted in lost return on investment, lost investment, opportunity costs arising from missed better investments (dejan malinić and nikola stevanović, 2009). at long-term period, losses suffer all users of creative financial statements, because they consider them as a reliable source of information about the performance of the company. the most serious consequences of creative reporting still bear investors, particularly the investors to companies with significant dispersion of ownership and minority shareholders of companies in which there is one or a few large owners. consequences for the company are also dramatic because the company could go bankrupt, and if survive, it would be hard to regain the trust of investors and creditors, to attract the capital and to continue operations. material loses are accompanied by new created distrust of the system of financial reporting and the accounting profession. therefore, all that troubles cannot be recovered by material or prison punishment to the management, which is the most responsible for manipulation activities (malinić, 2008). concerning the fact that an efficient financial reporting system generates accurate, objective information about the company’s performances, provides a reliable basis for making good business decisions, strengthens the confidence of investors and creditors, decrease investment risk and provides lower costs of capital, it is clear what consequences creative financial reporting has for the capital market. the distrust of investors, lack of interest in investment, increased capital costs, inefficient capital market, is factors that adversely affect the economy of the country. conclusion manipulations of earnings and cash flows of the company are possible in practice if there are certain personal motives or pressure of management by owners of the capital. earning management may be accepted as a regular business practice if there are no materially significant violations of accounting rules, a deliberate intention of creating a misleading impression about the company performances, and if it contributes to the achievement of stakeholders’ interests. on the other hand, managers may often use their accounting discretion to manipulate earnings, which certainly affects the reliability of the financial reports. economic analysis (2013, vol. 46, no. 1-2, 28-39) 38 cash flow analysis can be used as a tool for discovering creative reporting on company’s profit, but even the cash flows can be subject to manipulation. while cash flows, by their nature provide much less opportunities for manipulation in relation to income, the practice have revealed the presence of creative cash flow reporting, which can be seen in examples of creative reporting of cash inflows and outflows related to receivables, investments, liabilities and expenses. aware of the information importance that cash flows from operating activities has for the users of financial reports, the managers often tend to present their company as one able to generate cash and cash equivalents by misclassifying cash flows, although sources from operating activities are not, or at least not to the extent sustainable. however, the possibility of manipulative management of cash flows as a real category is significantly lower compared to the possibilities of creative earnings shaping which represents the accrual accounting item. true and objective information about the cash flow and other company’s performances provide a reliable basis for making good business decisions and strengthen the confidence of investors, creditors and other stakeholders. stakeholders’ decisions on investment, credit approval, initiation and continuation of business relations, made based on unreliable and unrealistic accounting information will be incorrect. after some time, the effects of fraudulency on income, net cash flow from operating activities and stock prices will become evident, the security of the company violated and the investors’ confidence of the company undermined. references center for audit quality. 2010. deterring and detecting financial reporting fraud—a platform for action. international accounting standard 39: financial instruments: recognition and measurement. 2011. www.ec.europa.eu (accessed february 2, 2013). malinić, dejan. 2008. kreativno finansijsko izveštavanje: motivi, posledice i etički izazovi, in tranzicija i posle u regionu nekadašnje jugoslavije, belgrade: the serbian association of economists. milojević, d. 2006. revizija finansijskih izveštaja, belgrade: faculty for trade and banking and belgrade banking academy. mulford, c., and comiskey, e. 2005. creative cash flow reporting: uncovering sustainable financial performance, new jersey: john wiley & sons. stevanović, n. and malinić, d. 2009. fenomenologija bilansa: informaciona moć, rizici i posledice, ekonomika preduzeća, special issue tajne bilansa: menadžerski pristup, belgrade: the serbian association of economists. white, g., sondhi, a., fried, d. 2003. the analysis and use of financial statements, new jersey: john wiley & sons inc. wild, j., subramanyam, k.r. and halsey, r. 2007. financial statement analiysis, new york: mcgraw-hill/irwin. stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 39 kreativno cash flow izveštavanje motivacija i mogućnosti rezime – stejkholderi preduzeća donose poslovne odluke na osnovu informacija koje su prezentovane od strane menadžmenta. kvalitet donetih odluka, između ostalog, zavisi od kvaliteta i pouzdanosti informacija u finansijskim izveštajima. poslovna praksa pokazuje da su menadžeri skloni da prikažu pogrešnu sliku o finansijskom i prinosnom položaju preduzeća, često i u saradnji sa vlasnicima kapitala. postupci koje menadžment i investitori preduzimaju u cilju stvaranja pogrešnog utiska o performansama preduzeća, savremena literatura definiše kao kreativno finansijsko izveštavanje. prikazivanjem boljih finansijskih performansi nego što one stvarno jesu, pružaju se obmanjujući signali o preduzeću, a korisnici infomacija dovode u zabludu. cilj rada je analiza mogućnosti za sprovođenje kreativnog cash flow izveštavanja i faktora koji menadžment preduzeća i vlasnike kapitala podstiču na pogrešno ili lažno prikazivanje performansi preduzeća. nakon prikazivanja glavnih motiva kreativnog finansijskog izveštavanja, ukazujemo na primere pogrešne klasifikacije novčanih tokova. upravljanje dobitkom i novčanim tokovima menadžment može sprovoditi u okviru i izvan granicama računovodstvene regulative na više načina, ali je u radu poseban osvrt na postupcima kreativnog izveštavanja priliva i odliva gotovine koji su vezani za potraživanja, plasmane, obaveze i rashode preduzeća. posledice kreativnog izveštavanja o cash flow i ostalim performansama preduzeća mogu biti ozbiljne kako po stejkholdere, tako i po opstanak preduzeća, što je i obrazloženo u poslednjem delu rada. ključne reči: kreativno finansijsko izveštavanje, kreativan cash flow, klasifikacija novčanih tokova, neodrživi novčani tokovi article history: received: 15 february 2013 accepted: 6 may 2013 microsoft word 2010_1_2.doc original scientific paper method of banks valuation horvátová eva*, university of economics in bratislava, faculty of national economy, department of banking and international finance, bratislava, slovakia udc: 336.717 jel: g21 abstract – since there is not a special common framework for valuation banks and it gives possibilities to create establishment, improvement and adaptation of various approaches to measuring the value of banks and financial institutions. most approaches banks valuation note the strong dependence of financial institutions value from market interest rates (mishkin, f., miller, wd, copeland, t., koller, t., damodaran, a., and others). each approache reflects greater or lesser degree of accuracy depending on the method of determining resources for owners, the discount factor, approaches to defining the rate of growth and methods of measurement. key words: banks valuation methods, free cash flow equity, discounting factor, cost on equity, beta factor introduction the issue of banks and financial institutions valuation have been written relatively few comprehensive theoretical and methodological work. the valuation is carried out by experts and expertise for different purposes and with varying degrees of methodological accuracy of the estimate of input factors. a significant shift in valuation theory and practice came when r. c. merton (1973) [1], introduced the risk-neutral valuation model for financial assets. bank valuation under this model can be interpreted as determining the value of a call option on the value of bank assets.1 currently, (august 2009), r. c. merton (2009) in the context of the financial crisis makes the promotion of a market valuation of banks and their components. it states that banks and entities that oppose the use of market valuation, are trying to hide the fall in prices. equally critically views on issues of aid, saying that the government is trying to solve complex problems easily. he also expressed the desire to stimulate trading in securities market in order to restore the natural function of the market in setting prices. about using of derivatives, the lack of market information for investors blames frozen market.2 * address: dolnozemská cesta 1, 85235 bratislava, slovakia., e-mail: eva.horvatova@euba.sk 1 merton, r. c. an intertemporal capital assets pricing model. econometrica. vol. 41, 1973. http://ideas.repec.org/a/ecm/emetrp/v41y1973i5p867-87.html 2 merton, r. c.: mark it to market. august, 19, 2009. http://www.swampreport.com/investments/scholes-and-merton-mark-it-to-market/ horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 51 a. damodaran (2002) says, that „the fundamental valuation rules may be applied equally to companies such as to financial services institutions“3, should be pointed here. some approaches to the bank valuation note the strong dependence of financial institutions value from market interest rates (mishkin, f., miller, wd, copeland, t., koller, t., damodaran, a., and others). each approache reflects greater or lesser degree of accuracy depending on the method of determining resources for owners, the discount factor, approaches to defining the rate of growth and methods of measurement. t. copeland highlights that the interest rate risk should focus attention on 4 factors: 1 interest margin between the market rate and bank rate, as well as their flexibility to market developments, 2 dynamics of tidal funds, 3 degree of substitution of banking products and services as an alternative to interest-rate changes, 4 need to cover risks arising from maturity mismatch of assets and liabilities part of the profit. koch, t. w. (2005), samuelson, klein and monti formulate a conclusion on the positive relationship between net income and the relative market power of banks. these theoretical ideas support empirical research work such as damodaran, a., as well as other authors. a significant shift in valuation theory and practice came when r. c. merton (1973) [2] introduced the risk-neutral valuation model for financial assets. bank valuation under this model can be interpreted as determining the value of a call option on the value of bank assets.4 valuation of banks and financial institutions by the yield method business valuation models are largely based on discounted cash flow approach (dcf model) and assume some growth stages, which is typical for different growth rate of cash flow or resources for owners. expression of fcfe (free cash flow equity) in financial institutions the annual effect on the owner may be defined differently. this may be as free cash flow to shareholders (fcfe free cash flow equity) generated as operating profit by reducing the costs that are not spending in the current period and the investment needed work and investment property for the operation. according w.d. miller, the desire is to move closer to the category income of owners net proceeds, which could be as bank potencial of dividends. sometimes, in this case refers to the free cash flow to shareholders (free cash flow equity). using cash flow as a basis for calculating income of owners as dividend income potential for the owners of the bank is inappropriate for two reasons: 3 damodaran, a.: investment valuation. 2-nd edition. john wiley & sons, 2002, 2002. isbn 978-0-47175121-2, page 603. 4 merton, r. c. an intertemporal capital assets pricing model. econometrica. vol. 41, 1973. http://ideas.repec.org/a/ecm/emetrp/v41y1973i5p867-87.html economic analysis (2010, vol. 43, no. 1-2, 50-60) 52 • statement of cash flows in the banking business is not suitable for determining sources for owners, such as dividends as source for owners can be paid only from real net income after tax and not from the movement of cash (cash flow); • bank and company profits are not equally attainable by shareholders, in the bank there is no problem with the availability of cash to shareholders because of the nature of the vast majority of assets and liabilities, although other types of businesses can generate significant differences between cash flow and profits in the sense that the business generates profits, but not sufficient cash flow; • the main source of income in banking is the differences between interest income and expense, as well as fees for services. the valuation of financial institutions can not be made without respect of interest income and expense as the most significant component of their income and capital growth, or its renewal. the calculation of fcfe in banks and financial institutions can be implemented in two basic ways: 1-st method of expressing fcfe: fcfe = net income growth of capital + other income it should be noted that net income is not equal to cash flow. with the growth of financial institutions should also increase its capital. growth fcfe lowers the capital, because it means that the bank is inserted into the banking business of profits that would otherwise be paid to owners as dividends. otherwise, if the bankʹs growth has not been accompanied by an adequate increase in the capital, it could happen to failure of financial institutions due to lack of solvency. 2-nd method of calculating fcfe: fcfe = resources from issue of shares preference shares + dividends capital increase (+ decrease in capital) changes in bank capital are resulting from the relationship between balance, profit and loss statements, cash flow and value of financial institutions. changes in assets and liabilities are reflected in changes in equity. equally polemical recommendation is adding into the value of cash flows the initial cash balance. the problem is the fact that they were a combination of yield method valuation and substance valuation method. since the yield valuation takes into account the future potential of banks, it leads to the discussions on the question of the length of the period under review (planning period). for example, w. d. miller (1995) [1] 5 advised to examine 10 years, others, such as m. tucek 6 recommend 2-3 years. this follows from the specifics of the environment, for example, in u.s. valuation concerns small, local banks are not investment activities and 5 miller, w. d.: commercial bank valuation. john villey and sons, inc., 1995, isbn13 9780471128205, page 28. 6 hrdý, m.: oceňování finančních institucí. praha: grada publishing, 2005, isbn 80-247-0938-4, page 35. horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 53 planning for 10 years it may be relatively simply. banks in slovakia perform mixed operations, and planning the future results for longer than 5 years could cause problems. net income as a basis for potential dividend or resource for owners by koller, t., goedhard, m. and wessels, d. (2005) [1] can establish two basic ways: 7 1. on net interest income, or 2. model based on interest margins (spread model). determination of the discount factor a particular problem is the correct determination of the discount factor to be within the individual models recommended. it is necessary to respect the logical links between the numerators and denominators and formulas used to discount the recommended indicators. there are different approaches for determining the interest rate for discounting, such as the determination of weighted average cost of capital. this method provides, in particular disposable cash flow for businesses, called the principle of free cash flow of firms (fcff). the bank is not appropriate given the high gearing ratio (leverage). for the purposes of the valuation of banks need to set the cost of equity. estimate the required rate of return on equity re in terms of banking, there are significant differences in the proportion of own and foreign sources of funding compared to other businesses. in the banking sector given the nature of the business of banking must accept a higher gearing ratio. cost of capital represents the expected rate of income investors given the risk level of the investment. since any form of business is associated with a higher risk than when depositing money in the bank, then the expected return is higher than interest rates in the bank. the role of the so-called risk-free rate rf (free of risk) may be selected interest rates on government bonds or yield to maturity of these types of bonds. yield to maturity is recommended to use as a discount factor such as for example m. marik (2007) [1]: ʺas a source for safe return to the czech capital market, we recommend using such proceeds to maturity of government bonds with maturities equal to ten or more years by source patria finance.“ 8 the cost of capital must be re invariably higher than rf in connection with the tax shield. required rate of return on equity can provide a number of ways to serve its particular setting: • gordon growth model, • capm (capital assets pricing model) or a model of capital assets • the average profitability • the cost of foreign funds 7 koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition, mc kinsey & company john willey & sons, inc., 2005, isbn: 978-0-471-70218-4, pages 670 671. 8 mařík, m.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ecopress, 2007, isbn 978-80-86929-32-3, page 218. economic analysis (2010, vol. 43, no. 1-2, 50-60) 54 • apt model (arbitrage pricing theory). 1. gordon growth model is based on a calculation of the growth rate of dividends: g sharesofprice dividends r t t e += +1 where: re = rate of return required by shareholders (return on equity) g = growth rate of dividends 2. capm is used frequently, although it also has some shortcomings. this model assumes that the risk premium is proportional in relation to systematic risk β. the capm can be re established as follows: ( )[ ]fmfe rrerr −+= .β where: rf = risk-free interest rate re = rate of return required by shareholders (return on equity) β = systematic risk e (rm) = expected return on market portfolio 3. the derivation of the discount rate based on average profitability. data on the average profitability of the industry are relatively accessible, and therefore in practice often used to determine the cost of equity. the disadvantage of this method is the impact on accounting practices can distort the indicator roe. the downside is mainly the lack of data on market value of capital of financial institutions, as the book value of capital is not suitable for these purposes. the basic conditions of dcf models include a requirement that the discount rate used to be in session with the risk profile of cash flow (for example: fcff ↔ wacc or fcfe ↔ re).9 for the valuation of banks is appropriate to use a model based on fcfe. fcfe is generally recommended to enjoy when financial leverage is stable and this is relatively high. using the fcfe model is preferred and recommended if it can generate a large difference between the dividends and fcfe. an alternative model is the dividend fcfe model. in practice, it could happen that the dividends could be higher than fcfe, the likely addition to the problems in the management of financial institutions and causing uncertainty in their valuations. it is recommended and preferred by hrdý, m. (2005) [1] model for the dividend fcfe model.10 9 kislingerová, e.: oceňování podniku. 2. přepracované a doplnené vydání. praha: c. h. beck, 2001, isbn 80-7179-529-1, page 160. 10 hrdý, m.: oceňování finančních institucí. praha: grada publishing, 2005, isbn 80-247-0938-4, page 23., and koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition, mc kinsey & company john willey & sons, inc., 2005, isbn: 978-0-471risk premium horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 55 using the fcfe valuation model, banks are avoiding the use of wacc. the average weighted cost of capital wacc is always lower than the cost of equity – re, which corresponds with the result that they are reduced by the so-called tax shield resulting from the use of foreign funds and netting interest expenses to the bank. determination of the beta coefficient another problem is the calculation of the beta coefficient. for example m. hrdý (2005) [2] 11 recommends using a simplified assumption that β is equal to one, because it assumes that changes in the profitability of financial institutions are equal to changes in market portfolio returns. another argument in favor of simplifying the calculation of the beta coefficient is that fairly significant change of beta affects the overall change in the risk premium in the relatively small scale, and also a rather complex calculation of the coefficient beta. above mentioned (the relatively low impact on the valuation premium) is shown on a graph. if the valuation is performed in less stable conditions, or if there are other reasons to choose a more accurate calculation of β, we use these basic approaches: 1. coefficient estimate based on historical data. 2. by analogy. 3. an analysis of factors. beta coefficient expresses sensitivity to market risk. actions that have beta between 0 and 1.0 tend to move in the same direction as the market, but not to an extent. rapidly growing company has beta over 5 years at level 1.11. the market growth of 1 % will increase the companyʹs stock price by 1.11 % or decrease by 2 % of the market reduces price of shares by 2.22 %. 12 70218-4, page 668., and mařík, m. and all.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ekopress, 2007, isbn 978-80-869929-3, page 206. 11 hrdý , m.: oceňování finančních institucí. grada publishing, praha 2005, isbn 80-247-0938-4, page 10. 12 brealey, r. a., myers, s. c.: teorie a praxe firemních financí. praha: east publishing, 1992, isbn 8085605-24-4, page 153. cost on equity (required return) by different degrees of risk (4 risk degrees) for maximum re 0 10 20 30 40 50 1 2 3 4 max. re is 20% max. re is 30% max. re iis 40 % economic analysis (2010, vol. 43, no. 1-2, 50-60) 56 beta coefficient may be measured on the basis of historical data and hence the change in performance of individual shares in the bank, depending on changes in market portfolio as follows: ∑ ∑ ∑ ∑ ∑ −× ×−×× = 22 ))(()( )()()()( mprmprn mprsrmprsrn β where: β a quantitative measure of the volatility of portfolio r (s) return on shares of a particular bank r (mp) return on market portfolio, n number of years of evolution. the disadvantage of this method is that it is not possible to reliably use knowledge about the development of beta from past to the future. the beta factor derives also by analogy from the following relationship by marik, m. (2007) [2]13 ( ) ( ) e d t e d t dul ⋅−⋅−      ⋅−+⋅= 111 βββ where: βu = beta at zero debt (unlevered beta)14 βl = beta entity debt (levered beta) βd = beta for debt = 0 t = tax rate this method of determining the beta is an appropriate indicator in the valuation of banks. βeta coefficients are published for each industry and country. as the beta for foreign capital is 0, the resulting relationship is: ( )       ⋅−+⋅= e d tul 11ββ this relationship expresses the dependence of beta on the degree of indebtedness of the entity. with this option you can use data on individual sectors of beta. coefficients are published for debted and indebted companies. the objective determination of β is the worldʹs best practice accepted valuation model capm. it is recommended that indicators of the environment of the u.s. market have been adjusted to current country risk. capital costs are then expressed by: 13 mařík, m.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ecopress, 2007, isbn 978-80-86929-32-3, page 225. 14 data on the average values of β coefficients for each industry states are published on website of aswath damodaran (www.damodaran.com , section updated data). the average value of β in 2009 for european countries indicated 1.04 and the average βu is at 0.80. horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 57 rpcrpmrr fe +⋅+= β where: rpm = market risk premium rpc = country risk premium is recommended to calculate than 1.5 times the risk of failure in the country (0,7.1,5) + 0.6 difference between inflation in the u.s. and for example in slovakia. determination of the cost of equity based on capm (on the example of slovakia) current risk-free return is 3.5 %; the risk premium for the capital market in slovakia 7.21 % 15 country risk premium 2.21 % unlevered beta for specialized banking services 0.23 %, the ratio of debt and equity 0.95 %. ( ) ( )( ) 41,095,019,01123,011 =⋅−+⋅=      ⋅−+⋅= e d dul ββ 67,821,221,741,05,3 =+⋅+=+⋅+= rpcrpmrr fe β the cost on equity methods based on capm model, are assuming the input data set to 8.67 % in slovakia. practical problems and procedures of bank valuation a key practical problem when evaluating the bank will determine the future anticipated net effect on the owner, plans for future net earnings. future development of profit can be detected in two ways: • regression analysis; • a financial plan based on data compiled from balance sheet and profit and loss account. the method of regression analysis is appropriate for the valuation of banksʹ long-term stable conditions, and operating in developed economies. regression analysis is more suitable for banks than for companies, because regulatory frameworks for business banking ensure continuous development without major fluctuations. nevertheless, the most accurate and most reliable way to estimate deemed dividend potential is derived from the financial plan for the bank. the expert must be able to assess future development of bank finances and key items of bank profits. the aim should be to approximate the planned balance sheet and profit and loss account over the next 5 years. important indicators are known profit generators such as loans and other earning assets, recently banks have a large proportion of income from fees for services, which should also be included in the calculations. 15 http://pages.stern.nyu.edu./adamodar/ economic analysis (2010, vol. 43, no. 1-2, 50-60) 58 the task of valuing the bank by the yield method is ultimately provided by continuing value to the bank. the formula for calculating the discounted value of continuing is as follows: ( ) ( ) ( )5 5 1 1 . 1. igi gdiv cv +− + = where: cv continuing value of bank div5 expected dividend paid in the 5-th year i interest rate used to discount g expected dividend growth rate per year with a similar approach is also encountered in determining the value of ongoing (continuing value) in the work by t. koller, m. goedharda and d. wessels (2005) [2]: 16 ( )gk rone g ni сv e −       −⋅ = 1 where: ni expected net revenue in 1-st year after the end the projected period g expected dividend growth rate per year ke cost of equity (required return) rone increasing the return on new capital conclusions – why is bank valuation important at present, confidence in the banking and financial sector is simulated by states and their guarantees. experience of banking sector restructuring in sr gives an example of how many banks are able to operate with inadequate or even having a negative value of capital. if it is well known that a major bank failure is undesirable because it would cause serious economic problems, then a function of confidence in the bank does not perform as bank capital, as some fiction or a social agreement, which may have different real form. the question arises whether the trust bank can reliably operate on this basis. it is undisputed and confirmed that the practice in the short term is possible. in the medium and long term, it is only a matter of time before such a basis for confidence in a banking institution is exhausted and positive incentives will be more costly than alternative problems for radical action against the bank. such confidence is not inexhaustible; its boundaries are identical with states and capabilities of countries. there is a risk of such an approach, on the other hand, if the banks do not use this second chance, the financial crisis could be even greater. 16 koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition, mc kinsey & company john willey & sons, inc., 2005, isbn: 978-0-471-70218-4, page 669. horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 59 at present, the consequences of the financial crisis occurred requirements (for example, merton r.c.) to value banks by the market valuing approach, which uncovered a genuine reality and lead to more real situation on the financial and banking market. such an approach would certainly be very appropriate. valuation of banksʹ issues are important because the focus has to be not on profit growth, but on growth of stability and hence the value of the bank. banks managers also should not have rewards based on profit but on the basis of value growth of institution, which they manage. therefore, the states and supervisory institutions to carefully analyze the effectiveness of its intervention measures to support banking and financial market and take such measures that would prevent the repeat similar problems. access to regulate the banking sector varies depending on the distance of negative experiences. this area will be clearly show degree of risk in dealing with its negative consequences. addressing the negative consequences of the risks of using public funds is a sign that many economic entities, in principle, are not able to cover all the risks that they may occur, and therefore in my view, essential is that such entities to regulate the rate of risk-taking potential exist. it is necessary to believe that negative experiences will serve as a warning against gambling of people and countries, as in the historical experience translated it into a collective sacrifice of wealth necessary to prevent fatal consequences of similar threats. references adams, m., markus, r.: a new approach to the valuation of banks. http://www.campusforfinance.com/fileadmin/content/cffrc/documents/2007/banking_i_adams.pdf allen, f., galle, d.: comparing financial systems. cambridge: mit press 2000. isbn 0-262-01177-8. benninga, s.: bank valuation. new york instirute of finance course in singapore, www.wharton.upenn.edu, february 13, 2001. benninga, s. , sarig, o.: bank valuation. february 13, 2001. http://senverb.boun.edu.tr/pdf/bank%20valuation.pdf brealey, r. a., myers, s. c.: teorie a praxe firemních financí. praha: east publishing 1992, isbn 8085605-24-4. calomiris, ch. w., doron nissim: activity based valuation of bank holding companies. working paper 12918. http://www.nber.org/papers/w12918. davis, s. i.: bank mergers. lessons for the future. london: macmillan 2000. isbn 0-333-91260-8. damodaran, a.: investment valuation. 2-nd edition. john wiley & sons 2002. isbn 978-0-471-75121-2. www.damodaran.com (sekcia updated data). http://pages.stern.nyu.edu./adamodar/ freixas, x., rochet, j. ch.: microeconomics of banking. cambridge: mit press 1998. isbn 0-262-06193-7. horvátová, e.: bankovníctvo. žilina: georg 2009. isbn 978-80-89401-03-1. hrdý, m.: oceňování finančních institucí. praha: grada publishing, 2005. isbn 80-247-0938-4, kidwll, d. s., peterson, r. p., blacwell, d.w.: financial institutions, markets and money. forth worth: the dryden press 1993. koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition. mc kinsey & company john willey & sons, isbn 0471702188, isbn: 978-0-47170218-4. levy, h., sarnat, m.: kapitálové investice a finanční rozhodování. praha: grada publishing 1999. isbn 807169-504-1. economic analysis (2010, vol. 43, no. 1-2, 50-60) 60 kislingerová, e.: oceňování podniku. praha: c. h. beck, 2001. isbn 80-7179-529-1. mařík, m.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ecopress 2007, isbn 978-80-86929-32-3. merton, r. c.: an intertemporal capital assets pricing model. econometrica. vol. 41, 1973. http://ideas.repec.org/a/ecm/emetrp/v41y1973i5p867-87.html merton, r. c.: mark it to market. august, 19, 2009. http://www.swampreport.com/investments/scholesand-merton-mark-it-to-market/ miller, w.d.: commercial bank valuation. john wiley and sons, inc., usa 1995, isbn13 9780471128205. mishkin, f.: economics of money, banking and financial markets. reading: addison-wesley 2003. isbn 0-321-20049-7. rose, p. s., hudgins, s. c.: bank management and financial services. boston: mcgraw hill 2005. isbn 007-286163-0. sharpe, w.f., alexander, g.j.: investice. praha: victoria publishing 1993. isbn 80-85605-47-3. sinkey, j. f.: commercial bank financial management. london: prentice hall 1998. isbn 0-13-521048-8. received: 7 january 2010 article history: accepted: 7 march 2010 microsoft word 2011_3_4_finalna ver.doc         notes from the editor‐in‐chief          the journal  is published  twice a year  in  issues that contain peer  articles and book reviews spanning all of the following subject areas  such  as  unemployment,  inflation,  economic  underdevelopment,  globalisation and international economic integration, finance, changing  forms and boundaries of markets and planning, organization culture  and behavior ,management,  transformation of industrial organizations  and economic systems, experimental studies in economics and uneven  development and instability in the world economy. in addition, the journal covers environmental and  ecological  issues,  economic  stabilization,  labor  relations, monetary management and   other  topics  within the discipline of economics. ea is also open to interdisciplinary or other submissions which  explore  innovative  approaches  including  critical  contributions  to  economic  theory,  debates  on  economic policy and interpretations of recent economic changes.  we occasionally publish special issues of the journal, devoted to a particular topic.    the main  text of a manuscript must be submitted as a word document  (.doc).  it  is  strongly  recommended that you use the author submission guidelines to help you to prepare your submission to  the journal. authors should submit their manuscripts online at eaoffice@ien.bg.ac.rs.        prof. dr. mirjana radović marković, frsa, fwaas, femaas          doi: 10.28934/ea.22.55.2.pp20-30 first online: november 1, 2022 original scientific paper covid-19 and serbian stock market response: a panel data approach bojan đorđević1 | sunčica stanković14f* 1 megatrend university belgrade, faculty of management zaječar, zaječar, republic of serbia abstract in this paper, the authors attempted to explore the relationship between the covid-19 coronavirus pandemic and the stock market in the republic of serbia. the main research variables on the stock market are the daily values of the belex 15 and belex line indices and trading volume. for the pandemic variables, official daily data on the number of new covid-19 cases in serbia, europe, and the world were taken. by applying the panel regression analysis for the period from 03/06/2020 to 12/30/2021, the empirical results show a positive and significant influence of the number of daily infected in serbia and europe on the stock market index value, at the same time, the influence of daily infected ones on trading volume is negative but statistically significant only when it comes to the new cases of coronavirus per day at the level of europe. the presented results indicate the resilience of the serbian capital market to internal and external shocks. keywords: covid-19, stock market indices, belgrade stock exchange, panel data analysis jel classification: c33, d53, i10 introduction the covid-19 pandemic, besides the uncertainty and panic, led to a temporary lockdown in many states and the slowdown of economic activities. almost two years after the pandemic started, the companies’ performance downfall is visible in all sectors, affecting the financial markets, specifically stock markets (okorie and lin, 2021). according to zaremba et al. (2020) and singh et al. (2020), in terms of the covid-19 crisis, the intervention of governments and central banks of numerous countries has significantly increased the volatility of the international capital market. at the same time, the official statistics of who mark the increase in the daily number of infections and deaths all over the world, along with the growing resistance of the population towards vaccination (world health organization, 2021). financial markets reacted quickly, reflecting the magnitude of the crisis potential. in march 2020, the s&p 500, euro stoxx 600, and nikkei 225 indices plummeted by 9.5, 8.3, and over 10%, respectively. a similar situation happened with the chinese financial market, affecting the value of the sse composite index of 7.72% and the szse component index of 8.45%. the indices of the belgrade stock market on the serbian capital market have experienced, during february and march 2020, a significant drop in their values, following global stock indices. companies’ stock prices and belex 15 and belex line index values continually and intensively kept plunging until march 24, 2020. since then, the values have been going up. the initial * corresponding author, e-mail: suncica.stankovic@fmz.edu.rs bojan đorđević, sunčica stanković 21 reaction of markets was brutal and escalated, which is commonly expected investors' behavior in times like these. on the other hand, there is an opinion that the market recovered by investors’ faith in normalization time and life and economic activities (naseem et al., 2021). crucial psychological moments and positive signs for investors, which also transmitted to the serbian capital market, came from the global vaccine manufacturers – first in the form of development announcements and later as the presence and distribution of covid-19 vaccines. bearing in mind the current state of the pandemic and the dynamic of price movements on global stock markets, the subject of this research is the covid-19 and serbian stock market response through the implementation of the panel regression analysis. the goal is to investigate relations between indices values and trading volume on the belgrade stock market on one side, and daily infections in serbia, europe, and the world, on the other. following the subject and goal of the research, there are two questions: 1) does the number of daily infected in serbia, europe, and the world affect the value of the belgrade stock market index? 2) does the number of daily infected in serbia, europe, and the world affect the volume of trading on the belgrade stock market? to answer the research questions, we structured the paper as follows: after the introduction, the second part gives a short literature review, reflecting on the most significant results; the third part presents research methods; part four exposes empirical results, while the last part portrays conclusions, restrictions, and recommendations for future studies. literature review the global pandemic contributed to an increase in research on covid-19 influence on financial markets. analyzing key indicators of pandemic effects on overall and local levels (the number of infected, deceased, and vaccinated, in correlation with prices and yield for most relevant global and regional stock market indices), most of the obtained results show a significant correlation and the effect of a current pandemic on market volatility and stock price movements. a short review of some latest research is set hereafter. singh et al. (2020) examined the pandemic impact on the stock markets of g-20 countries, using an event study to measure abnormal returns (ars) and panel data regression to explain the causes of ars. the observed window comprises 58 days after the news of the covid-19 outbreak was released on the international media, and the estimation window consists of 150 days before the announcement. the results confirmed the recovery of stock markets from the covid-19 negative impact. zaren and hizarci (2020) analyzed the possible effects of covid-19 on stock markets using daily stock indices data. the cointegration test using covid-19 daily infections and deaths was used to question possible outcomes on the stock markets. the sse, kospi, and ibex35 indices have a cointegration relationship with the number of infections, while ftse mib, cac40, dax30 indices don't. onali (2020) researched the effects of the pandemic on the dow jones and s&p500 indices. the outcomes confirmed the covid-19 crisis did not affect the us stock market returns. however, var models indicated the number of coronavirus-related deaths in italy and france had negative implications on stock market returns and positive ones on the vix returns. ali et al. (2020) tested the effect of the covid-19 crisis on the global financial market. analyzing periods of epidemic and pandemic, they stress the substantial effects of the pandemic on commodity and stock markets. the results show a negative correlation between gold price movements and the resistance of the chinese capital market. baker et al. (2020) gained results of the pandemic’s severe effect on the us stock market compared to the 20th-century historical crises. höhler and lansink (2020) measured the pandemic influence on the volatility of stocks of companies that manufacture and distribute consumer goods listed within the most relevant global stock market indices. the results show considerable effects of the pandemic on the growth of volatility of all companies’ stocks, apart from the ones of companies that produce and supply food. bai et al. (2020) used the garch-midas model to analyze the pandemic effect on stock markets in the usa, china, great britain, and japan. a significant impact on the international stock market was 22 economic analysis (2022, vol. 55, no. 2, 20-30) evident, but individually a small effect on the chinese stock market. lee and lu (2021) researched how the covid-19 pandemic affected the taiwanese stock market. the result was the stocks of companies with a higher level of corporate social responsibility (csr) are more resilient to the current crisis. ozkan (2021) tested a market efficiency hypothesis on the stock market of several developed countries. the gained results of econometric models indicate high power to predict abnormal yields during the pandemic. hsu and liao (2022) explored behavior in the us market, with stock volatility, trading volume, and yield as elementary variables on one side and the number of infected and deceased on the other side. there is a positive correlation between the coronavirus effect and stock price volatility and trading volume and a negative correlation between the pandemic and stock yield. amin et al. (2021) inspected the pandemic effect on stock market indices in north, central, and south america. through panel regression analyses, they deducted the number of infected has a considerable bad influence on stock price volatility, except for the south american countries, with no significant statistical correlation. sahoo (2021) and bora and basistha (2021) studied the covid-19 influence on the indian stock market, comparing stock index yields from two different periods – before the crisis and during one. the outcomes obtained by the regressional and garch model show a statistically significant positive correlation with stock market volatility and movements during the pandemic. tapaloglu et al. (2021) used the panel data analysis method to present the relationship between the pandemic and stock markets in turkey, belgium, germany, france, italy, spain, the united kingdom, the united states, china, and the netherlands. covid-19 data is based on the total number of cases and the total number of deaths, while stock market data relies on major stock indices of countries. there was a negative relationship between the total number of cases and the stock market and a positive one between the total number of deaths and the stock market. khalid et al. (2021) used a panel quantile regression model of 17 developed stock markets to show the pandemic's impact on stock market returns and volatility. they proved there is no significant impact of the coronavirus on stock returns. moreover, it had a positive effect on stock market volatility. research methodology to analyze the relation between daily infections in serbia, europe, and the world and index value on the belgrade stock market, that is, trading volume, we used daily data for the period 03/06/2020 to 12/30/2021. there is a time series (t) of 462 days, while the number of observed entities (n) is two (belex line and belex 15). therefore, the number of observations encompassed within these panel analyses is 924. due to the robustness of the data, the dependent variables are logarithmically transformed. data on daily infected was gathered from the web portal our world in data, while the information on index value and trading volume was from the belgrade stock exchange web page. table 1. description of the variables used in the regression analysis variable description source belex 15 indice b15 stocks of the 11 most liquid serbian companies daily data of b15 value belgrade stock exchange https://www.belex.rs/trgovanje/indek si/belex15/istorijski belex line indice bl stocks of the 34 serbian companies daily data of bl value belgrade stock exchange https://www.belex.rs/trgovanje/indek si/belexline/istorijski trading volume daily data of the number of stocks belgrade stock exchange https://www.belex.rs/trgovanje/indek si/belex15/istorijski https://www.belex.rs/trgovanje/indek si/belexline/istorijski bojan đorđević, sunčica stanković 23 variable description source number of new cases of coronavirus in serbia daily data who https://covid19.who.int/ number of new cases of coronavirus in europe daily data who https://covid19.who.int/ number of new cases of coronavirus in world daily data who https://covid19.who.int/ the dependent variables of the research are as follows: the first analysis – the belgrade stock exchange index value (belex 15 and belex line); the second analysis – tk trading volume. the independent variables in both analyses are the number of daily infections in serbia, europe, and the world. the description of variables is presented in table 1. the descriptive statistics of variables used in the analyses are given in table 2. it shows calculated values of the central tendency measures and variabilities. data on the number of observations, arithmetic mean, standard deviations, that is, the average deviation of arithmetic mean, minimal and maximal parameter values are in the columns. table 2. descriptive statistics of the research variable variable obs. mean std. dev min max stock indices values 924 1156.358 426.6729 606.62 1721.16 trading volume 924 1.08e+07 3.42e+07 26131 4.52e+08 serbia 924 2081.121 2438.846 0 9983 europe 924 156306 128847.1 1510 989061 world 924 540773.1 176226.8 25521 1934140 source: authors’ calculation the following graphs (figure 1 and figure 2) illustrate the movement of belgrade stock market index value, belex line and belex 15, and trading volume from march 6, 2020, to december 30, 2021. based on figure 1, it can be noted that the movement trend of both indices is uniform. after the start of the coronavirus pandemic, the value of both indices decreased, and then with the stabilization of the financial market, the value of both indices increased. živković (2022) also points to the marked volatility and uniform trend of the observed indices in the period from 2008-2022. figure 1. movement of stock market index values and trading volume on bse source: authors 50 0 10 00 15 00 20 00 mar2020 dec2021mar2020 dec2021 belex line belex 15 in de x va lu es 0 5. 00 0e +0 8 mar2020 dec2021mar2020 dec2021 belex line belex 15 tr ad in g vo lu m e 24 economic analysis (2022, vol. 55, no. 2, 20-30) research methods research methodology and data analyses are based on panel data, that is, on regression models of panel data (panel data regression model – pdrm). the preliminary part of econometric analysis evaluates different formulations of statistic models and then runs various tests to choose the most suitable model for research data, as well as econometrical diagnostic tests to check if the model presumptions are fulfilled (specification model errors, multicollinearity, auto-correlation, and heteroscedasticity). the analysis uses strictly balanced datasets (“full” time series). the least-squares model (pooled ols – pols), fixed-effect model (fe), and random-effect model (re) were used for testing. the following model is specified to explain the dependent variables by using independent ones: 𝑌𝑌𝑚𝑚𝑡𝑡 = 𝛼𝛼 + 𝛽𝛽1𝑋𝑋1,𝑚𝑚𝑡𝑡 + 𝛽𝛽2𝑋𝑋2,𝑚𝑚𝑡𝑡 + 𝛽𝛽3𝑋𝑋3,𝑚𝑚𝑡𝑡 + 𝑢𝑢𝑚𝑚 + 𝑒𝑒𝑚𝑚𝑡𝑡 (1) where: 𝑌𝑌𝑚𝑚𝑡𝑡 – dependent variable: in the first research ln(index value – iv), in the second research ln(trading volume – tv). 𝑖𝑖 – entity (in the first analysis: 1 = belex line value, and 2 = belex 15 value; in the second analysis: 1= belex line trading volume, and 2= belex 15 trading volume); 𝑡𝑡 – time (in both analyses: 1 = 06.03.2020.... 462 = 31.12.2021.). 𝛽𝛽 – coefficient for respective independent variables; 𝛼𝛼 – intercept; 𝑋𝑋1 – independent variable (number of daily infections in serbia s); 𝑋𝑋2– independent variable (number of daily infections in evropi e); 𝑋𝑋3 – independent variable (number of daily infections in the world w); 𝑢𝑢𝑚𝑚 – the individual impact of the ith entity; 𝑒𝑒𝑚𝑚𝑡𝑡 – the error term. results of econometric tests a) model 1 was evaluated through econometric tests, where the dependent variable of the stock market index value (iv) is given as a linear stochastic function of independent, i.e., explanatory variables: 𝐼𝐼𝐼𝐼𝑚𝑚𝑡𝑡 = 𝛼𝛼𝑚𝑚 + 𝛽𝛽1𝑆𝑆 + 𝛽𝛽2𝐸𝐸 + 𝛽𝛽3𝑊𝑊 + 𝑢𝑢𝑚𝑚 + 𝑒𝑒𝑚𝑚𝑡𝑡 (2) the random effects model was chosen as the most appropriate model (table 4). according to the determination coefficient, for the re model, 9% (r2 = 0.09) variations of the dependent variable are explained based on independent variables. the values of f statistics point to statistical significance re model (prob > f = 0.0000). hausman’s test checked whether the individual effects are correlated with regressors, in which case the fe model would be more suitable. according to hausman’s test results, the significance is higher than 0.05 (χ2 = 0.00, p = 1.0000). thus, we accept the null hypothesis claiming that the re model is more appropriate than the fe model. the justification of the re model is tested with the breusch and pagan lm test (lagrange multiplier) for testing the existence of individual effects. if the test significance is > 0.05, the null hypothesis (no heterogeneity between observed entities) cannot be rejected, which means pols is more suitable than the re model. the test results indicate the level of significance is lower than the set level (χ2 = 2.0e+05, p = 0.0000), so we can conclude the re model is more suitable than the pols model. ramsey reset test was used to check if the model bojan đorđević, sunčica stanković 25 is well-specified. the results gained (f(3, 917) = 0.62; prob > f = 0.6049) indicate no significant variables left out of the model. in the next step, with the use of the pasaran cd test, we looked for serial correlation problems in the model. the null hypothesis is – no serial correlation. the statistical significance of the test is higher than 0.05 (p = 0.4511), meaning the null hypothesis about the non-existence of a serial correlation can be accepted. also, wooldridge’s test for autocorrelation in the panel data indicates there is no serial correlation (p = 0.1910). white’s test was used for heteroscedasticity testing in model 1. if the χ2 statistic probability obtained by this test is higher than the error risk α (α = 5%), the null hypothesis cannot be rejected. the probability value of chi statistics in this test is 0.1121, and with the error risk of 5%, we cannot discard the null hypothesis, confirming the homoscedasticity errors in the model. results from the panel analysis for the re model indicate a positive and significant influence of the number of daily infections in serbia and europe on the index value of the belgrade stock market, while the effect on a global level is positive but not statistically significant. table 4. evaluation of random-effect model with index value dependent variable, and diagnostic tests index values coef. std. err. t p>|t| serbia 5.60e-06 8.97e-07 6.24 0.0001 europe 2.16e-07 1.79e-08 12.10 0.0001 world 1.15e-08 1.15e-08 0.99 0.321 constant 6.928381 .3817168 18.15 0.0001 diagnostic tests hausman’s test χ2(3) = 0.00; p = 1.0000 lm test chibar2(01) = 2.0e+05; prob > chibar2 = 0.0000 ramsey reset test f(3, 917) = 0.62; prob > f = 0.6049 pasaran cd test 0.438; p = 0.4511 wooldridge’s test f(1, 1) = 18.593; prob > f = 0.1910 white’s test χ2 (9) = 12.60; prob > χ2 = 0.1121 note: r squere = 0.09; prob > f = 0.0000; root mse = 0.39; number of observations = 924. source: authors’ calculation to test linear dependence between explanatory variables, that is, to probe the existence of harmful multicollinearity in a regression model, the variance inflation factor (vif), as well as tolerance factor – 1/vif, were used. based on the results in table 5, it can conclude the model has no harmful multicollinearity. table 5. multicollinearity test variable vif 1/vif serbia 1.56 0.640600 europe 1.73 0.577339 world 1.35 0.740278 mean vif 1.55 source: authors’ calculation b) model 2 was econometrically tested, where the dependent variable stock trading volume (tv) is presented as a linear stochastic function of independent variables: 𝑇𝑇𝐼𝐼𝑚𝑚𝑡𝑡 = 𝛼𝛼𝑚𝑚 + 𝛽𝛽1𝑆𝑆 + 𝛽𝛽2𝐸𝐸 + 𝛽𝛽3𝑊𝑊 + 𝑢𝑢𝑚𝑚 + 𝑒𝑒𝑚𝑚𝑡𝑡 (3) 26 economic analysis (2022, vol. 55, no. 2, 20-30) table 6. evaluation of re model with stock trading volume-dependent variable, and diagnostic tests trading volume coef. std. err. t p>|t| serbia -.0000211 .000022 -0.96 0.338 europe -8.83e-07 4.38e-07 -2.01 0.044 world -6.48e-08 2.83e-07 -0.23 0.819 constant 15.40123 .1904107 80.88 0.0001 diagnostic tests hausman’s test χ2(3) = 0.00, p = 1.0000 lm test chibar2(01) = 8.50; prob > chibar2 = 0.0018 ramsey reset test f(3, 917) = 0.60; prob > f = 0.5913 pasaran cd test 0.638; p = 0.3312 wooldridge’s test f(1, 1) = 17.904; prob > f = 0.1477 white’s test chi2(9) = 13.20; prob > chi2 = 0.1536 note: r squere = 0.13; prob > f = 0.007; number of groups = 2; number of obs. = 924. source: authors’ calculation the random effects model was chosen as the most appropriate model (table 6). as stated in table 6, parameters with the independent variable are statistically significant. the coefficient determination value denotes that 13% of the dependent variable variations (stock trading volume) are explained with the re model, and the f statistic values suggest statistical significance in the re model (prob > f = 0.007). by hausman test results, the significance is higher than 0.05 (χ2 = 0.00, p = 1.000), so we accept the null hypothesis the re model is more suitable than the fe model. the breusch-pagan lm test results point out that the significance level is lower than the set one (χ2 = 8.50, p = 0.0018), so the conclusion is the re model is more suitable compared to pols. the results from the ramsey reset test (prob > f = 0. 5913) prove there are no significant variables left out of the model, meaning the model specification is good. pasaran test statistical significance is higher than 0.05 (p = 0.3312), so the null hypothesis on serial correlation non-existence is acceptable. wooldridge’s test for autocorrelation in the panel data indicates there is no serial correlation (p = 0.1477). white’s test was used to test the model’s heteroskedasticity. the value of χ2 statistics probability in this test is 0.1536, which confirms the model errors are homoskedastic. according to the results for the re model, trading volume on the belgrade stock market is negative but not statistically significant for the number of daily infections in serbia and the world, while the number of newly infected in europe is negative on a statistically significant level. conclusion the conducted research had a goal to probe the correlation between the index stock value of belex15 and belex line, trading volume on the belgrade stock market on one side, and the number of newly infected in serbia, europe, and the world, on the other side. the results gained by the panel regression analysis for the random effect model (re), which was econometrically tested, well-specified, and most appropriate for the research, indicate a positive and significant influence of daily infections in serbia and europe on the belgrade stock market index value, while the global effect is positive but not statistically significant (model 1). these results are unexpected. however, soon after the beginning of the pandemic, when the value of both indices fell, the government took preventive measures, with the aim of maintaining economic stability, by supporting micro, small and medium enterprises. this package of economic measures to bojan đorđević, sunčica stanković 27 mitigate the consequences of the coronavirus included: tax policy measures (such as, for example, deferring the payment of payroll taxes), direct assistance to companies for employees (e.g., direct assistance to entrepreneurs who are taxed at a flat rate and who pay income tax real income, to micro, small and medium-sized enterprises in the private sector payment of assistance in the amount of the minimum), measures for liquidity of the economy (e.g. support to the economy through the development fund of the republic of serbia) and other measures (e.g. payment of 100 euros to all citizens of legal age). these preventive measures obviously had a positive impact on the serbian capital market. the obtained results are in accordance with the research results of waheed et al. (2020), who examined the impact of the covid pandemic on the karachi stock exchange and concluded that the covid pandemic has a diverse impact on developing economies, compared to developed economies, which faced serious declines in this period. in the second analysis (model 2), econometric tests also proved it is best to use the model with random effect (re). the results gained by the panel regression analysis for the random effect model (re) indicate a negative but statistically insignificant correlation between the number of newly infected in serbia and the world and the trading volume on the belgrade stock market. the number of newly infected in europe correlates negatively with the trading volume on the belgrade stock market on a statistically significant level. the obtained results are consistent with the results of research on other stock markets, where we refer to öztürk et al. (2020), zaren and hizarci (2020), onali (2020), đorđević and stanković (2021), naseem et al. (2021), who have empirically gained similar conclusions. according to the research results, r square records small values for both models (9% for the first and 13% for the second model). this means that only a small percentage of the variations of the dependent variable (in the first model stock market index value, and in the second stock trading volume) can be explained by means of independent variables (the number of daily infected in serbia, europe, and the world). this speaks in favor of the fact that variations in the capital market in serbia depend on other important explanatory variables, which should be included in the model. however, according to the subject of the research, only covid 19 variables were included in the research, and it can be concluded that these variables can explain a very small part of the variations in the serbian stock market. historically speaking, after the initial panic and significant fall of the belex 15 stock index (fall of over 200 index points) in february/march 2020, the serbian stock market recovered and somewhat adapted to the uncertainty caused by the pandemic. in 2021, there were two strategic moves to develop the capital market in serbia: 1. consolidation of the commercial bank (listed on the belgrade stock exchange: kmbn) by the slovenian nlb group, and 2. the strategic partnership of the belgrade and athens stock market (greece) was one of the ways to improve the capital market and set the stock market as a central piece of the serbian economy. this move would contribute to better visibility and attractiveness of home market securities to foreign investors who are present and trade in inconsiderable volume, not accounting for the current conditions (bbc news, 2021). we can conclude that, under the current turbulent conditions, there has been a quick recovery of the stock market, there was no greater capital outflow from the belgrade stock market, and the shock hasn’t been enormous and devastating. simultaneously, in 2020/2021, all other significant stock indices in europe and the world recorded a swift recovery and growth, a characteristic of stock markets. favorable information gained in 2020 from the covid-19 vaccination manufacturers (phizer, astra zeneca), and a set of economic measures of many countries, contributed to a better investors’ psychological climate in all markets. in a crisis, panic in the market is not in compliance with long-term investment strategies. the current pandemic is not only a possibility but also a necessity for investors to consider their investment portfolios and carry out a hedge and optimize. many authors and stock market analysts highlight the inclusion of gold as a safe asset, futures and options trade, 28 economic analysis (2022, vol. 55, no. 2, 20-30) and also the inclusion of some cryptocurrencies into portfolios for diversification and reduction of risk to a minimum. the limitations of this research are in its sensitivity to new information and data. for that, we need further research that would include new information and data on the subject, like stock yield and trading analysis, number of deaths, number of vaccinated people in serbia, europe, and on the global level, to secure valid information for politicians, investors, portfolio managers and ceos in the decision-making process. the crucial implication of this research is a further study on factors connected with pandemic waves that affect the volatility of the serbian stock market. in the end, the results of this study will be of use to the domestic and foreign professional public because they will provide valuable information on the behavior of financial markets in developing countries during the crisis. also, the study can be helpful to state decision-makers to implement the necessary activities and reduce the potential undesired effects of the current health crisis. references abuzayed, bana, elie bouri, nedal al-fayoumi, and jalkh naji. 2021. “systemic risk spillover across global and country stock markets during the covid-19 pandemic.” economic analysis and policy, 71: 180–197. https://doi.org/10.1016/j.eap.2021.04.010 adcock, christopher, xiuping hua, khelifa mazouz, and shuxing yin. 2014. “does the stock market reward innovation? 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2022 revised: october 19, 2022 accepted: october 21, 2022 https://doi.org/10.1016/j.jfs.2019.100721 https://doi.org/10.1093/rcfs/cfaa012 https://www.reuters.com/article/us-health-coronavirus-markets-chaos-iduskbn20z3wb https://www.reuters.com/article/us-health-coronavirus-markets-chaos-iduskbn20z3wb https://doi.org/10.1002/pa.2621 https://doi.org/10.1177/0972150920957274 https://doi.org/10.5539/ijef.v13n3p31 https://doi.org/10.1080/13504850210148125 https://doi.org/10.2307/1911841 https://doi.org/10.1002/pa.2290 https://covid19.who.int/ https://doi.org/10.1016/j.frl.2020.101597 https://doi.org/10.32951/mufider.70615 ea_2014_3-4 udc: 336.781.5 005.334 jel: e43, f31 cobiss.sr-id 211781644: scientific review interest rate swaps pepić marina1, national bank of serbia, belgrade, r. serbia abstract – interest rates changes have a huge impact on the business performance. therefore, it is of great importance for the market participants to identify and adequately manage this risk. financial derivatives are a relatively simple way of protection from adverse changes in interest rates. interest rate swaps are particularly popular because they reduce interest rate risk to a minimum with a relatively low initial cost and without great risk, but also because of the fact that there are many modifications of the standard swap created to better satisfy the different needs of market players. key words: interest rate risk, standard interest rate swap, non-standard interest rate swaps introduction due to the large impact that interest rates changes have on the business performance, it is very important appropriately to manage this type of risk. financial derivatives (futures, options and swaps) are a very simple way to minimize interest rate risk, which is why they are extremely popular, and their use in the world is increasing drastically year by year. according to the bank for international settlements, from all financial derivatives traded on the otc market, interest rate derivatives have recorded the largest market value, primarily interest rate swaps. however, this is not the case in serbia. in serbia, the interest rate derivatives market does not exist. thus, this paper aims to highlight the possibilities offered by this type of derivatives when it comes to protection against interest rate risk. in the paper first will be explained basic concepts related to the interest rate swaps. after that it will be explained, with an example, how standard interest rate swap can be used as a tool for protection against interest rate risk. after that, some non-standard variants of interest rate swaps, created to better satisfy different needs of market participants, will be briefly discussed. finally, at the end of the paper attention will be drawn to the advantages and disadvantages of the interest rate swaps. interest rate swap interest rate swaps appeared in the u.s. in the eighties because of the increased need for financial instruments that could be used to eliminate the interest rate risk. interest rate swap is an agreement between two parties in which they agree to exchange sequence of interest payments (peterson drake, fabozzi, 2010, p. 378). interest is calculated on the notional 1 karadjordjev trg 3, belgrade, marinapepic@hotmail.com economic analysis (2014, vol. 47, no. 3-4, 69-80) 70 principal that is never exchanged. on agreed dates, one party has an obligation to make payments calculated at a variable rate and the other side has to make payments at a fixed / variable rate. thus, one set of payments must always be at a variable rate linked to a reference interest rate (usually libor). if the dates on which the parties have to make payments coincide, usually is paid only the difference in interest. set of payments calculated at a fixed rate is the fixed leg of the swap, and the set of payment calculated at a variable rate is the variable (floating) leg of the swap. the party which pays at fixed rate and receive at variable rate is the buyer of the swap (long position) while the swap seller (short position) is considered to be the party that pays at a variable rate and receive at a fixed interest rate. swap rate – by contracting the interest rate swap parties agree to exchange set of interest payments on agreed future dates, where, as noted above, one set of payment is calculated at a fixed, and the other at a variable rate. the variable rate is linked to a reference rate, while fixed-rate is set in the way that present value of future payments that parties would exchange are equal in the time of swap initiation. hence, swap rate is fixed rate at which one set of interest payments is calculated and which provides equality of present values of future payments at the time of concluding the swap agreement (cvitanić, zapatero, 2004, p. 302). obligations of the party that will pay a fixed rate are known in advance. however, this is not the case for the party that pays at a variable rate, because variable rate changes depending on the change of reference rate to which it is bound. the value of futures for the period is usually taken as an estimation for the variable rate and in that way obligations are calculated. the value of the swap – in the moment when it is signed value of the swap is equal or close to zero, i.e. the present values of cash flows that counterparties will exchange are equal. however, over the time the value of the swap changes depending on the interest rates movements in the market, because interest rate shifts change the present value of the cash flows that parties pay or receive. the value of the swap is equal to the difference between the present value of cash flow that party receives and the present value of the cash flow that the party pays (fabozzi, 2000, p. 578). swap spread in the swap market, the convention is to set the floating leg at libor and quote only the fixed rate (reilly,brown,2003, p. 1018). in the table below, the first column represents swap maturity, the next two are offer and bid quotes for each maturity, and the last one is the bid spread over the benchmark t-bond (government bond with the same maturity). for example, the bank is quoting for 5-years swap 5.25% and 5.19%, which means that the bank is willing to pay a fixed rate of 5.19% and receive libor, and to pay libor and receive a fixed rate of 5.25%. the bid-offer spread is therefore 6 basis points. the bid-offer spread is not the same as swap spread. say the 5-year t-bond (benchmark bond) is trading at a yield of 4.88%. the 5-year swap bid and offer rates in the example are 31 basis points (the difference between 5.19% and 4.88%) and 37 basis points (the difference between 5.25% and 4.88%) above the yield on tbond, so the bank could quote the swap rates also as a swap spread (spread over the t-bond yield): ‘37–31’. this means that the bank is willing to pay 31 basis points above the t-bond yield and receive libor or to receive 37 basis points above the t-bond yield curve and to pay libor (choudhry, 2005, p. 110). pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 71 table 4. swap spread swap quotes spread 1 4,50 4,45 +17 2 4,69 4,62 +25 3 4,88 4,80 +23 4 5,15 5,05 +29 5 5,25 5,19 +31 10 5,50 5,40 +35 source: eales and choudhry ,2003, p. 77. thus, swap spread is the spread over the t-bond yield curve. swap spread is a function of conditions on swaps and bonds markets, as well as of the credit risk of counterparties. swap yield curve a large number of swap contracts led to the formation of the yield curve for different maturity swap contracts. swap yield curve is created based on swap rates for different maturities (fabozzi, 2007, p. 96). swap termination there are four ways in which parties can get out of the swap (chance, 1998, p. 583). these are: 1) close out party coming out of the swap pays / charges present value of the swap to the counterparty. 2) sale transferring the swap to a third party after which this party takes over all obligations from the swap agreement by the end of the contract period. the party that is getting out of swap transfers the swap to a third party by paying / charging the present value of the swap. 3) neutralization of the existing swap by entering into a new swap with the same conditions (same fixed and variable interest rate and payment period), but on the opposite position (cash flows are opposite compared to the first swap). 4) using a previously bought option to terminate the swap. standard interest rate swap the most common and simplest type of interest rate swap is a standard (plain vanilla or generic) swap. it involves the exchange of a set of periodic interest payments calculated at a fixed rate for a set of periodic payments calculated at a variable rate in the agreed period of time. both sets of interest payments are calculated on the notional principal that is never exchanged. the variable interest rate is linked to a reference interest rate (libor rate and the t-bill). interest rate swaps are used to neutralize the interest rate risk related to the difference in sensitivity of assets and liabilities to interest rate movements. it can be used to transform the interest rate sensitive assets into interest rate-insensitive, and vice versa, and to transform the interest sensitive liabilities into interest rate insensitive and vice versa (hull, 2003, p. 127). transforming liabilities suppose an investor tend to borrow $ 1 million at a floating rate. however, additional debt at the variable rate will undermine compliance between interest rate sensitive assets and liabilities. in the event of rising interest rates in the market, the increase in the liabilities will be greater than the increase in income, as interest-sensitive liabilities exceed by one million dollar the interest-bearing assets. the result would be, therefore, decline in the net interest margin and investors profitability. to avoid this risk, the investor will want to convert $ 1 million of liabilities with variable interest rates in the $ 1 economic analysis (2014, vol. 47, no. 3-4, 69-80) 72 million liability insensitive to interest rates movements, tiding interest-sensitive assets to interest-sensitive liabilities. entering into interest rate swap will enable him this. therefore, the investor will contract interest rate swap under which he will be required to pay at fixed rate and receives at variable rate. variable income from the swap will be equal to the losses from the additional variable debt, and the net result will be a fixed obligation from swap. transforming assets interest rate swaps can be used to transform variable income into fixed income and vice versa. suppose that investor b issued bonds in the amount of million dollars, and the funds invest at a variable rate. this will disturb the balance between interest sensitive assets and liabilities, as interest sensitive assets will be for $ 1 million bigger than the interest-sensitive liabilities. therefore, he will enter the swap, same as investor a, but in the opposite position. if interest rates fall, the fall in income on the active side will be greater than the costs fall on the passive side, and the result will be a drop in profits. by entering into interest rate swap, the investor b eliminate this interest rate risk by converting $ 1 million of assets with variable income to $ 1 million of income with fixed income. in this case, if interest rates fell, the decline in interest sensitive income would be equal to drop in costs and profitability would remain unchanged. therefore, investor b will enter into interest rate swap in which he will have to pay at variable rate, and receive at fix. profit/loss in swap would neutralize variable income from investments, and the net result will be a fixed income from the swap. between investor a and investor b, for example, could be contracted interest rate swaps as follows: investor a pays to investor b a fixed interest rate of 5% per annum on the $ 1 million (notional principal) for the next 3 years, and the investor b pays to investor a 6m libor plus 1% on $ 1 million in the same period, with the half year payments. 6m libor at the time is 3.2%. figure 1. interest rate swap source: author the first exchange of payments will be six months from the time of the swap contract. the investor a has to pay 5% per year on a million dollars, so in six months he will have to pay $ 25,000 (5% * 0.5 * $ 1,000,000). investor b will be required to pay interest equal to the value of 6m libor at the time of swap contracting plus 1% on a million dollars for six months, i.e. he will have to pay $ 21,000 ((3.2% +1%) * 0.5 * 1.000. 000 dollars). the second set of payments will be for another six months, or one year from the swap contract. for investor fixed rate 5% over 3 years libor + 1% over 3 year receives b pays pays receives a pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 73 a amount to be paid is the same, $ 25,000. however, investor b will have to pay the interest rate equal to the value of 6m libor at the time of the first exchange of payments plus 1% on a million dollars for six months. if 6m libor was then, for example, 3.8%, investor b will have to pay $ 24,000 ((3.8% +1%) * 0.5 * 1,000,000). until the end of the swap, investors would exchange payments four more times every six months as set out in table 2. table 5. interest rate swap, an example 6m libor cash flow at float. rate cash flow at fixed rate net cash flow for fixed rate payer net cash flow for fixed rate receiver 0 3,2 1 3,8 21.000 25.000 -4.000 +4.000 2 4,3 24.000 25.000 -1.000 +1.000 3 4,5 26.500 25.000 +1.500 -1.500 4 4,6 27.500 25.000 +2.500 -2.500 5 4,9 28.000 25.000 +3.000 -3.000 6 5,4 29.500 25.000 +4.500 -4.500 total +6.500 -6.500 source: author like forwards, each side in the swap must have a lot of information about the other side to be sure that the contract will be fulfilled. the need for information on one side, and the problem with low liquidity of swap market may limit the use of swaps. however, hiring intermediaries, such as investment banks and especially large commercial banks, solve these problems. they have the ability to collect information about the creditworthiness and reliability of the parties at low cost, and are able to match them in swap. because of these, investors rarely enter in a swap directly and bank mostly occurs as intermediaries. in this case, investors do not enter into a swap with each other, but with the bank. swap between investor a and investor b will probably look as shown on graph below, where a bank or other intermediary will appear between investors. figure 2. interest rate swap with intermediary source: author fixed rate 5,05% over 3 years fixed rate 4,95% over 3 years libor + 0,95% over 3 year libor + 1,05% over 3 year receives b pays intermediary pays receivespays receivespays receives a economic analysis (2014, vol. 47, no. 3-4, 69-80) 74 investor a agrees to exchange with the bank a fixed interest payment of 5.05% for an variable interest payment of 6m libor plus 0.95%. on the other hand, the bank enter into a swap agreement with investor b, in which it have to exchange a fixed interest payments of 4.95% for variable payments at the rate of 6m libor plus 1.05%. notional principal is $ 1 million, and the contract period is 3 years, with the exchange of payments every six months. on the one hand, the bank makes a profit on the difference between 5.05%, received from investors a, and 4.95% that pays to investor b, and on the other hand on the difference between 6m libor plus 1.05%, which receive from investor b, and 6m libor plus 0.95%, that pays to investor a. so in this case the bank earns a total of $ 2,000 (0.2% * $ 1,000,000) as a mediator in the interest rate swap. investor a and investor b voluntarily give up profits entering into swap (they receive 0.05% less and pay a 0.05% more), because this agreement brings two significant benefits. first, the bank is able to match the two sides, which probably would not have been possible without her help. second, in this way investors avoid the risks associated with the creditworthiness of the counterparty. these advantages of doing business with a bank as intermediary are reason why both investors will likely be ready to engage her, although that costs. non-standard interest rate swap interest rate swaps are traded otc. these are not standardized contracts and can fully adapt to the different market needs, and in time, a large number of basic swap contract modifications appeared. in the literature usually the following types of interest swaps could be found (hull,2003; fabozzi,2007) basis swap the interest rate swap in which both sets of payments are calculated at different variable interest rates (chance, 1998, p. 636). if the investor took a loan, for example, of one million pounds on which he pays 1m libor and at the same time invest funds at interest rate 1m tibor plus 30 basis points, the difference between these two rates will determine the investors profit. if the current 1m tibor equal 1m libor plus 10 basis points, it means that the investors will be earning 40 basis points. however, market rates do not change always in the same direction and intensity so that if there is a change in the relationship between two rates and interest rate spread will be changed. if investor wants to capture the initial interest rate spread he can enter into interest rate swap. cancelable swap the interest rate swap in which one party has a right to terminate the swap on one or more agreed dates (hull, 2003, p. 603). terminating the swap is the same as entering in the opposite swap. if the swap is cancelable on a single date, then this swap is to the party who has the right to cancel it the same as the standard swap plus a long position in an option to enter into the opposite swap. to the other side it is the same as the standard swap and a short position in the option to entry into the opposite swap. for example, a tenyear swap with the right to cancel it after 6 years is the same as the standard ten-year swap and option to enter an opposite four-year swap. if there are a number of possible cancellation dates, then this swap to the party who has the right to cancel it is the same as a standard swap plus a long position in bermuda swaption to enter the opposite swap, and to the other side is the same as the standard swap and short position in bermuda swaption to enter the opposite swap. for example, a five-year swap with the possibility of cancellation between pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 75 2nd and 5th year is the same as the standard five-year interest rate swap and bermuda swaption to enter the opposite swap that matures in five years. compounding swap from the standard swap differs only in the fact that there is only one exchange of payments (hull, 2003, p. 595). at the end of the swap period counterparties exchange all the payments. cancelable compounding swap is a swap in which one party has the possibility to terminate the swaps on certain dates (hull, 2003, p. 604). in the case when the party that has right to do so terminate the swap, both counterparties at the time of termination pay the compounded value of all the payments up to the time of termination of the swap. conditional (accrual) swap is a swap in which the interest is calculated only for the days when floating interest rate was within a certain range or below/above agreed level (hull, 2003, p. 603). when it comes to standard swap the fixed rate interest is calculated by multiplying the interest rates and the number of days for which the calculation is made (the number of days in the month or quarter) and dividing with the number of days in the year. however, in this type of swap, interest is calculated only for those days when the variable rate was below/above or within some agreed range, so the notional principal is not multiplied by the total number of days in the period, but by the number of days in which the variable interest rate fulfilled agreed condition. (hull, 2003, p. 127) yield curve swap is the swap in which both set of payments are related to the same rate, but a different maturity (martellini,priaulet,priaulet,2003, p. 345). for example, an investor can enter in swap to receive 3m libor rate and to pay 6m libor rate. non-parallel shift in the yield curve in this case result in interest rate spread changes for the investor. ascending (step-up or accreting) swap is a swap in which, unlike most of the swaps where notional principal is constant, the notional principal increases over time (arditti, 1996, p. 291). suppose that an investor take a loan that he pulls in installments, so over the time the value of the debt increases. in this case he will arrange a swap with notional principal that increases over time. descending (amortizing) swaps are those in which the notional principal decreases over time (kolb, 1999, p. 633). for example if the investor borrowed funds at a variable rate, since it was better at the moment, but he wants the debt at fixed rate, he will initiate a swap. in addition, if the funds are invest so that the investor expects every month that he will be able to repay some of the debt, he will initiate a swap in which notional principal decreases over time. rollercoaster swap is a combination of the previous two types of swaps. notional principal in this case, first increases and then decreases (arditti, 1996, p. 291). it is used when the value of debt is growing at first, and after some point begins to decline. index amortizing swap is a swap in which the notional principal is decreasing depending on the level of interest rates (chance, 1998, p. 636). the lower the interest rate, the greater the reduction in notional principal. libor in arrears swap is the one in which floating-rate of interest is calculated at the floating-rate observed on day of payment, opposed to a standard swap where the payment is calculated at floating-rate value observed on the day of the last payment (hull, 2003, p. 599). economic analysis (2014, vol. 47, no. 3-4, 69-80) 76 constant maturity swap is the interest rate swap that allows the fixation of duration of funds received under the swap (chance, 1998, p. 638). this assumes periodical adjustments of floating rate, with the exception that in this type of swap, floating rate is usually related to swaps rate of a certain duration (rather than libor). for example, a variable interest payable semi-annually can be linked to a five-year swap rate. differential swap is a swap in which interests are calculated at floating rates related to the different currencies (hull, 2003, p. 601; chance, 1998, p. 637). for example, paying 6m sterling libor on notional principal of 100 million pounds, and receiving 6m euro libor on the same principal. zero-coupon swap is an extreme example of the swap. in this case, a fixed interest rate is equal to zero, and payment is made at swap cancelation at fair swap value (arditti, 1996, p. 292). it is used in situations where a party has liquidity problems until swap cancelation. prepaid swap is the one in which one party (usually the party that pays at a fixed rate) at the time of swap initiation pays the present value of all his payments during swap life, and then receives payments on agreed dates (at variable rates) (fabozzi, 1996, p. 172). besides these, there are swaps in which the interest is not calculated at the same notional principal. for example, paying on the principal of $ 100 million, and receiving the payments on the notional principal of $ 150 million. swap as a basis for other derivatives futures swap forward/futures swap is the interest rate swap in which the exchange of interest payments start on agreed future date. an investor ,who plans to borrow in two months $ 100 million for a period of 5 years at the rate of libor, and expected that interest rates will rise in two months, and wants to fix his costs, may do so by entering into forward swap under which he will be paying a fixed rate on the notional principal of $ 100 million over 5 years, and receiving a libor, with the exchange of interest payments starting in two months (arditti, 1996, p. 291) . after two months, interest rates have risen, but the investor will still lend funds as planned. the increase in borrowing costs due to a higher rate will be offset by the increase in inflow from the swap, and the investors cost will depend only on pre-agreed fixed swap rate. therefore, by initiating the forward swap investor fixes his obligations without any additional cost and protect against interest rate risk in the event of unfavorable movements in interest rates. however, this strategy prevents the investor to benefit in the event of favorable market movements. in fact, if interest rates fall after two months, opposite to the investors’ expectations, his costs would not be lower because the savings from borrowing at a lower rate would be neutralized by reduced inflows on variable leg of the swap. swaption swaption some options may be embedded into the swap. callable swap gives the right, but not the obligation, to the party that pays at fixed rate to terminate the swap (arditti,1996, p. 298). party will use his right if there is a fall in the market rates because it can then enter pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 77 into a new swap at a lower rate. swap with a put option gives the right but not the obligation, to the party that receives a fixed rate to terminate the swap, and he will do so if market rates increase, because than he can enter into a new swap to receive at higher fixed rate. these features built into swap are not the same as swaption. swaption is a separate option that gives the holder the right to enter into swap. call (payer) swaption gives the owner (purchaser) right to enter into swap in which he has an obligation to pay at pre-arranged fixed rate (kolb, 1999, p. 639-640). he will use his right if market rates rise, because then contracted rate will be lower than the market, and therefore the amount to be paid. time (receiver) swaption gives the owner right to enter into swap in which he has an obligation to pay at a variable rate. this option will be used if market rates fall, because then costs are lower while he has to pay at a lower rate than the market. swaption are similar to the forward swap except that in this case there is no obligation to enter into swap. swaption buyer, therefore, has the possibility to protect himself from adverse market movements, but also to gain on the positive. if, for example, investor can borrow in three months at a variable rate for a period of 5 years, and wants the liability to be at a fixed rate, he will buy swaption that allows him to enter into the five-year swap in which he will be paying at a fixed rate of 10%, and receiving at a variable rate. after three months, if the market rate is less than 10%, he will let the swaption expire. however, if the market rate in three months is more than 10%, he will use the opportunity of entering into swap and consequently will have liability at fixed rate of 10%. so in this way the investor wants to ensure that in three months, regardless of how much is the market rate, he will pay no more than 10%. advantages and limitations of interest swaps in order to eliminate the interest rate risk, investors, instead of engaging in interest rate swaps, may alter their balance sheets converting assets with fixed interest rate in interestsensitive assets and vice versa. however, such a strategy would be more expensive for several reasons. first, institutions have significant transaction costs when they are rearranging their balance sheets. second, different financial institutions have informational advantages in giving loans to certain customers (mishkin, eakins, 2006, p.665). therefore, the adjustment of the balance sheet, in order to eliminate the interest rate risk, may result in the loss of these benefits, which financial institutions are generally not ready to give up. interest rate swap solves this problem by allowing institutions to convert fixed rate assets in interestsensitive assets, or vice versa, without any changes in the balance sheet. in this way, high transaction costs are avoided, and the financial institution can continue to grant loans when they have comparative advantages. interest rate swap has a huge advantage over other financial derivatives. in fact, contrary to the interest rate futures and options that are used for a much shorter period of time (usually no longer than one year), swaps can be concluded for a very long time, sometimes even 20 years (mishkin, eakins, 2006, p.665). if the financial institution has to manage the interest rate risk in the long period, the financial futures and options won't be very useful, but interest rate swaps would be. economic analysis (2014, vol. 47, no. 3-4, 69-80) 78 the third advantage of the interest swaps is that they allow the two institutions to exploit their comparative advantage in borrowing in the markets at a fixed or variable interest rate. suppose that investor a has a better credit rating and can either borrow a million dollars at variable interest rate, let’s say, libor plus 2%, or to issue bonds with a fixed interest rate of 7%, while investor b can borrow a million dollars at the rate of libor plus 2.5% or to borrow at a fixed rate of 9% (mishkin ,eakins, 2006, p. 665). investor a has better conditions, i.e. he has an absolute advantage in borrowing at fixed and at a variable rate, because he has a better credit rating. however, investor a has a comparative advantage in borrowing at fixed interest rate, while investor b has a comparative advantage in borrowing at a variable interest rate. by entering into swap, both institutions would lower their borrowing costs. the ability to exploit comparative advantage in borrowing at variable interest rates as opposed to borrowing at fixed rates is an important swaps feature that has greatly contributed to great popularity of swaps. possibility of using the comparative advantages when it comes to borrowing is often the subject of criticism. the frequently asked question is how the possibility of arbitration did not result in equality of the spread between the fixed and the spread between variable interest rates at which investors with different credit rating may barrow. the reason for this is in the nature of contracts available when it comes to borrowing at a fixed and variable rate. when it comes to borrowing at variable interest rate there is possibility of periodic adjustments of the interest rate, so if the credit rating of investor change interest rate can be adjusted. however, this possibility does not exist when it comes to borrowing at fixed interest rate. the difference in the spread between the rates for investors of different credit rating reflects the likelihood that they go bankrupt. in the short run, likelihood that the situation will worsen is not big so the spread in rates is lower than in the long run. in fact, statistics show that, with time, the probability, that position of investors with lower credit rating will worsen increases faster than the probability that a credit rating of investors with higher credit ratings will deteriorate. therefore, with the increase of the borrowing period, increase rates at which investors with different credit ratings can borrow. although interest rate swaps have significant advantages that make them very popular within financial institutions, they also have some drawbacks that limit their usefulness. swap market, as well as forward market, may suffer from a lack of liquidity. in addition, the parties often find it difficult to connect each other to agreed swaps. in addition, swaps are subject to the same default risk as forward contracts. however, the default risk in the swap is not the same as in other instruments because it applies only to interest, while the risk for the full amount of the notional principal does not exist, because it is never exchanged. if one party would not be able to fulfill its obligations and pay the interest, the other side could simply stop paying its obligations. in addition, if counter party is no able to fulfill his obligations, it does not have to be bad for the other side. for instance, if it comes to interest rates fall, the party that pays at fixed rate and receive at variable interest rate will be in a worse position, so it would be suitable for this side if the counterparty stops with fulfilling its obligations and if it comes to the termination of the swap. these disadvantages are successfully overcome with the help of intermediaries, such as investment banks and especially large commercial banks, which have the ability to collect pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 79 cheaply information on the creditworthiness and reliability of the parties, and are able to match them in swap. of course, interest rate swaps bear risks for banks that occur as an intermediates and that is way there is a series of regulations designed to limit the risk to which they may be exposed based on financial derivatives. conclusion financial derivatives, primarily interest rate swaps, are extremely popular hedging instruments against adverse changes in interest rates. its popularity interest rate swaps owes primarily to the fact that they provide protection against risk in a relatively simple manner and without high initial costs. in addition, interest rate swaps do not carry a high risk because the notional principal is never exchanged, but only the interest payments, and one counterparty may simply cease to perform its obligations if the other counterparty stops fulfilling its obligations. moreover, in practice, due to the need to adapt to the different needs of market participants, a large number of modifications of the standard interest rate swap incurred. interest rate swaps market suffers from certain drawbacks, but they are successfully overcome, so that in developed countries, interest rate swaps are far leading by the value of notional principal and the gross market value in relation to other financial derivatives. references arditti, f. d. 1996. derivatives a comprehensive resource for options, futures, interest rate swaps and mortgage securities, boston: harvard business school press. chance, d. m. 1998. an introduction to derivatives and risk management, 5th ed. fort worth, harcourt college publishers. choudhry, m. 2005. fixed-income securities and derivatives analysis and valuation, princeton: bloomberg press. culp, c. 2004. risk transfer – derivatives in practise. new jersey: john wiley and sons. cvitanić, j. and zapatero, f. 2004. introduction to the economics and mathematics of financial markets, cambridge: mit press. eales, b. and choudhry, m. 2003. derivative instruments: a guide to theory and practice, oxford: butterworth heinemann. fabozzi, f. j. 1996. measuring and controlling interest rate risk, new hope, pa: frank j. fabozzi associates. fabozzi, f. j. and mann, s. v. 2005. the handbook of fixed income securities, 7th ed. new york: mcgrawhill professional. fabozzi, f. j. 2007. fixed income analysis, 2nd ed. new jersey: john wiley and sons. peterson d. p. and fabozzi, f. j. 2010. the basics of finance an introduction to financial markets, business finance, and portfolio management, new jersey: john wiley and sons. hull, j. c. 2003. options, futures and other derivatives. 5th ed. new jersey: prentice-hall. kolb, r.. 1999. futures, options and swaps. 3rd ed. cambridge: mass, blackwell publishers. martellini, l., priaulet, p. and priaulet, s. 2003. fixed-income securities valuation, risk management and portfolio strategies, chichester, england: john wiley and sons. mishkin, f. s. and eakins, s. g. 2006. financial markets and institutions, boston: addison-wesley. reilly, f. k. and brown, k. c. 2003. investment analysis and portfolio management, 7th ed. mason, ohio: south-western/thomson learning. economic analysis (2014, vol. 47, no. 3-4, 69-80) 80 stephens, j. 2002. managing interest rate risk – using financial derivatives. chichester, england: john wiley and sons. kamatni skupovi rezime – promene kamatnih stopa imaju veliki uticaj na uspešnost poslovanja. zbog toga je za tržišne učesnike od velikog značaja da prepoznaju i adekvatno upravljaju ovim rizikom. finansijski derivati predstavljaju relativno jednostavan vid zaštite od neželjenih promena kamatnih stopa. kamatni svopovi su naročito popularni s obzirom na to da omogućavaju svodjenje kamatnog rizika na najmanju moguću meru uz relativno male inicijalne troškove i bez velikog rizika, ali i zbog činjenice da na tržištu postoje različite modifikacije standardnog svopa kako bi se što bolje prilagodili različitim potrebama tržišnih subjekata. ključne reči: kamatni rizik, standardni kamatni svopovi, nestandardni kamatni svopovi article history: received: 25 october 2012 accepted: 15 may 2014 microsoft word 2009_3_4-korigovano.doc professional paper employee development and knowledge-based organization kolaković kristijan*, institute of economic sciences, belgrade marinković vladimir, megatrend univerzitet, belgrade stefanović saša, institute of economic sciences, belgrade udc: 005.966.5 jel: d21, l20, m14, m20, m21, m50 abstract – in the conditions of constant market changes, fast development and spread of technology, multiply competition and „over night” product superannuation, successful companies became those who create new knowledge, spread it out trough the entire company and implement it rapidly in the new technologies and products. these activities define company as knowledge – creating organization which only and principal task is ongoing innovation. those are the companies that understood that the learning and new knowledge are the key to success, and that the development is crucial for future survival. the notion of education, development and knowledge creating company, or in other words an organization that develops and learns, in the most pragmatic way expresses the attitude of modern, successful companies versus the development and knowledge of employees. another name for this kind of organization is knowledge – based organization. the aim of this paper is to show that the employee development is a key procedure in implementing human resource politics. in order to create learning organization it is a necessity for the employees to have formal and informal education and to acquire it throughout entire professional career. life-long learning politics is the basic premise of the company’s market competiveness considering the fact that the knowledge is the only resource that grows with use and not disburse. the main conclusion of the paper states that the most successful companies and national economies are those based on knowledge, or in other words highly educated and trained human resources. high level of inventiveness and innovations, without which a modern market cannot be imagined, can be achieved only in following the path of permanent employee development, which also represents one of the main motivators in accomplishing efficiency and effectiveness of the companies. key words: employee development, learning organization, knowledge based organization introduction the changes, quotidianly dictated by the new technologies and the occurrences on the global market, established new relations among the companies at all levels. the new economy, based on knowledge, recognizes human knowledge and its usage in its full capacity as the basic factor of the market competiveness. this is also supported by the fact that the knowledge is the only resource that grows with use and that the subject of a main contest on the global market is precisely human knowledge and the unlimited possibilities of its growth. alongside new era in global economy, new game rules and new trends regarding * address: zmaj jovina 12, 11000 beograd, republika srbija, e-mail: kristijan.kolakovic@ien.bg.ac.rs economic analysis (2009, vol. 42, no. 3-4, 69-77) 70 employee development in the companies came also. new flexible labor markets, more and more flexible employment models, accentuation of the human resource management in organizations are set to rights and represent the base for the creation of a flexible and competitive organization. the dynamic growth of new technologies and science established completely new relations at the global market and raised standards of employees’ growth and education in organizations. new technologies and business automation definitely have large impact on the cut back of the administrative employees and they reduce the need for manual labor but in the same time they create the need for the new employees that implies human resources highly educated in the fields of creation of new products and services as well as creation of new consumer needs at the market. as far as for the companies doing business in conditions created by the transition process, it is of the essential importance to harmonize their business with the every-day changes that happen on the market and that, in this sense, they position themselves as highest as possible in comparison to the competition coming from the countries whose economy started its dynamical growth ten years ago. the employee development model in modern companies and its competitive advantages is presented in this paper. also, the main accent is put on the education and its importance as the base of the growth, both in micro and macro level. employee development in a modern company employee development implies a set of measures and activities within a company directed towards adjustments of knowledge, capabilities and skills of the employees to the future business requirements. this process has for its goal to assure the qualifications of the employees needed to overcome the demands caused by the changes but also synchronizing them with the entrepreneurial and individual goals. employee development is a process in which the main agents are the company and the employees (individuals). these agents have each its own interests. the interest of a company is the augmentation of the working capabilities and motivation of the employees, to the end to reassure competitive advantages in the long run and future development of the company. the interest of employees could be summed up in increasing job security, better chances for promotion, recognitions and professional affirmation, as well as the better earnings. in the human resource development it is necessary to respect the interests of each of the suggested agents and to assure that the process goes in the way that it connects the foregoing interests and pleases the both sides. the goals of the employee development in the company should be the following: 1. permanent adjustments of the employee qualifications to the changes of the job requests; 2. safeguard and increase the company’s competitive advantages; 3. marketing effects on the extern labor market; 4. higher possibilities to fulfill the needs for new knowledge and skills using the internal sources; kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 71 5. motivation of the employees; 6. investments in future success with a low level of material investing; 7. encouragement of the mobility and multifunctional work within the company; 8. assure and use the high quality potentials coming from the internal sources. the summery of the employee development arises from the comparison of the job requests and the existing capabilities of the employees. that is why it is necessary for the managers to have a clear vision about the goals, strategic and operational plans and requirements of the future business, as well as the assessment of the future directions regarding technology, market and environment that could influence concrete demands regarding the level and the caliber of the adequate knowledge, skills and behavior. in the same time, it is also necessary to follow up personal aspirations, interests and particularly the results of the employees. this has strong motivational effects considering the natural human needs for consideration and self-actualization. the employee development understood as the factor of company’s success and strategic advantage in market conditions, cannot be took for granted nor left to the personal assessments and interests of the employees than it should be well imagined and goal driven process by the direct superiors. education as the key aspect of employee development increased dynamic of the development of new technologies had extremely positively influenced the education growth process. more precisely, the new technologies and the demand for constant improvement determinatively influenced shaping the content and the forms of the educational system organization in each country. in the same time, increased creative power of the human labor, based on new technologies, has produced large material base for the educational system development and the accessibility of the education to the members of every social status. the introduction of new, more productive machines has contributed largely to the democratization of education and by which to the democratization of the entire society. exactly the growing dynamics of the technological development, which also signifies the necessity for constant improvement of professional and skilled knowledge of the employees, was the one who stipulated the two basic directions of the educational process development in all countries, or in other words built simultaneously two foundations of the education: • formal educational system – spreading from elementary school to university, including master and doctoral studies, which is legally recognized and implies certain procedures put in function of the systematical acquisition of general and professional knowledge; • informal educational system – which is essentially just the follow up of the education obtained in the schooling process within the formal educational system and which nowadays takes place throughout the entire working life, which is largely part or functionally attached to the working process and whose bearers are in large amount the companies themselves, most certainly in cooperation with the appropriate professional institutions involved in education, scientific and professional work. economic analysis (2009, vol. 42, no. 3-4, 69-77) 72 this division is getting more and more conditional, especially these days, so the titles should be also tentatively interpreted. so-called “informal educational system” is also being developed within a certain methodological, pedagogical and andragogical norms as the formal educational system, and has more or less stabile, but flexible, adjustable organization, formal tasks and procedures. in other words, formal and informal educational systems are not separated, independent systems but the parts of one unique functional ensemble to which the most appropriate name could be “life long learning process”. the fine line of separation between these two subsystems – formal and informal educational system, consists also of their different timelines. the formal educational system – or as often called “schooling”, normally takes place in early life – childhood or youth. this refers to the part of a life when, not only from the educational aspect but seen also from the aspect of a human life in its wholesome, the basic life experiences, moral and social values foundations, roots of all of that that represents perspective of the world are acquired, the time when the motivation to obtain knowledge, and this considers education, is the biggest. informal education starts with the partial or full endings of the formal education and represents its logical sequence. in modern era this part of education, with different intensity, lasts for entire working life. the best attestations on this subject are the information from the research according to which employees in economically and technologically developed countries change their jobs, or even a career, five to seven times during their working life. there is a difference between operating modes of the formal and the informal educational processes. the participants of the formal educational system are exclusively or mostly focused on the activity of schooling process. informal education is, above all, part of working process and is being held in most of the cases as a part of technological and organizational processes, or in other words it represents continual activity in order to adjust labor structure by its professional characteristics to changes in technology and organization. also, the essence of formal and informal education differs. the formal education is focused on the basic knowledge, which is providing general information about the world and time, trough historical and contemporary dimensions, about the basic laws of natural and social environments, about the reaches of the modern-age civilization. the informal education, using formal education as a logical stronghold, offers above all practical knowledge related to a certain domain of production or services, to the ways of using existing or new technologies, to the improvement of the individual professional skills and knowledge in order to increase productivity and quality of work as well as the encouragement of each individual to take part in the process of organizational and technological innovation. finally, the protagonists of formal and informal educational systems are different. the protagonist of the formal educational system is a scholar system, from elementary school to university, whose business is mostly financed from the budget – with the money of the taxpayers, which enables the actualization of the principle of equal accessibility to all levels and kinds of formal education to the members of different social layers. however, for the sake of true, it must be said that the principle of equal accessibility to education, or in other words the permanent professional improvement and development is also established and respected within the companies. thereby, while with the state this is influenced by political motives, within the companies this is one of the important components of a successful kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 73 participation in the global market game. the protagonists of the informal education are essentially companies that, trough creation and realization of the educational programs put in function of increasing professional and expert knowledge of the employees, use logical and expert support of the scientific and educational institutions, or if they are larger, economically and technologically stronger enterprises, they create its own educational, scientific research and educational subsystems. however, real interdependence between formal and informal educational system also stipulates the establishment of the permanent functional connection between their agents – formal educational system, companies and other agents of informal education. constant fortification of the functional connections between formal and informal educational system implied that these two systems become the subject of attention of politics, owners, capital, entrepreneurs and employees. each of foregoing agents has a need and interest to influence the definition and realization of the concepts of these two subsystems. there for, it could be said that the education, as the formal so as the informal, stopped being just a matter of an individual and became large strategic question, responsibility and interest of all social agents and one of the basic tests of the success in the fight against the discrimination. of course, the education still rests in part a question of each individual, but above all in the context of actual fulfillment of the right to be educated and the possibility to choose a profession, educational profile that is most acceptable to an individual. this choice, the one of the most important ones in the life of each human, so called the “destiny choice”, represents the crossroad where the personal freedom and the employee’s dignity openly face. the role of the employees in the creation of a learning organization a simple definition of a learning organization is that it is an organization in which the employees constantly learn new things and apply what has been learned in improving the quality or the services. that is a place where the employees perpetually broad their potentials in order to create results that they really want, where new and expansive models of thinking are developed, where the collective aspiration is set to free and where the employees learn how to learn together all the time. that is an organization that constantly broads its capacity in order to create its future. it is of the great importance for a learning organization that the innovation of new knowledge is not a special activity – it is a behavior mode, that is the way of existence in which each employee is an entrepreneurial. in simple words, a learning organization is an organization capable to create, absorb, develop and pass on the knowledge and modify its behavior in the way that it reflects its knowledge. an important difference between traditional and learning organization is the problem solving. while the first one is shaped to achieve efficiency, and is directed toward it, the second one is shaped on the idea of problem solving. learning organization is the one in which each employee is included in identifying and solving problems allowing organization continuous experiments, changes, improvements and enlargement of its capacities, to grow, learn and fulfill its purpose. the basic characteristics of a learning organization are: economic analysis (2009, vol. 42, no. 3-4, 69-77) 74 • it develops and learns constantly, increases the level of overall organizational development and knowledge; • constant learning and development became mandatory and part of a job description of each member of the organization; • transferring learned and produced knowledge also became obligatory for everybody. in a learning organization everyone is a teacher and a student in the same time; • the dedication to the development and learning, to acquiring and transferring the knowledge became an important factor of the individual performance assessment; • learning and development are not separated, isolated and specialized activities but the important parts of the organizational culture, behavior mode and of the upraise of an organization; • the essence of a continuous development is a creation of new ways of thinking, changes in behavior and application of what has been learned and acquired trough practice – while creating and changing products and services and continuous problem solving; • the development programs and knowledge are the basic assets as well as the biggest competitive advantages of a learning organization; • the learning organization is not determined by neither its technology, structure nor any other “hardware” but by its culture oriented towards development and knowledge, which produces and recognizes knowledge and innovations; that is a culture of continuous learning, innovations and constant changes. those organizations learn from its own experience, but also from the experience and the best practice of the others; • a learning organization assesses its competitive potentials and strategic advantages trough the quantity of knowledge, skills and capabilities in comparison to the competitions’; • the activities and the attitude toward learning in this kind of organization are strongly determined by the information regarding whether the organization’s overall knowledge, and also its competitive advantage, increases or decreases on daily basis in comparison to the competition. as it is often stressed, one of the important competitive advantages is a life-long learning and broadening of knowledge, as the principal assignment of the employees in order to reassure personal competitive strength in internal and external surroundings. a constant learning became the only path toward continuous changes, innovations and development, as for the organization so as for the employees. an important advantage of what is happening in an organization oriented towards learning is also the growth and application of a long-run development, learning and proficiency model. the important dimensions of this approach are: • the development and learning became parts of each assignment, which implies the defacement of the differences between the job execution and learning; • the employees should acquire skills related to other jobs and executors from its organizational unit and should understand the relation between its own job and kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 75 the activities in their organizational unit as well as the goals of the entire organization. in fact, the “flexible employee” concept is being developed trough cross training and continuous learning; • an active, informal interaction between employees, teams, trainers and supervisors is strengthen and institutionally supported all the time; • the employees should constantly transmit their knowledge to the other colleagues but also they should learn from the others; • learning became one continuous process of intensive interaction in which the knowledge circulates and spreads in all directions and everyone is simultaneously teachers and students. the supervisors, managers they become more and more trainers, or in other words teachers, substituting professional trainers and the development and learning are more and more executed within the company. conclusion during the last five decades, the human resource development has grown into one of the most significant modern strategic components in all levels. almost every organization approaches human resource development strategically which leads to the incensement in efficiency, productivity and profitability. besides that, in most of the cases both the employees and the organizations reflect to the matter of human resources more as to a certain challenge, investment in need than as to a burden, unnecessary waste of time and money. the education became the most important segment of the employee development. successful organizations are dedicating more and more time, effort and resources to the education and proficiency of the employees. the knowledge economy is the new reality. it changes the concept of values and signifies the beginning of the end of the conventional economy. the influence of the new technologies on a society, philosophy, politics, religion, culture and all the other human activities directs to a system of knowledge management. knowledge is the only category that grows with use. it is an impalpably good, immaterial product which is manifesting in the forms of information, scientific, literal, amusing and artistic creations. the knowledge is getting more and more imposed as a driving force of the new economy whose development is based on learning organization. knowledge, as an abstract assets and the new most important basic business resource has to be carefully managed. the management understands that only education and deepening the knowledge of the employees can create a competitive advantage in comparison to the other organizations. the insufficient investments in human resources means for the company lost of the market share and decrease of the profits. it is assessed that the most successful companies invest annually around 5% of its profits in the employees’ education. also, they consider that five to ten percent of the working hours should be spent on the employees’ education, depending on a job type and the education level. it is consider that the highly educated employees, engineers for instance, should spend at least 10% of their working hours on expanding their knowledge in order to rest in the same level as the freshly graduated, and 20 to 25% if they want to maintain the equal value for the employer and for the society. regarding the managers, it is economic analysis (2009, vol. 42, no. 3-4, 69-77) 76 assessed that they should spare 20% of the working hours annually to their own education in order to prevent “superannuation”. certain organizations spend more money on education than the all higher-schooling institutions in a country. for example, in 1987 ibm spent 750 millions of dollars on the education which is more than the budget of harvard university. the american organizations spent 4.1% of its profits averagely on training and development of the employees and averagely 62 hours of training for each employee in 2002. the money investment in human resource education increases on daily basis and it is quite logical that this trend will continue in the future. this can be supported with the statement of alan greenspan, the former president of the usa federal reserves’ board, dated from february 2004 where he said that “the key aspect of creation of the wealth in the usa, and no doubt in entire world, is the level of the knowledge and skills of the population. nowadays, to manage one economy, which is fur more complex than it used to be, deeper and wider knowledge is required more than ever. our education in the usa has to provide skills that are adequate for effective functioning of our economy”. how much the employee development is important for quality and profitable business these days also illustrates the example of “microsoft” and its owner bill gates who insists that the key of success does not lie in size but in the faith in company’s employees and their development. he is convinced that the key to a modern company’s success is to hire suited labor and than provide them with the possibility to work in small groups and give them large-scale proxies. gates still finds time to meet his employees and chat about their ideas. in this way he motivates employees to invest bigger effort and to be more loyal to the company. bearing in mind the goals, adjusted to the development strategies, that the market oriented companies should fulfill in future, and regarding the necessity to achieve consensus about these goals, forms and ways to achieve them among all of the agents in a modern company, as well as regarding the experiences from the practice of the modern states with developed market economies, it is necessary to focus on achieving the following priorities: • motivation of every employee, unions and management in order to obtain the largest possible business and working results; • encouraging all agents – employees, employers, unions, to initiate and develop new inter-relations in accordance to the market economy, based on tolerance, mutual trust and awareness of common company’s interests; • contribution to easier and better observation of potential and actual conflict sources within the company and rebuilding efficient, peaceful mechanisms to solve them; • affirmation and encouragement of the development of a new concept and practice regarding corporate culture and management; • contribution to the livelong, stable growth and to the full usage of the available human resources; • permanent point out of the advantages of the participation, enrollment and influence of wider spread of people in the process of definition and realization of the company’s development strategies; • inducting livelong, systematical educational process and especially the common educational programs for all of the agents of industrial relations in the companies. kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 77 in order to increase their competitive capabilities, or in other words in order to be able to confront the demands coming from the environment and to become more productive and competitive, the companies invest large amounts of money. they are dedicating their attention more and more to the human resource development because, in this way, they increase their productivity, employees’ motivation, bearing in mind in the same time that exactly the people, and not the expensive technology, are its most valuable resource. the expensive and modern technology is almost equally available to everybody, but the competitive advantage to one company over the others resides in human resources, in their knowledge and competences as well as in the ways of they are using it. if the capitalism so far mainly relied on the exploitation of natural resources and physical labor of human resources, the upcoming decades will show that in the future it will be exclusively founded on the grounds of the exploitation of the 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(2008), organisational behaviour and analysis, pearson education limited, essex senge, p. m. (1990), the fifth discipline, new york, doubleday ćamilović, s., vujić, v. (2007), osnove menadzmenta ljudskih resursa, tecon, beograd watkins, k. e. (1990), business and industry, handbook of adalt and continuing education, san francisko received: 5 august, 2009 article history: accepted: 9 september 2009 microsoft word 2009_3_4-korigovano.doc review book review corporate governance, performances measurement, and normative coordination of internal control systems by professor valter cantino, phd in his book “corporate governance, performances measurement, and normative coordination of internal control systems”, published by company data status from belgrade, professor valter cantino, phd, with his professional, pragmatic and simple approach, elaborates the corporate governance, performances measurement, and normative coordination of internal control systems. as such, this book presents the precious source which offers the unique cognition regarding the fact that the author lives and works in italy. it is not necessary to emphasize how important is for serbian economic public to acquaint with the experiences and practise in italy through this significant book, especially at the moment when serbia traces its way towards eu members and when the serbian companies face the chalenges of radical changes in their business operations. this book is also popular among students, both masters and phd studies, for dynamic business environment, where changes create changes. the productivity is imposed to companies as an imperative, and they are not only expected to note changes in time and react faster and more efficiently than competition, but the companies should be the initiators of these changes. by intensive changes, the environment creates the pressute to management to adjust continually to requests for costs reduction, companies transformation along with efficiency increas, management effectiveness, that professor cantino writes about. it is also important to mention that the translation of this book into serbian is a result of strategic cooperation between faculty for management, university of turin and bba and institute of economic sciences from belgrade. the cooperation started with tempus project buona, and along with book of professor valter cantino, dean of faculty for management, university of turin, the result of this cooperation is master program at belgrade banking academy, that enables students to get dual diploma. for publisher data status, this book presents the first edition translated from italian into serbian. professor valter cantino”s book consists of four chapters: • the first chapter examines the corporate governance and companies” business operations evaluation zdravković, a., et al., book preview, ea (2009, vol. 42, no. 3-4, 86-90) 87 • the second chapter examines the business risks and internal control systems • the third chapter deals with the funcitioning of control undersystems in companies according to the rules of italian law, analyzed as the task of the most important menagars and organs • the fourth chapter discusses the integrated models for measurement, control and coordination of business performances the first chapter starts with the analysis of relation between companies and environment with special view on political and legal environment as a context in which the corporate governance rules, and affect, as a part of legal regulations. the experiences proved that former governance systems were not reliable enough and the result was break-up of big companies, numerous affairs and scandals. thus, the legislators took measures in order to modify the governance rules. professor valter cantino used the case of italy to show the changes in governance rules of a company, realized in in the set of new laws, codes, regulations. the alternative governance models were introduced by the reform of company law. analysing the corporate governance as “team of management rules and procedures which the management and control system consists of, and defining legal and moral obligations to be obeyed by economic subject in performing its economic activity”, the author provides the basic model characteristics of corporate governance which companies can apply. starting with shareholders structure and structure stability, the author indicates the differencies between private, partnership and public companies, giving the detailed analysis of corporate governance model in italy. the civil law reform in italy offered the italian companies the new solutions and possibilities to choose the model that suits most their governance dynamics. the basic characteristics of italian models are completed with scheme reviews which define clearly the role of control organs. as a result of company trasnsformation process, the management faces the growing pressure due to stronger competitiveness and continual tendency for efficiency increase as well as challenge of founding the solution for greater transparency towards all interested parties. in this context, professor valter cantino focuses on the strategy which enables the company to realize the goals and achieve the the expected results. regarding the fact that even the potentially successful strategies do not achieve the a priori expected results, and that a number of assumptions affect the transformation of strategic tendencies into desired results, the author defines the strategy diagram. the company success depends mostly on its ability to adjust to changes and to face the pressures of environment. the author presents the basic characteristics of companies with performances, that provide concept definition of corporate performances governance along with the elements, the modern organiations should affect, in order to become the same. according to the author, professor valter cantino, in economic sense, the risk is a condition for existence of a company. the company’s business operations and decision processes are carried out in the circumstances of uncertainty. indicating the close connection between the risk management systems and internal control systems, the second chapter of the book examines business risks and internal control system. the author emphasizes that the internal control is an integral part of management system and risk control. in uncertain circumstances the task of a company”s management is to govern the business risk potrfolio economic analysis (2009, vol. 42, no. 3-4, 86-90) 88 and in that context, to be acquainted both, with risks, which jeopardize the goals realization and with the actions which should be taken to prevent and control them. thus, only by the consolidation of risk management system and internal control the efficient corporate governance could be reached. the internal control system is becoming a crucial element for efficient management of a company. it is the control which is carried out within a company, in order to provide goals realization and maintenance of the state of formal and vital regulations. the internal control has an important role in risk management process by its own control and advisories. under the company’s risk management professor valetr cantino considers the following activities: risk defining, that encompasses the review of risk processes and potential risk analysis, and control system projections, that includes preventive control system analysis and evaluation of remained risks. the numerous financial scandals initiated the necessity for strengthening a company’s internal control system systematicallly by the corporate governance norms with a special accent on management responsibility. the author illustrated the evolution of business risk management model and internal control system in usa and europe. the third chapter explores systematically the norms and procedures regarding a company’ organs that are incorporated into a company’ control system, with special view on internal auditing function, function of head of financial department and advisory body, on the case on corporate governance in |italy. according to the definition of the institute of internal auditors, the internal auditing presents “independent and objective, control and advisory system, aimed at better efficiency in organization”. in this part, the author explains how the operational control concept, which is performed by internal auditing, contributes to the goals realization and operational risks management process. a special attention is given to the control system realization of the head of finance. the need of the italian companies to be present on the international financial markets requires the adjustment to the international practice, which resulted the approach of head of finance function to ‘international model’, cfo, and in author’s opinion these two functions will probably cover one another in future.in this context, the foundation of internal accounting and management control system is of great importance for head of finance to realize his operational activities successfully. the author illustrated graphically the project for evaluation and internal control system coordination dividing it into five stages: evaluation, analysis, process view,corrective activities and monitoring. the goals and associated activities of each of these stages are explained in details. eight years ago, for the first time, the italian legislation introduced the term criminal liability for organizations that is added to the individual criminal liability. in order to prevent itself from this kind of liability for possible individual criminal liability, a company has to apply a relevant prevention organizational model. upon detailed description of all possible aspects of criminal liability, which could be transferred on a company, the author discusses about legal recommendations regarding the establishment of “preventing model”. the conclusion is that the preventing control system can protect a company from responsibility only if there is no possibility that the criminal act has been done due to the ignorance or wrong interpretation of regulations and directives in a company. zdravković, a., et al., book preview, ea (2009, vol. 42, no. 3-4, 86-90) 89 the effective implemenation of preventive regulation mechanism in a company requires a corresponding advisory body, authorised for periodical functioning check up. the author systematizes the various tasks and activities which are in charge of advisory body, emphasizing the significance of its autonomy, independency and professionalsim that enables a company to perform its ethic codex. professor valter cantino begins his presentation of integrated model for measurement, control and business performances coordination by description of legal changes which enlarged the importance of organizational part of a company, which is in charge of financial management and control, that is, its head chief financial officer (cfo) in business performances measurement process. speaking about more and more complex and strict demands for tracing the economic and financial data, financial management and control are faced with, as a result of severe normative system, the author focuses on a problem of unsufficient economic efficiency, that could occur as a consequence of such coordination. having in mind the fact that the research activities are more and more exposured to the growing demands of normative coordination, the effective result could be reached by transfer from separatecorporate governance solutions to holisitc ones. to contribute successfully to performances measurement and normative coordination, integrated into control system of a company, the organizational part for financial management and control has to establish a systematic and fruitful cooperation with other services, incorporated in the process of data processing and information regarding the management and financial issues. the author refers to clearly defined hierarchical structures between cfo and subjects who perform control activities within complete corporate governance project, with special accent on relation modalities of cfo and board of directors. the information systems, management control and human resources organiazation and development are typical section which take part in information process of a company performances. from the view of information technologies, the author points out two important aspects for elaboration of economic and financial information: regular evaluation of incorporated procedures coordination with information processes and effectiveness of information instruments in integrated management of a company. the special attention is given to erp information systems (enterprise resource planning) in controlling the data coordination, especially in consodilation of a group of companies and difficulties in realization of procedures which differ from existing procedures. by law, the cfo function is to confirm the identical statements in accounting books and official documents which a company submits to the market. the completeness of assumptions on continual business procedures monitoring and specific checks of proper control are inevitable pre-conditions for objective and credible review of a company’s performances. in this context, the author analyses the concept of relation between cfo and internal auditing as customer-supplier, whereas the service for internal auditing provides information regarding the adequacy,and functionality of internal control system. in addition, the cooperation between cfo and advisory body, which contributes to transparency of control system, is also of great importance. finally, professor valter cantino, analyses the implementation of integrated measurement model, control and normative coordination of business performances. the first economic analysis (2009, vol. 42, no. 3-4, 86-90) 90 illustration shows the model which, by synthetic presentation of relations between management instruments, internal control systems, and coordination with internal rules, results the coherent corporate governance model, including the instruments for business performances measurement and coordination with internal and external norms. the second illustration, which refers to “spider’s net of norms, depicts the internal control system and corporate governance rules as “railtracks connected by ties, specific domains regulated by relevant norms. thus, by adding the new norm ties, a company can safely trace its future way. zdravković aleksandar, institute of economic sciences, belgrade beraha isidora, institute of economic sciences, belgrade domazet ivana, institute of economic sciences, belgrade ea_2014_1-2 udc: 007:004]:336.71 jel: g21, o3 id: 207714060 scientific review the impact of it on the banking productivity jevtić boris1, raf, belgrade, serbia kovačević vladan, tehnicom, belgrade, serbia, vučeković miloš, singidunum university, belgrade, serbia abstract – there has been much debate on whether the investment in information technology provides improvements in productivity and business efficiency of banks and, weather the usage of the opportunities of digital technologies to better serve customers and achieve firm goals the proliferation of technologies offers vast new opportunities. this paper investigates the impact of ict capital on productivity in banks. for the analysis, data from various research reports, and reliable studies on banking efficiency and productivity and digitalization of their services are employed. the results obtained shed some light on the relative impact of ict capital, and provide new insights about the structural dynamics between these factor inputs. we find that the banks as financial service sectors in developed countries are quite similar in terms of efficiency, and that efficiency and productivity depends more and more on ict capital. although, the financial services industry and banks in particular increasingly invest in technologies to improve their online banking and more recently their mobile payment solutions, the serbian case, as banking sector in transition countries, shows slower implementation of new digital trends in operational activities of the banks. at the same time, banks use tools such as social networks, digital tools kits, online competitions, online advertising campaigns, mobile apps, location-based services and online market research to connect with customers. the paper also provides an overview of digital trends in general and the banking industry in particular and best practices how digital media tools are helpful to achieve marketing goals, and ultimately generate higher revenues at lower costs. the contribution of the paper can be seen also in: deeping the understanding of (stationary and mobile) digital technologies in the marketing tool box; further exploring the digital landscape and the types of digital customers in the banking industry, and in discussions the cases of the introduction of a mobile payment system key words: serbian banks, financial crisis, productivity, ict, digitalization introduction the banking industry world-wide is being transformed. the global forces for change include technological innovation; the deregulation of financial services at the national level and opening-up to international competition; and equally important changes in corporate behaviour, such as growing disintermediation and increased emphasis on shareholder value. in addition, recent banking crises have accentuated these pressures. the banking industries in central europe and south east europe have also been transformed as a result of 1 doctorial studies, tadeusa koscuska 86, belgrade, email: boris.jevtic10@gmail.com economic analysis (2014, vol. 47, no. 1-2, 193-204) 194 privatisations of state-owned banks that had dominated their banking systems in the past. with the increasing use of standardized products and services in the banking business that are based on electronic risk ratings of customers, the banking industry increasingly utilizes computers and telecommunication equipment connected via the internet as the ordinary distribution channel of their services. ranging from online brokerage and home banking to electronic insurance contracts, information and communications technologies (icts) have changed the financial service industry significantly over the past decade. banks that deploy technology more successfully to get more from the higher-quality knowledge employees they attract will gain large business model advantages—and drive substantial growth and productivity gains. in further table is showed executives weighting in on the major developments that will be important for business over the next five years, employing. information streams as the infinite by-product of a knowledge economy, and support the idea that the best companies will turn this free good into gold. table 1. the impact of global forces on business,( % of executives who mark the force), 2010 forces reshaping the global economy is important for business with the positive effect on profits is being actively addressed by their company the great rebalancing 85 48 72 the productivity imperative 57 40 58 the global grid 61 41 68 pricing the planet 48 23 51 the market state 57 39 29 source: source: mckinsey global forces survey of 1,400 executives, 2010 a final productivity driver will be something businesses are creating in digital bucket loads: information. although the volume of data created is expected to increase fivefold over the next five years, best-guess estimates suggest that less than 10 percent of the information created is meaningfully organized or deployed. to sustain wealth creation, developed nations must find ways to boost productivity; product and process innovation will be the key. the banking industry exhibits the highest proportion of it investment compared to all other industries after 1995 (for the us see e.g. council of economic advisors, 2001, for the eu see eito, various yearbooks 1996 until 2001). the financial service industry will only be able to grow steadily in the future by innovations in terms of new financial services. while automatic teller machines and credit cards were the early enablers to reduce the need for front-desk service workers, such as cashiers etc., the pervasiveness of the internet provides the opportunity to offer and use ubiquitous financial services from virtually everywhere. a particularly attractive option is the conduct of financial transactions via mobile communications devices. this transformation process has not been completed yet, so that one might expect that there is a still on-going labour-saving process that could last well into the nearand even mid-term future. jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 195 in this paper is investigated the impact of ict capital, and labour input at different skill levels, on aggregate productivity and employment in the financial intermediation sector. literature overview several studies over the years have been conducted at both the industry and firm-level to examine the impact of it on productivity. there has been much debate on whether or not the investment in information technology provides improvements in productivity and business efficiency. firm-level studies, primarily in the manufacturing sector, have shown that there are significant positive contributions from it investments toward productivity. using data collected through a study of retail banking institutions in the united states, it could be concluded that additional investment in it capital may have no real benefits and may be more of a strategic necessity to stay even with the competition. however, the results indicate that there are substantially high returns to increase in investment in it labor, and that retail banks need to shift their emphasis in it investment from capital to labor. brynjolfsson (1993) and wilson (1993) provide reviews of this literature on the business value of it. some studies have drawn on statistical correlation between it spending and performance measures such as profitability or stock value for their analyses (dos santos et al. 1993, strassman 1990), and have concluded that there is insignificant correlation between it spending and profitability measures, implying thereby that it spending is unproductive. brynjolfsson and hitt (1996), however, caution that these findings do not account for the economic theory of equilibrium which implies that increased it spending does not imply increased profitability. the researches which have been drawn upon the economic theory mostly use a technology or production function which relates the output of a firm to its inputs and contribute significantly to the establishment of the “it paradox” with the industry-level studies of the midand late 1980s; this “paradox” indicated a negative correlation between it investments and productivity. more recent firm-level studies, however, paint a more positive picture of it contributions to productivity. these findings raise several questions about miss-measurement of output by not accounting for improved variety and quality, and about whether it benefits are seen at the firm level or at the industry-level. such issues have been discussed in brynjolfsson (1993), and to a lesser extent in brynjolfsson and hitt (1996). one illustration of the industry-level studies is that of morrison and berndt (1991), which found that in the manufacturing industry, “estimated marginal benefits of investment in it are less than marginal costs, implying over investment”. of late, the increased availability of firm-level data has led to several other studies which report results different from those found in industry-level studies. loveman (1994), for example, using data from the management productivity and information technology database in a cobb-douglas production function framework, concludes that for the manufacturing firms included in his study, there is no significant contribution to output from it expenditure. lichtenberg (1995), on the other hand, concludes that there is significant benefit from investment in it. for his analysis, he draws data from annual surveys conducted between 1988 and 1991 by information week and computer world magazines. using a cobb-douglas production function, he estimates that there are “substantial excess returns to investment in computer capital” and further, that one information systems employee is equivalent to six non-is employees in terms of marginal economic analysis (2014, vol. 47, no. 1-2, 193-204) 196 productivity. the latest in this trend of research is brynjolfsson and hitt (1996) and hitt and brynjolfsson (1996). brynjolfsson and hitt (1996) use data from two sources: the dataset compiled by the international data group, and standard and poor’s compustat ii database. the idg data includes self-reported firm-level details of it expenditure collected annually. using this data in a cobb-douglas production function, brynjolfsson and hitt conclude that “computers contribute significantly to firm-level output.” in fact, they find that computer capital contributes an 81% marginal increase in output, whereas non-it capital contributes 6%. similarly, they show that is-labor is more than twice as productive as non-is labor. most of such studies relating to the contribution of it toward firm-level productivity have been restricted to the manufacturing industry, possibly owing both to a lack of data at the firmlevel in the service industry and perhaps, more significantly, the difficulty of unambiguously identifying the “output” of a service industry. the latter problem is particularly persistent in the banking industry, which is the focus of this study. as parsons, gotlieb, and denny (1993) argue in the banking industry, “the growth of output, and the measurement of productivity, is very sensitive to the choice of output. parsons, gotlieb, and denny (1993), in fact, is one of the very few studies that deal with the impact of it on banking productivity per se. they conclude from their estimation of data from five canadian banks using a trans log production function that, while there is a 1723% increase in productivity with the use of computers, the returns are very modest compared to the levels of investment in it. productivity of banks highlights the productivity and efficiency of banks critically impacts the productivity and efficiency of all economic activity and is a matter of concern for policy makers and economy watchers, while the banks form the core of a nation’s financial system, performing the vital function of financial intermediation through liquidity, maturity and risk transformation. the banking efficiency could be like highlighted as allocation and operational. allocational efficiency focuses on ensuring that the precious financial resources are allotted to the most productive activities as per development needs of society. it seeks to ensure that the broad national priorities are furthered through the process of resource allocation and that the interests of the most vulnerable sections are protected. operational efficiency means banks seek to provide financial services in a safe, secure, speedy and cost effective manner. the goal should be to ensure that the transformation function generates least friction in terms of time and cost overlays. these concepts of efficiencies have considerable inter-linkages and the challenge for banks is to ensure optimal performance on both fronts. technology in banking according to mckinsey institute (2013), as top retail banking trends could be seen further predictions: � drive-to-digital: impacting delivery, marketing and service usage � payment disruption: new players, technologies and innovations � increased competition: neo banks and non-traditional player pressures jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 197 � branch optimization: maybe not branchless, but certainly less branches � focus on customer 3.0: digitally astute, social and yearning for insight � breaking down silos: product and data silos begin to crumble � simplifying engagement: removal of friction and steps to engage � improving contextual experiences: leveraging data for improved service � differentiating brands: avoiding commoditization in a digital world � global innovation perspective: expanding view of tomorrow's innovations according to conventional wisdom, new information technology is not at present likely to impinge much on the development of the banking industry in the emerging economies, which remain technologically behind the industrial countries. for example, the low level of penetration in most emerging economies means that the internet is not seen as a threat to traditional banks. given the signs of a possible bursting of the e-banking .bubble. in the united states and europe, some have also argued that the issue of electronic banking may go away before the emerging markets need to worry about it. this conventional view can be challenged on several grounds. as noted above, the major issue about new it is its impact on the processing of information, which is the very essence of the banking business. perhaps the most significant innovation has been the development of financial instruments such as derivatives that enable risk to be reallocated to the parties most willing and able to bear that risk, thereby inducing more investment in real assets and fostering the development of banking and financial markets in general.4 the use of such instruments is not the preserve of industrial countries: � with their increasingly sophisticated it applications, banks in the emerging economies use new financial instruments daily in their transactions. their banking systems and financial markets are thus in a position to advance much more rapidly from a rudimentary to a fairly advanced stage of development of risk management and other commercial banking functions. such potential skipping of financial development stages would not have been possible in the past, when information processing technology was not readily available, and when the development of futures markets and other domestic financial institutions that enable unbundling and shifting of risks on a large scale was much more time-consuming and costly. � the potential for rapid development of commercial banking functions offered by alternative delivery channels such as atms, debit cards, telephone, internet and electronic banking should not be underestimated. despite the still low level of usage of such channels (with the exception of atms, which are now very widespread), the vast majority of banks in the emerging economies see such channels as a must for their industry. banks fighting for some important part of the retail market believe that they have to offer such services as an essential marketing tool, although the true demand for them has so far been limited. � in advanced economies, new technology is affecting the structure and performance of the banking industry in the emerging markets mainly through its impact on the costs and the determination of optimal scale. branch-based transactions are much more expensive than alternative delivery channels. this economic analysis (2014, vol. 47, no. 1-2, 193-204) 198 cost advantage would seem to favor smaller institutions, as investments needed to attract deposits or provide banking services via the internet are in principle lower than the costs of setting up a traditional branch network. at the same time, investments needed to develop adequate back office and risk assessment systems are very high, creating considerable cost advantages for larger institutions. moreover, branch networks are not expected to shrink as a result of the however, just because share prices of internet stocks fall, this does not mean that the impact of new technology on banking will disappear. table 2. costs of banking transactions (in us dollars) estimates by us department of commerce (1998) estimates by booz, allen & hamilton (1997) estimates by goldman sachs & boston consulting group physical branch 1.07 1.07 1.06 phone 0.52 0.54 0.55 atm 0.27 0.27 0.32 pc-based dial-up 0.11 0.02 0.14 internet 0.01 0.01 0.02 source: sato, hawkins and barentsen (2001) banks are increasingly losing their privileged access to information about investment opportunities, and are thus under pressure to merge or build alliances with domestic or foreign-owned banks and technology companies in order to share the costs and exploit the benefits of the development of new it applications. for retail banks, today’s markets are fraught with challenges: new digital competitors and digitally empowered customers prominent among them. yet most still pursue business as usual, striving to be all things to all customers. despite their best efforts to focus on the customer, many still don’t offer what their customers actually want. these banks also tend to manage their extensive channel networks—including digital—separately, and not as a holistic function impacting all aspects of their retail operation. according to the accenture report (2013, conducted online interviews with more than 2,000 us retail banking customers of the 15 most leading retail banks doing business in the us today. when asked how happy they are with the performance of their primary bank provider, 71 percent declared themselves “satisfied” and 68 percent said they would be “extremely likely” to recommend their primary bank to a friend, family member or colleague). this research, however, also reveals just how fragile this apparent customer loyalty really is. more than a quarter (26 percent) of bank customers who remain with their primary provider do so simply because they consider switching to be a hassle. among them, about half just haven’t seen competing offers compelling enough to make them move, and the other half believe the process of switching to another bank is just too difficult. this not only exposes the tenuous relationship banks have with their customers. it also confirms that the right offering and approach can induce them to switch. jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 199 industry newcomers have understood that in the post-financial crisis environment the most fundamental question in retail banking has changed from “how do you find your future customers?” to “how do new customers find you?” and they are leveraging their innate advantage as digital pure plays to deliver the speed, convenience and low-cost personalized service that today’s customers increasingly seek. traditional players, of course, also have an innate advantage—the extensive branch networks that customers still value, as our research confirms. but they cannot afford to ignore what the nimble new entrants are telling them: winning with digital in the future will be all about winning more satisfied and loyal customers with trusted, transparent and compelling offerings. and that means becoming an integral part of customers’ lives: an agile, ubiquitous presence, wherever those customers may be. in an era of industry consolidation, new entrants, expanding regulation, more onerous capital requirements, and continuing economic volatility, traditional retail banks urgently need a lower-cost operating model that can generate more predictable and sustainable revenues. indeed, if traditional providers don’t move swiftly and decisively to build such a model, they will lose more customers. the core challenge for traditional fullservice providers: how to build a seamless digital customer experience—and optimize its power with a better and more cost-effective complementary offering in the branches that customers still find so attractive. common characteristics of the emerging disruptors � emphasize social responsibility � focus on customer centricity and empowerment � present simpler fee structure to customers � provide personal financial management tools and access to other accounts � embedded with social media, especially facebook � leverage big data and analytics � offer mobile bill pay, p2p, remote-deposit, free atm access one source of concern related to new banking technology is the emergence of a digital divide in the access to banking services. according to this view, better educated and more affluent customers will be able to obtain improved service from banks through the internet over the medium term, while the services provided to poorer and older customers will deteriorate as branches are closed, particularly in remote areas. these concerns have led some policymakers to seek a continued role for the state owned commercial banks that maintain traditional, nationwide branch network. with the rapid expansion of ownership of smartphones and tablet devices, today's consumer wants to be able to research, purchase and manage their financial services on demand using the device(s) of their choice in virtually any location. reinventing the financial services purchase funnel, the way people conduct daily banking, the delivery of insight, and the interaction between channels, the drive-to-digital will provide both opportunities and challenges for financial institutions of all sizes. economic analysis (2014, vol. 47, no. 1-2, 193-204) 200 figure 1. emerging disruptors source: accenture report, 2013 in 2014, it is expected to be seen greater experimentation in new products and revenue build around mobile, web and social commerce, and the emergence of drive-to-digital competing with drive-to-branch. mobile and web have all been about brochure ware and transactional services to this point – finally we’ll start to see a concerted effort to revenue fulfillment digitally. there will be a realization that channels are owned by consumers, and not banks, and thus must meld into a digital experience that exists seamlessly regardless of channel or device. the silos of traditional retail delivery channels will begin to erode and a more holistic approach to a digital banking experience will take hold. in a mobile-first environment, banks will begin to support more complex types of functions and transactions on the small screen, new forms of authentication that better balance security and convenience, and more relevant, contextual information delivery via alerts, push notifications, and other forms of messaging. banks will also likely promote mobile banking to an older, more risk-averse cohort than in the past. the impact of ict on serbian banks productivity the efficiency of the serbian banks operations has an important bearing on overall economic health of the country. the serbian banking system which is 78 percent foreign owned in these where state capital is dominated has not succeeded in balancing allocation and operational efficiency focuses on ensuring that the precious financial resources are allotted to the most productive activities as per development needs of society. it seeks to ensure that the broad national priorities are furthered through the process of resource allocation and that the interests of the most vulnerable sections are protected. in the purpose jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 201 to support the usage of the it technologies in banks national bank of serbia has adopted the decision on minimum information system management standards for banks, (rs official gazette, 2013). for the purpose of this decision: • information system should be implemented as a comprehensive set of technological infrastructure (hardware and software assets), organization, people and procedures for the collection, processing, storage, transfer, presentation and use of data and information; information system resources would include software assets, hardware assets and information assets; software assets would adopt all types of system and application software, software development tools and other software and hardware assets would include computer equipment, communication equipment, data storage media, and other technical equipment supporting the functioning of the information system. • information assets in banks should be improved as data in files and databases, program code, configuration of hardware assets, technical and user documentation, internal regulations, procedures, with information system users authorized to use the information system (employees in a financial institution, employees in other entities accessing the information system of a financial institution, clients of a financial institution accessing the institution’s information system through electronic interactive communication channels). as information system risk is shown to be very high in state owned banks, the possibility of negative effects on the financial result and capital, achievement of business objectives, operation in accordance with regulations, and reputation of a financial institution due to inadequate information system management or other system weaknesses which negatively affect the system functionality or security, and/or jeopardize the business continuity of the financial institution, controls are proposed to design and monitor policies, procedures, practices, technologies and organizational structures relating to the information system and established to reasonably ensure that business objectives of a financial institution will be achieved and that undesired events will be prevented or detected. controls would differ by the implementation method (administrative, technical and physical) and purpose (preventive, detective and corrective). different type of controls in that process which would be provided mean; administrative controls means the adoption and implementation of policies, standards, plans, procedures and other internal acts, and the establishment of an adequate organizational structure, for the purpose of achieving and maintaining the adequate level of information system functionality and security; technical controls means controls implemented in hardware and software assets of the information system and physical controls are controls protecting the information system resources from unauthorized physical access, theft, physical damage or destruction; preventive controls means controls aimed at the prevention of problems and incidents; detective controls means controls aimed at the detection and recognition of problems and incidents, and the identification of problems and incidents which occurred; corrective controls means controls aimed at the limitation and elimination of problems and consequences of incidents. information system security would have to uphold the principles of confidentiality, integrity, availability, authenticity, accountability, non-repudiation and reliability as well as confidentiality of data and information not to be disclosed or made available to unauthorized economic analysis (2014, vol. 47, no. 1-2, 193-204) 202 persons. the integrity of data, information and processes would have to be better protected from unauthorized or unforeseen modifications, or that any such modifications do not remain undetected; availability of data, information and processes more available and usable on request of the authorized party; accountability would be upgraded so that each activity in the information system may be traced uniquely to its source. it has to support the faster electronic banking systems development which enable bank clients to use services offered by banks (access to financial information, electronic payment) from a remote location through electronic interactive communication channels (e.g. internet banking, mobile banking, telephone banking). greater efficiency in banking operations in serbian banks would have to ensure that the cost of financial intermediation is minimized. at a time when the global and serbian economy are facing challenges on multiple fronts, efficient financial intermediation would provide impetus to the process of economic recovery by channelizing funds to the most productive sectors at the improvement in productivity and efficiency, and the resultant decline in cost of providing financial services will help in furthering financial inclusion, although it seems to be very hard task, as banks don’t demonstrate the will to decrease the cost of their services very soon. more importantly, it will help in converting the improved access to financial services into improved usage. this improved usage will make the financial activities commercially viable for the banks and encourage them to scale up their initiatives. hence, banking productivity and efficiency has a direct impact on improving financial access and financial usage. the recent decline in economic growth has presented significant challenges to banks through rising impairment of assets, pressure on margins and volatility in noninterest income. in this demanding business environment, improved operational efficiency could help banks in standing up to the challenges and enable them to maintain their health and profitability. as banks form the core of the serbians financial system, the health and profitability of banks will help in ensuring stability and resilience of the entire financial system. thus, from a systemic stability perspective also, improved productivity and efficiency of the banking system is a definite positive. discussions and conclusion this paper has shown the importance of it capital in the overall productivity and profitability of the banking industry. the results of the research point to the need to continually invest in software and hardware capital in banks. this research can be extended in several directions. first, using data collected from us reports, eu reports and serbian banking system, analysis can be conducted as to what firm-level characteristics differentiate banks that use it better from those that do not. are there any business process-related parameters that make it use more productive in some cases, and not in some others? what can we say about human resource practices and work-organization, and how they affect the implementation and use of it? does the it capital budgeting process influence it contributions toward productivity and efficiency? how does the decision-making process about it investments affect the success of it implementation--do firms that employ “technology committees” to make it-investment decisions see better returns from it than jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 203 those that rely on “pioneers” who promote it use in the firm? we will seek to explore these and other related questions in our future research. the serbian banking system, taken as an case in the paper, has seen important productivity improvements over the last two decades, bridging the gap with new private banks and foreign banks. however, the pace of progress has declined, largely due to lack of desired impetus. our banks have to strive towards closing this gap. banks’ gains in operational efficiency have, however, come at the cost of their allocation efficiency. the improved operational efficiency has been a result of technological progress and structural changes in balance sheet towards more wholesale business. the operational efficiency gains, though profitable for the banks, have not had the desired beneficial impact on the society as a whole, particularly the rural areas, individuals and small businesses. it can be concluded that the vulnerability of the banking system has increased on account of the imbalances arising from growth in operational efficiency without commensurate rise in allocation efficiency. references accenture report. (2013). banking 2020 thought leadership series benston, g.j., g.a. hanweck, and d.b. humphrey. (1982). “scale economies in banking: a restructuring and reassessment,” journal of money, credit and banking, 14:1 435-450. brynjolfsson, e.. (1993). “the productivity paradox of information technology,” communications of the acm, 35: 66-67. brynjolfsson, e. and l. hit. (1996). “paradox lost? firm-level evidence on the returns to information systems spending,” management science, 42: 541-558. dos santos, b.l., k.g. peffers, and d.c. mauer (1993). “the impact of information technology investment announcements on the market value of the firm,” information systems research, 4(1): 1-23. hitt, l. and e. brynjolfsson. (1996). "productivity, business profitability, and consumer surplus: three different measures of information technology value,” mis quarterly, june, 121-142. loveman, g.w. (1994). “an assessment of the productivity impact of information technologies,” in t.j. allen and m.s. scott morton (eds.), information technology and the corporation of the 1990s: research studies, mit press, cambridge, ma. morrison, c.j. and e. r. berndt. (1991). “assessing the productivity of information technology equipment in the u.s. manufacturing industries,” national bureau of economic research working paper 3582, january, parsons, d., c.c. gotlieb, and m. denny. (1993). “productivity and computers in canadian banking,” in z. griliches and j. mairesse (eds.) productivity issues in services at the micro level, kluwer, boston. sato, hawkins and berentsen. (2001) for an overview of developments in e-finance. bis papers no 4. economic analysis (2014, vol. 47, no. 1-2, 193-204) 204 uticaj it na bankarsku produktivnost rezime – aktualne su brojne diskusije o tome da li ulaganje u informacione tehnologije obezbeđuje poboljšanja u produktivnosti i efikasnosti poslovanja banaka, te da li korišćenje mogućnostii digitalnih tehnologija za u ciju boljih usluga klijentima i postizanja ciljeva banke, širenjem ovih tehnologija i pruža ogromne nove mogućnosti. ovaj rad ispituje uticaj ikt kapitala na produktivnost banaka. za potrebe analizu korišćeni su podaci iz raznih izvještaja, istraživanja i studija o bankarskoj efikasnosti i produktivnosti i digitalizacii usluga. dobijeni rezultati bacaju svetlo na relativan uticaj ikt kapitala, i pružaju nov uvid o strukturi dinamike između ovih faktora inputa . nalazimo, da su banke kao finansijski sector usluga u razvijenim zemljama veoma slične u pogledu efikasnosti, i da efikasnost i produktivnost zavise sve više ikt kapitala. iako industrija finansijskih usluga i banke povećavaju svoja ulaganja u tehnologije u cilju unapređenja elektronskog bankarstva i plaćanja, srpske banake, kao sektor zemalja u tranziciji, pokazuje sporiju primenu novih digitalnih trendova u operativnim aktivnostima banaka. istovremeno, banke koriste alate kao što su društvene mreže, digitalnih alata kompleti online takmičenja, online reklamnih kampanja, mobilne aplikacije usluge bazirane na lokaciji i onlajn tržištu istraživanja da se povežu sa kupcima. rad takođe daje pregled digitalnih trendova globalno ubankarskoj industriji, naglašva najboluu praksu i alate digitalnih medija u podršci marketinških ciljeva, većih prihoda sa nižim troškovima. doprinos rada može se videti takođe u: produbljavanju razumevanja (stacionarnih i mobilnih) digitalnih tehnologija u kao marketinških alata, upućivanju na dalja istraživanja digitalnih oblasti, vrstama digitalnih kupaca u bankarskoj industriji, i dalje diskusije dobrih primera uvođenja mobilnog sistema plaćanja. ključne reči: srpske banke, finasijska kriza, produktivnost, ikt, digitalizacija article history: received: 30 december 2013 accepted: 8 may 2014 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp72-83 original scienfitic paper econometric modeling and forecasting of interest rates in montenegro bojan pejović1* | vesna karadžić1 1 the university of montenegro, faculty of economics, podgorica, montenegro abstract the econometric modelling and forecasting have a growing importance in both the development of modern models and theoretical approaches and as bases for proper policy decision making. this paper investigates the possibility of applying the box-jenkins approach and vector autoregressive models in modelling and forecasting interest rates in montenegro. the motivation for this research lies in the fact that the interest rate level is one of the key determinants of the montenegrin economic development dynamic due to the specific characteristics of its financial market. the empirical analysis is done on the monthly values data of weighted average lending interest rate of banks on new loans in the period from december 2011 to january 2018. our research has proven that the box-jenkins approach and var models can be successfully used for modelling and forecasting the interest rate level in the montenegrin, quite a bank-centric, system. moreover, the results recommend the use of the box-jenkins approach and the estimated ar model for forecasting interest rate since it has better performances than the var model. the estimated ar model may find its application in helping the decision-makers to create better economic policy decisions. despite some limitations, regarding specifics of montenegrin economy and statistical base, to a certain degree our results are in accordance with research done for other countries. key words: forecasting, autoregressive models, interest rate forecasting, box‐jenkins, var, ar jel classification: c32, c51, c52, e43 introduction the topic of interest rates has been in the focus of the public attention over a long period, and as a consequence of the strong influence of interest rates on economic developments. the interest rate levels and its change significantly determine the companies’ decisions to invest, the decisions of individuals on savings and consumption, as well as the decisions of the authorities regarding monetary and economic policy. numerous scientific and professional papers deal with interest rate issues, due to their wide range of influence and importance in the economy. papers are often concerned with interest rates modeling and forecasting, as well as exploring the links, relationships and interdependencies of interest rates and many other macroeconomic indicators. the pronounced specifics of the montenegrin economy and its underdeveloped financial market make the level of interest rates one of the key determinants of economic development. in the complex structure of interest rates in montenegro, the average weighted active nominal * corresponding author, e-mail: bojanpejovic@hotmail.com bojan pejović, vesna karadžić 73 interest rate of banks on newly approved loans is especially highlighted, as a key determinant of the economy dynamism. many factors that operated in the past as well as numerous factors that still have impact have led to the formation of banks’ high-interest rates in montenegro. a very small market characterized by high operating costs, with insufficiently strong competitive forces between a large number of banks in the market, as well as a high share of bad loans, high customer risk with high existing indebtedness, and high country risk caused by fiscal imbalances have led to high active interest rates over a long period of time. the very high-interest rates on the part of banks and micro-credit institutions do not allow for the economic growth dynamization and development to the extent necessary to ensure the recovery of the economy after the 2008 economic crisis. due to the limited instruments of the central bank of montenegro and the absence of an emission function due to the introduction of euroization in montenegro, the level of interest rates is a critical factor on which further movement the overall economic dynamics will depend. to address the above-mentioned questions, the paper focuses on econometric modeling and forecasting the active interest rate on newly approved loans in montenegro. two theoretical approaches will be tested and two types of models, namely the autoregressive moving averages model and the vector autoregressive model will be evaluated using empirical data available from the central bank of montenegro for the 2011 to 2018 period. therefore, three research hypotheses are formulated, i.e. h1: box-jenkins approach provides a statistically significant interest rate forecast in montenegro. h2: var model provides a statistically significant interest rate forecast in montenegro. h3: box-jenkins approach gives better prognostic results compared to var model in case of interest rate in montenegro. the purpose of the research is to estimate and compare the models that can be used to model and forecast the interest rates aiming to determine a better model, the model that is best fit for the given case. the approaches used in this paper have been used by numerous other researchers and they usually produce the best results. forecasts of future interest rate values based on a model that proves to be the best have practical application through influencing decision-makers and increasing the quality of their decisions leading to the desired results. successful forecasting of future interest rate values helps better the perception of the reality in order to take preventative action on time, to anticipate future changes and adapt behavior to new circumstances. forecasting allows one to spot an undesirable trend on time so that it can act to eliminate it and achieve the desired results. the paper is structured as follows: a literature review is presented in the next section. the third section describes the methodology used for time series modeling and forecasting of interest rates. data analysis and empirical results are presented in the fourth section. prediction and evaluation of the model's prognostic performance are given in the fifth part. finally, conclusions and proposal for further research are presented in the last section of the paper. literature review numerous scientific studies have been carried out aiming to predict the future value of macroeconomic variables such as gdp, inflation, interest rate, etc. interest rate forecasting is a challenging topic, and many researchers are, therefore, concerned with it. there are certain differences in the subject matter of the research, which vary due to the specific nature of the national economy, the availability of data and the affinity of researchers. ahmed, vveinhardt, nawaz, and streimikiene (2017) have used the 6-month kibor rate for the four years from 2012 to 2015 to estimate an adequate arima model that can be used for 74 economic analysis (2020, vol. 53, no. 1, 72-83) forecasting. they confirmed the assertion that the arima model can be successfully used to forecast the kibor rate and that it is of great importance for decision-makers. alnaa and ahiakpor (2011) estimated the arima (6,1,6) model using monthly inflation data and the box jenkins methodology. based on the indicator and the calculated rmse, the effectiveness of the inflation forecasting model was confirmed. by creating an adequate var model, cologni and manera (2008) successfully introduced the relationship between oil prices, inflation, and interest rates and provided a useful tool for monetary policymakers. the researchers evaluated the var model for the possible impact of changes in oil prices on macroeconomic variables, monetary policy, and the economic system. different results have been achieved in different countries due to the countries' specificities. dua (2008) has shown that different models (arima-garch, lvar, bvar, vecm) should be used to predict interest rates in india depending on the type of interest rate and the forecast horizon. research has shown that the multivariate model outperforms univariate models when it comes to longer-term forecasts. the arima and var models were used to forecast inflation measured by the harmonized index of consumer prices (hicp) in austria. fritzer, moser, and scharler (2002) concluded that over a longer time horizon, the var model would provide a more accurate hicp forecast than the arima model, and its use is recommended in further studies. in the case of the inflation forecast, according to hoa (2017), the forecasting performance of the model depends on the time horizon in which the forecasting is made. it is confirmed that with monthly data the var_m2 model gives a better forecast, while for the quarterly data the ar (6) model provides a better inflation forecast. to obtain an optimal model for short-term interest rates forecasting, radha and thenmozhi (2006) compared the forecasting performance of three models: arima, arima-garch, and arima-egarch. depending on the type of interest rate, different models have different performances. for commercial papers, the arima-egarch model is the best, while for implicit yield 91 day treasury bill, overnight mibor rate and call money rates the arima-garch model gives the best forecasts. razak, khamis, and abdullah (2017) predict future gdp growth using the var and arima models. out-of-sample model forecast values are compared and the mean absolute percentage error (mape) results confirm that the var model is superior to the arima model in this case. according to zhang and rudholm (2013) in sweden, the ar (1) model gives the best gdp per capita forecast over the arima and var models, while the var model gives the worst forecast. methodology the two types of time series models, the univariate (arima) and multivariate (var), are utilized in this paper for the purpose of interest rate forecasting and models performance comparison. time series models known as arima models can be very successfully specified by implementing box-jenkins methodology (box & jenkins, 1976), a particularly significant specification methodology. box-jenkins methodology is a very popular and frequently used in academic research (ahmed et al., 2017; etuk, 2013, yuan, liu & fang, 2016; iqbal & naveed, 2016; seneviratna, & shuhua, 2013; moffat & david, 2016; okafor & shaibu, 2013; radha & thenmozhi, 2006; xue & hua, 2016; yuan, liu & fang, 2016). according to dimitrios (dimitrios, 2006) the name arima is derived from: ar = autoregressive, i = integrated, ma = moving averages. a univariate autoregressive model of moving averages (with or without the required series differentiation) in the general notation can be specified as: bojan pejović, vesna karadžić 75 if in the process of model specification series were differentiated in order to obtain the required stationarity, we are talking about integrated autoregressive models of moving averages, i.e. arima (p, d, q), where d represents the order of model integration. time series models that include more than one series are multivariate (multidimensional) models. in these models, the behavior of the dependent variable is explained by the action of several observed series, unlike univariate (one-dimensional) models where the behavior of the dependent variable is explained by the influence of the previous values of one series. the vector autoregressive (var) model is the most represented and commonly used model in the class of multivariate models. the attraction of the var approach, as proposed by sims (1980), is mainly that there is no reliance on the restrictions of economic theory to indicate which variables occur in each equation. in var, every variable in the system is assumed to be endogenous. this contrasts to the standard theory-based method in which causal relationships between the variables is implied. so, when we are not sure that a variable is truly exogenous, each must be treated symmetrically. take for example the time series affected by present and past values of x and, at the same time, the time series affected by present and past values of y. in this case, we will have a simple multivariate model: where both yt and xt are assumed to be stationary and uyt and uxt are uncorrelated white noise errors. the var model has been used extensively for forecasting and has achieved excellent results in scientific research (carriero, kapetanios & marcellino, 2009; gerdesmeier, roffia & reimers, 2017; sarantis & stewart, 1995; salazar & weale, 1999). the data are obtained from the central bank of montenegro. the data are of the time-series form, i.e. the monthly data from december 2011 to january 2018. the method of analysis in this paper is the ordinary least square (ols) which is used to estimate structural parameters of the model in such a way, so as to minimize the sum of the deviations of the actual observation from their model estimated values. it is one of the most commonly used methods in estimating econometric models and it produces the best, linear, unbaised estimates (blue) (koutsoyiannis, 1997). empirical work based on time series assumes that the underlying time series is stationary. the stationarity is an essential property in defining a time series process. a stationary time series is the one whose parameters, such as mean, variance, autocorrelation, etc. are all constant over time. hence, according to standard econometric procedure it is necessary to firstly check the data for possible non-stationarity. this need arises from the fact that if a time series data is non-stationary, the regression performed on variables with unit root would be “spurious” (granger and newbold, 1974) or “dubious” (phillips, 1987). stationarity can be tested by using several tests. in this paper the augmented dickey fuller (adf) test is implemented. secondly, it should be tested whether the identified non-stationary series are co-integrated. the variables are said to be co-integrated if they satisfy the condition that there exist at least (k1) cointegrating equations i.e. stationary linear combinations of individually non-stationary variables (maddala and kim, 1998). several diagnostic tests have to be done in order to check for the specification of the model, as well as for the possible problems of heteroscedasticity, autocorrelation, multicolinearity and residual normality. for that purpose jarque-bera (jb) test, breusch-godfrey test, var residual serial correlation lm test, breusch-pagan-godfrey test, var residual heteroscedasticity tests, empirical distribution test and var residual normality tests are employed. 76 economic analysis (2020, vol. 53, no. 1, 72-83) analysis and results this part of the paper presents the results of the empirical research that focuses analysing and modeling the empirical data on interest rates in montenegro. the interest rate dynamics is monitored from the 12th month (december) of 2011 (the first available data on interest rate (ir) published by the cbm) to the 1st month (january) of 2018 (the last available data). the banks’ average weighted active nominal interest rate on newly approved operations is recorded on an annual basis. the monthly consumer price growth rate (cpi) from december 2011 to january 2018 is also monitored, as the second time series. the descriptive statistics for the twotime series analyzed are presented in table 1. table 1. descripotive statistics source: own elaboration. according to jarque-bera value the analyzed ir and cpi time series are normally distributed. in table 2 the ordinary and partial autocorrelation function of the interest rate time series are presented. the autocorrelation coefficient declines slowly from 0.893 on the first lag to 0.186 on the 20th lag when it is not statistically significant. the standard error of the autocorrelation coefficient is calculated as =0.1162. based on the z critical values, the 95% confidence interval for the autocorrelation coefficient is . table 2. correlogram of interest rate lags(k) ac pac q‐stat prob 1 0.893 0.893 61.464 0.000 2 0.841 0.214 116.72 0.000 3 0.819 0.195 169.89 0.000 4 0.799 0.105 221.23 0.000 5 0.775 0.04 270.17 0.000 6 0.761 0.078 318.08 0.000 7 0.72 -0.105 361.62 0.000 8 0.702 0.054 403.6 0.000 9 0.65 -0.185 440.16 0.000 10 0.603 -0.091 472.08 0.000 11 0.563 -0.069 500.35 0.000 12 0.548 0.077 527.63 0.000 13 0.499 -0.112 550.62 0.000 series ir cpi sample 2011m12 2018m01 2011m12 2018m01 observations 74 74 mean 7.914 0.135 median 8.210 0.100 maximum 10.190 1.100 minimum 5.270 -0.800 std. dev. 1.380 0.407 skewness -0.212 0.279 kurtosis 1.707 3.178 jarque-bera 5.706 1.060 probability 0.057 0.588 bojan pejović, vesna karadžić 77 lags(k) ac pac q‐stat prob 14 0.433 -0.192 568.21 0.000 15 0.403 0.088 583.7 0.000 16 0.38 0.027 597.68 0.000 17 0.327 -0.077 608.24 0.000 18 0.283 -0.057 616.26 0.000 19 0.231 -0.066 621.72 0.000 20 0.186 -0.05 625.31 0.000 source: own elaboration. the results of augmented dickey-fuller (adf) unit root test are presented in table 3. based on the calculated probabilities, the null hypothesis is rejected for both time series at a 5% significance level. therefore, it is concluded that none of the two time series have a unit root and, hence, they both are stationary. table 3. unit root test series unit root test t‐statistic adf test statistic prob. ir augmented dickey-fuller -3.473 -6.284 0.000 cpi augmented dickey-fuller -2.901 -6.393 0.000 source: own elaboration. after examining and confirming the normality and stationarity of the interest rate series several different models were estimated using the box-jenkins methodology. based on statistical and econometric criteria, which will be shown below, it is concluded that the ar (1) model is superior to the other estimated ones. the chosen estimated model is shown in table 4. table 4. ar (1) model dependent variable: interest rate method: least squares sample (adjusted): 2012m01 2018m01 included observations: 73 after adjustments variable coefficient std. error t-statistic prob. c 10.2292 0.2068 49.4735 0.0000 @trend -0.0610 0.0048 -12.7987 0.0000 @month=12 -0.6417 0.1613 -3.9785 0.0002 ar(1) 0.4823 0.1021 4.7244 0.0000 r-squared 0.9030 akaike info criterion 1.2566 adjusted r-squared 0.8988 schwarz criterion 1.3822 s.e. of regression 0.4417 hannan-quinn criterion 1.3067 f-statistic 214.1232 durbin-watson stat 2.1871 prob(f-statistic) 0 inverted ar roots 0.48 source: own elaboration. in the specified model, the dependent variable ir (average weighted interest rate on newly approved loans) depends on the value of the interest rate in the previous period (ar(1)), the effect of the trend and the impact of the dummy variable (month=12). all independent variables in the model are statistically significant, at a 5% significance level. a coefficient of determination of 0.90 indicates that 90% of the variation of the dependent variable is explained 78 economic analysis (2020, vol. 53, no. 1, 72-83) by the model, so from the standpoint of that criterion the model is good, as confirmed by the fstatistic. values of information criteria: akaike, schwarz, and hannan-quinn are smaller in the model compared to other models evaluated. the estimated ar (1) model will be used as a benchmark in comparison to the corresponding var model. after analyzing a larger number of var models that meet the econometric criteria and are specified and estimated with and without a constant, with a larger and smaller number of lags, the model with the best characteristics is chosen as the final one. the specified model is representative of multivariate time series models and is used to be compared to a previously selected estimated model to represent the class of univariate time series models. table 5. var model dependent variable: interest rate sample (adjusted): 2012m03 2018m01 included observations: 71 after adjustments variable coefficient std. error t-statistic ir(-1) 0.4840 -0.1168 [ 4.14436] ir (-2) 0.2631 -0.1215 [ 2.16606] ir (-3) 0.2454 -0.1146 [ 2.14133] cpim(-1) -0.1319 -0.1560 [-0.84567] cpim(-2) -0.3090 -0.1593 [-1.94057] cpim(-3) 0.2377 -0.1546 [ 1.53713] r-squared 0.8879 akaike info criterion 1.4490 adjusted r-squared 0.8793 schwarz criterion 1.6402 s.e. of regression 0.4796 mean dependent 7.8625 f-statistic 103.0033 s.d. dependent 1.3806 source: own elaboration. based on the estimated model, we can see that the interest rate value at time t depends on the interest rate value from period t-1, t-2 and t-3, as well as the value of the price growth rate from period t-1, t-2 and t-3. the model does not contain a constant. the estimated model largely describes interest rate variations by endogenous variables, so a model determination coefficient of 0.887 indicates that approximately 89% of interest rate variations are explained by the model. the estimated var model meets all the validity conditions of the model. the diagnostic test results shown in table 6 prove that the model is characterized by the absence of autocorrelations, the absence of heteroscedasticity, and normality of the distribution of residuals. forecast results and models evaluation the real and projected interest rates based on the autoregressive ar (1) model are shown in figure 1. model ar (1) will be used in comparison with the specified vector autoregression model (var) to determine a superior model for interest rate forecasting in montenegro. the forecast with a deviation of +/2 standard deviations is presented, that is, an interval forecast of the interest rate for the next six months is given with a probability of 95%. we note that the real value of the interest rate is within the interval, with the exception of the 5th month. bojan pejović, vesna karadžić 79 4.0 4.5 5.0 5.5 6.0 6.5 7.0 m1 m2 m3 m4 m5 m6 m7 m8 m9 m10 m11 m12 m1 m2 m3 m4 m5 m6 m7 2017 2018 ir irtb irbb irf_dy1 figure 1. actual and model ar (1) forecast interest rate for the period 2018m1-2018m7 source: own elaboration the real value of the interest rate for the period 2017m1 to 2018m7 as well as the forecasted value of the interest rate for the period 2018m2-2018m7 with deviations of plus/minus two standard deviations is presented in the figure 2. we note that the real value of the interest rate does not go beyond the 95% confidence interval and is within the limits of plus/minus two standard deviations presented. 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 m1 m2 m3 m4 m5 m6 m7 m8 m9 m10 m11 m12 m1 m2 m3 m4 m5 m6 m7 2017 2018 ir (varscen) ir_bb ir_tb ir figure 2. actual and model var forecast interest rate for the 2018m1-2018m7 period. source: own elaboration. it is demonstrated in the figure 3. that the var model forecast is slightly lower than the ar(1) model forecast, and in this sense, the var model underestimates the interest rate to a greater extent than the ar(1) model does. deviation from this phenomenon occurs only in the fifth month when a sharp decrease in the interest rate to the level of 4 is noted, probably due to some external shock, possible cbm incentive measures or significant changes in the european capital market. a sharp decrease in the interest rate that occurred in the fifth month is not a common occurrence: the sample data indicate that such an occurrence is recorded for the first time in 2018 and requires a more detailed analysis. 80 economic analysis (2020, vol. 53, no. 1, 72-83) 4.6 4.8 5.0 5.2 5.4 5.6 5.8 6.0 6.2 6.4 m1 m2 m3 m4 m5 m6 m7 2018 ir_ar ir ir (varscen) figure 3. real and forecast interest rates based on ar (1) and var models. source: own elaboration an overview of the probabilities for the diagnostic tests: autocorrelation (breusch-godfrey test and var residual serial correlation lm tests), heteroscedasticity (breusch-pagan-godfrey test and var residual heteroscedasticity tests) and residual normality (empirical distribution test and var residual normality tests) for the both evaluated models are given in table 6. the tests are given in the appendix. with a 5% error rate, the null hypothesis is confirmed, so the models are characterized by the absence of autocorrelation, heteroskedasticity, and the normal distribution of residuals. table 6. diagnostic test results (probabilities) model autocorrelation (prob.) heteroscedasticity (prob.) residual normality (prob.) ar(1) 0.0994 0.2881 0.7338 var 0.7191 0.806 0.3646 source: own elaboration. after the statistical and econometric validity of the model is established, a comparison of the model's forecasting performance is investigated. in table 7 the real and forecasted values of interest rate and the most important calculated statistics are given based on which the choice of the optimal model is made. table 7. real values and ar (1) / var model interest rate forecasts with the most important statistics most important statistics february 2018 march 2018 april 2018 may 2018 june 2018 july 2018 interest rate (real) 6.25 6.11 5.88 4.37 5.67 6.01 ar model forecast 5.73 5.66 5.59 5.53 5.47 5.41 var model forecast 5.62 5.45 5.46 5.43 5.39 5.36 e ar(1) 0.52 0.45 0.29 -1.16 0.20 0.60 var 0.63 0.66 0.42 ‐1.06 0.28 0.65 mse ar(1) 0.27 0.24 0.19 0.48 0.39 0.38 var 0.40 0.42 0.34 0.53 0.44 0.44 rmse ar(1) 0.52 0.48 0.43 0.69 0.62 0.62 bojan pejović, vesna karadžić 81 source: own elaboration. based on the calculated statistics, and especially the most commonly used mse (mean squared error) statistics in model comparisons, it can be concluded that a first-order autoregressive model containing a trend and a dummy variable is superior to the estimated vector autoregressive model. the ar(1) model prediction error is higher only for the fifth month, which is caused by external shock and falling interest rate, as discussed previously. the values of all statistics for the first-order ar(1) model are less than the values of the var model statistics, which is consistent with the aim to specify a model with minimal forecast error and the best forecast performances. many other researchers who have researched within their national economies using the same methodology have come to similar results. it has been confirmed that the arima model can be successfully used in forecasting the kibor interbank rate, and recommendations have been made for its use in other countries when forecasting interest rates (ahmed, r.r., et al. 2017). interest rate forecasting in india was addressed by a group of researchers who came to the conclusion that different models (arima-garch, lvar, bvar, vecm) should be used depending on the type of interest rate and the forecast horizon (dua, p. 2008). in order to obtain the optimal model to forecast the short-term interest rate, the forecasting performance of the arima, arima-garch and arima-egarch models was compared (razak, n. a. a., et al., 2017). conclusion the two most frequently used types of time series models, the univariate and multivariate, are investigated in this paper for the purpose of interest rate forecasting and models performance comparison for the case of montenegro. box-jenkins methodology and vector autoregressive model approach have the greatest application and often give the best forecasts, compared even to more complex econometric models. applying the box-jenkins methodology, several univariate autoregressive models are specified, estimated and evaluated. based on the econometric criteria, primarily on information criteria and adjusted coefficients, the best model from the class of autoregressive models is selected, namely ar (1). accordingly, the first research hypothesis stating the box-jenkins approach provides a statistically significant interest rate forecast in montenegro is confirmed. alternative var model as one of the classes of multivariate models is specified. after var model estimation and evaluation, the second research hypothesis claiming the var model provides a statistically significant interest rate forecast in montenegro is proved. hence, it can be concluded that both approaches lead to the estimation of adequate models that can be used in modeling and forecasting interest rates in montenegro. to determine the optimal prognostic model, the forecast performance of previously estimated models, ar (1) in the class of univariate models and var models in the class of multivariate models, are compared. the comparison is done on the bases of actual forecast error, the mean square error, the root mean square error and the mean absolute error. the results of this analysis indicate that for interest rate forecasting in montenegro box-jenkins approach produces better prognostic results in comparison to the var model approach, i.e. the third research hypothesis is true. in this paper only two types of models have been analyzed, and it must be remembered that there could have been different results had other types of models been included in the analysis. the obtained results relate to time series that are short and of questionable quality, regarding var 0.63 0.64 0.58 0.73 0.66 0.66 mae ar(1) 0.52 0.49 0.42 0.61 0.52 0.54 var 0.63 0.65 0.57 0.69 0.61 0.62 82 economic analysis (2020, vol. 53, no. 1, 72-83) the montenegrin economy that is small, open and with specific foreign exchange regime (eurozation). the results could be different if the sample size and data quality is increased, so models need to be tested at different periods. therefore the presented results must be taken with caution. despite the mentioned limitations, the results and conclusions presented in this paper are in accordance, to a certain degree, with the research conducted in other countries and can be valuable in decision making policy and further research regarding interest rate forecasting in montenegro. future aspects of this research may focus on the application of other methodologies and the estimation of new models with better forecasting performances, such as autoregressive distributed lag models, artificial neural network models, error correction models, generalized autoregressive conditional heteroskedastic models, conditional volatility models, etc. references ahmed, r., vveinhardt, j., ahmad, n., & streimikiene, d. 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(2013). monthly nigerian interbank call rates modeling by seasonal box-jenkins approach. journal of research in marketing, 1(1), 22-29. fritzer, f., moser, g., & scharler, j. (2002). forecasting austrian hicp and its components using var and arima models (no. 73). gerdesmeier, d., roffia, b., & reimers, h. e. (2017). forecasting euro area inflation using single-equation and multivariate var–models. folia oeconomica stetinensia, 17(2), 19-34. granger, c.w.j. and newbold, p. (1974). spurious regression in econometrics. international journal of social science, vol.5, no.1. hoa, t. t. (2017). forecasting inflation in vietnam with univariate and vector autoregressive models (no. book). the graduate institute of international and development studies, international economics department. iqbal, m., & naveed, a. (2016). forecasting inflation: autoregressive integrated moving average model. european scientific journal, 12(1), 83-92. koutsoyiannis, a. (1997). theory of econometrics: introductory to exposition of econometric methods, 2nd edition., macmillan publishers ltd, london maddala, s.g. and kim, i.m. (1998). unit root, cointegration, and structural change, cambridge university press, new york moffat, i. u., & david, a. e. (2016). modeling inflation rates in nigeria: box-jenkins’ approach. international journal of mathematics and statistics studies, 4(2), 20-27. okafor, c., & shaibu, i. (2013). application of arima models to nigerian inflation dynamics. research journal of finance and accounting, 4(3), 138-150. phillips, p.c.b. (1987). time series regression with unit root. econometrica, vol. 55, no. 2. bojan pejović, vesna karadžić 83 radha, s., & thenmozhi, m. (2006). forecasting short term interest rates using arma, armagarch and arma-egarch models. in indian institute of capital markets 9th capital markets conference paper. razak, n. a. a., khamis, a., & abdullah, m. a. a. (2017). arima and var modeling to forecast malaysian economic growth. journal of science and technology, 9(3). salazar, e., & weale, m. (1999). monthly data and short-term forecasting: an assessment of monthly data in a var model. journal of forecasting, 18(7), 447-462. sarantis, n., & stewart, c. (1995). structural, var and bvar models of exchange rate determination: a comparison of their forecasting performance. journal of forecasting, 14(3), 201-215. seneviratna, d. m. k. n., & shuhua, m. (2013). forecasting the twelve month treasury bill rates in sri lanka: box jenkins approach. iosr journal of economics and finance (iosr‐jef), 1(1). sims, c. a. (1980). macroeconomics and reality. econometrica: journal of the econometric society, 1-48. xue, d. m., & hua, z. q. (2016). arima based time series forecasting model. recent advances in electrical & electronic engineering (formerly recent patents on electrical & electronic engineering), 9(2), 93-98. yuan, c., liu, s., & fang, z. (2016). comparison of china's primary energy consumption forecasting by using arima (the autoregressive integrated moving average) model and gm (1, 1) model. energy, 100, 384-390. zhang, h., & rudholm, n. (2013). modeling and forecasting regional gdp in sweden using autoregressive models. dalama university. article history: received: november 19, 2019 accepted: december 12, 2019 ea_2019_2 doi: 10.28934/ea.19.52.2.pp137-151 scientific review concentration measuring techniques in banking sectorlorenz curve and gini coefficient maja dimić1* | svetislav paunović2 1 university union nikola tesla, faculty for business stadies and law, belgrade, serbia 2 university union, belgrade banking academy, belgrade, serbia abstract the paper presents the indicators of market concentration in the banking sector with a focus on the lorenz curve and the gini coefficient. the authors present the results of the empirical research of concentration levels in the banking sector in selected countries in the cee region (serbia, croatia, montenegro, bosnia and herzegovina, macedonia, bulgaria, romania and albania) in the period 2007-2012. the level of market concentration can be exploited and operationalized by using different concentration indicators. the contribution of this research is reflected in the comparative empirical analysis of the results of our previous research that was focused on quantification of the most frequently used indicators of concentration (concentration ratio 4 and herfindal-hirshman index), and the results obtained using the lorenz curve and the gini coefficient. the paper analyzes the level as well as variability of these indicators and tests the degree of their correlation. individually observed, concentration indicators have relatively low capacity to present the real nature of competition in the banking sector in the analyzed countries as well as to provide a good estimate of possible future trends. the results of our analysis indicate that, for the purpose of a more precise and better understanding of the relevant issues of market concentration in the financial sector, several indicators of concentration need to be analyzed simultaneously. additionally, improvement of methodology should provide a more reliable basis for a precise definition of adequate policies and legislation in this area. key words: level of concentration, gini coefficient, lorenz curve, banking sector, cee region, economic crisis jel classification: g21, g01 introduction concentration is a measure of market power, whereby market power can be defined as a company's ability to increase the price of a product / service without reducing total sales. in this context, competitive business in the industry is distorted in uncontrolled economic systems. this market position can lead to monopoly behavior, which is reflected in unjustified price increases (and extra profit), lower product / service quality, the lack of innovativeness, the use of cheaper and low-quality raw materials in the production process (barjaktarović, filipović & dimić, 2013). the concept of concentration in the financial sector defines the form of interconnection of institutions whereby they come under common control thus creating a certain level of economic * corresponding author, e-mail: maja.dimic@fpsp.edu.rs 138 economic analysis (2019, vol. 52, no. 2, 137-151) unity which, by the time of association, did not exist (šubić, 2009). larger part of the theory of industrial organization can be applied in the financial system. however, the banking sector is part of a group of specific business branches where oligopoly structure can be found in the market. the reason for this kind of market structure lies in the fact that banks aim at achieving profit margins justifying shareholder investments, thus attracting a higher level of capital. perfect competition in the financial sector is not market-sustainable, because of the following: • endangering the profit margins of financial institutions. under the conditions of perfect competition in the market, financial institutions would achieve minimum profits, which would prevent the accumulation of capital necessary to protect against potential losses. • the problem of asymmetry of information is raised and the moral hazard increases. financial institutions operate under "too big to fail" principles, take on greater business risk because they are certain that in the event of an emergency, the state will stand in their defense. • increasing the level of passive rates in the banking sector with the aim of attracting as many customers as possible. the increase in passive interest rates would have an effect on an increase in active interest rates. the scientific literature adopts several reasons which can lead to the increased concentration in the financial system. hawkins & mihaljek (2001) cite the following groups of motives which encourage institutions to consolidate in the financial sector: • benefits (economy of scale, organizational activity, diversification of risks); • economic reasons (motives for checking the level of concentration that emerge after the crisis or during the increase in the business cycle); • other motives (defending against the takeover and managerial motivation to capitalize). the objective of the paper is to elaborate characteristics of gini coefficient as a measure of the concentration, to quantify gini coefficient in the banking sector in selected cee countries as well as to compare the results with findings of our previous research (barjaktarović, filipović & dimić, 2013; dimić, 2015; dimić, 2018; dimić, paunović & tešanović, 2019) which was based on most frequently used indicators of concentration (concentration ratio 4 and herfindal-hirshman index). in this context, we also test the degree of their correlation. the main hypothesis of the paper is that there is a high average value of gini coefficient, indicating the relatively high level of concentration in the banking sector of analyzed countries during the period 2007-2012. the auxiliary hypotheses are: h1: there are significant differences in the degree of correlation between individual concentration indicators (cr4, hhi and g). h2: degree of concentration in the banking sector is poorly correlated with the level of economic development. the paper will be structured as follows: within the first section previous research that relates to indicators of concentration will be elaborated followed by the methodology of research and data collecting. within the third section the results of our survey will be presented. finally, the conclusion and recommendations will be given. previous research the turbulence of the environment and market changes have led to the need for business entities re-examine themselves and to design their business strategy in order to gain competitive advantage in the market (raičević & medenica-mitrović, 2018). in this context, the degree of concentration represents an important structural variable in any business area. various levels of concentration of individual industries or companies in the economic branches maja dimić, svetislav paunović 139 are the first indicator of the market structure (dimić, 2015). in this context, the significance of the indicator of concentration is found in the interpretation of structural changes in the market. concentration indicators reflect changes in the level of market concentration, which are the consequence of entering or leaving of the companies from the branch, as well as merging of companies in the industry. concentration indices are therefore considered as the starting point for conducting anti-monopoly policy, whereby the value of concentration indicators can be used in the decision-making process on whether to approve the uniting of companies. concentration indices belong to a group of indicators of structural approach, as they describe the state and changes in the market structure (dimić, paunović & tešanović, 2019). different authors have indicated certain characteristics that the indicators of concentration need to possess. hall & tideman (1967) cited the following characteristics of the concentration index in their research: • they should be one-dimensional, which practically means that they should be unambiguous in order to be comparable between different branches and different times. • they should be independent of the size of the branch indicating their intercomparability. practically speaking, for measuring of concentration the absolute value of the variables is not important, but their distribution among the participants in the market • concentration indices affect the changes in market share of the corporation. thus, the shift of market share from small to larger companies increases, and the shift from bigger to smaller reduces the value of the concentration index. • concentration index should range from 0 to 1. this characteristic is not ultimate, but it is desirable because the indices in such a state are more useful for analysis. depending on the purpose of the research, market concentration can be measured by numerous indicators. in their scientific paper bikker & haaf (2000) presented theoretical explanations of concentration indicators: concentration ratio, herfindal-hirshman index, entropy measure, the lorenz curve, the gini coefficient, the comprehensive industrial concentration index cci, hannah and kay (hki), hall-tideman index (hti), hause index (ha). table 1. indicators of market concentration index title tag and interval value index value interpretation concentration ratio 1/n≤ cr≤1 the value of the index is approaching 0 when a larger number of identical entities are present on the market, and value 1 takes the situation when the sum of "r" entities make the entire industry. herfindahl-hirschman index 1/n≤hhi≤1 the higher value of the index indicates the higher concentration. in case of a monopoly, it is worth 10,000. entropy measure 0≤e≤logn greater entropy value indicates lower concentration. in case of a monopoly, the value of the index is equal to 0. lorenz curve indicates the distribution of population in population. the larger the concentration the further the curve from the direction of even distribution. gini coefficient 0≤g≤1 the bigger the coefficient the larger the conentration. in case of total uneven distribution it amounts to 1 comprehensive industrial concentration index 0≤cci≤1 the value of the index ranges from 0 to 1. value 1 occurs in case of a pure monopoly. hannah and kay index hki; α>0; α ≠1 the lowest values of α parameter emphasize the influence of small companies, while the highest values of α parameter point out the influence of big companies on concentration. 140 economic analysis (2019, vol. 52, no. 2, 137-151) index title tag and interval value index value interpretation hall-tideman index 0≤hti≤1 value close to 0 means the presence of a larger number of banks of the same size, while the index value of 1 signals the presence of a monopoly. hause index 0≤h≤1 index is equal to the value of 1 in case of a monopoly, while the value 0 occurs in the presence of an infinite number of identical banks in the market. source: dumićić et al. (2012), ljubaj (2005) the most commonly used concentration measurement techniques are the concentration ratio 4 (cr4) and herfindahl-hirschman index (hhi). these techniques are widely accepted and used by referent institutions that analyze, monitor and make decisions regarding the control of the degree of concentration. in this context, one of our previous surveys could be a good basis for a broad comparative analysis of concentration indicators. in the analysis that is the subject of this paper, the aforementioned commonly used techniques are added a theoretical and methodological review of the lorenz curve and the gini coefficients as well as the empirical analysis of the level of concentration in the banking sector in cee countries during the world economic crisis based on these techniques. comparative analysis of the obtained results and practical implications are also the subject of our research. theory and methodology lorenz curve and gini coefficient the lorenz curve is a graphical instrument through which it is possible to monitor the uniformity of the distribution of selected variables, and can therefore successfully be used for analyzes of concentration of various industrial sectors or markets (marinković, 2007). the lorenz curve shows the distribution of the cumulative numerical sequence on its parts. it is constructed in the first quadrant of the coordinate system and consists of the points whose coordinates are determined by the members of cumulative sequences (tipurić, kolaković & dumičić, 2002). thus, using the lorenz curve it is possible to show the link between the cumulative number of companies and their cumulative market share. the x-axis shows the number of firms (f) grouped by size, from the smallest to the largest, while the y-axis shows the percentage of the offer (from 0% to 100%). the first step in constructing a graph with the lorenz curve is defining the curve of 45°: the first point will have coordinates [0,0] and the last one [1,1]. as data is compared by size, x-axes are counted as the values of the empirical functions of distribution, according to the following formula: (1) i= 1, 2, … n the y-axes are the members of cumulative sequence of proportions of subsum and are calculated according to the following formula: (2) j=1, 2, ...n maja dimić, svetislav paunović 141 the curve of 45°, is interpreted as a line of perfect equality, i.e. an even distribution of offers among companies. the equilibrium of distribution is observed on the basis of deviation of the lorenz curve from the curve of 45 °, which shows the absolutely equal distribution of market share among all participants (kostić, 2009). as the lorenz curve moves away from the ideal distribution, the concentration of the sector is becoming more pronounced. an absolutely uneven distribution means that one company provides 100% offer in the sector. figure 1. lorenz curve the main deficiency of the lorenz curve is the unevenness of the distribution of market share between individual companies. in determining the degree of concentration, the number of companies will not play a significant role, so one company with 100% market share and ten companies with 10% of market share will be at 45 ° (kostić, 2008). also, the lorenz curve does not show an easily comparable numeric data. in order to overcome the deficiency, this instrument of concentration is supplemented by the gini coefficient (g). the gini coefficient is a parameter that follows the logic of the lorenz curve. the value of the gini coefficient is determined by the deviation of the lorenz curve from the line of perfect equality. this measure of concentration is based on the assumption that companies' participation in the industry is split between the lowest and the highest. the gini coefficient gives us a unique numeric indicator that describes the position of the lorenz curve by determining the ratio between the area of the line of perfectly even distribution and the lorenz curve (a) with the area below (or above) the line of perfectly even distribution, which by definition, mathematically, amounts to a half of the quadrant in which the lorenz curve is drawn (marinković, 2007). the coefficient can be calculated in two ways: (3) where the interval represents the area below the lorenz curve. another way for calulating the gini coefficient is according to the following formula: , i= 1,2, ... n (4) where: n stands for the number of companies; μ stands for the average size of the company's sales on the given market 142 economic analysis (2019, vol. 52, no. 2, 137-151) ri the ranking which the ith company occupies (companies are ranked according to the size of sale or their market share, ranging from the smallest to the biggest); qi scope of sale of the ith company. the value of the gini coefficient can range from 0 to 1. if the gini coefficient has a value of 0, all firms are of the same size and there is no concentration on the market. in this case, the lorenz curve lies on the line of a perfectly equal distribution and the area between them cannot be mathematically expressed. when the obtained value approaches 1, there is a huge disproportion in the size of the offer among companies, i.e. one company dominates the industry. the main disadvantage of this indicator is that it ignores the number of firms and solely observes the inequality in the offer between them. the industrial branch with two companies identical in size has the same value of the gini coefficient as the industry with 100 firms of the same size, although the competitive structure of these two industries is completely different (lipczynski & wilson, 2001). datasource and framework methodology in this part of the paper, an empirical study of concentration levels in the banking sector was carried out in selected cee countries in the period 2007-2012, using the lorenz curve technique and the gini coefficient. the territorial starting points for empirical research are the countries which the international monetary fund classified and defined as cee countries.1. our research includes the following countries of the cee region: serbia, croatia, bosnia and herzegovina, montenegro, macedonia, romania, bulgaria and albania. the analysis of the level of concentration in the banking sector is based on the following development criteria: assets (total balance sheet) of the banking sector, loans granted to the non-financial sector and deposits of the non-financial sector (dimić, 2018). data used in the research were collected on the websites of relevant financial institutions responsible for the control and supervision of banking sector operations as well as other available sources and publications of institutions responsible for the financial sector. table 2. data sources for the banking sector country data sources for the banking sector serbia national bank of serbia (banking sector – analyses and reports, bank web sites, auditors’ reports, annual reports) croatia croatian national bank (bulletin on banks) bosnia and herzegovina banking agency of the federation b&h (concise report of external auditors on banks’ financial statements in fb&h) montenegro central bank of montenegro (journal of central banking, banks’ balance sheets and profit and loss accounts) macedonia national bank of the republic of macedonia (report on banking system of the republic of north macedonia) romania national bank of romania (monthly bulletin of nbr) bulgaria central bank of bulgaria (banks in bulgaria) albania albanian association of banks (banking system monthly bulletin) source: national banks of the analyzed countries 1 according to the classification methodology used by the international monetary fund in its reports (world economic outlook), the following countries are listed in the group of central and eastern european countries (cee region): albania, bosnia and herzegovina, bulgaria, montenegro, croatia, lithuania, latvia, hungary, macedonia, poland, romania, serbia, kosovo and turkey. maja dimić, svetislav paunović 143 data processing was aimed at identifying the levels of concentration in the banking sector in the analyzed countries and their dispersion in the period 2007-2012, using the lorenz curve and the gini coefficient. the analysis was carried out in several steps: • calculation of concentration indicators in the analyzed countries using the three development indicators of the banking sector (assets, loans granted to the non-financial sector and deposits of the non-financial sector). • determining the average values of concentration indicators for each particular country in the analyzed period as well as the average weighted concentration indicators for the analyzed region in each individual year. bearing in mind that different levels of realized balance sheet totals, loans granted to non-financial sector and non-financial sector deposits are reported in the group of analyzed countries in the region of central and eastern europe, shares of individual countries are taken as the weights in the total amount of individual indicators of the analyzed region; • determining the statistical measure of variability using coefficient of variation (expressed as a ratio of standard deviation and mean value of concentration indicator, i.e. average weighted concentration indicator value). in this context, the following are analyzed: dynamic changes (variability) of the level of concentration by countries in the period 2007-2012, as well as the changes (variability) of the level of concentration between the countries analyzed for each year. • comparative analysis of the previously obtained results based on the use of cr4 and hhi and the results obtained using the gini coefficient was made. also, the correlation analysis of the obtained results was done. • the survey also included establishing the intensity of the ratio of the individual concentration indicators and the gdp per capita. in this context, the spearman’s correlation coefficient (5) where ρ – stands for spearman’s correlation coefficient; d – stands for the difference between the ranks x and y; n – stands for the number of pairs of ranks of the x and y variables; is used, which is suitable for data that can be ranked, especially for smaller series of data. correlation coefficients range from -1 to 1, with the sign indicating the negative or positive correlation or the absence of correlation (0). research results – lorenz curve and gini coefficient the lorenz curve allows for a clear understanding of the distribution of the banking market (according to analyzed criteria) in cee countries in the observed period. based on our research, the following key points and characteristics of the banking sector can be stressed. level of concentration (based on total assets ) serbia the first 50% of banks in the domicile market have a share of 13% of total banking sector assets, while the remaining 50% of banks account for 87% of the market. 90% of banks have a share of 67% of total assets croatia 50% of banks have a share of 4% of total assets. 90% of banks have a share of 45%, the remaining group of participants (10%) possesses about 55% of banking sector assets. 144 economic analysis (2019, vol. 52, no. 2, 137-151) level of concentration (based on total assets ) bosnia and herzegovina 1/3 of banks have a share of only 3.5%. montenegro 90% of the participants in the banking market have a share of 75% of total assets macedonia 50% of banks have a share of only 10% of total banking sector assets romania about 30% of the market participants have a share of only 1%, while 90% of the bank has a slightly more than 50%. bulgaria 90% of banks have a share of 65% of total assets. albania 50% of the market participants participate in the market with 12%, while 95% have a share of 75%. figure 2. lorenz curve for the banking market according to the criteria of total assets source: based on authors' calculations maja dimić, svetislav paunović 145 regarding the criterion of the loans granted to the non-financial sector as well as collected deposits, the following results were obtained2: level of concentration based on loans granted to non-financial sector level of concentration based on collected deposits from nonfinancial sector croatia 2/3 of banks have a share of 6.6%, while 96% of the market participants have a share of 75% 50% of banks have a share of 4.5%. bosnia and herzegovina 50% of banks have a share of 5%, while 90% of banks have a share of little more than 50%. 2/3 of banks have a share of 12%. montenegro 50% of banks participate with 20% in total loans granted to the nonfinancial sector. 2/3 of banks have a share of 25%. macedonia 95% of market players have a share of 75%. 2/3 of banks have a share of 17%. bulgaria 50% of banks participate with 8%. 2/3 of banks have a share of 20%. albania 2/3 of banks have a share of 25% 95% of banks have a share of 70%. as far as gini coefficient in the banking sector in the group of analyzed countries is concerned, it can be stated that the average values of the gini coefficient show relatively similar values of the concentration according to the total loans granted to the nonfinancial sector (0.68), the deposits collected from the nonfinancial sector (0.67) and the total balance sheet (0.66). generally, average values are in the medium to high concentration zone. values of the gini coefficient, according to the total assets of the banking sector, show that serbia, bulgaria, albania and partially montenegro have values of 0.5. other countries in the analyzed region recorded values ranging from 0.6 to 0.8, with the highest degree of market share inequality in croatia in the observed period. according to the criterion of loans granted to the nonfinancial sector, the level of concentration measured by the gini coefficient gives similar results as in the previous case. thus, in the four of the six analyzed countries in the region there is a high value of the gini coefficient ranging from 0.6 to 0.8. obtained values of the gini coefficient for deposits collected from the non-financial sector show that croatia and bosnia and herzegovina, with values above 0.7, may be ranked as markets with a high degree of inequality of market share distribution. 2 serbia and romania are excluded from the average values according to the criterion of loans granted to the non-financial sector and collected deposits of the non-financial sector due to the lack of data. 146 economic analysis (2019, vol. 52, no. 2, 137-151) based on total assets of banking sector based on loans granted to non-financial sector based on collected deposits from non-financial sector figure 3. gini coefficient in banking sector source: based on authors' calculations our previous research, in which the indicators cr4 and hhi were calculated, showed that the degree of concentration and inequality in the banking sector in the region stagnates in the observed period. on the basis of the calculated average values of the cr4 indicator, the banking maja dimić, svetislav paunović 147 market, measured by all three criteria of development, belongs to a group of highly concentrated markets (above the 50% limit value). contrary to the share indices of the four largest banks', the average values of hhi in the banking sector in the region, according to all three analyzed development criteria, show the values which indicate a mid-concentrated market (from 1,000 to 1,800 points). the following table presents data that relate to the variability (expressed by coefficient of variation) of the gini indicator on the banking market according to countries in the period 20072012 as well as data related to the variability of the gini indicator among countries per years. the obtained results show that values of coefficients of variation among countries, according to all three criteria of development, are greater than the variation that occurred in individual countries. coefficients of variation of the gini indicator show that the biggest changes occurred on the banking market of montenegro (loans granted to the non-financial sector 15.3%), while on the other hand, the least oscillation was present on the banking market in croatia. regarding the coefficients of variation between countries, the maximum values (all three indicators of the banking sector's development) were recorded in 2012. table 3. coefficients of variation of the gini coefficient (in %) in banking sector coefficient of variation in countries in the period 2007-2012 coefficients of variation among the countries per years country balance sheet total granted loans collected deposits year balance sheet total granted loans collected deposits serbia 1.6 n.a. n.a. 2007 11.3 10.7 10.6 croatia 1.0 1.1 1.3 2008 11.1 11.0 10.7 bosnia and herzegovina 5.5 6.1 6.4 2009 11.4 12.9 12.0 montenegro 13.1 15.3 12.4 2010 12.8 13.8 12.5 macedonia 4.5 3.4 5.5 2011 12.8 14.3 13.0 romania 2.4 n.a. n.a. 2012 13.1 14.8 13.7 bulgaria 2.0 0.6 1.1 albania 1.6 2.7 3.2 source: authors' calculations the following table summarizes the ranking of countries according to analyzed indicators of concentration in the banking sector based on the criterion of the balance sheet total in 2007 and 2012 (the rank 1 represents the highest level of concentration, while the rank 8 represents the lowest level of concentration). according to the largest number of analyzed indicators of concentration, the banking market in serbia was the least concentrated market in the group of analyzed countries in the observed period. also, an overview of country rankings changes according to the concentration indicators in the banking sector (regarding the criterion of balance sheet total) was prepared. the results obtained show that there were no significant changes in the ranking of countries according to certain concentration indicators in the analyzed period. thus, the ranking of countries according to the indicator cr4 remained unchanged in 2012 compared to 2007 in all analyzed countries. the highest oscillations were recorded in the ranking of countries according to the hh index (in five out of eight countries). analyzed by countries, the banking market in romania and serbia did not record changes in country ranking according to none of the analyzed concentration indicators in the observed period. 148 economic analysis (2019, vol. 52, no. 2, 137-151) table 4. country ranking and change in ranking (according to concentration indicators based on total assets) 2007 2012 change in country ranking cr4 hhi g cr4 hhi g cr4 hhi g serbia 8 8 7 8 8 7 = = = croatia 3 5 1 3 4 1 = -1 = bosnia and herzegovina 2 4 3 2 1 3 = -3 = montenegro 5 1 8 5 5 8 = +4 = macedonia 1 2 4 1 3 6 = +1 +2 romania 6 6 2 6 6 2 = = = bulgaria 7 7 5 7 7 4 = = -1 albania 4 3 6 4 2 5 = -1 -1 source: authors' calculation our research has shown that there are differences in the degree of correlation among the analyzed concentration indicators. because of that, in terms of statistics, it is difficult to talk about the capacity of only one indicator, if analyzed independently, to show the real nature of competition in the banking sector in the analyzed countries and to provide quality estimates of possible future movements. a statistically significant positive correlation between the indicators cr4 and hhi (0.911) was found with the significance threshold of 0.01, as well as the relative weak correlation of the gini coefficient with the indicators of cr4 and hhi. in this context, in order to have a more accurate insight into the concentration level, it is necessary to include a greater number of concentration indicators as well as their integral understanding. table 5. pearson correlation coefficient between concentration indicators (according to the criterion of total assets) cr4 hhi g cr4 pearson correlation 1 .911** .209 sig. (2-tailed) .000 .154 n 48 48 48 hhi pearson correlation .911** 1 -.023 sig. (2-tailed) .000 .876 n 48 48 48 g pearson correlation .209 -.023 1 sig. (2-tailed) .154 .876 n 48 48 48 **. correlation is significant at the 0.01 level (2-tailed). *. correlation is significant at the 0.05 level (2-tailed). source: authors' calculation additionally, a qualitative assessment of common and specific elements characteristic for the sector (nature of the market and the relationship between competitors on it) is needed (lipczynski & wilson, 2001). these elements have greatly influenced or will affect the development of banking in the analyzed countries. starting from the research in which deidda & fattouch (2005) analyzed the relationship between economic growth and bank concentration, concluding that in relatively underdeveloped countries the concentration in the banking sector was negatively correlated with economic growth, we tried to test the strength of the relation between the concentration level (expressed by cr4, hhi and g concentration indicators) and the gross domestic product per capita (gdp per capita) indicator, using the correlation of ranking, on the example of analyzed countries in 2007 and 2012. maja dimić, svetislav paunović 149 table 6. spearman's correlation coefficient between the concentration indicators (according to the criterium of total assets) and gross domestic product per capita 2007 2012 gdp per capita gdp per capita cr4 correlation coefficient -.310 cr4 correlation coefficient -.333 sig. (2-tailed) .456 sig. (2-tailed) .420 n 8 n 8 hhi correlation coefficient -.286 hhi correlation coefficient -.571 sig. (2-tailed) .493 sig. (2-tailed) .139 n 8 n 8 g correlation coefficient .381 g correlation coefficient .452 sig. (2-tailed) .352 sig. (2-tailed) .260 n 8 n 8 source: authors' calculation obtained spearman’s coefficient values argue that the level of concentration in the banking sector is poorly correlated with the level of economic development, since in all observed parameters the correlation value is moving to the zone of very low values. this, on the one hand, points to the fact that the analyzed countries at relatively similar levels of development had significantly different levels of concentration, but also the fact that some countries, although at different levels of development, had similar levels of concentration of the banking sector. in the first case, a group of countries that have almost equal gdp per capita (serbia, bosnia and herzegovina and macedonia) had large differences in the level of concentration. on the other hand, although croatia and albania vary significantly according to the level of economic development (three times higher gdp per capita in croatia than in albania in 2012), they have similar levels of concentration in the banking sector (according to total assets). having in mind the analyzed development criteria (balance sheet, granted loans and collected deposits), it can be stated that the banking sector in the region lags behind the banking sector in the eu countries, primarily due to the low and underdeveloped market, political, economic and credit risks, but also insufficient innovativeness and high poverty rates. most of the reform reflected in the privatization of state-owned banks and the opening of the domestic financial market for foreign investments. at the beginning of the restructuring process, the domination of state-owned banks was noted. several years after, the market share of foreign investors was higher. regarding the number of participants in the banking market, in the number of banks in the region was stagnant. the lack of interest of foreign banking groups can be explained by the fact that fewer banks have been attractive for takeover, that the banking market in the region is oversaturated, that the banking profit margins have fallen (due to which many investors left the market in the region), but also the negative effects of the world economic crisis, which have led to the increase in the venture investments and the fall in liquid assets available to foreign investors. conclusion the results obtained by empirical research in analyzed countries in the period 2007-2012 indicated high average level of concentration in the banking sector measured by gini coefficient. regarding the hypothesis 1, the results of the correlation analysis of the cr4, hhi and the gini coefficient indicated significant differences in the degree of correlation between individual concentration indicators. from the findings of the conducted research we can conclude that relatively different conclusions can be drawn about the level of concentration on the banking market in the analyzed countries in the region while using different techniques and indicators of concentration. if analyzed individually, the indicators have relatively low capacity to present the real nature of competition in the banking sector in the observed countries as well as to provide a 150 economic analysis (2019, vol. 52, no. 2, 137-151) good estimation of possible future trends. therefore, simultaneous analysis of several concentration indicators is needed. regarding the hypothesis 2, our research indicated that the degree of concentration in the banking sector is poorly correlated with the level of economic development. in order to obtain clearer images of market concentration in the financial sector, recommendation to decision-makers in referent institutions and regulatory bodies is to include a greater number of concentration indicators in their reporting on the level of concentration in the banking sector, which can contribute to a more precise definition of adequate policies and legal regulations in this area. in addition to the quantitative analysis of the level of concentration, it is also necessary to qualitatively assess the common as well as the specific elements of the banking sector in the countries of the region. in this context, it is necessary to take into account the specificities of individual countries (institutional barriers, geographic barriers to entry, macroeconomic indicators and historical aspects) as well as the characteristics of the banking sector. the referent regulatory bodies are expected to establish appropriate mechanisms and instruments of economic and financial policy and controlling as well as to define legal regulation in this area that will encourage the enlargement of the market scene in the analyzed sectors (which should contribute to further business efficiency), but also to prevent the creation of undesirable and over-concentrated markets and market structures. in this context, the approach and methodology used in this research can contribute to a better and more accurate understanding of all 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''role of foreign banks in integration of banking industry’’ economic journal, 22(2):296-313. article history: received: may 29, 2019 accepted: september 27, 2019 doi: 10.28934/ea.21.54.2.pp82-93 preliminary report design and packaging an important factor in consumer behavior when buying juices merima činjarević1 | emir agić2 | enisa dizdarević3 | adi alić2 muamer halilbašić40f* 1 university of sarajevo, school of economics and business, department of microeconomics, sarajevo, bosnia and herzegovina 2 university of sarajevo, school of economics and business, department of marketing, sarajevo, bosnia and herzegovina 3 university of sarajevo, school of economics and business sarajevo, sarajevo, bosnia and herzegovina 4 university of sarajevo, school of economics and business, department of economics, sarajevo, bosnia and herzegovina abstract the primary purpose of this research is to investigate the consumers’ implicit taste associations (sweetness. freshness, and naturalness) towards the color of product packaging in the context of the non-alcoholic beverage product category – orange juice. moreover, the current research aims to assess how incongruity, as opposed to congruity, between the color package and product color-code/norm may shape a consumer's evaluation (liking/disliking) of a product. the findings indicate that green appears to be the color that would lead to the highest perception of freshness and naturalness. in contrast, grey is the color implicitly associated with artificial flavors and perceived to be stale. the results of this study do not provide evidence for the existence of color/taste correspondences in terms of perceived sweetness. also, findings suggest that incongruent (atypical) color package – white, might lead to more favorable consumer attitudinal responses than the product’s color-code package – orange. the current research offers relevant insights for both researchers and practitioners. key words: package color, taste, cross-modal correspondences, orange juice jel classification: m31 introduction in the modern market, consumers are faced with a mélange of products and advertising messages, making the entire buying process highly complex. even though many factors have a bearing on what and why consumers buy, when consumers purchase day-to-day products such as snacks, candies, or soft drinks, they tend to make quick choices among available product alternatives based on visual cues (spence & velasco, 2018). although consumers can rely on other sensory cues (e.g., auditory cues, haptic cues) to make their product judgments, the use of visual cues seems to dominate over other single-sensory signals. bearing this in mind, marketers and product designers are trying to create compelling visual cues to lure the consumers' attention and influence consumers' evaluation of products or brands (kauppinen-räisänen & jauffret, 2018). considering that the color is the first visible feature of a product noticed by the consumer, the * coressponding author, muamer.halilbasic@efsa.unsa.ba merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 83 color of a product packing is regarded as the vital visual cue (e.g., piqueras-fiszman & spence, 2011; spence & velasco, 2018). hence, the choice of color of product packing plays a significant role at every stage of the buying process and drives the consumer along the marketing funnel, i.e., attention-interest-desire-action (beneke et al., 2015). the fundamental premise is that the color package almost instantly creates the sensory and high-order expectations of the product (e.g., freshness, sweetness, crispiness). this is particularly true for low-involvement and low-cost products such as food and beverages (beneke et al., 2015; lyons & wien, 2018). however, it is necessary to highlight that using the color package in evoking the favorable first impression of the product and eliciting positive consumers’ responses at different stages of the buying process is a challenging task. in some cases, by changing the color package, the company may succeed at the first stage of the buying process, i.e., grabbing consumers' attention and encouraging them to buy on impulse (spence & velasco, 2018). however, the same company may experience failure at the second moment of truth by discovering that the consumers are experiencing post-purchase dissonance or buyer's remorse (garber et al., 2000; spence & velasco, 2018). the story of crystal pepsi shows what happens when the change in the color of a product package does not meet consumers’ expectations about the product’s sensory attributes (e.g., taste). pepsi co. introduced crystal pepsi in 1992 as a caffeine-free version of traditional pepsi cola. to underline the characteristics of the new soda drink and as well as to attract consumer's attention, pepsi co. replaced the typical color (dark brown) with an atypical one (transparent color). crystal pepsi was advertised with the slogan "you've never seen a taste like this", pointing out the change of color packing and introducing the new taste. however, when crystal pepsi was released, the consumer reaction was less than enthusiastic. one year after the launch, pepsi co. discontinued the production and sale of crystal pepsi. it has been argued that the drastic change in color package (transparent color) has contributed to the failure of crystal pepsi. more precisely, based on the transparent-colored package of crystal pepsi, consumers had created expectations that new soda drinks would have different tastes compared to regular coke. they were displeased when the new product tasted almost the same (krishna et al., 2017). the case of crystal pepsi demonstrates that a color package can induce consumers' sensory expectations (taste/flavor) and affect the consumers’ positive or negative evaluation (liking/disliking) of a product or a brand. the phenomenon of cross-modal correspondences can explain the color-induced expectations of the sensory properties of a product. previous research has shown that consumers express consistent cross-modal correspondences across the different types of sensory stimuli (e.g., spence & deroy, 2014; velasco et al., 2016). several studies demonstrated that consumers tend to match specific tastes with product package's particular visual attributes, including the color, shape, and graphics (e.g., velsco et al. 2016; piquerasfiszman et al., 2012). one of these cross-modal correspondences that have particularly attracted the attention of both scholars and practitioners is the color-taste/flavor correspondences (e.g., barnett & spence, 2016; carvalho et al., 2017). cross-modal correspondences of the color package and taste can be explained by the fact that people are inclined to associate basic tastes (e.g., bitter, sweet, sour, salty) with a particular color of product/brand packaging (spence et al., 2015). for instance, black and brown packages are associated with bitter tastes, yellow packages with sour flavors, and red and orange packages with sweet tastes (spence et al., 2015). moreover, extant literature implies that consumers are also prone to associate a specific package color with a particular product category. for instance, consumers usually expect to find different milk brands in white boxes, water in blue containers, and dark chocolate in red packages. these specific expectations regarding the match (congruency) between the color of a particular product and the typical package color traditionally associated with its product category are known as color codes/norms (garaus & halkias, 2019). previous research reveals that consumer's perception of congruity/incongruity of the color package with color code/norm can influence consumer responses. 84 economic analysis (21, vol. 54, no. 2, 82-93) although the color-taste correspondences have been explored across a range of food and beverage products, the associations between the color package and expectations about the taste of orange juice remain unexplored. orange juice is an appealing product choice for this research since it is the most popular fruit juice flavor, well-known for its health benefits (kim et al., 2013). albeit the study's findings published by deliza et al. (2003) suggest that orange juice is very likely to be a product where color/taste correspondences exist, additional research is required to validate this claim. in terms of congruity/incongruity of product package with product category color norm, extant research suggests that orange is a typical color associated with orange juice (garaus & halkias, 2019). however, there is a lack of research exploring the effect of the atypical color of orange juice package on consumer responses (liking/disliking). given that schema incongruity theory postulates that moderate deviations from consumers' expectations may lead to positive responses, it is lucrative to investigate the consumers' preferences toward typical color packages of orange juice. the present study aims to: (1) examine consumers' implicit taste associations (sweetness, freshness, and naturalness) toward the color packages of orange juice; (2) assess consumer evaluation (liking/disliking) toward the color of orange juice package by including both typical and atypical product category colors. theory and hypotheses color-taste correspondences the fundamental premise of crossmodal correspondences is that individuals tend to match a " consistently sensory feature, or attribute, in one modality—either physically present or merely imagined—with a sensory feature in another modality” (deroy & spence, 2013, p. 644). according to spence (2011), three different mechanisms can trigger crossmodal correspondences: structural, statistical, and semantic. structural correspondence refers to the innate tendency of the human brain to assign more profound meaning to the stimulus using the neural mapping of sensory stimuli. statistical correspondence is the result of perceptual learning, and it reflects the learned correlation between attributes of different sensory stimuli. semantic correspondence occurs when standard linguistic terms are used to describe different stimuli. although the theory of crossmodal correspondences is deeply rooted in cognitive psychology, it has also been applied in packing design research. in terms of food and beverage packing design, most researchers have focused on how visual stimuli (e.g., shape, color) can influence basic tastes. regarding the shape, it has been established that angular package shape is associated with bitter, sour, and salty tastes while rounded package shape is related to sweet and rich/creamy tastes (chen et al., 2018; spence & ngo 2012). moreover, previous research suggests that manipulating the package shape itself may influence the intensity of taste. for instance, becker et al. (2011) examined how the shape of the lemon yogurt package (angular vs. rounded) affects the taste intensity. they found that an angular, as opposed to a rounded, package shape is related to the higher level of taste intensity. also, it has been demonstrated that glass/cup shape may influence the taste/aroma of wine, beer, and coffee (delwiche & pelchat, 2002; mirabito et al., 2017; van doorne et al., 2017). for instance, van doorne et al. (2017) confirmed the existence of shape-taste symbolism in the case of milk-based coffee drinks (cappuccino). more precisely, their study revealed that shape influences the expected liking, bitterness, and the rated quality of the cappuccino. also, they found that angular shape, compared with a rounded shape, is associated with a higher level of likeability, bitterness, and the drink's quality. previous research has also confirmed the existence of color-taste symbolism. koch and koch (2003) explored the associations between ten colors (red, green, yellow, blue, brown, orange, purple, black, grey, and white) and eight tastes (sweet, sour, bitter, salty, citrusy, syrupy, fruity, and bubbly) in the context of soft drinks. they found that five out of ten colors are associated with basic tastes, namely red and orange, related to sweet tastes, green and yellow to sour tastes, and merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 85 white to bitter and salty tastes. the colour/taste correspondences have been also validated in other studies (e.g., ares & deliza, 2010; piqueras-fiszman & spence, 2011; piqueras-fiszman et al., 2012; rebollar et al., 2012). moreover, it has been suggested that color saturation, i.e., the intensity of color, may affect the intensity of the product taste. for instance, becker et al. (2011) found that highly saturated color is associated with more intense taste sensations by manipulating the saturation level of lemon-greenish-colored yogurt package. tijssen et al. (2017) showed how the manipulation of color attributes (hue, brightness, and saturation) affects the consumer's expectations about the taste of a product as well as the evaluation of a product. by using the implicit association tests (iats), they demonstrated that red package is associated with the highest expectations for sweetness, creaminess (dairy milk), fattiness (sausage), and flavor intensity (dairy milk and sausage). also, the study's findings of tijssen et al. (2017) confirmed that the expected intensity of taste could be manipulated by changing two attributes of color, namely the brightness and the saturation. overall, previous research indicates that color package attributes (hue, brightness, saturation) are likely to be transferred to the consumer's evaluation of the product itself (see table 1. for a review of selected studies published in this area). table 1. review of studies that have investigated the association between the color package and sensory properties of a product author(s) (year) product package color studied main findings ares and deliza (2010) milk dessert yellow black white milk dessert in the yellow package was perceived to be sweet, delicious, vanilla flavor, and dulce de leche. milk dessert in the black package was perceived to be bitter with chocolate flavor. milk dessert in the white package was perceived to be sour and tasteless. becker et al. (2011) yogurt yellowgreenish yogurt from the high saturated yellow-greenish package was perceived to have more intense taste than yogurt from the low saturated yellowgreenish package. rebollar et al. (2012) chewing gum warm colors cold colors grey chewing gums from warm-colored packages were judged to be fruity, sweet, and acidic. chewing gums from cold and grey-colored packages were judged to be spicey and with menthol flavor. piquerasfiszman et al. (2012) strawberry mousse white black mousse served at a white plate, compared to the same mouse served at a black plate, was perceived to be more intense and sweeter. piquerasfiszman and spence (2012) hot chocolate white cream red reddish orange hot chocolate served in orange (with a white interior), and dark-cream colored cups increased the chocolate flavor of the drink and, thereby, improved acceptance of the beverage. hot chocolate served in the dark-cream cup was perceived as sweeter and with a more intense aroma. beneke et al. (2015) bottled water warm colors neutral colors cold colors consumers preferred the neutral-colored package as opposed to neutral and cold-colored packages. 86 economic analysis (21, vol. 54, no. 2, 82-93) author(s) (year) product package color studied main findings huang and lu (2015) breakfast cereal ice-cream iced tea yogurt red blue green the majority of respondents associated the red packaged products with a sweet taste, whereas the green and blue-colored packaged products are associated with healthiness. tijssen et al. (2017) dairy drink sausage blue (both products) purple (dairy milk) red (both products) green (sausage) dairy milk from the red-colored package was perceived to be more taste intense and sweeter. sausage milk from the red-colored package was perceived to taste more intense and high-fat. the relationship between color brightness expected the intensity of taste depends on the product category (positive relationship of dairy brink but negative for sausage). the relationship between color saturation and the intensity of taste was found to e positive for both products (dairy milk and sausage). da rosa et al. (2019) cookies (buttery vs. cereal) grey blue-to-green red-to-yellow cookies from red-to-yellow and blue-to-green colored packages were preferred over the cookies from the grey-colored package. ares and deliza (2010) milk dessert yellow black white milk dessert in the yellow package was perceived to be sweet, delicious, vanilla flavor, and dulce de leche. milk dessert in the black package was perceived to be bitter with chocolate flavor. milk dessert in the white package was perceived to be sour and tasteless. based on this backdrop, we formulated the following hypotheses: h1: orange juice from the warm-colored package is perceived to be sweeter than orange juice from cold-colored and neutral-colored packages (white and grey). h2: orange juice from cold-colored packages is perceived to be fresher than orange juice from warm-colored and neutral-colored packages. h3: orange juice from cold-colored packages is perceived to be more natural than orange juice from warm-colored and neutral-colored packages. typicality in color packing marketing scholars argue that consumers tend to organize products within their corresponding product category based on the level of perceived typicality (celhay & trinquecoste, 2014). in the case of the color package, the typicity refers to the degree to which the color of the product package conforms the generic color code/norm of its category (van ooijen et al., 2016; garaus & halkias, 2019). for instance, a color code typically used for ketchup is red, mayonnaise yellow, and organic food green. the rationale behind the choice of color codes in packing is that such stimuli are processed more fluently than other stimuli (winkielman et al., 2006). also, they are positively related to the consumer emotional and attitudinal responses (garaus & halkias, 2019). however, incongruity theory suggests that using an atypical color package may attract consumer attention and lead to more positive responses (van ooijen et al., 2016; schoormans & robben, 1997). spence and velasco (2018) pointed out how nabisco' breakfast cereal brand alpen moved merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 87 away from predominantly bright color code and embraced the black product packing to stand out from other breakfast cereal brands. against this backdrop, we formulate the following hypothesis: h4: atypical package color, compared to the typical package color, will lead to a more favorable attitude (liking) toward a product. methodology stimulus development considering that color associations differ among cultures, a pre-study was conducted to identify a standard package design for a selected product (orange juice) in the country where research was performed bosnia and herzegovina. the findings of the pre-study were used as a framework for developing mock packages for a fictional brand of orange juice named orange splash. we created mock packages and a fictional brand to avoid potential bias in consumer responses (e.g., familiarity with existing brands and consumers' habits). also, the findings of our pre-study allowed us to select realistic typical and atypical package colors for orange juice. using google's image search, we found that orange is a typical package color for orange juice, while white can be qualified as potential atypical color. to examine the presence of color-taste symbolism, we selected five colors, namely orange (corresponding to the warm-colored package), black and green (corresponding to the cold-colored packages), and grey and white (corresponding to the neutral-colored packages). in line with previous studies, we manipulated only the hue, holding other attributes of color (value and saturation) constant. furthermore, we did not include other visual and verbal packing elements (shape, size, graphics, country of origin, etc.) in mock packages to avoid potential interaction effects between the package color and other package attributes. the visual design of the mock package was created in adobe photoshop by a professional designer. participants and procedure two hundred fifty-five undergraduate students from the largest university in bosnia and herzegovina participated in the experiment. participants were randomly assigned to five experimental groups, and each group was exposed to a different stimulus. considering the treatment design, each participant had the opportunity to see and rate only one out of five images of mock packages. participants were asked to evaluate taste properties of orange juice using the three semantic differential scales, namely sweet/sour, fresh//stale, and natural/artificial. each of these scales had seven categories, represented by numbers ranging from -3 to +3. for instance, sweetness scale had 7 categories, namely “very sweet” (-3), “sweet” (-2), “slightly sweet” (-1), “neither sweet nor sour” (0), “slightly sour” (+1), “sour” (+2), and “very sour” (+3). at the end of the experiment, respondents were exposed to all stimuli (five different mock packages), and they were asked to rate the liking of each package, using the 5-point likert scale (1 – “most preferred” to 5 – ‘’the least preferred”). analysis and research findings table 2. describes the respondents’ demographic characteristics. out of 255 respondents, 63.5 percent were female and 36.5 percent male. all respondents were young consumers, and the majority of them were 18-20 years old. in terms of frequency of purchase, 13 percent of respondents have purchased orange juice daily. more than one third of respondents (37.2 percent) are heavy buyers of orange juice since they are buying orange juice on daily or weekly basis. one-third of the respondents (27.8 percent) are light buyers as they have purchased orange juice at least once in a month. the most preferred orange juice brands are cappy, juicy, and fructal. 88 economic analysis (21, vol. 54, no. 2, 82-93) table 2. demographic profile of respondent variables categories frequency (%) gender female 63.5 male 36.5 age 18 – 20 years old 69.9 21 – 24 years old 30.1 frequency of orange juice purchase on daily basis 13.3 at least once per week 23.9 2 – 3 times per month 34.9 at least once per month 27.8 type of favorite orange juice brand juicy 35.7 cappy 44.3 fructal 15.3 others (rauch, takovo, to) 4.7 source: author’s own research an anova analysis was used to test potential differences in consumers' evaluation of orange juice taste (sweetness, freshness, naturalness) among five different colors of orange juice package. when those differences were significant, genuinely significant differences were determined by employing the post-hoc for pairwise comparison. observed differences were regarded as significant if the p-value was 0.05 or lower. statistical analyses were carried out using spss. to assess the reliability and validity of anova statistics, levene's test of homogeneity of variances was carried out. for two variables (“sweetness” and "naturalness"), the f values of levene's test were greater than 0.05, indicating that null hypothesis (no difference) for the assumption of homogeneity of variance is met. on the other hand, f-value of levene’s test for the variable “freshness” was less than 0.05, suggesting that null hypotheses (no differences) for the assumption of homogeneity of variance can be rejected. given that the assumption of homogeneity of variance is violated for two variables (“sweetness” and “naturalness), we employed games-howell’s post hoc test for pairwise comparison instead of tukey post hoc test. table 3. means and differences with tukey's test and games-howell's post hoc test for color/taste cross-modal correspondences taste attributes warm color cold colors neutral colors f statistic s p-value orange (a) green (b) blue (c) white (d) grey (e) sweetness 1.34 1.38 1.74 1.30 1.12 1.322 0.262 freshness -1.48 -1.78c,e 1.00b 1.40 1.19 2.184 0.071* naturalnes s 0.10 0.69e -0.08 0.53e -0.22 2.268 0.062* note: values with different superscripts in the mean are significantly different (p < .05) according to tukey’s test and games-howell’s post hoc test means in a column based on the 7-point likert scale ranging from -3 (sweet/fresh/natural) to +3 (sour/ stale/artificial) source: author’s own research an anova analysis showed no significant differences in perception of sweetness between the five experimental groups ((f(1.322); p>0.05). therefore, hypothesis h1: orange juice from warmcolored package is perceived to be sweeter than orange juice from cold-colour packages and neutral-colored packages, is not supported. surprisingly, findings revealed that all five selected merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 89 colors are associated more with sour tastes than with sweet tastes. regarding the general premise that cold-colored packages are perceived as fresher than warmand neutralcolored packages, results of anova confirmed this assumption ((f(2.184), p<0.05). the pairwise comparisons test indicates that a significant difference in the perception of freshness exists between cold-colored and natural-colored packages. tukey’s post hoc test revealed that orange juice in the greencolored package was perceived as fresher than that in the grey-colored package. furthermore, a significant difference was observed in the perception of freshness between green-colored and blue-colored packages, indicating that green color is associated more with freshness than blue. however, it should be noted that no significant differences in the perceived freshness of orange juice were found between green and orange packages and green and white packages. this result suggests that green, orange, and white packages are closely associated with the perceived freshness of orange juice. since significant differences in the perception of freshness were observed between green (cold color) and grey (neutral color) packages, hypothesis 2: orange juice from cold-colored packages is perceived to be fresher than orange juice from warm-colored and neutral-colored packages, is partially supported. in terms of perceived naturalness, significant differences were found between five experimental groups (f (2.268), p<0.05). gameshowell’s post hoc test for pairwise comparisons showed a significant difference in the perceived naturalness of orange juice among green and grey packages and white and grey packages. no significant differences were observed between the other pairs of color packages. this result indicates that green and white packages are closely associated with the perception of naturalness. bearing this in mind, hypothesis h3: orange juice from cold-colored packages is perceived to be more natural than orange juice from warm-colored and neutral-colored packages, is partially supported. in line with our expectations, the atypical color of the orange juice package – white (mean rank = 2.54), led to a more favorable attitude (liking) than the typical color – orange (mean rank = 2.80). moreover, the friedman rank sum test shows that consumer preferences toward a product differ among different package colors (χ=52.97; p<0.01). thereby, hypothesis h4: atypical package color, compared to the typical package color, will lead to a more favorable attitude (liking) toward a product, is supported. however, we should note that incongruity with the product category color norm in some cases (grey-colored package) resulted in a less favorable attitude /liking) than typical color-orange. discussion and conclusion the present study was designed to explore the degree to which consumers implicitly associate particular tastes (sweetness, freshness, and naturalness) to specific product packaging colors. against this backdrop, this study provides compelling empirical evidence to support the existence of cross-modal correspondences between color and taste (color/taste correspondences) in product packaging. more precisely, the current study investigates how cold-, warm-, and neutralcolored packages are tied to the perceived sweetness, freshness, and naturalness of a product (i.e., orange juice). the overall results indicate that green seems to be the color that would lead to the highest perception of freshness and naturalness. in contrast, grey is the color that is implicitly associated with artificial flavors and perceived to be very stale. contrary to our expectations, we did not confirm the effect of package color on the perception of sweetness. this finding contradicts extant research arguing that warm colors (e.g., orange, red) are likely to stimulate the taste of sweetness (e.g., rebollar et al., 2012; spence et al., 2015; tijssen et al., 2017). one way to explain why warm color (orange) did not evoke the highest level of perceived sweetness in our study is that the color/taste correspondences vary across cultures (carvalho & spence, 2019). another possible explanation is that sweetness is not a taste attribute that is primarily associated with the chosen beverage (orange juice). grounded in the schema incongruity theory, the present study was carried out to investigate how the use of typical and atypical package colors influences consumer's attitudes 90 economic analysis (21, vol. 54, no. 2, 82-93) (liking/disliking) toward a product. our findings suggest that the deviation from the generic color code/norm of product category might trigger a more favorable attitude (liking) toward a product. more specifically, findings suggest that consumer attitude toward a product (orange juice) differs among different product packaging colors. in terms of typicity, results reveal that a whitecolored-package is likely to lead to a more favorable attitude (liking) toward a product (orange juice) than orange, confirming the product's color code/norm. however, it should be noted that previous research have showed that some consumer segments (e.g., young consumers, consumers with higher level of innovativeness, consumers who are 'expert' in product category) are more prone toward atypical packaging (celhay & trinquecoste, 2015). considering that our sample includes only young consumers (18-24 years old), the reported propensity toward the atypical color of a package, opposite to the typical color of a package, is not particularly surprising. the present study contributes to the extant literature in marketing and food science by exploring the applicability of color/taste correspondences in the context of non-alcoholic beverages, namely orange juice. the findings extend our knowledge about the phenomenon called ‘sensation transference' in the area of product packing design by providing empirical support to the idea that people are inclined to transfer sensations and perceptions derived from product packing elements to the product itself. more precisely, the present study suggests that green is the color that is most related to the perception of sweetness and freshness of orange juice. furthermore, the current research contributes to the schema incongruity theory by demonstrating that incongruity, opposed to congruity, between the color package and product color-code/norm may generate more positive attitudinal responses toward the product. the current research provides managerial implications for orange juice manufacturers and packing designers. since consumers tend to associate a specific color of orange juice packing to certain taste attributes, orange juice manufacturers should concentrate not only on the taste properties of orange juice itself but also on the visual elements of product packing. by changing the color of product packaging, the marketers may shape consumers' expectations/perceptions regarding the taste of the orange juice stored in such packing. if marketers want to trigger expectations/perceptions of freshness and naturalness, they should opt for green-colored packages. moreover, marketers should use trial experiments to assess consumers' attitudinal and emotional responses toward the typical (orange) and atypical (white) orange juice package. although our study suggests that white-colored package is likely to lead to favorable consumers' responses, marketers should be cautious about using atypical package colors. any deviation from the typical package color may generate confusion about the product and lead to negative feelings and attitudes (garaus & halkias, 2019). the present study has some limitations that offer pathways for further research. first, in the current research, only the package color is manipulated to avoid any potential interaction between the package color and other visual and verbal elements of packing (e.g., shape, graphics, nutritional claims, etc.). although this decision enabled us to assess the isolated effect of color packages on consumers' evaluation of a product, it does not reflect the real-life correspondences among multiple stimuli. thus, future research should emphasize the possible cross-modal correspondences between color, shape, and taste attributes. moreover, our research focuses on only one product category – orange juice, which makes the results merely applicable to this product category. thereby, future studies are encouraged to deepen our knowledge about color/taste correspondences in the context of other food and beverages. moreover, in this study, the selection of package colors was based on the pre-study carried out using the google picture search engine. thereby, qualitative research addressing the issue of correspondence between package colors and taste attributes would be welcomed in the future. such research may contribute to identifying taste attributes and package colors that are relevant for the chosen product category and, thereby, provide more reliable findings regarding the color/shape symbolism. lastly, the present study focuses only on younger consumers (18 – 24 years old). since color/shape symbolism and reactions to (a)typicity of color packages may vary across different merima 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“on tasty colours and colourful tastes? assessing, explaining, and utilizing crossmodal correspondences between colours and basic tastes.” flavour, 4: 23. doi: https://doi.org/10.1186/s13411-015-0033-1 tijssen, irene, cees de graff, elizabeth h. zandstra, and gerry jager. 2017. “why a 'light' product should not be light blue: effects of package color on perceived healthiness and attractiveness of sugar-and fat reduced products.” food quality and preference, 59: 46-58. van doorn, george, andy woods, carmel a. levitan, xiaoang wan, carlos velasco, cesar bernal-torres, and charles spence. 2017. “does the shape of a cup influence coffee taste expectations? a cross-cultural online study.” food quality and preference, 56: 201–211. van ooijen, iris, marieke l. fransen, peeter w.j. verlegh, and edith g. smit. 2016. “atypical food packaging affects the persuasive impact of product claims”. food quality and preference, 48: 33-40. velasco, carlos, andy t. woods, olivia petit, adrian d. cheok, and charles spence. 2016. “crossmodal correspondences between taste and shape, and their implications for product packaging: a review.” food quality and preference, 52: 17–26. merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 93 winkielman, piotr, jamin halberstadt, tedra fazendeiro, and stave catty. 2006. “prototypes are attractive because they are easy on the mind.” psychological science, 17: 799–806. article history: received: september 9, 2021 accepted: october 18, 2021 design and packaging an important factor in consumer behavior when buying juices merima činjarević1 | emir agić2 | enisa dizdarević3 | adi alić2 muamer halilbašić40f* introduction theory and hypotheses color-taste correspondences methodology stimulus development participants and procedure analysis and research findings discussion and conclusion references microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp97‐108 scientific review organizational culture in serbian companies according to the denison model snežana kirin1 | gordana gavrić2* | sandra kirin3 1 university of belgrade, innovative center of faculty of mechanical engineering 2 faculty of business economics and entrepreneurship, department for management 3 statistical office of the republic of serbia abstract the phenomenon of organisational culture is an important source of competitiveness of today's organisations, and therefore, organisational culture is an important research topic of modern management science. finding the balance between diametrically opposite requirements, for stability and flexibility, is a challenge in managing organisations in a modern business environment. these requirements are incorporated into denison's model of organisational culture, applied in this research on companies in serbia. according to the denison model, organisational stability factors are its mission and consistency, while factors that characterise its flexibility are the organisation's adaptability and the involvement of employees. a well‐formulated mission with which all employees are familiar makes the organisation unique on the path to achieving the desired goal. consistence that relates to a well‐defined system of values and rules facilitates resolving conflicts and other problems in the day‐to‐day functioning of the organisation. on the other hand, organisations with high participation of employees are more efficient and more likely to implement changes, while the ability to quickly and adequately adapt to challenges from the environment allows organisations to preserve their competitiveness on the market. the obtained results of the research showed that there is a balance of the factors of stability and flexibility, which according to the model is a welcomed result, but also that there is a significant place for improvements in the organisational culture. the results presented in this paper may serve as useful information for policymakers to plan changes that improve business efficiency. key words: organisation culture, denison model, mission, the involvement of employees, consistency, adaptability, serbian companies jel classification: m14 introduction today's business environment is marked by the fourth industrial revolution characterised by the growing demand for connectivity, communication and networking, automation, digitisation, flexibility, “smart” management, ecology, and social responsibility. complex business conditions increase business risk and the importance of organisational culture, which permeates all the activities of organisations, becomes more and more prominent. “due to the complexity of the human factor in the company, it takes a lot of expertise and relevant skills to successfully guide people's behaviour in accordance with the strategy and goals of the company” (kirin, mitrovic, borovic & sedmak, 2016, p. 825). * corresponding author, e‐mail: gordana.gavric@vspep.edu.rs 98 economic analysis (2019, vol. 52, no. 1, 97‐108) despite a number of works dealing with the organisational culture, there is no unique definition and tools for its measurement. according to edgar h. schein, organisational culture means “a pattern of shared basic assumptions learned by a group as it solved its problems of external adaptation and internal integration (…), and it is a product of joint learning”(schein, 2013). janicijevic states that “organizational culture is defined as a system of assumptions, values, norms, and attitudes, manifested through symbols which the members of an organization have developed and adopted through mutual experience and which help them determine the meaning of the world around them and how to behave in it” (janicijevic, 2012, p. 25). in short, organisational culture is a powerful force that holds together members of an organisation (janicijevic & milovanovic, 2015) giving it uniqueness, and the fact that it is invisible and intangible makes it a real puzzle for imitators and competitors. “organizational culture like “operating system” leads an organisation and its activities, shaping the way its employees think, work, and how they feel”(vukotic, sukovic, rasevic, maksimovic & goati, 2014, p. 406). organisational culture establishes value systems. if we want a “culture to be a “tailwind” to business success, there has to be compliance between organisation’s management principles and its organisational culture”(gavric, sormaz & ilic, 2016, p. 28). stone d.l. and all considered “the impact that values may have on (a) the establishment of performance criteria, (b) the methods used to measure” (stone, stone‐romero & lukaszewski, 2007, p. 160). according to j. chatman and c. o’reill, to make progress “future research should focus on conceptualizing and assessing organizational culture as the norms that characterize a group or organization that if widely shared and strongly held, act as a social control system to shape members’ attitudes and behaviours”(chatman & o’reill, 2016, p.199). “alvesson & sveningsson, 2015; katzenbach, steffen, & kronley, 2012; lorsch & mctague and others stated that managers have also recognised the importance of culture because of the presumed relationship between certain types of organisational cultures and effective organisational performance” (chatman & o’reill, 2016, p.202). an example of this is the company chrysler which, after struggling for survival, accepted the change of culture, involving employees in the entire process, focusing on learning and “put emphasis on quality and they once again, became a successful and profitable company” (krouse, 2012, p. 28). “today, it is clear to almost all managers that the key to long‐term success lies not in individual strategies and effective management of resources, but in, so far largely neglected dimension of governance, the cultural dimension” (cardona & ray, 2009, p. 32). in other words, “in order to understand the source of competitive advantage of a company, one must understand its organisational culture” (janicijevic, 1997, p. 23). according to korn ferry survey in july 2014, with more than 500 global respondents, “72 per cent said they feel culture is extremely important to organisational performance, but only 32 per cent said their organisational culture aligns to a great extent with their business strategy. the survey also showed that despite the high ranking in importance, only 25 per cent believe they have identified and communicated their culture to a great extent, and only 35 per cent believe their employees are able to articulate their culture to a great extent” (eaton & kilby, 2015, p. 5). recognising the importance of organisational culture problem in serbia, the authors did extensive research using the denison model based on following factors of organisational culture: mission, employee involvement, consistency and adaptability (denison & mishra, 1995), which also allows displaying a degree of each dimension appliance. this model is chosen because it is generally applicable and it balances the need for stability of a company, represented by its mission dimensions and consistency as well as the need for flexibility, represented by employee involvement and adaptability. the aim of the conducted research is to point out critical aspects of the organisational culture whose improvement will improve the efficiency and competitive advantage of the serbian companies, and the conclusions will serve as useful information for decision makers to make better decisions. snežana kirin, gordana gavrić, sandra kirin 99 factors of organization culture according to denison model “a mission is an important aspect of organisational culture. unclear missions, as an image or label, or its absence results in the company being left at the mercy of market forces”(gavric, sormaz & ilic. 2016, p. 28). mission differentiates the company in relation to its competitors, fueling sharing of values that brings business success and competitive advantage to an organisation. the behaviour produced by the mission should lead an organisation to significant financial results, not to its exerting of a mission formulation. consistency is reflected by the presence of stability, which implies well‐defined value and a system as the foundation of a strong organisational culture. sharing key values and expectations among employees will facilitate the resolution of disputes and other efforts in an organisation functioning. lamberg j. a. states that, although “flexibility and speed are considered sources of competitive advantage in a dynamic environment, researches of development strategies see consistency as a necessary condition for company survival (e.g. barnett & hansen, 1996; sheth & sisodia, 2002)(lamberg, tikkanen, nokelainen & suur‐inkeroinen, 2005)”(gavric & stankovic, 2015, p. 132). “using established business practices, a company develops efficient processes and routines that support its long‐term goals and strategies through knowledge that the organisation remains independent of the departure of individual” (gavric & stankovic, 2015, p.132). unlike traditional hierarchical organisations, which tend to have standard policies and procedures when dealing with certain issues, organisations with high employee involvement can make more effective decisions on specific environmental problems or special customers’ requirements, but also have a chance to be more flexible and faster in their decision making (lawler, 1993). also, changes will be easier to introduce if the power of attorney concept and employee involvement is already developed. jovanovic states that “failures in organisational learning also limit organisational adoption and ability to change” (jovanovic, 2015, p. 147). he examined “one of the most important organisational learning issues, the distinction between lower‐level learning and higher‐level learning. lower‐level learning is characterized by improvements or refinements of existing beliefs, understandings, and organisational processes. higher‐level learning involves developing completely new beliefs, understandings and organisational processes” (jovanovic, 2015, p. 147). a perceived need for continuous development of employees is in accordance with the research in which cvjetkovic stated that “it is necessary to raise employees’ awareness on quality achievement as the factor of business operations improvement. it is of exceptional importance for serbian companies to realize that it is necessary to change the way and the philosophy of business operations in the future” (cvjetkovic, 2015, p. 69). a danger for the survival of modern companies is their rigidity and a possible decrease in organisational flexibility and resilience. nowadays, a company’s flexibility is the most important factor for its survival, presented by its ability to meet new habits, tastes and needs of consumers and customers, as well as to change the way of treating employees because they want to become important subjects of business by engaging in more decision‐making. companies that fail to rapidly adjust to the new demands of the global market, would stay behind or taken over by stronger and more successful entrepreneurial players. by compression of space and time, the process of globalisation exposes workers, companies and states to increasing pressure, imposing fast and efficient adjustment to all stakeholders (jaksic, 2009). companies face the challenge to learn and move through this wave of transition as easily and as creatively as possible (radovic markovic, 2008). adequate and timely response in unpredictable business conditions is essential, and a prerequisite for such response of 100 economic analysis (2019, vol. 52, no. 1, 97‐108) management is that employees have a habit of learning, skills and knowledge as well as a desire to learn' (torrington, hall & taylor, 2004). “organizational culture should be cultivated, set in the function of a company's success, but its negative impacts should be avoided” (gavric, sormaz & ilic, 2016, p.27). researching of organizational culture in serbia using the denison model the questionnaire that was distributed in 2015 was used as the research instrument. the questionnaire was distributed in two ways: personally and via facebook. it was designed in the form of a likert scale as that is the most suitable method for evaluating opinions and attitudes. the scale was created in the following way: 1 – completely disagree with the given statement, 2 – partly disagree with the given statement, 3 – neither agree nor disagree with the given statement, 4 – partly agree with the given statement, 5 – completely agree with the given statement. the entire questionnaire was based upon the denison model (denison & neale, 1999) with the slightest of alternations of the researched statements. the following programs were used for the analysis of the obtained data: ibm spss statistics 21 and ms excel. this paper presents a descriptive statistical data analysis. a total of 1000 respondents, i.e. employees who came from various companies from twenty‐ nine serbian cities, took part in this research. tables 1 and 2 describe the personal characteristics of respondents and the companies in which they work. table 1. description of the personal characteristics of the sample frequency percentage gender мale 520 52 female 460 46 missing 20 2 total 1000 100 age 18–30 340 34 31–40 380 38 41–50 190 19 41–60 80 8 over 60 10 1 level of education high school / highly skilled workers 420 42 college 270 27 faculty 200 20 master 90 9 phd 20 2 years of service to 5 350 35 6–15 390 39 16–25 160 16 26–35 90 9 over 35 10 1 work position worker 640 64 low‐level manager 190 19 middle‐level manager 90 9 top‐level manager 80 8 source: ibm spss statistics 21 snežana kirin, gordana gavrić, sandra kirin 101 table 2. description of the companies frequency percentage company size micro 200 20 small 171 17.1 medium 338 33.8 large 291 29.1 company activity services 204 20.4 public administration and mandatory social security 178 17.8 production 140 14 education 116 11.6 finance and insurance 84 8.4 transportation and storage 66 6.6 lodging and meals 47 4.7 health and social care 43 4.3 information and communication 39 3.9 administrative and support service activities 36 3.6 professional, scientific and technical activities 26 2.6 arts, entertainment and recreation 19 1.9 real estate services 2 0.2 company ownership domestic 860 86 foreign 140 14 ownership structure private 520 52 state‐owned 440 44 public 40 4 source: ibm spss statistics 21  exploring the mission dimension for the mission testing, the following statements were observed:  “there is a long‐term purpose of the company existence as well as its development direction”,  “our strategy leads other organisations to change the way they compete in the industry”,  “there is a clear mission that gives meaning and direction to our work”,  “there is a clear strategy for the future”,  “our strategic direction is clear to me",  “leaders set goals that are ambitious, but realistic”,  “there is widespread agreement about goals”,  “the leadership has "gone on record" about the objectives we are trying to meet”,  “we continuously track our progress against our stated goals”,  “people understand what needs to be done for us to succeed in the long run”,  “we have a common vision of what the organisation will be like in the future”,  “short‐term thinking seldom compromises our long‐term vision”,  “leaders have long‐term thinking”,  “our vision creates excitement and motivation for our employees”, 102 economic analysis (2019, vol. 52, no. 1, 97‐108)  “we are able to meet short‐term demands without compromising our long‐term vision“(denison & neale, 1999, p. 2‐14‐2‐15) mean values for compliance with the preceding paragraphs are shown in figure 1. the  figures will show only key words of the statements.  figure 1. results on the mission source: ms excel the results showed that the mean value of the compliance with the individual positions varied between grades 3 and 4, i.e. between the neither agree nor disagree and the partially agree scale measures concerning the researched statements. the overall mean is 3.56. a minimum value of the mean compliance is reported in relation to the following statements:  “our vision creates excitement and motivation for our employees” (3.14)  “we have a common vision of what the organisation will be like in the future” (3.28)  “short‐term thinking seldom compromises our long‐term vision” (3.32) the greatest values of the mean compliance are reported related to the following statements:  “there is a long‐term purpose of the company existence as well as its development direction” (3.99)  “there is a clear mission that gives meaning and direction to our work” (3.88)  “our strategic direction is clear to me” (3.76) the strongest factors related to the dimension of mission defined in the denison model are strategy, goals, and vision. in addition to these factors, the experience of employees, company size and position in it, ownership of the company (and the fact whether it is domestic or foreign), level of education, employee activity as well as social environment also influence mission understanding of enterprises in serbia. snežana kirin, gordana gavrić, sandra kirin 103 exploring consistency dimension the following statements are considered:  “the leaders and managers do what they say”,  “there is a characteristic management style and a distinct set of management practices”,  “there is a clear and consistent set of values that governs the way we do business”,  “ignoring core values will get you in trouble”,  “there is an ethical code that guides our behaviour and tells us right from wrong”,  “when disagreements occur, we work hard to achieve "win‐win" solutions”,  “there is a "strong" culture”,  “it is easy to reach consensus, even on difficult issues and key issues”,  “there is a clear agreement about the right way and the wrong way to do things”,  “our approach to doing business is very consistent and predictable”,  “people from different parts of the organisation share a common perspective”,  “it is easy to coordinate projects across different parts of the organisation”,  “working with someone from another part of this organisation is not like working with someone from a different organisation”,  “there is good alignment of goals across levels” (denison & neale, 1999, p. 2‐10‐2‐11) mean values for compliance with the previous statements are shown in figure 2. figure 2. results of consistency source: ms excel the results of the analysis of compliance with the views of the consistency show that all the answers are in the interval between 3 and 4, i.e. between the neither agree nor disagree and the 104 economic analysis (2019, vol. 52, no. 1, 97‐108) partially agree scale measures concerning the researched statements. the minimum obtained value is related to the statement that all employees have equal chances and opportunities for promotion (“people from different parts of the organization share a common perspective” (denison & neale, 1999, p. 2‐10)) – it is the closest to the value: neither agree nor disagree, while the closest value 4– partly agree (3.85) is related to the statement: “ignoring core values will get you in trouble”(denison & neale, 1999, p. 2‐10). lower values are related to the following statements: • “people from different parts of the organisation share a common perspective” (3.08) • “the leaders and managers do as they say” (3.23) • “it is easy to reach consensus, even on difficult issues and key issues” (3.24) • “it is easy to coordinate projects across different parts of the organisation” (3.39) the main factors of consistency by the denison model are defining core values and business ethics in an organisation and their implementation in dealing with co‐workers, clients and all interested parties in order to reach agreements and management coordination. in organisations with strong consistency, employees understand a ʼbig pictureʼ without creating obstacles to goal achievement. an experience, organisation size, an employee's position in it, the culture of an organisation, i.e. domestic or foreign ownership, gender, company activity and social environment where a company is located also influence attitudes towards consistency. exploring dimensions of employee involvement aspects of employee involvement have been seen through empowerment, personal development and team orientation. in terms of transitional changes, employee involvement contributes to a faster and more successful acceptance and implementation of the necessary modifications. the following statements were observed:  “most employees are highly involved in their work”,  “decisions are usually made at the level where the best information is available”,  “information is widely shared so that everyone can get the information he or she needs when it's needed”,  “everyone believes that he or she can have a positive impact”,  “business planning is ongoing and involves everyone in the process to some degree”,  “cooperation across different parts of the organisation is actively encouraged”,  “people work like they are part of a team”,  “teamwork is used to get work done, rather than hierarchy”,  “teams are our primary building blocks”,  “work is organised so that each person can see the relationship between his or her job and the goals of the organisation”,  “authority is delegated so that people can act on their own”,  “there is a continuous investment in the skills of employees”,  “the capabilities of people are viewed as an important source of competitive advantage”,  “problems seldom arise because we have the skills necessary to do the job”(denison & neale, 1999, p. 2‐8‐2.9) mean values for compliance with the previous statements are shown in figure 3. snežana kirin, gordana gavrić, sandra kirin 105 figure 3. results for employee involvement source: ms excel the result shows that employees are the least involved in the planning process (mean = 2.95) and they disagree with the statement that they rarely face problems because they have all the skills needed for the job (mean = 3). values of approvals given by the respondents along with the other statement vary between 3 and 3.5, i. e. around the neutral position. the results show that there is no value close to 4 in any statement describing employee involvement, which is in correspondence with the statement. the maximum value is obtained in the statement that decisions are made where the best information are obtained so that it can be interpreted by the importance of the decision‐making process. it can be said that the following was observed:  small influence of employees on business policy creating and  a need for continuous development of employees. the study of employee involvement showed that obtained factors were identical to involvement factors in the denison model: teamwork, professional development and empowerment (through access to information and decision‐making where the information are available). exploring the adaptability dimension the following statements were examined:  “the way things are done is very flexible and easy to change”,  “we respond well to competitors and other changes in the business environment”,  “new and improved ways to do work are continually adopted”,  “attempts to create change seldom meet with resistance”, 106 economic analysis (2019, vol. 52, no. 1, 97‐108)  “different parts of the organisation often cooperate to create change”,  “customer wants, and needs are being mentioned and have directly influence on decisions and business”,  “we encourage direct contact with customers by our people”,  “we view failure as an opportunity for learning and improvement”,  “innovation and risk‐taking are encouraged and rewarded”,  “learning is an important objective in our day‐to‐day work”,  ‘we are familiar with the work of other sectors at all times”(denison & neale, 1999, p. 2‐ 12‐2‐13) mean values for compliance with the previous statements are shown in figure 4. figure 4. results on adaptability source: ms excel it may be noted that the minimum value of the compliance degree is related to the following statements:  “the way things are done is very flexible and easy to change” (3.23)  “innovation and risk‐taking are encouraged and rewarded” (3.25)  “attempts to create change seldom meet with resistance” (3.29). conclusion in order to highlight the values of organisational culture in serbia, the research has been conducted and presented, using the denison model of organisational culture. the research included a sample of 1,000 respondents in enterprises in serbia, during 2015. values for all four dimensions of the model have been obtained – mission, consistency, the involvement of snežana kirin, gordana gavrić, sandra kirin 107 employees and ability – that vary in the interval from neutral attitude to the attitude "partly agree”. this means that the awareness level of the mission is foggy among the staff, consistency dimension is between values “it is both existent and non‐existent,” employee involvement in the business planning is on a low level, and when it comes to adaptability dimension, there are no concrete measures to stimulate innovation. by the analysis of organizational culture, we have concluded that the aspects of this culture, the improvement of which will improve the efficiency and competitive advantage of enterprises in serbia, are: innovation rewarding, investment in continuous employee development, greater influence of employees on the policy and planning of future activities, short‐term interests that jeopardize the long‐term mission of the company, opportunities and advancement opportunities to all employees, defining a common vision that stimulates and motivates employees with leaders and managers who act in accordance with what they saying and creating a climate in which changes that lead to progress encounter less resistance of employees. this means that in all dimensions of the observed model, there is room for improvement of the organisational culture in concretised areas, which can serve to policy‐makers as useful information for making better decisions. the need for long‐term planning that balances short‐ term and long‐term goals is noted. the results obtained in 2011 by nikolic, savic & markoski, regarding organizational culture in companies in serbia indicated that certain "strategic issues should be improved, such as: quality making strategic decisions, the attitude of the company towards change and innovation, the vision and mission of the company, teamwork, encouraging the creativity of individuals, etc. (nikolic, savic & markoski, 2011, pp. 649). from this, it can be concluded that the situation in the companies in serbia has not changed drastically in relation to 2011 and that the critical points are innovation, the vision and the mission and the involvement of employees. the significance of the research lays in the fact that it has covered a large sample and therefore, it brings an important contribution to the perception of the state of organisational culture in serbia. the study complements findings reached by researchers who have studied the problem of organizational culture. further studies of organisational culture in serbia should be directed to the application of other general models as well as to the development of specific models for concrete, real situations. references chatman, a. j. & o’reill, a. c. 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(anti)liberalizam i ekonomija. belgrade: center for economic research of institute of social sciences article history: received: november 29, 2018 accepted: may 26, 2019 microsoft word 2010_1_2.doc original scientific paper differences between harmonized indices of consumer prices and consumer price indices in selected countries milecová zuzana*, technical university of košice, faculty of economics, slovakia udc: 338.51 jel: c12, e31, e58 abstract – the aim of the paper is to analyse the differences between the harmonized indices of consumer prices and the national consumer price indices on the theoretical as well as on the practical levels. we are dealing with defining the differences between the indices not only in the euro area and in v4-countries, but also in serbia. the main differences are geographic and population coverage and owner-occupied housing. for statistical testing we have used a paired two sample t-test, which allows us to test the null hypothesis that the difference between the indices has a mean value of zero. out of all 21 realised tests we reject null-hypothesis in 14 cases. key words: harmonized index of consumer prices, consumer price index introduction the consumer price indices (cpis) constitute one of the key macroeconomic indicators, play an important role in monetary policy and economic analysis, are typically referred to in wage negotiations and often used for indexing prices in contracts. however, the underlying concepts and methods differ across countries. that is the reason why the harmonized indices of consumer prices (hicps) were constructed, they facilitate the carrying out of international comparisons. in addition, the hicp serves as one of the convergence criteria to assess whether a member state is ready to join the euro area. by means of hicp the european central bank (ecb) defines price stability as a year-on-year increase in the hicp for the euro area of below but close to 2% over the medium term. the hicp has found an important place in the economy and has replaced the cpis in several areas. on the other hand, the measurement of inflation in two different ways is after all confusing for consumers. that is one of the reasons why the significant differences between indices were not desirable. an example is the price progress in the slovak republic in august 2008. inflation measurement by the cpi rises from 2.2 to 2.4 per cent and the hicp showed the decrease from 1.1 to 0.7 per cent year on year. we can not clearly say which index is correct. simplest would be to have only one price index, but both have their justification in the economy. that is the reason why it is important to discuss the differences between the hicps and cpis. in each country the differences between these two indices were analysed. according to the results we can say that the most important differences are consumption expenditure coverage and treatment of owner-occupied housing (ooh). * e-mail: zuzana.milecova@tuke.sk milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 71 this paper deals with the differences between the hicps and cpis on both theoretical and practical levels. the aim is to analyse the differences between the used indices in the euro area and in v4-countries and also in serbia. for statistical testing a paired two sample ttest was used. we tested the null hypothesis that the difference between the indices has a mean value of zero. differences between indices in euro area both hicps and cpis measure the changes in the prices over time of buying goods and services. the used calculation method is the same, laspeyres chain index. the hicps and cpis are based on the same data sources, but they measure inflation with different concepts or methods. [9] in each member state analyses were realised to identify the differences between the national indices and the hicps. for example in netherlands the indices were compared by leendert (2001), in belgium by druant (2001). the differences between the indices in austria were analysed by fluch and rumler (2005). ray barrell, simon kirby and rebecca riley analysed the differences in uk and the results were published in the national institute economic review in 2003. in the slovak republic kosseyova and doliak (2005) published the analysis of the differences. ahnert and branchi (2005) analysed the main differences in all european union countries. some information about the differences is available on the websides of individual statistical offices. with respect to these studies, the most important difference is the geographic and population coverage. the cpis applying the residence concept reflect price changes in all goods and services purchased by consumers living in the country concerned, including their purchases abroad. by contrast, the domestic concept covers all consumption expenditure in the country concerned, regardless of who (residents or non-residents) purchased the goods and services. the hicps apply the domestic concept. [7], [9] decision about including the domestic concept is not random. ecb needs an index to monitor price changes in the territory of an individual member state, not in individual households. [8] on the other hand the choice of concept may have important impact on the differences between the indices in small countries like luxemburg. we could find the differences between the indices in coverage of institutional household’s spending too. most national indices follow only spending of private households. as an example we can mention estonia, latvia, slovenia, sweden, belgium, luxemburg and portugal. [1] the differences are also in the number and coverage of items in goods and services basket, especially in subsidized areas, such as in health, social protection, education and insurance services. [8], [9] for example in france are healthy services excluded from the cpi. the netherlands’s national price index follows some costs paid within healthy care and includes membership fees in sport and social clubs. the national index in sweden includes some items of social protection. games of chance are excluded from the cpi index for example in italy and in germany. the national index in germany includes lottery tax and motor vehicle tax. [1] but the most important factor affecting the international comparability between the cpis is the treatment of ooh. sixteen of twenty seven european union countries exclude ooh economic analysis (2010, vol. 43, no. 1-2, 70-82) 72 by calculating the cpis. [7] ooh is included in the cpi for example in denmark, sweden, germany, ireland, netherlands, austria and finland, but this countries use different approaches to cover ooh. in the hicp is ooh still excluded, because it has not yet been decided how owner-occupied housing should be covered. [1] the differences are formed by rounding the indices on individual aggregation levels too. [9] some national statistical institutes use different aggregation formulas in their national cpi and hicp for aggregation at the lowest levels of the index. [7] the consumption basket and the expenditure shares of the items covered in the national cpis and the hicps may be updated at different intervals. [7] france, italy, luxemburg, portugal, estonia, latvia, lithuania, slovenia, sweden and uk update weights in consumer basket for calculating the national cpis annually. the other member states review basket weights mostly every five years. updates interval in greece is as late as six years. [1] different update interval leads to the fact that there are many new goods and services which are in basket of the hicp, but the cpi does not cover them yet. for example organic food, air tickets, mobile phones and computers, were covered in the hicp sooner than in the cpi in belgium. [6] the methods used to estimate prices for goods when their quality is changing over time are differ across countries. the differences are in coverage of price reductions during winter and summer sales periods. there may be also differences between the national classifications used for the cpi and the harmonized classification of the hicp. [8] the progress of the hicps and the cpis is shown in picture 1 in the annex. table 1 differences between indices in euro area mean variance p-value hicp 1.97 1.53 belgium cpi 1.97 1.52 1.000000 hicp 1.49 0.70 germany cpi 1.46 0.57 0.168871 hicp 2.91 2.80 ireland cpi 3.10 6.35 0.069507 hicp 3.26 0.95 greece cpi 3.25 0.94 0.844333 hicp 2.84 1.51 spain cpi 2.89 1.52 0.041505 hicp 1.68 0.83 france cpi 1.55 0.70 7.38e-23 hicp 2.26 0.47 italy cpi 2.21 0.46 0.022933 hicp 2.48 2.19 luxembourg cpi 2.09 1.08 1.83e-11 hicp 2.64 1.56 malta cpi 2.44 1.67 0.003881 hicp 2.24 1.40 netherlands cpi 2.14 0.83 0.00124 hicp 1.70 0.77 austria cpi 1.80 0.85 9.75e-06 milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 73 hicp 2.58 1.69 portugal cpi 2.64 1.55 0.001239 hicp 5.34 7.20 slovenia cpi 5.31 7.15 0.008323 hicp 5.90 13.76 slovakia cpi 6.11 12.51 9.46e-10 hicp 2.51 2.42 cyprus cpi 2.65 2.01 0.000706 hicp 1.75 1.12 finland cpi 1.72 1.62 0.513191 sources: eurostat, national data, own calculations for statistical testing of the differences between the indices we used a paired two sample t-test. we have assumed normal distribution, which was verified by visual methods. we tested the null hypothesis that the difference between the indices has a mean value of zero on significance level 5%. if the p-value is less than 0.05, we reject the null hypothesis and if the p-value is more than 0.05, we cannot reject the null hypothesis. the results of this analysis are in table 1. we tested data from january 1998 to october 2009 for all sixteen countries, which gradually accessed the euro area (142 observations). in just five cases we could not reject the null hypothesis (belgium, germany, ireland, greece and finland). according to this analysis, we could not clearly say that there are no significant differences between the national cpis and the hicps in the euro area. ahnert and branchi (2005) analysed the differences between the hicps and the individual cpis. the aim of their research was to prove that the differences are not significant and there is a decreasing trend. to confirm this hypothesis, authors draw up an index as simple weighted average of the cpis of the euro area member states. the country weights are equal to the countries share of household final monetary consumption expenditure (hfmce) in total. this index was compared with the official monetary union index of consumer prices (muicp), which is configured by eurostat of the hicps of the member states participating in the emu. [1] this analysis inspired us to repeat calculations of current information and review present situation. von der lippe (2001) states the compiation method of the muicp index as follows [17]:       ⋅⋅      ⋅      = ∑∑∑ === mt k m mt k m mm k m mmt hchchcm 11 22 1 110 ... . (1), where m stands for the muicp, h for the individual hicps, cm represents the country weights, k the individual member states (m = 1, ..., k) and t is for the time. hmt is then the link (from t-1 to t) for country m. formula (1) represents time series of the muicp, which could by written as follows: tt mmmm ⋅⋅⋅= ...210 . (2), greece accessed the euro area in the year 2001 and the muicp index has been extended, as shown in formula (3): economic analysis (2010, vol. 43, no. 1-2, 70-82) 74       +⋅= +++++ = ++ ∑ 1,11,11, 1 * 1,01,0 tktktm k m tmtt hchcmm . (3), 1211,0 ... ++ ⋅⋅⋅= tt mmmm . (4), where t+1 states for the year 2001. star marks out the new country weights system after access of a new member state. the muicp has been extended progressively with access of individual member states to the euro area. the index includes sixteen countries till today. necessary data are published by individual national statistical offices, oecd and eurostat. we found the differences of up to 1.3 percentage points between data published by oecd and individual statistical offices. the same data are published only for germany, france and italy. for our model we used data published by statistical offices of member states, because they are revised. the country weights used in individual years are published on the web-side of eurostat. figure 2. muicp versus aggregated cpis sources: eurostat, national data, own calculations the result of calculations is shown in figure 2. we can confirm that the differences between the muicp and the index composed from the cpis have been diminishing over time. on the other hand, we tried to use the statistical test, to identify if the difference between the indices is significant or not. table 2. differences between muicp and aggregated cpis mean variance p-value muicp 1.96 0.67 euro area aggregated cpis 1.92 0.63 0.000184 sources: [1], eurostat, national data, own calculations milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 75 for statistical testing we used a paired sample t-test as in the previous case. we analysed data from january 1998 to october 2009. considering the fact that the p-value of analysed data is less than 0.05, we decided to reject null-hypothesis that the difference between the indices has a mean value of zero. differences between indices in v4-countries the differences between the hicps and the national cpis in v4-countries are collected by eurostat and the statistical offices of the individual countries. the hungarian national cpi includes approximately 900 items, which are observed in 35150 outlets depending on their character. altogether more than seventy-five thousand prices are collected monthly. [11] the main differences between the indices in hungary concern the coverage of owner-occupied housing and games of chance which are excluded from the hicp and the expenditure of foreign visitors which are excluded from the national cpi. the national cpi does not monitor development of expenditure of institutional households. the weights are updated in hungary every year, but weights for the hicp are updated every 5 years, only if required, review is made annually. [10], [11] the number of price representatives in consumer basket for the cpi calculation in the czech republic (cr) is 729. consumer prices are surveyed in 35 selected districts in the cr and in the capital of prague. consumer basket represents approximately 55,000 prices to be surveyed monthly. [4], [13] regarding the differences between the hicp and the national cpi in the czech republic, consumption expenditure of non-residents in the economic territory of the country is included in the hicp, but excluded from the national cpi. institutional households are excluded from the cpi, unlike from the hicp. expenditure of investments in the owner-occupied houses (major repairs) is included in the national cpi, but excluded from the hicp. the purchase of the house itself is excluded from both indices. [10] in poland there were about 1,800 representative consumer goods and services chosen for completing the cpi in 2009. on average, there are about 292 thousand prices collected each month in 209 price survey regions. [3] regarding the differences between the hicp and the national consumer price index in poland, institutional households and consumption expenditure of non-residents in the economic territory of the country are included in the hicp, but excluded from the national cpi. games of chance are included in the national cpi, but excluded from the hicp. another contributory factor to the differences between the hicp and the national consumer price index concerns the use of different weights. the cpi is calculated with the use of weights from the household budget survey for the previous year, while the hicp utilizes weights from the national accounts. owner-occupied housing is excluded from the hicp and from the cpi, too. weights for the cpi are reviewed annually. [10] the slovak cpi covers approximately 90 % of all households and the calculation is based on consumer basket with 709 representative items. prices of goods and services are collected in about 13,400 outlets and business premises. number of price quotations is about 90,000. [16] the main difference between the hicp and the national cpi in the slovak republic concerns the coverage of owner-occupied housing, in particular imputed rents and economic analysis (2010, vol. 43, no. 1-2, 70-82) 76 expenditure on major maintenance and repair which are excluded from the hicp. the weights for the cpi are reviewed annually. [10] the progress of the hicps and the national cpis in v4-countries is shown in figure 3. figure 3. progress of cpis and hicps in v4 countries hungary 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 18,0 20,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp czech republic -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp poland 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp slovakia -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 18,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp sources: eurostat and individual statistical offices the introduction of the hicp is an advantage in terms of convergence criteria and monetary policy, especially in the slovak republic. the inflation measured by method of the hicp is less than inflation measured by method of the cpi. the reason for this progress is that the cpi includes the ooh, which significantly increased in last months. the ooh was recently monitored only as monthly payments for repairs and maintenance of owner occupied apartments calculated per an apartment’s square meter floor (regular payments to so-called repairs fund). the government decided to support insulating homes by interest-free loans within anti-crisis measures. residents began to use them massively. this has led to the increase of payments to repair fund. significant increase of the cpi and its deviation in the hicp is not due to inflation, but due to numerous projects of insulating homes. this progress forced statistical office to change the method to calculate the ooh. the repair fund is only 60% of the ooh today, the other 40% are other items related to housing. data of the cpi were revised retroactively from january 2009. [12] for statistical testing we used also a paired two sample t-test, as in the previous cases. milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 77 table 3. differences between indices in v4-countries mean variance p-value hicp 7.16 11.13 hungary cpi 7.17 10.89 0.844968 hicp 4.59 12.49 poland cpi 4.54 12.74 0.030217 hicp 3.16 7.97 czech republic cpi 3.44 8.61 8.38e-21 sources: eurostat, national data, own calculations we tested data from january 1998 to october 2009 for v4-countries (the analysis of slovakia is in table 1). in just one case we could not reject the null hypothesis (hungary). in the other three cases we reject the null hypothesis, that the difference between the indices has a mean value of zero. according to this analysis, we could not clearly say that there are no significant differences between the national cpis and the hicps in v4-countries. consumer price indices in the republic of serbia in the republic of serbia two retail price indices were used on national level until january 2003. the first, the retail price index (rpi) is used as national inflation measure and deflator of output and assets. retail prices are the prices that retail outlets, individual agricultural producers and service providers apply in selling their products and services to end users, including the turnover tax. the second, the consumer price index, is a type of cost of living index and is used for wages, pensions and other social benefits revaluation. the weights for the rpi are based on structure of retail turnover of goods and services. the weights for the cpi were calculated from structure of household consumption. [5] the national cpi in serbia has different classification from coicop and follows seven sub-categories of goods and services. food; tobacco and beverages; clothes and footwear; housing and household operations; hygiene and health care; education, culture and entertainment; vehicles and services. [7] serbian national statistical office started to calculate the cpi by coicop in january 2007. [5] this index presents a special retail prices index that is being calculated according to the methodology that is harmonized with recommendations for retail prices index calculation in the european union. cpi-coicop is comparable with the hicp of the european union. [15] statistical office of the republic of serbia has published monthly series of indices on the web-side from january 2000 till now. for better demonstrations of the differences between the mentioned indices, we decided to construct figure 4 from shorter time series (from january 2003 to october 2009). economic analysis (2010, vol. 43, no. 1-2, 70-82) 78 figure 4. progresses of cpi, cpi-coicop and rpi in the republic of serbia (y-o-y) 0 2 4 6 8 10 12 14 16 18 20 01 03 06 03 11 03 04 04 09 04 02 05 07 05 12 05 05 06 10 06 03 07 08 07 01 08 06 08 11 08 04 09 09 09 cpi-coicop cpi rpi sources: statistical office of the republic of serbia the main difference between the cpi-coicop and the index of retail prices is coverage, because the list of products and services also includes rent, financial services, educational services as well as catering trade services. the indices use different weight systems and classification by calculating. also the formula for the index calculation at the lowest level of aggregating is different for the cpi-coicop and for the rpi too. [15] table 4. differences between rpi and cpi-coicop mean variance p-value rpi 8.89 5.19 the republic of serbia cpi-coicop 8.93 11.97 0.894883 sources: statistical office of the republic of serbia, own calculations for statistical testing we have used a paired sample t-test as in the previous cases. we tested data from january 2007, when the cpi-coicop was introduced in to the practice to the present (october 2009). considering that the p-value of analysed data is more than 0.05, we cannot reject null-hypothesis that the difference between the indices has a mean value of zero. we could test only the 35 observations this time. the rpi was the official measure of inflation in serbia for a long time, but from the start of 2009 the cpi became the main inflation indicator, which is targeted by the national bank of serbia. their aim is to have measurements for inflation comparable with eu. [14] time series of the hicp for serbia are not available so far. conclusion the harmonized index of consumer prices replaced the national consumer price index in several areas. the harmonized index is used as one of the convergence criteria, which milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 79 assesses the readiness of a member state to join the euro area. european central bank defines price stability through the harmonized index of consumer prices. but in economy there are differences between the indices. the main differences are geographic and population coverage and owner-occupied housing. for statistical testing we used a paired sample t-test, which allows testing if the difference between the indices has a mean value of zero. we tested data from january 1998 to october 2009 from all euro area member states and v4-countries. from 19 realised tests in the countries of the european union, we cannot reject the null-hypothesis in only six cases (belgium, germany, greece, ireland, finland and hungary). in the other cases we had nullhypothesis rejected on a significance level of 5 per cent. considering the realised analysis we could not clearly say that the differences between the indices are not significant. in the next step we have drawn up an aggregated cpi index. this analysis confirmed that the differences between the indices have been diminishing over time. on the other hand, the statistical test did not confirm the null-hypothesis. in the republic of serbia three retail price indices are followed; the retail price index, the consumer price index by national structure and the consumer price index by coicop. while the national bank of serbia used the retail price index as the main indicator until december 2008, from the start of 2009 it is targeting the cpi-coicop. considering the statistical analysis we cannot reject the null-hypothesis that the difference between the indices has a mean value of zero. references [1] ahnert, h., branchi, m. the hicp as an anchor for european consumer price statistics [online]. 2005 [cit. 2009-12-21] available on the internet: <http://www.oecd.org/dataoecd/14/45/34996095.pdf>. [2] astin, j. the european union harmonized indices of consumer prices (hicp) [online]. 1999 [cit. 2010-01-16] available on the internet: <http://www.ottawagroup.org/ottawa/ottawagroup.nsf/home/meeting+5/$file/1999%205th%20 meeting%20-%20astin%20john%20%20the%20european%20union%20harmonized%20indices%20of%20consumer%20prices%20% 28hicp%29.pdf>. [3] central statistical office of poland consumer price index [online] 2009 [cit. 2010-01-15] available on the internet: <http://stats.oecd.org/mei/default.asp?lang=e&subject=8&country=pol>. [4] czech statistical office consumer price indices user’s methodological manual [online]. 2010 [cit. 2010-01-06] available on the internet: <http://www.czso.cz/csu/2009edicniplan.nsf/p/710109>. [5] jankovic, m. price collection in unstable market conditions [online]. 2006 [cit. 2010-01-17] available on the internet: <http://www.unece.org/stats/documents/ece/ces/ge.22/2006/mtg2/11.e.ppt>. [6] druant, m. belgian hicp: a major step forward in the accurate measurement of inflation [online]. 2002 [cit. 2010-01-16] available on the internet: <http://www.pedz.unimannheim.de/daten/edz-ma/eus/02/ks-pb-02-003-en.pdf>. issn 1725-1338. [7] ecb understanding price developments and consumer price indices in south-eastern europe [online]. 2007 [cit. 2010-01-16] available on the internet: <http://www.ecb.int/pub/pdf/scpops/ecbocp57.pdf>. issn 1725-6534. economic analysis (2010, vol. 43, no. 1-2, 70-82) 80 [8] eurostat hicp-cpi differences [online]. [cit. 2009-12-21] available on the internet: <http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/documents/tab/tab/hicpcpi%20differences>. [9] eurostat harmonized indices of consumer prices (hicps): a short guide for users [online]. 2004 [cit. 2009-12-21] available on the internet: <http://epp.eurostat.ec.europa.eu/cache/ity_offpub/ks-be-04-001/en/ks-be-04-001en.pdf>. [10] eurostat information note on the harmonized indices of consumer prices, compliance monitoring [online]. 2008, 2009 [cit. 2010-01-12] available on the internet: <http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/methodology/compliance_monitoring [11] hungarian central statistical office consumer price index booklets october – december 2006 [online]. 2002 [cit. 2010-01-14] available on the internet: <http://www.eszt.hu/images/inflacio.pdf>. issn 0864-8409. [12] kovalčík, j. inflácia je po oprave výrazne nižšia [online]. 2009 [cit. 2009-10-01] available on the internet: <http://ekonomika.etrend.sk/ekonomika-slovensko/inflacia-po-oprave-vyraznenizsia.html>. [13] kudlák, k. k výpočtu indexů spotrěbitelských cen v čsú [online]. 2002 [cit. 2010-01-09] available on the internet: <http://www.cepin.cz/cze/prednaska.php?id=187>. [14] raiffeisen banka a.d. serbia economic report no. 18 [online]. 2009 [cit. 2010-01-17] available on the internet: <http://www.raiffeisen.at/ebusiness/services/resources/media/10232967115041025308884300_1025311539513_1025311893931-496114812233705012-1-na-de.pdf>. [15] statistical office of the republic of serbia communication nr. 345 price statistics [online]. 2009 [cit. 2010-01-17] available on the internet: <http://webrzs.statserb.sr.gov.yu/axd/en/dokumenti/saopstenja/cn11/cn11112009.pdf>. issn 0353-9555. [16] statistical office of the slovak republic metodika spotrebiteľské ceny (inflácia) [online]. 2010 [cit. 2010-01-14] available on the internet: <http://portal.statistics.sk/showdoc.do?docid=1670>. [17] von der lippe, p.: inflation in europe – different measures and their users [online]. 2001 [cit. 2010-01-09] available on the internet: <http://von-der-lippe.org/dokumente/ceies_english.pdf>. received: 6 january 2010 article history: accepted: 22 march 2010 anex 1 picture 1. progress of harmonized indices of consumer prices and national consumer price indices in euro zone member states belgium -4 -2 0 2 4 6 8 19 98 m 01 19 98 m 10 19 99 m 07 20 00 m 04 20 01 m 01 20 01 m 10 20 02 m 07 20 03 m 04 20 04 m 01 20 04 m 10 20 05 m 07 20 06 m 04 20 07 m 01 20 07 m 10 20 08 m 07 20 09 m 04 cpi hicp germany -1,0 0,0 1,0 2,0 3,0 4,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp ireland -8,0 -6,0 -4,0 -2,0 0,0 2,0 4,0 6,0 8,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp greece 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp spain -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp france -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp italy -1,0 0,0 1,0 2,0 3,0 4,0 5,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp cyprus -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 7,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp luxemburg -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 7,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp malta -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 7,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp netherlands -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp austria -1,0 0,0 1,0 2,0 3,0 4,0 5,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp portugal -3,0 -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp slovenia -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp slovakia -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 18,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp finland -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp source: eurostat and individual statistical offices microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp48‐55 original scientific paper assessing organisational maturity in predictive analytics of telecommunications companies in the republic of macedonia kalina trenevska blagoeva1 | marina mijoska1* 1 ss.cyril and methodius university, faculty of economics ‐ skopje, department for e‐business, republic of macedonia abstract data analytics and predictive analytics are among major trends companies are facing worldwide. in a highly digitalised environment, it is not only to question the usage of data analytics but how analytically mature organisations are. the goal of this paper is to assess organisational maturity in predictive analytics of telecommunications companies in the country. in order to assess the level of organisational maturity in predictive analytics, we use predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competence, deployment and governance). for each dimension, four maturity levels are defined: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony (capgemini, 2012). survey results confirmed that analysed companies fully understand the benefits of predictive analytics as a valuable source of gaining competitive advantage from data. the overall level of predictive analytics maturity is set between levels 2 or 3 for almost all dimensions. this research is the first attempt to analyse organisational maturity in predictive analytics in the country. its originality derives from the specific characteristics and development of the telecommunications sector. this sector is one of the most advanced service sectors in the country and hence represents a benchmark concerning digital transformation. results of this survey provide useful information needed to design a roadmap for migrating towards higher maturity levels key words: organisational maturity, predictive analytics, predictive analytics maturity framework, telecommunications sector, republic of macedonia jel classification: m19, l96 introduction companies in all industries worldwide are using and benefiting from data analytics. data analytics, especially big data analytics, advanced analytics, and predictive analytics, are among the major trends for 2017 companies worldwide are facing (gartner, 2017). but, in spite of how powerful data analytics is, almost every organisation of every size is currently struggling with the challenges associated with building a proper analytics team and becoming a data‐driven * corresponding author, e‐mail: mijoskam@yahoo.com kalina trenevska blagoeva, marina mijoska 49 organisation. in the literature, there are a variety of explanations about what a data‐driven company is and how an organisation can become one. an organisation where every individual can use data to improve decision‐making and has ubiquitous access to the needed data can be considered as a data‐driven company. there is no doubt that more companies will attempt to drive value and revenue from their data (forester, 2017). “predictive analytics is a branch of the advanced analytics which is used to make predictions about unknown future events and uses many techniques from data mining, statistics, modelling, machine learning, and artificial intelligence to analyse current data to make predictions about future” (www.predictiveanalyticstoday.com). predictive analytics provide analysing large amounts of data with different variables; it includes clustering, decision trees, market basket analysis, regression modelling, neural nets, genetic algorithms, text mining, hypothesis testing, and decision analytics (mishra and silakari, 2012). the goal is to go beyond knowing what has happened to providing a best assessment of what will happen in the future (https://www.forbes.com). data and analytics are also changing the nature of industry competition. the most significant changes are reported in high tech, media and telecom, and consumer and retail (mckinsey, 2016). the ability to derive new insights from data using analytics techniques can enhance the decision‐making process in companies. in today’s analytics economy, in which data science is increasingly adopted by companies across all industries, it is not only to question the usage of data analytics but how analytically mature organisations are since the higher levels of analytical maturity provides better perspectives. in this sense, analytical maturity refers to organisations being able to get their business to its optimal potential by using predictive analytics. using the maturity model can provide an understanding of the current state and help management form a strategy of what level of capability is desired in order to support the achievement of organisations objectives. the telecommunications sector has seen momentous growth over the past decades and continues to be a critical force for growth, innovation, and disruption across multiple industries/countries. as a whole, the telecommunications industry generates upwards of 1 trillion euro in service revenues each year (https://www.statista.com/). the 54 telecommunications companies on the 2018 forbes global 2000 list claim more than $3.4 trillion in assets and totalled nearly $1.5 trillion in revenue last year (www.forbs.com). while in the past revenue was essentially sourced from a traditional landline and wireless services, today the range of products and services available in this industry is persistently increasing, offering further opportunities for revenue creation. the telecommunications industry is competing on analytics and embracing the new science of winning by investing in data science capabilities within the enterprise. these companies use predictive analytics for analytical customer relationship management (acrm), fraud reduction, bad debt reduction, price optimisation, call center optimization, etc. in the study published by ernst & young “global telecommunications study: navigating the road to 2020“, participants scored “improving big data and analytics capabilities” as very important in order to boost their organisational agility, with nearly 40% of respondents selecting it as a priority. consumer behavior has changed significantly in the last five years. consumers are shifting to applications like whatsapp, facebook messenger, snapchat, and instagram rather than calling and texting. according to stephan gatien, general manager of telecommunications business, sap, the core services of telcos – text, voice, and data – are actually evaporating and the revenue associated with these services is evaporating as well. the big challenge in this industry is to determine how to offset the degradation of this revenue coming from text, voice, and data to a certain extent, by buying new services that will be relevant to subscribers. in the article. “turning data into insights: how digitization creates new opportunities for the telecommunications industry, julie stoughton, the head of telecommunications marketing and communications at sap, stated that telecommunications 50 economic analysis (2019, vol. 52, no. 1, 48‐55) companies are trying to reinvent themselves and stay relevant in the digital era. this has led to two major trends. first, companies are focused inward on their customer experience. they need to retain their most valuable customers and secondly, telcos are looking outward. they’re considering how they can monetize the enormous volume of iot data currently in their possession. there is no doubt that data analytics is not going to be neglected as a valuable tool for achieving that reinvention, not only for telecommunications companies but other service companies as well (stoughton, 2018) the telecommunications industry is area specific industry regarding predictive analytics use. this counts for the telecommunications sector in the republic of macedonia as well. this sector is one of the most advanced service sectors in the country and hence represent a benchmark concerning digital transformation. in line with global trends, the telecommunications market in the country is developing rapidly, particularly in the mobile segment. telecommunications in the republic of macedonia include radio, television, fixed and mobile telephones, and the internet. according to the latest report of agency of electronic communications of the republic of macedonia ‐aec, the telecommunications market in the country is fully dominated by two companies (makedonski telekom and one. vip) in all segments of the market (mobile, internet, fixed lines). according to the data of the same report, in 2017, the mobile operators' share in the mobile telephony market per number of active subscribers shows that makedonski telekom’s share was 47.97%, while one. vip operator’s share was 49.57%. the market share of mobile operators in the republic of macedonia by revenue generated from the provision of mobile communication services on the retail market is as follows: makedonski telekom has the largest market share at 52.56%, while one. vip operator has a market share of 47.21%, with a third operator having an insignificant share of 0.23%. the market shares were calculated for the total revenue, which represents the sum of revenues arising from call initiation service, monthly subscription, data transfer, terminal equipment, sms, mms, roaming (traffic, sms and data), and other revenues. the operators’ share in the total number of active subscribers to broadband and narrowband internet access via mobile network (2g/3g/4g) states that one.vip operator has a market share of 52.18%, makedonski telekom has a market share of 46.51%, while the third operator has an insignificant market share of 1.31% (www.aek.mk). methodology and results according to the latest data and analytics global executive study and research report (2018) prepared by mit sloan management review, organisations can outperform by making use of data from multiple sources. these organisations are considered innovative and analytically mature. data analytics in companies matures differently with regards to different aspects/dimensions and different parts of an organisation (departments). in practice, the maturity path of an analytical organisation is not linear in all dimensions and departments. it has a more complex trajectory which is not synchronised nor by dimension or sector/department. according to lismont (2017) “it is not unfamiliar that analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy”. (lismont, 2017). but, what analytically mature organisation means and how one organisation can become innovative and analytically mature. different authors and consulting groups propose different analytics maturity models/frameworks in order to reach a predefined analytical maturity level. in the literature, one of the latest research representing a summary of the existing analytics maturity models is one of chen and nath (2018). according to their research, numerous maturity models have emerged recently, following the proliferation of the predictive analytics tools development. chen and nath (2018) suggest that business analytics maturity models can kalina trenevska blagoeva, marina mijoska 51 be categorized by the following determinants: technology, organization, capability, and impact ‐ focused. one of the latest is the analytic processes maturity model (apmm) for evaluating the analytic maturity of an organisation (grossman, 2018). the apmm identifies analytic‐related processes in six key process areas, defined as: 1) building analytic models; 2) deploying analytic models; 3) managing and operating analytic infrastructure; 4) protecting analytic assets through appropriate policies and procedures; 5) operating an analytic governance structure; and 6) identifying analytic opportunities, making decisions, and allocating resources based upon an analytic strategy. based upon the maturity of these processes, the apmm framework of grossman (2018), organizations can differ i.e. reach five maturity levels defined as: level 1 ‐ organizations that can build reports level 2 ‐organizations that can build and deploy models; level 3 ‐ organizations that have repeatable processes for building and deploying analytics; level 4 ‐organizations that have consistent enterprise‐wide processes for analytics; and level 5 ‐ enterprises whose analytics is strategy driven. this model is based upon the capability maturity model ‐ cmm that is the basis for measuring the maturity of processes for developing software created by software engineering institute, carnegie mellon university. another approach which provides estimation of analytics maturity i.e. analytical maturity levels differs organizations in three major categories based on their relative level of sophistication in adopting analytics i.e. 1) the analytically challenged organizations display limited analytical capabilities; 2) analytical practitioners largely use analytics to track and support performance indicators; and 3) analytical innovators incorporate analytics into virtually every aspect of their strategic decision‐making, including gleaning data from a variety of sources such as direct measurement and sensors, industry data, and third parties (ransbotham and kiron, 2018, p.7). according to the defined methodology, in order to determine the relative analytics proficiency of an organization, it is suggested to calculate the analytics core index, based on the organization’s core analytics capabilities in three major areas like: (1) ingesting data (capturing, aggregating, and integrating data); (2) analyzing data (descriptive analytics, predictive analytics, and prescriptive analytics); and (3) applying insights (disseminating data insights and incorporating insights into automated processes). in detail. the analytics core index is calculated by assessing how effectively the organisation performs these seven analytics‐related tasks and activities defined like 1. capturing data, 2. aggregating/integrating data, 3. using descriptive analytics, 4. using predictive analytics, 5. using prescriptive analytics, 6. disseminating data insights and 7. incorporating analytics insights into automated processes (ransbotham and kiron, 2018, p.9). the measurement process is based on a five‐point scale ranging from very ineffective to very effective. the analytics core index score represents the sum of the responses to the seven questions, scaled to a range from 0 to 100. higher levels of analytical maturity are associated with higher levels of customer engagement, which in turn is associated with higher scores on the analytics core index, which in turn is associated with greater use of diverse data sources. this means that organizations that make effective use of a wide range of data sources — from different types of technologies and different types of entities, such as customers, vendors, competitors, and publicly available sources — are more likely to use analytics to generate higher levels of customer engagement and gain a competitive advantage than organisations that use fewer sources of data. (ransbotham and kiron, 2018, p.9). according to lismont et al., (2016), the application of analytics in organisations generally differs with regards to five different aspects like: data, enterprise or organisation, leadership, targets or techniques and applications, and the analysts who apply the techniques themselves. in their research, they found that the analytics organisation in companies matures with regards to these aspects. moreover, analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy (lismont et al., 2016). 52 economic analysis (2019, vol. 52, no. 1, 48‐55) in our survey in order to assess the level of organisational maturity in predictive analytics, we use the predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. in different business units within the same organisation, there are different maturity levels. for that reason, managers from different organisational sectors were approached and interviewed. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competency, deployment and governance). for each dimension, managers were asked to choose the appropriate level of usage out of four available maturity levels: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony. this framework can serve as a roadmap for moving the organisation towards achieving its predictive analytics goals. the suggested framework which defines analytics adoption level of an organisation and its environment is illustrated in figure 1. figure 1. the pamfa – dimensions and maturity levels source: capgemini. 2012. “measuring organisational maturity in predictive analytics: the first step to enabling the vision”, p.8. according to the defined methodology, the five different aspects/dimensions of predictive analytics maturity are assessed. the first dimension is vision and strategy. it is rare today for an organisation to develop software and information systems, without striving to use the data in best way. in this sense, having an analytics vision and strategy is very important, as the long term decisions an organisation makes about how it uses its data is needed. by defining maturity level of this dimension, the companies can write a broad “analytical map” in which the current level of the organisation will be stated, accompanied with the vision of the future wanted level. the roadmap can help in harmonising predictive analytics incentives with the organisation’s high‐level strategic goals. it demonstrates where legitimisation, or execution of extra activities, is required. pamfa looks at the current predictive analytics strategy, distinguishing any gaps and key enablers required for execution. having a vigorous methodology set up makes it conceivable to prioritise analytics initiatives based on enterprise level business imperatives, not departmental ones. the second measurement is called – enablers, and it alludes to discovering how prepared the company’s environment is to adopt or pursue predictive analytics. pamfa examines the data condition, legacy solutions, analytics process, and technology and support arrangements. it likewise survey the association's comprehension of predictive analytics and its impression of the advantages. among the empowering enablers considered in the framework are an information framework that suits predictive analytics needs and a justified portfolio of applications. kalina trenevska blagoeva, marina mijoska 53 the third dimension is competence. this implies that organisations ought to have a full understanding of all current predictive analytics projects, and of parts where analytics could be used further on. next is deployment. this measurement estimates the organisations capacity to convey predictive analytics and coordinate it into business processes which is a basic part of predictive analytics maturity. the central matter predictive analytics is to power is the decision making capability of the organisation. the last, fifth dimension in the pamfa is governance. governance is a regularly disregarded yet fundamental part of predictive analytics. therefore, it is essential to look at the organisation’s modelling lifecycle management and its administration of model precision and pertinence. for every one of these measurements, four maturity levels are characterized. level 1 is called impromptu. at this level, sporadic and secluded analytic capability results from impromptu undertakings done by a solitary administrator or speciality unit. the second dimension is named solo. level 2 is separated into two sub‐levels: amateur solo, implying that predictive analytics abilities and procedures exist for the most part at an individual dimension, and are not natural to the organisation, and professional solo which is a brilliance inside a silo. predictive analytics processes, capacities and environment meet up to address business issues adequately, yet just for individual tasks. level 3 is named ensemble. on this level, one can perceive predictive analytics activities crosswise over business functionalities, with certain procedures being made together. the last, most developed level is symphony level, where well‐organised, company’s wide activities apply analytics for achieving business advantage. this framework can fill in as a guide for moving the organisation towards accomplishing its predictive analytics objectives. pamfa is structured not exclusively to distinguish the present dimension of predictive analytics development, yet additionally to find the company's ideal analytics maturity level (iaml). the iaml is the dimension that would empower the firm both to capitalise on existing assets and furthermore to put ideally in extra assets, so as to accomplish key objectives and infer greatest business benefits. the results of the survey confirm that analysed companies fall somewhere around level 2 or 3 for almost all dimensions. more precise, results for each dimension are shown in the table below. table 1: survey results vision and strategy enablers competency deployment governance a b a b a b a b a b level 1 impromptu level 2 solo * * * * * level 3 ensemble * * * * * level 4 symphony regarding the first dimension, vision and strategy, analysed companies are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not formulated enterprise vision and strategy for using predictive analytics as a valuable asset for the company as a whole. although some employees in separate departments have an analytics vision, yet there is no single formulated analytics strategy, even for that department. the achieved level is relatively high and can be a boost for achieving higher level on other dimensions. the maturity of the analysed companies for the second dimension – enablers is on level 2 (solo). this implies that separate business departments may work together with innovation or business intelligence units, yet there is almost no data exchange. while discussing this 54 economic analysis (2019, vol. 52, no. 1, 48‐55) dimension with the managers‐respondents, it was obvious that they are not satisfied with the alignment of the processes. the third dimension is called competency. analysed companies in our research are on level 2 of maturity. this implies that some business units, individual competency may exist, but it is not used widely on a regular basis. the reported level is in correlation with the reported level of the dimension enablers, and the silo thinking is still an obstacle in this companies for performing predictive analytics and monetizing its results. for the fourth dimension ‐ deployment, the answers from the interview are more dispersed. this means that company a is on the second level of maturity and company b on the third. level 2 (solo) means that in company a integration with the business information systems is manual. for company b which is on level 3 (ensemble), this score shows that the analytics is integrated with decision‐making systems. for both companies, the predictive analytics model output is not yet integrated with business intelligence systems, decision‐making systems and business information systems. the last dimension (governance) for both companies shows level 3 of maturity. this level, ensemble, means that business unit level governance in both companies exist but, there is still a limited enterprise‐level governance. according to the results, the overall level of predictive analytics maturity is set between levels 2 and 3 for analysed companies. although both companies are doing well on maturity journey, there is an evident difference in the maturity of the fourth dimension – deployment. the pamfa can serve as a plan for guiding the organisation to achieving its predictive analytics objectives. this framework is designed not only to identify the current level of analytical maturity but also to discover the organisation’s ideal analytics maturity level (iaml) (capgemini, 2012). the limitation of the research methodology is the subjectivity that is expected in assigning the levels by the managers‐respondents. overestimating the levels of maturity is possible. however, this bias is present in every methodology of this type. with respect to initially measurement, vision and methodology, broke down organizations are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not characterised and verbalised a venture vision and technique for utilizing it on a big business level. increasingly exact, an investigation people in some speciality units have an examination vision, yet there is no enunciated examination methodology, notwithstanding for a solitary speciality unit yet. vision is explained by individual speciality units, alongside the it, who need to help the vision. the accomplished dimension is moderately high and can be a lift for accomplishing a more elevated amount on different measurements. conclusion organisations nowadays are focused on predictive analytics as a valuable tool to use data for achieving competitive advantage. the telecommunications sector in the country is one of the most advanced service sectors and hence represent a benchmark concerning the digital transformation. the results of our survey confirmed that telecommunications companies in the country understand the benefits of predictive analytics as a valuable source to gain a competitive advantage from data. the interview results confirm that organisations fall somewhere around level 2 or 3 for almost all dimensions. this survey results provide useful information needed to design a plan for migrating towards the higher levels of maturity. the road to achieve higher levels across all dimensions is hard, and it will take full management commitment in order to maintain competitive. this research is the first attempt to analyse organisational maturity in using predictive analytics in the country. its originality derives from the specific characteristics and development of telecommunications sector in the country and its importance. knowing where an organization is on this journey will help managers/strategists to kalina trenevska blagoeva, marina mijoska 55 adopt ideal analytics maturity level, i.e. the highest level that would enable organisations to derive maximum business benefits and achieve its strategic objectives. further research can include companies from other industries in the country (finance, health) since the pamfa can be used to measure and describe their predictive analytics efforts. references agency for electronic communications of the republic of macedonia. 2018. “report on the development of the electronic communications market in the republic of macedonia for 2017.“ https://www.aek.mk capgemini. (2012). „measuring organizational maturity in predictive analytics: the first step to enabling the vision.“ https://www.capgemini.com ernst & young. (2015). “global telecommunications study: navigating the road to 2020.“ https://www.ey.com grossman, robert l. (2018). “a framework for evaluating the analytic maturity of an organization.“ international journal of information management, 38: 45–51 chen, l. & nath, r. (2018). "business analytics maturity of firms: an examination of the relationships between managerial perception of it, business analytics maturity and success", information systems management,. 35(1): 62–77 lismont, j., et al. (2017). “defining analytics maturity indicators: a survey approach.“ international journal of information management, 37 (3): 114‐124 mckinsey global institute. (2016). “the age of analytics: competing in a data‐driven world.“ https://www.mckinsey.com mishra, n. & silakari, s. (2012). “predictive analytics: a survey, trends, applications, opportunities & challenges.” international journal of computer science and information technologies, 3 (3): 4434‐ 4438 morabito, v. (2015). “big data and analytics: strategic and organizational impacts.“ springer ransbotham, s. & kiro, d. (2018). “using analytics to improve customer engagement, findings from the 2018 data & analytics global executive study and research report.” mit sloan management review, https://www.sloanrieview.mit.edu stoughton, j. (2018). “turning data into insights: how digitization creates new opportunities for the telecommunications industry.” https://www.digitalistmag.com trenevska blagoeva, k., josimovski, s., mijoska, m. & jovevski, d. (2018). “determinants of analytics usage to improve customer engagement in chosen macedonian companies.“ knowledge ‐ international journal, 22(1): 187‐192. valdez‐de‐leon, o. (2016). “a digital maturity model for telecommunications service providers“, technology innovation management review, 6 (8): 19‐32 https://www.digitalistmag.com. https://www.forbs.com https://www.gartner.com https://www.infoworld.com https://www.predictiveanalyticstoday.com https://www.statista.com article history: received: may 16, 2019 accepted: june 21, 2019 doi: 10.28934/ea.22.55.2.pp66-78 first online: december 8, 2022 original scientific paper business process innovation of serbian entrepreneurial firms mihailo paunović1 | marija lazarević-moravčević1 | marija mosurović ružičić17f* 1 institute of economic sciences, belgrade, serbia abstract innovations are vital for improving living standards and can affect not only individuals but also institutions, economic sectors, and the whole country in many ways. this paper investigates the innovation performances of serbian entrepreneurial firms. it focuses on business process innovations related to product and business process development. the sample consists of serbian start-ups, which were founded in 2015, from five industries. the data about these entrepreneurial firms were collected via a questionnaire. the respondents assessed various statements about product and business process development innovations on a five-point likert scale (1-strongly disagree; 5-strongly agree). the statements were derived from several indicators within the balanced scorecard’s process perspective. they were modified to fit the new definition of business process innovation provided by the oecd/eurostat (2018) and according to the context of serbian entrepreneurial firms. the statistical analysis involved descriptive statistics, frequencies, reliability analysis, and one-way anova. the results indicate that most of the entrepreneurial firms introduced innovations that enabled them to operate more efficiently, improve their processes, establish certain routines, respond to customer complaints faster than their competitors, and develop a product or a service more quickly than their competitors. no statistically significant differences were found regarding introducing business process innovations among entrepreneurial firms from different industries. this paper can help policymakers assess the contribution of innovation to economic goals and monitor and evaluate the effectiveness of their innovation policies. keywords: innovation, entrepreneurship, business process innovation, serbia jel classification: o31, o32 introduction there are different interpretations of the innovation phenomenon in the professional literature. despite those differences, the expert community agrees that innovation is essential for the development of both the economy and society. innovation is a driver of economic growth (schumpeter, 1934); it affects employment growth and improves the quality of life (atkinson & ezell, 2014); and presents a condition for creating a competitive advantage (porter, 1985). innovation is important for all companies, regardless of their size or the activity they perform. companies that do not possess the ability to innovate lose their established positions in the market and are "doomed to fail" (drucker, 1996). in both theory and practice, innovation has been identified as a factor of growth, structure, transformation and the survival of various industries (barney et al., 1987; malerba, 2006). the * corresponding author, e-mail: marija.mosurovic@ien.bg.ac.rs mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 67 differences in growth rates between individual industries are well-known and obvious, as well as the fact that growth rates in certain industries constantly decline, while the other industries record highly intensive growth. high growth rates can be associated with a greater share of technological innovation in new products and processes and a high rate of diffusion of these innovations in the global economy. on the other hand, industries with a negative growth rate are generally characterized by a low rate of research and development intensity and a low rate of technological changes. however, the connection between technological progress and the growth of an industry does not necessarily mean that only technological innovations can encourage growth (freeman & louçã, 2001). similarly, it also does not always mean that the companies operating in low-tech sectors benefit less from their innovations. the results of innovation development in the market showed that a significant number of incremental improvements had better results in the market compared to the new technology itself (freeman, 1989; mosurovićruzičić & kutlača, 2015). innovations can result not only from scientific and technological knowledge, but also from the informal forms of knowledge and learning based on experience, increasingly depending, nowadays, on business process development as well. the strategic resource in the industrial society was capital, while in the post-industrial society (modern scientific and technological revolution), knowledge has become the basic productive force, i.e. leading to the creation of a "knowledge society" or "entrepreneurial society". by developing high technology, the factors of production, the structure of production, and business motives also keep changing. the problems of modern society can be solved and further developed on a new technological basis (ilić, 2003). innovations are needed by every company regardless of its size. the question of the influence of the size of an organization on its innovative ability has been discussed in numerous studies, and the agreement of the expert community has yet to be reached. some authors believe that larger firms are generally less efficient in introducing innovation compared to smaller ones (cooke et al., 1997; kamien & schwartz, 1975). dess et al. (2007) state that the larger the company is, the fewer innovative solutions there are. drucker's opinion is that it is not the "size" that is an obstacle to entrepreneurship and innovation, but the way of operational management and functioning of a company (drucker, 2020). furthermore, certain research has shown that small companies invest less in research and development due to a lack of financial resources; still, they conduct these activities more efficiently than large systems and can faster launch new products (burns, 2011). it is necessary to highlight the fact that the innovative activity of a company is not exclusively determined by financial capabilities, but this depends on the "stimulating organizational context in which such creative ideas arise and afterward get implemented (mosurović ružičić, 2012)". certain characteristics of small systems, such as simple organizational structure, effective communication and decision-making, strong organizational culture and employee commitment (kamenković & lazarević-moravčević, 2018; mosurović & kutlača, 2011; paunović et al., 2022) can encourage the innovative activity of these systems. also, the pressures from the environment (technology development, intense competition, changes in consumer demands, etc.) impose the need to review the existing business models and introduce innovative solutions related to a process or product. due to the lack of financial resources, small companies primarily implement innovations that do not involve high investments in research and development. these are usually innovations in the field of marketing and service delivery. we are talking about the innovations related to the application of new marketing methods which mainly involve certain changes in design, product packaging, promotion, placement, as well as the methods of defining the prices of products/services. the goal of innovation in marketing is to provide a better response to customer needs, to open new markets, or to ensure different product positioning in the market. small organizations are extremely innovative in the way how they manage customer relationships. smaller systems can find new ways to connect with customers and suppliers that 68 economic analysis (2022, vol. 55, no. 2, 66-78) enable them to reduce costs and time from ordering to the delivery of products. smaller organizations have proven to be extremely innovative in the market communication segment, especially during the crisis caused by the global outbreak of the covid-19 pandemic. due to the changes in consumer habits and behavior, there was a need to apply new approaches in market communication, implying the use of various online marketing tools (lazarević-moravčević et al., 2021). the authors of the paper investigate the innovation performance of entrepreneurial firms in serbia while focusing on business process innovation related to product and process development in companies. the paper starts with two research questions: (1) what is the innovation performance of entrepreneurial firms in serbia, and (2) does belonging to a specific sector impact the innovative performance of entrepreneurs? the methodology of the oslo manual, a guide for measuring innovation developed by eurostat and the oecd, will be used to define and analyze business process innovation. although there are different definitions in the literature, the term entrepreneurial firm is most often associated with start-ups not older than seven years. van praag and versloot (2007) define an entrepreneurial firm as a company meeting one of the following three criteria: (1) employing less than 100 people, (2) being founded less than seven years ago, and (3) a company which is new in the market. for these authors, the terms "entrepreneur" and "entrepreneurial firm" have the same meaning. accordingly, in this research, the term entrepreneurial firm means a start-up company in the republic of serbia, which was founded in 2015 and which has less than 100 employees. 203–218. theoretical background the etymological meaning of the verb innovate can be found in the latin language: innovare – to renew, to make something new again, and the noun innovatio means a new invention that improves a product or a method of work, a novelty, a change. the term innovation can be interpreted in different ways. according to schumpeter (1934), innovation represents conquering new markets, introducing new products and processes, using new raw materials, changing management and organization, etc. the same author points out that innovations are drivers of economic growth and that entrepreneurs, especially those who are inclined to take risks, are initiators of change and bearers of innovation. innovation includes technical, design, production, management and commercial activities for the purpose of launching a new or improved product/process in the market (freeman, 1982). the authors hill and jones (2007) interpret innovation as the improvement of a product, a production process, a management system, and the organizational structure of a company. stošić (2007) believes that „innovation implies the transformation of new ideas into new products/processes”. to put it differently, it can be understood as the process of turning an idea into a practical application realization. the definition of innovation generally refers to the development and successful conversion of an invention into a useful product (product innovation) or a technique (process innovation) considered worthy enough to be launched into the market, or to be used in a company. therefore, first of all, a distinction needs to be made between an invention and an innovation. innovation is the market realization of an invention. not all inventions end up becoming innovations, only the ones that have met the three basic classification requirements for a standard patent: (1) an invention needs to be new; (2) useful; (3) and to justify the inventiveness phase, i.e. "it needs to be non-obvious to experienced practitioners in the technological field" (semenčenko & kutlača, 2018). peter drucker believes that for the success of an innovation, it is necessary to perceive a need for it, and that innovation is not linked only to high-tech companies, but also to low-tech companies (drucker, 2020). mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 69 the growing attention that the innovation phenomenon attracts is related to a large number of factors that are partly determined by the economic discipline, and partly related to the increase in the empirical perception of the importance of technological factors for competitiveness and growth. for example, the number of empirical studies that underline the importance of technological innovation for achieving a competitive advantage is constantly increasing (castelli, 2012; farny & binder, 2021; nelson, 1988). according to the organization for economic co-operation and development (oecd), an innovation is "a new or improved product/process (or their combination) that is significantly different from a previous product/process and that is made available to potential users (product), or put into use (process)" (oecd/eurostat, 2018). in the latest edition of the oslo manual, a manual for measuring innovation, it is said that innovation changes the characteristics of one or more products or a business process, and, accordingly, a distinction is made between two basic types of innovation: product innovation and process innovation. in addition to the distinction between the two basic types of innovation in literature and practice, there is also a classification of innovations according to the degree of change they entail: radical and incremental innovations. radical innovations imply revolutionary changes and represent the abandonment of existing practices. on the other hand, incremental (gradual) innovations refer to the improvement of existing practices, i.e. products and services (dess et al., 2007). some authors make a difference between business model innovation, product process innovation, and marketing (latifi et al., 2021). different interpretations of the term business process innovation can be found in the literature. the author gershon (2009) believes that business process innovation implies the systems and methods for improving the business performance of an organization, while varela et al. (2020) state that a company implements business process innovation if it has introduced one or more business functions significantly different from previously introduced business processes. the oslo manual, whose methodology is mostly used in the paper, defines business process innovation in the following way: "a business process innovation is a new or improved business process for one or more business functions that differs significantly from the firm's previous business processes and which has been brought into use in the company" (oecd/eurostat, 2018, p. 72). business process innovations include improvements in various business activities such as producing goods and services, marketing and sales, information and communication technology, distribution and logistics, administration, etc. based on the above-mentioned, it can be concluded that the term innovation is broader compared to the development of new products, processes, or technology. innovation implies the introduction or change to a new state (johannessen et al., 2001). although there are innovations that are the result of a spur-of-the-moment idea, the majority of successful innovations are the result of a diligent and targeted search for innovation opportunities that can be spotted on rare occasions. the connection between entrepreneurship and innovation, as well as their impact on economic progress, has been proven in numerous studies. there is consensus that the entrepreneurial orientation of firms determines and improves their innovativeness (khalili et al., 2013; minafam, 2017; zen et al., 2016). most of those researches elaborate only on the technological dimension of innovation within the entrepreneurial framework (acs & gifford, 1996). there are some researches that observed just particular components of a business innovation process in terms of the relationship between corporate entrepreneurship and innovation performance (minafam, 2017), the relationship between innovation in business and smes performance (muparangi & makudza, 2020), etc. however, there are only a handful of studies that integrate all the elements of business process innovation. one of the reasons could be that the definition of business process innovation that we used in this paper is from the latest oslo manuel edition from 2018. 70 economic analysis (2022, vol. 55, no. 2, 66-78) entrepreneurship can be described most simply as a process in which an individual or a group of people uses an organizational effort to seize valuable opportunities and create value (drucker, 1996), and innovation is a specific tool of entrepreneurs, i.e. a means by which entrepreneurs use a change as an opportunity to perform various production or service activities (drucker, 2020). entrepreneurship begins with innovation, i.e. innovation is one of the basic characteristics of entrepreneurship. when talking about an entrepreneur, drucker notes that what successful entrepreneurs have in common are not certain personality traits, but a commitment to innovation. in fact, an entrepreneur is "an independent innovator, meaning that the activities of this individual include, but also go considerably beyond, technical inventions and their utilization" (baumol, 2002). innovation is the way entrepreneurs use existing and create new business opportunities. there are four types of sources of such opportunities within a company or an industry: (1) unexpected events, (2) inconsistencies, (3) the need to perform a process, and (4) changes in the structure of an industry or market. three additional sources also exist outside a company, i.e. in its environment: (1) demographic changes, (2) changes in perception, and (3) the emergence of new knowledge (drucker, 2002). it is necessary to emphasize the fact that entrepreneurship is present in different areas of human activities and implies different behaviors. the most significant are: taking the initiative, practical use of resources, and accepting risks (čičovački & kulić, 2022). the authors bolton and thompson (2004) find a connection between invention, creativity, and entrepreneurship. their opinion is that "creativity is the starting point, whether it is related to invention or finding new business opportunities. that creativity is transformed into a practical reality (a product or a service) by means of innovation. afterward, an entrepreneur puts that innovation into the context of the company and thus creates a value recognizable in the market". there is a difference between creativity and innovation, i.e. creativity is a part of the process of creating innovations. creativity contributes to the creation of innovations, but it can also be used for other things. on the other hand, to turn creativity and invention into a business reality, it is necessary to place them in an entrepreneurial context that primarily refers to identifying business opportunities. the relationship between creativity, invention, innovation, identifying business opportunities, and entrepreneurship is shown in figure 1. figure 1. creativity, invention, innovation, business opportunities, and entrepreneurship source: the authors based on burns (2011). invention innovation ability to spot opportunities ability to be creative competitive advantage mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 71 based on what has been said, it can be concluded that innovation and entrepreneurship are closely related and that, together, they can determine the development of an economy and society. innovation is a way how entrepreneurs exploit existing or create new business opportunities, and this does not happen by accident. the key role in their creation is played by entrepreneurs who are characterized by focus, persistence, and dedication. data and methodology the data on the entrepreneurial firms were obtained based on an online questionnaire that was sent to them via email. along with the questionnaire, the respondents were also sent a cover letter in which they were informed of the purpose of the research and the time needed to complete the questionnaire in order to motivate them to give their answers. within the first thematic unit, there were general questions describing the structure of the sample (table 1). in addition, the respondents evaluated various statements related to the implementation of innovations regarding product and process development in the company, using a five-point likert scale (1-absolutely disagree, 2-disagree, 3-partially agree, 4-agree, 5-absolutely agree). the questionnaire method of data collection was chosen since the research subject could best be approached in that way. having finished the data collection phase, the statistical data processing phase began in which the ibm spss (statistical package for the social sciences) software was used, enabling high-quality and analytically correct data processing. the research was conducted in compliance with the procedures characteristic of empirical research. the indicators of business process innovation were systematized at a general level based on several indicators in the alignment list in the process perspective section. they were further modified in order to fit the new definition of business process innovation given by the (oecd/eurostat, 2018), and the business context of the entrepreneurial firms in serbia. the statistical analysis included descriptive statistics, frequencies, reliability analysis, and the comparison of the arithmetic means of several samples (one-way anova). the sample included start-up companies established in 2015 from five different sectors from the territory of the republic of serbia. the initial database consisting of 1,131 companies was obtained from the ministry of economy of the republic of serbia. the founders of those companies were sent a questionnaire via email. between december 2018-april 2019, 140 valid answers were collected, indicating that the response rate was 12.38%. this study uses the definition of a start-up company provided by the global entrepreneurial monitor (gem, 2018), according to which an entrepreneurial firm or a start-up is a company old less than 42 months. when the survey was conducted, all companies participating in the research were less than 42 months old. table 1 shows the sectoral structure of the companies that participated in the research and that constituted the final sample. the structure of the sample showed that the majority of the companies from the wholesale and retail sector participated in the research, while the smallest number of the companies was from transport and storage. 72 economic analysis (2022, vol. 55, no. 2, 66-78) table 1. number of the companies that participated in the research sectors included in the sample number of the companies percentage in the sample 1. manufacturing industry 40 29% 2. wholesale and retail 46 33% 3. transport and storage 12 9% 4. information and communications 16 11% 5. professional, scientific, innovative and technical activities 26 18% in total 140 100% source: the authors regarding the size of the companies participating in the research, 130 are micro-enterprises, and only 10 of them are small enterprises. it can also be noticed that 56 companies have their headquarters in belgrade, 10 in novi sad, while the other companies have their headquarters in other towns in serbia. table 2 displays the descriptive performance indicators of the companies in the sample at the end of 2017. table 2. descriptive indicators for the companies in the sample at the end of 2017 arithmetic mean median standard deviation the minimum the maximum sales revenue (in thousands of dinars) 36,059 21,337 42,184 361 224,387 operating profit (in thousands of dinars) 1,707 518 5,590 -19,589 33,745 net profit (in thousands of dinars) 1,368 335 4,838 -19,856 28,706 number of employees 7 5 7 3 49 source: the authors the entrepreneurial firms participating in the research have an average of seven employees. the smallest number of employees is three, and the largest is 49. as for profitability, only 15 entrepreneurial firms have reported a net loss, while the remaining 125 have reported a positive net result. results and discussion on a five-point likert scale (1-absolutely disagree, 2-disagree, 3-partially agree, 4-agree, 5absolutely agree), the respondents rated six statements related to the introduction of business process innovations regarding product and process development in their companies. table 3 shows the results of the research. it shows the descriptive statistical indicators for each of the six statements based on which the innovative activity of the entrepreneurial firms in serbia was measured. mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 73 table 3. descriptive indicators for the statements based on which the innovative activity of the entrepreneurial firms was measured product and process development number of responses arithmetic mean standard deviation 1. our enterprise introduced numerous innovations that resulted in more efficient operations. 140 3.61 1.04 2. majority of employees are committed to introducing innovations that lead to the continuous improvement of the processes performed in the company. 137 3.69 0.94 3. certain routines have been established in our company, which has led to more efficient operations. 140 3.88 0.83 4. the innovations we introduced allowed us to respond to customer complaints more efficiently than our competitors. 136 3.96 0.93 5. the innovations we introduced allowed us to develop a product/service faster than our competitors (a shorter period from creating an idea to the market launch). 133 3.53 1.07 6. customer suggestions lead to the improvement of the processes that take place in the company. 140 3.46 0.98 source: the authors bearing in mind that the entrepreneurs rated their innovative activities on a five-point likert scale and that the mean values of all their answers were greater than three, it can be concluded that the majority of the entrepreneurial firms in the sample implemented business process innovations related to product and process development in the company. to be precise, 55% of the respondents cited that their company implemented numerous innovations that led to more efficient operations, 62% that most of their employees were committed to introducing the innovations leading to the continuous improvement of the processes they performed, 70% that the established routines in their company led to more efficient operations, 70% that their company introduced the innovations that enabled them to respond to customer complaints more efficiently than their competitors, 51% that their company introduced the innovations that enabled them to develop a product/service faster than their competitors, and 53% that certain customer suggestions led to the improvement of the processes taking place in their company. the research results indicated that entrepreneurial firms that participated in the study introduced numerous business process innovations that enabled them to operate more efficiently, improve the processes, establish certain routines, respond more quickly to customer complaints compared to the competition, and develop products/services faster than the competition. what is interesting is that more than two-thirds of the companies established routines that enabled more efficient operations and introduced innovations that enabled them to respond faster to customer complaints compared to the competition. furthermore, more than half of the surveyed companies paid attention to customer feedback and improved their processes accordingly. in order to determine whether there are statistically significant differences regarding the introduction of business process innovations among the entrepreneurial firms belonging to different sectors, a statistical technique was used to compare the arithmetic means of several samples (one-way anova). for this purpose, the companies belonging to transport and storage, information and communications, and professional, scientific, innovative and technical activities are classified as service companies in order to make their number similar to the number of the companies belonging to the sectors manufacturing industry (manufacturing enterprises) and wholesale and retail (trading companies). table 5 shows the results of a oneway anova test for business process innovations related to product and process development in the companies. since homogeneity of variance is a necessary assumption for using a one-way 74 economic analysis (2022, vol. 55, no. 2, 66-78) anova test, levene's test for equality of variances was conducted, whose results are displayed in table 4. table 4. the test of homogeneity of variances development of products and processes levene statistic sig. item 1 0.85 0.43 item 2 1.71 0.19 item 3 0.38 0.69 item 4 0.58 0.56 item 5 0.18 0.83 item 6 0.06 0.94 the results are significant at the 0.05 level source: the authors the results of levene's test for equality of variances are not statistically significant for any of the six statements that the respondents stated in the questionnaire, which indicates that the decision to use a one-way anova test is justified. table 5. descriptive statistics and one-way anova development of products and processes n mean std. dev. one-way anova f sig. item 1 manufacturing 40 3.58 1.13 0.41 0.67 trade 46 3.52 1.05 services 54 3.70 0.96 item 2 manufacturing 40 3.53 1.01 1.74 0.18 trade 44 3.61 0.95 services 53 3.87 0.86 item 3 manufacturing 40 3.90 0.84 0.48 0.62 trade 46 3.96 0.82 services 54 3.80 0.83 item 4 manufacturing 38 3.87 0.91 0.24 0.79 trade 46 4.00 0.99 services 52 3.98 0.90 item 5 manufacturing 37 3.59 1.04 0.56 0.57 trade 44 3.39 1.15 services 52 3.60 1.03 item 6 manufacturing 40 3.68 1.02 1.72 0.18 trade 46 3.48 0.96 services 54 3.30 0.96 the results are significant at the 0.05 level source: the authors the results of the one-way anova test are not statistically significant for any of the six statements that the respondents rated in the questionnaire, which indicates that there are no significant differences regarding the introduction of business process innovations among entrepreneurial firms belonging to different sectors. manufacturing companies (manufacturing industry), trade companies (wholesale and retail), and service companies (transport and mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 75 storage, information and communications, as well as professional, scientific, innovative and technical activities), on average, introduced an equal number of business process innovations related to product and process development in their companies. cronbach's alpha coefficient was used to determine the reliability of the measuring instruments. it measures the internal consistency and indicates how closely related the questions in the questionnaire are which measure the same type of influence. reliability means that the respondent should get the same result if he/she completes the questionnaire under exactly the same conditions at two different points in time, and two respondents who are identical in everything should get the same result (paunović, 2021). the general rule is when the value of this coefficient is above 0.7, it is considered acceptable. due to the fact that the value of cronbach's alpha coefficient is 0.775 for the instruments based on which the innovative activity of the entrepreneurial firms was measured, it can be concluded that they have adequate reliability. conclusion entrepreneurship and innovation represent the basic factor of technological progress, economic and social growth and development. more precisely, "innovativeness, entrepreneurship and economic development are inextricably linked, interdependent, and in continuous correlation" (šormaz, 2021). innovativeness represents one of the basic dimensions of entrepreneurial orientation. it implies the willingness of a company to permanently introduce new or improve the existing products and processes, and to find new markets and new ways of serving them. innovation is vital for every individual, organization, economic sector and economy as a whole. in dynamic business conditions, innovation represents a basic condition for the survival, growth and development of an organization and presents a source of competitive advantage. to the best of the authors’ knowledge, based on the review of the available literature, no similar research has ever been conducted in serbia, having entrepreneurial firms as its subject. some aspects of business process innovations of family businesses were analyzed (paunović et al., 2022); however, a comprehensive review of entrepreneurial firms has not been done. the paper analyzes the innovative ability of entrepreneurial firms in serbia. based on the research, it can be concluded that most of the surveyed entrepreneurial firms introduced innovations in business processes related to product and process development in the company. more precisely, most of the entrepreneurial firms introduced innovations that enabled them to operate more efficiently, improve processes, establish certain routines, respond faster to customer complaints compared to competitors, and develop products/services faster than competitors. in the paper, no statistically significant differences were found regarding the introduction of business process innovations among entrepreneurial firms from different sectors. this research indicates the importance of analyzing business process innovation in entrepreneurially-oriented companies, and represents only one perspective of the research topic. there are certain limitations of the analysis that can serve as a good basis for conducting further research. the geographical aspect of the research, which results from the fact that the research was conducted only in the entrepreneurial firms in serbia, is one of the shortcomings. companies from other countries were not included, which did facilitate data collection, but, at the same time, limited the use value of the collected data. the results of this research are valuable for decision-makers at all levels. the managers of entrepreneurial firms should pay attention to business process innovation elements in their strategies. on the other hand, the conclusions of this research could be useful for the policymakers at the governmental level to stimulate the entrepreneurial behavior of companies. the importance of entrepreneurship for economic development is essential, especially in the era 76 economic analysis (2022, vol. 55, no. 2, 66-78) of the digital economy when business process functions should be aligned with digital technology development (wang et al., 2022). the authors analyzed only one of the six types of business process innovations from the oslo manual, that is, only business process innovations related to product 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(2016). innovative entrepreneurship and competitive performance: the prime/brazil case. revista de negócios, 20(2), 40. https://doi.org/10.7867/1980-4431.2015v20n2p40-56 article history: received: 23.11.2022 revised: 6.12.2022 accepted: 8.12.2022 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp1-12 original scientific paper the puzzle of relationship between the economic growth and happiness: an inter-country analysis yazdan naghdi1* | hamid amir taemeh2 | soheila kaghazian1 1 the islamic azad university, west tehran branch, faculty of economics, department of economics, tehran, iran 2 phd student of economics in firuzkuh, islamic azad university abstract in economic research, the relationship between economic growth and happiness is ambiguous. happiness does not show a positive or negative dependence on economic growth over time. based on the theoretical foundations and using interdisciplinary concepts in economics, e.g. political economy, technology philosophy, generalized method of moments (gmm), and data of 153 countries over the period 2000–2018. the total number of observations in this research is 13,770. also, the model of this research has been estimated by the software eviews. this paper tries to show that the one-dimensional look at economic growth and ignoring the growth consequences, including emotional gap, environmental degradation, and oligarchy (lack of healthy democracy), have a crucial role in creating growth and happiness. the main purpose of this study is to accept or reject the theory of easterlin, called the “easterlin puzzle”. according to easterlin puzzle, the growth and development of countries do not increase the happiness of the people in those countries. based on the model estimated in the present study for 153 countries, the theory of easterlin is not approved, and economic growth has had a small but significant effect on shortand long-run happiness in these countries. key words: emotional gap, economic growth, happiness, gmm model, oligarchy jel classification: d60, fo2, o17, q50 introduction for neoclassical economists, the measures of well-being include wealth, asset, consumption, or the sum of money held by each individual. however, happiness has a special place in the concept of welfare. according to empirical studies, happiness is very important in human economic performance, because life satisfaction will improve people’s intelligence, competence, and productivity. while grief reduces productivity. so, countries where people are happy, economic growth is often higher (li and lu, 2009). there are many factors that affect happiness. variables such as life expectancy, income distribution, education, social freedom, employment, etc. are all factors that affect the happiness in a society. economists have always wondered whether economic growth bring happiness. in order to answer this question, and based on empirical studies, we try to examine if the puzzle of easterlin paradox (easterlin, 1974) is confirmed in different countries. according to easterlin paradox theory, economic growth does not make people and communities happy. whereas, according to many economists, increasing * corresponding author, e-mail: y_naghdi@yahoo.com 2 economic analysis (2021, vol. 54, no. 1, 1-12) economic growth will increase prosperity, and increase the happiness of individuals in a society. the main purpose of this study is to investigate the puzzle of easterlin paradox. most research in iran have addressed the effects of inflation and unemployment on happiness. yet, the main feature of the present study comparing to other research is the wide range of 153 countries and using social, political, and economic indices to study the effects of these variables on happiness. while these two features have not been taken into consideration. the remainder of this paper is organized as follows. section 2 describes the theoretical foundations with respect to the oligarchy, technology, and the economic growth model. section 3 reviews the empirical literature on the subject matter, and provides a summary of the literature in a table. in section 4, the ambiguity of growth and happiness are explained. section 5 introduce and estimates the model, and finally section 6 concludes the paper. literature review for the first time, the debate of happiness and its effect on the economy was studied by easterlin in the united states. he showed that with the economic growth, happiness in the united states did not increase much. so, for the first time, easterlin paradox came up. according to this puzzle, there is no relationship between economic growth and people’s happiness. the paradox states that at a point in time happiness varies directly with income both among and within nations, but over time happiness does not trend upward as income continues to grow. various theories have been advanced to explain the paradox, but the paradox itself is solely an empirical generalization. yet, almost all post-easterlin economists rejected this theory (stevenson and wolfers, 2008). so, it has always been a question among economists whether economic growth can bring happiness. the existence of the paradox has been strongly disputed by other researchers. kanbe and ratzel (2010) said that the evidence shows an inverse ushaped relationship between income and happiness. they claim that in the early stages of economic growth, happiness increases until it reaches its maximum point, and then along with economic growth happiness will decrease. because the demand for higher income requires more work and more work reduces utility and happiness. economics science is organized according to growth patterns, and almost one-dimensional economic growth is the main goal of government planning in most countries. entrepreneurship and creativity move in the direction of further growth, and it seems that any scientific theory that can accelerate economic growth is more valuable. yet, the economic growth has had very significant effects, such as an increase in the emotional gap, environmental degradation, the consolidation of oligarchy systems, which we have very little thought about. economic growth has increased much, but there have also been paradoxes, one of which is the paradox of growth and happiness. emphasizing that economic growth is valuable and essential for community life, we try to show that although economic growth and the increase in consumer goods and services bring about happiness, its negative effects on other aspects of life impose a great deal of suffering on communities, resulting in a decline in happiness in communities. in order to better understand and take a different look at the economic growth, it is necessary to first study the two concepts of oligarchy and technology, then look at economic growth models. democracy and oligarchy can government impact directly on happiness? wagner et al. (2009) who conclude that higher-quality institutions increase satisfaction with democracy. for this reason good governance can also impact on happiness. better rule of law, lower corruption, less regulation of political participation are all associated with higher degrees of satisfaction. therefore, there is a positive relationship between democracy and happiness. yazdan naghdi, hamid amir taemeh, soheila kaghazian 3 in a simple sense, oligarchy refers to a form of government in which a small group controls the power and authority of the country. in other words, the country is run by few people. oligarchs are the clever dictators who, with the appearance of democracy, use the functions and thoughts of the dictatorial system to maximize their personal interests at the expense of the poverty and suffering of the citizens. in almost 85% of countries, there is oligarchy with different ranges. douglass north emphasized the role of security and the military in shaping and sustaining oligarchy. the game of security begins: the group that overthrows security, or the group that provides security, seizes power, and always keeps the fear of insecurity alive for the sake of self-preservation. oligarchs as political geniuses set themselves up with enough knowledge to achieve their goals, quickly destroy competitors, seize key resources, and, after the stability of their rule, begin to form exploitative political and economic institutions. oligarchy systems by exploiting institutions disrupt the process of natural economic growth in society. unless the inclusive institutions are formed, and citizens break the vicious circle of oligarchy, they will always be in poverty and economic crises. the cause of poverty and wealth in different countries is more involved with politics than it is about economics. it is the policy that determines the process of economic growth and development that brings about prosperity or poverty in societies. in almost every continent, oligarchy is associated with the industrial economy, affecting the path of economic growth and development in many countries. chart 1 shows the average trend of oligarchy in all countries around the world over the period 1800–2010. in many countries, oligarchy has entered the form of democracy, and has had its destructive effects. chart 1. oligarchy flow (1800–2010) source: world history website technology technology is the focal point of many fields such as philosophy of science, political science, sociology, mathematics and technical sciences, ethics, religion, history, anthropology, etc. technology cannot be fully defined, and therefore cannot be controlled or guided. as long as natural order was established in the world, and technique and technical development on the one hand and civilization elements on the other hand did not destroy nature, the question of technology did not make sense. but the development of technology in the industrial and postindustrial era and the changing pattern of production have given rise to a rationality that seeks to achieve certain goals. harnessing social realities through tools and techniques led to the conquest of rationality focused on the vehicle-goal chains, and the components of civilization not based on this rationality were vanished. the oligarchs adopted new patterns of production that were based on the structure of socio-economic classes. the unequal distribution of means of production among 4 economic analysis (2021, vol. 54, no. 1, 1-12) social groups created such classes. on the other hand, the authority of cultural traditions was called into question. the most outward manifestation of technology and the rationality that governs it is to conquer nature for the benefit of man. if we accept the definition of technology as applied science, we must say that science has been organized in the new world according to the pattern of technology, because the more a discipline was applied, the more it served human. in other words, the rationality of technology, that is, the means–end rational was spread to other sciences, even the human sciences, so that philosophy was overrun by science, and no longer determined the legitimate status of science. the naturalistic epistemology foundations determined the legitimate status of science. scientists interrogate nature as a slave under the master, unaware that the slave will overtake the master someday. water crisis, all kinds of pollution, extinction of species, global warming, etc. are the calamities rationality has created in short-run for mankind. technology, like any other phenomenon, has always unknown characteristics and numerous facets. technology is not the mere result of our decisions, planning, and policies. the phenomena and events of this world always have consequences that are not under our control. in order to understand technology, it is necessary to study these five themes: tools, using tools, methodology, cognitive and normative framework, and socio-technical systems. a tool is something that has a causal or a characteristic that, if used in a certain way, a certain purpose is achieved. technology is an artificial (man-made) tool, not a natural one, and it requires learning. methodology1f1 is the description of the method, that is, what happens in practice to achieve the goal. in methodology, it is difficult to describe what actually happens in practice. in other words, it requires skill. the cognitive-normative framework refers to a behavioral and educable model that regulates social relationships and reactions to which most people adhere, and are punished by law if they disobey. in addition, the cognitive-normative framework guides people on how to respond in different situations. technology encompasses all the material and spiritual possessions of societies. technology cannot only be expressed in terms of equipment. knowledge, skills, culture, value, legal system, and other factors must also be included. on the other hand, the personality of technology can be examined in three domains: technology as hardware, technology in law, and technology as system. in fact, technology encompasses all of these concepts. defining technology is defining and combining all these concepts together. the important point is that technology with all its complex, unknown, and uncontrollable dimensions has become the main engine of economic growth models. it seems that the process of producing goods and services is more involved in the technology cycle than is appropriate to the needs and priorities of consumption. the impact that technology has had on the production process has had negative, unknown, and unpredictable effects on other aspects of human life. technological development brings economic growth. however it also enhances social wealth on the one hand by increasing the income levels and wealth and causes certain social problems on the other hand. technological development makes very important contributions to the economic and social-cultural life. a study conducted in america reveals that people work more than the past; virtues like industriousness and self-discipline are more valued; entrepreneurship increased and people increased their technological capabilities for their new careers. however in spite of these positive developments, the fluctuations and uncertainties created in the commercial life by the technological development caused uncertainties in the job positions of the employees. while technological development eliminated certain jobs and work areas and 1. for further reading, see the philosophy of technology translated by taqavi (2009) and his lectures on the philosophy and science and technology, faculty of philosophy, sharif university of tehran. yazdan naghdi, hamid amir taemeh, soheila kaghazian 5 made a negative impact to employment on the one hand, it created new job opportunities and taught other methods to perform the jobs on the other hand (hülya kesici,2015) economic growth models perhaps the most prominent growth models are the harrod–domar model, solow–swan model, and the new r&d model. the growth pattern of harrod–domar emphasized capital accumulation, and was very useful in its time. with the industrial revolution and the emergence of technology, and the transformation in weaponry, european colonization brought wealth to europe, which provided the resources needed to produce industrial goods. new industries and technologies that needed investment were expanded with european colonial funding, and the role of technology became very crucial. the solow–swan model institutionalized the role of technology-based knowledge in production. the knowledge part of which was applied in human resources (training, management, and resource allocation), and a part was applied in machinery was the main growth factor. the solow–swan model that perhaps is the most effective model of economic growth led to communities, which because of natural and geographical conditions, and most importantly for the plunder of resources by the colonists, were frustrated by the improvement of their lives, to get closer to the developed communities. it can be said that the solow-swan model best served to increase the well-being of poor countries that has been one of the important and valuable impacts of modern science and technology. yet, the excitement of production created by technology and other factors has continued in all countries. new models of economic growth extended the boundary of technology-based knowledge, and made technical creativity and innovation a major driver of economic growth. the innovation economy and the entrepreneurial economy shaped by new ideas, and extended the new technologies as the engine of growth in the process of production of goods and services. growth models were developed based on human capital specialized in technology, and the human mind became the technical center of all economic processes. considering the growth models, the following can be considered: 1. economic growth is valuable. communities enhance the growth of knowledge for enhancing technical knowledge. as a result, other aspects of knowledge in the social, ethical, and family sectors do not grow proportionally to the growth of technology knowledge. 2. the process of training and acquiring skills in countries to achieve technology-based science that leads to more productivity is costly. so, people need to spend a lot of time on training. due to the high rate of technical science growth and the high rate of science depreciation, people have no time to acquire science to grow other aspects of life. 3. economic growth takes a lot of time. that is, people have to constantly think about growth, and work constantly to align themselves and society with growth indicators. 4. measuring the economic growth is almost straightforward. in other words, the rate of economic growth and the material and human resources, as well as the time devoted to growth, are quite measurable. but other growth aspects of life, perhaps even more valuable, have been forgotten. the average national production in the world has increased. productivity and product diversification has raised, and this is a result of the good performance of growth models, in which new technology and science lie. along with this growth, we destroyed the environment, run out energy resources, and transformed the earth’s face. perhaps this is the biggest shock that economic growth has had. yet, the paradox is that many people are poor, and suffer from hunger. in industrial civilization, although the human wealth has increased dramatically, equitable distribution has not occurred, and the income gap and consequently the emotional gap 6 economic analysis (2021, vol. 54, no. 1, 1-12) between the society’s classes is expanding. the distribution of wealth and income has always been one of the main unresolved issues of the economy (piketty, 2014). the rapid change in technology has disengaged and enslaved human beings. this rapid change has led to insecurity, and has greatly weakened family structure, and created new suffering and anxiety in communities. as a result, the economy of happiness was formed, as economic thinkers gradually realized that the human satisfaction and happiness in industrial societies was declining. economic growth has directly and indirectly caused problems in societies. the paradox led to create research in this direction, some of which are reviewed in the following. previous experimental studies studies on the effect of economic growth on happiness are reviewed in table 1. table 1. studies on the relationship between economic growth and happiness scholar title results richard easterlin (2002) economy of happiness statistical research in selected countries shows that health, ethics, religious beliefs, and democracy are more effective than happiness in economic growth. val dusek (2006) philosophy of technology economic growth has become involved in the technology cycle rather than bringing prosperity to people, and has become a tool for technology growth. luigino and porta (2007) economy of happiness econometric models and mathematical optimization models in selected countries show that rising levels of income and gdp in countries have not only had an effect on happiness, but have also, in some cases, reduced the happiness and well-being of communities. eisler (2007) real wealth of nations research by statistics and psychology observations shows that protecting the environment and ethics against economic growth can increase happiness in societies. li and lu (2009) happiness and development they used social variables such as suicide rate to study the relationship between happiness, and development, and for economic variables, they used the logarithm of gdp and capital share. results of this study showed a positive significant relationship between growth and happiness. dutt and radcliff economy, happiness, and politics economic growth and happiness have no significant relationship. economic growth is a necessity for happiness, but economic growth has not followed happiness growth. acemoglu and robinson the cause of poverty and richness in countries statistical and historical research across all the countries of the world in the last 500 years show that politics was the main driver of economic growth and development in countries that increase the happiness and satisfaction of societies. sacks et al. (2012) costs of economic growth more economic growth leads to higher growth in life satisfaction. palacios-huerta (2013) forecasting the next 100 years from an economic perspective happiness has a positive impact on community well-being and environmental protection. ricardo (2015) how does philanthropy guide people? ethical crises in the process of economic growth have reduced the happiness of societies. humans need altruism more than economic growth to be happy. waldinger (2015) what makes our lives happy? he shows on the continent of america that the main factor in happiness was social communication, and that economic growth had no significant relationship with happiness. yazdan naghdi, hamid amir taemeh, soheila kaghazian 7 scholar title results marks (2017) happy planet index (hpi) using the econometric panel data model for 167 countries, he showed that gdp growth had no significant relationship with the happiness level of societies. whp (2017) world happiness report (whr) results showed that there was no significant relationship between economic growth and happiness, and emphasized the crisis of happiness in the world. according to the results of table 1, there is an ambiguous relationship between economic growth and happiness. the ambiguity of growth and happiness from the statistical data in chart 2 it can be seen that, despite the high economic growth rate in the world, the rate of happiness is almost constant. therefore, it can be said that there is a vague relationship between happiness and economic growth. a survey of the average per capita income of countries and their level of happiness in the last century (1972–2016) reveals the ambiguity of the two variables. chart 2. world average of per capita national production and happiness (1972–2016) source: world happiness index (whi) report (2018) model introduction and estimation in the present study, variables has been selected, so that they have the greatest impact on the happiness level of the communities along with economic growth. these variables are: emotional gap (eg) resulting from inequality, environment (env), democracy (dem), domestic product (gdp), and happiness (hpi).  emotional gap (eg) resulting from inequality according to wilkinson (2010), atkinson (1970), and wilkinson and pickett (2010), economic inequalities, e.g. income inequality, reduce well-being and happiness in societies at a significant level, and create emotional gaps. in addition, surveys and reports by hpi, whr, and hdr that show the effect of countries’ per capita income inequality on their life expectancy and satisfaction level confirm the effect of inequality on the reduction of happiness. these reports indicate that income inequalities cause emotional gaps in societies, and drastically reduce people’s satisfaction. emotional gaps due to unequal distribution of income and wealth in society has have a profound effect on the education level, social skills, and physical health of individuals. emotional gaps reduce motivation and hope for community life skills and endeavors. in addition, emotional gaps reduce creativity and entrepreneurship in most small firms (and even large firms). on the 0 2 4 6 1972 2016 whi-gdp gdp happiness 8 economic analysis (2021, vol. 54, no. 1, 1-12) other hand, emotional gaps increase the dissatisfaction with life, and enhance crime (crime economy). this index has been studied by the uk inequality research agency and the development plan for all countries. statistical data of the average income of 0.10% of the highest level of community income over the average of 0.10% of the lowest level of community income in all countries of the world is represented by the united nations development program as r/p ratio, which have been used in this study.  environment (env) countries contribute to environmental degradation according to the six indices that are part of the world bank’s development data. countries with one-dimensional programs that prioritize economic growth have the most effect on environmental degradation, reducing the well-being of their nation and the planet as a whole. the environmental degradation index has been measured and explored by the global footprint for all countries.  democracy (dem) the oligarchy and democracy in the societies have a profound effect on happiness and shaping the path of economic growth. the global democracy ranking and freedom house classify countries in terms of democracy in four groups: full democracy, flawed democracy, hybrid regime (noncentralized state), and authoritarian regime. accordingly, they consider five principles for measuring and ranking democracy in countries: 1. the electoral process and the plurality of parties, 2. government structures, 3. political freedoms, 4. political culture, 5. civil liberties.  gross domestic product (gdp) gross domestic product per capita based on purchasing power parity (ppp$) across countries is used to show the level of economic activity and economic growth of countries.  happiness (hpi) following the paradoxes in economic growth and happiness in the world, the happy planet index (hpi) was launched to measure happiness at the planet level. hpi measures sustainable prosperity and happiness, and compares how countries use their natural resources to achieve sustainable levels of prosperity and happiness. the four indices of life expectancy, satisfaction, inequality in life achievements, and environmental degradation are used. according to li and shi (2019), li (2015), lin and lu (2009), cogoy (2009), bruni (2009), and dutt (2010), equation 1 has been used to assess and determine the effect of variables on happiness. the experimental model of this study is taken from previous studies and modified: 𝐻𝑃𝐼 = 𝛽 𝐺𝐷𝑃 + 𝛽 𝐸𝐺 + 𝛽 𝐸𝑁𝑉 + 𝛽 𝐷𝐸𝑀 + 𝛽 𝐻𝑃𝐼 + eit + vi (1) the statistical data collected from 153 countries over the period 2000–2018. 𝐻𝑃𝐼 is happiness level, 𝐻𝑃𝐼 is lagged happiness, 𝐸𝐺 is emotional gaps of the societies, 𝐸𝑁𝑉 is countries’ environmental impact and degradation, 𝐷𝐸𝑀 is democracy level, 𝐺𝐷𝑃 is domestic product per capita, 𝑒 is error term that includes all unobserved economic effects, and 𝑉 is fixed effects in each country. we take the logarithm of the model, and calculate the model’s first-order difference. this will remove all variables, e.g. the fixed effects of countries that are fixed over time, and cause estimation problems. ln (𝐻𝑃𝐼 ) = 𝛽 ln (𝐺𝐷𝑃 ) + 𝛽 𝑙𝑛(𝐸𝐺 ) + 𝛽 ln (𝐸𝑁𝑉 ) + 𝛽 ln (𝐷𝐸𝑀 ) + 𝛽 ln (𝐻𝑃𝐼 ) + 𝑒 + 𝑉 (2) yazdan naghdi, hamid amir taemeh, soheila kaghazian 9 ∆ln (𝐻𝑃𝐼 ) = 𝛽 ∆ln (𝐺𝐷𝑃 ) + 𝛽 ∆𝑙𝑛(𝐸𝐺 ) + 𝛽 ∆ln (𝐸𝑁𝑉 ) + 𝛽 ∆ln (𝐷𝐸𝑀 ) + 𝛽 ∆ln (𝐻𝑃𝐼 ) + ∆𝑒 (3) table 2. estimating the effects of variables on happiness in short-run prob. z coefficients variables 0.00 4.69 0.45 ∆ln (𝐻𝑃𝐼 ) 0.00 5.99 0.25 ∆ln (𝐺𝐷𝑃 ) 0.00 -5.33 -1.25 ∆ln (𝐸𝐺 ) 0.00 -6.59 -0.36 ∆ln (𝐸𝑁𝑉 ) 0.07 -1.87 -0.52 ∆ln (𝐷𝐸𝑀 ) 153 countries 0.0006 j-statics source: research findings as expected, environmental degradation (env) caused by new technologies has a negative effect on happiness. the emotional gap (eg) that results from the unequal distribution of income and wealth also has a negative effect on happiness. in addition, oligarchy and flawed democracy (dem) have a negative effect on happiness. as predicted, economic growth and increasing commodity production (gdp) in societies had a positive effect on happiness. humans are happy with material and economic opportunities. provided that this economic growth does not have a negative outcome, and does not damage other aspects of life. furthermore, due to the coefficient sign of the happiness variable with one lag (𝐻𝑃𝐼 ), it can be seen that the happiness of the previous period has a positive significant effect on the current happiness. in table 3, the relationship between variables in the long-run has been estimated. long-run coefficients are calculated indirectly through the partial adjustment method(𝜃 = ). the estimates still confirm the theoretical foundations. the effect of long-run economic growth on happiness has increased. long-run environmental degradation has also caused human suffering, and emotional gaps and unhealthy democracy in most long-run oligarchies because of the psychological effects on human life have a greater negative effect on happiness, and still create the greatest level of suffering. the environmental degradation caused by economic growth also has a negative effect on people's happiness. for example, air pollution caused by economic growth causes people to get sick and upset. among the research variables, the lack of democracy has the negative impact on happiness. in other words, if democracy is less, people are sadder. also, income inequality (eg) has a greatest negative effect on happiness. so governments need to do more to reduce income inequality. humans are greatly damaged by the cruelty of emotional and oligarchy in the long-run, and happiness in societies drops sharply. by comparing the results of the shortand long-run estimates, it can be seen that both shortand long-run economic growth have a positive significant effect on happiness. the long-run effect of economic growth on happiness is greater than the short-run. in addition, shortand long-run estimates do not confirm easterlin paradox. that is to say, contrary to easterlin’s view, the economic growth of countries has increased people’s happiness in both shortand long-run (although the results of this study are not for the whole world, but only for 153 countries, over the period 2000–2018. while this relationship was ambiguous, according to chart 2, which explored the relationship between growth and happiness over a longer period for the whole world). furthermore, according to nili, babazadeh khorasani, and shadkar (2015), abounouri and eskandari (2016), and jaafari (1981), raising the per capita income will increase the people’s satisfaction and happiness. as a result, wealthier countries are happier than other countries. results of these studies, like that of the present study, do not confirm the easterlin paradox. 10 economic analysis (2021, vol. 54, no. 1, 1-12) table 3. comparing the variables’ effect on happiness in the shortand long-run z-statistic short-run z-statistic long-run variables 5.99 0.25 7.43 0.45 ∆ln (𝐺𝐷𝑃 ) -5.33 -1.25 -6.21 -2.27 ∆ln (𝐸𝐺 ) -6.95 -0.36 -3.45 -0.65 ∆ln (𝐸𝑁𝑉 ) -1.87 -0.52 -2.57 -0.94 ∆ln (𝐷𝐸𝑀 ) source: research findings sargan test is used in (gmm) models to determine the appropriateness of the estimate. this test used to determine the valid over identifying restrictions. sargan test has a 𝜒 distribution. in performing the sargan test, with respect to j-statistic, the instrumental variable rank, and the number of regressions in the model, the probability value equals 1 that is higher than 0.05, and the j-statistic value equals 0.0006. in terms of autocorrelation, the error term has first-order ar(1) correlation, and does not have the second-order ar(2) correlation. according to the tests, the moment method is verified, and the generalized method of moment (gmm) has been used properly. the general meaningful of (gmm) model is confirmed by the wald test. the arellando-bond serial correlation test was performed and the validity of the gmm model was confirmed (z=-1.83). conclusion in this study, based on social, political, and environmental variables and the data from 153 countries over the period 2000–2018, we found that economic growth had a positive significant effect on happiness (the easterlin paradox is rejected). economic growth is very valuable, and no society can achieve happiness without economic growth, but the negative consequences of economic growth, including environmental degradation resulting from one-dimensional thinking and partial selfish rationality in societies, have created a lot of suffering for humans. the environmental degradation caused by economic growth also has a negative effect on people's happiness. for example, air pollution caused by economic growth causes people to get ill and upset. among the research variables, the lack of democracy has the negative impact on happiness. in other words, if democracy is less, people are sadder. also, income inequality (eg) has a greatest negative effect on happiness.. so governments need to do more to reduce income inequality. humans in all societies with all levels of economic growth suffer from emotional gaps, social inequalities, environmental degradation, and oligarchy. the ambiguity of economic growth and happiness, rather than being an economic phenomenon, is because of policies and ethical crises of policymakers. thus, economic growth along with reducing inequality and poverty, preserving the environment, enhancing democracy, and meeting the basic needs of society increases the effect of economic growth on happiness. the results of this study were the same as the results of sacks (2012) and palacios-huerta (2013) studies, but the results of this study were not the same as the results of li and shi (2019), li (2015) and mark (2017) studies. therefore, it can be said that the relationship between happiness and economic growth is ambiguous. countries examined in the model are: argentina, armenia, australia, austria, bahrain, bangladesh, belgium, bolivia, brazil, bulgaria, bhutan, canada, chile, china, colombia, costa rica, croatia, cyprus, czech republic, denmark, ecuador, egypt, el salvador, estonia, fiji, finland, france, qatar, germany, ghana, greece, guinea, hong kong, hungary, iceland, india, indonesia, iran, ireland, palestine, italy, jamaica, japan, jordan, kazakhstan, cambodia, kenya, south korea, kuwait, kyrgyzstan, lebanon, lithuania, libya, malawi, mali, maldives, malaysia, macedonia, malta, mauritius, mexico, mongolia, morocco, namibia, nepal, netherlands, new zealand, norway, nigeria, pakistan, panama, new guinea, paraguay, senegal, serbia, sierra yazdan naghdi, hamid amir taemeh, soheila kaghazian 11 leone, peru, philippines, poland, portugal, romania, russia, rwanda, oman, singapore, slovak republic, slovenia, south africa, spain, sri lanka, syria, sweden, switzerland, taiwan, thailand, togo, tobago, tunisia, turkey, timor-leste, tanzania, uganda, ukraine, eritrea, united arab emirates, england, united states, uruguay, vietnam, venezuela, yemen, zambia, and zimbabwe. references abounoori, e., & eskandari, j. 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(2010). the spirit level: why equality is better for everyone. london: penguin. world happiness report (whr). retrieved from https://worldhappiness.report/ article history: received: october 10, 2020 accepted: april 29, 2021 doi: 10.28934/ea.22.55.1.pp63-75 original scientific paper stock markets integration between western europe and central and south-eastern europe: latest trends jelena minović18f* | irena janković2 | vlado kovačević3 1 institute of economic sciences, department for environmental economics, belgrade, serbia 2 university of belgrade, faculty of economics, department for economic policy and development, belgrade, serbia 3 institute for agricultural economics, 11060 belgrade, serbia abstract the aim of the paper is to examine the stock market integration between western europe and selected countries of central (austria, czech republic, poland, hungary, slovakia, and slovenia) and southeastern europe (greece, croatia, serbia, bosnia, bulgaria, and romania). in order to achieve this goal, we used a bivariate bekk model to obtain time-varying covariances and correlations for the period april 15, 2013 march 29, 2019. our results showed that austria has the highest degree of integration among countries in central europe, followed by the czech republic, poland and hungary. additionally, greece has the highest degree of integration among all countries in south-eastern europe, followed by romania, and croatia. thus, stock markets of central europe are more integrated with western europe than stock markets of south-eastern europe. key words: stock market integration, multivariate garch, bekk model, central europe, south-eastern europe jel classification: g15, f36, c32, c58, o16 introduction financial integration is a term used to explain the level and the strength of financial market connectedness across various markets. the higher connectedness usually results in the higher financial and broader economic integration of countries. more precisely, the connectedness measures are tracking the degree of co-movement of market returns and volatility behaviour within and across markets and asset classes. as in bracker et al. (1999), we interpret a greater degree of co-movement to reflect greater capital market integration. bekaert & harvey (1995) found that some emerging markets exhibit time-varying integration. while the integration of financial markets can bring benefits in the form of broader economic integration and connectedness of countries it in parallel may affect the investors’ portfolio choices. if “financial integration is high, the benefits of diversification may be reduced. the degrees of financial integration provide valuable insights into capital flows across countries and enhance awareness of market co-movements” (chen et al., 2014). the focus of analysis in this paper is financial integration between central and south-eastern europe (see) and western european stock markets. more developed european countries started * corresponding author, e-mail: jelena.minovic@ien.bg.ac.rs 64 economic analysis (2022, vol. 55, no. 1, 63-75) economic and monetary integration decades ago. as a result, significant convergence among interest rates, gdp growth rates and other macroeconomic indicators occurred in the pre-crisis period. after the global financial crises, 2007-2008, many unresolved disbalances came to surface that resulted in a debt crisis in the eurozone in 2010-2012. the adoption of the euro and unique monetary policy appeared to be insufficient for broader economic integration of euro area member states. further fiscal integration was necessary for a more stable economic and monetary union. as bekaert et al. (2013) showed “membership in the eu significantly lowered discount rates and expected earnings growth differentials across countries. in contrast, the adoption of the euro was not associated with increased integration”. the countries of central and south-eastern europe faced significant changes in the previous three decades. while central european countries shifted relatively fast from communism and social ownership to market oriented economies, the transition process was slower and more painful in a certain number of south-eastern european countries especially in the balkan region. while most of these countries developed bank-based financial systems, their financial markets developed to a certain extent allowing the measurement of co-movements and estimation of the level of financial integration. the stock market of central europe is characterised by greater depth and liquidity in comparison to south-eastern european countries. although balkan equity markets have been active for a relatively short period of time, consequently lacking in a substantial market depth regarding the listed companies and capitalisation, inflows of international portfolio investments and trading activity have still been increasing (syriopoulos, 2011). marjanović & đukić (2020) stand out that the western balkan region has been an attractive destination for foreign portfolio investment in recent years. the paper aims to examine the capital market integration for selected countries of central and south-eastern europe. to achieve this goal, we have followed the methodology of horvath & petrovski (2013). we used the bivariate bekk model to obtain time-varying covariance (comovements) and then correlations. we have selected the period from april 15, 2013, to march 29, 2019. for the countries of central europe we have investigated: austria, czech republic, poland, hungary, slovakia, and slovenia, and for south eastern europe we have selected: greece, croatia, serbia, bosnia, bulgaria, and romania. correlation between selected countries of southeastern europe and developed countries is found to be around zero, except for greece (average correlation coefficient is about 0.4), croatia whose average correlation coefficient is about 0.2, bulgaria (with an average correlation coefficient 0.1) and romania (with average correlation coefficient 0.3). this value of the correlation coefficient (integration) is still much lower in comparison to the selected central european countries (average value of the correlation coefficient is over 0.7 for austria, about 0.4 for hungary and poland and around 0.5 for the czech republic), except for slovakia and slovenia. on average, south-eastern european countries appeared to be less integrated with western europe than central european countries. the paper consists of five parts. the introduction is presented in the first section. a discussion of related literature is presented in the second section. the third section explains the research methodology and used data. the fourth section contains the results of the analysis, and discussion. the conclusion is presented in the fifth section. literature review horvath & petrovski (2013) examined the stock market integration between western europe and selected countries of central (the czech republic, poland and hungary) and south-eastern europe (macedonia, croatia and serbia). by estimating multivariate garch models in the period 2006-2011, they found a higher level of integration between western and central europe. the correlation between see stock markets and developed european markets was found to be zero. they also conclude that the crisis period did not significantly change the degree of stock market integration between investigated groups of countries. jelena minović, irena janković, vlado kovačević 65 tilfani et al. (2020) used dynamic analysis (or the detrended cross-correlation analysis, dcca) in order to investigate “the evolution of integration in central and eastern european stock markets”. they found that stock markets of “czech republic, hungary, croatia, poland and romania are most integrated, while some of eastern european stock markets such as bosnia, montenegro, serbia and slovakia are less integrated”. büttner & hayo (2011) analysed “the determinants of stock market integration among eu member states for the period 1999-2007”. these authors utilized “bivariate dcc-mgarch models to estimate dynamic conditional correlations between european stock markets”. further, they tried to explain the comovements by “interest rate spreads, exchange rate risk, market capitalisation, and business cycle synchronisation in a pooled ols model”. taking care of differences between euro area countries and old and new member states of the eu they evaluated the impact of the introduction of a common currency on financial market integration. they concluded that stock market integration processes are enhanced by the size of market capitalisation but impeded by fx risk between old member states in the eu and the euro area. interest rate spreads and business cycle synchronization, also help explaining equity market integration. chen et al. (2014) investigated the stock market integration between the frontier and leading markets over the period 2000–2011. they used time-series analysis and concluded that leading markets could granger-cause frontier markets. authors found the frontier markets' relationship with leading markets to be dependent on different regions' characteristics. they stressed that the global financial crisis had largely influenced the causality between the frontier and leading markets. chen (2018) investigated the comovements of “stock market returns of a group of 34 countries at the global and regional levels, simultaneously”. the author used a bayesian dynamic latent factor model. he compared the comovements between developed and emerging markets across regions and found the significance of different factors for the fluctuations of stock markets. he found the global factor to be an “important source of fluctuations for most markets and the regional factor as another important reason for the fluctuations in emerging markets, especially markets in south america and east asia regions, but not in most developed markets”. his results suggest “that the degree of a market's comovements with international stock markets is closely associated with its own country's integration into the global economy”. égert & kočenda (2007) analysed “comovements among three stock markets in central and eastern europe and interdependence, which may exist between western european and central eastern european” (cee) stock markets. these authors employed the var framework (granger causality tests) on the 5-minute tick intraday data for stock indices. their “results showed the bidirectional causality for returns as well as volatility series”. they found “no robust cointegration relationship for any of the stock index pairs or for any of the extended specifications”. fratzscher (2002) followed the integration process of stock markets in europe since the 1980s. by implementing a trivariate garch model with time-varying coefficients, he found that: european stock markets have become significantly integrated from 1996, that euro area got important position among global financial markets and finally, that european stock market integration is to a large extent explained by monetary unification and elimination of fx rate volatility. hardouvelis et al. (2006) examined whether the 1990s in europe, in parallel with regulatory harmonization, and the introduction of the single currency, were characterized by higher stock market integration. they concluded that a decrease in interest rates and inflation rates differentials coincided with higher stock market integration for analysed countries except for the uk that decided not to enter the euro area. kenourgios & samitas (2011) analyse “long-run relationships among five balkan emerging stock markets (turkey, romania, bulgaria, croatia, serbia), the united states, and three developed european markets (uk, germany, greece), during the period 2000–2009”. they confirm long-run cointegration between balkan markets within the region and globally. additionally, they 66 economic analysis (2022, vol. 55, no. 1, 63-75) implement “the ag-dcc multivariate garch model to capture the influence of the global financial crises on the correlation dynamics among developed and balkan stock markets”. they conclude that stock market dependence is heightened supporting the herding behaviour during the 2008 crisis. lean & teng (2013) examined “the financial integration of the u.s. and japan and two emerging economies china and india with the malaysian stock market”. they used “a dcc-mgarch approach to examine the correlations among these countries in a time-variant manner”. according to them, it was apparent that “financial integration between malaysia and china started to evolve in april 2004. strong financial integration between the stock markets in india and malaysia” was examined. on the other hand, “the volatility spillover effect from the us to malaysia ceased, especially in the short term. accordingly, the study suggests that in the long run, investors in malaysia could profit from diversifying their portfolios in china and japan relative to india and the u.s”. guidi & ugur (2014) investigated “the integration between south-eastern european stock markets (bulgaria, croatia, romania, slovenia and turkey) and their developed counterparts (germany, the uk and the usa)”. they analysed the period 2000-2013 and found static cointegration between see markets and the german and uk market (but not with the usa market). the dynamic cointegration analysis showed time-varying cointegration among the see and developed markets, especially during crisis. they conclude that diversification benefits did exist during the period that included crises, despite evidence of dynamic cointegration during most of the crisis period. al nasser & hajilee (2016) examined “stock market integration among five selected emerging stock markets (brazil, china, mexico, russia, and turkey) and the world’s major developed stock markets (the us, uk and germany)” in the period 2001-2014. they used “the bounds testing approach to cointegration and error-correction modelling to determine the shortand long-run relationship between emerging stock market returns and the returns of the developed stock markets”. their results indicate the existence of “short-run integration among stock markets in emerging countries and the developed markets”. however, the authors indicate that in the “longrun, stock price indices in all emerging countries show a significant relationship only with germany stock market index”. alotaibi & mishra (2017) assessed “the degree of stock market integration and gained insights on its variation through time for the six member countries of the gcc (bahrain, kuwait, oman, qatar, saudi arabia, and the united arab emirates)”. these authors developed an international financial integration index for gcc stock markets and analysed the period from june 2002 to october 2013. they utilized “an international asset pricing model of time-varying market integration and dcc-garch methodology”. authors showed that “there are wide ranges in the degree of integration for gcc stock markets and none of them appeared to be under complete segmentation”. they found that “trade openness, financial market development, turnover and oil revenue had a significant positive impact on the integration index of gcc stock markets. the global financial crisis had a significant negative impact on the integration index”. narayan et al. (2014) examined the “patterns and causes of stock market integration of selected emerging asian countries against the us, australia, china, and india for the period” 2001-2012. they used the “arma-dcc-garch framework to derive the correlations for 22 pairs of countries using daily, weekly, and monthly returns”. these authors found that the time-varying bilateral correlations were highly volatile. they suggest that apart from the global financial crises (20072009), the “underlying economic and financial conditions have also been responsible for the higher correlations between analysed stock markets”. syriopoulos (2011) examined “the dynamic interdependencies, linkages and causality effects between major balkan equity markets (romania, bulgaria, croatia, turkey, cyprus and greece) and developed equity markets (the us and germany)”. this author utilized error-correction vector autoregression models to investigate financial integration, causality effects and jelena minović, irena janković, vlado kovačević 67 cointegration vectors. his results show that “the balkan markets follow a common path of growth and become gradually more integrated with the mature international markets”. methodology and data data in this analysis we choose daily closing levels of following indices: the stoxx europe 600 index, atxprime (vienna stock exchange), px (prague stock exchange), bux (budapest stock exchange), wig (warsaw stock exchange), sax (bratislava stock exchange), sbitop (ljubljana stock exchange), atf (athens stock exchange), crobex (zagreb stock exchange), belex15 (belgrade stock exchange), birs (bosnian stock exchange), sofix (sofia stock exchange), and bet (bucharest stock exchange). “the stoxx europe 600 index represents large, mid and small capitalization companies across 17 countries of the european region: austria, belgium, denmark, finland, france, germany, ireland, italy, luxembourg, the netherlands, norway, poland, portugal, spain, sweden, switzerland, and the united kingdom”.9f1 similar to horvath and petrovski (2013), we have used the stoxx europe 600 index as the benchmark for developed european stock market movements. however, horvath and petrovski (2013) used data for the period 2006-2011, and instead of bosnian, they used the macedonian index. compared to paper by horvath and petrovski (2013), we have significantly expanded the scope of countries. while these authors used three countries from central and three countries from south-eastern europe, we have selected twelve countries for the period 2013-2019. the daily closing prices of the indices are chosen from april 15, 2013 to march 29, 2019. the source of data is the website: https://www.investing.com/indices/ (as in minović, 2022). we study the daily returns, which are represented by the logarithmic difference of prices using the equation: rt=(log(pt)-log(pt-1))x100, (1) where pt is the closing price of a stock index on a trading day t, and pt-1 is the closing price of a stock index on a trading day t-1. table 1 presents the key indicators of all observed stock exchanges, such as the year of establishment, market capitalization, and the relevant index. table 1. key indicators central europe austria czech republic hungary poland slovakia slovenia year of establishment 1771 1993 1990 1991 1991 1989 market capitalization (eurmill) 102,050 23,574 25,231 140,113 index atxprime px bux wig sax sbitop see greece croatia serbia bosnia bulgaria romania year of establishment 1876 1991 1992 2001 1997 1995 market capitalization (eurmill) 33,525 18,004 4,576 1,968 13,685 18,160 index atf crobex belex15 birs sofix bet source: federation of european securities exchanges statistics, december 2018; https://investopress.com/european-stock-exchanges; belgrade stock exchange; banja luka stock exchange; bratislava stock exchange; ljubljana stock exchange. 1 https://www.investing.com/indices/ https://www.investing.com/indices/major-indices https://investopress.com/european-stock-exchanges https://www.investing.com/indices/major-indices 68 economic analysis (2022, vol. 55, no. 1, 63-75) multivariate garch model: the bekk model “engle & kroner (1995) proposed a quadratic formulation for the parameters that ensured positive definiteness of conditional variance-covariance matrix ∑t, and this became known as the bekk model” (brooks et al. 2003). according to “this model, the number of parameters increased linearly with the number of assets. therefore this model is relatively covetous and suitable for a large set of assets” (de goeij and marquering, 2004). “the bekk model follows the following form: ' ' ' ' 0 0 1 1 1 1 , q pk k t ki t i t i ki ki t i ki k i k i c c a a b bε ε− − − = = = = ∑ = + + ∑∑∑ ∑∑ (2) where c0 is a lower triangular matrix, and aki and bki are 𝑁𝑁 × 𝑁𝑁 parameter matrices (hafner and herwartz, 2006). based on the symmetric parameterization of the model, ∑t is almost surely positive definite on provision that c0c0’ is positive definite” (tsay, 2005; minović, 2009). as proved by “engle and kroner (1995), the necessary condition for the covariance stationarity of the bekk model is that the eigenvalues, i.e., the characteristic roots of * * * * 1 1 1 1 ( ) ( ) q pk k ik ik ik ik i k i k a a b b = = = = ⊗ + ⊗∑∑ ∑∑ should be less than one in modulus”. “hence, the process can still render stationary even if there is an element with a value greater than one in the matrix. this condition is different from the stationary condition required by the univariate garch model, that is, the sum of arch and garch term has to be less than one” (minović, 2009). also, “the bekk model is not very flexible and can, therefore, be misinterpreted. however, if the covariance demonstrates a different degree of persistence than the volatilities, it is obvious that either the volatility or the covariance process can be misinterpreted” (baur, 2004; minović, 2009). using the mgarch model, we obtain time-varying variances and covariances between stock market returns. in this way, it is possible to calculate a time-varying correlation coefficient, i.e., conditional correlations defined by the following equation: ρ12,𝑡𝑡 = 𝜎𝜎12,𝑡𝑡 �𝜎𝜎11,𝑡𝑡𝜎𝜎22,𝑡𝑡 (3) where conditional variances are 𝜎𝜎11,𝑡𝑡, 𝜎𝜎22,𝑡𝑡, respectively, and conditional covariance is 𝜎𝜎12,𝑡𝑡. minović (2008) wrote about “application and diagnostic checking of multivariate garch models in serbian financial market”, while njegić et al. (2018) used three types of “bekk-garch models in order to analyses the dynamic nexus and bidirectional spillover effect between stocks and exchange rates in major emerging markets”. results and discussion table 2 presents the unit root results for the original series (logp) and their daily returns (ri,t). the augmented dickey-fuller (adf) test was used. the results in table 2 show that the original series in levels are not stationary, while daily returns are stationary. after obtaining the stationary return series, the volatility modeling of the same, followed by employing univariate garch models (for detail see minović, 2022). subsequently, the mgarch methodology (bekk model) was applied to calculate time-varying variances and covariances (equation (2)). then, using equation (3), all the time-varying correlation coefficients presented in figures 1 and 2 were calculated. jelena minović, irena janković, vlado kovačević 69 table 2. unit root tests adf europe (stoxx) austria (atxprime) czech republic (px) hungary (bux) poland (wig) slovakia (sax) slovenia (sbitop) logp -3.124 -2.099 -2.427 -2.380 -2.334 -2.320 -2.266 return -38.048 -35.686 -37.771 -38.150 -35.497 -44.806 -37.055 greece (atf) croatia (crobex) serbia (belex15) bosnia (birs) bulgaria (sofix) romania (bet) logp -1.575 -2.433 -2.072 0.155 -1.352 -2.603 return -22.506 -14.994 -35.711 -37.624 -37.351 -22.627 source: authors’ estimation note: critical value (at 5% level) is -3.413. schwarz's automatic selection of the lag length has been used for the unit root tests. figures 1 and 2 show the time-varying correlations for indices of selected central and southeastern european countries and the stoxx 600 indices. table a1 in appendix a presents descriptive statistics of stock market returns for all analysed indices. minović (2022) described possible causes of volatility decline or volatility increase for these analysed markets. the austrian index is found to have the highest volatility in the second and third quarters of 2015 (correlation ranges from 0.4 to 0.9), followed by the third quarter of 2016, while the stoxx 600 index had the highest volatility in the third quarter of 2015 and the second quarter of 2016. the czech index had higher volatility at the end of the third quarter of 2015, then in the first and third quarters of 2016. however, the largest variation of the correlation coefficient in the case of the czech republic was in the fourth quarter of 2017 (correlation ranges from 0.0 to over 0.7). the hungarian index had pronounced volatility over the whole observed period, however it was the highest in the third quarter of 2015. although the average value of the correlation coefficient for hungary is 0.4, there is a remarkably variable correlation starting from 0.1 to 0.7 in some periods. the polish index had strong volatility in the first quarter of 2014 and the third quarter of 2015. the average value of the correlation coefficient for poland is about 0.4, with the value of this coefficient was greatly varying in the first quarter of 2014 and the third quarter of 2016 (the value is 0.1 to 0.8). the slovak sax index had pronounced volatility, especially in the period around the first quarter of 2015. although the average value of the correlation coefficient for slovakia is about 0.0, a highly variable value of this coefficient was observed over the analysed period (from -0.4 to over 0.3). the slovenian index had the highest volatility at the end of the third quarter of 2015, while the largest variation in the correlation coefficient for slovenia was recorded just then and in the first quarter of 2018. the average value of the correlation coefficient is about 0.1, while this coefficient takes values from -0.05 to 0.4 in individual periods. the correlation coefficients for slovakia and slovenia are found to be the lowest among all central european countries analysed and in terms of values, are closer to the correlation coefficients characteristics of south-eastern europe. judging by the values of correlation coefficients, it can be said that all analysed markets of central european countries are integrated with the western european market with the exception of slovakia. 70 economic analysis (2022, vol. 55, no. 1, 63-75) austria czech republic hungary poland slovakia slovenia figure 1. time-varying correlations for central europe source: authors’ estimation the greek index showed strong volatility, especially in the third quarter of 2015. during this period, the correlation coefficient for greece varied from -0.2 to 0.6, although the average value of the correlation coefficient for greece for the whole observed period was about 0.4. the croatian index had the highest volatility in the second quarter of 2017 (then the correlation coefficient for croatia is negative). however, the correlation coefficient in the observed period varied greatly from negative values to positive values (from -0.2 to 0.6). the average value of the correlation coefficient for the whole observed period for croatia is around 0.2. high volatility of the serbian index was observed, with the highest volatility in the first quarter of 2019. the average value of the correlation coefficient for serbia is about 0.0 in the whole observed period. figure 3 shows a highly variable correlation coefficient for serbia, whose values range from -0.4 to 0.6 in individual periods. similar to the serbian index, the bosnian birs index is very volatile and also had the highest volatility in the first quarter of 2019. in addition, a variable property of the correlation coefficient for bosnia is observed, ranging from -0.5 to 0.4. the average value of the correlation coefficient for bosnia for the whole observed period was about 0.0. this result implies that the serbian and bosnian capital markets are not markets that are integrated with the western european market. the bulgarian index had strong volatility, especially in the third quarter of 2014 and the fourth quarter of 2016. the average value of the correlation coefficient for bulgaria was about 0.1 for the whole observed period. the value of the correlation coefficient for bulgaria varies greatly from -0.4 to 0.7. the volatility of the romanian index was highest at the end of the fourth quarter of 2018 and at the beginning of the first quarter of 2019. the average value of the correlation coefficient for the whole observed period for romania was about 0.3, while in figure 0.4 0.5 0.6 0.7 0.8 0.9 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_atxprime -0.2 0.0 0.2 0.4 0.6 0.8 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_px .0 .1 .2 .3 .4 .5 .6 .7 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_bux .0 .1 .2 .3 .4 .5 .6 .7 .8 .9 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_wig -.4 -.3 -.2 -.1 .0 .1 .2 .3 .4 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_sax -.1 .0 .1 .2 .3 .4 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_sbitop jelena minović, irena janković, vlado kovačević 71 2 one can observe a highly variable character of the correlation coefficient. the value of the correlation coefficient for romania ranges from -0.4 to 0.8. from the results obtained for southeastern europe, it can be concluded that the greek market is the most integrated with the western europe market among all other analysed southeast european markets. according to the level of integration, the romanian, croatian and bulgarian capital markets follow the greek market. greece croatia serbia bosnia bulgaria romania figure 2. time-varying correlations for south eastern europe source: authors’ estimation our results are in accordance with those of horvath & petrovski (2013), in that the degree of comovements between western and central europe was found to be higher than the degree of comovements between western and south-eastern europe. the correlation between selected countries of south-eastern europe and the developed countries is around zero, except for greece (average correlation coefficient is about 0.4), croatia whose average correlation coefficient is about 0.2, bulgaria (with an average correlation coefficient 0.1) and romania (with an average correlation coefficient of 0.3). this value of the correlation coefficient (integration) is still much lower than for the selected central european countries (average values of the correlation coefficient are over 0.7 for austria, around 0.4 for hungary and poland and around 0.5 for the czech republic), except for slovakia and slovenia. serbian, bosnian and slovakian stock markets are not significantly integrated with the western european market (with an average correlation coefficient 0.0). additionally, our results coincide with those of tilfani et al. (2020) about the stock markets of central and eastern european integration. -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_atf -.4 -.2 .0 .2 .4 .6 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_crobex -.4 -.2 .0 .2 .4 .6 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 corrrel_stoxx_belex15 -.6 -.4 -.2 .0 .2 .4 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 corrrel_stoxx_birs -.4 -.2 .0 .2 .4 .6 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_sofix -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_bet 72 economic analysis (2022, vol. 55, no. 1, 63-75) table 3. the average value of the correlation coefficient central europe austria (atxprime) czech republic (px) hungary (bux) poland (wig) slovakia (sax) slovenia (sbitop) aver. aver. correl. coeff. 0.74 0.51 0.41 0.43 0.03 0.10 0.37 see greece (atf) croatia (crobex) serbia (belex15) bosnia (birs) bulgaria (sofix) romania (bet) aver. aver. correl. coeff. 0.39 0.16 0.03 -0.06 0.11 0.25 0.15 source: authors’ calculation table 3 presents the average values of the correlation coefficients. the average correlation coefficient of the whole of central europe is much higher than the average correlation coefficient of southeast europe. from these results, it follows that the stock exchanges of central european countries are more integrated with western europe than the stock exchanges of southeast european countries. conclusion this paper examines the degree of stock market integration for selected central and southeastern european countries from april 15, 2013, to march 29, 2019. we followed the idea and methodology of horvath & petrovski (2013). for central europe (ce), we have selected the following countries: austria, czech republic, hungary, poland, slovakia, and slovenia, while for south-eastern europe (see) we have selected the following countries: greece, croatia, serbia, bosnia, bulgaria, and romania. to obtain the degree of individual market integration, conditional correlation coefficients were calculated for each selected country using the multivariate garch model, i.e., bivariate bekk. our results showed that austria (the correlation coefficient of 0.7) has the highest degree of integration among all countries in central europe, followed by the czech republic (the correlation coefficient is 0.5), poland and hungary (the correlation coefficient is 0.4). additionally, greece (the correlation coefficient is around 0.4) has the highest degree of integration among all countries in south-eastern europe, followed by romania (the correlation coefficient is around 0.3), and croatia (the correlation coefficient is around 0.2). this result could be due to greece's membership in the eurozone since 2001, which is not the case for the other see economies studied. it emphasizes the possible significance of shared monetary (currency) regimes in understanding capital market co-movements. in comparison to other economies in central europe like as austria, czech republic, poland, hungary, and slovenia, slovakia's stock exchange is less integrated with western europe (we) capital markets. this result could be due to slovakia's geographical, cultural, and institutional distance from western europe financial markets, which could lead to reluctance on the part of we investors to put their money into the slovakian economy. when we aggregated the correlation coefficients along the entire territory of central and southeastern europe, we found that the average value of this coefficient for central europe is around 0.4, while the average value of the coefficient for south-eastern europe is around 0.1. serbian, bosnian and slovakian stock markets are not significantly integrated with the western european market. we can conclude that the stock markets of central europe are more integrated than the stock markets of south-eastern europe. this result coincides with horvath & petrovski (2013) but covers a broader range of countries and a different time frame. our results about the stock markets of central europe integration coincide with tilfani et al. (2020). similarly to our results tilfani et al. (2020) found that serbian, bosnian and slovakian stock markets are less integrated. the research in this paper may be of benefit to potential portfolio investors looking to diversify their portfolios. the obtained results show that the conditional correlation coefficient is negative jelena minović, irena janković, vlado kovačević 73 in most cases, i.e., periods in the case of slovakia, serbia and bosnia. therefore, it can be concluded that these markets can potentially be good for portfolio diversification but taking into account the fact that see markets bear specific types of risks as well as political and strategic factors that could change investor market preferences. radišić (2011) states that without having the information necessary to plan a strategy for entering a foreign market (and therefore strategies for making an investment decision), it is impossible to imagine the realization of an investment by a portfolio investor. investors, on the other hand, would not be willing to invest in the shares of corporations if they were to be a part of a highly corruptive society (radišić, 2011). goel & budak (2006) emphasize that comprehensive reforms are needed in transition countries to reduce corruption, while estrin and uvalić (2013) state that government instability, frequent early elections, high unemployment rates, high public debt and poor economic recovery are factors which impede foreign investments in the balkan region. economic policymakers in see countries must make every effort to improve their performances and indicators to make their countries more attractive for investments (radišić, 2011). future research could extend over a longer period to include more countries. additionally, in future research, it is possible to use some other versions of the mgarch model instead of the bekk model. acknowledgements the authors acknowledge the financial support of the ministry of education, science and technological development of the republic of serbia. this paper was presented at the international scientific conference econometric modelling in economics and finance at the institute of economic sciences in belgrade in october 2019. we are grateful for the constructive and useful comments made by participants of this conference. references al nasser, omar m., and massomeh hajilee. 2016. 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"revisiting stock market integration in central and eastern european stock markets with a dynamic analysis." post-communist economies 32(5): 643-674. tsay, ruey s. 2005. analysis of financial time series. john wiley & sons, new jersey. jelena minović, irena janković, vlado kovačević 75 appendix table a1. descriptive statistics of stock market returns stoxx atxprime px bux wig sax sbitop mean 0.008 0.008 0.003 0.025 0.008 0.02 0.011 median 0.023 0.032 0.021 0.031 0.017 0.000 0.003 maximum 1.785 1.549 1.942 2.158 1.305 3.960 1.507 minimum -3.167 -2.865 -2.047 -2.718 -2.530 -4.052 -2.1060 std. dev. 0.408 0.450 0.362 0.453 0.397 0.474 0.326 skewness -0.527 -0.500 -0.461 -0.1200 -0.541 -0.005 -0.254 kurtosis 7.825 5.504 6.097 5.027 5.921 12.508 6.055 jarque-bera 1554.131 447.457 648.776 263.204 601.564 5586.649 595.553 prob. 0.000 0.000 0.000 0.000 0.000 0.000 0.000 obs. 1529 1477 1491 1480 1488 1483 1490 atf crobex belex15 birs sofix bet mean -0.014 -0.003 0.007 -0.003 0.012 0.012 median 0.039 0.000 0.003 0.000 0.007 0.017 maximum 5.098 0.994 1.217 2.235 2.449 2.961 minimum -7.764 -1.351 -1.739 -2.808 -2.057 -5.164 std. dev. 0.954 0.234 0.283 0.344 0.313 0.385 skewness -0.902 -0.486 -0.275 -0.465 0.076 -1.983 kurtosis 13.400 7.121 6.054 13.403 10.408 31.289 jarque-bera 6764.046 1107.717 602.028 6799.445 3378.740 50694.92 prob. 0.000 0.000 0.000 0.000 0.000 0.000 obs. 1457 1483 1501 1496 1477 1491 source: authors’ estimation article history: received: april 19, 2022 revised: june 3, 2022 accepted: june 14, 2022 microsoft word 2009_1_2.doc an analysis of parentsʹ strategies of child labour and education in developing countries damien bazin, university of nice sophia antipolis (unsa) and macroeconomics and international finance research centre (cemafi), faculty of law, political science and economics, france augendra bhukuth, university of versailles saint-quentin-en-yvelines (uvsq) and center of economics and ethics for environment and development (c3ed), france key words: child labour, education, informal sector jel: j13, j24, j44 abstract this paper sheds light on the trade-off between child labour and education in developing countries. we show there are different strategies of education that parents can adopt to enhance children’s wellbeing. we distinguish four categories of education: formal education, vocational training, non-formal education and informal education, implying that child labour and education analysis is no more binary. hence, these educations are suitable for different categories of households (the richer of the poor and the poorer of the rich). these households make their decision about education and child labour according to the adult labour market and their income. in an environment characterised by a high level of youth unemployement these households prefer investing in informal education. we specify explicitly that we make a commitment to do not proceed to any kind of tests. our critical point of view is to assert that education, as such, could not be summed up to a simple binary arbitration. on the contrary, we defend a conceptual approach. introduction since the creation of the ipec (international programme for eliminating child labour), the focus of the ilo (1997) has been to eradicate child labour entirely but, progressively, this institution has recognised that the task would be hard to achieve (schlemmer 1997). hence, priority has been given to eradicate the worst forms of child labour with special attention paid to education to achieve this goal. the ilo (1997) and other institutions, like unicef and unesco, consider that school is a perfect substitute for child labour. the idea behind this is that a child enrolled at school is one child less in the labour market; so parents should be encouraged to provide children with an education. this hypothesis does not take into account the fact that in some countries child labour and education can be mutually reinforced as children combine schooling and work to support their education (grootaert and kanbur 1995; akabhayashi and pscharopoulos 1999; pscharopoulos and patrinos 1997; ray 2004). as education and child labour are seen as perfect substitutes, analytical frameworks on this issue tend to focus on the reasons why parents do not invest in their children’s education (baland and robinson 2000; ranjan 2001), while emprirical studies point to the reasons for drop-out from schooling (jensen and nielsen 1997). hence, education is not playing its role in keeping children out from the labour market. in the ilo’s analysis (1997), the different educational strategies of households are not taken into consideration. economic analysis 1-2 (2009) 7-18 8 indeed, all the households do not have the same strategy towards child labour and education. in this paper we present these different strategies and show in which context they are adopted in order to have a better understanding of the phenomenon and to facilitate decision makers to take actions against child labour and to implement proper policies regarding to different categories of households’ expectations. in the second section of this paper, we explore the binary trade-off between child labour and education by making the education a heterogenous variable. thus we present different forms of education possibilities available to parents for ensuring their children’s wellbeing. the third section describes the choices of households. the fourth section analyses the reason why parents choose informal education to ensure their children’s well-being, and finally we conclude with some policy recommendations. taking seriously diversity in forms of education child labour analysis: a binary approach according to baland and robinson (2000), in an economy where poverty exists alongside the imperfections of the credit market, the level of child labour is socially inefficient. this hypothesis is also supported by ranjan (1999, 2001) who argues that poor parents would like to invest in their children’s education but cannot afford to because they are excluded from the formal credit institutions. rammohan (2001) states that parents rely on child labour for security in their old age. baland and robinson argue that children and parents cannot come to a commitment engaging the former to reimburse the latter for the effort needed to educate them. altruistic parents care for their children’s wellbeing. thus, we argue that they want to endow their children with human capital but the notion of education is not the same as it is understood in the economic literature. the models of baland and robinson and of ranjan consist of describing a binary trade-off between child labour and education; we state that the problem of child labour and education is far from being binary. there exists different forms of educations (formal education, vocational training, non-formal education and informal education) and parents have all these alternatives of education to ensure their children’s future wellbeing. our analysis is based on the strategies parents adopt to ensure the household’s survival depending on the decision of child labour and education. dessy and pallage (2001) state that there is a co-ordination failure between a household’s decision to school and the decision of enterprises to invest in high technology. parents fail to invest in education because they are not sure that enterprises will invest in high technology, contrarily enterprises do not invest in high technology because they are not sure of parents’ investment in children’s education. we argue that this lack of co-ordination cannot be solved if parents don’t feel that they are gaining by investing in their children’s education. in an environment where the informal sector is expanding, poor parents consider that this sector is suitable to enhance their children’s future wellbeing, particularly when the formal sector is unable to absorb all the young educated people. according to mukherjee and sinha (2005) and ballet and bhukuth (2006), parents give a minimum level of education (primary education) to their children and put them into the informal sector to acquire informal skills. according to gormly and swinnerton (2003), returns to education in the adult labour market affect children’s school d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 9 enrolment. hence, child labour and schooling decisions are closely related to the adult labour market. basu (2000) states that the minimum wages in the labour market push parents into sending children onto the labour market. thus, in an environment where the formal labour market is fully integrated, parents whatever their financial situation would invest in children’s education because the returns of education are high. baland and robinson (2000) demonstrate that incertainty on the expected benefits of investment in children’s education leads to a non optimality situation because the choice of work is not required for assuring children’s well-being. therefore, the analysis of baland and robinson is based on a binary trade-off between education and child labour. the binary approach is not suffisient to understand the households choices of education and child labour. therefore, we go farther this analysis to show the existence of different forms of education and why parents do not invest in the formal education. distinguishing several forms of education “education” is a generic term covering different forms of learning. hence, households have several possibilities to ensure their children’s well-being. we distinguish between four types of educations: formal education, formal vocational education, non-formal education and informal education. formal education: schooling given by public or private schools that follow the curriculae defined by the ministry of education. the knowledge shared is general and theoretical. vocational training or formal apprenticeship: the prolongment of the formal education, oriented towards professional formation and technics. it is thus complimentary to formal education. the programme is both practical and theoretical; it is often considered to be more theoretical by entrepreneurs in the informal sector (charmes 1985a,b). the skill is destinated to the modern enterprises of the formal sector (liimatainen 2002). the courses are inflexible and standardised (liimatainen 2002). non-formal education: non-formal education1 works outside the formal education circuit. non-formal education is dispensed by non-governmental agencies, as well as government agencies and private institutions. non-formal education replaces formal education in rural areas where schooling is not available to a high number of people. indeed, non-formal education is for people in the informal sector and increases their capacity to work in the formal sector. this system of apprenticeship is not for children who are likely to enter the labour market, but for adults or confirmed apprentices of the informal sector. so it is very rare to find children who have finished their primary education or dropped out, or even children from vulnerable households, in this form of education. the ngos focus on teaching civic education, the apprenticeship of reading and writing. this type of programme is more oriented towards technical formation. the aim of non-formal education is to improve the skill of those in the informal sector so as to improve their wages and, so, their standard of living. informal education or traditional apprenticeship: informal education is technical and professional education dispensed in the informal sector by a master to young apprentices. 1 this kind of knowledge acquiring system has been developed by unesco in 1991 at the conference of jontien in thaïland for promoting education in developing countries facing a crisis of their formal educational system. economic analysis 1-2 (2009) 7-18 10 the informal sector is characterised by a lack of structures in terms of the organisation of apprenticeships (liimatainen 2002). the informal apprenticeship system distinguishes from the other forms of formations by its operationality. indeed, the informal apprenticeship forms the skill that the informal sector needs. the development of the informal sector: a factor of child labour the informal sector gives young apprentices the opportunity to become entrepreneurs who enjoy a high social position in society. so the idea that the informal sector does not permit the accumulation of capital is rejected by charmes (1992) who states that owning a business can provide a high income. this evidence is also supported by a study carried out in several sub-saharan countries (gasarian and maldonado 2001; gaufryau and maldonado 2001). some informal activities are more lucrative than others, such as repairing tvs, radios, cars and jewels. this sector welcomes not only the poor but also young, educated people. the wage in the informal sector depends on several factors: the qualification of the employees, the statuts (permanent workers, occasional workers, helpers and apprentices) and the activity. in sub-saharan africa, more than 70% of the active population works on the informal sector2. the dynamisn of the informal sector is related to the formal sector; both sectors are connected; the former plays the role of subcontracting for the latter. the parental choice about education or work affects a child’s future life. the choice to educate or send to work is a decision influenced by the socio-economic environment. poor households live in an environment where the informal sector is dynamic, absorbing the surplus of labour, whereas the formal sector appears to be in crisis3. the informal sector is no longer characterised by a lack of capital accumulation and, indeed, enables individuals to become rich (charmes 1992). hence, apprentices have an opportunity to become entrepreneurs, giving them social mobility. so parents choose the informal sector because they estimate that working in the informal sector gives their children a skill that might be informal, but is necessary for working in the sector. enlarging the household choices of education all the theoretical models (baland and robison, 2000; ranjan 2001; dessy and pallage 2001) on child labour that deal with the trade-off between work and education fail to consider the different forms of education available to households and the financial resources that dictate educational choices. households living in extreme poverty clearly lack the financial resources and choose the option of child labour. so, whatever the economic situation, if living standards are not improved, they do not invest in their children’s education. indeed, these households cannot live without child labour. we support the idea of basu and van (1998) who stipulate that a household puts its child into the labour market if and only if the adult members of the household cannot support the household. hence, income poverty is central in our analysis of trade-off against child labour and education. the 2 according to maldonado (1998), in benin 95.5% of the active population are wage employees in the informal sector. 3 this is particularly true in subsaharan africa. d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 11 luxuary axiome is supported by some empirical studies led by edmonds (2004) in vietnam and admassie (2002) in sub-saharan africa. differentiating categories of households we assume that rich households invest in formal education, knowing how important education is for assuring the household’s and its children’s continued wellbeing whereas the poorest of the poor take the decision of child labour because they cannot give up the opportunity cost of education. the most interesting cases lie within the circle of the graph below. households living near the poverty line are vulnerable households that can fall into extreme poverty (for the richest of the poor) and into poverty (for the poorest of the rich). the economic context and income fluctuations influence the choice of the household’s head (grootaert 1998). according to its economic situation, a household considered to be “the poorest of the rich” will make a different choice to a household living in “the richer of the poor” category. indeed, the populations considered the “richest of the poor” and the “poorest of the rich” have an interest in improving their economic situation and to do so by investing in their children’s formal education. hence, these categories of household (“the poorest of rich” and the “richest of the poor”) are sensitive to income fluctuations and to the overall economic situation. the graph below shows the possibilities of investment in children’s education for different types of households according to their levels of income. households inside the circle have four possibilities of investment. these households can invest either in formal education, vocational training, non-formal education and informal education. figure 1. possibilities of investment in education of children by different levels of income i riches = formal education the poorest of the poor = child labour poverty line the richest of the poor the poorest of the rich vocational training non formal education the poorest of the poor the richest of the rich formal education informal education the richest of the poor the poorest of the rich economic analysis 1-2 (2009) 7-18 12 in this figure, we do not have a binary choice households have four choices about educating children. we assume that formal education and formal vocational training can be assimilated as formal education, since they compliment each other using similars types of teaching and both give access to the formal labour market. also, non-formal education and traditional apprenticeship can be categorised as informal education, even if they appear to be distinct. by regrouping the different categories of education into two main categories, we make these household’s educational choice binary. hence, the household of the categories « the richest of the poor and the poorest of the rich » has to choose between child labour, formal education and informal education to ensure the wellbeing of children. we are going to discuss informal education that is seen as an alternative to child labour and to formal education. revising the trade-off between education and labour we assume that education is thought of as an asset by the households once the investment is realised. parents are investors and they want their investment to be fruitful at the end of the investing period. education is a long-term investment which makes it risky. the risk is the probability that you can still be unemployed. investment in education is a kind of asset that the investors themselves do not possess, but that benefits another person (alderman and king, 1998). the transfer of gains depends on the person benefitting from his investment. there are two kinds of educational cost: direct and indirect. the former is the cost of admission, buying uniforms, school materials (books, pens, etc) and travel costs. in some countries, educational fees are an obstacle for households too poor to educate their children. to overcome this, unesco has implemented the programme, education for all (efa), to provide compulsory education to every child in low developing countries. according to jensen and nielsen (1997), travel costs are also a factor affecting school enrolment. lack of transport means that children have to walk long distances to reach school, so that they are often late and too exhausted to follow classes. the children also suffer a high risk of being attacked on the way to school. the indirect cost is the opportunity cost of education. the poorest households cannot give up the financial resources that child labour contributes to the household’s survival. in the analysis of cost and benefit, the household compares the cost of its investment to its benefits. the cost of investment in education is short term (annual or monthly) until the end of schooling, whereas its benefits are long term. for a better understanding of the tradeoff between education and child labour, we make three assumptions: 1) we assume that households actualise their expenses realised annually at the term of the educational level (primary, secondary and tertiary education in relation with the strategies adopted): ( ) ( ) ( )∑∑∑ === + + + + + = o i o ot m i m ms n i n np a r c r c r c c 1 , 1 , 1 , 111 . therefore, we state that the actualised cost4 of primary education is cheaper than secondary education: 4 r is the rate of interest and the n=m=o=6 are the period of schooling. the whole period of schooling is then n+m+o=18 years which is relatively a long term for poor households. d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 13 ( ) ( )∑∑ == + < + m m ms n i n np r c r c 11 , 1 , 11 , and the actualised cost of the secondary education is less than tertiary education: ( ) ( )∑∑ == + < + o i o ot m i m ms r c r c 1 , 1 , 11 . hence, poor households can afford to invest in primary education, but cannot afford to go beyond this level as cost increases with higher levels of education. 2) the long-term benefits of education are effective when the child becomes an adult salaried worker in the formal sector. the household needs to anticipate these future benefits, but this is difficult to do so in an uncertain environment without access to information. indeed, the household is not at all certain that the child will find stable employment to repay the parents. in such an environment, the household compares the actualised expenses to the income prevailing in the formal labour market. hence, in the short term, the actualised expenses5 (ca) is compared to the wage the child could earn in the informal market, i.e. the opportunity cost of education wc and in the long term they will be compared to the profitability of the investment in education. the actualised expenses (ca) include the direct costs of education. distinguishing between the short and long term the short-term trade-off when ca wc = , the parent is indifferent to the choice between education and child labour, and will enroll the child in education out of concern about the child’s wellbeing. in the case where ca wc < and ca wc > , the choice about whether or not to educate is difficult. when ca wc < , a household living in extreme poverty has the child work as it needs the child’s wage to survive. since the household’s decision is made according to its economic status and the child’s wellbeing, the household compares ca with the future wage of the child. however, the child’s opportunity of future gain depends on the economy and the likelihood of finding a job in the modern sector. this hypothesis is shared by alderman and king (1998), and quisumbing and otsuka (2001), showing that girls in developing countries have a lower rate of enrolment as the opportunity to find a well-paid job in the formal sector is small. we assume that what is true for girls can be extended to all children regardless of gender. the long-term trade-off the parents need to anticipate the future wage of the children by putting a value on their investment which corresponds to the current adult wage waf applied in the formal labour market. this means that parents compare an adult wage to the actualised expenses of education. so we have three possibilities: 5 the household compares ( )∑= + n i n np r c 1 , 1 the cost of the primary education to the child labour wage, wc. economic analysis 1-2 (2009) 7-18 14 (i) afa wc = where the household is indifferent to choosing between education and child labour. the preference is given to education if parents are altruists and are not living in extreme poverty. (ii) afa wc > where educational expenses are higher than the wage of adults in the formal labour market, so poor households don’t consider it worthwhile to invest in children’s education. in this case, accessing the credit market would allow parents to finance their investment (ranjan 2001). (iii) afa wc < where education is a profitable asset, so parents do invest in their children’s education. however, when adult salaries in the labour market are high – higher than the anticipated expenses – poor parents will not invest in education if there is a high rate of unemployment among young educated people. the economic context is crucial for the parents’ decision about child labour and education (“hypothesis of coordination failure”, dessy and pallage (2001)). in the context of growth with creation of employment, parents invest in education. in low developing economies there is a high rate of unemployment among young educated people and a crisis of the formal sector; so parents lose confidence in school institutions that they don’t think are adapting to the demands of the labour market. factors explaining parental choice of informal education when households have several possibilities of investment, why don’t they choose the formal education? the crisis of formal education the education system in developing countries, particularly in sub-saharan africa, is in profond crisis with a high drop-out rate from schools. at the beginning of the 1980s, all the developing countries were submitted to the structural adjustment programme which consisted of improving the economic performances of economies facing a crisis of their balance of payment. institutions, such as the world bank and the international monetary fund, gave financial help in exchange for demands to reduce the public deficit; open public market to private investors; liberalise the capital and labour markets, all of which had some drastic consequences for these economies. the restructuring of public enterprises has meant redundancy for inefficient workers. their unemployment has an immediate effect: a decrease in family income. indeed, these people were unable to find a job in the formal sector and had to work in the informal sector where wages are lower. the loss of income is compensated by sending other household members – children and women – out to work (grootaert 1998). the consequence of which was an increase in children dropping out of school. the school drop-out rate has not been immediate; it accelerated with the reduction of the public deficit, accompanied with smaller amounts of state budgets going into primary education (cornia et al. 1987). this has been disastrous for educational systems. teachers have not been paid and infrastructures broke down. parents have financed the maintenance d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 15 of schools6. according to canagarajah and colombes (1996), teachers in ghana have asked their students’ families for domestic or farm work to compensate for their unpaid salaries. parents have also let their children drop out of school to go and work in the labour market to improve the household income. in keyna classes are overcrowded, with some 50 pupils in each classes, making it difficult for teachers and with pupils often having to repeat classes. in the macro-economical context of developing countries characterised by unemployment of young, skilled people within a formal sector in crisis, the long-term benefits of education appear to be nil. parents feel they are investing in a non-profitable asset. to encourage investment in education, the economic environment must be favorable. school is not seen as a vehicle that enables social mobility. parents (mostly the poor) judge the institution as ill adapted to the wider socio-economic context (gérard 1992) that fails to create employment for young, skilled people. the failure of the education system is also explained by a fast increase in africa’s population. in turn, the education system is unable to meet the demands of the extra number of enrolled children. this problem can also be related to what we have described above. the hypothesis of substitution between formal and informal education education in the informal sector is a different way of acquiring skills than education in the formal system. charmes and oudin (1994) and oudin (1990) have stated that formal education and traditional apprenticeships are complementary within the formal sector. vocational training is a prolongment of formal education as the teaching is theoretical and practical. these two forms of education give access to jobs in the formal sector. formal and informal education gives access to two different labour markets, even if individuals employed in the formal sector can work in the informal sector7. a person with formal skills can work in both sectors; the contrary is less likely8. the formal and informal labour markets are thus dichotomous. the choice of education for children altruistic parents will always invest in education for enhancing the wellbeing of their children. according to the economic theory of child labour, children’s wellbeing cannot be ensured outside of formal education because it gives access to formal employment distinct to the informal employment (ranjan 2001). wages in the formal sector should be higher than those in the informal sector. parents invest in education according to their financial resources and of the overall economic situation. households living in extreme poverty have little choice but to put their children into the labour market as non-qualified, occasional workers or helpers. the choice of these households is restricted by the need to survive. children change several jobs without learning any specific skills, ending up with incomplete skills across different activities. they 6 according to cornia et al. (1987) in africa, schools being in worst states parents have made enough efforts for maintaining them in state, they were paying teachers in nature (hen, vegetables and so on) for encouraging them keeping on teaching their children. 7 examples of pluriactivities illustrate the interactivity between these two different sectors. 8 taillors from the informal sector can work in the formal enterprises of textiles as it was the case in mauritius island. economic analysis 1-2 (2009) 7-18 16 learn to manage in the informal sector. their limited social network means that they do not have access to the most demanded informal education (ballet and bhukuth 2006) for which they need to be recommended by someone known to the master (charmes 1985a,b). the indigent households aren’t properly trusted by apprenticeship masters, which only reinforces their marginalisation. in the figure above, there is a move from the left to the right in the parents’ choice of education. the preference for work is high among the indigent households and the tendency changes by moving towards the right. in other words, the better the potential for the household income, the more parents prefer to invest in formal education9. therefore, poor households prefer investing in informal education rather than in formal education. rich households know the importance of education; they prefer putting their children into formal education which permits them to be different from the poor population. as bourdieu (1986) points out in another context, those of developed countries, educational strategies are also a significant means to maintaining differences between social classes. conclusion and policy recommendation we have studied the difficulties faced by households when weighing up the benefits of child labour versus education. this trade-off is more difficult for households facing financial constraints. poor households cannot give up the opportunity cost of education. to ensure their children’s wellbeing, therefore, they provide their children with an informal education that is different to formal education. hence, the trade-off is no more binary because there are different types of education for different categories of households. parents base their decision about formal schooling on the formal adult labour market. if such a market is characterised by unemployment of young, educated people while the informal sector is expanding, parents prefer to give their children an informal education. analysing the tradeoff between child labour and education in terms of costs and benefits, gives a new insight to the issue of child labour. formal education must appear to enable social mobility in order to encourage parents to invest in formal education. in developing countries, parents are not convinced that schools play a role in forming the type of skilled labour market that society wants (in the formal sector, bhukuth and bennani, 2006). so, in such an environment, (poorer) parents tend to choose informal education that prepares their children for the informal sector and contributes to its development. according to the sociologist schlemmer (1999), school is not “the norm” in most developing countries of sub-saharan africa; it is their colonial heritage. people are not aware of the importance of educating children. in most developing countries, primary level school requires less financial resources than other levels of education, and more resources should be allocated to it. more modern schools must be built both in urban and rural areas and more effort must be made to improve the training of teachers. states also need to encourage private initiatives in order to reduce unemployment among young educated person to inspire confidence in the long-term benefits of education. 9 parent’s income is high enough to offer children’s an education. d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 17 references admassie a. 2002. explaining the high incidence of child labour in sub-saharan africa. 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(1999), l’ecole ou le travail. cahier ares 1: 155-167. ea_2012_3-4 original scientific paper foreign direct investment and economic growth: evidence from asian selected countries soleimani sheida*, department of economics of shiraz university, iran behname mehdi**, department of economics of ferdowsi university of mashhad (fum), mashhad, iran udc: 339.727.22(5)"1980/2010" ; 338.1(5) jel: f21, f43 id: 195856140 abstract – the purpose of this paper is to investigate the influence of foreign direct investment (fdi) on economic growth in asian countries for the years 1980-2010. the ips unit root test indicates that variables are stationary in level and hausman test proves that we should apply the random effects model. having estimated the model we come to the conclusion that fdi has positive and significant effect on economic growth and variables such as human capital, economic infrastructure and capital formation have positive effect on gdp. however, population, technology gap and inflation have negative effect on the economic growth. key words: foreign direct investment, economic growth, asia, panel data introduction one of the main concerns of the governments is to promote development and welfare level of the country. in the past two decades, fdi has been known as an important factor for growth and development. in the recent years, the asian countries such as thailand, malaysia, indonesia and china have attracted a significant portion of the fdi of the world. this action has been influential on economic growth in asian countries, in a way that the economic growth has been increased to 7.7% in southern asia in 2005, 13.8% in pakistan, 8% in afghanistan, 8% in bhutan and 8% in india. the capital flow to asian countries initiated in 1990 with an increasing rate following a decrease in 1980. the fdi has been increased in asian developing countries from 396 million dollars in 1980 to 102,066 million dollars in 2001. this rate is equal to 13.9% of the whole fdi in 2001 (unctad 2002). the world bank reports illustrated the capital growth in southern asia to be 23.6 billion dollars in 2005. this major share of this growth belongs to india attracting a considerable fdi of this region. in pakistan, privatization and natural resources has caused the increase of fdi which was 1.1 billion dollars in 2004 to 2.2 billion dollars in 2005. the paper aims to shed a * department of economics of shiraz university, iran, sheidasoleimani22@yahoo.com ** department of economics of ferdowsi university of mashhad (fum), mashhad, iran, mehdi_behname@yahoo.com economic analysis (2012, vol. 45, no. 3-4, 67-74) 68 light on whether fdi has had any share in the increase of economic growth in asian countries or not. so many researches have been done in this regard. borensztein and gregorie & lee (1978) proved that fdi in an endogenous model provides the grounds for growth in developed countries. blomstorm and kokko (1997, 1998) asserted that fdi provides economic growth in developing countries. on the other hand, balasubramanyan et al. (1996) indicated that fdi, plays more important role in economic growth as compared to export. carkovic and levine (2005) also showed that fdi leads to the increase of economic performance. however, gorg and greenaway (2004) proved that fdi does not have any influence on economic growth. behname (2011a, 2011b, 2011c) shows that gdp has a positive effect on fdi and fdi also has a positive effect on gdp. theoretical issues application of industrial policies such as tax and subsides to attract fdi signifies great benefits of foreign capital for the host countries. the multinational firms bring about advantages such as advanced technology, trade secret, brand name and trademark, management techniques and marketing strategies (dunning 1993). but the most important effect of fdi is the increase of growth in the host country. we could examine the effect of fdi on economic growth within the framework of the growth models. in neoclassical growth model, it is believed that fdi just influences the per capita output level and has no effect on growth rate. however, in modern theories of economic growth, it is believed that fdi is effective on growth rate and level. based on the recent theories, the main factor influencing the growth rate is the high technology in advanced countries which is transferred to the developing countries through fdi (borensztein et al 1998). because of the absence of essential grounds for the formation and improvement of technology in developing countries, these countries have to import these technologies into their country through fdi. on the other hand, through the spillover of technology to other domestic sectors, national economy would benefit this system. when the production technology is improved at the national level, the products would be supplied with higher quality and lower cost, and consequently, national production and per capita output would increase. in other words, technology is the potential source of productivity profits through spillover to domestic enterprises. borensztein et al (1998) proved that the difference in level of human capital in different countries influences the level of attracting technology which finally would affect the economic growth. so, possessing human capital cause the increase of growth rate. on the other hand, it is to be considered that fdi cause the promotion and elevation of the level of human capital and improve the management techniques in developing countries. fdi also could increase production and economic growth through the improvement of infrastructures. the multinational enterprises for extraction and transporting raw materials and also sales of final products are forced to modify the transportation and communication systems. the modifications of these infrastructures facilitate transportation of products and therefore, production process is improved. the effect of fdi on economic growth depends on the conditions of the host country. these conditions include trade openness, high rate of soleimani, s., et al., fdi and economic growth, ea (2012, vol. 45, no, 3-4, 67-74) 69 saving and the existence of human capital. the highness of these criteria improves the conditions of host country's enterprises through demonstration, and contract effects, as well as the increase of exports. data and methodology before estimation of the model, we should be ensured of the stationarity of variables. dickey-fuller, (1981) augmented dickey and phillips-perron tests are used to measure the stationarity of time-series variables, however, for panel data which have higher power compared with time-series, other tests are applied. these tests are: im, pasavan and shin (2003), levin, lin and chu (1992). among different unit root tests in econometrics literature, the llc and ips are more famous than others. both of these tests have been made based on adf. assuming that data are homogeneous, llc test has been made for dynamics of autoregressive coefficients for all panel parts. however, ips more generally considers heterogeneity of this dynamics. the benchmark model of autoregressive is as follows: ititiitiit xyy εδρ ++= −1 (1) where shows i = 1,2,…n of the countries from the times of t=1,2,….,t. itx are exogenous variables in the model. iρ is the autoregressive coefficient and itε is the static process. if iρ <1, iy is weakly stationary and if iρ =1, then iy has a unit root. in this paper, ips test was used for the unit root, because the economic structures of the respective countries are different. table 1. unit root test and panel data gdp inf pop hu inv fdi ope -3.44* -4.21* -3.13* -2.45* -2.09* -4.53* -2.54* the variables are stationary at the 5% confidence level. as defined in table 1, all the variables were significant in 5% level. it means the variables are stationary, and so, spurious regression is avoided. the hausman (1978) test was used to select the fixed effect or random effect models. this test shows that the random effect model should be applied. economic analysis (2012, vol. 45, no. 3-4, 67-74) 70 methods the main variables for economic growth in this study include investment, population growth, gdp per capita, infrastructure (telephone line), inflation, productivity, human capital and foreign direct investment. this paper applies the panel data model for estimation of the parameters for southern asia countries (e.g. bahrain, iran, saudi arabia, qatar, kuwait) we have chosen these countries because ones have the same economic structures and they are exporting oil countries. the basic specification for the model is itititititititit bxfdiinvhupopinfg εββββββ +++++++= 543210 where g is the real gdp per capita growth of country i, inf is infrastructure, pop is the population growth and hu is human capital in the host economy. fdi is the foreign direct investment and inv is gross capital formation as a percentage of gd. the group of x includes a group of variables to test the robustness of results (e.g. dummy variables, interaction of fdi with other variables, inflation…). we could consider the endogenous form of the model i.e. fdi to be a dependent variable. the technology gap is measured by the following: ( ) ititit yyygap /max−= where the gdp per capita of iran is used as y max. before proceeding to estimate panel data, we carry out unit root tests to examine whether the variables are stationary. the data set used covers 6 countries over the period 1980-2010. the sources of variables are undata, the world bank group, unctad and growth data resources. empirical results the results of the main equation are shown in table 2. the specifications of column 2.1 are based on the main variables of fdi, hu and pop. the effect of human capital and foreign investment variables on economic growth is positive and significant. behname (2011a) and borensztein et al (1998) show the same results for the different countries. fdi such as domestic investment increase aggregate demand and aggregate demand augment domestic output. the effect of population on growth is positive, but insignificant. we insert inv to the equation to explain column 2.2. this equation shows that capital formation has positive effect on economic growth. in this column all of the variables are positive and significant. if population has a high human capital, increasing it augment gdp. in equation 2.3 the infrastructures are also inserted. the proxy required for infrastructure is the telephone line. in this clarification the infrastructure has positive effect on economic growth, but fdi has no effect on growth. aitken et al (1997) show the same results in their study. in explanation 2.4, we insert technology gap. this variable has negative effect on growth, and in this equation, fdi has positive and significant effect on economic growth. in explanation 2.5, we insert the interaction relation of technology gap and fdi, which has negative effect on economic soleimani, s., et al., fdi and economic growth, ea (2012, vol. 45, no, 3-4, 67-74) 71 growth. these variables affect gdp in an indirect way. in the last explanation, we insert infr inflation rate, as an economic risk, into the equation which has negative effect on economic growth. table 2. impact of fdi on per capita gdp growth 2.1 2.2 2.3 2.4 2.5 2.6 constant 3.12** 1.21 1.33** 2.31** 1.22 -1.31 (-2.32) (1.09) (2.09) (2.22) (0.42) (-1.14) pop 0.42 0.12** -0.51** -0.13 0.14 0.21** (1.02) (2.05) (-2.13) (-1.21) (-1.01) (-2.15) hu 0.93** 0.71** 0.92** 0.31** 0.21** .23** (2.11) (1.21) (2.12) (2.01) (2.13) (2.27) fdi 0.19** 0.39** 0.45 0.22** 0.31*** 0.11* (2.12) (2.11) (1.01) (2.11) (3.52) (1.91) inv 0.13** 0.21** 0.21 0.25** 0.20** (2.31) (2.30) (1.33) (2.12) (2.35) inf 0.25** 0.22** 0.63 0.22** (2.00) (2.31) (1.13) (2.04) gap -0.09** -0.11** -0.07 (-2.16) (-2.08) (-1.24) fdi*gap -0.14** -0.21 (-1.98) (-0.91) infr -0.29** (-2.10) notes: t-values reported in parentheses; *** significant at 1% level; ** significant at 5% level; * significant at 10% level. table 3 shows the results of fdi equation. this table studies the effect of gdp on fdi. in equation 3.1, the effect of economic growth and human capital on fdi attraction has been positive, while population shows negative effect. based on this table, economic growth, human capital, trade, capital formation and economic infrastructure have positive and mostly significant effect on attracting foreign capital, while population and economic risk, inflation, leads to the decrease of foreign investment. aitken & harrison (1999) and de mello (1997) show the same results. here ope is openness that a positive effect on fdi, it means that openness and fdi have a complementary relationship. economic analysis (2012, vol. 45, no. 3-4, 67-74) 72 table 3. impact of growth on fdi inflow 3.1 3.2 3.3 3.4 3.5 3.6 constant -2.19** 2.19*** 1.34** -2.21** -2.50 -1.44 (-2.00) (3.32) (2.11) (-2.14) (-1.21) (-1.51) gdp 0.09** 0.02** 0.02 0.03** 0.04** 0.03** (2.32) (2.28) (1.17) (2.01) (2.11) (2.01) hu 0.30** 0.325 0.21* 0.32 0.23** 0.03 (2.14) (1.11) (1.98) (1.32) (2.14) (1.03) pop -0.24** -0.35** -0.28 -0.21 -0.24** -0.23 (-2.22) (-2.11) (-1.02) (-1.14) (-2.28) (-1.37) ope 0.02** 0.03** 0.05** 0.04** 0.10 (2.31) (2.16) (2.10) (2.14) (1.29) inv 0.32** 0.52* 0.25** 0.02** (2.09) (9.88) (2.15) (1.98) infr -0.15** -0.13** -0.14** (-2.01) (-2.50) (-2.24) inf 0.21*** 0.21** (3.22) (2.16) fdi*gap 0.36** (2.06) notes: t-values reported in parentheses; *** significant at 1% level; ** significant at 5% level; * significant at 10% level. conclusion the study examines the influence of foreign direct investment (fdi) on economic growth in asian selected countries for the years 1980-2010. having applied the stationarity, it has been concluded that all the variables are stationary and we would not be trapped with spurious regression. the hausman test shows that our selection is random effect model. in two other separate tables, we examined the effect of fdi on economic growth, and the effect of gdp on fdi. in each table, we insert variables into the equation separately to be compared. the results of fdi effect on growth indicate that fdi has significant and positive effect on economic growth in asia region. with regard to these facts, we come to the conclusion that it is necessary for the countries of asia to attract the fdi in order to improve growth and welfare of their country. on the other hand, the second table, the effect of gdp on fdi, indicates that factors such as human capital, trade, economic infrastructure and capital have positive effect on attracting fdi. so, the countries located in this region are able to increase their fdi and consequently the growth of their country by emphasizing these variables. among other factors effective on economic growth, we could mention economic infrastructure, human capital, decrease of technology gap and capital formation which soleimani, s., et al., fdi and economic growth, ea (2012, vol. 45, no, 3-4, 67-74) 73 increase the growth. however, the population growth, the increase of technology gap, and inflation increase leads to the decrease of economic growth. based on the obtained results, the countries of asia should devote their most attention to economic infrastructure and capital formation, since it directly increases gdp and affects it indirectly through attracting fdi. references aitken, b. j., hanson, g. h., & harrison, a. e. 1997. “spillovers, foreign investment, and export behavior.“ journal of international economics, (43): 103-132. aitken, b. j., & harrison, a. e. 1999. „do domestic firms benefits from direct foreign investment?.“ american economic review, (89): 605-618. akinlo, a. e. 2003. „globalisation, international investment and stock market growth in subsaharan africa“. institute of developing economies v.r. f series, 382. balasubramanyan, v. n., salisu, m., & sapsford, d. 1996. „foreign direct investment and growth in ep and is countries.“ the economic journal, (106): 92-105. behname, 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social development, united nations, new york. direktna strana ulaganja i ekonomski rast: dokazi iz odabranih zemalja rezime – svrha ovog rada je da istraži uticaj direktnih stranih ulaganja na privredni rast u azijskim zemljama u periodu izmedju 1980 i 2010 god. koršćen je ips jedinični test. nakon procena ,došlo se do zaključka da direktna strana ulaganja imaju pozitivan i značajan uticaj na privredni rast ,dok varijable kao što su ljudski kapital, privredna infrastruktura i kapital imaju pozitivan učinak na društveni bruto proizvod. međutim, stanovništvo, tehnološki jaz i inflacija imajui negativan učinak na privredni rast. ključne reči: direktna strana ulaganja, privredni rast, azija, panel podataka article history: received: 17 july 2012 accepted: 23 october 2012 ea_2014_3-4 note oft he editor-in-chief the concept of the journal is such that it gives the advantage to multidisciplinary approach to various subjects. it also emphasizes publishing of the scientific papers, which have an empirical and a research character. however, there is also the place in the journal for quality theoretical papers as well, reviews of the latest publications of national and international significance and scientific critiques and discussions. all papers are subjected to anonymous review, and the authors are notified of its outcome within one month. papers are sent in via e-mail to the address of the redaction. the potential authors are advised not to send the papers which are not laid out according to the technical instructions for writing the papers. such papers will not be taken into consideration for publishing. besides this, we insist on language correctness and a professional translation to english language. any manuscript submitted to the journals must not already have been published in another journal or be under consideration by any other journal. the journal does not have page charges or submission fees. prof. dr. mirjana radović-marković, european academy of sciences and arts (easa), salzburg,austria academia europea (ea), london, united kingdom world academy of art and science (waas), united states royal society of arts (rsa), london, united kingdom bulgarian academy of science and arts (basa), sofia, bulgaria editor in chief microsoft word 2008_01_02.doc original paper    instabilities, crises and agenda for possible reform of     the international monetary system and the international     financial architecture in the xxi century    amra kožarić, faculty of economics, university of tuzla    key words: instability, global economic system, international monetary system,     international financial architecture    udc: 338.23:336.74          jel: f33    abstract ‐ recent global, world occurrences (turbulence, volatility, risks, huge transaction costs,  the weakness of public and private banking, financial structures, instabilities in the international financial  activities and excessive international financial crises) made clearly, that the current international monetary  system canʹt insure global stability and prosperity, neither the system can adapt to a more modern economic  and social structure. instabilities and unbalances, which characterised the system in the past century and at  the beginning of the xxi  century, have been brought by the economic globalization, in other words financial  globalization. intensive widespread of these instabilities, between developing countries and even to the in‐ dustrialized world, have influenced on the international policymakers (called as the international financial  institution) to start the initiatives about possible reform of the international monetary system and its inter‐ national financial architecture.   introduction  recent global, world events (turbulence, volatility, risks, huge transaction costs, the weakness  of public and private banking, financial structures, instabilities in the international financial activi‐ ties and excessive international financial crises) on the international economic and financial stage,  made clearly that current international monetary system canʹt insure global stability and prosper‐ ity, neither the system can adapt to a more modern economic and social structure. namely, ad‐ verse, unfavourable and overload volatile global financial movements brought the international  monetary system and its structure (the international financial architecture) in the state of deep cri‐ sis and collapse, with expressive risks and instabilities from the actual international economic and  financial integration. suggestions for exceeding this negative situation become actually, a workable  and necessary initiative of the international financial and other institutions, for creating the fun‐ damental framework of agenda of the future reform of the international monetary system and the  international financial architecture. it was realized, that the international financial crises are very  «contagious and contaminate», and that they have a «strength» to spread  even to the industrial,  developed countries with sound economic structures and macroeconomic management. however,  the most unsuccessful and vulnerable are shown by developing countries and countries in transi‐ tion (emerging nations). this pattern has been aggravated by premature, previous and hasty liber‐ alization of the capital flows, fragile domestic financial structures and very weak financial regula‐ tion and supervision of the national and international financial institutions. thus, there is no need  for wondering, that the special place in reforming of the international monetary system take de‐ veloping countries and countries in transition. regardless of how is the reform of the monetary  system running, it is certain clear that there is need for better coordination and collaboration be‐ tween international economic policies of both, industrial developed and developing countries.        volume 40 • spring 2008 • 105  instabilities and crises of the current (actual) international monetary system and the  international financial architecture: necessity for reform  in last few decades, process of globalization had a big influence on the evolution and func‐ tioning of the international monetary system. although the system was changing and adopting to  new circumstances and environments, becoming aware of its disadvantages and lacks, that same  institutional  framework  of  international  economics  (the  international  monetary  system)  didnʹt  avoid cyclic movements, which emerged in the middle of the xx. century and at the beginning of  the xxi century. namely, the system has been agitated with the international financial crises, start‐ ing with erm crisis (european exchange rate mechanism, 1992./93), «tequila» crises 1994./95,  and  crises in asia, russia, brazil, argentina in the period from 1997. till 2001. excessive and foster lib‐ eralization  of  the  international  capital  flows,  frequent  speculative  strokes  on  the  international  monetary and national financial systems, evolution and appearance of the financial disturbances  and crises, (un)adequate established foreign exchange rate regimes etc., were  just some of a few  global financial problems spread in the last decades. besides, insufficient, slowly and unsuitable  activities of  the  international financial  institutions  in  the field of: maintaining  the  international  economic relations, solving the financial crises and supporting suitable developments and growth  of developing countries, were pointing that there were a serious problems in the system. such in‐ stabilities and economic unbalances are became more global and systematic, and trying to solve  this limits are not enough. additionally, the problems in the international financial architecture are  more strengthen with the existence of a huge volume of the international financial transactions and  insensitive transfer of financial instruments, also with the integration of the international financial  markets, with inconsistent of the exchange rate policy with macroeconomic performances, prob‐ lems in creating a stable currency configuration, a single global currency, increasing systematic  risks, a deep corruption in governments («crony capitalism») and also with problems of maintain‐ ing the international liquidity. all that, interrupted global financial stage and had influence on de‐ creasing the possibilities for keeping the international trade in balance. this aggravates the current  situation, because the high‐risk financial activities can deepen the unbalances in the future.   unfortunately, at the beginning of the xxi century, the diagnosis of instabilities and prob‐ lems in the international economic relations is still remaining. although, there was established an  actual coordination between macroeconomic politics on global level, the biggest monetary prob‐ lem, which global economy is facing with, specially developing countries, made an impression that  the current international monetary system is more unstable today, than in last decades. todayʹs  monetary system is threatened by collapse, but that shouldnʹt prevent the international and na‐ tional economic politics to learn about the structure of the system, about the arrangements, proce‐ dures, instruments and institutions, which are necessary for defining common standard of valuing  global currencies. hence, it is necessary to do something, in way that global economy becomes  more stable and resistant on sudden and unexpected gaps. a propos, there is an important ques‐ tion: can the current international monetary system resist of the challenges of economic or financial  globalization, so as the question: what kind of the international financial architecture would suit to  the current international monetary system?. all past and current instabilities were raison d’être for  forehand  (timely)  action  and  the  reform  which  realizes:  providing  the  international  liquidity,  global consistency of the macroeconomics policies and financial regulation in developed and de‐ veloping countries, crisis resolution, crisis prevention, solving debt problems, liberalization of the  capital flows, involving or bailing the private sector in solution of currency and debt crises. in this  respect,  in global academic economic  literature, more and more attractive, will become a crisis  management discipline (crisis resolution, crisis prevention) which might ex ante, with new tools  prevent financial disturbances. with predicted, anticipated reform of the international monetary  2007 ‐ 106  •  economic analysis®  system,  it should be only partly decreased  frequencies of  the  turbulences and bring  long‐term  monetary stability which will strength the international trade and keep the global economy more  resilience versus the erratic financial disturbances. no expectations to creating alias a «new inter‐ national monetary system». it must be emphasized that the present system is badly equipped to  prevent financial crises and only partly equipped to manage them and that is also one of the rea‐ sons of reforming it.  the recent crises (crises in usa, europe, 2007/08.) have demonstrated a serious problem in  global economy: the enormous, huge discrepancy that exists between an increasingly sophisticated  and dynamic international financial world, with intensive financial globalization, and the lack of a  adequate institutional framework to regulate it. in other words, existing institutions are inadequate  to deal with financial globalization. this is true of institutions at the international level, which have  manifested significant shortcomings in the consistency of macroeconomic policies, and in the man‐ agement of international liquidity, financial supervision and regulation, it is true, also of national  institutions in the face of globalization. these systemic deficiencies, above mentioned, and the as‐ sociated threat of recurring crises in the future have, thus, underscored the need for a comprehen‐ sive, immediate reform of the international monetary system, geared to prevent costly crises and to  manage them better if they occur. besides, these systematic shortages became the threats to global  system, even with the possibilities to appear in the near future. and, excessive liberalization of  international capital flows, (un)adaptable foreign exchange rate regimes, financial and technical‐ technological solutions and innovations did not effect  just on the increasing of the international  financial transactions, also on the increasing volatilities in the international economic relations. a  several times, repeatedly, on the conferences preceded by the international monetary fund (imf),  the world bank and the other international financial institutions, have been noticed the needs for  (possible) reform of the international monetary system in way to prevent the crises situations. the  expected results of the (possible) reform of the system and financial architecture will be based on  improvement of global economic prosperity and welfare, on forming global financial market, a  single currency and single monetary and fiscal policy.   this chaotic state in the international monetary system provoke numerous discussions, that  there is no the international monetary system, then the «no system» or even «clear‐cut» system.  because of existence of huge proposals for the reforming of the international monetary system, it is  hard to establish unique consensus about how the reform of the system should be realized. in‐ stance for,  r. mundell suggested the fixed exchange rate and a single currency, m. friedman free  floating exchange rate,  j. williamson    target zone, r. mckinnon coordination of  the macroeco‐ nomic politics, j. tobin foreign exchange tax proposal and capital control, etc. thus, there isnʹt an  optimism for creating the «clear‐equalize» international monetary system. it is impossible to estab‐ lish single currency and single exchange rate which will be appropriate for all countries. no single  currency regime is right for all countries at all time, and no single «rules of the game» for the de‐ veloping countries and developed countries.  the fundamental framework of agenda for future reform of the international monetary  system and the international financial architecture  the reform of the international monetary system and the international financial architecture,  for a long time, was metaphorical. however, in the last few decades of the xxi. st century has been  realized that for the long term global prosperity, stability and welfare is indispensable the reform  of the international monetary system and the international financial architecture. the first serious  move about this theme was noted in mexico on the conference called the united nations interna‐ tional conference on financing for development in march 2002. at the same time, that skip was  volume 40 • spring 2008 • 107  considerable as the main (key, basic) turning point in completing the agenda for possible reform of  the  international monetary system and the international financial architecture. even then, there  were established a composition of the reform (directives): minimizing the financial and market  risks (because these risks could bring back again the systematic, currency, debt crises), insure sta‐ bility and «calm» functioning of the system and insure the early warning system with so‐called  financial indicators for assessing financial system soundness (mpi). in other words, there is need  for starting new activities for correcting the basic weaknesses, which    the current international  monetary system revealed at the beginning of the xxi century.    the possible directions for reforming the international monetary system and international fi‐ nancial architecture became  the real challenges for policymakers, international financial institu‐ tions, as on its broad, as on its complexity. namely, the starting premise for reforming the system is  that, the significant economic growth, integration of the international financial markets of the one  part, and a new structure of  the monetary system and  financial architecture of  the other part,  would contribute to larger investments and development in global economy, especially in the de‐ veloping  countries.  the  main  goal,  is  actually,  to  enhance  the  international  integrated  system,  which will be establish on stabile economic policies, stabile national financial system, more open  international financial markets, bigger transparency, legitimacy and right social‐economic polities.  there is need for harmonization of the rules, rights and accountabilities of different constituents in  global economy staring with: governments, citizens, private corporations, special financial institu‐ tions and international financial organizations. the international monetary fund (imf) isnʹt only  responsible for performing already mentioned activities. it should be involve the other interna‐ tional financial organizations and institutions as: the world bank, oecd, bank for settlements and  the other special financial agencies, institutions and non‐profit organizations. with the regarding  to justification and indispensable reform of the monetary system, in meanwhile the number of di‐ rections has been increase (since 2002. up to 2008.). reforms in this area must be addressed with a  sense of urgency in several key areas:   o strengthening and reforming the international financial institutions, thereby improv‐ ing transparency, international standards and codes, international codes of conduct,  improved information, quota, voice reforms,  o involving the private sector in crisis resolution and crisis prevention,  o improving the «crisis management» discipline,  o enhancing social politics of developing countries,   o adopting adequately foreign exchange rate regimes,  o provisioning of adequate international liquidity in times of crisis,  o orderly debt workouts,  o capital account management,   o liberalization of the capital flows,   o strengthening  national  financial  systems  and  enhancing  financial  supervision  and  regulation, etc. [imf,(2007), 9‐15.]  proposals and suggestions for the reform go in two lines: the first one, is consideration of re‐ shaping the goals and models of the current international monetary system and the other one, is  establishing the different, but new tools, rules for system and new international financial institu‐ tions, with new missions and functions («new rules of the game»). still remain to see in which di‐ rection reform needs to run.  2007 ‐ 108  •  economic analysis®  as we can notice, there are many areas of potential or possible reforms, but it will be intro‐ duced just few of them.   the most controversial dilemma is reforming the international monetary fund (imf), as a  main holder (carrier) of the international monetary system. the arguments of the adherents of the  fund (proponents), understand that this central institution will gets out its members and staff with  weaker financial status from the economic difficulties, and enable them prosperity and progress.  the other side, the opponents of the fund think that the institution has the monopolistic position,  putting the developing countries in bigger economic and financial problems. no matter of, many  discussions put on the first place strengthening and reforming the international financial institu‐ tions. the main goal of this activities is mostly directed on improving efficiency of the institutions.  so, the international economic policy are agreed that, imf and world bank should have (and keep)  a central role  in the  international monetary system and strengthening the cooperation between  developed and developing countries. in that way, with supervision and regulation the monetary  system would be more robust. also a less radical reviewers and mostly of the members of the  fund, consider appropriate that institution need to stay «with us», and reform of that institution  should go towards the agency which will help in eliminating global misery and poverty. there are  many opinions how the reform of imf should go, but the main subjects are improving the activi‐ ties in the surveillance of global economy (imf surveillance over the policies of creditors as well  debtors, national financial systems) and finding balance between confidential advices and possible  escalation [salvatore d., (2007), 790]. fundamental directions is actual in the current year (2008)  and will be in the next two or three years. besides, the fundʹs surveillance is being influenced by  efforts to improve transparency and accountability of its members, to develop international stan‐ dards and financial sector assessments. simplify, it became clearly that the prevention and resolu‐ tion of the financial crises, require greater transparency and disclosure of information, regarding  the activities of the public sector, financial markets and institutions and international financial in‐ stitutions.   now, imf publish most of country documents and policy papers (from different countries),  and imfʹs goal is encouraging and promoting transparency in member countries. also, the fund  has to form an efficient and independent mechanism for its politics, programs and operations (ac‐ countability), which will help the institution to demonstrate the responsibility and to justify trusts  to its participants in the international financial markets. the action in the international institution  (imf, world bank) has so far concentrated on setting standards for improving the timeliness and  quality of information concerning key macroeconomic variables, and transparency of public sector  activities including fiscal, monetary and financial policies or data dissemination, transparency of  fiscal, monetary and financial policies and banking supervision. and of course, the transparency is  the «the gold rule» for the successful of reforming of the system. the governments, non‐financial  and international financial institution, have to subjugate to those standards and codes. however,  the special problem for developing countries, is that they arenʹt agreed, completely, with adoption  of these standards, because there are a lot of different standards and very often the institution put  on adoption the «one‐fits –all standards», which sometimes donʹt suit to the economic politics of  emerging markets. anyway, we emphasis the agenda of these standards and codes: code of good  practices on fiscal transparency, code of good practices on transparency in monetary and finan‐ cial policies, special data dissemination standard (sdds), data dissemination standards, basel  core principles, financial sector assessment programme etc.   there are some initiatives for reforming the activities of the world bank. two key principles  are guiding the bank’s work in support of the reform of global system: the bank’s primary focus is  to assist developing countries integrate with the global financial system based on demand‐driven  volume 40 • spring 2008 • 109  country assistance strategies, and the bank is well placed to bring developing country experience  and perspectives to the discussions that are underway on reform (trainings, consultation).   imf and the world bank need to work better together, in way of creating the stronger culture  of cooperation, creating a more equalize dialogue and monitoring process (voting methods). al‐ though, the fund and other international financial institutions work for usa (which possesses a  huge influence in decision‐making), those organizations shouldnʹt forget their mission: supporting  the sustainable development, long term reconstruction of economies, short term financial supports,  collaboration with its staff, human rights, environmental protecting, social care system and wel‐ fare. recent events in the world economy have underlined an important link between economic,  social issues and global system, and that economies depend, both, on stable relationships between  governments and their citizens and strong social cohesion. an efficient social system, by equipping  people for change, builds trust and encourages people to take the risks which are a necessary part  of a competitive modern market. this in turn helps to mitigate the risks and spread the benefits of  globalisation. effective social policy can help in building the support for necessary reforms and  ensuring that the burden of adjustment doesnʹt fall disproportionately on the poorest and most  vulnerable groups in society (still, there is a big problem‐a deep financial gap and improper distri‐ bution international liquidity in times of crisis between developed and developing countries). and,  if policy makers succeed to restore confidence and promote stable growth, parallel, they will re‐ duce poverty and supporting social welfare. therefore,  the  initiatives on social policy must be  taken forward together with the initiatives on debt relief and poverty reduction.  imf surveillance hasnʹt been successful in preventing international financial crises. because  of that, involving the private sector in crisis prevention and crisis resolution is very an important  direction. one of the most complex tasks is how could the private sector be involve in crisis pre‐ vention and resolution. in that way, the international financial institutions suggest to develop bet‐ ter cooperation between debtor and creditor, finding a new crisis prevention measures and new  institutions for crisis resolution. the role of the private sector in reforming of the system, should  help in promotion cooperative decisions between countries in debt and private sector, and improv‐ ing the activities which will decrease risks of investors. these framework, which relief cooperation  debtor/creditor, can minimize frequency and intensity of crises, but the crises canʹt be eliminate. in  view of the growing size and integration of the financial markets, every major financial crisis now  has global ramifications. consequently, preventing a crisis is a concern not only for the country  immediately affected, but also for other countries. with the increased frequency of crisis in emerg‐ ing markets, a consensus has emerged on the need to provide contingency financing to countries  experiencing payments difficulties. above (preliminary) direction is often supplement by the dis‐ ciplines which are called crisis prevention and resolution. and, imf has been working on the crea‐ tion  the  adequate,  supplemental  reserve  facility  (srf)  or  new  contingent  credit  line  (ccl)  which will improve the stability of the international monetary system and decrease the frequency  of the crises. the activities are still actual and will be the theme of discussions on the next interna‐ tional conferences.   the crucial question is adoption and choosing the adequate and properly exchange rate re‐ gime. so, the actual regime today  is hybrid foreign exchange rate system. the system  includes   three blocks: hard peg fixed exchange rate regime (monetary union, dollarisation, eurisation, cur‐ rency board),  intermediate regimes (adjustable peg, crawling peg, basket peg and target zone),  managed  and  clean  floating. also, countries could  decided    between  two solution:  to  use  free  course or to tide up  the currency to one of leading currencies like us dollar. there are suspicions   that this  solutions  couldnʹt stop instabilities and financial crises  in countries. neither of this sys‐ tem is favourable to terms of trade and competence. countries with flexible exchange rates are no  2007 ‐ 110  •  economic analysis®  less vulnerable to financial crises than those with pegged fixed exchange rates. this provoke dis‐ cussable questions: which exchange rate regime is best?, who is right?.[pilbeam k., (2006), 289].  is there progress or ...?  despite the general consensus, that the reform of the global monetary system is‐imperative,  by then no efforts are done towards reform. developed, industrial countries arenʹt ready for acti‐ vating developing countries in discussions about the mentioned theme. the biggest disappoint‐ ment was shown by  the international public financial institutions and their little  interesting for  reconstruction of the global finance. mostly economists can find the main reasons for the reform of  the international monetary system and international financial architecture, in excessive volatility  international capital mobility and foreign exchange rate regimes, in deepening gaps between de‐ veloped and developing countries, and in frequent appearance of the «virtual contagion and dis‐ ease» of monetary system (demonstrated by financial crises and large but extremely volatile and  highly concentrated private capital flows). the predictable reforms they called the «cure», which  should mitigate  instabilities and  frequency of  the  financial appearance and   bring a  long  term   monetary stability, specially in the developing countries. also, the reforms should have the same  echo in the national, as in the international economic policies, which means‐the effects of the pro‐ posed reforms should compose the long term period, so that the results of  renovating of the sys‐ tem could manifest also on developing countries.   the tasks, which global economy had established, are the challenges to all actors of the inter‐ national  monetary  system,  starting  with  industrial,  developed  countries,  developing  countries,  international financial institutions and actors on the international financial markets (banks, pen‐ sion funds, commercial institutions). so, if developing countries want to be involve in progress of  reforming and modernizing the monetary system and the financial architecture, they need to cre‐ ate the consistent strategy of negotiating with developed countries. from the start, countries with  difficulties should represent needs for a new  international financial architecture, providing  the  main directives for sustainable economic growth and development. instance for, providing a few  credit facilities, strengthening and regulations of national financial system, accepting and improv‐ ing the standards and good practice, codes, liberalization of capital account, decreasing the possi‐ bilities for beginning and spreading crises by cooperating with industrial countries, their investors,  exporters, and creditors, international banks and companies.  the progress for the reforming started, but insufficient. the current international financial  institutions and their arrangements are seem so inadequately, and the international financial crises  are still actual. from all that reasons, it is very necessary to, intensively, follow all «mini» progress  of reforms of the international monetary system. so, the developed countries, should strength as  their own individual financial system, macroeconomic politicises, so as the resistance on vulner‐ abilities and crises. however,  the progress on reforming  the  international financial system and  financial architecture doesnʹt go asymmetrical in developing and developed countries. one of the  reasons is, even if they know that the problem already exist, but there isnʹt defined the adequately  framework of the international monetary system, that should adapt to new environments and cir‐ cumstances. also, there is no consensus, which will support and realize the reform in the future.   given this support, why has more progress not been made? an important part of the answer  seems to be that while there is broad consensus on the need for reform, there is far less agreement  on specific measures needed to build a new financial architecture (table 1). all actors have a indi‐ vidual approach  to  the reform of the  international monetary system and international financial  architecture. analyzing the table 1., it is very hard to find common denominator of these direc‐ tions (improving and adoption the international standards and codes, improving the level of inter‐ volume 40 • spring 2008 • 111  national  liquidity,  developing  the  global  finance,  adoption  the  international  regulation, orderly  debt workouts, participations of the developing countries...), which will suit all actors, in the same  time and under different circumstances. also, there is no common attitude toward each one direc‐ tions. only that we can emphasise is, adopting of standards, codes, good practise and  transpar‐ ency.    table 1.: looking a progress of reform of the international monetary system  agreed/disagreed  yes/no  industrial,  developed  countries  developing  countries,  countries in  transition  international  financial  institutions  (imf, world bank...)  definitive  outcomes    adoption of codes and  standards  yes, for equal‐ ize adoption  yes, for equal‐ ize adoption  yes, for equalize adoption  changes occur  provision of sufficient  international liquidity  no large pro‐ vision for  developing  countries  yes, searching  for adequate  directives of  provision of  sufficient  international  liquidity  yes, searching for ade‐ quate directive of provi‐ sion of  sufficient  international liquidity  changes do  not  occur  increased development  finance  no, not  enough  no, not  enough  yes, but not enough  changes do  not  occur  provision of sufficient  and appropriate  international regulation  yes, but not  enough  yes, but not  enough  yes, but not enough  changes do  not  occur  increased participation  by developing  countries  not ready for  activating  developing  countries  yes, but not  enough   unclear  changes do  not  occur  adoption of standstill  and orderly debt work‐ outs  yes, some  quite keen,  but no pro‐ gress  varies,  not too keen,  but no pro‐ gress  quite keen, but no pro‐ gress  changes do  not  occur  conclusion  modernizing and redesigning the international monetary system and the international finan‐ cial architecture are very important for all world. it is very important to support these mutual‐ connected trends and activities of reforms in the future. debates about reforming the international  monetary system and international financial architecture, still will remain in the framework of the  theory and politics of the representatives (the international financial institutions, the international  monetary fund (imf) and world bank). the main factor which are stopping the realization of the  reform, is asymmetrical policy‐economic interests of developed, industrial countries and develop‐ ing countries. because of that, the global prosperity is not yet accomplish.   efforts  in creating  the new  international financial architecture are becoming «hostage» of  agreements between developed countries (g7)  and developing countries.  to decrease these prob‐ lems, mostly economists have to continue the discussions and to organize diverse debates about  exploring the factors which brought international monetary system in this situation. also, debates  should compose: detail problems of weak national financial systems, unreasonable way of lending,  2007 ‐ 112  •  economic analysis®  inconsistent macroeconomic politics and foreign exchange rate regimes, problem of confidence,  problem of international liquidity, etc.  reference  intenational monetary fund, (2007), annual report, imf, washington d.c.  pilbeam k., (2006), international finance, third edition, palgrave macmillan, new york.  salvatore d., (2007), international economics, ninth edition, john wiley & sons, inc., new york.    microsoft word 2009_3_4-korigovano.doc review conference review on the occasion of successful completion of the tempus project „business university of the new age in serbia-bbabuona”, realized jointly by the belgrade banking academy; school of management (saa), university of turin; and law school, university of seville, in premises of the institute of economic sciences in belgrade on july 22nd, 2009 was held the international conference: ʺbusiness opportunities in serbia: the case of italian business sector and role of management educationʺ. conference was supported by the institute of economic sciences, belgrade chamber of commerce and iceinstituto nazionale per il commercio estero, ufficio di belgrado. the vice-president of the government of the republic of serbia and the minister of economy and regional development, mr. mlađan dinkić, opened the conference. in his presentation minister took chance to emphasize on the importance of international cooperation, especially of foreign investments and transfer of knowledge. he presented the case of joint venture made by fiat and zastava, and the importance of italian investors in serbian transition process. he mentioned several very important italian companies operating in serbia, including banca intesa, generalli insurance, sai fondaria and many others who have enabled serbian industry to overcome transitional problems, and become competitive on international level. the first session of the conference, attended by a number of guests, was dedicated to the most significant results of cooperation between bba, saa and the university of seville in a framework of tempus project. the introductory welcome speech gave professor hasan hanić, dean of bba, professor stefan dukiandjiev, international coordinator of tempus belgrade office, professor guiseppe dutto, professor of saa and the head coordinator of buona project, professor miguel angel adame, professor of law school seville and professor valter cantino, dean of saa. professor dutto, as a coordinator of tempus buona project presented the achievements of the project and briefly gave insight of what buona brought to belgrade banking academy. after less than one year of cooperation within the tempus project “business university of the new age in serbia (buona)”, saa, the university of turin, school of management and bba (belgrade banking academy) have reached an agreement economic analysis (2009, vol. 42, no. 3-4, 91-94) 92 on widening their cooperation beyond the scope of tempus and initiating joint master&mba study program: financial / banking and business management. according the agreement at the end of their studies, students will be granted two diplomas, a serbian master, and one issued by the university of turin, which is a strong certification of the quality of the bba master & mba program. the cooperation involves the following basic features: • joint development of program curricula • joint development of courses. under the tempus buona project, serbian professors spend in average two weeks at saa where, in close cooperation in with italian professors, they select literature, develop courses contents, and become acquainted with modern teaching methodologies. • delivery of part of the lecturers by italian professors • mandatory study visits of serbian students to turin to attend classes and visit italian businesses • development and introduction of european quality standard system at bba. the agreement, signed by the rectors of the two universities saa and bba belong to, i.e. the university of turin and the union university of belgrade has a far reaching strategic relevance for both bba and the serbian education community, considering that according to the latest surveys, and the university of turin is ranked no. 1 among large italian universities. the implementation of superior standards in the education process and the enforcement of european quality procedures will open unique opportunity for serbian students to obtain master and/or mba diplomas by studying at bba in belgrade, which will be valid all over europe. with a new study program “financial banking and business management”, belgrade banking academy in cooperation with prestigious partner from europe1 the saa of the university of turin, provides students in serbia with the opportunity to study in belgrade according to the highest european standards and achieve both the master bba degree an the other one recognized in eu countries, which opens the door for better employment in financial institutions and companies throughout europe, by equal conditions granted to students from other european countries. the courses at the mmb studies are performed by remarkable teachers from the university in turin (italy) seville (spain), and other european universities, together with top national professors trained at european universities in the frame of tempus program. the textbook literature is in english and serbian. the way of taking exams will be completely adjusted to the partners’ respecting eu standards. in order to further strengthen equivalence with international standards a seven days professional visit and internship at the university of turin will take place. in accordance with serbian law on higher education and bologna declaration, upon the successful completion of the master studies, the student will be granted academic title graduated manager – master. the students of mmb, thanks to the use of modern teaching methods, will acquire complex knowledge and professional skills in various management disciplines, as well as general management, and will be capable to 1 in the year 2008 the university in turin, comprising the saa, was entitled the best quality university in italy. zubović, j., conference review, ea (2009, vol. 42, no. 3-4, 91-94) 93 work in banks and companies covering practically all business activities and, by gaining adequate experience, to achieve top management careers in serbia, eu countries, and other countries of developed market economy. upon completion of additional courses earning 30 ects and having defended their thesis, the students will be granted by saa and bbamba diploma (master in business administration). the second part of the conference celebrated the presentation of italian companies in serbia. the main presenters were the representatives of leading italian companies doing business in serbia and official representatives of italy: • dr. thomas botzios, first secretary of embassy of the republic of italy in belgrade, • dr. fabio corsi, national institute of italian foreign trade in belgrade, • giovanni de filippis, general manager fiat group automobiles, • dr. giancarlo miranda, vice president of executive board coo banca intesa ad. belgrade, • dr. christian neu, vice general director of fondiaria sai group, • dr. romano rossi, owner of progetti international • dr. ivano canteri, global marketing manager, chamber of commerce, turin – centre for foreign investments dr botzios presented the role of italian embassy in attracting italian companies to invest in serbia. he also gave an insight of investment framework which foreign investors are facing in serbia. his speech opened a topic presented by dr corsi about economic cooperation between italy an serbia. in the year 2008 italy was the third trade partner of serbia. according to statistical office of the republic of serbia the total exchange between the two countries amounted to 2,2 billion euro, 1,47 billion euro of which, italian exports into serbia (+13% a rise compared to the same period of 2007) and 763 million euro of italian imports from serbia (-4,5% compared to the previous year). the balance of trade amounted to 713 million euro in favour of italy. dr corsi gave the insight of business opportunities for italian companies in serbia. he briefly introduced serbian business environment, including legal and economic details. further on he emphasised on the importance of italy as a trading partner, being third most important trade partner after russia and germany with total foreign exchange reaching 2.2 billion euro. in the second part of presentation dr corsi explained what key industries in serbia with an interesting perspective are for italian investors. the next presentation was made by mr giovanni de filippis representing fiat group automobiles in serbia. he gave us the complete perspective of the way his company is operating, what is there organisational structure, what are their affiliations worldwide and finally he explained on what basis the joint venture agreement between zastava and fiat were set. economic analysis (2009, vol. 42, no. 3-4, 91-94) 94 dr miranda the coo of banca intesa belgrade made the presentation of their company activities in serbia. he showed us ho their clients are, what is their market share, how did they expand since entering serbian market, and finally what they expect in the future of the financial industry in serbia. dr neu from fondaria sai group spoke about considerations of a foreign investor in the serbian insurance market. at the beginning he introduced us to fondaria sai group giving all structural and financial data of their international operations. it was followed by the perspective on the serbian economic and political landscape, giving statistical detail on how serbia is trailing in insurance business compared to countries in the region. with detailed presentation of serbian insurance market he assured us that serbia has its perspective in this industry, and that all regulatory obstacles have been removed for this industry to become fast-growing. at the end of his presentation dr neu presented the achievement of the ongoing transformation program of ddor, novi sad. dr rossi from progetti international made presentation of his company operations in serbia and he spoke about the cooperation set between his company and belgrade banking academy and the institute of economic sciences in belgrade. the final presentation in the second part of the conference was made by dr canteri from the turin chamber of commerce of the region piemonte in italy. the third part was dedicated to of bba teachersʹ, ies researchers and other authorsʹ papers presentation. at the beginning of this session deputy deans at bba – professors zvonko brnjas and predrag dedeić talked about the role of management and financial education in contemporary business. this was followed by over 15 presentation of scientific papers. those presentations made this conference not to remain only promotional from the aspect of business cooperation between italy and serbia, but it set a very strong foundation for such cooperation based on scientific research made by prominent researches in this area. to conclude, the international conference business opportunities in serbia was a very important meeting, especially in the period of hard economic crisis, to enable sustainable development of economy in serbia, focusing on financial industry which has to give pace to all other economic sectors of the serbian economy. it is necessary to support such conferences and we hope to see even more of them in the future. zubović jovan, institute of economic sciences, belgrade microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp128‐137 scientific review the impact of accounting harmonization on financial statements quality in serbia danijela anđelković1* | danijela zubac2 1 university “union union ‐ nikola tesla“, belgrade, faculty of entrepreneurial business, belgrade, serbia 2 higher technical professional school zvecan, serbia abstract the general process of the world market globalisation and the great influence of international financial organisations, especially the imf and the world bank, caused the need for standardisation and harmonisation of financial statements of the participants involved in international economics and trade. in this process, in the republic of serbia, the international accounting standards board (iasb) and the iasb.s project for ias/ifrs implementation have a crucial role. by adopting the international financial reporting standards ‐ ifrss (including international accounting standards ‐ iass), financial statements prepared in serbia may be comparable with financial statements in other countries. starting from this, the main goal of the research is to indicate whether the financial statements in serbia based on the iasb project can be comparable with financial statements in other countries, and on this basis can they satisfy the needs of external users of information (investors, creditors and others). in doing so, it points to the experience in the republic of serbia, the accounting practice and experiences of other countries, above all members of the european union. the results of the research show that, in addition to the ias/ifrs, the us generally accepted accounting principles (gaaps) and the directive 34 of the european union represent the key segments of professional regulation contributing to greater accounting harmonisation, and on this basis, the higher quality of financial reporting. most countries that have national accounting regulations align the accounting rules in the most important issues with those regulations. key words: accounting standards, harmonisation, ifrs, iasb jel classification: м41, м48, g15 introduction financial statements represent an important and reliable basis for the management, and in particular for the external users, to acquire information about enterprises from the business environment, both by branches and by the areas to which they belong, which is fundamental for making strategic decisions. the information power of the statement is the most important given that based on it, by applying the relevant analysis, conclusions on the enterprise's yield, assets and financial position are made. comparable and transparent financial statements represent a basis for deeper and more liquid financial markets, for strengthening investors’ confidence, and thus to overall financial stability. all this, in turn, contributes to the construction of a modern market structure in the function of ensuring greater competitiveness among enterprises. several countries, including the republic of serbia, has accepted the international accounting standards/international financial reporting standards (ias/ifrs) as the single financial * corresponding author, e‐mail: andjelkodani@gmail.com danijela anđelković, danijela zubić 129 reporting framework for all enterprises, taking into account, to a certain extent, formal specificities applicable to small and medium‐sized enterprises. unlike serbia, most other countries that have their national accounting regulations align their accounting rules with their accounting practices, with the ias/ifrs, but also with other standards, such as the directive 34 of the european union. in the context of the quality and interest of users, the international federation of accountants (ifac) has established specific accounting rules and principles, and thus greatly harmonised the accounting, i.e. the system of preparation and presentation of financial statements (fletcher, 2002). "factors determining the development of accounting at the national level also contribute to accounting diversity at the international level (saudagaran, 2004)." this is confirmed by the generally accepted conclusion of adhikari and tondkar: "accounting and reporting standards and practices are not developed in a vacuum, but reflect the specific environment in which they are developing (haskins, ferris, & selling, 2000)." starting from the above statements, the research objective in this paper is to indicate to the iasb.s project of ias/ifrs review, highlighting the problems faced by national enterprises in their implementation, especially when it comes to small and medium‐sized enterprises. in doing so, it highlights the accounting practice and experience in certain countries, especially from the neighbouring and comparable environment of serbia. this is particularly related to those countries that also had an obligation to implement the ifrss, prescribed by domestic legislation, and in which the general content of the financial statements was under the significant influence of the ias 1 and eec directive iv (1978) and now the eu directive 34 (2013). the iasb‐s project of the international financial reporting standards making economic decisions by enterprises in different markets of goods, services and capital, as well as many others, is not possible without reliable, transparent and comparable accounting information, expressed through certain financial statements. the international financial reporting standards, i.e., the international accounting standards and related documents creation and approval, such as the framework for financial statements and other documents preparation and presentation, are under the jurisdiction of the international accounting standards board (iasb) in great britain. according to the iasb, the purpose of financial statements is to offer the information on the financial results and the financial position of an entity useful to a wide range of users so that they could evaluate management quality shown by the entity management, and enable them to make economic decisions. the purpose of financial statement submission can usually be met through attention directly to the needs of the existing and potential investors and other external information users. such external users need the information to evaluate the entity’s ability to increase revenue and on that basis, to evaluate positive financial results. according to anđelković & vujić (2019), “the process of value creation is not based on the traditional formula where it begins with input and ends with output”. however, although financial statements lack all the information necessary for the users, they still provide the framework within which information users can compare specific information gained from other sources (kothari & barone, 2012). the international federation of accountants (ifac) has an important role in this process, determining certain accounting principles through standards in the information quality and user interest contexts, thus harmonising accounting to a large extent, i.e., financial statement preparation and presentation system. when it comes to professional regulation activities definition, we should also state, according to barth, landsman, lang & williams (2012), generally accepted accounting principles – us gapp. the association of accountants and auditors of serbia was among the first to recognize the necessity for standardization and harmonization in accounting in the republic of serbia; as ifac full member, it reached the decision and declared the direct implementation of the international accounting standards at the end of december 1998, along with the expected legislative support. in may 2002, the iasb published the final preface to the international financial reporting standards, with the following basic goals (stefanović, 2003): 130 economic analysis (2019, vol. 52, no. 1, 128‐137)  to develop a set of high‐quality, comprehensible and applicable global accounting standards with the high‐quality, transparent and comparable information in financial reports as a result, to help the participants in world capital markets and other users in reaching economic decisions;  to promote the use and mandatory implementation of these standards;  to take an active part in finding a solution to the national accounting standards and the ifrs convergence along with the national standard‐makers. the decision reached by the iasb and the financial accounting standards board (fasb) in the united states of america is of particular importance in the context of the above stated goals, which establishes their mutual cooperation for a higher degree of conformity within the united states between generally accepted accounting principles (us gaap) and the international financial reporting standards (ifrs), formerly known as the international accounting standards (ias). the successful outcome of this harmonisation will significantly improve global capital market efficiency: the costs would be reduced, report comparability improved as well as corporate management (ivkov, 2014). new international financial reporting standards should offer a key contribution to more correct and accurate financial report compilation in the future, in order to create prerequisites for reaching more reliable financial and business decisions (dragojević, miljević & milojević, 2012). the international accounting standards can be applied in various ways. the in ias/ifrs application is as follows (klikovac, 2008):  ias/ifrs are used as the national standards in the countries where there are no national accounting standards, i. e., financial reporting standards, or in the countries that have ceased to implement them.  ias/ifrs are used as the international benchmark in many industrial countries and the growing market countries developing their standards.  ias/ifrs are accepted by numerous stock exchanges and regulators allowing foreign or domestic companies to submit financial statements compiled according to the ias/ifrs.  ias/ifrs have been recognized by the european commission and many other international bodies. when it comes to the national law on accounting that contributed to financial reporting harmonisation, apart from later adopted ias/ifrs, the law adopted in 1996 had particular importance (stevanović & ilić, 1996), because it was based on the european union directives and other international accounting standards. the aforementioned law represents a further step in creating assumptions for financial reporting quality improvement in relation to the previous laws from 1989 and 1990. according to the aforementioned law (1996), financial reporting harmonization should have left enough possibilities for national professional regulation. some provisions of the former law were completed starting from the provisions of the fourth and seventh directives as well as the international accounting standards. for example, it refers to the mandatory compilation of the cash flows statements in addition to the balance sheet and income statement, as well as the parent company liability to compile and present an additional report annexe, in addition to the consolidated balance sheet and income statement. the income is a form of the result and regular company financial reports, and the contents of the balance sheet, income statement and cash flows statements are completely adapted to the demands in form and content stated in the eu directives and the international accounting standards (škarić & dendić, 2005). according to the above‐mentioned authors, the adoption of the law on accounting and auditing (2002) was a condition for ias/ifrs acceptance in financial report position evaluation. several changes in this law influenced its more complete harmonisation with ias/ifrs. it is stated there that “legal entities and entrepreneurs are obliged danijela anđelković, danijela zubić 131 to manage bookkeeping, financial report compilation and presentation according to the accounting principles defined within the ias. the ias will be applied for financial report recognition, evaluation and presentation.” the adoption of law on accounting and auditing (2002) continued the efforts referring to the financial report harmonisation. however, a lot of issues regulated by the former law on accounting from 1996 were not regulated by the law on accounting and auditing valid at the time, or at least they were not regulated in the appropriate manner. in that context and according to the paper by vukelić (2010), we can state that the historical aspects of the regulations are important for the legal regulations in the area of financial reporting. škarić and dendić (2005) consider these as the most important weaknesses of the law from 2002:  the request that the ias has to be applied in all companies, regardless of size;  the division of the jurisdiction of the state and professional organisations that is not distinct;  the non‐existent specific mechanism for the provision of high‐quality translation for the ias as the normative foundation for financial report compilation;  the deadline provided for the ias application was not appropriate. the adoption of the law on accounting and auditing in 2006 as well as in 2009 continues the efforts to organise the accounting profession and the achievement of full harmonisation with the international accounting regulations. these laws enabled the establishment of institutions referring to the chamber of authorized auditors and national commission for accounting. the provisions of these laws related to the ias application should enable the compilation of the compatible financial statements. faced with the new financial reporting model based on the ias/ifrs, the attention of our companies, primarily their accountants, was mostly attracted by ifrs 1 (the international financial reporting standards, 2009). this is the consequence of the fact that the ifrs 1 establishes the procedures the companies must follow during the initial application of the ifrs as the foundation for the preparation of their financial statements. in the course of the practical application of these procedures, the subjects are faced with the challenge of retrospective application combination with certain exceptions, and it makes the initial ifrs application rather complex. from the point that financial report quality can be provided in accepting the ias as the national accounting standards, the aforementioned laws on accounting and auditing imposed their application as mandatory. the republic of serbia accepted the international financing reporting standards as the only framework for financial reporting in all companies. only small taxpayers are exempted from this obligation because they can decide not to apply the ifrs if their securities are not traded in the organised securities market. on the basis of the research conducted in the previous 18 years of the twenty‐first century, when a need for harmonization in accounting appeared as a result of the growing globalization in the world of business, the leading authors in the international accounting reached the results indicating the existence of a number of causes for the international differences in financial reporting. some of the most common in the references are (alexander, britton & jorissen, 2005): 1) legal system, 2) funding sources, 3) the relation between financial and tax reporting, 4) the influence of national accounting profession, 5) inflation levels, 6) microeconomic theory, 7) business development and 8) historical coincidence (accidence). the differences mentioned above question the possibility of financial reporting comparison between entities from various countries. compatibility problem is particularly manifested in foreign financial report analysis necessary for making investment and credit decisions. therefore, the users should carefully identify the causes of the differences in the analysis of these reports, i. e., they have to determine whether they come from the accounting measurement differences, basic environment factors (primarily social, political, legal, economic) or whether they are caused by the true differences of the attributes measured. based on this, we can state that our country unilaterally accepted the 132 economic analysis (2019, vol. 52, no. 1, 128‐137) international financial reporting standards as the only framework for financial reporting for all companies (small taxpayers exempted) when it adopted the new law on accounting (2013; 2018), disregarding the differences in the accounting measurements, basic environment factors as well as company size and structure. this kind of accounting system design in a country – national accounting system, had a negative effect on the financial information quality for their users (especially investors and creditors). based on these statements, we can say that financial reporting quality improvement perspectives also depend on the consideration of the basic factors influencing financial reporting in each country, especially if it aspires to a certain union of the countries, as is the case with our country. however, in this case, the differences influencing financial reporting cannot be minimised to such an extent that they result in “the unique set of the international financial reporting standards”. also, the differences in company size structure, the business they deal in, whether the company securities are rated on the stock exchange or not, as well as other specific points, should define a commitment to apply the ias/ifrs. the iasb project of the ifrs for small and medium‐sized enterprises the adoption of the new law on accounting (2018) continued the efforts towards the achievement of financial reporting total harmonisation. there is a special international financial reporting standard for small and medium‐sized entities ‐ ifrs for smes, approved by the international accounting standards board (iasb) for financial reporting position recognition, evaluation, presentation and disclosure. in doing so, there is still a possibility for small entities to decide in favour of ifrs application related to large entities. in relation to small and medium entities, the new law on accounting, unlike the previous law on accounting and auditing, specifies the special ifrs application for large entities that have an obligation to compile consolidated financial reports, as well as for public companies. regular annual financial report for entities applying the ifrs, i. e. ifrs for smes, includes, according to the law on accounting (2013; 2018): 1. balance sheet, representing an overview of assets, liabilities and capital of a legal entity on a given day; 2. income statement, representing an overview of revenues, expenditures and business results incurred in a given period; 3. the statement on the rest of the result, which consists of income and expense items (reclassifications due to correction included), not recognised in the balance sheet as required or allowed according to other ifrs. the components of this result consist of items recognized within capital according to certain ifrs requirements; 4. capital changes statement, providing information on the changes in legal entity capital during the reporting period; 5. cash flow statement, providing information on cash inflow and outflow as well as cash equivalents during the reporting period; 6. notes to the financial statements, containing descriptions or breakdowns of the items disclosed in the aforementioned reports, the accounting policies applied, as well as information on items that did not qualify for recognition in these reports, and they are significant for the assessment of the financial position and legal entity performance, as well as other information in accordance with ifrs requirements. according to the financial reporting committee decision, a draft of the croatian accounting standards was started for small and medium entities in the republic of croatia. the accounting standards were based on the ifrs, but they also accepted some specific points based on the small and medium‐sized enterprises needs in croatia. based on the financial reporting standards committee decision from 2006, balance sheet, as well as profit and loss account is danijela anđelković, danijela zubić 133 stipulated by law, in form and content compliant with the fourth eu directive, as well as the former law on accounting. the form and content of abbreviated balance sheet and profit and loss account is stipulated for the companies classified as small enterprises according to the aforementioned law on accounting. consequently, small enterprises are only required to compile an abridged balance sheet, profit and loss account, but not cash flow statement or capital change statement as previously stated in our professional regulations. “according to the law on accounting from january 2008, the implementation of the national croatian financial reporting standards (cfrs) was introduced. according to these standards, small and medium‐ sized enterprises are required to implement the ifrs only if their securities are quoted in the securities market or preparing to be introduced into the croatian market. otherwise, small and medium‐sized enterprises are not required to implement ifrs (klikovac, 2008). the stated approach is in accordance with the statements from the first part of this paper related to the financial reporting harmonization, the creation of our national professional accounting regulations, with considerations of the international differences present in financial reporting (legal system, funding sources, financial and tax reporting relations, the influence of the national accounting profession). in the absence of expert criticism and professional normative regulation ethics, it was the easiest to accept the ias/ifrs implementation automatically and completely for financial reporting purposes. also, we should take care of our close environment in relation to the european union, and consider the professional accounting regulation of its members as well as the relation to the ias/ifrs. if we consider the case of croatia in this context, the basic stabilization and association agreement between croatia and the european union anticipates croatia’s commitment to adjust its legislation to the eu regulations within the deadlines. likewise, the national program of croatia for eu accession from 2005 accepted the commitment to adopt the eu legislation in accounting. thereby, it was necessary to harmonize the law on accounting with the fourth and seventh directive, as well as the eu provisions regulating the accounting system in the european union. the new law on accounting was created according to the eu provisions, and therefore croatia, as well as most of the eu countries, does not require the mandatory implementation of ifrs for all companies, but only for those large listed companies or those preparing for listing. the rest of the companies in croatia are given the opportunity to choose whether to implement the ifrs or any other standards approved by the financial reporting standards committee. the fact remains that the national accounting standards differ in certain segments in some of the countries. in other words, not all companies have an obligation to implement international accounting regulations. thus, for example, only the companies with the securities quoted at the american stock exchange have to compile their financial statements according to the us gaap. on the other hand, mandatory implementation of the ias/ifrs is explained differently in the eu countries, while mandatory ias/ifrs implementation refers to all the companies in our country, although it is structured in a different way depending on the company size (dmitrović – šaponja, milutinović & šijan, 2010). mandatory implementation of the ias/ifrs is defined for large companies separately from the implementation for small and medium‐sized enterprises. in doing so, the burden of regulations and financial statement simplification for small and medium‐sized enterprises was not considered, especially when it comes to micro subjects and entrepreneurs. the experiences about financial statement quality improvement for small and medium‐sized enterprises have already existed when we speak about the european union. in fact, previous accounting directives: eec directive iv (1978), and eec directive vii (1983), for small and medium‐sized enterprises, and particularly for micro subjects, often represented great regulatory burdens. an appropriate audit of the accounting directives was carried out, and there were significant simplifications in financial statements structure for small and medium‐sized enterprises in new eu directive 34 (2013). the focus of special attention in terms of regulatory burden reduction was on micro subjects. harmonisation of legal regulations with professional regulations, i.e. eu directive 34 (2013) and the international financial reporting standards, is particularly emphasised on the path to financial reporting quality improvement. on that basis, national accounting regulations that strive and 134 economic analysis (2019, vol. 52, no. 1, 128‐137) participate in the standardisation process become an active participant in the modern, international financial reporting system. the key role in the financial reporting harmonisation process at the international level belongs to the european union, which has a significant impact on the international accounting standards board (iasb). it strives to adjust the ifrs to its interests and the interests of the eu member countries with its influence (anđelković, 2018). the first european attempt to harmonise financial reporting at the international level was, as mentioned, through the eec directive iv (1978) and eec directive vii (1983) introduction. in june 2013, a new eu directive 34 was adopted, on annual financial statements. this newly adopted eu directive 34 (2013) replaces the fourth and seventh directives through their integration, with certain changes and additions. a separate part of the eu directive 34 (2013) refers to large companies with the quotes at the stock exchange as well as the consolidated financial statements. ias/ifrs implementation is prescribed for the listed companies. most of the eu members allow (do not prescribe) ias/ifrs implementation in the course of the compilation of consolidated financial statements for the companies not quoted at the stock exchange. the directive requires consolidation for the group of companies over a certain size, and the audit based on this requirement. presented balance sheets in terms of form (in horizontal and vertical forms) and according to the assets and liabilities structure have been framed in order to fit all companies, regardless of their legal form and size. one of the balance sheet models can be used by large, medium‐sized and small enterprises. when it comes to small and medium‐sized enterprises, there are certain simplifications. small enterprises compile their balance sheets according to the same scheme, but they only show the positions marked by letters and roman numerals. further analysis, denoted in arabic numbers, does not refer to these companies. directive 34 pays special attention to the recognition rules in the context of financial reporting quality improvement. the main methodology of business events evidence and evaluation is based on the historical cost principle, i. e. price (production costs) or purchase value in order to provide information reliability in financial statements. however, the directive allows the national legal systems to use alternative evaluation methods, as in the case of a fair value method. the basic goal of eu directive 34 (2013) implementation is to increase financial information comparability and transparency on the basis of the aforementioned statements and other normative scopes; in order to achieve that, it is necessary for the eu member states to provide a common framework for balance position recognition, their measurements and financial statement presentation (andjelković, 2018). financial statements comparability as one of the means of communication among the member state companies is increasing, bearing in mind its significance for their users. these are only some of the examples, not the only ones, indicating the differences among the national regulations of certain countries. all that, along with the above‐mentioned issues, indicates that the process of financial reporting harmonisation at the global level is difficult to achieve, considering the companies not quoted at the market, especially when it comes to medium‐ sized and small enterprises. but surely, as ensues from the discussion on the eu directives, in some parts of the world “the language of accounting will be changed”. in this context, martić (2013) states that extensible business reporting language – xbrl appeared at the end of the 1990s, used for structural business information exchange via web, widely accepted in the international accounting community, promising a revolution in financial reporting and business information exchange. xbrl standard offers a wide range of advantages in business information collection, storage and processing, as well as financial statements compilation and disclosure. in one part of the paper on “harmonization of serbian accounting standards with the eu standards”, vukelić, đuričin & belopavlović (2011) state that “the development of the global economy imposes a need for the harmonisation of financial reporting. in order to make relevant decisions, capital investors demand a unique system of financial reporting at the global level and also expect that domestic competent institutions will create such a regulatory framework which will elevate the domestic financial reporting to a higher level. hence they have expectations in view of legal solutions, which would provide conditions for the standardisation and compliance danijela anđelković, danijela zubić 135 with the best solutions in the countries with developed market economies“. in connection to this, đuričin (2012) illustrates the same issue in a separate part of the paper, related to the national accounting standards harmonisation with the eu standards. in this context, the critical review of the national financial reporting is indicated as well as the recommendations for the national accounting regulations improvement. in the context of the public companies functioning and characteristics, bearing in mind the specific environment, milojević (2018) also raises the question of financial reporting quality improvement. finally, we can state that in addition to various solutions in terms of ias/ifrs implementation (from full acceptance of the ias/ifrs for all the companies to the exclusive implementation of their own standards), generally speaking, we can state that the ias/ifrs are accepted, as a rule, in the companies where securities are publicly traded with, while the others implement the national standards. according to this, the american securities and exchange commission (sec) requires foreign companies with the securities listed in the stock exchange to present their financial statements periodically. nevertheless, the reporting requirements for foreign companies are essentially the same as the ones set for national companies. the foreign companies may present secondary financial statements compiled based on the us gaap. thereby, the sec requires the canadian companies procuring capital in the us capital market to publish any deviation from “the generally accepted accounting principles” in the usa, and to present the financial effect of these deviations on the property, financial structure and success of the company. according to barth, landsman, lang, & williams (2012), the question of accounting standards comparability based on ifrs and us gaap arises in this context. the aforementioned discussion in this paper results in the statement that the process of global financial reporting harmonisation refers primarily to large companies that are listed on the stock exchange. conclusion the current tendencies of the national accounting regulations show that, in addition to the ias/ifrs, the us generally accepted accounting principles (gaaps) and the eu directive 34 (2013) represent the key segments of professional regulation. most countries that have their national accounting regulations align their accounting rules in the most important aspects of these regulations. hereby, not all enterprises have an obligation to implement international accounting regulations. the european union plays a key role in the process of harmonising financial reporting at the international level, and it also has a significant impact on the international accounting standards board (iasb). the newly adopted eu directive 34 relating to the annual financial statements particularly contributes to this. the republic of serbia should have its national accounting regulations, its own accounting rules which, as we strive to the european union accession, must be harmonised in the most important issues, in the first place with eu directive 34 (2013). the directive 34 (2013) sets out the form and content of the financial statements, the rules for the preparation of financial statements of large, and especially medium and small‐sized enterprises. it also regulates other issues that seek to adopt the ifrs to the interests of the european union and the national interests of its member states. the implementation of the ias/ifrs may be mandatory for large enterprises and listed enterprises. likewise, the implementation of the ias/ifrs for small and medium‐sized enterprises often represents a large regulatory burden. from this aspect, an appropriate review of the ias/ifrs should be carried out and a significant approximation of the regulatory framework to the interests of small and medium‐sized enterprises. in this case, the implementation of the ias/ifrs may be mandatory for medium‐sized enterprises whose securities are quoted on the stock exchange. for other enterprises, the implementation of the ifrs would be permitted, but not prescribed. this would leave the possibility to create special 136 economic analysis (2019, vol. 52, no. 1, 128‐137) national standards for small and medium‐sized enterprises. the process of global harmonisation of financial reporting when it comes to the unlisted enterprises and especially when it comes to small and medium‐sized enterprises can be relatively difficult to achieve. special attention, when it comes to professional accounting regulations, should be directed at micro entities, given their importance and contribution to the economic development of our country and the 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(2011). harmonization of serbian accounting standards with the eu standards, in the publication: serbia and the european union: economic, coimbra, portugal, the institute of economic sciences, belgrade baking academy – faculty of banking, insurance and finance, pp. 92‐104. article history: received: april 9, 2019 accepted: june 3, 2019 doi: 10.28934/ea.22.55.2.pp31-48 first online: november 1, 2022 preliminary report the quest towards obtaining a competitive advantage in organizations through managing the human capital nikaela wilson1* | iva vuksanović herceg25f* 1 university of belgrade faculty of economics, belgrade, serbia 2 university of belgrade faculty of economics, department of business economics and management, belgrade, serbia abstract the aim of this paper was to shed light on how managing human capital can contribute to obtaining a competitive advantage in organizations. this was done by conducting a literature review by examining and synthesizing the available literature from various research and scholars. moreover, it included research into the different perspectives pertaining to the elements and approaches of human capital as it relates to competitive advantage in organizations. the literature reveals that human capital plays a significant role as a contributor to obtaining a competitive advantage in organizations, which ensures high quality in the selection and recruitment of employees. based on the literature, certain challenges may be encountered regarding human capital, and these challenges may inhibit the attainment of competitive advantages. furthermore, the paper brings to light the approaches to utilizing human capital to achieve a competitive advantage. the resource base view and the human capital theory were the approaches discussed and considered relevant in navigating human capital towards a competitive stance. the distinctive character of the organization could be realized through the human capital concept; investing in employees bring about new ideas and solutions to the organization. while other resources are owned by the organization, such as technology and equipment, the human capital emanates from the employment relationship and could not be regarded as organizational-owned property but is also privy to its success. human capital is viewed as an essential component of intellectual capital. industry 4.0 was also seen as an important contributor to competitive advantage as the advanced technology seems to employ more modern ways of getting the job done. even though advanced technology is necessary, among other factors, the quest towards the achievement of competitive advantage lies in the role of adequately managing human capital because human capital neutralizes threats, exploits opportunities, and enhances organizational efficiency that has the potential to lead to a competitive advantage keywords: human capital, competitive advantage, intellectual capital, industry 4.0, resource-based view, employees jel classification: l21, m12, m54, o34 introduction various aspects of the global environment changes have pointed to the relevance of human capital in organizations. preceding research has revealed that organizations have become more aware that holding a competitive stance based on technology is volatile and that managing the intangible resources in terms of their human capital is a better approach to a more sustainable * corresponding author, e-mail: ivav@ekof.bg.ac.rs 32 economic analysis (2022, vol. 55, no. 2, 31-48) advantage (johanson, mårtensson & skoog, 2001). according to bontis, dragonetti, jacobsen & roos (1999), human capital is synonymous with the human aspect comprising the intelligence, the skillset, and the level of expertise found within the organization that gives it its unique trait. the term human capital often pertains to employees in general and considers what they collectively contribute to the organization in terms of the knowledge they possess, their overall job, their life experiences, and their skill sets. davenport (1999) opined those employees within the workplace are the ones in possession of these elements. therefore, managing such a resource within organizations is crucial to attaining a competitive advantage. one cannot discuss human capital without mentioning intellectual capital, as they are intertwined. numerous experts support the view that intellectual capital is vital in obtaining organizational performance (sydler, haefliger & pruksa, 2014). klein and prusak (1994) defined intellectual capital as the intellectual information that has undergone a formalized process that has enabled the capturing and leveraging to yield more valuable assets. the organizations’ innovative performance in compliance with vision 2020 requires both information and the management of intellectual capital as they are crucial areas for the majority of organizations, especially those that are knowledge-driven (gogan, artene, sarca & draghici, 2016). the term competitive advantage was coined by porter; he emphasized that it is achieved by the organization when the value perceived by the customers exceeds that of production (porter, 1985). wang (2014) further elaborated that competitive advantage is achieved when organizations display exemplary performances in comparison to their competitors by executing certain actions and displaying particular attributes that put them in more favourable positions than others. technological innovations and the competitive business world have been contributory factors that oblige organizations to manage a certain amount of capital toward sustaining and attaining a competitive advantage. the survival, relevancy, and continuity of organizations depend on how they are composed to respond to and compete with competitive challenges. the probability of organizational success depends on the effectiveness and management of organizational capital and resources (peteraf & bergen, 2003). similarly, kraja & osmani (2013) considered human capital as a main factor of competitiveness. kuehn (2018) views human capital as a significant asset that complements the structure of a company. a multitude of studies shows that human capital is a resourceful sector for determining organizational level in a competition (ndinguri, prieto & machtmes, 2012). in order to obtain a competitive advantage, there must be proper utilization and management of the human aspect and navigating it in such a way that the objectives of the organizations can be realized. it is generally perceived that the operation of the organization is also based on the knowledge which is obtained through its human base. the employees are the source of such knowledge, and the successful management of those that possess the knowledge can aid in building a solid infrastructure that can assist in obtaining such advantage. human capital is a substantial investment toward achieving a competitive advantage for organizations because it represents an employee’s natural ability that generates economic value (alnidawi, alshemery & abdulrahman, 2017). many researchers have established the fact that knowledge and human capital could guarantee organizations a competitive advantage. it upholds that human capital is capable of ensuring a competitive advantage for organizations. therefore, the concept is valuable for developing employees’ skills and abilities that eventually produce innovations in the organization (alnidawi et al., 2017). managing human capital encompasses coordinating and arranging the job duties of the people within the organization and managing them in a specific way so that the organization’s objectives can be accomplished. hence, organizations need to value human capital management in the company’s structure. it is important to emphasize that organizational performance may also be linked to human capital since employees’ knowledge and experiences are unavoidable components of competitive advantage (hili, gani, hamzah & rahman, 2017). human capital, therefore, ensures nikaela wilson, iva vuksanović herceg 33 that the organization enjoys an extended period of competitive advantages (liang & gong, 2017). it should also be pointed out that human capital can be considered one of the most important integrals of organizational assets because employees contribute ideas, exploit opportunities and propose recommendations for overcoming organizational challenges. without their relevant input, achieving a competitive outcome would be less likely to be attained. organizations need to value people and link the management of the market, products, services, finances, information, and customer needs to human capital. particularly, as human capital ensures that knowledge, skills and experiences are transformed into creative ideas, goods, and services for the organization (boon, eckardt, lepak, & boselie, 2018). an organization that seeks to accommodate dynamic changes, including political, economic, cultural, social, and technological changes in organizations, needs human capital elements and competitive advantage components to succeed (al-omari, alomari & aljawarneh, 2020). an organization’s ability to structure management methods toward creating policies and conditions that energize human minds to renew old ideas and innovate new approaches is essential in the process (aljawarneh & atan, 2018). furthermore, organizational resources may also be used to attain growth and ensure continuity (alwagfi, aljawarneh & alomari, 2020). the changes and challenges faced by several organizations, therefore, call for a review of competitive strategies (van sluijs & kluytmans, 1994). hence, the purpose of the study is to explore how organizations can achieve a competitive advantage; it aims to highlight the approaches and challenges through its human capital. the approaches to managing human capital can be made in various ways. however, the ways of using human capital to achieve a competitive advantage will be analyzed from the resource base perspective and human capital theory. it will also take into consideration intellectual capital and industry 4.0 in addition to highlighting the crucial role of human capital in maintaining and obtaining a competitive advantage. from this, it was hypothesized that managing human capital plays a contributory role in obtaining a competitive advantage. the concept of human capital, elements and approaches for achieving competitive advantage in organizations youndt, snell, dean & lepak (1996) described human capital as a concept that enables individuals to possess un-separated skills, knowledge, and competence to maximize organizational profits. cabrita and bontis (2008) emphasized that the human capital concept assists the organization in tapping and accumulating employees’ ideas and experiences. it encourages employees to devote time, effort, skills, and capabilities to the growth of the organization (seleim & ashour, 2007). widodo (2015) described human capital as employees’ ability to introduce changes and produce modern and contemporary ideas to support the organization while responding to market and technological challenges. human capital establishes a stepwise link between solutions and employees’ knowledge toward aspiring for organizational success (burma, 2014). memon, mangi & rohra (2009) opined that human capital could ensure productivity with the cooperation of employees. human capital could be adequately evaluated with certain indicators such as employee capability, employee motivation, organizational climate and structure, teamwork, efficiency, and leadership (chrysler-fox, pharny & roodt, 2014). the collection of employees’ energy, knowledge, experiences, sacrifices, loyalty, commitment and creative ideas constitute human capital (weatherly, 2003). thus, the individual’s skill, attitude and abilities establish the performance and productivity of the organization. human capital diagnoses the employees that possess intellectual skills, abilities and experiences that could propose suitable suggestions to customers’ wants through creative ideas. the worth of human capital is visible in organizational performance, productivity, relevancy and sustainability (delery & roumpi, 2017). alomari (2020) asserted that human capital is an 34 economic analysis (2022, vol. 55, no. 2, 31-48) inimitable rare resource that requires the organization’s ultimate security and protection against other competitors from reduplicating it. furthermore, a study conducted on the management of human resources as a mediating mechanism on the influence on the outcomes of organizations by jiang, lepak, hu & baer (2012) revealed that, once adequate effort is placed on developing the abilities of the employees, it makes them more effective and more competent employees. therefore, this can instill a feeling of comfort and belongingness in the mind of the employees. in turn, they might be more willing to share knowledge within the organization and be more productive, which can result in a better outcome. this can potentially improve the competitive stance of the organization. human capital elements for achieving competitive advantage in organizations human capital comprises various areas, and it is further discussed in the subsequent section as a contributor to competitive advantage in terms of employees’ natural and personal skills, employees’ commitment, employees’ knowledge, and employees’ innovative skills within the organization. employees’ natural and personal skills while natural skills are god-gifted abilities, personal skills encompass the experience attained from previous and existing job positions. the job skills are mostly acquired through training, workshop and work experiences (al-maghraby, 2004). al-tarawna & al-salihy (2004) argued that renewal skills, termination skills, evaluation skills, support skills, concentration skills, and coordination skills substantially complement human competence. these natural and personal skills that are honed by the employees serve as beneficial pivots in the pursuit of achieving competitiveness. human capital, in terms of employee skills, is used within the organization to obtain a competitive advantage. employee skill is one of the inescapable components of human capital that can generate advantages for the organization through competitive advantage strategies. the employee, if allowed and motivated by the structure, has the power to devote natural and personal skills toward acquiring organizational goals. the skills can also be shared with other employees while collectively discharging organizational tasks and activities. employees’ commitment zehir, gurol, karaboga & kole (2016) contended that organizations could acquire uniqueness through employees’ high performance, while commitment boosts employees’ performance in the organization (khalique & pablos, 2015). massingham & tam (2015) conducted a study on the relationship between human capital, value creation and employee reward. the study was done on employees from the second largest public sector organization in australia, based on three annual surveys between 2009 to 2011. the variables used were, first, employee capability; secondly, employee satisfaction; and thirdly, employee commitment. the findings from the study revealed that human capital is an important aspect of intellectual capital as there is an increased interest regarding how intellectual capital can be utilized to establish value in the organization. the main results revealed that employee capability and employee satisfaction had a positive relationship with the importance of work activity in a direct way. also, it was revealed that an employee’s capability only had a direct positive relation to the salary. however, as it pertained to employees’ commitment and the importance of job-related obligations, there was a direct negative relationship between them. similarly, it was revealed that no relationship existed between pay and the aspects of employee satisfaction and employee commitment based on the results that were obtained from the survey. furthermore, time commitment and management generate task fulfilment and effective performance for an nikaela wilson, iva vuksanović herceg 35 organization, thus strengthening organizational reputation among competitors. commitment enables employees to engage themselves in change and combine experiences together towards developing organizational capacity (massingham & tam, 2015). employees’ commitment helps organizations acquire a competitive advantage, retain survival and manage relevancy in the business vicinity (abu bakr, 2006). time management and commitment result in generating modern and productive products for potential beneficiaries in a short period because employees strongly dedicate their time to the organization to provide for the customers’ needs. hence, employee commitment magnetizes a large number of customers to the organization, thereby ensuring a competitive advantage. based on the literature, it is evident that employee commitment can be used to promote organizational work, competitive advantage strategies, growth, and outstanding performance. once employees display a level of commitment to achieving the organization’s objectives, it will be reinforced by the various outcomes. employees’ knowledge employees’ level of knowledge in operations, industry, profession, technology, dynamical and environmental changes adequately represents the significant role of knowledge in developing organizational competitive advantage (lau, chan & man, 1998). the knowledge that the employees possess is paramount as it can be a deciding factor in the advantage the organization garners over others and the position it holds in the industry. such a reservoir of knowledge serves as a catalyst for new service and product developments which can initially give the organization an edge over others. organizational tasks could only be discharged and achieved with job knowledge and competency. to achieve a competitive advantage, an organization needs a regulatory environment that provides knowledge and motivation for employees (alnidawi et al., 2017). employees’ innovative skills this is a process of transforming ideas into practice alongside producing innovative goods and creative services for customers’ needs (moorhead & griffin, 2000). innovation and creativity go hand in hand, ensuring sustainable competitive advantages. with the aid of creative and innovative tools, modern processes that generate value for customers, ideas that reduce production and delivery period so that the products can reach customers quicker, and initiatives that open opportunities and widen global professional networks could be achieved for organizations. it enables employees to modernize ways, approaches, and methods of running the affairs of the organization (al-sarn, 2000). innovation may appear in different forms, such as technical, product, managerial, and process innovation (al-saffar, 2008). innovations may as well propel other competitors into competition-race. the level of an individual’s innovative ideas is determined by an individual’s curiosity (sipa, 2018). according to yaseen dajani & hasan (2016), intellectual capital is a determinant that is a catalyst for innovation in the organization. furthermore, it can be viewed as an asset and a collection of knowledge that can be used for a given purpose in achieving a competitive advantage. galovska (2015) perceived innovation as a significant integral that defines organizational success. therefore, innovative skill allows an employee to boost productivity and achieve a competitive advantage for organizations through inventive means. it may be used for extraordinarily presenting ideas that solve issues in the competitive market and support organizational objectives and help in sustaining an advantage. 36 economic analysis (2022, vol. 55, no. 2, 31-48) intellectual capital and competitive advantage numerous studies have been conducted, displaying the relationship that exists between intellectual capital and competitive advantage. for instance, a study conducted by chahal and bakshi, (2015) on the relationship between intellectual capital and competitive advantage focused on the role that innovation plays in learning in organizations. the study was conducted on 144 banks in india. the findings revealed that intellectual capital had a positive and direct relationship with a competitive advantage. it pointed out that innovation had a mediating role between intellectual capital and competitive advantage. also, innovation and organizational learning played a part in competitiveness. furthermore, in another study conducted in jordan on telecommunications companies by yaseen et al. (2016) on the impact of intellectual capital on competitive advantage, it was revealed that relational capital and structural capital account for 48.4% of the competitive advantage, and both positively influence competitive advantage. based on this finding, it is safe to say that human capital has an indirect influence on competitive advantage since it is a part of relational capital. in response to globalization and competition among different organizations, a committed organization’s focus should perhaps be emphasized on creating a competitive advantage that transcends services provided by other competitors in the marketplace. the infrastructure of competitive advantage is needed to overcome functional, efficacious and highstandard market competition. the competitive strategies promote the status and relevancy of the organization over other competitors in the global marketplace (porter, 1985). similarly, a study was conducted by janošević, dženopoljac & bontis (2013) on 100 serbian companies on the influence that intellectual capital has on their financial performance. the intellectual capital efficiency was measured based on the value-added intellectual coefficient (vaic). findings revealed that the operating revenue, profit and net profit were not a consequence of the efficient utilization of intellectual capital in the companies. however, it was revealed that structural and human capital affect return on equity and return on asset, while physical capital affected the return on equity. the survey also revealed that intellectual capital had a minor impact on financial performance. the level of intellectual capital is a limiting factor in competitiveness growth. however, it should be noted that during that time, the serbian economy was going through a crisis. also, just as corporate performance cannot be assessed by using one measure, intellectual capital should not be analyzed from solely one perspective (janošević et al., 2013). the two common types of competitive advantage according to porter (1985), in general, competitive advantage can be viewed in terms of comparative advantage and differential advantage. the comparative advantage is an organization’s capacity to produce at a reduced cost compared to to others providing the same service or products. typically, this advantage is obtained by allowing the products or services to be sold at a cost that is lower than its rivals. while the differential advantage is achieved when the product or service produced can be differentiated from others and can be viewed as superior by the users. if the organization pays attention to its human capital along with the proper management of the employees, this can clearly put the organization in a better position than its competitors, which may be lagging behind in this area. the resource base perspective to achieve competitive advantage many researchers have been seeking to comprehend the components that act as deciding factors in the profit level of organizations. according to peteraf and bergen (2003), the main underlying presumption of the resource base approach is that organizations compete based on their capabilities and the resources that they have. the resource base view originated in 1984 by nikaela wilson, iva vuksanović herceg 37 wernerfelt, as a contributor to competitive advantage theory (fahy, 2000). wernerfelt (1984) alluded that a resource can be those tangible assets that contribute to the organization in terms of added strengths or weaknesses. nevertheless, those resources can either be of tangible or intangible nature, tangible in the form of skilled personnel, plant and machinery, and intangibles such as reputation, know-how, and expertise in marketing and the production processes (wernerfelt, 1995). similarly, barney (1991) reiterated that resources could be categorized into two main areas. first is the human capital aspect, such as intellect, training, and experience. second, the physical capital, such as the technology, equipment, and plant, and organizational capital, such as the structure. the dominant claim of this perspective is the argument that competitive advantage is derived from certain resources within the organization, and these resources are considered rare in other organizations or they are lacking in the competitors’ organizations. therefore, they are viewed as superior resources by the competition. according to bridoux (2004), this perspective implies that the resources in the organization provide the basis for a strategy, a strategy that can enable the organization to better exploit the resources within its own organization relative to that of the competition. similarly, donnellan & rutledge (2019) stated, as per the resource base model, it’s the unique resources and capabilities that account for the differences in the performance of the firm rather than the structural characteristics of the industry. it is further argued that the resources that are rare, not easily substituted, and hard to duplicate/imitate form the key set of the resources that give the firm a strategic advantage over others. therefore, by focusing on these components of the model, it might be easier to recognize the resources that could possibly provide a sustainable competitive advantage for the organization. the resource-based view is one of the common theories used to explain the organization's sustained competitive advantage. the underlying premise of this view is that organizations can obtain a strategic competitive advantage when they are in possession and control of assets that are scarce and non-substitutable and in an organization that is capable of handling them (kraaijenbrink, 2011). similarly, according to foss (1996), the resource base view is geared more towards the long term and provides a more detailed analysis of the competitor. this may be useful to ascertain any threat of imitation in the future by the competitor by analyzing the competitor’s capabilities and resources. additionally, the resource base perspective explores the collective groundwork based on an economic infrastructure by delving into the concept of human capital in establishing a competitive advantage for the organization. furthermore, due to this resource perspective, other academicians have used this application in prioritizing the human aspect as a means to explore how it assists the organization in obtaining a competitive advantage, as demonstrated by wright, mcmahan & mcwilliams (1994). similarly, youndt et al. (1996); jackson & schuler (1995) are proponents of this view as they sought to incorporate learning within organizations. furthermore, barney (1991) pointed out that there are several components that can create a competitive advantage and emphasized human capital as one of such components. he elaborated further that this type of competitive advantage occurs when the organization device a plan of action that differs from prospective competing organizations. in essence, from the perspective of the resource base view, competitive advantage is linked to any resource in the firm that differentiates it from its competitors. rose, abdullah & ismad (2010) conducted a study pertaining to an organization`s resources and competitive advantage as it relates to performance within the organization. it was concluded that looking at the competitive advantage from a resource point of view is important mainly as it may be applied as a framework or guide for organizations to improve their level of competitive advantage and overall performance through applying and manipulating the resources within the organization. 38 economic analysis (2022, vol. 55, no. 2, 31-48) a study conducted by donnellan & rutledge (2019) on jp morgan chase revealed how the resource base view was employed to synchronize the resources found in the company with its strategy to achieve its target of being the highest-ranked bank in the united states. this entailed the implementation of changes to their environment both internally and externally and fully exploiting the competencies and resources that were at their disposal. this case study indicates how the firm looks internally to find out the resource gaps that appeared within their organization. it revealed that they made the necessary adjustments to ensure they had the resources and abilities to yield much better returns. these changes led to an increase in their revenue. even though organizations cannot afford to prioritize only their internal resources and exclude others, what this case study revealed is that analysis using the resource-based view is crucial’, and organizations should not neglect internal operations if they want to maintain a competitive advantage. the resource base view strategizes the resources that may be useful for the growth of organizations (gerrard, 2005). it exposes the rapport between a firm’s performance and internal features (barney, 2001). the internal characteristics represent organizational resources, which may appear as physical, technological, or financial (mahoney, 1995). according to amit & schoemaker (1993), an organization’s capacity is largely seen in the organization and combination of resources alongside tacit elements such as expertise and knowledge. resources and capabilities constitute the core strategic sources of competitive advantage. in the presence of rare, valuable, non-substitutable, and imperfectly imitable resources, resources can ensure and guarantee a competitive advantage (gerrard, 2005). in this regard, the more organizations invest in capabilities, the higher they acquire a competitive advantage (eisenhardt & martin, 2000). approaches based on the theory of human capital according to armstrong and taylor (2014, p.70), managing people can be approached based on the human capital theory. this entails receiving certain answers by asking specific questions that are stated below: what are the main driving forces behind creating value in the organization? which skillsets do these individuals hold? what are the required skillsets necessary to achieve the organization’s essential objectives? what measures can be implemented regarding attracting, developing, and retaining these skills that they possess? what can be done regarding cultivating an atmosphere and culture that enables the promotion of learning that is beneficial in meeting the requirements of the employees and the organization? which measures can be implemented to incorporate and utilize the explicit component and tacit component of knowledge that is being generated? this theory assists in determining the impact that the employees have on the company and the overall worth they add to those that have a stake in the organization. in addition, it portrays that human resource practice is useful and worthwhile. it is valuable because it adds to the assets of the organization in terms of the return on investments. furthermore, it points in the direction and navigation of the prospective organization strategy that will communicate the relevant strategy and practice designed to boost the effectiveness of managing employees (armstrong & taylor, 2014). the underlying principle surrounding the human capital theory is that an individual’s learning abilities can be compared in terms of value to other resources that are a part of producing the services and products (lucas, 1990). the ability of the organization to obtain advantages from human capital does not rest solely on the specific skills of the employees. it also nikaela wilson, iva vuksanović herceg 39 depends on the ability of the organization to create and leverage the supply and demand side movement constraint to retain the human capital at reduced costs against that of rival firms. however, it is the assumption that employees might seek employment elsewhere if they are willing to accept a salary reduction (campbell, 2012). according to davenport (1999 p.10), human capital comprises knowledge such as iq, intelligence, general and work-specific knowledge; behaviour such as work expression, abilities, norms, and beliefs; skills that are needed to carry out the task such as physical body mobility of the job; personal talent that is innate to the individuals; and effort which is the use of their innate talents and abilities in addition to time. similarly, wuttaphan (2017) opined that the theory of human capital illustrates the importance of maximizing labour in addition to how employees’ knowledge, skills, and abilities can be accumulated within the organization that can contribute to improvements in the employees’ abilities. he elaborated further that the value of this theory is generally accepted as a way to improve the performance of the organization, so it relies on the above-mentioned attributes as a value creation concept in organizations. the general presumption of the human capital theory is that educated and well-trained employees lead to greater productivity. it maintains that investing in human capital can potentially result in a competitive advantage in the organization. tan (2014) summarized the criticism surrounding human capital theory (hct) on moral, empirical, practical, and methodological grounds. hct is harmful to hr because of its heavy reliance on educational measures while evaluating workforce competence. according to barro (1991), previous studies used registrations or literacy levels to determine national human capital. formal qualifications are a limitation of hct toward human capital. formal qualifications do not cover traditional accredited competencies acquired experientially or informally by an individual (colardyn & bjornavoid, 2004). furthermore, the absence of defending one’s educational attainment prevents hct from complementing hr (green and mcintosh, 2007). another limitation in hct is the workforce crisis and the ‘war for talent’. the role of hct in the hr field is to ensure positive performance through the configuration of competencies (cafferkey, 2018). winterton (2009) argued that the organization actively needs an individual’s intelligence and learning ability to demonstrate work performance. competitive advantage and managing human capital the probability of achieving organizational goals may be perceived through organizational commitment and the ability to influence its performance with human capital. human capital, including employees’ ability, skills and knowledge, is considered a tangible resource that contributes tremendously to organizational growth than any other organizational asset (garavan, morley, gunnigle & collins, 2001). human capital may also appear to enhance the performance of employees through training and organizational development programs (mahdi, nassar, & almsafir, 2019). providing an organizational environment that gives freedom to employees while aiming to utilize employees’ intellectual skills for organizational growth may also be a contributing factor. the environment should provide training and workshops that develop problem-solving and all interrelated skills for employees. as it pertains to the management context, the ways adopted by management to ensure competitive advantages for the organization are important. the organizational structure constructed and provided by management can add value to organizational goals. management should ensure that the structure provides for employees’ needs and specify conditions that promote interactions between processes and individuals. numerous motivational factors need to be adequately included in the organizational structure. in addition, organizations can nurture employees’ skills and competence to secure competitive advantages (gannon, roper & doherty, 2015). tacit knowledge is instrumental to competitive advantage and could largely be developed within the organization (chaudhry & 40 economic analysis (2022, vol. 55, no. 2, 31-48) roomi, 2010). the effectiveness of tacit knowledge development plays an important part in employees’ commitment to the organization (alnidawi, et al. 2017). barney (1991) researched the correlation between strategic competitive advantage and the organization's assets. the indicators used to represent the potential of the organization’s resources to bring about sustained competitive advantage were rareness, substitutability, value and imitability. the findings revealed that competitive advantage is based on the assets that the organization possesses, and the resources that are considered valuable, rare, inimitable, and nonsubstitutable possess the potential to bring forth a sustainable competitive advantage within the organization. therefore, managing human capital is crucial to achieving a competitive advantage within organizations. according to hitt & duane (2002), it is imperative that the management team properly manage such a resource within the organization, which involves the evaluation of the present talent repository and initiating the necessary adjustments to develop or acquire the relevant expertise from external sources and removing by means of layoff those human resources or those relationships that are external to the organization that is no longer beneficial. this also entails paying attention to the policies as they could be used to achieve organizational goals successfully. it is expected that management establishes policies that honour rewards, compensations, promotions, and career advancement since these are the factors that boost employees’ motivational spirit. the policies are anticipated to limit or eliminate pressures on employees so that employees can get inspired. the absence of effective management of human capital may downgrade the organizational level of performance in the marketplace. alnidawi et al. (2017) perceived the unavoidable role of human capital in creating a competitive advantage in companies. human capital management ensures the management of talent, individuals, and employees through retention, engagements, training, workshops, and development programs (human capital management, n. d.). hence, the concept could be used to develop, retain and attract customers to create value for the organization. industry 4.0 and human capital in achieving competitive advantage across the globe, the fourth industrial revolution is revered as the driving force behind technology, and technology propels formal or informal disruption while molding individuals. the impact of technology is two-fold; it can be predicted at times while unpredictable at other times, and it can be negative in one instance while positive in another. in the years ahead, artificial intelligence and automation will be more prevalent and will be transforming the work environment as employees begin to be more connected and engaged with smart machines. this type of human-to-machine interaction is expected to bring about a lot of benefits, including better productivity, work quality improvement in production and business performance (balalle & balalle, 2018). the study by kazancoglu & ozkan-ozen (2018) highlighted the transformation from conventional and old-fashion production processes to more digital, technologically equipped smart factories. the study revealed that demanding a high level of intelligence from the workers will contribute to an environment that will emphasize the importance of having the ability to handle complex matters, interact with modern interfaces, have knowledge of information technology, and solve problems, multi-tasking, and overall flexibility. in this regard, it is important that the organization’s management team pay keen attention to the human capital as they have the capabilities. industry 4.0 can help to create more knowledgeable workers that can influence worker productivity, improve quality, efficiency and determine the success level of the organization. the workforce will be significantly impacted by industry 4.0 since the transformation directly affect the employees. the traditional roles of the workforce decline as a result of the nikaela wilson, iva vuksanović herceg 41 introduction of high-tech equipment that is synchronized, which enable easy communication among these machines and equipment, which makes them more self-reliant. as such, the job descriptions are significantly transformed; one, in particular, is the interaction or interface between the employee and the machine (romero, bernus, noran, stahre, & fast-berglund, 2016). according to a paper published in the european patent office, by the year 2025, it is projected that 26-30 billion of devices, found in both the household and organizations, will be embedded with software and processors in addition to being equipped with the necessary sensors and connected to (iot) internet of things. they will be able to function independently, collecting or exchanging data among themselves. when they are merged with other technology, for instance, artificial intelligence and cloud computing, they will facilitate the automation of the business process such as the intellectual jobs that were previously performed by people. they have already been in use in various sectors ranging from areas in manufacturing, agriculture, the transportation industry and even health (meniere, 2017). industry 4.0 possesses a contradictory impact on role and performance. it may aggravate available structural imperfections and reduce the progress of climate crisis resolution. business organizations broadly need modern and updated rules for operations (cooper & kaplan, 1988). industry 4.0 has led to the synthesis of the physical and cyber world and propelled the ongoing movement towards a combination of innovation streams. the impact of industry 4.0 is ambivalent; it can pose both advantages and possible issues. if it is not properly managed, it can worsen the existing past structural imbalances as organizations cannot continue to operate under the former rules of the past (đuričin & vuksanović herceg, 2020). these types of changes will affect the management and prompt modern approaches to the business model, strategic vision and organizational structures. among all sectors, actionable information is considered the major requirement for achieving a competitive advantage. dynamic approaches enable business organizations to overcome data flows, critical infrastructure and actionable information challenges. several platforms, technologies and resources can generate room for competitive advantages (ardito, petruzzelli, panniello & garavelli, 2019). in general, since the onset of the 4th industrial revolution, it may be argued that the major difference observed is the technology used and how it is merging more and more in everyday human life and creating the demand for new skills. it’s happening at a more rapid speed and has led to a lot of innovation. challenges in utilizing human capital to acquire a competitive advantage the challenges of human capital may differ based on the type of organization, its location, the industry in which it operates, the type of business activities it engages in, and also the pool of talent. one of the fundamental issues with human capital is that, as opposed to other capital that the organization owns, such as the database, patents, etc., the human capital can simply exit the organization without returning (coff & raffie 2015). therefore, this proves why managing human capital should be seen as a priority and why it poses a long-term issue in firms as it relates to obtaining a competitive advantage. there are several factors that may inhibit the realization of competitive advantages through human capital. according to a research report by the society of human resource management, it was revealed that achieving greater levels of engagement among employees is a major challenge, as cited by 38% of the human resource personnel; also, leadership training was noted by 31%, sustaining a compensation level that was deemed competitive was noted by 29%; also a challenge to retain the top performers 26% and retention in general 25%, a specialist with the specific skill-sets 24%, while sustaining benefits that are competitive such as retirement health coverage, etc. was 24% (shrm, 2015). these are some of the challenges that were outlined according to human resource professionals. 42 economic analysis (2022, vol. 55, no. 2, 31-48) according to a study conducted by gonzalez (2008) on facing human capital challenges in the 21st century in selected arab countries, it was revealed that the demand for qualified employees is outgrowing the actual number of skilled personnel. with regard to the gulf countries, it should be noted that foreigners dominate the workplace. an employee’s skill, for instance, may need certain organizational inputs and support before implementation, of which the organization lacks the structure and policies to make it available and achievable. goals setting between employees’ promotion and organizational development may likewise delay the organization from achieving competitive advantages. high-number of feedback interventions may clash with organizational objectives, thus decreasing task fulfilment and performance. while positive feedback motivates employees to work more, negative feedback unfavourably affects employees’ strengths and feelings toward organizational assignments. a low level of knowledge, experience, training and information about organizational-task reduces employees’ support and participation toward achieving competitive advantage. mullins (2007) opined that education is a route for advancing their careers; if the organization intends to maintain high productivity levels, it is important that employees are given opportunities for education. the unavailability of motivational instruments may pave the way for employees’ light-hearted commitment to organizational objectives. excessive organizational objectives and customers’ feedback may be an issue for employees’ activeness in activities. it is the duty of employers to provide solutions to challenges faced by employees. however, it becomes a harmful situation when the employer’s knowledge, experience, exposure, and intellectual skills are far below the employee’s capabilities. factional conflicts may also be a major concern among employees because certain members may detest teamwork and cooperation, thus impeding knowledge-sharing within the organization. factional sentiments give room for selfish and sluggish attainment of objectives. factional conflicts imply that some employees would lack updates about the ongoing activities in the organization. investment priority between employees and the organization would have farreaching practical effects on competitive advantage, especially when employers prefer to invest in the organization instead of human capital resources. the highlighted issues, if left unaddressed, would impede the realization of human capital in the organization. the industry 4.0 revolution, with the digitalization of more and more aspects of the workplace and technology changing every day, might pose some challenges regarding keeping abreast of the latest developments. more organizations are embracing the latest technologies, which will create demand for new skills. this will place more demanding requirements on the low-skill employees since the task might require new skills that some employees do not have. therefore, the employees must seek to acquire better knowledge. if the opportunities are not provided, this might lead to frustration and reduced motivation. if employees are faced with these dilemmas at the workplace, it might dampen their productive spirits and hence, affect the organization’s competitive stance in a negative way. concluding comments the literature reveals that human capital plays a significant role as a contributor to obtaining a competitive advantage in organizations, especially in today’s age of global competition, producing value-worthy products and services is a major concern. a lot of effort has been placed into improving this. even though competitive advantage can be viewed in terms of comparative and differential competitive advantage, in essence, it can only be achieved through placing emphasis on the effective management of human capital since they are the driving force behind it. in a competitive market, organizations strive to be in a position that gives them an edge over others. human capital is the real resource; they possess the know-how, knowledge, and skills. if they deem their work environment satisfactory, this can lead to motivated employees; hence they’ll express a willingness to exert more energy and attention, which will ultimately lead to nikaela wilson, iva vuksanović herceg 43 better outcomes. this translates into improved production, yielding better results and fostering an environment that can create a competitive advantage. managing human capital ensures high quality in the selection and recruitment of employees so that available talent can be evaluated and needed value can equally be supported with investment. human capital management structures the performance expectations of the organization. the managers are the ones that assess organizational goals through employees’ commitments, capabilities, and contributions. therefore, managing human capital plays a role in enhancing employees’ performance in organizational assignments, duties, and obligations. based on the literature, there are certain challenges that may be encountered regarding human capital, and these challenges may inhibit the attainment of competitive advantages in organizations. human resource personnel and the availability of adequate training for the potential leaders in the rganization secure the top-performing employees. also, the integration of more technology in the workplace has posed a challenge since it requires employees to be retrained to obtain more advanced knowledge in this area. some employees do not possess the necessary skills and may also oppose learning. in addition, retaining and acquiring specialists can be considered among the challenges that organizations face. furthermore, employees’ reluctance to be team players and the lack of cooperation thereby restrict the sharing of knowledge. if knowledge is not being circulated, it may damper the spread of ideas, creativity, and the necessary knowledge that leads to innovation which can potentially affect competitiveness. the afore-spotlighted human capital elements depict how they complement the organization to acquire a competitive advantage. employees’ natural, personal and innovative skills, in addition to their commitment, knowledge, and experience, are instrumental to quality ideas and valuable advantages that realize organizational objectives. employees’ knowledge, particularly the one that is constantly updated with training and workshops, can navigate an organization to the advantageous side in all plans, services, and activities. besides, competitive advantage may be unachievable alongside an obsolete structure. a structure that lacks motivational factors would definitely discourage employees from using human capital to ensure competitive advantage. furthermore, the paper brings to light the approaches to utilizing human capital to achieve a competitive advantage for an organization. the resource base view and the human capital theory were the approaches discussed and considered relevant in navigating human capital towards a competitive stance. the distinctive character of the organization could be realized through the human capital concept; investing in employees brings new ideas and solutions to the organization. while there are other resources that the organization owns, such as technology and equipment, the human capital emanates from the employment relationship and could not be regarded as organizational-owned property but is also privy to its success. although training and experience additionally enhance human capital, it is essential to state that employees often come along with human capital to the organization. the effectiveness of human capital can be perceived in the employee’s productive capacities. employees’ energy, attributes, enthusiasm, knowledge, inventiveness, and life experience constitute human capital, thus contributing to achieving an organization's competitive advantage. furthermore, there is an increased interest in how intellectual capital is being utilized to establish value in the organization. human capital is viewed as an important component of intellectual capital. industry 4.0 was also seen as an important contributor to competitive advantage as the advanced technology seems to employ more modern ways of getting the job done. even though advanced technology is necessary, among other factors, the quest towards the achievement of competitive advantage lies in the role of properly managing human capital because human capital neutralizes threats, exploits opportunities, and enhances organizational efficiency that has the potential to lead to a competitive advantage. 44 economic analysis (2022, vol. 55, no. 2, 31-48) references abu bakr, m. h. 2006."human resources entrance to achieve competitive advantage." university house, alexandria, egypt. aljawarneh, nader mohammad saleh, and tarik atan. 2018. 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"human capital theory: the theory of human resource development, implications, and future." life sciences and environment journal 18 (2): 240-253. youndt, mark a., scott a. snell, james w. dean jr, and david p. lepak. 1996."human resource management, manufacturing strategy, and firm performance." academy of management journal 39(4): 836-866. zehir, cemal, yonca gurol, tugba karaboga, and mahmut kole. 2016."strategic human resource management and firm performance: the mediating role of entrepreneurial orientation." procedia-social and behavioral sciences 235: 372-381. article history: received: june 2, 2022 revised: october 19, 2022 accepted: october 20, 2022 udc: 332.122(470) 502.131.1:332.155 cobiss.sr-id: 252602124 scientific review economic efficiency of implementation of the concept of sustainable development of the urbanized territories in russia kseniia lapshina1* | natalia bakaeva2 | olga sotnikova3 1 voronezh state technical university, voronezh, russia 2 southwest federal university, kursk, russia 3 voronezh state technical university, voronezh, russia abstract the necessity of transition to sustainable development of the urban territories is proved. the concept of the natural-socio-technical model of urban territories is offered. green building as one of the aspects of unity in urbanized areas and the natural environment is presented. the basic principles of the paradigm of safe and comfortable urban environment that is compatible with the biosphere are formulated. the structure of the humanitarian balance and the methodology for quantifying them are described. the model of sustainable development of the environment through the comparison of human capacities and parameters of the environment is simulated. the criteria for the compatibility of urbanized territories with the biosphere were formulated as a measure of the sustainability of their development. the example of calculation of an indicator of biospheric compatibility of urbanized areas in relation to transport construction and road infrastructure of the city is given. it shows the economic efficiency of realization of the concept of sustainable development and the creation biospherically of the urban environment on the example of road infrastructure of the city. key words: economic efficiency, city infrastructure, transport system, ecological safety, urban ecology jel classification: q56, q01 introduction the last decades have shown that the terrestrial biosphere in general and her separate components – ecosystems of various levels – have limited potential for ensuring the normal functioning and reproduction in the conditions of excessive impact of human activity. therefore among global problems which solution is badly checked in the existing development models the important place is taken by such problems as exhaustion of available natural and resource capacity of earth and pollution of the environment of the planet. therefore the concept "sustainable development of the urbanized territories" is so widely used and discussed by the scientific world community, including russia. as ideologists of transition to sustainable development the most advanced and progressive organizations of both the world community and the certain countries act. * e-mail: kseniia_lapshina@mail.ru 10 economic analysis (2017, vol. 50, no. 3-4, 9-19) today the concept of sustainable development is considered as means of an exit from the ecological deadlock of development of a modern civilization. the cities which have become the leading form of the human settlement and the urban environment created by the person are centers of a modern technogenic civilization. but development of a civilization at insufficient accounting of laws of interaction between society and the nature accompanied by essential impact on components natural environment. it conducts to catastrophically consequences for the biosphere and the person as one of parts of the biosphere. the world famous scientists involved in new concept of compatibility of the urbanized territories are barber, brown, clemens, daniel, dasgupta, goldman, hamilton, heal, korowitz, meadows, mozes, randers, stievers, tadani, wagner a. and others. in russia in academy of architecture and construction sciences the founders of this new concept of compatibility of the urbanized territories with the biosphere are academicians ilyichev and kolchunov and others. the russian higher education institutions in the cities: kursk, oryol, voronezh, are actively engaged in the decision of problems of a numerical experiment of assessment of compatibility of the urbanized territories with the biosphere. as a result the modern cities gradually turn from the centers of development of a civilization into sources of destruction of the surrounding nature and degradation of the population. the widespread point of view that the market model of economic development and the concept of a possibility of his self-regulation will automatically solve all arising environmental problems is insolvent. it was shown by the analysis of trajectories of economic development and an ecological condition of those countries which in the last decades have passed to market economy. the economy and the market badly adapt to the actions having perspective focus concerning the interests of future generations. profit today and at any cost – such is the motto of today's economy of the majority of the countries. the basic principles of the conceptual approach we will state the basic principles of transformation of the city in compatible with biosphere and developing the person. principle 1. the unification of the city and the surrounding nature, respect for earth, unity of consciousness because the person is generated by the nature, he is her part, without her he can't exist and has to serve a maternal organism. the solution of the problem of sustainable development initially means interaction with the nature, preservation of her self-sustaining state. anthropogenic loading shouldn't exceed the limit providing such state. the following principle helps to understand that it hinders the achievement of unity with the nature in activity of the city. principle 2. connection of two contrasts (external and internal activities of the city). external withdrawal of resources from the biosphere: air, water, fossil minerals and energy resources (gas, oil, etc.) and throw-in of waste in her: msw, sewer drains, production wastes, gaseous products of burning at combined heat and power plant, state district power plant, in propulsion systems and many other things. internal is a living environment and indicators of impact on the population: quality of the urban environment, health and life expectancy, education level, income, human potential, etc. both activities of the city are interdependent and deterioration or improvement of one of them in the same way influences another. kseniia lapshina, natalia bakaeva, olga sotnikova 11 initially activity of the cities has to be directed to reduction of external and internal negative impacts, promote restoration of capacity of the biosphere and, finally, lead to the graded beginning reproduction of the clean biosphere. indicators of realization of this principle are, on the one hand, quantitative assessment of consumption of resources and formation of pollution, on the other hand, quantitative characteristics of a condition of quality of life and level of human potential in the urbanized territory. it is necessary to use existing or to create the new criteria allowing quantitatively (on the basis of correlation dependences) to estimate results of external and internal activity of the city. for example, in a qualitative sense it is such characteristics as: extent of renovation of the territory from waste and her involvement in economic circulation; volume of investment into "green" industries and creation of new jobs; availability of housing; depression of consumption of energy resources on ensuring vital activity of the cities; decrease of emissions of a carbon dioxide and so forth. principle 3. drawing up and calculation of triple (humanitarian) balances of biotechnosphere construction and the solution of the system of the equations establishing quantitative standard ratios between: a) biosphere life potential; b) population and number of places of satisfaction of needs of the population for the cities; c) needs of people and technospheres in resources of the biosphere and a possibility of the biosphere to satisfy these requirements. triple (humanitarian) balances of biotechnosphere establish harmonious proportions between various parts of the biosphere, including the population and also the list and quantity of the withdrawn resources in unit of time with a binding to the territory of the city. if the given ratios of triple (humanitarian) balance of biotechnosphere aren't kept, then in the city (further on hierarchy: the region, the country) it is necessary: 1) to reorientate productions, to enter innovations into a technosphere to reduce pressure upon the biosphere and to reduce negative impact on the population; 2) to limit population in this city at the existing technologies in a technosphere. in case the humanitarian balance of biotechnosphere isn't reached, then development of the city will degrade, if it is reached it will progress, grade. progressive development of the cities promotes conservation, restoration of the biosphere and the person, improves quality of life in general. as the person himself is a part of the biosphere, he influences it through the vital activity and can reduce or enlarge the biosphere sizes. as calculated components of the equations of triple balances of biotechnosphere it is offered to apply [15]: • technosphere unit: one place of satisfaction of needs of the person framed by people (for example, a workplace, the educational place, the medical place, the vacation spot and others); • biosphere unit: the site of the biosphere which potential on norms symbiotic corresponds to technosphere unit, i.e. one place of satisfaction of rational needs of the person; • biotechnosphere's unit: the site of the biosphere including technosphere unit, i.e. one place of satisfaction of needs of the person which is in standard symbiotic ratios with the biosphere. principle 4. legislative and standard fixing of humanitarian balance of biotechnosphere of the city, or phased transition to it. 12 economic analysis (2017, vol. 50, no. 3-4, 9-19) for each city it is necessary to set legislatively the triple (humanitarian) balance of biotechnosphere determining the extreme sizes of a technosphere at the available capacity of the biosphere or to carry out phased transition to it (acceptance of organizational and technical actions, updating and development of normative legal acts, etc.). legislative and normative documents have to be based on the principle of prophylaxis and anticipation of possible dangerous situations in the cities, and not just on the facts of their detection and elimination of consequences. the control system of the city has to provide daily regulation of its activity; to establish degree of admissible risks of emergency situations on the basis of introduction new the biosferosovmestimykh of technologies; to bring to the level of the main priority: preservation of life and human health, development of the person and so forth. indicators (indicators) of realization of this principle will be: quality of the legislative initiatives, normative documents and legal acts guaranteeing humanitarian balance of biotechnosphere or phased transition to him. it is necessary to regulate the rational criteria, standard functions concerning: 1) and use sites under building, streets, green zones, etc., 2) water supply and water disposal, 3) power engineering specialists, 4) the air basin according to climatic seasons. for each factor all stages of his use from withdrawal from the biosphere before formation of waste and their processing consistently are considered. it is especially important that concerning social criteria it is necessary to develop normative documents and legislatively to approve them. principle 5. knowledge as necessary condition of existence of the city strategic development of the city is based on knowledge and includes the following elements: professionalism (vocational higher education, preparation and retraining of highly skilled managing directors of shots, improvement of knowledge in the system of continuous education); intelligence (use for preparation and implementation of programs of development of experts from the universities, scientific research institute, the academic and professional communities); reliable information; preparation of new actions and development of programs for improvement of biotechnosphere; recommendations about elimination of negative factors and offer on human development. within strategic city map on the basis of the analysis of the available information (the general, survey, special, statistical, analytical, etc.) the purposes of management coordinate with resources by means of the innovative programs of development which are result of creative, business activity of scientists, engineers, businessmen, authorities. important result is participation of scientists specialists of the relevant branches in reorientation of the existing productions to the new resource-saving directions and low-waste technologies that is extremely important for the cities with an intense ecological situation. innovative projects and programs have to be directed not to creation of the new equipment, technologies and goods and to the coordinated progressive development of technologies, the organizations and goods in their unity and interrelation with the biosphere feeding them. innovative programs have to include the actions and economic expenses providing transformation of the saved-up wastes, i.e. pathologies of economy and society, into a development resource. at the same time not used members of society (the unemployed, criminals) are involved in a useful social and economic turn as waste of harmful productions. we suggest, that the technologies compatible to biosphere are considered to be the actions providing an economic opportunity to use industrial and household wastes, low-quality raw kseniia lapshina, natalia bakaeva, olga sotnikova 13 materials and renewable resources for creation of the high-quality products competing with the traditional items received from originally taken natural resources. in such technologies the price of the used natural resources has to correspond to costs of their reproduction. the compatible to biosphere technologies in construction the innovative offers developed and collected by the russian academy of architecture and construction sciences [16], and which have proved the economic efficiency and investment attractiveness can be examples of that. the offers illustrate, for example: transformation of solid household (organic) waste (msw) to the gaseous products used for development of energy or for additives in fuel; application of waste of logging production, fight of glass-container raw materials in production heat-insulating the crystalline materials of foam and glass. rather small volume of use of innovations in construction branch and the limited list of objects of “green” construction in russia is explained by legal lack of regulation of process of their realization or immunity of economy to innovations now. the problem of not demand of innovations again is well confirmed by the main motto of real market economy "profit at any cost". the major factors influencing resource-saving, for example, at design and construction of buildings as a part of program actions, are: rational choice space planning of decisions, survivability of constructive systems of buildings, term of their service; decrease in resource intensity, ecologically safe construction materials. as result decrease in use of non-renewable natural resources. quantitative indices of effectiveness of programs of development can be criteria of their selection at competitions, and the projects containing the technologies reducing the biosphere could not be allowed to participation in a competition in general. in germany, japan and some other countries the applicant who has submitted the proposal containing innovations concerning biotechnosphere on a competition receives essential preferences in points at assessment of the competitive offer. in russia, unfortunately, there is no such practice yet; even directive introduction of innovations practically doesn't work as in the country there is no economical and legal system stimulating innovative development of branches and municipal economy. finally, indicators of realization of the principle of "knowledge" will be: quality of target programs of regional development, effectiveness of actions for improvement of biotechnosphere and recommendations about elimination of the factors interfering symbiotic progressive development. all programs have to contain quantitative indices of implementation of innovative projects by means of program and target or share mechanisms of management. principle 6. creation of harmonious social climate on the basis of this principle it is expedient to estimate internal stability and wellbeing of the city, progress in development of the person and in restoration of the nature. for similar assessment it is necessary to use indicators: social tension, moral atmosphere, the fact that "terrestrial happiness" the family wellbeing, the birth of children and other indicators characterized by data of the statistical reporting on a social status on regions is called (birth rate and mortality, prevalence of deviant behavior owing to alcohol and drugs, life expectancy), quality of labor, the actual assessment of human potential and another. principle 7. satisfaction of rational needs of the person through functions of the city for harmonious development of the person rational requirements of him as person (vital, emotions, will, geniality and kindness, aspiration to knowledge, the need for creativity, sense of beauty) have to be satisfied with functions of the city: life support, entertainments and emotions, power, mercy, knowledge acquisition, knowledge of the world and creativity, communication with the nature. any of needs of the personality isn't main, all of them are necessary, and without satisfaction of any of them people won't be harmonious. 14 economic analysis (2017, vol. 50, no. 3-4, 9-19) as the principles of biospheric compatibility are implemented through the functions of the city designed to provide satisfaction of rational needs of the person and, respectively, through his infrastructure, we will address the analysis of these functions in practice of a urban planning. life support ─ this existence of worthy housing, jobs and their transport availability, providing with food, objects of life and life, available medical care. all life support system is rather difficult, and it is difficult to overestimate its importance. the problems connected with life support take 90% of working hours of the city administration today. entertainments and emotions ─ this is the creation of recreational zones in the cities, theme parks, squares, sports constructions and playgrounds, bars, restaurants, dance halls and so forth, convenient for use by the population of the city. in the city, as a rule, there are these or those opportunities for satisfaction of these needs of the person parks and attractions, cafe, bars and restaurants, dance halls and discos, game zones, the disneyland and many other things. saturation of the city by these objects depends on many factors, including on the number of inhabitants, on the level of income of the population, fashion and other. the power ─ is the mission personifying functions of management of the city (respect for discipline, control, the choice of the purposes and priorities at their achievement, etc.). the person in the course of the development is forced to operate himself self-discipline, control of emotions, the choice of the purposes and priorities at their achievement, etc. in a bigger measure these functions are necessary for community of people. in the city elements of the power have to have the corresponding architectural expression and placement on the master plan of the city: buildings of governing structures (administrations of areas, cities, areas and so forth), legislative, law enforcement agencies (police, prosecutor's office, courts, etc.), representation of the state participation (mails, banks, pension funds, etc.). the mercy ─ is the central point of needs of the person. the geniality and kindness which are received by the child under normal conditions the developed harmonious personality cause the reciprocal need to make something similar in the matured person. in the city – there are the objects representing and performing functions of the help to persons in need: to large families, aged, to disabled people, families with adopted children, etc. day nursery, gardens, educational, educational and specialized schools, out-of-school clubs on interests and other institutions; for physically weak, needy and socially unprotected groups of the population a nursing home and aged, doss houses, buildings of salvation armies and many other things. knowledge ─ that means the establishment of relationships of cause and effect in the world that always was need of the person. the understanding of the events which are taking place both around the person and in him, are extremely important for individual needs of the person and for city life. in the social plan traditionally this need of the person is satisfied with an education system kindergartens, schools, higher educational institutions, advanced training courses, retrainings, the systems of continuous professional retraining, etc. knowledge makes the person independent, and the education system and its personnel structure make the country intelligently independent. therefore the universities, higher education institutions, schools were always significant objects in the city and their importance can't be neglected. these objects in many respects define also its architectural appearance, form the place of the city in hierarchy of the cities including on the level of development of human potential. knowledge of the world and creativity ─ is the need for creativity which is the integral line of the person (to understand an essence of the observed phenomena and the taking place events, to create something new) and is implemented in the form of various creative organizations divided into two segments: kseniia lapshina, natalia bakaeva, olga sotnikova 15 • the scientific creativity (fundamental science, i.e. science as creativity) which is carried out by the russian state academies of sciences, the educational organizations: universities, academies, institutes); • the art creativity shown in the form of arts (architecture, a sculpture, painting, music, literature, theater, etc.). respectively in the city there always existed and have to be buildings and constructions in which these high needs of the person as however, and requirements of society, are satisfied. theatrical buildings, conservatories, concert halls, the museums, temples usually are architectural monuments, define architectural appearance of the city and though in a quantitative sense it is only several objects, they create in many respects the unique image and internal relevancy of the city, determine his creative potential for further development of the person. communication with the nature ─ is important function of the city as the person as a species, has indissoluble interrelation with the nature, actually he uses the goods granted to him by earth, the nature and the biosphere. during evolution human has created the life support system. however the need of communication with space, earth, the nature remained in the form of requirement of contemplation of fine, inspiration with images of natural harmony. the person needs to feel an initial natural basis and as a psychological support and as an esthetic factor. from these positions in the city there have to exist wildlife "impregnations" in the form of parks, natural monuments, certain reserved places with picturesque landscapes, a harmonious combination of a landscape and architectural objects. ancient architects paid attention to importance of this party of existence of the city, architects stand up for it and inhabitants rejoice to it. the charm of many old cities is defined by indissoluble communication with the surrounding nature which is shown in many respects a sufficient aeration, good illuminating intensity, existence of healthy reservoirs, but also picturesque landscapes, a harmonious combination of a landscape and architectural objects, etc. in the modern cities there is a danger of not only reductions of natural landscapes, but also their transformations to aloof territories and also in this context there is a problem of video pollution and light pollution. residential areas of the modern cities as "the stone jungle", aggressive in the impact on the central nervous system of the person, promote not only to depression of health of the people living in them but also turn them into socially dangerous persons. all functions of the city are closely interconnected among themselves. realization of these functions, together with other principles of transformation of the city in compatible with biosphere and developing the person, provides achievement of a condition of favorable medium for life and development of the person. excellent feature of the offered approach of measurability of functions of the city is that it allows to give a quantitative assessment to such concepts as quality of life, safety, favorable environment, comfort. quantitative estimates of representation to the inhabitant of functions of the city on time spent for their satisfaction form the basis of a technique of feasibility of these functions. the following step is an opportunity to survey advantages of the cities, plans of strategic planning and perspective versions of the master plan, to estimate as far as they correspond to needs of the person and as the person and balance of its time can change as a result of realization of this or that option. principle 8. reliability it is necessary to create "constitution" of the city according to which the city has to play the role in the constellation of other cities adequately: capital (of country, of region, of district), monoprofile or industrial city, resort, military base, city university, shopping center and many other things. it is necessary to maintain the traditions of ethnos which have developed in the 16 economic analysis (2017, vol. 50, no. 3-4, 9-19) cities, culture, to bring up the relations of respect and preservation of the nature, to involve the councils of elders in management process. to promote a unification of the cities, development of friendly communications between them in the field of economic and cultural cooperation, education, medicine, environment protection, etc. joint holidays, friendly visits, exchange of experience and so forth. communication and information transfer between people, ability to collaboration (exchange of the ideas, thoughts, intentions, feelings, information, etc.) necessary living conditions and development of the person in the city and society. observance of diverse conditions of public life, the system of behavior, norm, value, professional knowledge and another unite people in various social communities (group of people): labor unions, creative public organizations, clubs on interests, association. the purpose of such association simplification of communications between representatives of various cultures, ethnoses, decrease in conflict potential in the city, society, the state. communications between social communities have to be based on the principles of biospheric compatibility. if cooperation between people and groups of people is the basis for interaction, then development of the personality and society will be friendly and harmonious. otherwise there are unorganized mass of people (crowd and other their versions) that generate rumors, panic and fear in society, which is less controllable or uncontrollable by the city and the country in general. if the previous clauses and this point are implemented, then it is possible to speak about the comfortable environment for life and development of the person. principle 9. knowledge = force ─ this is the knowledge of the truth, objective reality allowing to pursue the correct policy is reasonable to apply law enforcement agencies, to make interaction between various layers in the city and a boundary by the cities. the cities have to develop the style, have memorials, city holidays. the ability to dispose by force assumes knowledge of functions of the city, his political, economic, social, ecological situation, relationship of groups and certain people, their interests, understanding of strategy and tactics by means of which force is got and being kept. knowledge promotes establishment of multilevel communications inside and between regions, development of the national idea, and strategy as bases for application of internal law enforcement agencies, planning of defense of the country, image of the country, etc. the greatest efficiency to "force" is given by "knowledge" allowing achieving the required objectives minimum spending resources; to convince people of their personal interest for this purpose; to turn opponents into allies. the principle "knowledge=force" ensures safety of residents. the indicators of safety of medium of vital activity are: counteraction of crime and anti-terrorist activity; information security; fire safety; mitigation of consequences and depression of level of impact of natural and technogenic catastrophes, ecological safety; sanitary and epidemiologic safety; safety of infrastructure facilities and transport. if all previous clauses are implemented, then it is possible to speak not only about comfortable (favorable), but also safe medium in the city for development of the person. thus, stated above represents the sequence, hierarchy of points, positions, actions for transfer of the city in biosferosovmestimy and developing the person. today, according to official data [1, 2], the major factors of destabilization of the urban environment and regressive development of the cities are: 1. the ingredient pollution of the air basin and its implication as in the form of the local phenomena a photochemical smog, acid deposits, and on a global scale formation of greenhouse effect, destruction of an ozone layer in a stratosphere. formation of climatic conditions of the city, meso and the microclimatic features of the urban environment, meteorological factors influencing processes of dispersion of emissions and localization of contaminants are bound to a condition of the atmosphere; kseniia lapshina, natalia bakaeva, olga sotnikova 17 2. pollution of water medium and formation of a significant amount of the crude sewage, including due to the lack of treatment facilities and a shabby condition of water supply systems. difficulties of providing urban population with drinking water are experienced practically by all regions of the country, and its sanitary state doesn't meet the existing requirements of norms and rules (40% of superficial and 17% of underground sources) [3, 4]. the problem of incidental developing of infectious diseases as which reason serves the low-quality water medium is also acute; 3. erosion and deflation of the soil in the cities and in adjacent territories, formation on the anthropogenic broken or anthropogenic transformed territories of artificial structures and specific educations different from natural structures by their properties. the factors blasting natural structure of a soil integument in the cities, that have the "sealed" day surface, reinspissation and the raised loads on the soil, its salinization and poisoning. a special problem for the modern cities is the modification of geological medium in a litosphere which is shown in the form of various dislocations: failures, sags, karst phenomena, landslides and gullying; 4. parametrical (thermal, mechanical, sound, vibratory, optical, electromagnetic) and radioactive pollution; development of new types of energy carriers with negative ecological consequences; 5. territorial offensive ("expansion") of the city at the environment through direct contact transport networks, utilities etc., leading to reduction of the sizes and violation of integrity of natural complexes and also decrease in their stability and efficiency of favorable impact on the urban environment. so, annual reduction of the area of forests results from activity of the person with a speed about 7,3 million hectares a year; 6. the adverse effect of the city on a plant and animal life leading, as a rule, to violation of natural processes of activity both separate species of plants and animals, and all biocenosis. by estimates of experts, daily and forever from 100 to 200 types of live organisms and plants disappear. loss of the habitat, its pollution and overexploitation of biological resources by the person are the reasons of it; 7. accumulation of dumps, tailings dams, waste heaps and other results of long-term economic activity, problem of their utilization and elimination. only in russia there are more than 500 million m3 of radioactive wastes and about 20 thousand tons of the fulfilled nuclear fuel; 8. global distribution of super toxic substances through trophic chains that leads to violation of endocrine and reproductive systems of the person, manifestation of disintegration of genetic programs of the person that can lead to degeneration of the nation; 9. low level of ecological consciousness and culture of the population, is a consequence of what the insufficient efficiency of administrative and, first of all, control functions in the field of environmental management and environmental protection take place; low level of ecological regulation of town-planning activity, including lack of rent payments for use of natural resources, for the territories polluted by dumps, etc. finally, the cities as civilization carriers, get the prevailing function destroyers as they destroy the nature, and together with her and own population. 1) the urban environment represents dynamic system which condition is caused by: 2) external influences (for example, climatic factors, change of requirements of the standard-right base, social standards and qualities of life, change of education level and culture of society and others, defining a possibility of cooperation with the biosphere); 3) internal interactions between components (for example, rendering services, social tasks, environmental protection, etc.; 18 economic analysis (2017, vol. 50, no. 3-4, 9-19) 4) the intra making processes (for example, the intra production and economic relations). thus, the urban environment is the system open for external managing directors of influences, i.e. the influences transferring system to a new state. on the basis of the above-stated principles of transformation of the city in compatible to biosphere and developing the person the conceptual model of the safe urban environment as natural socio technical structure is constructed [24]. in conceptual model natural socio-technical structure of the urban environment we have allocated the following components: • the natural component as the part of the external environment containing resources for the person, interacting with objects of city infrastructure and which is exposed to negative technogenic impact; • the social component as the part of the external environment which is also interacting with objects of city infrastructure and expecting satisfaction of the requirements at certain risks. besides, the person as the representative of society, being a part of the environment, indirectly is influenced by negative technogenic impact; • the technological component making power impact on natural and social environments, and defining first of all, a possibility of formation of an adverse ecological situation in a certain territory. the basic novelty in creation of conceptual model of the safe urban environment in the form of open dynamic system in this case is that her state is defined by other specific laws which are based on mutual influence of parts of model which make her, as a part of uniform natural socio technical structure with external influences. conclusion for an example we have executed calculation of an indicator of biospheric compatibility of the territory of the motor transportation enterprise on the example of one of the cities of the central part of russia with the population about 400 thousand people. on the basis of the analysis of the received indicative values of factors conclusions on development of normative documents or concepts of program documents, for example, of target programs of innovative development for motor transportation infrastructure and other life support systems of municipal economy functioning in close interrelation with motor transportation system are drawn. the general recommendations about development of programs of development of objects of motor transportation infrastructure contain the following stages. at the initial stage conceptual installation and the general purpose of innovative development of the city transport system according to the fundamental principle of paradigm 1 by the biosphere of compatibility are formed. on the basis of the formulated general purpose tactical targets as which, for example, there can be following are developed: 1) realization of purposes of strategy of ecological reconstruction and safe development of motor transportation infrastructure of municipal economy; 2) development of new regional criteria for evaluation of quality of ecological safety of objects of motor transportation infrastructure of municipal economy; 3) development and legislative fixing of branch humanitarian balances of a biotechnosphere or phased transition to them; 4) realization of the program actions which are based on the principles of program goals management and share mechanisms of managing; 5) introduction to economic circulation the compatible to biosphere technologies eliminating imbalance of objects of motor transportation infrastructure and providing kseniia lapshina, natalia bakaeva, olga sotnikova 19 realization of functions i am proud for the maximum satisfaction of public benefits in the conditions of market economy; 6) establishment of target standards of the socio-economic indexes characterizing quality and technical capabilities of motor transportation system and objects of motor transportation infrastructure, for example, of costs of transport availability, etc. it should be noted separately that application of a program and target method of management of realization of program actions is based on share mechanisms of management by means of which participants of programs of development are called to work for the end result with "personal" responsibility of everyone. references brand ulrich. 2012. “green economy – the next oxymoron? no lessons learned from failures of implementing sustainable development”, gaia 21(1): pp. 28-35. ilyichev v. a., emelyanov s.g., kolchunov v.i., eds. 2015. "principles for the transformation of the city into biosferosovmestimyj and developing people." a scientific monograph. 184 pp. jeremy rifkin. 2013. “the third industrial revolution”, vii, 233-242. kennet m. and felton j. 2012. “the green built environment: a handbook.” the green economics institute. kennet m. and courea e, pepinyte 2011. “handbook of green economics.” the green economics institute. kennet m. 2012. “the green economics reader. the green economics institute.” shmelev s. 2017. “green economy reader. lectures in ecological economics and sustainability.” springer, 463 pp. https://www.springer.com/gb/book/9783319389172. shmelev s. 2012. “ecological economics: sustainability in practice.” springer, 248 pp. https://www.springer.com/gb/book/9789400719712. shmelev s., shmeleva i.a., eds. 2012. “sustainability analysis: an interdisciplinary approach.” palgrave, 335 pp. https://www.springer.com/gb/book/9780230355248. united nations division for sustainable development (undesa). 2012. “a guidebook to the green economy”. united nations environment programme. 2010. “green economy report: a preview.” http://www.unep.org/greeneconomy/linkclick.aspx?fileticket=jvdftjopxsa%3d&tabid=135 0&language=en-us. united nations environment programme. 2010. “developing countries success stories.” http://www.unep.org/pdf/greeneconomy_successstories.pdf. united nations environment programme. 2010. “a brief for policymakers on the green economy and millennium development goals.” http://www.unep.org/greeneconomy/portals/30/docs/policymakers_brief_gei&mdg.pdf. article history: received: october 6, 2017 accepted: october 25, 2017 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp1-17 original scientific paper demographic changes and sustainable demographic development in the western balkans verica janeska1* | aleksandra lozanoska1 | elizabeta djambaska1 1 ss. cyril and methodius university in skopje, institute of economics-skopje, skopje, republic of macedonia abstract the main goal of this paper is to identify the challenges of the sustainable demographic development in terms of the changes and current demographic situation in the western balkan countries and to detect the importance of population policies. the analysis is based on the relevant indicators for demographic changes identified in the sustainable development strategy of the eu. the comparative analysis is made for the following countries: albania, bosnia and herzegovina, croatia, montenegro, republic of macedonia and serbia. the available data from the eurostat statistics and other relevant data sources and studies for the last decade are used. the added value of this research is in the comparison of the demographic indicators and recognizing their importance for the sustainable demographic development of this region as one of the key preconditions for the future sustainable development. the results of the analysis show that the demographic changes are big challenge for the sustainable development in all western balkan countries. they have implications in many domains and should be in the focus of the demographers, researchers and policy makers in different fields of the macroeconomics. the lack of data for old-age income adequacy and public finance sustainability imposes the need for comprehensive database in each country as a precondition for continuous monitoring of the demographic changes and for creating appropriate policies regarding the sustainable development. based on the results of this research, the common areas where the population policies of these countries should be directed are identified. key words: demographic changes, sustainable demographic development, western balkan, employment rate of older workers jel classification: j1, j21, q01, h5 introduction the sustainable development means improvement of the quality of life and the welfare of the existing and future generations through making relations between the economic development, protection of the environment and social justice. in these terms the changes in the population development are very important because they have significant influence on all aspects of the sustainable development. in contemporary conditions, worldwide they are manifested in certain misbalance between the working-age population and older population, which has implications on the economic and social development, especially on the social transfers. having on mind the importance of the human resources, particularly human capital, as a one of the key factors for sustainable economic development, many studies are observing the * e-mail: verica@ek-inst.ukim.edu.mk 2 economic analysis (2018, vol. 51, no. 1-2, 1-17) demographic changes and trends. intensified demographic changes are a global phenomenon resulting from two almost universal trends: declining fertility and increasing life expectancy. most countries in the world experience declining fertility or have stagnating fertility. in most developed countries fertility is below replacement level, and the majority of countries report increasing life expectancies. as a consequence, most parts of the world will witness demographic aging – defined as a rise in median age of populations and a growing share of people above age 65 – during this 21st century. large discrepancies, however, will remain (muenz, 2007). his assumptions, today become real and has happened sooner than expected. the western balkan countries in the last decade are facing major demographic changes, due to low birth rates, changing family structures and intensified emigration abroad. it results with accelerated demographic ageing that implicates serious challenges for the economic and social development and is expected to become even more important in the future. therefore, the sustainable demographic development is one of the key aspects of the western balkan countries’ sustainable development. this paper is considering the demographic changes and the sustainable demographic development in the western balkan countries: albania, bosnia and herzegovina, croatia, montenegro, republic of macedonia and serbia. the comparative analysis is based on the set of sustainable development indicators agreed upon for monitoring the sustainable development strategy of the european union (eu sds). the demographic changes can be followed through one key indicator which refers to the employment rate of the older workers, as well as through several others divided in three groups: demography (life expectancy, population growth, total fertility rate, migration and old-age dependency); old-age income adequacy (income level of over-65s compared to before); public finance sustainability (government debt, retirement, the impact of aging on public expenditure, pension expenditure projections). the analysis refers to the period 2006-2016 and the eurostat database (and world bank database for one indicator) as comprehensive source of comparable data is used. almost all previously mentioned indicators, except: the impact of aging on public expenditure and pension expenditure projections, for which there isn’t any data in the eurostat and world bank databases, are analyzed. although for some of the indicators there isn’t data or the data is incomplete for some of the western balkan countries, the paper gives certain knowledge for the changes and current conditions regarding the sustainable demographic development in these countries. overview of the demographic indicators employment rate of older workers the employment rate of older workers (55-64 years) is important indicator for the sustainable development because it shows the ageing of the population, the adaptability of the labour force market, the sustainability of the pension and social system. also, higher employment rate of older workers is guaranteeing strong public finances. the available data for this indicator for the period 2007-2016, despite some oscillations, show that it has a tendency of increase in all western balkan countries (table 1). it is highest in the republic of macedonia (almost 12 percentage points) and in serbia (nearly 11 percentage points), and lowest in croatia (for 1.5 percentage points). comparable data1 for 2015 shows that the numerical value of this indicator is in the range from 28.2% (bosnia and herzegovina) to 53.6% (albania). concerning the employment rates of older workers by sex, the differences between the employed men and women were and remain emphasized. regardless of the more highlighted 1 because for bosnia and herzegovina the employment rate of older workers for 2007, 2008, 2009 and 2016 is calculated for the age group 50-64 years, the comparison between the western balkan countries is made for 2015. verica janeska, aleksandra lozanoska, elizabeta djambaska 3 dynamics of the women’ employment increase, the employment rate of men is significantly higher in all analysed western balkan countries. for example, in 2015 the employment rates of older men were in range from 37.3% (bosnia and herzegovina) to 66.9% (albania), while of women from 19.8% to 39.2% in the same countries (figure 1). table 1. employment rate of older workers (55-64 years) in the western balkans, 2007-2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania : : : 48.3 54.7 56.3 51.1 51.2 53.6 : bosnia and herzegovina 31.9 34.4 34.0 26.8 27.0 27.2 27.7 28.5 28.2 36.8 croatia 36.6 37.1 39.4 39.1 38.2 37.5 37.8 36.2 39.2 38.1 montenegro 37.7 34.2 35.6 35.6 34.1 37.0 38.7 39.3 40.0 41.2 republic of macedonia 28.8 31.7 34.6 34.2 35.4 35.4 37.9 38.6 40.1 40.7 serbia 33.5 40.6 39.3 32.9 31.4 31.6 34.3 36.7 37.3 44.2 * the employment rate for 2007, 2008, 2009 and 2016 are for the age group 50-64 years source: eurostat database, employment rates by sex, age and citizenship (%), last accessed: 12.4.2018 if we compare this indicator in eu28 with the western balkan countries, the situation was and remains unfavourable for the second ones. in 2015, the employment rate of the older workers is 53.3% (for men 60.1%, while for women 46.9%). in the observed period the increase of the employment rates of older women in eu28 is also more emphasized and significantly higher than in western balkan countries. figure 1. employment rate of older workers (55-64 years) in the western balkans and eu28, by sex, 2015 source: eurostat database, employment rates by sex, age and citizenship (%), last accessed: 12.4.2018 the lower employment rates of older workers, as well as the discrepancies between western balkan countries are result of a several factors, such as: the different employment sectors, retirement ages, and opportunities for early and partial retirement, retention of older workers, employment policy incentives and incentives to work longer. furthermore, the sectorial distribution has an impact on the employment rates by providing more or fewer opportunities to find a job or to remain employed. considering the intensity of the population ageing in each country, the values of this indicator can be assessed as unfavourable in terms of the social transfers’ sustainability. 4 economic analysis (2018, vol. 51, no. 1-2, 1-17) until 2011, the employment rate of older workers has been evaluated against the target set out in the lisbon strategy and the eu sds, which was to increase the average eu employment rate among older men and women (55 to 64) to 50% by 2010. based on the available data, on eu level the target is met, while none of the western balkan countries (except albania), until 2016 didn’t reach that goal. in the publication titled: employment and social developments in europe 2012 (european commission, directorate-general for employment, social affairs and inclusion directorate a, 2012) is stated that increasing the employment rates of older workers has become a focus of policy actions because it is considered a promising answer to the demographic challenge of structural longevity. a longer working life can both support the sustainability and adequacy of pensions, as well as bring growth and general welfare gains to an economy. with employment rate of older workers of 55.2%, eu is concerned and aware of the importance to increase it. the western balkan countries with lower values of this indicator and intensified demographic ageing have to pay more attention to increase the employment of older workers in order to expect sustainability of the pension systems as one of the key aspects of sustainable development. demography life expectancy the increase of the life expectancy implicates greater and longer demand for pensions, health care and social protections, as well as long term care for the elderly. in terms of identifying the influence of the life expectancy on the sustainable development of a country, it is important to perceive the life expectancy and the healthy life years at age 65 in which one person is capable to have a good and quality life. however, due to the lack of complete and comparable data for the analysed western balkan countries, this analysis refers only to the life expectancy at age 65. therefore, one should have in mind that we are observing the expected years of life, but without knowing how long the people will be in good and healthy condition. the available data on this indicator are from the eurostat database and is referring to the period 2006-2016 for croatia, montenegro, republic of macedonia, serbia and albania for 20142016 (there is no data for bosnia and herzegovina). the expected number of years left to live at age 65 for the total population at this age, in the period 2006-2016 has a tendency of slow, but constant increase in four out of the five analysed countries. it amounts as follows: in serbia for 1.4 years, in croatia 1.3, in montenegro for 1.0 and in the republic of macedonia for 0.9 years. albania in 2016 is characterized with a nearly the same life expectancy at age 65 as it was in 2014 (table 2). having on mind the differences between men and women regarding their health, physical and psychical conditions, it is important to identify the life expectancy at age 65 by sex. this indicator, for men, as well as for women has continuous increase, although, the expected number of years left to live is higher for women. the gap between men and women’s life expectancy in 2016 remains around 3.6 years in croatia, 2.7 in montenegro, 2.5 in serbia, 2.0 in republic of macedonia and 1.5 years in albania. when it comes to the life expectancy of men, in 2016 albania is distinguished with the highest (16.8 years), while macedonia with the lowest life expectancy at age 65 (14.5 years). as for the women, croatia has the highest (19.2 years) and macedonia, again, has the lowest value of this indicator (16.5 years). in 2016 the life expectancy at age 65 in eu28 amounts 20.0 years for the total population, 18.2 for men and 21.6 years for women. life expectancies in the balkan countries (albania, montenegro, republic of macedonia and serbia) are comparable to the life expectancies in the lowest ranked eu member states. verica janeska, aleksandra lozanoska, elizabeta djambaska 5 table 2. life expectancy at age 65, by sex, in the western balkan countries, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 total albania : : : : : : : : 17.6 17.0 17.5 bosnia and herzegovina : : : : : : : : : : : croatia 16.3 16.1 16.4 16.5 16.7 17.0 17.0 17.4 17.5 17.1 17.6 montenegro 15.1 15.2 15.7 15.7 16.3 16.2 16.2 16.3 16.4 16.2 16.1 republic of macedonia 14.6 14.3 14.6 14.9 15.0 15.0 14.9 15.5 15.4 15.3 15.5 serbia 14.6 14.8 15.0 15.0 15.2 15.2 15.4 15.7 15.8 15.7 16.0 males albania : : : : : : : : 16.6 16.2 16.8 bosnia and herzegovina : : : : : : : : : : : croatia 14.2 14.1 14.4 14.5 14.7 15.1 15.0 15.3 15.5 15.2 15.6 montenegro 14.0 14.1 14.5 14.7 15.2 14.9 15.1 15.0 15.1 15.0 14.6 republic of macedonia 13.6 13.3 13.6 13.9 13.9 14.0 13.9 14.4 14.5 14.3 14.5 serbia 13.5 13.6 13.8 13.8 14.0 13.9 14.0 14.3 14.4 14.4 14.6 females albania : : : : : : : : 18.5 17.8 18.3 bosnia and herzegovina : : : : : : : : : : : croatia 17.8 17.8 18.0 18.0 18.2 18.6 18.7 19.1 19.1 18.7 19.2 montenegro 16.0 16.0 16.7 16.7 17.3 17.4 17.2 17.5 17.5 17.2 17.3 republic of macedonia 15.5 15.2 15.6 15.8 16.0 15.9 15.9 16.4 16.2 16.2 16.5 serbia 15.6 15.8 16.0 16.0 16.2 16.3 16.5 16.9 16.9 16.8 17.1 source: eurostat database, life expectancy by age and sex], last accessed: 12.4.2018 the population ageing process and longer life expectancies at age 65 in almost all analysed western balkan countries, may lead to higher public spending on older people. however, elderly people are not just recipients of pensions or long-term health care, rather the public health-care costs for older people depend on their health status. because elderly people are often the ones who provide care for other elderly people, improvements in their health status may mean they are able to provide more care to others (for example, to a spouse or a parent). furthermore, elderly people often engage in volunteer work or help look after grandchildren, thus providing important services to society that would otherwise have to be purchased in the marketplace (doyle, mckee, rechel, grundy, 2009). population growth one of the indicators important for the sustainable demographic development is the population growth, measured through the crude rate of total population change. the data in table 3 shows that in the last decade western balkan countries were faced with unfavourable changes, because majority of them noticed certain population decrease. concerning these data, we should have on mind that maybe they aren’t reflecting the real situation due to the intensified emigration abroad in all these countries and lack of relevant data for its scope. in this terms, striking is the example of republic of macedonia, which according this data have a positive population growth, but in the population estimations the real scope of the emigration abroad is not considered. the available eurostat data shows that in the last decade only in the eu receiving countries the number of macedonian citizens is increased for about 140.000 6 economic analysis (2018, vol. 51, no. 1-2, 1-17) persons. also, significant is their rise in overseas and other receiving countries all over the world. so, there isn’t any doubt that in the analysed period the republic of macedonia has faced negative population growth rates. considering the available data for the crude rates of total population change for the western balkan countries, one can conclude that croatia is distinguished with very unfavourable change due to the most intensive total population decrease (table 3). in the observed period the value of the crude rate of total population change is in range from 0.2% (2006) to -8.7% (2016). similar is the situation in serbia where the value of this indicator is also negative, but the decrease has constant and significant intensity (from -3.8% to -5.1%, respectively). in bosnia and herzegovina, the changes in the population growth are negative since 2010, but less intensified and in 2016 the crude rate of total population change amounts -1.8%. for albania there is a lack of data for some of the years, but in the period 2013-2015 it is also faced with the decrease of the total population. table 3. crude rate of total population change in the western balkan countries, 2008-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 1.1 5.5 4.6 : : : : -1.0 -1.3 -2.2 -3.3 bosnia and herzegovina 0.4 0.0 0.0 0.0 -0.3 -1.0 -0.9 -1.2 -1.5 : -1.8 croatia 0.2 -0.4 -0.5 -1.6 -3.0 -3.2 -3.2 -3.6 -5.1 -8.2 -8.7 montenegro 2.5 1.5 2.6 4.4 1.4 0.7 0.9 1.0 0.9 0.2 0.3 republic of macedonia 1.7 1.6 1.7 2.0 2.2 1.2 1.2 1.7 1.6 1.0 1.2 serbia -3.8 -4.4 -4.2 -3.9 -4.2 -4.8 -4.9 -4.8 -4.5 -5.4 -5.1 source: eurostat database, http://appsso.eurostat.ec.europa.eu/nui/submitviewtableaction.do, last accessed: 24.4.2018 the crude rate of total population change in eu28 despite the oscillations has positive values. the population growth is mainly driven by positive net migration (indicating that immigration is exceeding emigration). since the demographic ageing is accelerating, and under the assumption that fertility will rise but still will remain at a relatively low level, negative natural change (more deaths than live births) would be inevitable in the future. therefore, positive net migration is expected to be only factor contributing to long-term population growth in eu28. quite opposite is the situation in the western balkan countries which are faced with an intensified emigration abroad of young population, which is narrowing the population reproductive base, which implies significantly decreased or negative natural population increase. at the same time, they are challenged with accelerated demographic ageing. so, in near future these countries will face even higher negative crude rates of total population change and very unfavourable demographic situation. total fertility rate the total fertility rate (tfr) is an indicator which shows whether there is a simple reproduction of the population in a country. when the tfr is smaller than 2.1, once all other conditions are unchanged, there is an assumption that the total and working-age population are decreasing. according the available data from eurostat, the western balkan countries are facing with below-replacement fertility, despite the manifested oscillations of the tfr indicator values (table 4). so, there are small changes in the tfr values in the period 2006-2016 and in the position of the separate western balkan countries. in 2006 the numerical values of this indicator are in range from 1.38 (albania) to 1.73 (montenegro), while in 2016 from 1.42 (croatia) to 1.79 verica janeska, aleksandra lozanoska, elizabeta djambaska 7 (montenegro). although with below-replacement fertility montenegro is separated with relatively better position among western balkan countries. the eu28 is also characterized with below replacement fertility, although in the analysed period the value of tfr is increasing (from 1.54 in 2006 to 1.60 in 2016) and is slightly better compared to majority of the western balkan countries (european commission and eurostat, 2011). these changes in the tfr, more or less, are result of the changes in the family structures, influenced by fewer marriages, more divorces and increasing share of children born outside marriage. the possibility of a flexible and less traditional family life seems to have a positive impact on individual child-bearing decisions. also, fertility tends to rise when the welfare of the country is increasing. table 4. total fertility rate in the western balkan countries, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 1.38 : : : : : : : 1.79 1.67 1.56 bosnia and herzegovina : : : : : 1.27 1.24 1.25 1.26 1.31 1.33 croatia 1.47 1.48 1.55 1.58 1.55 1.48 1.51 1.46 1.46 1.40 1.42 montenegro 1.73 1.80 1.89 1.98 1.70 1.65 1.72 1.73 1.75 1.74 1.79 republic of macedonia 1.46 1.46 1.47 1.52 1.56 1.46 1.51 1.49 1.52 1.50 1.50 serbia 1.43 1.38 1.40 1.44 1.40 1.40 1.45 1.43 1.46 1.46 1.46 source: eusrostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tps00199&plugin=1, last accessed: 12.4.2018 *source for bosnia and herzegovina for 2011-2014 http://mecometer.com/whats/bosnia-andherzegovina/total-fertility-rate/, for 2015-2016: http://www.worldometers.info/world-population/bosniaand-herzegovina-population/ the changes in the total fertility rates in the western balkan countries are accompanied by a significant change in the fertility features and determinants. the majority of life births in the western balkan countries were within wedlock. it means that, mainly, fertility decline in the last decades was under the influence of marriages and divorce changes (fewer marriages and more divorces). although, an increase in the number of life births outside marriage is a common feature of the western balkan countries (except bosnia and herzegovina), its share in the total live births is considerably lower than in eu28 (about 40.0% in 2015) and have no significant influence on the fertility increase. concerning the timing of childbearing in western balkan countries evident is the postponement of the first births. changes of the mean age of childbearing are relatively small or insignificant, while mean age of women at the birth of the first child indicates significant increase in all observed countries. regarding this indicators, the panel regression results show that mean age of women at the birth of a first child have statistically a significant impact on the tfr for all western balkan countries (janeska, lozanoska, 2017). migration in analysing the migration in terms of the sustainable development, the crude rate of net migration plus adjustment should be calculated. the available eurostat data for the western balkan countries show that the value of this indicator has been fluctuating over time. so, in three out of six countries it has a negative value over the whole analysed period (2006-2016). they are: montenegro, republic of macedonia and albania. it means that the emigration in these countries is higher than immigration. based on the data from table 5 in montenegro the crude 8 economic analysis (2018, vol. 51, no. 1-2, 1-17) rate of net migration has raised from -0.1 per 1000 persons (2006) to -1.5 per 1000 persons (2016). in republic of macedonia there is a slight decrease of the value of this indicator (from 0.3 to -0.1). the crude rate of net migration has the highest value in albania, where in the period 2013-2015 (for which there is available data) this indicator has decreased (from -6.3 per 1000 persons to -5.7 per 1000 persons). croatia is characterized with positive value of the crude rate of net migration until 2009. after this year the indicator started to fall and in 2016 has reached value of -5.4 per 1000 persons. serbia and bosnia and herzegovina are the only two countries that have positive net migration, but in 2016 it was 0.0 per 1000 persons. having in mind these changes, it can be noted that majority of the western balkan countries have greater emigration than immigration, although not with high scope. but, different studies and data sources show that almost all western balkan countries are facing intensive emigration abroad, which imposes doubt about the relevance of the available data, or possibility that countries doesn’t have complete registration of the people who are emigrating. table 5. crude rate of net migration plus adjustment in the western balkan countries, 20062016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania -4.4 -0.4 -1.7 : : : : -6.3 -6.5 -5.7 : bosnia and herzegovina 0.1 0.3 0.0 0.1 0.1 -0.1 0.0 0.1 0.0 : 0.0 croatia 2.3 2.1 1.4 0.2 -1.0 -0.9 -0.9 -1.1 -2.4 -4.3 -5.4 montenegro -0.1 -1.5 -1.5 0.0 -1.5 -1.5 -1.5 -1.5 -1.5 -1.5 -1.5 republic of macedonia -0.3 0.1 -0.3 -0.3 -0.3 -0.4 -0.5 -0.2 -0.2 -0.2 -0.1 serbia 0.5 0.3 0.4 0.7 0.6 0.3 0.0 0.0 0.3 0.0 0.0 source: eurostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tps00019&plugin=1, last accessed: 12.4.2018 when it comes to the situation in eu28 there is a positive crude rate of net migration, meaning that the number of immigrants is higher than of emigrants, and in 2016 it amounts 3.0%. although, the migrant workers have positive influence on the economies of the receiving countries, the analyses are showing that the sustainability of the public finances can’t rely on the migrations. nevertheless, the strategy of sustainable development of eu recognizes the favourable contribution of the positive net-migration in terms of the challenges imposed by the demographic changes (janeska, 2012). migration affects demographic changes in various ways (postponing population decline, have positive influence on the population ageing, since the migrants usually are younger and have higher fertility rates, increasing the labour market supply, solving specific labour market shortages etc.) (european commission, 2007). since the western balkan countries are facing intensive emigration abroad, it is obvious that they have the opposite situation concerning the consequences of the migration on the sustainable demographic development. these consequences can be seen in the population growth, natural population increase and population ageing. so, as it was mentioned above, migrations have significant influence on the population growth due to a large proportion of children, young working-age population and population of fertile age lives abroad. regarding the consequences to the natural population increase, inevitable is the fact that the share of live births abroad in the total live births is continuously increasing. for illustration, in one research for the republic of macedonia, for the purpose of identifying the factors which influence the natural population increase of the migration contingent in germany, switzerland and italy, the correlated component regression is used. the results from the calculations are implying that the share of the macedonian live births in these three countries in the total verica janeska, aleksandra lozanoska, elizabeta djambaska 9 number of live births in the country, is significantly correlated with the increase of the share of total number of migrants in the total population of the republic of macedonia, as well as with the participation of women in these countries in the total women population in the republic of macedonia (janeska, lozanoska, djambaska, 2016). the consequences on the demographic ageing process in the western balkan countries are also very concerning. in situation, when the emigration of the young population is significantly intensified, the ageing process in these countries is accelerating. demographic ageing has numerous implications, and one of them is the increase of the old age dependency ratio. old age dependency ratio the old age dependency ratio is an indicator of the balance between the older population and the working-age population. it gives information about the potential pressure of the population aging on the public finances. it is determined by the age limit for retirement, by the level at what the pension system depends on the paid contributions or the public financing. the high value the old age dependency ratio implies great burden on the pension system which is based on the paid contributions, especially in terms of lower age limit for retirement. this indicator also gives information about the sustainability of the pension system in terms of the current demographic changes and the expected increase of the public consumption in the future decades. the available data on the old age dependency ratio in the western balkan countries shows that in all of them the value of this indicator is increasing (table 6). the highest increase is characteristic for albania, where from 13.1% (2006) it rose to 18.5% (2016). relatively higher increase is noticed in the republic of macedonia, from 16.0% to 18.5%, respectively. in the rest of the analysed countries the increase is around 10%. it is very important to notify that croatia and serbia are differentiating from other western balkan countries with the highest old age dependency ratio during the whole observed period. it is in range from 26.3% (2006) to 29.0% (2016) in croatia and from 25.1% (2010) to 28.5% (2016) in serbia. in the eu28 the old-age dependency ratio in the period 2006-2016 is significantly increasing from 25.0% to 29.3%. population projections point towards even stronger dependency of older people on persons of working age, as the ratio is expected to increase up to 50% in 2060. the trend towards a growing share of older people (aged 65 and over) in the total population and shrinking working-age population (15-64 years) has been observed for a long time. population ageing is a major driver of the expected increase in pension expenditure in the eu (eurostat, 2015). table 6. old-age-dependency ratio (per 100 persons) in the western balkan countries, 20062016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 13.1 13.3 : : : : : : 17.5 18.0 18.5 bosnia and herzegovina : : : : : : : : : : : croatia 26.3 26.5 26.7 26.8 26.7 26.5 26.7 27.1 27.6 28.3 29.0 montenegro 19.1 19.2 19.3 19.2 19.1 18.9 19.0 19.2 19.6 20.2 20.8 republic of macedonia 16.0 16.0 16.2 16.3 16.4 16.5 16.6 16.9 17.5 18.0 18.5 serbia 25.7 25.6 25.6 25.4 25.1 25.1 25.3 25.9 26.7 27.5 28.5 source: eurostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tps00198&plugin=1, last accessed: 12.4.2018 the high values, as well as the increase of the old age dependency ratio, in all western balkan countries implies heavier burden on the working-age population to provide social expenditure 10 economic analysis (2018, vol. 51, no. 1-2, 1-17) to support the ageing population. therefore, the countries should (if they didn’t) undertake reforms to limit the increasing effect of a population ageing on public pension expenditure. these reforms should include cancelation or restriction of the early retirement schemes, increasing the statutory ages or providing incentives to stay in the labour market beyond the legal retirement age on a voluntary basis. old-age income adequacy the old-age income adequacy measured through the aggregate replacement ratio is gross median individual pension income of the population aged 65-74 relative to gross median individual earnings from work of the population aged 50-59, excluding other social benefits. considering the available data on this indicator for the western balkan countries, i.e. the lack of data for all countries and for the complete analysed period, the comparison is difficult to be made. therefore, the analysis is focused only on identifying the changes and current situation in the countries for which there is available data. according the data in table 7, among the three countries for which there is a comparable data on this indicator, republic of macedonia has the highest aggregate replacement ratio, which increased from 55% (2012) to 72% (2016). it means that in 2016 the pensioners aged 65-74 had on average incomes equal to 72% of the average earnings of people close to retirement (aged 50-59). in serbia the value of this indicator in the period 2013-2016 is around 47%. for croatia there is data for longer period (2010-2016) and according it, the aggregate replacement ratio had a continuous increase until 2015 (from 0.32% to 0.40%), in 2016 the pensioners aged 65-74 had on average incomes equal to 39% of the average earnings of people close to retirement (aged 50-59). table 7. aggregate replacement ratio (in %) in the western balkan countries, 2010-2016 2010 2011 2012 2013 2014 2015 2016 albania : : : : : : : bosnia and herzegovina : : : : : : : croatia 0.32 0.36 0.36 0.37 0.40 0.40 0.39 montenegro : : : : : : : republic of macedonia : : 0.55 0.60 0.65 0.70 0.72 serbia : : : 0.49 0.47 0.47 0.47 source: eurostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tespn070&plugin=1, last accessed: 12.4.2018 the average income of people aged 65 and over in the eu28 relative to the earnings of people in their 50s has increased by six percentage points in the period 2010-2016. this increase, as well as the increase of the value of this indicator in the western balkan countries is a result of the same changes in the demographic structure of the population by age. given the pressure on pension funds due to the effects of demographic ageing, it is very unlikely that pensions of elderly people would actually increase. the increase in the replacement ratio might rather be a result of decreasing incomes of the working-age population. besides addressing poverty, pension systems play a role in allowing retirees to maintain adequate living standards comparable with those achieved during their working lives (eurostat, 2015). over the past decade most of the western balkan countries have reformed their pension systems to improve their medium and longer term sustainability as a precondition for delivering on adequacy objectives. however, the countries have to face trade-offs and difficult choices when trying to reconcile and optimize sustainability and adequacy concerns. achieving the goal verica janeska, aleksandra lozanoska, elizabeta djambaska 11 of cost-effective and safe delivery of adequate benefits that are sustainable is quite challenging (european commission, 2012). public finance sustainability government debt when it comes to the public finance sustainability in terms of the sustainable demographic development, the government debt as a percentage of gdp is an important indicator to be considered. based on the available and comparable data for the period 2006-2016 in all western balkan countries, the general government gross debt as a percentage of gdp, although with some oscillations, has a tendency of increase (table 8). the highest increase of 45.5 percentage points is characteristic for croatia, while the lowest for macedonia 8.1 percentage points. in the rest of the western balkan countries it is as follows: montenegro for 35.0 percentage points, serbia for 33.8, bosnia and herzegovina for 23.2 and albania for 14.8 percentage points. it is very important to point out that there is an eu reference value for the government debt of 60% of gdp.2 considering the available data on the western balkan countries, only in bosnia and herzegovina and in the republic of macedonia the value of this indicator didn’t reach that threshold. in the other countries, although in different year, the reference value of the government debt is exceeded. the general government gross debt in the eu28 has also increased sharply from 60.1 % in 2006 to 86.7 % in 2014. in 2016 it reached 83.5%. the big changes with this indicator happened after 2009, and were result of the economic crisis. unfortunately, there have been no signs of recovery since the onset of this crisis. in eu28 the government debt is exceeding the eu reference value starting from 2006 (except in 2007) (eurostat database, 2018). table 8. general government gross debt as a % of gdp in western balkan countries and eu28, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 56.7 53.6 55.1 59.7 57.7 59.4 62.1 70.4 72.0 73.7 71.5 bosnia and herzegovina 21.2 18.7 30.9 35.1 42.8 43.1 43.4 44.5 45.0 45.4 44.4 croatia 38.9 37.7 39.6 49.0 58.3 65.2 70.7 82.2 86.6 86.7 84.4 montenegro 36.3 31.0 32.1 41.4 43.7 48.6 56.9 58.7 63.4 69.3 71.3 republic of macedonia 30.6 23.5 20.6 23.6 24.1 27.7 33.7 34.0 38.1 38.2 38.7 serbia 40.3 33.4 32.4 36.0 43.7 46.6 57.9 61.1 71.9 76.0 74.1 source: the world bank data, https://data.worldbank.org/indicator/gc.dod.totl.gd.zs?locations=al, last accessed: 10.4.2018 the increase of the government debt as a percentage of gdp is a consequence of several factors: revenue shortfalls due to the decline in the economic activity, measures to support the economy, including large-scale interventions to support the financial sector, as well as the effect of negative or very low economic growth (eurostat, 2015). recognizing that high levels of government debt are not sustainable in the long-term, the western balkan countries should put greater emphasis on reviving their economic growth. 2 the current provisions are defined in the 2012 consolidated version of the treaty on the functioning of the european union (http://eur-lex.europa.eu/legal-content/en/txt/?uri=celex:12012e/txt). 12 economic analysis (2018, vol. 51, no. 1-2, 1-17) retirement regarding the sustainable demographic development one of the key aspects is the retirement. it can be explained with the duration of working life (in years). in the eurostat database there are available data on this indicator only for three out of six western balkan countries. so, according to this data, the duration of working life is increasing (table 9). it is highest in croatia and lowest in the republic of macedonia. however, the differences among these three analysed countries aren’t very big, since this indicator is between 30-32 years in croatia and macedonia, and a little bit lower in montenegro (28-30 years). when it comes to the duration of working life it is important to see the differences by sex. in the western balkan countries, the number of years a person could be expected to be active in the labour market throughout his or her life, in the analysed period, was always higher for men. for illustration, in 2016 in croatia the duration of working life for men was 33.9 and for women 30.2 years, while for macedonia 37.2 and 24.4 years, respectively. a slight convergence between the two sexes is visible over time, meaning that the gap is narrowing. in eu28 the changes in this indicator are relatively similar. it means that the number of years a person could be expected to be active in the labour market is increasing. for example, from 33.8 (2006) to 35.6 years (2016). the duration of working life is higher for men than for women. also, the differences according this indicator between men and women are tightening, because this number for men has increased from 36.9 (2006) to 38.0 years (2016), while for women from 30.6 to 33.1 years, respectively. table 9. duration of working life (in years) in western balkan countries and eu28, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania : : : : : : : : : : : bosnia and herzegovina : : : : : : : : : : : croatia 31.2 31.5 31.7 31.8 31.6 31.4 31.2 31.1 32.3 32.6 32.2 montenegro 27.8 28.7 28.7 30.1 30.8 31.2 republic of macedonia 30.0 30.2 30.6 30.9 31.1 31.1 30.9 31.3 31.3 31.2 31.0 serbia : : : : : : : : : : : source: eurostat database, http://appsso.eurostat.ec.europa.eu/nui/show.do?dataset=lfsi_dwl_a&lang=en, last accessed: 23.4.2018 the world has largely focus attention on the pension system, because of the increasing need to cover pension benefits of socially excluded groups and provide all conditions to enable older population, economic independence and the necessary conditions for living standards. worldwide, 25% of the population covered by adequate social protection, and half has no social protection. the level of social protection depends on the level of gdp, employment rates in the relevant sectors of the economy, the share of self-employed in the labor market. in order to overcome the problem of social protection recommended modification of the contribution rate to social security, to be available to many socially disadvantaged, i.e. pension insurance are recommended and structural reforms in the macroeconomic environment in order to create conditions for the functioning of the pension system (đukić, balaban, radisavljević, 2017). challenges and policies of the sustainable demographic development the small population growth and the intensive demographic aging, which assumes decrease of the working-age population, as well as the increase of the life expectancy, accompanied with low fertility rates, undoubtedly will have unfavourable influence on the economic growth and sustainable demographic development of the western balkan countries. it is real to expect that verica janeska, aleksandra lozanoska, elizabeta djambaska 13 these changes will significantly influence the sustainability of the pension systems and the provision of the health and social protection for the older population, on middle and long-term. the need to anticipate these changes is especially emphasized in the terms when they can’t be compensated by postponed retirement and labour force immigration, which can jeopardy the sustainable development and the welfare of the population. the analysis of the available indicators important for the sustainable demographic development gives relevant knowledge for the current conditions and expected changes. in these terms, the main challenges of the sustainable demographic development can be identified. these challenges are as follows. it is necessary to apply more implicit measures of the population policy which can provide higher and sustainable increase of the fertility rates. also a set of policies and measures directed towards decrease of the emigration abroad of highly educated young population, especially in terms when there is a large number of unemployed with high educational level, should be adopted. it is very important to increase the employment rates, including those of the older workers, which is the key assumption to provide sustainability of the social transfers in the future. no less significant is the restructure of the social protection system, since it is expected the contingent of elderly to be significantly increased. the demographic changes in the western balkan countries in the last decades are being watched in absence of appropriate population policy which can direct them, regardless of the manifested unfavourable changes in the natural and migration movements of the population. the need for comprehensive population policy in the western balkan countries was identified in the sixties and seventies of the last century, anticipating the possible consequences of the demographic changes on the economic and social development. unfortunately, the creators of the population policy didn’t recognize the significance of this question, neglecting the long-term consequences and implications of the population development. the insights in the population policies show that in most of the balkan countries the "major" concern about population ageing appears earlier than the concern for "too low" fertility. the western balkan countries have policies related to fertility: with the purpose to "raise" it, and one (albania) to "maintain" its level. only bosnia and herzegovina government preferred "no intervention" (un, world population policies database, 2018) the current demographic situation indicates delayed fertility policies, measures and activities with relatively small effects on fertility "raise". experiences show that policies designed to increase fertility have only had limited success. so, the western balkan countries should design fertility policies to their specific pathways to low fertility and the social, economic and institutional environment in which fertility behaviour occurs. in circumstances when the importance of the biological factors is declining, they should pay more attention on the socioeconomic determinants of the fertility decrease and its complexity. in this respect recommendations in four areas of intervention are pointed out. related to pro-natalist policies measures should be more complex and focused on the socio-economic factors that determine childbearing postponement to older ages. financial incentives should be better targeted and focused on reduction of the opportunity cost of having children. because marriages are still an important determinant of fertility increase, the western balkan countries must pay more attention on family friendly policies with consistent measures and activities. also, the western balkan countries should implement proper policies concerning work-life balance, because the compatibility between childbearing and labour force participation of women is one of the key determinants influencing fertility (janeska, lozanoska, 2017). ageing will pose a challenge for government finances and social programmes. on the one hand, as the proportion of individuals of working age declines, so will government revenues from employment taxes and the growing number of elderly will need health care. in many advanced economies, pension systems risk bankruptcy. these problems can be tackled by policy reforms, such as changing employment, pension and tax policies. the decline in working-age populations could slow economic growth. indeed, the economist intelligence unit's economic 14 economic analysis (2018, vol. 51, no. 1-2, 1-17) projections for croatia and serbia to 2030 take this factor into account, and on this basis predict a decline in the rate of economic growth in these countries (european environment agency. 2010). in the present conditions, when the working-age population is under the continuous pressure to provide the social expenditures for support of the ageing population, it is necessary to take policies and actions for the elderly. this means to provide incentives the elderly to work longer, to increase the retirement age and continuous to develop their skills and lifelong learning. healthy public finances, reflected by general government gross debt, are essential to meet the needs of ageing populations and to promote economic growth while preventing debt from being handed down to future generations. in addition to pensions, which make up a big part of public expenditure, other expenditure might be needed to provide adequate old-age care and social protection. with an ageing population, the western balkan countries are facing trade-offs between pensions that are sustainable, on the one hand, and adequate, on the other. besides addressing poverty, pension systems play a role in allowing retirees to maintain living standards comparable to those achieved during their working lives, thus preventing social exclusion of the elderly. the shift towards longer working lives (later retirement) in the western balkan is essential to support the sustainability and adequacy of pension systems. conclusion the western balkan countries are facing major demographic changes, including decreasing of the population growth rate due to the below replacement fertility rates, an ageing population accompanied with increase of the life expectancy at age 65 and old-age dependency ratio, changing family structures and intensified emigration abroad. since 1990, western balkan countries have lost around a tenth of their populations. they could lose another 14 percent of their current populations by 2050, not least because of emigration, especially of young people. the low fertility rates of around 1.3 children per woman are another contributor to the rapid shrinkage of the populations of the west balkan states. at the same time, those populations are aging rapidly: while today around 15 percent of inhabitants are at least 65, this figure will probably rise to 26 percent by mid-century. in future, providing adequately for the growing number of old people is likely to pose a major challenge for the comparatively poor countries of the western balkans (sievert, s. at al. 2017). these changes have imposed serious challenges for the economic, social and sustainable demographic development. based on the analysis on the available demographic indicators in terms of the sustainable demographic development, several relevant conclusions can be made. the demographic changes in the western balkan countries can be assessed as unfavourable due to the negative changes which are characteristic for the majority of these indicators. although is characterized with increase, the employment rate of older workers is still relatively low, which imposes the question of the social transfers’ sustainability on medium and long term. the population ageing process and longer life expectancy at age 65 in almost all western balkan countries, mean that the public expenditures for pensions and for health and social protection will increase. however, one should consider that although the elderly are recipients of the previously mentioned public spending, significant amount of these costs depends on their health and social status. according the available data on the population growth seen through the crude rate of total population change, most of the western balkan countries are facing negative trend of this indicator, i.e. a decrease. this changes are expected since most of them are facing intensive emigration abroad, especially of young population, which is shrinking the population reproductive base and consequently results in decrease or negative natural population increase. verica janeska, aleksandra lozanoska, elizabeta djambaska 15 that is implicating very concerning demographic situation in the future demographic development of these countries. the total fertility rate (tfr) although has a tendency of increase, shows that in all western balkan countries there isn’t a simple reproduction of the population, i.e. that they are facing below replacement fertility. this implicates further decrease of the total population. the most important determinants of low tfr in these countries are the changes in the marriages and divorces, the postponed timing of childbearing, and the mean age of women at the birth of first child which is significantly rising. recent studies show that the western balkan countries are characterized with significant intensification of the emigration abroad. the emigration abroad implicates large proportion of children, young working-age population and population of fertile age to live abroad. it causes the population growth of the western balkan countries to decrease, their natural population increase to be negative and the demographic aging to accelerate. the shrinking proportion of the working-age population combined with the rising number of retirees puts pressure on public finances. this is reflected by the old-age dependency ratio, which has been continuously increasing over the last decade in all western balkan countries. these changes impose heavier problem for the working-age population to provide social expenditures to support the elderly. in these terms, the old-age income adequacy, measured through the aggregate replacement ratio is important indicator for the sustainable demographic development, but moreover for sustainability of the pension systems. the average income of people aged 65 and over relative to the earnings of the people in their 50s has increased in almost all western balkan countries. since, these countries are facing great pressure on their pension systems and it is very unlikely that the pensions will actually increase, it is necessary for the western balkan countries to start or to continue reforming their pension systems in order to provide their medium and long term sustainability. the government debt as a percentage of gdp is increasing in all western balkan countries. the available data shows that only in bosnia and herzegovina and in the republic of macedonia the value of this indicator didn’t reach the eu reference value (the government debt of 60% of gdp), while in the other countries, although in different years, it is exceeded. the high levels of government debt are not sustainable in the long-term, and the western balkan countries should put greater emphasis on intensifying their economic growth. but, due to the demographic changes, particularly the intensified emigration abroad, the growth should be achieved in terms of reduced human capital, which is one of the most important factors for economic development of these countries. all above mentioned demographic changes have more or less significant impact on the sustainable demographic development of the western balkan countries. since, all these countries are facing the increased impact of population aging on the public expenditures and on the pension system sustainability, it is an imperative for them to take consistent and comprehensive population and fertility policies, with particular attention on the emigration abroad. main challenges of the sustainable demographic development in the western balkan countries are the following: application of more implicit measures of the population policy to stimulate the fertility rates increase; decrease of the emigration abroad, especially of the highly educated and young persons; increase of the employment rates, including those of older workers; restructure of the social protection system, particularly for the older population, in context of its expected increase. development has been equated with the economic growth for decades, where the increase in the gross national product (gnp) per capita has been an indicator of the increase in the quality of people’s life. although economic growth is certainly a necessary condition for increase in personal well-being, it however does not necessarily correspond with the improvement of people’s life conditions. for example, it is noticed that, in some countries, relatively high level of gross national product gnp per capita is not followed by the high quality of life as expressed in 16 economic analysis (2018, vol. 51, no. 1-2, 1-17) terms of life expectancy, adult literacy, and infant mortality (radovanović, 2017). it implies the need for different approach to the demographic issues and more resources for implementation of the demographic policies, considering the importance of the sustainable demographic development for the economic development. having in mind the current demographic situation in the western balkan countries it is even more emphasized. references doyle, y., mckee, m., rechel, b., grundy, e. 2009. “meeting the challenge of population ageing”. bmj (clinical research ed.), 339. b3926. issn 0959-8138 doi: 10.1136/bmj.b3926 đukić, g., balaban, m., radisavljević, g. 2017. “the macroeconomic framework of the functioning of public compulsory pension insurance”. economic analysis, [s.l.], v. 50, n. 1-2, p. 26-37, oct. 2017. issn 2560-3949. available at: <http://www.library.ien.bg.ac.rs/index.php/ea/article/view/342>. date accessed: 31 may 2018. european commission. directorate-general for employment, social affairs and inclusion directorate a. 2012. “employment and social developments in europe 2012”, brussels. european commission. 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macedonia”. proceedings of the scientific symposium in honour of the 100th birth anniversary of academician kiril miljovski (1912-1983). macedonian academy of sciences and arts. ss. cyril and methodius university in skopje. faculty of economics-skopje. skopje. p. 171-190 verica janeska, aleksandra lozanoska, elizabeta djambaska 17 muenz, r. 2007. “aging and demographic change in european societies: main trends and alternative policy options”. sp discussion paper no.0703. hamburg institute for international economics. p. 1 radovanović, bojana. 2017. “well-being – resources, happiness and capabilities: theoretical discussions and the evidence from the western balkans”. economic analysis, [s.l.], v. 46, n. 34, p. 152-163, oct. 2017. issn 2560-3949. available at: <http://www.library.ien.bg.ac.rs/index.php/ea/article/view/265>. date accessed: 31 may 2018 sievert, s. at al. 2017. “europe’s demographic future-where the regions are heading after a decade of crises”. berlin institute for population and development. p.138 un world population policies database. 2018. http://www.un.org/en/development/desa/population/publications/policy/worldpopulation-policies-2013.shtml last accessed: 28.4.2018 article history: received: april 30, 2018 accepted: june 1, 2018 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp92-103 scientific paper panel cointegration analysis of total environmental taxes and economic growth in eu countries vera mirović1 | branimir kalaš1* | nada milenković1 1 university of novi sad, faculty of economics in subotica, department for finance and accounting, subotica, serbia abstract the paper investigates the nexus between total environmental taxes and economic growth for twenty-eight eu countries from 1994 to 2018. the objective of this research is to evaluate the longrun relationship between these variables based on panel data analysis. the analysis includes panel cointegration test as well as panel ordinary least squares such as dols and fmols models. the results identify long-run relationship between total environmental taxes and economic growth in selected countries. likewise, there is a significant relation running from total environmental taxes to economic growth measured by gross domestic product rate. empirical findings confirm that revenue of environmental taxes have positive impact on economic growth measured by gross domestic product rate. key words: environment taxation, economic growth, panel cointegration, eu countries jel classification: e60, h23, q5 introduction – theoretical background economic growth has become the basic aim of developing countries without adequate consideration of environmental issues (mitić et al. 2019). however, as environmental issues become more relevant, governments have realized the significance of balanced economic and environmental development (gao et al. 2019). pautrel (2009) argue that effect of the environmental policy can have positive implications to the economy when impacts of pollution on health are reduced. zhou et al. (2020) detected that an increase in environmental tax rate can reduce the use of polluting consumer goods by households as well as investment in polluting factors by companies. likewise, their growth can negatively impact employment, income and economic growth and include both effects: substitution effect and income effect on household consumption. likewise, wesseh et al. (2017) highlight that tax policy is often more efficient or less distorted than direct regulation. accordingly, taxes are effective tools to modify consumers' behaviour in terms of sustainability (kosonen and nicodème, 2009). for most environmental problems, adequately determined fiscal policy is the most natural tools for including environmental detriment into the products price and non-market actions (heine et al. 2012). stram (2014) determined that tax revenues enables stability and support for research focused on energy sources and emissions reduction in the long-run. according that, many economists and international institutions determine environmental taxes as the most efficient market-based * coressponding author, e-mail: branimir.kalas@ef.uns.ac.rs vera mitrović, branimir kalaš, nada milenković 93 tools (lin and li, 2011). mirović et al. (2019) highlight that tax forms should take an important place in the economic policy of each country. the findings of castiglione et al. (2014) suggest that countries should take advantage of the relationship between economic growth and institutional enforcement ie, the nexus between economic development and environmental awareness in order to provide an adequate environmental tax policy. environmental taxes enhance the costs and price products for the environment and decrease the pressure on it. (piciu and trică, 2012) where davidović et al. (2019) determined environmental taxes as crucial for more effective environmental protection. andrei et al. (2016) emphasized that environmental taxes have significant impact on economic sustainability in post-transition countries. environmental taxes are increasingly considered as essential part of the economic policy where their proper design can enable economic incentives, dynamic innovation. it implies that these taxes help achieving economic, social and environmental benefits (withana et al. 2014). accordingly, environmental taxes have a more relevant role in europe and especially in the scandinavian economies compared to the rest of the world at the beginning of the 2000 (radulescu et al. 2017). also, bachus et al. (2019) determined that taxes are robust tool for reducing complex environmental problems in the world. labeaga and labandeira (2020) defined environmental taxes such as cost-effective corrective approach which contributes development and uses clean technologies. liobikiene et al. (2019) argue that environmental taxes are imposed with the aim to decrease negative effects to environment. on the other hand, borozan (2018) argue that energy taxes are not efficient policy tool for directly effecting electricity consumption due to various subventions and exemptions through european union. vukadinović and ješić (2019) cite that ecological modernization that includes carbon tax, a decline of labour costs and subsidies for research and development. tantau et al. (2018) determined significant impact of environmental tax revenues in european union to recycling rate of municipal waste for the period 2010-2014. further, aubert et al. (2019) point out regressive effect of indirect taxes where environmental taxation decreases consumers’ purchasing power and has regressive implications to poor consumers compared to rich. the nexus between the environment and economic growth is one of the most essential relation for policy makers (mitić et al. 2017). the standard way to evaluate economic success is by measuring economic growth (petrov and trivić, 2018). analyzing causality between environmental taxes and economic growth, in oecd countries from 1995 to 2006, morley and abdullah (2010) identified long-run causality between economic growth and environmental taxation. likewise, this analysis manifested short-run causality between these variables in the reverse direction. liang et al. (2007) and highlight that effect of carbon tax may depend on the economic conditions of an economy. hájek et al. (2019) indicate that it’s more environmentally efficient if taxes have been collected for a longer time. dökmen (2012) researched the relationship between environmental taxes and economic growth in twenty-nine eu countries for the period 1996-2010. the results of panel vector autoregressive models identified positive and statistically significant effect of environmental taxes on economic growth in these countries for the observed period. abdullah and morley (2014) investigated causality between environmental taxes and economic growth in eu countries and oecd countries for the period 1995-2006. empirical results showed long-run causality running from economic growth to increased environmental tax revenues, as well as, short-run causality in the reverse direction. loganathan et al. (2014) analysed the relationship between carbon taxation and economic growth in malaysia from 1974 to 2010. their findings suggest that there is bidirectional causality between these components for the analysed period. li and masui (2018) found that the environmental tax and carbon tax would lead to a gdp loss of 0.1% to 0.67% and highlighted that energyintensive sectors will have bigger damage compared to service sector and agriculture that will have a small growth. he et al. (2019) confirmed that environmental taxes are cointegrated with energy consumption, economic growth, and co2 emissions in china, finland and malaysia. 94 economic analysis (2021, vol. 54, no. 1, 92-103) similarly, busu and trica (2019) revealed significant and positive effect of environmental taxes on economic growth in eu countries for the observed period 2010-2017. the need for research is manifested in providing information support and giving guidance to economic policymakers in eu about the long-run relationship between total environmental taxation and economic growth in these countries. it implies that fundamental goal of this research is to reveal are environmental taxes significant for economic growth in eu countries. the structure of this paper is as follows. after the introduction and definition of necessity of environmental tax approach, there is an analysis of environmental taxes and gross domestic product in eu countries from 1994-2018. the greatest part of this research includes empirical analysis and results which consist panel cointegration tests and different panel models such as pols, dols and fmols. the last segment includes summarizes and conclusion about cointegration between total environmental taxes and economic growth in eu countries from 1994 to 2018. the necessity of environmental tax approach and double dividend hypothesis over the last three decades, ecological modernisation has emerged as a strong political discourse in which economic growth, environmental protection as well as energy security are jointly intensifying (machin, 2019). the government should implement stricter and more comprehensive system of environmental policy in order to provide future sustainable development. it implies reasonable tax system and design of ecological policy system based on neutrality (yang et al. 2019). according to european environmental agency green taxes are classified into three categories: cost-covering charges, incentive taxes and fiscal environmental tax forms (european environmental agency, 1996). the main purpose of cost-covering charges is covering the costs of regulation and control and implies that users pay for consumption of environmental resources. further, incentive taxes are created in line with pigouvian tax where core idea is to change the behaviour of the polluter in the long-term. fiscal environmental taxes are main driving force of green tax reforms where highlight the tax for use of resources without significant change to the budgetary balance (maxim and zander, 2019). environmental taxation has been increasingly seen as an effective economic tool to make incentives in terms of cleaner production and consumption habits (freire-gonzález, 2018). own resources based on taxes for the european union can be a powerful tool to the current lack of sustainability because they have the potential to cover existing sustainability gaps in tax systems in the eu (krenek and schratzenstaller, 2017). there is a growing consensus that environmental taxes are not only a promising instrument to reducing environmental effects, but also a way to increase public revenues and decrease fiscal pressure (freire-gonzález and ho, 2019). alexeev et al. (2016) argue that an emissions taxes are used as an environmental policy instrument to decline environmental damages. bachus et al. (2019) highlight an importance of recycling the revenues from an environmental tax reform and defined a “ladder of acceptability of revenue recycling options” based on: a) financing special environmental programmes; b) reducing taxes on labour, consumption, corporate income, property or other distortionary taxes; c) returning the additional tax forms from one sector to that same sector in a way that is not proportional to the emissions, pollution or resource use; d) eliminating regressive effects of the environmental taxes; e) reducing public debt or adding to the general budget. kirchner et al. (2019) provided that carefully designed tax policy about co2 can potentially enable an equitable double dividend, where the double dividend hypothesis implies the possibility of realizing economic and environmental benefits as a result of implementing an environmental tax policy and recycling revenues (wesseh et al. 2019). this theoretical approach is a widely examined topic that considers the possibility of producing additional economic benefits using environmentally beneficial tax measures (maxim and zander, 2019). the early version of the double dividend hypothesis can also be determined as the efficiency double vera mitrović, branimir kalaš, nada milenković 95 dividend in which the essence was that green tax reform can decrease pollution and increase economic efficiency (maxim et al. 2019). double dividend hypothesis arises from progress of the environmental conditions as a result of environmental tax incentives as well as improvement of economic conditions due of the shift from high distorting taxes to less distorting taxes (freiregonzález, 2018). sasmaz (2016) examined the effect of environmental tax reforms on environment and employment in fifteen countries in eu (austria, belgium, denmark, finland, france, germany, greece, ireland, italy, luxembourg, the netherlands, portugal, spain, sweden, united kingdom) for the period 1995-2012. using panel cointegration and fully modified ordinary least square tests, this analysis showed the validity of double dividend hypothesis in these countries. methods and materials in this research twenty-eight eu countries are analysed for the period 1994-2018. the research used eurostat for environmental taxation and imf for gross domestic product. in order to stationary, panel unit root tests are applied for selected variables. after we determined that variable are stationary at first difference and integrated of order one process or i(1), we have applied cointegration analysis. after identifying long-run relation between variables, an analysis has included different panel models such as pols, dols and fmols. before presenting panel cointegration estimation it is necessary to develop research hypothesis which is defined as follows: h1: environmental taxes have significant and positive impact on economic growth in eu countries. panel cointegration test is often used to identify a potential long-run relation between two or more variables. the long-run relationship implies the variables move together over time. the panel cointegration test allows for cross-sectional interdependence with both different individual effects and deterministic trends can be determined as follows: lnyit = αit δit  βilneit εit (1) εit=ρitεit-1 + uit (2) where i = 1,…n reflects the panel member, t = 1,…t refers to the time period, y reflects the gdp, tet reflects the total environmental taxes and βi reflects the slope coefficient. the parameters αit and δi allow for possibility of country-specific effects and deterministic trend effects, where εit manifests the evaluated residual deviations from the long-run relation (adhikari, chen, 2012). empirical analysis and results this segment includes analysis trend of gross domestic product rate and total environmental taxes from aspect of their share and collected revenue from 1994 to 2018. after that, empirical study implies panel cointegration tests and three models such as pols, dols and fmols. 96 economic analysis (2021, vol. 54, no. 1, 92-103) -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 austriaaustria -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 belgiumbelgium -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 bulgariabulgaria -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 croatiacroatia -8, 000 -4, 000 0 4, 000 8, 000 12, 000 1995 2000 2005 2010 2015 cypruscyprus -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 czech rczech r -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 denmarkdenmark -20, 000 -10, 000 0 10, 000 20, 000 1995 2000 2005 2010 2015 estoniaestonia -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 finlandfinland -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 franc efranc e -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 germanygermany -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 greecegreece -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 hungaryhungary -10, 000 0 10, 000 20, 000 30, 000 1995 2000 2005 2010 2015 i relandi reland -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 i talyi taly -20, 000 -10, 000 0 10, 000 20, 000 1995 2000 2005 2010 2015 latvialatvia -20, 000 -10, 000 0 10, 000 20, 000 1995 2000 2005 2010 2015 l ithuanial ithuania -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 l uxembourgl uxembourg -4, 000 0 4, 000 8, 000 12, 000 1995 2000 2005 2010 2015 maltamalta -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 netherlandsnetherlands 0 2, 000 4, 000 6, 000 8, 000 1995 2000 2005 2010 2015 polandpoland -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 portugalportugal -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 romaniaromania -8, 000 -4, 000 0 4, 000 8, 000 12, 000 1995 2000 2005 2010 2015 slovakiaslovakia -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 sloveniaslovenia -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 spainspain -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 swedensweden -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 united kingdomunited kingdom figure 1. gdp rate in eu countries source: authors calculation based on imf although gross domestic product is being criticized for not adequately representing social welfare in terms of development, the gdp is a dominant and widely used indicator for measuring economic activity (sanyé-mengual et al. 2019). the gross domestic product in the european union was around 13.94 trillion euros which reflects the total value of all goods and services produced in eu countries. figure 1 shows trend of gdp rate in eu countries for the period 19942018. the average gdp rate was 2.68%, where ireland had the highest average gdp rate of 6.05% during observed period. on the other hand, italy had the smallest average gdp rate of 0.69%. analyzing by countries, estonia, lithuania and slovakia had average gdp rate above 4%, while other countries had smaller growth rate of gross domestic product. the level of average gdp rate of 2% was recorded in latvia, luxembourg, malta and romania, while most of countries had mean gdp rate around 2%. twelve of twenty-eight economies had mean gdp rate below eu average, while greece and italy recorded average gdp rate below 1%. vera mitrović, branimir kalaš, nada milenković 97 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 aus tri aaus tri a 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 bel gi u mbel gi u m 0. 5 1. 0 1. 5 2. 0 2. 5 3. 0 3. 5 1995 2000 2005 2010 2015 bu l gari abu l gari a 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 c ro ati ac ro ati a 2. 0 2. 4 2. 8 3. 2 3. 6 4. 0 1995 2000 2005 2010 2015 c yp ru sc yp ru s 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 cz ech rcz ech r 3. 5 4. 0 4. 5 5. 0 5. 5 1995 2000 2005 2010 2015 den m arkden m ark 0. 5 1. 0 1. 5 2. 0 2. 5 3. 0 1995 2000 2005 2010 2015 es to n i aes to n i a 2. 4 2. 6 2. 8 3. 0 3. 2 3. 4 1995 2000 2005 2010 2015 fi n l an dfi n l an d 1. 8 2. 0 2. 2 2. 4 2. 6 1995 2000 2005 2010 2015 fran cefran ce 1. 6 1. 8 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 germ anygerm any 2. 0 2. 5 3. 0 3. 5 4. 0 1995 2000 2005 2010 2015 greecegreece 2. 0 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 hu ngaryhu ngary 1. 5 2. 0 2. 5 3. 0 3. 5 1995 2000 2005 2010 2015 irel an direl an d 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 ital yital y 0 1 2 3 4 1995 2000 2005 2010 2015 latvi alatvi a 1. 6 2. 0 2. 4 2. 8 3. 2 1995 2000 2005 2010 2015 li thu an i ali thu an i a 1. 6 2. 0 2. 4 2. 8 3. 2 1995 2000 2005 2010 2015 luxem b o urgluxem b o urg 2. 4 2. 8 3. 2 3. 6 4. 0 1995 2000 2005 2010 2015 mal tamal ta 3. 2 3. 3 3. 4 3. 5 3. 6 1995 2000 2005 2010 2015 n eth erl an d sn eth erl an d s 1. 6 2. 0 2. 4 2. 8 1995 2000 2005 2010 2015 p o l an dp o l an d 2. 0 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 p ortu galp ortu gal 1. 5 2. 0 2. 5 3. 0 3. 5 4. 0 1995 2000 2005 2010 2015 r om an i ar om an i a 1. 8 2. 0 2. 2 2. 4 2. 6 1995 2000 2005 2010 2015 sl o vaki asl o vaki a 2. 5 3. 0 3. 5 4. 0 4. 5 5. 0 1995 2000 2005 2010 2015 sl o ven i asl o ven i a 1. 4 1. 6 1. 8 2. 0 2. 2 2. 4 1995 2000 2005 2010 2015 sp ai nsp ai n 2. 0 2. 2 2. 4 2. 6 2. 8 3. 0 1995 2000 2005 2010 2015 swedensweden 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 uni ted k i ngdo muni ted k i ngdo m figure 2. total environmental taxes in eu countries source: authors calculation based on eurostat after presenting gdp rate in eu countries, next figure manifests share of total environmental taxes in the gross domestic product from 1994 to 2018. environmental tax revenues in the european union totalled 324.6 billion euro which is 3% increase in nominal terms compared to previous year and 49% higher than in 2002 (https://ec.europa.eu/eurostat/web/productseurostat-news/-/ddn-20200219-1). european union has growth of the environmental tax revenues in the period 2005-2008, but since 2008 the revenue based on environmental taxes decreased in these countries (munitlak ivanović and golušin, 2012). total environmental taxes had average share 2.66% of gdp during observed period, where denmark had the highest mean share 4.43% of gdp. on the other hand, spain is a country with the smallest average share 1.9% of gdp for the analyzed period. economies such as croatia, italy, malta, netherlands and slovenia had average share above 3% of gdp, while most of analyzed countries had mean share around 2%. seventeen of twenty-eight countries recorded mean share of total environmental taxes below eu average during observed period. in most cases, environmental taxes refer to exploitation of natural resources such as energy and water as well as waste generation. the highest part of the revenue is raised through taxes on energy products where significant level of revenues is also collected via taxes on motor vehicles (golušin et al. 2013). an increase of environmental taxes in the european union resulted in a growth of revenues based on environmental taxes where fifteen countries increased environmental taxes including excise duties on energy products and electricity (hodžić and bratić, 2015). table 1. descriptive statistics of total environment tax revenue country mean std. dev min max austria 6532.03 1485.61 3974.84 8855.83 belgium 8231.15 2125.01 5303.99 12407.2 bulgaria 826.56 485.71 84.2 1648.09 croatia 1289.79 210.53 1001.29 1853.35 cyprus 430.93 143.06 188.62 589.4 czech r 2726.52 1046.46 1205.44 4507.93 denmark 9567.33 1404.39 6099.74 11065.4 98 economic analysis (2021, vol. 54, no. 1, 92-103) country mean std. dev min max estonia 325.14 214.89 25.61 708.95 finland 4993.47 1095.01 2930.92 6848 france 38132.77 7260.88 30139 55949 germany 53626.48 6113.61 41524.55 59737 greece 4933.84 1371.79 3190.58 7162 hungary 2263.69 706.98 905.53 3142.61 ireland 3754.73 1089.64 1565.12 5186.03 italy 45331.86 8566.98 31015.51 58735 latvia 453.99 296.92 40.74 982.72 lithuania 477.46 202.47 95.99 899.78 luxembourg 812.43 204.56 468.77 1039.61 malta 186.48 62.04 87.6 321.75 netherlands 19100.53 4280.41 11190.14 25832 poland 7352.46 3546.65 1939.76 13500.41 portugal 4146.89 587.75 3047.89 5270.52 romania 2154.67 1167.89 499.25 4239.84 slovakia 1155.87 642.48 374.32 2232.7 slovenia 1099.30 323.05 632.25 1609.66 spain 16594.21 3486.29 9976.01 22066 sweden 8582.46 1472.35 5292.38 10341.43 united kingdom 46627.26 8772.09 25538.44 63763.36 total 10418.23 15691.72 25.61 63763.36 source: authors calculation results of descriptive analysis show that france, germany, italy and united kingdom have the highest mean level of total environment tax revenue in the analyzed period. in these countries, environment revenue are above thirty-five billion euro which is far more than other economies. the mean total environment tax revenue are 10418.23 billion euro, where only six countries recorded higher revenue level compared to average value in observed period. it implies that there is a greater difference between selected countries, where for example germany has more than fifty billion euro which is far more than baltic countries (estonia, latvia and lithuania). the smallest standard deviation is identified in malta (62.04), while united kingdom and france had the highest value of standard deviation. it implies that these economies had no stability in environment revenue level in observed period. table 2. stationary tests variable levin-lin-chu test im, pesaran shin test augmented dickey-fuller test phillipsperron test gdp intercept -11.83 -9.99 201.483 192.91 gdp intercept & trend -10.81 -7.59 152.-55 149.92 δ gdp intercept -23.68*** -22.77*** 479.524*** 1073.35*** δ gdp intercept & trend -18.69*** -18.81*** 362.08*** 1255.52*** tet intercept -2.18 -6.47 25.35 32.25 tet intercept & trend -2.07 -0.04 64.32 50.18 δtet intercept -16.67*** -14.27*** 293.24*** 347.92*** δtet intercept & trend -15.29*** -13.21*** 250.35*** 310.03*** source: authors calculation the results of these tests show that selected variables are not stationary at level, but variables are stationary at first difference. it implies that null hypothesis can be rejected at the 1% when applying each variable at first difference. it can notice that these variables are stationary at first difference and integrated of order one process. after we confirm that variables are the first vera mitrović, branimir kalaš, nada milenković 99 difference, the next step is to estimate the long-run nexus between selected variables (nguyen and kakinaka, 2018). table 3. cointegration tests cointegration gdp tet tet – gdp intecept intercept & trend intercept intercept & trend within-dimension panel v-statistic -2.27** -6.56*** -0.32** -4.78*** panel rho-statistic -12.59*** -6.80*** -15.98*** -17.74*** panel pp-statistic -26.72*** -31.69** -16.17*** -18.06*** panel adf-statistic -19.48*** -23.18** -15.51*** -17.98*** between-dimension group rho-statistic -10.45*** -14.92*** -9.52*** -15.16*** group pp-statistic -40.21** -50.89*** -16.89*** -17.49*** group adf-statistic -20.84*** -24.26*** -15.03*** -18.46*** source: authors calculation table 3 presents panel cointegration test statistics between gdp and tet for analyzed period 1994-2018. the analysis manifests a cointegration between gdp and tet and can reject the null-hypothesis of no cointegration. presence of a cointegration between gdp and tet implies that these variables move together in the long-run and we can conclude there is a long-run relation between gdp and tet in eu countries from 1994 to 2018. after identifying the cointegration relationship, the next step is to examine the cointegration coefficients of independent variables by using panel fully modified ordinary least squares (fmols) and panel dynamic ordinary least squares (dols) models (bilgili et al. 2016). the long-run cointegration vector is analyzed by these panel models. table 4. results of different panel models variable gdp model ols dols fmols tet 0.18 (0.03) 0.21 (0.01) 0.23 (0.02) r-squared 0.41 0.72 0.68 source: authors calculation table 4 reflects the results of the panel ols, dols and fmols estimators for eu countries. the empirical results show that tet have positive and significant effect on gdp. first, ols shows that a 1% increase in revenue of total environmental taxes enhances gdp by 0.18% with 41% explanation of variations in this model. second, dols reflects that a 1% increase in revenue of total environment taxes raises gdp by 0.21% with 72% explanation of variations in this model. finally, fmols manifests that a 1% increase in revenue of total environmental taxes rises gdp by 0.23%. conclusion environmental policy is a necessary for sustainable economic development although some economists cite that society have to choose between environmental policy and economic growth. environment taxes can be a very powerful tool to increase public revenues and contribute to the environment protection. namely, these taxes can be more considered by eu countries to improve green economic activity and discourage”dirty” industries. this paper should reveal are environmental taxes statistically significant for economic growth in eu countries and the research examines the relationship between total environmental taxes and economic growth for 100 economic analysis (2021, vol. 54, no. 1, 92-103) twenty-eight eu countries for the period 1994-2018. the objective of this paper is to evaluate the long-run relationship between these variables based on panel data analysis that includes panel cointegration test, and three models such as pols, dols and fmols. the results show long-run relationship between total environmental taxes and economic growth in eu countries for the observed period. empirical findings reflect that environmental taxes have a positive and significant impact on economic growth which implies that hypothesis h1 can be accepted. precisely, results of different panel models manifest that a 1% increase in total environmental taxes enhances gdp, where fmols model has shown a greatest change of gdp by 0.23%. these empirical findings confirm previous research studies (morley and abdullah, 2010; dökmen (2012; abdullah and morley, 2014; he et al. 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(2020). “environmental tax reform and the “double dividend” hypothesis in a small open economy”. international journal of environmental research and public health, 17(1): 1-21. doi: 10.3390/ijerph17010217 article history: received: april 24, 2020 accepted: april 29, 2021 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp69‐80 original scientific paper challenges and perspectives of development of private pension funds in serbia marija đekić1 | miloš nikolić1 | tamara vesić1* 1 faculty of business, economy and entrepreneurship, belgrade, serbia abstract following the successful implementation of the chilean reform, the world bank proposed a solution from three pillars of the pension system: compulsory state, compulsory private and voluntary private pension insurance. serbia, like many other developed and undeveloped countries, has only adopted the third pillar, in addition to the already existing state. the introduction of compulsory private insurance was also considered. however, there are no market conditions or financial possibilities for achieving this idea. voluntary pension funds in serbia were introduced by the 2005 laws. there are seven voluntary pension funds in serbia, managed by four management companies. so far, the funds have achieved positive yields, although due to limited investment opportunities, these rates were very modest. in addition to limited investment opportunities, one of the problems is the accumulation of funds. the problem of population savings has many sides, and it is certain that some of the causes can be sought in bad experiences from the past. the paper analyses the limitations and possibilities for further development of private pension funds. key words: voluntary pension insurance, private pension funds, savings, private pensions, security in old age jel classification: g23, j32 introduction the pension systems of most countries in the world are based on a system of ongoing financing, which is characterised by the fact that employees, through contributions, finance the pensions of those people who have completed their working life. however, this kind of intergenerational solidarity is not sustainable in the long run. the main reasons for this tendency are demographic and financial nature. for the sustainability of such a pension system, demographic factors are not favourable due to the ageing of the population and the increasing share of those over 65 in the total population, from one, and low fertility rates, on the other. the problem of financing pensions in serbia arose in the 1980s with the occurrence of deficit in the pension and disability insurance fund. it reached its peak in the 1990s in times of crisis, sanctions and economic decline. the decrease in the number of employees, avoidance to pay employee contributions and a widespread grey economy brought about a decline in the number of policyholders (pjanic & lucic, 2012). as a result, there is greater pressure on the financial side because currently employees are unable to fund pensions without increasing their contributions. * corresponding author, e‐mail: tamara.vesic@vspep.edu.rs 70 economic analysis (2019, vol. 52, no. 1, 69‐80) the increase in contributions in serbia is not an appropriate measure because it affects the increase in operating costs, which can further reflect the reduced competitiveness of the company and the economy, as well as the increase in tax evasion. in serbia, there are tougher measures regarding the non‐registration of workers, but this form of grey economy is still at a high level. in the case of a state pension system, workers often try to reduce the excessive burden of pure taxes by adjusting their working lives and work volumes, or by switching to an informal labour market, most commonly in developing countries, where there are ways to avoid pension and other taxes. companies respond to more labour costs by adopting less labour‐ intensive technology or by switching to informal markets (corsetti & schmidt ‐hebbel, 1995). so, the reform of the pay‐as‐you‐go system should not be directed just towards expenditures or to the reduction of insurance rights, but it should also include a better look at income: better control over the payment of contributions for compulsory pensions or disability insurance; an increase in the number of employees; and the reduction in the grey economy; etc. (kosanovic & paunovic, 2010). since 1981 close to forty countries have introduced systemic pension reforms that have replaced all or part of prior pay‐as‐you‐go (payg) schemes with privately managed systems. since the great recession, some european countries that had partly privatised their pension systems between the mid‐1990s and early 2000s increasingly scaled back their mandatory private retirement accounts and restored the role of public provision (wang, williamson & cansoy, 2016; naczyk & domonkos, 2016). in the period after the crisis, because of the increase in unemployment and the reduction of tax revenues, the redirection of contributions to private pension insurance has become too expensive, so some countries have permanently (hungary, bulgaria since 2015), and some temporary (estonia) suspended the second pillar of pension by reducing the contribution rate (poland, romania, latvia, lithuania, slovakia) (horstmann, 2012, p. 11) the process of globalisation, that is, the process of integration of the world economy has a great influence on the reforms of the pension system. this can be seen in eastern europe, where countries that are hoping to join the european union must reduce their fiscal deficits and limit the overall debt burden (schiffrin & bisat, 2004). these are requirements that involve a reduction in investment in pension insurance and must be undertaken prior to eu accession (domonkos & simonovits, 2016). with this in mind, it is clear that reforms of the pension system are necessary not only in countries in transition but also in all countries that are facing the problem of financing pensions (kastratovic, kalicanin, 2017). „serbia opted for a more traditional western european approach, combining payg cost‐containment parametric reforms with the introduction of tax‐preferred supplementary private pensions” (altiparmakov & matkovic, 2018). in this regard, the process of starting the reform of the pension system in serbia has led to the introduction of the third pillar of pension insurance, according to the world bank classification system. these three pillars the world bank proposed in its report “averting the old‐age crisis”, 1994, proposing the basic concepts and principles of model implementation. after that, her attention was focused on individual solutions adapted to the different conditions and needs of countries with different structure of the population (tolos, wang, zhang & shand, 2014). additionally, although the eu does not elaborate a unitary approach for all member states since about 2000, the commission has implemented the multi‐pillar approach of the world bank. the approaches of the eu are summarised and systematised in the 2012 white paper (windwehr, 2017). of course, in addition to the fact that the reform allowed the appearance of the first and third pillar of the pension system, periodic changes occurred in the functioning of the pension system, as well as the introduction of new and changing existing one's legal provisions. however, in this paper, the functioning of private pension funds in serbia is analysed and the obstacles faced by these institutional investors. marija đekić, miloš nikolić, tamara vasić 71 sector for voluntary pension funds in serbia the past few decades of old‐age pension policy have been characterized as an age of privatisation (ebbinghaus, 2015). in recent decades “pension privatisation,” has become one of the most widely implemented reforms (holzmann, hinz & dorfman, 2008). in the early to mid‐ 1990s, many european countries introduced voluntary pension funds. in the period from 1998 to 2006, some countries in europe introduced a three‐tier model of the pension system. pension reforms enacted since the 1980s can be grouped into three categories: parametric reform, supplemental systemic reform and extensive systemic reform (wang, williamson & cansoy, 2016). pension reform is not cheap, but a good fiscal discipline can make it feasible. the main problem of replacing the paygo system with the system of individual pension accounts is high transitional costs. if active contributors contribute to the new system, there remains a financial gap in the old one. the number of contributors then decreases, but the government must continue paying to current pension beneficiaries. these high fiscal costs were evident during the chilean reform. what's extraordinary in chile is that although total tax burdens have fallen by about 10% of gdp, fiscal accounts have remained in surplus for most of the time since the late 1980s. the long‐term effects of replacing the system are positive, as shown by all previous estimates, as well as projections of the world bank that the debt of the pension system without reform in 2050 would amount to 211% of gdp, and with the implemented reform, the debt should be zero (vial & melguizo, 2009). in chile, the idea of a private pension system has been developed, where each employee has his individual account in a private fund to which he pays contribution. the chilean private pension system model emerged as an alternative to the bismarck idea of the pension system. most countries in the world that have a pension system have entered the modified application of the idea that originated in chile (vukotic, 2004). several countries of the western balkans have introduced partially privatised three‐pillar pension systems in an environment of underdeveloped capital markets. it highlights the problems and risks facing the partially privatised pension schemes. the inadequate introduction of individual private‐sector pension accounts in many european developing countries stems from high operating costs and unhedged capital markets. these conclusions are based on empirical data for one decade in developing countries that have privatised retirement systems (altiparmakov, 2011). the western balkans' pension system analysis suggests that those countries that have not introduced a three‐pillar pension system do not have to do that yet, but focus on improving the efficiency of existing pay‐as‐you‐go systems (bartlett & xhumari, 2007). the second pillar in the developing countries is characterized by high administrative costs and very low contribution rate, which represent the main reasons for leaving this type of pension system (oecd, 2013, p. 10). since there is no evidence that the introduction of the second pillar into the domestic pension system creates conditions for a safer and sufficiently high pension, the reforms kept the parametric changes in the first pillar, and in 2006, the first voluntary pension funds emerged as a result of the introduction of the third pillar. however, voluntary pension insurance in serbia began to develop before the adoption of the law on voluntary pension funds and pension plans, in 2002, when certain forms of savings were similar to today's voluntary pension insurance (damnjanovic, 2017). the third pillar was designed as a voluntary private pension scheme. however, well known is that pensioners are vulnerable and disadvantaged groups, and in 2014 7.9% of the poor in the age group of 46‐64 years, and 7.4% of the poor in the group of 65 years and more, so it is necessary to take into new reforms to order to improve that facts (djukic, balaban & radisavljevic, 2017). many authors (bartlett & xhumari, 2007; altiparmakov, 2011; altiparmakov, 2013) agree that, as the reform continues, serbia should focus on parametric changes of the first pillar and the adequate integration of voluntary pension funds into the pension system of serbia. 72 economic analysis (2019, vol. 52, no. 1, 69‐80) the current state of the voluntary pension funds sector in serbia voluntary pension insurance, as a form of pension insurance, is in our country at the beginning of its development and represents an additional form of retirement benefit. at the end of 2017, voluntary pension funds in serbia operated four management companies that managed the assets of seven voluntary pension funds, one custodian bank and five intermediary banks. membership in the fund is divided into the accumulation phase ‐ the period when the funds are paid, and the withdrawal phase. in the period from 2008 to the end of 2017, the number of users increased by almost thirty thousand. of course, the number of contracts is higher, given that one user can conclude more contracts with voluntary pension funds. from year to year, the number of users and contracts increases, but so far positive movement of investment units, fondex and net assets of funds have been recorded. fund assets are the sum of the various investment instruments in which the asset is invested. the net asset value is equal to the difference between the fund assets value and the fund's liabilities on the same day, ie to the result of the multiplication of the number of investment units and the value of the investment unit. the net assets of pension funds at the end of the third quarter of 2017 amounted to 34.9 billion dinars. the change in the value of the assets is influenced by the net payments of funds into funds, payments of funds from funds and the profits made by the funds from the investment (national bank of serbia, 2017). the nominal net return on investments in pension funds in serbia for 2016 amounted to 7.4% and real 5.8%. in the period after the financial crisis, i.e. for the period from the end of 2011 to the end of 2016, serbia is among the countries that achieved the highest five‐year average real investment rates (without investment costs), that is, serbia is in second place with 7, 1%, and only the dominican republic with 8% in front of serbia. this oecd report covered 45 countries (oecd, 2017). table 1. net assets of voluntary pension funds by years. year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 net assets (bill. din.) 3,1 4,6 7,2 9,9 12,5 16,0 19,7 23,6 28,9 32,8 34,9 source: national bank of serbia, 2017 in serbia, it is still difficult to determine the stable rate of return of pension funds due to the frequent fluctuation of the value of pension fund units. funding costs are high, which significantly reduces yields. structure of investment of voluntary pension funds in serbia pension funds in diverse financial markets primarily invest in long‐term securities with high yields. their investment strategies depend on several factors. due to legal constraints, public funds invest more in low‐risk securities, while private pension funds invest in shares, futures and other risk capital to achieve higher yields. voluntary pension insurance in serbia differs from the public in that the funds in the personal accounts of the insured are invested and the realised profit is credited quarterly to each account, thus increasing these funds. a favourable tax treatment, which implies the exemption from the tax on all profits, as long as funds held by the fund have resulted in funds being invested in securities for high tax burdens that yield and yield more. such a favourable tax treatment greatly influenced the growth of size and the importance of these institutional investors. the differences in the structure of the portfolio of pension funds depend on many factors in addition to the aforementioned tax restrictions, and above all the returns provided by various assets, the risks that carry those assets, but also many regulatory constraints. investments are marija đekić, miloš nikolić, tamara vasić 73 made to increase the total return but in accordance with the basic principles of investment activities related to portfolio security, portfolio diversification and portfolio liquidity. the pension funds' portfolio must contain liquid assets of a certain volume so that funds can at any time respond to the due liabilities. nevertheless, most of the assets of pension funds consist of long‐term financial investments in stocks and bonds. the safest and least risky instruments are long‐term government bonds, but many funds, for their greater return, nevertheless determine for holding shares in their portfolio. bonds in the past have taken a significant place in the structure of the portfolio of pension funds, as these institutional investors are cautious investors. in the us, japan and canada, during the 1980s, bonds accounted for 50% of the total assets, and in germany, 30%. however, in the united kingdom bonds accounted for around 20% of the total assets of the funds, while most of the portfolios constituted shares. today, corporative bonds and stocks prevail in the portfolio of pension funds in the world (labudovic, 2010). in the countries of central and eastern europe, the share of government bonds in the portfolio is even more pronounced. due to this structure of the portfolio, there is no significant difference between private pension funds and pension funds in the paygo system. in 2014, pension funds in the oecd countries invested on average 23.8% of portfolios in shares, 51.3% in bonds and bonds, and 9.6% of portfolios were in deposits and cash. private pension funds at the end of that year had $ 38 trillion worth of assets in oecd countries (oecd, 2015). unlike the developed financial markets, the serbian stock market, despite notable growth in the volume of transactions, is generally still very illiquid. the small number of companies whose shares are actively traded and an inadequate offer of shares are the main problems for the further development of the market. the liquidity coefficient, as a ratio of total turnover and total market capitalisation, is very low. the financial market of serbia imposes a large number of restrictions on institutional investors, and therefore on pension funds. one of these constraints relates to the inability of a good diversification of portfolios, i.e. pension funds are forced to invest in certain market segments. due to the low liquidity of the market, the prices of securities vary and move very quickly in very high ranges. also, a major constraint is the lack of low‐risk securities, such as corporate or municipal bonds. in 2007, before entering the financial crisis, there was a tendency to increase investment in shares, a slight decrease in the share of debt securities and an increase in the amount of transaction accounts, as a result of the underdevelopment of the capital market and the weak supply of financial instruments (matkovic, bajec, mijatovic, zivkovic & stanic, 2009). the largest part of the funds of pension funds in serbia was invested in bonds 83.7%, the next place in the structure of the assets of the funds was 7.5%, the shares were invested 7.1% of the assets, in the time deposits 1.1%, and the rest of the funds in the amount of 0.6%, was invested in other securities, real estate, investment units of open investment funds and other forms of receivables. compared to the previous year, the share of cash and the share of government bonds in the total portfolio structure of all funds decreased, while the share of time deposits and shares increased (national bank of serbia, 2017). perspectives for the development of the private pension fund sector in serbia the performance of the pension system and the development of the voluntary pension funds sector depend on the overall state of the economy of a country. obstacles for the development of the third pillar are numerous: low incomes, insufficient tax incentives, high rates for compulsory pension insurance, but also mistrust and lack of knowledge of potential beneficiaries (matkovic, 74 economic analysis (2019, vol. 52, no. 1, 69‐80) 2016). the perspectives of pension funds should be viewed in the context of the overall economic reforms, the economic environment and the institutional framework of the country. the european bank for reconstruction and development (ebrd) announces a set of indicators for the development of the countries in transition, on the basis of which it assesses the process of reforms of these countries from a planned to an open market economy. transition indicators range from 1 to 4+, where 1 represents little or no change compared to rigidly planned economies, and 4+ represents the standards of an industrialised market economy. table 2. transition indicators for the financial sector of the countries in the region for 2016‐ 2017 countries in the region financial sector banking insurance and fin. services private equity capital market bosnia and herzegovina 3‐ 2+ 2‐ 2 macedonia 3‐ 3‐ 1 2 montenegro 3‐ 2+ 1 2 serbia 3‐ 3 2 2 romania 3 3+ 3‐ 3‐ source: ebrd, 2016 the third pillar is a result of citizens’ voluntariness if strict legal regulations are created for its functioning with strict control by the state (birovljev, vojinovic & mirovic, 2015). for the voluntary pension funds to function in the right way, it is necessary to introduce several formal and material conditions, such as in the field of fiscal policy, which would improve tax incentives for contributions to voluntary pension funds. certain tax exemptions have been introduced in serbia since the creation of voluntary pension funds. in addition to being introduced, they have been increased several times. thus, in february 2009, by amending the law on personal income tax, the maximum non‐taxable payment into voluntary pension funds in serbia from 3,303 dinars was increased to 3 528 dinars (laketic, 2010). amendments to the law on personal income tax, which came into force on 1st of january 2016, this amount was increased to 5 501 dinars a month (law on income tax on income of citizens). this is not about large amounts, but it can be seen that there is the will and support of the state in the development of the third pillar of the pension system in serbia. employers were thus given the opportunity to increase the number of contributions they pay for their employees and that they were exempt from paying citizens' income tax and contributions for compulsory social security. table 3.total investments in pension funds in serbia in the period from 2010 to 2014. year investments in millions of dinars percent of gdp 2010 9912 0.3 2011 12493 0.4 2012 16366 0.5 2013 19747 0.5 2014 23654 0.6 2015 28954 0,7 2016 32860 0,8 source: oecd, 2017 the great potential for further growth in the number of pension funders is in companies with a large number of employees since the largest number of payments to pension funds is precisely the payment of employers' salaries. however, the slower development of private pension funds marija đekić, miloš nikolić, tamara vasić 75 in countries in the region than in developed countries has more causes. first of all, the limiting factor is a poorly developed capital market, which results in limited investment opportunities for these funds. secondly, the big problem is the poor experience of saving, fraud and fraud related to the financial institutions and the financial system of serbia. thirdly, on the eu level, a large number of regulations govern only indirectly operations of these investors. some of the relevant regulations are mifid, ucits, the directive on pension funds (pension funds directive) and directives, which are loosely linked to capital requirements (capital requirements directive). in serbia, there is still no clear regulations for these investors, although, for years, there are institutions that operate in this region (djekic, gavrilovic, roganovic i gojkovic, 2017). fourthly, there is a pronounced low level of cultural investment in serbia, that is, there is a lack of knowledge of the population and insufficient knowledge of the concept of private pension and the operation of private pension funds. therefore, in addition to the market, legal, political and institutional frameworks, there is a problem from the aspect of the population, which is very unfavourable for the accumulation of funds. according to (bilankov & aleksic, 2016) “an increased popularisation and education of the citizens would make these voluntary funds leading investors in the market.” empirical research ‐ methodological issues the aim of the paper is to examine the problems and the perspective of the development of voluntary pension insurance in serbia. since private insurance in serbia is characterized by the principle of voluntarism, since in serbia there are the first and third pillars of the pension system according to the world bank's categorization, it is concluded that the consciousness, opinion and opinion of citizens regarding private pension importance is of great importance for the further development of the pension system. in this regard, the following research questions were asked: how many respondents are familiar with the concept of voluntary pension insurance and private pension funds? how many respondents have confidence in financial institutions in serbia? how much does the impact on the decision on private pension insurance have a living standard? to obtain answers to the above research questions, empirical research was carried out using the survey method. the survey was conducted in the period from mid‐december 2017 to mid‐ january 2018, and the method of a random selection of respondents was applied. the sample of the respondents is a free random sample, consisting of 104 respondents. results analysis was performed using ibm spss statistics 21. depending on the characteristics of the variables and the relationships established between them, some results are shown by cross‐tabulation, while some variables show descriptive measures. also, a hi‐square analysis was performed, and data for variables were shown for which there is a proven linkage. results of empirical research in the conducted research, basic information about the respondents was obtained. the observed characteristics of the subjects can be summarised as follows: 1. in terms of gender, there is no significant difference between the groups, i.e. 51 (or 49%) of the male respondents, and the female 53 (or 51%); 2. regarding the educational structure, the highest number of respondents with the completed secondary school were 38 (or 36.5%) and completed basic higher education studies of 33 (or 31.7%); 3. regarding the age of the respondents, the majority of respondents belong to age groups of 25‐35 years (29 subjects or 27.9%) and 35‐45 years (28 subjects or 26.9%); 4. in terms of employment, most respondents are employed (89 respondents or 85.6%), while a small number of respondents are unemployed (15 respondents or 14.4%). 76 economic analysis (2019, vol. 52, no. 1, 69‐80) table 4. educational structure of respondents source: authors table 5. age structure of respondents up to 25 years 25‐35 years 35‐45 years 45‐55 years 55‐65 years 3,8% 27,9% 26,9% 20,2% 21,2% source: authors the largest number of respondents in this random sample is not a member of any private pension fund or even 92.3% of respondents. through cross tabulation, we can conclude that respondents, whether they are or not members of the private pension fund, state a low standard of living as the biggest obstacle for higher investment in private pensions. table 6. opinion of the respondents on the biggest obstacles to investing in private pensions in serbia funds are paid personally funds are paid by the employer they are not members in total low standard of living 3 2 62 67 % 2,9% 1,9% 59,6% 64,4% insufficient information on ppo 1 2 13 16 % 1,0% 1,9% 12,5% 15,4% poor trust of citizens in fin. institutions 0 0 12 12 % 0,0% 0,0% 11,5% 11,5% disinterested for security in the future 0 0 4 4 % 0,0% 0,0% 3,8% 3,8% i do not know 0 0 5 5 % 0,0% 0,0% 4,8% 4,8% in total 4 4 96 104 % 3,8% 3,8% 92,3% 100,0% source: authors the table below shows descriptive measures for the four questions asked by respondents. on all questions, the respondents gave answers on the lickert scale from one to five. however, on the first two questions, the answers are graded, so that the grades of 1‐absolutely agree, to 5‐ absolutely disagree; and on the other two issues i'm completely aware of the 1st, i'm not familiar with 5. based on the data, the following can be concluded: 1. respondents have different trusts in financial institutions, but the average attitude is neutral, that is, neither trust nor trust in financial institutions; 2. the respondents highly believe that a better standard is needed for citizens' interest, as is shown by the fact that no respondent replied that he disagrees with this claim, as well as the mean value and the standard deviation that indicates that there is no high deviation in answers); high school college/ university faculty‐basic studies college‐master studies phd studies 36,6% 13,5% 31,7% 16,3% 1,9% marija đekić, miloš nikolić, tamara vasić 77 3. the respondents are better acquainted with the presence and operation of private pension funds than with the concept of private pension insurance, but generally speaking, they are not familiar with each other or are partially acquainted. table 7. descriptive statistics for individual variables variables min max mean st. dev. 1. i have trust in financial institutions in the republic of serbia 1 5 3,06 1,022 2. is it necessary for a better standard of citizens' interest in investing in paid pensions 1 4 1,68 ,728 3. are you familiar with the concept of private pension insurance 1 5 2,78 1,024 4. are you familiar with the presence and business of private pension funds in serbia 1 5 2,91 1,098 source: authors also, it is important to note that 76.9% of respondents want additional income because they believe that state pensions are not enough for a secure age, and 4.8% of respondents consider that state pensions are not enough for security in old age, but that they do not want additional income. only 18.3% of respondents believe that state pensions are sufficient for a secure age, of which 15.4% still want additional income, while the other 2.9% do not want. the next graph shows the opinion of the respondents regarding the biggest advantages of investing in private pension funds. it can be concluded that as many as 39.4% of the respondents consider that the greatest advantage of investing in private pensions is that the amount of private pension does not depend on years of service, but on the total payments and how these funds are invested. table 8: the biggest advantages of investing in private pension funds according to respondents' opinion advantages percentage tax exemptions can be made to the contributions paid into the fund 4,8% private pension does not depend on the length of service, but from the total payments and income of the fund 39,4% they do not have to make regular payments but can be paused in monthly payments 16,3% they do not have to make regular payments but can be paused in monthly payments 11,5% they do not have to make regular payments but can be paused in monthly payments 11,5% none of the above 16,3% source: authors below are the data obtained by testing the variability of variables using the hi‐square test. only those links that we found statistically significant are shown in the body. based on the realized values of the hi‐square statistics, the significance level of the test (as. sig.) and the observation of the obtained coefficients (cramer's v and the contingency coefficient), we have come to the conclusion that there is dependence between the following variables: level of education and familiarity with the concept of private pension insurance; level of education and familiarity with the presence and operation of private pension funds in serbia; knowledge of the concept of private pension insurance and familiarity with the presence and operation of private pension funds in serbia. 78 economic analysis (2019, vol. 52, no. 1, 69‐80) table 9: results of the conducted empirical analysis using the hi‐square test variable pearson chi‐square df cramer’s v contingency coeff. first the other one val. as.sig. val. ap.sig. val. ap.sig. level of education familiarity with the concept of ppo 17,339 0,027 8 0,289 0,027 0,378 0,027 level of education awareness of the presence and business of ppf in serbia 15,607 0,048 8 0,274 0,048 0,361 0,048 familiarity with the concept of ppo awareness of the presence and business of ppf in serbia 91,041 0,000 4 0,662 0,000 0,683 0,000 source: authors  it can be concluded that respondents with a higher level of education are more familiar with the concept of private pension insurance and with the presence and operation of private pension funds in serbia. this relationship is statistically significant but not strong. we also conclude that those respondents who are familiar with the concept of private pension insurance are also familiar with the presence and operation of private pension funds in serbia. previous connections are logical, but the last connection is very strong and statistically significant. connections among other variables were also investigated, but no statistical data were obtained. conclusion the pension system in serbia, as well as the systems of a large number of countries in the world, faces the problem of functioning and the crisis in financing. in the last few years, pension spending in serbia is 13% of the gdp, which is 4.5% more than the average found in european countries in transition and it is a burden that serbian economy and taxpayers cannot bear in the long run (veselinovic, 2014). the most common reasons for the difficulty of financing state pension funds are demographic nature. due to the poor sustainability of state funds, many countries have gone through or are still going through the reform processes of the pension system. apart from the parametric reform of the state system of current financing, the reform of the pension system in serbia included the introduction of voluntary pension insurance. pension reforms in serbia have long since begun, but it cannot yet be considered that this process has been completed. during several reforms in serbia, the pension system has undergone certain changes that relate to parametric reforms in the first pillar of the pension system (according to the world bank classification system) and the introduction of the third pillar. the introduction of the second pillar is not a good solution, which is also supported by the experiences of other developing countries. further recommendations to ensure the better functioning of the pension system relate to the increase of the efficiency of the first pillar, but also the promotion of the development of voluntary pension funds in serbia. private pension funds (third pillar) exist in serbia for more than a decade, but their development is limited by market, legal, institutional and political factors. also, some of the restrictions also relate to the population of serbia, as can be seen from the conducted research. by analysing the answers to the set research questions, we conclude the following: 1. the knowledge of the respondents with the concept of voluntary pension insurance and private pension funds is not at a satisfactory level, and is related to the level of education of the respondents; 2. the level of confidence of respondents in financial institutions in serbia is not satisfactory, as on average respondents have a neutral attitude on this issue; marija đekić, miloš nikolić, tamara vasić 79 3. the largest number of respondents cite the standard of living as the biggest obstacle for higher private pension investments, and most agree that for citizens to invest in private pension funds, it is necessary to improve the standard of citizens in serbia. in future 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"europeanization in pension policy: the crisis as a game‐changer?" journal of contemporary european research 13 (3): 1301‐1318. law on income tax on income of citizens, "sluzbeni glasnik", br. 112/2015. article history: received: november 13, 2018 accepted: may 31, 2019 microsoft word 2010_1_2.doc original scienfitic paper economic assessment of selected bank mergers in the centraleast europe region in comparison with developed countries tej jakub*, ekonomická fakulta tuke, košice, slovakia udc: 336.7(4) jel: g15; e44; g34 abstract – my intention is to clarify the process of merging from the economic point of view, especially impact on financial results after the merger itself. examine and analyze differences in financial results, measured by using various ratio indicators, market value of shares and capital adequacy in the region of central and eastern europe in comparison with developed markets in the world. key words: economic situation, merger, the indicators of profitability, market value of shares, capital adequacy introduction nineties was characterized by a large number of mergers and acquisitions worldwide. this phenomenon belongs in the past decades to the preferred part of economic theory and practice. by the volume of capital bank mergers and acquisitions belong to highest rank of operations. they are closely linked with the globalization process and thanks to it very often cross national borders. economic assumptions of mergers wave in last decade is the rapid development of information technology, reducing the cost of communication and transport, markets deregulation and privatization. in particular, acquisitions are an integral part of the restructuring process in transition economies. merger itself has not always met planned expectations. there is no guarantee of achieving economies of scale, risk diversification and improvement of solvency. to fulfill all positive effects, it is necessary to prepare in advance more than just a basic plan and strategy. it is necessary to include regional specificities and all other relevant variables. material and method the intention of article is to clarify the processes of mergers from an economic perspective and impact on financial results after the merger itself. based on data from annual reports, it examines and analyzes the impact of mergers on banksʹ financial results, measured by various ratios or market value of shares and capital adequacy in the region of central and eastern europe in comparison with developed markets in the world. * address: boženy němcovej 32, košice, slovakia, e-mail: jakub.tej@tuke.sk tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 35 achievement and discussion merger usually means the process of merging two or more separate economic entities, which occurs through direct connection to their net assets. the merger, in most cases means the merger of relatively strong and equally important subjects, which is reflected in many aspects. the merger must be decided by the general assembly of all participating companies. as arguments for mergers and acquisitions is tend to be given many reasons. separations of reasons in favor of the merger and against them are widely various, and what some studies have considered clearly positive, others resolutely refuse. as an example, we can use the impact of mergers on employment and the expected impact of mergers on the effectiveness of the newly created bank. but the problem remains that many mergers are justified economically inefficient. analysis shows that the main problem is merging different corporate culture of companies. only few projects, of mergers and acquisitions have more than a basic plan how to solve this problem. others fail because of incorrect valuation of assets or hidden liabilities of the company [5, p. 243]. complicated structure of conglomerates, which occur after the merger, very often requires more administrative personnel. the preserved remains specialized, however often mutually competing departments. on the other hand are after mergers and acquisitions expected savings from reductions in staff or expenses costs (table. 1). these benefits would mean social costs in terms of increased unemployment. the problem in terms of social costs is also closing branches, usually associated with reducing supply of banking services, job cuts may not be the rule. table 1. estimates of cost savings in bank mergers (in% of total costs) sbc-ubs 23 bank of scotland-natwest 22 bank austria-credit anstalt 18 bankamerika-secpac 17 wells-first interstate 17 chemical-chase 16 swedbank-forenings 15 lloyds-midland 14 vereinsbank-hypobank 14 fortis-generale 11 source: davis, s. i. 2007 [2, p. 97] the most important argument for the merger is synergy. synergistic effect is based on the premise that combining two formerly separate companies involves an increase effect on the coupling value that is added to the sum of the merging companies. it is known that such effects arise when combining two companies, for example, that in newly established company arise economies of scale, reduce some costs, lower distribution costs and marketing costs, disposal of surplus or unused assets, or just using them. we can say that the 90th were synergies reason and argument of many mergers in the financial sector. acquisition of a economic analysis (2010, vol. 43, no. 1-2, 34-43) 36 major market positions, or the emergence of oligopoly or even monopoly, should be reflected in the growth of the value of the bank and decrease the value of competing banks however most of the studies decrease the value of rival banks didn’t demonstrate [1, p. 135]. the motive for mergers and acquisitions may also be to circumvent quotas, tariffs and other restrictions in foreign trade, reduce dependence on foreign trade or invest in a safe and predictable environment. for successfully manage of merger is very important to make valuation of both banks, which want to merge. financial valuation of bank aims to make its value by a sum of money. the potential of bank is then evaluate by cash equivalents. valuation methods can be divided into these main groups [4, p. 12-13]: 1. methods based on income analysis, 2. methods based primarily on an analysis of current market prices, 3. valuation methods based on cost (the cost of purchasing the property). researched bank mergers were divided into groups according to the region in which they took place. the first group included the mergers in developed economies such as japan, usa, gb, spain and republic of south africa. the second group included mergers acquisitions in transition economies of central and eastern europe. the oldest is the acquisition of csob by belgian kbc in 1999 in the czech republic. in it, kbc has acquired 65.69% stake for 40 billion czk. followed by series of austrian erstebank acquisitions in the czech republic, slovakia and romania. the other from region are the acquisition of komerční banka by french societe generale in 2001 in the czech republic, where there was a transfer of 60% of the shares for 40 billion czk and fresh unibanka merger with hvb bank in slovakia in 2007. table 2. the value of mergers under the merged total assets (eur million) merging banks total assets total mitsubishi tokyo fg + ufj holdings 2005 (japan) 779 338 593 396 1 372 734 jp morgan chase + bank one 2004 (usa) 955 077 269 512 1 224 589 sumitomo + sakura bank 2001 (japan) 500 886 414 775 915 661 royal bank of scotland + natwest 2000 (gb) 532 455 309 873 842 328 barclays + absa 2005 (jar) 785 852 51 009 836 861 santander + abbey 2004 (spain) 504 704 248 857 753 561 sg + kb 2001 (czech) 512 500 12 175 524 675 ersteg + bcr 2006 (romania) 181 703 13 519 195 222 kbc + csob 1999 (czech) 156 218 6 557 162 775 ersteg + ss 2001 (slovakia) 80 114 4 643 84 757 ersteg + cs 2000 (czech) 54 935 12 410 67 345 unibanka +hvb bank 2007 (slovakia) 1 504 2 178 3 682 source: own calculations based on annual reports of banks capital adequacy sense of capital adequacy is based on the assumption that the larger the capital of financial institutions, the more resources shareholders put in. and the greater will be their tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 37 interest for the proper operation of the institution not to lose this money, but to maximize their value. graph 1. capital adequacy ratio (%) 10 11 12 13 14 15 16 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author in case of problems means lower value of capital adequacy for the shareholders and depositors a higher probability of loss. when bank will be successful in its activities, the lower value of the capital adequacy means for shareholders higher probability of evaluation invested investments, but for clients only their deposit interest. raising capital adequacy means better security for clients, but on the other hand it means a reduction in institutions profit contributing to the unit of capital [9, p. 195]. from the previous graph 1 captivate an increase in capital adequacy of banks from central and eastern europe. this can be explained by the some restructuring and reducing the risk before merger, or consistent acquisition partner selection. however, the level of the years after the merger seems to be overly cautious, since the recommended minimum threshold is at 8%. conversely, banks from developed world economies reported relatively stable levels without significant trends at around 12%. profitability ratio indicators from all of profitability indicators, each of which focuses on a different type of profitability, was included in the analysis one of representative from each category. representations of the course are also most worldwide prevalent roe and roa. graph 2. shows the development of bank’s profitability ratio indicator r1 (net banking product * 100/ bankʹs business income) three years prior to the merger till period of three years after the merger. it is clearly visible that the group of banks from central and eastern europe after the merger increased the share of net banking product up to 75%. in the second group of banks throughout the whole period a clear downward trend with small stagnation economic analysis (2010, vol. 43, no. 1-2, 34-43) 38 in mergerʹs year, which means focusing on other areas, mainly on income from fees and commissions, or profits from financial operations. graph 2. bank’s profitability ratio indicator r1 40 50 60 70 80 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author graph 3. bank’s profitability ratio indicator r3 0 10 20 30 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author r3 indicator works with net profit before tax (r3 = net profit before tax * 100 / bankʹs business income + operating income + other income) and thus eliminates any tax differentials in all countries. already one year before the merger can be seen profit growth in both groups of banks, which continued also in subsequent years. so this indicator describes the merger as a great way how to increase net profit before tax. tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 39 graph 4. personal profitability r4 250 300 350 400 450 500 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author personal profitability ratio shows the effect which brings unit of labour in proportion to net banking product (graph 4). in international comparisons it is necessary to use net profit before tax due to different levels of taxation in different countries, and also apply profit to one employee. this comparison may indicate overstaffed banks or not very successful interbank organization, poor levels of technical equipment or in the extreme case low skilled and expertise of employees. optimization of branch network and reducing the number of employees is among the core theme of mergers. one might assume that after the merger it comes just increase of this parameter. however, in a group of banks from central and eastern europe was no bigger increase acting, even in the merger year there was a slight decline. and since labor costs were not growing by way to be able to explain this trend, mergers in this direction had not brought the desired effect. conversely group of banks from developed economies, recorded an increase to almost twice its value from the year before the merger and the trend seems to be strong enough also for the future. graph 5. return on equity – roe -30 -20 -10 0 10 20 30 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author economic analysis (2010, vol. 43, no. 1-2, 34-43) 40 graph 5. shows the performance of banks as measured by roe. it indicates to shareholders how effective their investments in shares are. visible is a positive increase in banks in central and eastern europe. already one year before the merger they reached a significant positive value and growth trend is maintained until the end of the period. by contrast the group of mergers in developed economies has value of roe still in the range 10 to 20% without significant changes in the mergerʹs year. thus the merger did not bring any significant effect to shareholders in the long run. graph 6. return on assets – roa 0,2 0,4 0,6 0,8 1,0 1,2 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author the fundamental problem of the indicator roe as the primary indicator of bank profitability, is that it does not take into account a possible leverage factor. the bank may indeed very easily increase its roe by increasing the total debt, namely use capital to cover a higher amount of assets. therefore, the analysis must be considered simultaneously with the second indicator roa. graph 6 roa shows how effectively assets are used to make a profit, then how much one unit of assets earns in average. the international standard is regarded as a value of 1.00 and as we can see, central european banks are reaching that point immediately one year after merger. in contrast with second group which are slightly below the standard and don’t exceed value of 0.8 throughout whole period of time. the following shape of curve caused japanese banks and their long-lasting crisis in its banking sector, which is marked by huge credit losses and overcapacity. market value indicator the most important indicator from this category is now considered the market price of shares, which immediately takes into account all relevant information affecting their level and is a very important tool for investors (graph 7). tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 41 graph 7. market price of shares 80 100 120 140 160 180 200 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author note except slovenská sporiteľňa, bcr, hvb bank and uni bank, which shares are not publicly traded. one year after the merger took place as expected, fall in central banks stock prices, but it was already deleted the next year and a year later, the average price reached 170% of the initial value. the curve of banks from developed economies has fall in mergerʹs year, but the following period was marked by a sharp strengthening price of shares up to 190% of initial value in the third year after the merger. graph 8. total loans / total assets ratio 35 40 45 50 55 60 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author one of the most important indicator for financing small and medium-sized enterprises (sme) belongs the volume of total loans to total assets (graph 8). which are in the banking practice divided in loans to households and small entrepreneurs, large corporate clients, special funding and loans to smeʹs. now we pay attention just to the last item which is drew in graph 9. economic analysis (2010, vol. 43, no. 1-2, 34-43) 42 graph 9. sme’s loans / total assets ratio 9 10 11 12 13 14 15 16 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author the share of smeʹs loans to total assets has a very similar trend as total loans to total assets. we can observe a significant trend of divergence in two groups since year before the merger, which is getting stronger every following year. mergers in the our region didn’t contributed to a better allocation of loans for small and medium-sized enterprises, but commercial banks are now paying increasing attention to the segment of small and mediumsized enterprises [8]. which do not provide such large volumes of transactions as large corporate customers, but better margins and future potential. this led in 2008 to increase of lending volume to this segment about the fifth, sometimes up to 30 %. conclusion the success of the merger affects many factors. we could say most important are managing rationalization of operations, gaining access to new banking techniques, optimizing economies of scale, portfolio diversification, synergy, and not least the success of the merger determine choosing of financing method of the merger. assessment of the merger success after several years of difficult, but most obvious way seems to be using different analytical methods and ratio indicators that can provide a fairly comprehensive view of economic performance following years after the merger compared to the years before the merger. all indicators should be monitored and assessed in longer period of time and it should be noted that even slight changes in the indicator level may indicate changes in the range of customers or changes in the financial market. the capital adequacy is showing some differences between merger groups. central and eastern europe region in the second year after the merger amounted value exceeding 15 %, so although in the eyes of clients were more secure, on the other hand, this meant reduction in institutions profit contributing to the unit of capital. profitability indicators also speak in favor of the merger in central and eastern europe region. mergers in our region didn’t contributed to a better allocation of tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 43 loans for small and medium-sized enterprises, but commercial banks are now paying increasing attention to the segment of small and medium-sized enterprises. better results of banks in transition countries in central and eastern europe, is generally attributed to a significant restructuring and rationalization process, which took place before the merger itself to attract acquisition partners. to evaluate the impact of mergers on banksʹ financial results can be done not only with using these methods and indicators, but also in other ways. summary the study gives an overview of the economic situation coupled with the merger of banks in the area of central and eastern europe in comparison with developed markets in the world. it applies to different types of mergers of banks ratio indicators, the market value of shares and capital adequacy. attention turns also to the issue of smeʹs loans measured by the range of indicators. references baláž, p., verček, p. globalizácia a nová ekonomika. bratislava: sprint, 2002, s.135. isbn 80-89085-067. davis, s. i. bank mergers. lessons for the future. london: macmillan 2000, s. 97. isbn 978-0-312-235529. kotulič, r., király, p., rajčíniová, m. finančná analýza podniku. bratislava: iura edition, 2007. 206 s. isbn 978-80-8078-117-0. mařík, m. určování hodnoty firem. 1. vyd. praha: ekopress, 1998, s. 12-13. isbn 80-7079-938-2. polouček, s. bankovnictví. 1. vyd. karviná: su v opavě 2005, s. 243. isbn 80-7248-264-5. polouček, s. a kol. bankovnictví. 1. vydání. praha: c. h. beck, 2006, s. 490. isbn 80-7179-462-7. rákoš, j. základy finančnej analýzy. in: manažment projektov v regiónoch. prešov: manacon, 2005, s. 83-100. isbn 80-89040-27-6. tej, j., brecik, m., krasnodębski, a. small and medium enterprise one of the aspects of the regional development. in: acta agraria et silvestria. vol. xliv/2: series agraria; sekcja ekonomiczna. kraków: wydawnictwo oddzialu polskiej akademii nauk, 2005. tej, j. ml., tej, j. ekonomické zhodnotenie fúzií vybraných bánk v regióne. in: anno 2009. prešov: pu v prešove 2009, s.191-202. dostupné na: http://www.pulib.sk/elpub2/fm/kotulic10/index.html, isbn 978-80-555-0005-8. received: 11 january 2010 article history: accepted: 23 march 2010 ea_2013_1-2 notes from the editor-in-chief the economic analysis (ea) seeks the input of top quality scientific papers with contributions from multiple disciplines. in line with this, we invite you to send us scientifically based research papers, case studies and book reviews in business economics, entrepreneurship, education, finance, employment, marketing and other scientific disciplines. i thank all our members of the editorial board and advisory board and reviewers for their continued support and encouragement. the journal is currently indexed with the following databases: directory of open access journals (doaj) ebsco gesis ullbe university databases cabell's directories of publishing opportunities google scholar. more information about the journal can be found on our website http://www.ien.bg.ac.rs/index.php/sr/asopis-ekon-analiza. we encourage potential authors to contact us if they have any questions about the relevance of their papers for submission. questions may be directed to the editorial office at eaoffice@ien.bg.ac.rs. may, 2013. yours, editor-in-chief prof. dr. mirjana radović-marković, fea, frsa, fwaas, femaas, skanu ea_2014_3-4 udc: 005.332:005.44 jel: f2, f6 cobiss.sr-id 211781900 conference paper the impact of globalization on the business ristovska katerina1, ristovska aneta, university ss. cyril and methodius, management, faculty of economics, skopje abstract – the modern liberal, capitalistic and economic action becomes a conglomerate of factors and reasons, analysis, information, means, mediums, skills and predispositions. in terms of minimized barriers and openness of the world, the inevitable process of the globalization and the business actions represent projects that are facing success potentials, as well as risk and failure potentials. the indisputable accent on these aspects is certainly the success and the reliability of the business ventures for which the ultimate goal is the economic satisfaction, minimizing the risks as well as the establishment of long-term experiences in order to maintain a particular enterprise in a particular environment. the participation on the world's global markets, the internationalization and the transfer of the business activities on all geographic meridians, encountering different and often uncertain environments is a constant business story of the international economic activity for at least three centuries ago. the global economic interaction is as old as it is old the society in its more or less organized form. from the industrial revolution until today, there is ongoing irreversible global economic integration. the reasons are simple, business and profits do not recognize borders, national and cultural unsurpassed characteristics, where more or less a mutual benefit of certain cooperation is recognized, a business connection is immediately established. key words: globalization, internationalization, business, global markets, economic integration introduction the global changes in the world, changes in political, economic and business activities as well as the development of technology, transport and communications, impose the need for enterprises in its struggle for survival, to change their strategies and go out from the borders of their own country. limited market, competitive pressure, demand for cheaper resources and the dynamics of the postmodern era, forcing business leaders to change their focus from traditional targets to alternative measures for successful business and the entrance on global markets, with the purpose of making competitive advantage. the impact of globalization on the business international business is a term used to describe all commercial transactions, in general, (private and governmental, sales, investments, logistics and transport) which occur between 1 master in mba, st. franc preshern 122, 1000 skopje, email: katerina.ristovska@gmail.com economic analysis (2014, vol. 47, no. 3-4, 83-89) 84 two or more regions, countries and nations beyond their political borders (radebaugh & sullivan, 2007). international business refers to those business activities which include crossborder transactions of goods, services or resources between two or more nations. transactions of economic resources include capital, skills, people for international production of physical goods or services, such as finance, banking, insurance, construction (joshi, 2009). according to rugman and collinson, international business analyzes transactions that take place across national borders in order to meet the needs of individuals and organizations. these economic transactions consist of trade (imports and exports) and foreign direct investment (rugman, collinson, & hodgetts, 2006). according to ball, international business is a business whose activities are carried out beyond the borders of their country and here not only include international trade and international production but growing service trade in areas such as transport, tourism, advertising, construction, retail and mass communication (ball, mcculloch jr., frantz, geringer, & minor, 2002). the companies that are active in international business are called multinational enterprises. multinational enterprise is an enterprise or corporation that owns substantial resources and performs various business activities through a network of branches located in different countries and each branch form its business strategy, based on the different market characteristics (cavusgil, knight, & riesenberger, 2008). multinational company is based in one country but has business activities in several countries. there are opinions that the multinational company is one that is so structured that conducts business or property held in many countries or a company is organized into global production parts. the reasons why a company becomes a multinational, ansoff separates the two categories (ansoff, 1984): • operational needs: providing materials, equipment, technology and release of surplus production; • strategic needs: ensuring the inviolability of future changes in the external environment, steady growth (maintaining historic patterns of growth, avoiding stagnation caused by saturation, increasing the volume of business, increasing the rate of growth) and better profitability. the development of international business activities coincided with widespread phenomenon of globalization of markets (cavusgil, knight, & riesenberger, 2008). the globalization of markets refers to the growing economic integration and the growing interdependence of countries worldwide. internationalization of the companies refers to the tendesncy of the companies to systematically increase the international scope of their business activities, while globalization refers to a makrotrend intensive economic relations between the countries in the world. globalization encourages companies to internationalize and to substantially increase the volume and types of cross-border transactions in goods, services and capital. also, the globalization leads to rapid dissemination and diffusion of products, technology and knowledge in the world, regardless of the origin. the process of globalization is a natural process that is a result of the growing and accelerated process of generalizing of the character and process of production. the development of science, engineering and technology and the expansion of markets for goods, worldwide, lead to internationalization of economic and financial developments and their global deployment. if globalization is understood as a process that leads to greater ristovska, k., et al., the impact of globalization, ea (2014, vol. 47, no. 3-4, 83-89) 85 economic integration of national economies, as a process of fragmentation of the world economy and the international economy, than the globalization is a process of opening of national economies through the removal of economic and financial boundaries of national economies and thus their transformation into an international economic and financial market (jovanovski, 2007). globalization is a worldwide trend, through which economies in the world lose their borders and connect to each other. the companies are no longer imprisoned in their borders and can implement a wide range of business activities around the world. many companies are present in markets around the world, procured their raw produce or conduct research and development worldwide. trade barriers fall and global trade between countries in goods and services is growing faster than domestic production. as a result of this, companies can not afford the luxury to assume that the success of the domestic market will lead to longterm profitability (cullen & parboteeah, 2010). the flow of money across national borders is freer, and companies seek better financing rates in the world and investors everywhere are looking for a more favorable return on investment. globalization, developed from economic aspect, has two main components: the globalization of markets and globalization of production. the globalization of markets refers to the merging of historically different and separate national markets into one big global market. in recent years, constantly is discussed that the tastes and preferences of consumers in different countries and nations begin to resemble on a global level and the way that they help in the creating of a global market. the companies that offer standardized products worldwide, help in the creation of a global market. the most common global markets are not the markets for mass consumer products, because there are still differences between countries in terms of tastes and preferences, which still have great meaning and a sort of brake on globalization, but these are the markets for industrial goods and materials that have universal need the world. the globalization of production refers to the tendency of the companies to find suppliers of goods and services from locations around the world, in order to realize the advantage of national differences in price and quality of the factors of production. companies do this in order to reduce overall costs and thereby to improve the quality or to improve the functionality of their product offering to compete more effectively(hill, 2008). in economics, internationalization is seen as a process of increased involvement of enterprises in international markets (susman, 2007). the process of globalization, the fight for survival, constant pressure and the need to preserve and strengthen the market position, force the companies to be willing to constantly innovate and explore opportunities for achieving competitive advantage and expanding business activities outside the domestic market. entrance of the companies in the global market becomes inevitable not only because of limitation of the domestic market but also because of the globalization; the domestic market share is under threat from foreign competition (bartels, buckley, & mariano, 2009). there are several specific factors that promote globalization and guide enterprises to strive for business development and growth through the international and global operations and include: political changes, development of technology, international business climate, market development, expenses and competition (ball, mcculloch, geringer, minor, & mcnett, 2001). economic analysis (2014, vol. 47, no. 3-4, 83-89) 86 • political changes. the globalization trend of unifying and socializing the global community, as well as, forming preferential trade agreements and groupings such as nafta and the european union, which united more nations in a single market, allow the companies significant market opportunities. two aspects of this trend, which contribute to the globalization of business operations are: progressive reduction of barriers for trade and foreign investment by most governments, which leads to intense opening new markets by international companies, which also exported them and build production facilities in them, and the privatization of most of the industry in the former communist countries, as well as opening up their economies to global competition. • development of technology. the development of computing and communication technologies has enabled increased flow of ideas and information across the borders of the countries, providing introduction of the consumers with the goods worldwide. internet and networking have enabled smaller companies to compete globally, as a result of the rapid flow of information, regardless of the physical location of the seller or buyer. also, allows international companies to hold corporate meetings among managers from headquarters and branches, without wasting unnecessary time for travel. • international business climate. the development of communication and information technologies have contributed to the process of globalization, but also provided instruments that facilitated the processes of globalization. newly emerging markets also recognize the economic benefits, technological development and growth opportunities that globalization provides them. • development of markets. information and communication technologies, the rapid development of international tourism, widespread cultural exchange and improved the living standards, in many developing countries have contributed to the emergence of a group of consumers in different countries and regions of the world with similar educational profiles, lifestyle, purchasing power and for good products, as well as, aspirations for high quality. this scenario, in combination with the liberalization of international trade and the availability of global distribution channels, opens great opportunities for companies that want to offer their products to global markets. large market potential exist outside of the domestic market, that is why the companies go out on the foreign markets, generate sales and have opportunities for profit that cannot be achieved at home. • expenses. the liberalization of trade and investment flows, which emerged in the 80s of the last century, which inexorably moved forward, is a stimulus for globalization of the businesses. trade liberalization, global consumer habits, rising development costs and the need for economies of scale, pressure from foreign competitors in the domestic market as well as the development of information and communication technologies, are considered drivers of the globalization. because of the need to introduce new products and investment in research, development and innovation, achieving economies of scale, reduce costs and access to cheaper raw materials; companies are forced to plan activities, taking into consideration the global market. economies of scale and cost reduction are the main goal of management. that is why companies decide to locate production in countries where the cost of developing and producing are smaller. • competition. one of the reasons that the companies join global strategies is the need of maintaining or gaining a competitive advantage in foreign markets and avoiding ristovska, k., et al., the impact of globalization, ea (2014, vol. 47, no. 3-4, 83-89) 87 competition in the domestic market. competition in international markets is huge and growing, with more multinational competitors who win markets worldwide. the companies improve their competitive position by opposing competitors in international markets or premature intrusion into the domestic market of the competitor in order to destabilize or to suppress its development. as the globalization increases the speed and prevalence, and for the companies more opportunities are opening easily, to perform on the international markets. the managers develop and adapt strategies for internationalization in order to transform their organizations into globally competitive enterprises. managers seek to coordinate the supply, production, marketing and other activities based on international activities. the organization of the company globally is a challenge and requires strategic positioning, organizational skills, a high degree of coordination and integration, attention to the needs of individual markets and the implementation of common processes. the strategy, in an international context, is an organization plan for positive positioning, compared to the competitors. this plan lead the company to selected customers, markets, products and services in global markets, not just a particular international market. the strategy in an international context should help managers to formulate a strong international vision, allocation of scarce resources on the world, the participation of the major markets, implementation of global partnerships, and involvement in competitive activities in response to global rivals and establish activities that add additional value on a global level (cavusgil, yeniyurt, & townsend, 2004). when the companies compete outside of their country, they face a number of challenges and pressures. these pressures and challenges to maintain competitiveness, require from the companies cut costs, in order the consumers do not evaluate their products or services as too expensive. this leads to the need to locate production facilities in places where production costs are lower, and the development of high standardized products in most countries. in the context of the pressure to reduce costs, managers must strive to be ready to respond to local pressures to adapt products to local market requirements, where the company is active. this requires differentiation of their offer and strategies in different countries, in order to preserve the tastes and preferences of consumers, but also the differentiation of distribution channels, management of human resources, and government regulations. because the strategies and tactics for differentiation of products and services in local markets create additional costs, they can also lead to increased costs for the company. these two pressures that enterprises face, resulting in four basic strategies that the companies use to compete in the global market. these strategies are: international, global, multi-domestic and transnational strategy (dess, lumpkin, & taylor, 2004). the strategy that will be chosen by the company depends on the pressure faced by cost-cutting and the importance of adapting to local markets. conclusion today, the word international company is quite a common phenomenon, which reflects actual business transactions and large expanses between a number of people from different cultures and with different approaches. what unites them in the complex network of relationships is the need of development, rapid exchange of resources and tools and economic analysis (2014, vol. 47, no. 3-4, 83-89) 88 integrated cooperation, which should contribute to ensuring cooperation and ensure the transfer of capital. can be concluded that today's decisions for crossing domestic borders and internationalize the business is a prerequisite for serious growth and development of a business entity. as such, he is always searching and analysis of potential areas where the company from small or medium business entity would become a corporate organization striving to constantly expanding and increasing its own portfolio. to make a decision to invest outside of the own borders is a complex and comprehensive process. this process is achieved through several stages and approaches that contain a longterm comprehensive analysis and scanning newly elected investment location. references ansoff, h. i. 1984. implementing strategic management. prentice-hall international, englewood cliffs, nj. ball, a. d., wendell, h., mcculloch, jr., frantz, l. p., geringer, j. m., minor, s. m. 2001. international business – the challenge of global competition. international edition, mcgraw-hill. bartels, l. f., buckley p., mariano g. 2009. multinational enterprises’ foreign direct investment location decisions within the global factory. unido, vienna. cavusgil, t. s., yeniyurt, s., townsend, j. 2004. “the framework of a global company: a conceptualization and preliminary validation”. industrial marketing management, 33. cavusgil, t., knight, g., riesenberger, j. 2008. international business: strategy, management and the new realities. prentice hall. cullen, b. j., parboteeah, k. p. 2010. international business, strategy and the multinational company. taylor & francis. daniels, d.j., radebaugh, h.l., sullivan, p.d. 2007. international business: environment and operations. prentice hall. dess, g., lumpkin, g.t., taylor, m. 2004. strategic management: creating competitive advantages. hill, w. l. c. 2008. global business today. mcgraw-hill irwin. joshi, m. r. 2009. international business. oxford university press. jovanovski, t. 2007. megjunarodni finansii. skopje: euro-mak kompanii. susman, i. g. 2007. small and medium-sized enterprises and the global economy. edward elgar publishing. uticaj globalizacije na poslovanje rezime – savremene liberalne, kapitalističke i ekonomske aktivnosti postaju konglomerat brojnih faktora i uzroka, analiza i tumačenja, podataka, medija, sposobnosti i predispozicija. kroz minimiziranje barijera i širenje otvorenosti ka svetu, neizbežni proces globalizacije omogućava poslovnim projektima potencijale za uspeh, ali istovremeno sa sobom nosi rizik od neuspeha. neosporni akcenat na polju globalizacije jeste uspeh i pouzdanost poslovnih poduhvata koji za krajni cilj imaju ekonomsko zadovoljstvo, minimiziranje poslovnog rizika kao i uspostavljanje dugoročnih iskustava kako bi se poslovanje određenog preduzeća održalo u dužem vremenskom periodu u određenom okruženju. internacionalizacija, učešće na globalnim tržištima i obavljanje poslovnih ristovska, k., et al., the impact of globalization, ea (2014, vol. 47, no. 3-4, 83-89) 89 aktivnosti na svim geografskim meridijanima, uz različita i često neizvesna okruženja, najmanje tri veka predstavljaju suštinu međunarodnih poslovnih aktivnosti preduzeća. globalna ekonomska aktivnost, u više ili manje organizovanom obliku, je stara koliko je staro društvo. tekuća globalna ekonomska interakcija se odvija neprekidno, od industrijske revolucije do danas. razlozi za globalizaciju su jednostavni, poslovna dobit ne poznaje granice, nacionalne i kulturološke karakteristike se zadržavaju a poslovna veza se odmah uspostavlja, osobito ako se radi o saradnji koja donosi obostranu korist. ključne reči: globalizacija, internacionalizacija, poslovne aktivnosti, globalno tržište, ekonomska integracija article history: received: 8 april 2014 accepted: 16 august 2014 microsoft word 2011_3_4_finalna ver.doc original research paper    optional approach for investment projects valuation and it’s  appliance to the project of producing healthy organic food   rovčanin adnan*, nuhić minela, sejdić amila, university of sarajevo, faculty of  economics, bosnia and herzegovina   udc: 330.322; 338.439   jel: q18; o22    opcioni pristup za vrednovanje investicionih projekata i  njihova primena na projekte u proizvodnji organske hrane        abstract – the aim of this paper is to present the appliance possibilities of optional approach  to  investment  projects  valuation,  as  well  as  new  theoretical  and  methodological  framework  of  investment analysis, to project of producing and selling healthy organic food.  unlike  traditional  methods  of  project  valuation,  this  new,  contemporary  approach  provides  valuation of management flexibility and possibility of adjustment (correction of previous decisions) in  accordance to the market conditions. in light of dramatic changes and increasing risks and uncertainty  in  investment decision‐making,  it  is necessary to complete the traditional approach by optional,  in  order  to  make  more  rational  allocation  of  resources.  the  necessity  of  using  optional  approach  is  reflected from the fact that the results of projects valuation according to the traditional and modern  approach may be contradictory.   this paper presents the black‐scholes and binomial option pricing model, and appliance of option  valuation  is shown on  the project of producing and selling healthy organic  food and healthy  food  restaurant  as  an  extension  activity.  while  traditional  methods  of  valuating  investment  projects  valuated the project of producing healthy organic food as unprofitable, the optional approach shows  that this project is acceptable, which confirms the importance of this approach    key words: real options, flexibility, risk, uncertainty, project valuation, organic food  introduction  investment project valuation is a specific way of measuring the benefits and costs ratio  during  defined  project  lifetime.  the  purpose  of  these  methods  is  to  quantify  arguments  about  acceptability  or  unacceptability  of  the  specific  project.  general  classification  of  investment projects valuation methods is in two groups, traditional and modern methods,  whereby the traditional methods of valuation include the standard discount cash flow (dcf)  method of analysis, or all those methods of assessment that do not consider the opportunity  costs  (benefits)  based  on  investment  in  project.  conventional  methods  are,  therefore,  the                                                         * address: trg oslobođenja ‐ alija izetbegović 1, sarajevo, bosnia and herzegovina, tel. +387 33 27 59  49, e‐mail: adnan.rovcanin@efsa.unsa.ba       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   45 method of net present value (npv), the internal rate of return method, the annuity method,  cost  recovery  method  and  the  coefficient  of  profitability.  on  the  other  hand,  modern  methods are based on access to opportunity, which means they take into account not only  the gross benefits  (costs) of  investment, but also missed  investment effects  (open,  ʺclosed  downʺ  investment  opportunities  (options)).  by  this  method,  it  is  possible  to  evaluate  the  flexibility  of  the  project,  respectively  possibility  of  adjustment  (correction  of  previous  decisions), in accordance to the market changes.  according to traditional approach, project value is just a simple difference between the  present value of returns and the present value of investment, while the optional approach  considered the project value more widely, as a difference of direct costs and benefits of the  project  (npv),  corrected  for  the  balance  of  the  closed  (open)  options,  after  starting  the  project. whereas the project with a real option is always worth more, or at least the same as  the  project  without  this  (these)  option(s),  it  is  clear  that  the  traditional  approach  underestimates the project value, and that the project is considered in a strictly deterministic  and static conditions. in conditions of increasing uncertainty, risk and changes, conventional  approach  is  becoming  less  relevant  for  the  assessment  of  projects,  and  in  the  valuation  process must include the value of real options.  there are three main real options that may arise in the process of valuation project as  follows:  • option to abandon  • option to expend   • option to contract  respecting that real options have the following similarities with financial options:  • represent the right, but not the obligation (as well as financial options);  • invested  funds  is  the  irreversible  investment  (the  price  paid  for  the  financial  option is non‐refundable);  • can not have a negative value (as well as financial options);    table 1. analogy between financial and real options (rovčanin, 2005, 551)      in the valuation process they can be equated with the financial, call and put options, and  model developed for valuation of financial options can be applied to real options with prior  stock price   investment expenditure of optional  project length of time till optional project risk free rate rate of return of alternative project  risk of investment project  s k t r  σ2  financial option  real option exercise price of option  time to expiration of option present value of optional project  risk of returns on stock    economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   46 introduction of certain analogies. so the option to abandon is equated with the financial put  option, the option to expend is equated with the financial call option, while the option to  contract is also a variant of the call option. models that are commonly used to evaluate the  financial and real options are the black‐scholes and the binomial model, which are presented  below.  in  order  to  evaluate  real  options  of  projects  by  models  mentioned  above,  it  is  necessary to previously make further analogy between elements of investment opportunities  and elements of european call and put options.  binomial option pricing model   binomial tree   binomial option pricing model finds its starting point in short time intervals in which the  stock price or some other related assets can take two values. given that recognizes only two  possible results, it has called the binomial model. the model observes the trend in the stock  price and other related assets over short time intervals throughout the life of the option.   the process of the binomial option pricing model consists of several stages, as follows:  1. making the pricing binomial trees;  2. calculating the options value in each final node of binomial tree;  3. progressively calculating the options value in each previous node. the value in the first  node represents the value of the option.  the model is based on several assumptions. it assumes the existence of perfect financial  markets, without disruptions and transaction costs. risk free  interest rate  is constant, and  stocks pay no dividends. binomial model  is based on  the binomial  tree which represents  price movements’ model of stocks or other related assets in the future. at the end of each  interval, possible future stock prices are being determined. this price evolution forms the  basis for options valuation. each node in the tree represents a possible price of a stock or  other forms of related assets in a specific time point.     figure 1. binomial tree    s  su sd suu  sud  sdd   the price tree is formed by going forward from valuation date to the date of expiry, or  maturity.   assumption is that the price of related assets is going to grow u (up) times or decrease d  (down) times for each step along the tree, where by definition is u ≥ 1 and 0 ≤ d ≤ 1. if the       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   47 symbol  of  the  current  price  is  s,  then  the  price  in  the  next  period  will  be  ussu ⋅=   or  ,dss d ⋅= where the probability that the price s is going to rise to su is p, and that is going to  decrease to sd, 1‐p. following the shown tree, the expected stock price for one time interval  can be calculated as a weighted average of two prices which are the result of movement of  current stock price to up or down. it can be shown by following formula:  du spsp ⋅−+⋅ )1(                    (1)  the value of call  options  in  the  final nodes of  the  tree  is calculated  as  the difference  between spot prices of related assets and the executive price of option. if the difference is  negative, the value of the option is 0. in one period binomial model, the value of call option  is equal to: )0 ,( ksmax u −=  in first final node, and  )0 ,( ksmax d −= in second final node.  the value of put option is: max (k‐su, o) on the first final node, and max (k‐sd, o) at the  second final node of binomial tree, where the k is exercise price, while s is the spot price of  related assets.  after completing the evaluation of options at each final node, we access to the valuation  of options on each previous node, starting from the final to the first node of the tree, where  the final result is value of the option.  replicating portfolio   binomial model is based on the principle of arbitration, claiming that the price of options  should match  the cost of creating alternative portfolio position, which will have  identical  effects  on  the  financial  investors.  the  model  is  based  on  the  idea  of  creating  risk  free  synthetic portfolio that is consisted of, in the case of call options on stocks, short positions in  call option and long in stocks on the basis of which it is made, whereby the first fully covered  by another.(šoškić, 2001, 319). in the case of put options, the synthetic portfolio is made of  short positions in put options and short positions in related assets. 1   mathematically it can be written, for call option:   cshv −⋅=                      (2)   where is:        du du ss cc h − − =            (3)  and  c  is  value  of  the  call  option  at  the  time  t0,  while  cu  and  cd  are  values  of  corresponding  call  option  price  associated  by  the  shift  of  property  to  the  up  and  down.  expression  (2)  represents  a  risk‐free  portfolio,  which  rejects  the  risk‐free  yield,  and  is  composed of h‐related assets and the amount of call options issued to the related assets. in  this sense, h is the number that shows how many units of property must be hold for each  issued call option to date projections of growth and falling prices of related assets, if we want  to have a risk‐free portfolio. starting  from  the probability of growth or decline of related  assets prices, it is necessary to determine the risk‐free portfolio that will produce the same  outcome, regardless of whether it will happen the first or second situation.                                                         1 damodaran, a. real options: facts and fantasy,  http://pages.stern.nyu.edu/~adamodar/pdfiles/execval/optval.pdf , (accessed 03 june 2010 )     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   48 dduudu chschsvvrv −=−===+⋅ )1(             (4)   solving system of equations for v, using expressions (3) and (4) and inserting in formula  (2) and  expressing c, formula  for calculating the value of call options is:   1)1( −+ − − + − − = r ss cscs s ss cc c du uddu du du              (5)     the same logic can be applied to the valuation of put options. specifically, the difference  is  reflected  in  the  opposite  position  of  the  holder  of  the  option  by  the  related  assets,  in  relation to the position of the holder of the call option, so the differences arise only in signs,  i.e. v=h⋅ s+h, and still is:  s ss cc r ss cscs x du du du duud ⋅ − − −+⋅ − − = −1)1(             (6)   where x – is value of put option at time t0.  probability of price movements of related assets   it has already been pointed out that the binomial model is based on only two possible  prices outcomes of related assets in the next specific time point, while the probability that the  price of related assets is going to the increase on su, is p, and is going to fall on the sd, 1‐p.  starting  from  the  expected return r, expected stock price can be calculated  through a  specified time interval. if we assume that:   du spsprs ⋅−+⋅=+⋅ )1()1(                 (7)  here is:  du dr ss srs p du d − −+ = − −+⋅ = 1)1(                 (8)  if  we  express  s  over  su,  sd,  r,  p,  from  the  form  (7),  and  insert  in  the  form  (5),  by  rearranging it is obtained formula for calculating the value of call option (9).  [ ]du cpcpr c ⋅−+⋅ + = )1( 1 1                 (9)  or, on the basis of the form (7), (8) i (9):  ⎟ ⎠ ⎞ ⎜ ⎝ ⎛ + ⋅⎟ ⎠ ⎞ ⎜ ⎝ ⎛ − −− +⎟ ⎠ ⎞ ⎜ ⎝ ⎛ + ⋅⎟ ⎠ ⎞ ⎜ ⎝ ⎛ − −+ = r c du ru r c du dr c du 1 1 1 1             (10)  multioperiodic model   if  one  interval  is  divided  into  several  smaller  intervals,  binomial  model  is  going  to  extend. in the case that binomial tree has only two time intervals, initial price of related asset       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   49 c cu cd cu cud  cdd  s  su  sd  sud sdd s will match the value of call option c. after the first time interval, expected prices of related  assets are su i sd with corresponding values of call and put options cd i cu, and xu i xd.     figure 2. multiperiodic binomial model – price of related asssets and value of  call option    possible price of related assets, after the second interval, are: suu and sud, which are  achievable in the case that after the first interval price of related assets has grown, and sdu  and sdd, which are achievable in the case that the price of related assets after the first interval  has fallen, and corresponding values of option are cuu, cud, cdu and cdd.  given that current price of call option from binomial tree with one interval is equal to:  [ ]du cpcpr c ⋅−+⋅ + = )1( 1 1                 (11)  expected valued of  call options, in the end of first interval for expecting movement of  price to upwards, is going to be:   [ ]uduuu cpcpr c ⋅−+⋅⋅ + = )1( 1 1               (12)  and for expecting movement to down:   [ ]dddud cppcr c ⋅−+⋅⋅ + = )1( 1 1                (13)  if the previous expressions (12) and (13) are inserted in model of present value of call  option,  form  (11),  it  is  obtained  the  value  of  call  option  for  binomial  model  with  two  intervals.  [ ]dduduu cpcppcp r c ⋅−+⋅−⋅+⋅⋅ + = 22 2 )1()1(2 )1( 1         (14)  if model is being spread, from the number of periods with observed periods one to n,  option pricing formula will take the form2:   [ ]0 ,max)1( )1( 1 0 kdsupp k n r c knkknk n k n −−∑ ⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ + = −− =           (15)                                                         2 benninga, s. et al. the binomial option pricing model,   http://finance.wharton.upenn.edu/~benninga/mma/mier63.pdf, (accessed 03 june 2010)  su    economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   50 this formula is recursive, it works backwards, starting from financial result of option on  day of maturity.   black‐scholes model  the  black‐scholes  model  is  one  of  the  most  important  concepts  in  modern  financial  theory. it was developed in 1973 by fisher black, robert merton and myron scholes and is  still widely used today, and regarded as one of the best ways of determining fair prices of  options.3 since the binomial model for pricing options converges on the black‐scholes model,  it is considered to be a special case of binomial model when the price process is continuous  and the number of iteration is infinitive.4 still, the black‐scholes model has not been derived  from binomial. the model was established before the binomial.   the assumptions of the black‐scholes model  there are several assumptions underlying the model:  • no dividends are paid out during the stocks life5  • option can only be exercised on the expiration date (therefore, it can only be used  in valuing the european options, but not american)  • markets are efficient which suggests that market movements cannot be predicted  • no commissions are charged while buying or selling options  • interest rates remain constant and known (the model uses the risk‐free rate in its  calculations)  • stock returns follow a lognormal distribution (the lognormal distribution is often  used to summarize the probability of different price changes)  the black‐scholes formula  the idea behind the black‐scholes model is hedging against the written call option with a  risk‐free portfolio. this portfolio is a replicating portfolio. if it is dynamically rebalanced it  will always match  the pay off on  the call option  that was written. therefore,  the present  value of this portfolio equals the present value of the call option.  [ ] [ ]loanbankpricesharedeltaoptioncallofvalue −⋅=          (16)  tzerobondsoptioncallofvalue ,0 −δ=               (17)  0sδ  is the long position in stock. it is not an entire share of stock but a fractional share of  stock  signified  by  delta.  this  long  position  is  combined  with  a  short  position  in  a  zero‐ coupon bond maturing in the future on time t  which is the same time when the call option  that we wrote will be presumably exercised. the short positions quantity equals the strike  price of the option  k . but since the strike price is a price on the significant date in the future,                                                         3 http://www.investopedia.com/terms/b/blackscholes.asp (accessed 1 septmeber 2010)  4 calculating option value using binomial with an indefinite number of subperiods is too complicated.  5 merton altereted the standard black‐scholes model to incorporate an annual dividend yield in the  formula which made the model usefull for dividend paying stocks.        rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   51 it  is necessary  to present value  that strike price by discounting  it with a discount rate  r   which  is risk‐free rate. still  the probability  that option expiries  in  the money and will be  exercised should also be considered. so the present value of the strike price is multiplied by  )( 2dn , a cumulative normal distribution function which represents the probability of the  option being exercised. so on the right side, beside  0sδ   is a probability adjusted present  value of the strike price:  rtkednsoptioncallofvalue −−δ= )( 20             (18)  also  0sδ needs  adjustments.  just  like  with  the  short  position,  cumulative  normal  distribution  function  )( 1dn   is  used. )( 1dn   represents  delta  )(δ or  how  many  fractional  share of stock should be long.   rtkednsdnoptioncallofvalue −⋅−= )()( 201             (19)  the  previous  formula  is  actually  the  black‐scholes  formula.  value  of  call  option  is  usually singed by c. so here is complete black‐scholes formula:  rtkednsdnc −⋅−= )()( 201                 (20)  where  t tr k s d σ σ ) 2 ()ln( 2 1 ++ =                   (21)  t tr k s tdd σ σ σ ) 2 ()ln( 2 12 −+ =−=               (22)  c = value of call option  )(dn  = cumulative normal distribution function6  k  = strike (exercise) price of the option  0s  = current value of the underlying asset (price of the stock now)  t  = life to expiration of the option  r = risk‐free interest rate  σ  = volatility of stock price and stock return rate (standard deviation)  e  = exponential term (2.7183)  ln  = natural logarithm   using the same analogy, the black‐scholes formula for put option is:  012 )()( sdnkednx rt −−−= −                 (23)  where is  x = value of put option.  the value of option value depends upon a number of current stoke price, strike (exercise)  price, time until expiration, risk‐free interest rate and standard deviation σ  .                                                         6 it is a probability that a normally distributed random variable will be less than or equal to d.    economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   52 ),,,,( 0 σrtkscc =                   (24)  standard  deviation  is  critical  variable  in  this  model.  the  reason  for  this  is  that  small  changes in standard deviation cause significant changes of the option value.   variables in the black‐scholes model  the call option value depends upon a number of factors:  • current stock price   0s   • strike (exercise) price  k   • time until expiration t   • risk‐free interest rate  r   • standard deviation σ .  ),,,,( 0 σrtkscc =                   (25)  current stock price  higher  the  current  stock  price,  higher  the  value  of  call  option.  the  measurement  of  sensitivity of current stock price changes is delta. the delta is a measure of the relationship  between an option price and the underlying stock price.   )( 1 0 dn s c ==δ δ δ                    (26)  since the  )( 1dn  is a probability, delta is a value between 0 and 1. for a call option, a  delta of 0.50 means a half‐point rise in premium for every dollar that the stock goes up.   gamma  is  sensitivity  of  delta  to  unit  change  in  the  underlying.  gamma  indicates  an  absolute change in delta.   2 0 2 s c δ δ =γ                       (27)  for example, a gamma change of 0.150 indicates the delta will increase by 0.150 if the  underlying price increases or decreases by 1.0. results may not be exact due to rounding.  strike (exercise) price  if the strike price increases, the value of a call option will decrease. however, the exercise  price does not change, so this measurement has sense only  in aspect of valuing the same  option with different strike price for purpose of comparing.  time until expiration   if the time until expiration is longer, the value of a call option is lower. theta is sensitivity  of option value to change in time. theta indicates an absolute change in the option value for  a ʹone unitʹ reduction in time to expiration.  t c δ δ θ =                       (28)       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   53 the option calculator assumes ʹone unitʹ of time is 7 days. for example, a theta of ‐250  indicates  the  optionʹs  theoretical  value  will  change  by  ‐.250  if  the  days  to  expiration  is  reduced by 7. results may not be exact due to rounding.7  risk‐free rate  if the risk‐free rate increases so will the value of a call option. rho is sensitivity of option  value to change in interest rate. rho indicates the absolute change in option value for a one  percent change in the interest rate.   r c δ δ ρ =                       (29)  for example, a rho of .060 indicates the optionʹs theoretical value will increase by .060 if  the interest rate is decreased by 1.0. results may not be exact due to rounding.  standard deviation  standard  deviation  is  critical  variable  in  this  model.  the  reason  for  this  is  that  small  changes in standard deviation cause significant changes of the call option value. if standard  deviation increases the value of call option will decrease. vega is sensitivity of option value  to change in volatility. vega indicates an absolute change in option value for a one percent  change in volatility.   δσ δc vega =                     (30)  for example, a vega of 0.090 indicates an absolute change in the optionʹs theoretical value  will increase by 0.090 if the volatility percentage is increased by 1.0 or decreased by 0.090 if  the volatility percentage is decreased by 1.0. results may not be exact due to rounding.  advantages and limitations of the black‐scholes model  the main advantage of the black‐scholes model  is speed  ‐  it  lets you calculate a very  large  number  of  option  prices  in  a  very  short  time.8  although  understanding  the  model  seems hard and complicated, using it is more than simple. just a couple of mathematical and  statistic operations and the value of call option has been calculated. the black‐scholes model  was designed  to value options  that can be exercised only at maturity and on underlying  assets  that do not pay dividends. however,  in practice, assets do pay dividends, options  sometimes get exercised early and exercising option can affect the value of the underlying  asset. adjustments exist. while they are not perfect, adjustments provide partial correction to  the black‐scholes model.9  also, option prices are very sensitive to changes in volatility. volatility however cannot  be directly observed and must be estimated. estimating volatility is a problem which is often  solved by using historical data or already estimated volatilities for specific industries or even                                                         7 http://www.optionseducation.org/advanced/volatility_greeks.jsp (accessed 1 september 2010) 8 http://www.hoadley.net/options/bs.htm (accessed 5 september, 2010)  9 http://pages.stern.nyu.edu/~adamodar/  (accessed 5 september, 2010)     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   54 companies.  these  last  estimations  are  usually  done  by  organizations  and  companies  themselves mostly by using previous price behavior, in other word historical data.  relation between binomial and  black‐schloes models  inputs  for black‐scholes model, as a special variant of binomial model, can be  used for approximation of factors u and d, using following equations:   ttr eu δ⋅+δ⋅− = σσ )2 2 1 (                   (31)  ttr ed δ⋅−δ⋅− = σσ )2 2 1 (                   (32)  where  tδ  is one of n intervals during the period t in which price of related assets has  been changed, while ohter symbols from edited equations are explained previously. by this  approximation,  probability  of  moving  asset  price  to  upward  is  determined  by  following  expression:   du de p tr − − = δ⋅                     (33)  the project of producing healthy organic food  this part of the paper illustrates the appliance of presented methodology to the project of  producing healthy organic food. to show this methods practically, the project has to have  an  option of some kind. this  project  can  be  expanded  by  opening  an organic restaurant  which represents our call option. in this way organic food production has added optional  value of restaurant which increases the value of the project. the net present value (npv) of  the project is calculated for the next five years.10 the calculation includes only net cash flow  per year and present cash flow per year using 12% discount rate and it is given in table  as seen  in  the  table,  the projects net present value  is negative  (npv=‐3.641,22 bam).  using only traditional valuation methods this project would be considered unprofitable and  would  not  be  accepted.  but  as  said  before,  traditional  methods  ignore  the  possibility  of  options. now we will see the results of option based valuating methods. opening an organic  restaurant  is an extension of  the  primary  project of producing healthy organic  food. the  decision to vertically integrate and invest in a restaurant should be made 3 years after the  start of producing healthy organic food.                                                           10 the five year calculation is given because this is agricultural project, and it is common for this kind  of project npv to be calculated for five years.        rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   55 table 2. net present value calculation of healthy organic food production (in bam11)    year of project  0  1  2  3  4  5  net cash flow  ‐112.500  13.062,5  21.972,5  31.640,95  42.137,48  53.538,1  present net cash  flow (12%)  ‐112.500  11.662,946 17.516,342 22.521,404 26.779,131  30.378,958  net present  value (nvp)  ‐3.641,22  source: authors’ calculation    total investment costs will be 250.000 bams, of which 150.000 will be provided by own  funds and 100.000 by credit funds. these funds will be used for the object itself, construction  and interior, equipments and craft resources. this calculation is given for 10 years, during  which the income raises by 3% mostly because the potential customers number is expected to  grow by 5‐10%.12 also, the goal is to double the sales of first year in the third year. this will  enlarge the material costs which will be rising by the year. costs such as payroll, marketing,  sales and other expenses are rather constant.  the net cash flow, present net cash flow, and net present value of the restaurant project  are given in table 3. used discount rate is also 12%.    table 3. net present value calculation of organic restaurant project (in bam13)  year of  project  0  1  2  3  4  5  6  7  8  9  10  net cash flow  ‐250.000  47.750  56.750 65.977 75.437 85.138 95.087 105.291 115.758  126.496  137.513  present net  cash flow  (12%)  ‐250.000  41.522  42.911 43.381 43.131 42.329 41.109 39.583  37.842  35.958  33.991  net present  value (npv)  151.756  source: authors’  calculation    net  present  value  of  this  project  is  positive,  therefore  the  project  is  acceptable.  net  present value is 151756 bams, which is a very high npv since it represents 60,7% of initial  investment. traditional methods can only calculates npv of these projects, but fail to show  correlation between them. the next part of this paper will show the value of organic food  production project, but with an existing option of organic food restaurant project.                                                          11 bam is international code for bosnia and herzegovina convertible mark, 1€=1,95583bam.  12http://www.bplans.com/organic_restaurant_business_plan/market_analysis_summary_fc.cfm  (accessed 5 september, 2010)  13 bam is international code for bosnia and herzegovina convertible mark, 1€=1,95583bam.     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   56 30.547,05 0 0 64.814,52 0  0  0 137.523,03  0  14.396,8  values  of  variables  for  black‐scholes  calculation  are  strike  price 000.250=k   bams,  current stock price  756.1510 =s bams and time to expiration  3=t  years. estimated risk‐ free rate in bosnia and herzegovina is 6%. the variable which has the most influence on the  result is the one which is also the hardest to predict – standard deviation. based on world  calculation of volatility for different kind of industry, standard deviation for food industry is  30%.14 inserting the above data in formulas (21) and (22), we calculate the values of  1d  and  2d and based on that the values of n(d1) and n(d2):  3582761,01 −=d    8778914,02 −=d   190001322,0)( 360068311,0)( 2 1 = = dn dn   using  known  inputs,  calculated  inputs  and  formula  (20),  the  value  of  call  option,  according  to  black‐scholes  is  14.967,13  bams.  binomial  model  gives  similar  results.  according  to  the equations  (31) and  (32), we have calculated u and d  factor  for binomial  model  and  they  are  1,37  and  0,75  respectively.15  next  figure  presents  possible  value  of  optional project in next three years.     figure 3. possible value of healthy organic restaurant project    in  the  next  phase,  according  to  described  methodology,  value  of  expend  options  is  calculated. value on first node is value of option and it is 14.396,8 bams.                                    figure 4. value of expend option                                                                         14 www.business‐spreadsheets.com   15 we assumed that  1=δt , it means that there is only one period each year.  207.426,13 113.837,87 155.597,13 283.517,91 212.677.15  116.719,69  85.393,95 387.523,03  64.057,13  151.756,20       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   57 strategic value of the project of producing healthy organic food by traditional, black‐ scholes and binomial model is presented in next table:    table 4. value of project of producing healthy organic food      traditional approach  modern approach  black‐scholes model binomial model value of the project  ‐3.641,22 11.325,91 10.755,53  investment decision  not accepted  accepted  accepted     source: authorsʹ calculation  conclusion  evaluation efficiency of capital investment without optional approach, i.e. without taking  into account real options, is not realistic and realiable basis for making investment decisions.  presented  project  of  producing  healthy  organic  food  is  the  example  which  can  serve  for  better understanding of real options and their valuation, but also it points out to necessity of  using an optional approach to the evaluation of investment projects, as an additional tool to  conventional valuation methods. indeed, these traditional methods evaluated the project of  producing healthy organic food as unacceptable, with a net present value of ‐3641.22 bams.  the option of extending of this project to projects of healthy food restaurant is evaluated by  modern methods, by black‐scholes and binomial model. according to black‐scholes model,  value of project is 11.325,91 bams, and according to binomial is 10.755,53 bams.  references  benninga, s., et al.(1997): the binomial option pricing model,   http://finance.wharton.upenn.edu/~benninga/mma/mier63.pdf, (accessed 03 june 2010);  bodie, z.et al. (2006): počela ulaganja, mate, zagreb;  brzaković, t. (2007): tržište kapitala‐ teorija i praksa, čugura print, beograd;  damodaran, a. (1999): applied corporate finance, john wiley & sons, new york;   damodaran, a.: option pricing theory and applications,    http://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/option.pdf, (accessed 08 may 2010);  damodaran, a.: real options: facts and fantasy,   http://pages.stern.nyu.edu/~adamodar/pdfiles/execval/optval.pdf, (accessed, 03 june 2010);  damodaran, a.: the promise and perile of real options,   http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1295849, (accessed 03 june 2010);  orsag, s. (2003): vrijednosni papiri, revicon, sarajevo;  orsag, s. (2006): izvedenice, hufa, zagreb;  rovčanin,  a.  (2000):  savremene  metode  ocjene  efikasnosti  investicija,  ekonomski  fakultet  u  sarajevu,  sarajevo;  rovčanin, a. (2006): upravljanje finansijama, ekonomski fakultet u sarajevu, sarajevo;   rovčanin, a. (2005): opcioni pristup vrednovanju kapitalnih ulaganja, ekonomski pregled, zagreb.  šoškić, d.(2001): hartije od vrednosti: upravljanje portfoliom  i  investicioni  fondovi,   ekonomski  fakultet  beograd, beograd;  www.real‐options.de, (accessed 08 may, 2010);   www.damodaran.com, (accessed 03 june, 2010).     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   58 http://www.optionseducation.org/advanced/volatility_greeks.jsp   (accessed 1 september 2010)  http://www.investopedia.com/terms/b/blackscholes.asp (accessed 01 septmeber 2010)  http://www.hoadley.net/options/bs.htm (accessed 5 september, 2010)  http://pages.stern.nyu.edu/~adamodar/  (accessed 5 september, 2010)  http://www.bplans.com/organic_restaurant_business_plan/market_analysis_summary_fc.cfm  (accessed 5 september, 2010)        apstrakt  –  cilj  ovog  rada  je  da  prikaže  mogućnosti  primene  opcionog  pristupa  prilikom  vrednovanja  investicionih projekata, kao  i novi  teorijski  i metodološki okvir analize  investicija za  proizvodnju i prodaju zdrave  organske hrane.   za razliku od tradicionalnih metoda procene, ovaj novi, kompleksni pristup obezbeđuje fleksibilno  upravljanje i mogućnost prilagođavanja (korigovanja prethodnih odluka) u skladu sa okolnostima na  tržištu. u  svetlu dramatičnih promena  i narastajućih  rizika  i neizvesnosti prilikom  investicionog  odlučivanja,  neophodno  je  dopuniti  tradicionalni  pristup  opcionim,  u  cilju  racionalnije  alokacije  resursa. neophodnost korišćenja opcionog pristupa ogleda se u činjenici da rezultati procene vrednosti  projekata u skladu sa tradicionalnim i modernim pristupom mogu biti kontradiktorni.   ovaj rad predstavlja black‐scholes i binomni model model vrednovanja opcija, i primenu opcionog  vrednovanja ilustrovanu na proizvodnji i prodaji zdrave organske hrane i restorana zdrave hrane kao  dodatne  delatnosti.  dok  su  tradicionalni  pristupi  vrednovanja  investicionih  projekata  procenili  projekat za proizvodnju zdrave organske hrane neprofitabilnim, opcioni pristup pokazuje da je ovaj  projekat prihvatljiv, što potvrđuje značaj ovog pristupa.     ključne reči: realne opcije, fleksibilnost, rizik, neizvesnost, vrednovanje projekata, organska  hrana        article history:  received:  27 october 2011 accepted:  14 december 2011          microsoft word 2010_1_2.doc guest editor’s notes the current volume of economic analysis provides a collection of original scientific papers and scientific reviews covering a wide range of topics from small and medium enterprises (sme) research to price stability and employment research, business logistics and business valuation. the most of articles were originated through the international cooperation in education and science of visegrad group countries and serbia in the field of the investment, banking and business, especially oriented on the small and medium enterprises. this scientific collaboration is currently cofinanced by visegrad strategic program project “strengthening the educational and scientific collaboration among faculties of economics within v4 and countries of south eastern europe” of international visegrad fund. within the frame of this project we have slowly but surely established international educational and scientific network of teachers and researchers from czech republic, hungary, poland, serbia and slovakia (see www.ekf.tuke.sk/ivf to recognize all eight project partners involved). the network coordinates the mobility of faculties´ project personnel; prepares workshops and meetings on best practices in educational and scientific areas within topics like investment, banking and business. we are also pleased to present the most of here published papers personally during the international scientific conference “economic prospect in the second decade of the 21st century” (14. – 15. april 2010) organized by belgrade banking academy and institute of economic science in belgrade. this current volume of economic analysis journal covers wide range of economic topics, there you are erős’s paper focuses on the growth theory and discusses the question whether or not government policies can be used to influence the long run growth rate of the economy. the author summarize the theoretical and empirical literature of the relationship between fiscal policy and long run economic growth shortly on the one hand, and on the other hand used the parameter estimates of a third generation study of developed countries to evaluate the fiscal policy actions taken in hungary and in ireland. she also mapped the explanation for the differences in these two countries’ reactions to some of the similar fiscal policy changes. the next three contributions are aimed at theory of investment and business valuation, especially applied in the financial sector. first one by horvátová proceeded with bank and financial institution valuation enlarging the last contributions in theory of investment value by r. c. merton using the risk-neutral valuation model and its variants. very close to this topic is the contribution focuses on the bank mergers in the central-east europe region. in the second one the author tej examined and analyzed differences in financial results in the central and eastern europe region in comparison with developed markets. finally, in more theoretical oriented paper by glova the author attempts to address key issue in designing algorithm for estimating of yield curve. the author proposed the application of matrix theory in yield curve points estimation. in her scientific review kotlebová discusses the future stance of currencies in the international monetary system. she mentioned the higher creation of savings in emerging economies compared to developed countries; higher investments of developed economies in comparison with developing economic analysis (2010, vol. 43, no. 1-2, 7-8) 8 countries; the current account deficit of the balance of payments in developed countries as opposed to the current account surplus of the balance of payments in emerging economies create new conditions for future stance of currencies in the international monetary system. she also highlighted the main trends in the future development the imf. milecová’s article analyzes the differences between the harmonized indices of consumer prices and the national consumer price indices on the theoretical as well as on the practical levels. author deals with defining the differences between the indices not only in the euro area and in v4-countries, but also in serbia. the main differences are geographic and population coverage and owner-occupied housing. using statistical methods the author test hypothesis of the difference between different the indices measuring price stability. vokorokosová in her paper addresses the influence and dependency between minimum wage increase and the amount of employed people. this article picks out minimum wage as an important part of employment research investigating two files; the number of working people aged 15 – 64 and all working labours. kościelniak reviews and analyzes information resources for financial monitoring in enterprises. grabara’s article focused on business realations in reverse logistics outsourcing, as key aspect of the cost reduction used in companies during fighting for survival, keeping or increases in sales levels and profits. more and more often observed tendencies to concentrate commercial and production companies lead to rise of demand for outsourcing in a reverse logistics chain. gubik’s paper intends to introduce the reader to the characteristics of supplier-purchaser relationships of smalland medium sized enterprises, based on an empirical research’s experiences using the questionnaire and its statistical evaluation. according to author’s opinion, we can draw conclusions on the intention to cooperate concerning the nature of the buyer-supplier relationships of companies, so a wide range of information can be concluded on smalland medium sized enterprises’ partnerships. please allow me to express my sincere appreciation to prof. dr mirjana radović marković for confidence. last but not least i want to thank all contributors and reviewers for their excellent work that they have done. jozef glova 2013_1_2 professional paper operational risk – challenges for banking industry knežević marija1, procredit bank, belgrade, serbia udc: 005.334:336.71 jel: g32 id: 198578188 abstract – operational risk covers wide range of events that either produce no effect on financial result of the institution or can strongly harm it. although it is present in the banking activity from its origins, industry interest increases during last decades of xx century. basel ii gave significant incentives in managing operational risk processes in banks all over the world. new, basel iii regulation imposes improvement in operational risk management indirectly, through guidelines for better management of liquidity and credit risk, thus emphasizing the importance of the most intangible factors of operational risk – internal factor contained in inadequate processes and procedures. in serbian banking system the most important contribution of basel standard implementation was raising awareness of the presence of this kind of risk, although it is still in the initial phase. high impact on the operational risk drivers has macroeconomic environment, banking system structure and client type that are offered financial support. having in mind that banks offers in serbia are primarily oriented toward retail clients, it is not surprising that the most important factor of operational risk, regarding number of risk events, are human errors with 54% in total. however, majority of financial losses are derived from clients’ frauds, more than 70%. in this paper, author indicates the most important factors and events of operational risk that are present in retail banks in serbia and their sources as a key element in mitigating their negative effects in the future. key words: operational risk, basel regulation, banking sector, operational risk factors, operational risk events, internal processes, frauds, human errors. introduction among numerous financial risks that are inherent to the banking activity, special place belongs to operational risk. its uniqueness comes not only from the fact that it follows every banking transaction from the beginning to the end, but also due to its fluid form and interconnections with other risks. it is quite often hard to make distinction between credit or market risk and operational risk on the other hand. however, industry interest in this matter emerged after several big losses that occurred in the late years of xx century. most of these cases were originated by internal frauds or inadequate process and procedures which encouraged employees to involve in activities that exposed banks to higher risk in order to achieve personal gains. one of the latest operational risk events is certainly libor fraud case that was discovered in the summer 2012 which could be also treated as the biggest scandal in banking industry! banks, that are members of the committee in charge of determination libor (one of the most important interest rates in finance) on a daily basis, reported 1 marijaknezevic@yahoo.com knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 41 incorrect data on interest rates they offer money to each other in order to present their financial situation more healthier, especially in period of crisis. these fraud activities of banks lasted six years with senior management involvement. having in mind worth of loans and contracts linked to libor, it is estimated that clients around the world were damaged with 1.5 trillion usd! after revealing scandal, crime investigations were opened and are still in progress. up to now, barclay bank was fined with 450 million usd, and swiss based ubs bank with 1.5 billion usd for manipulating with libor. recognizing importance of operational risk for modern banking, basel committee for banking supervision (through basel ii and iii), gave significant incentives in managing operational risk processes in banks all over the world. in serbia the most important contribution of basel standard implementation was raising awareness of the presence of this kind of risk, although it is still in the initial phase. operational risk management is still in initial phase and the purpose of the paper is to identify the main drivers of operational risk that domestic banks are faced with. the paper is organized as follows: the first section gives general characteristics of operational risk, section 2 analyze the most important and potential factors of operational risk in serbia, and section 3 concludes. main characteristics of operational risk definitions of operational risk goes from the broadest that describe it as all risks that are not originated by market or credit risk to the most used basel ii definition. according to it, operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. this definition includes legal risk, but excludes strategic and reputational risk (basel committee on banking supervision, 2006). by this, all major drivers of operational risk are covered. people (human factor) can produce operational risk events through unintentional errors during work, criminal activities, insufficient training or number of employees, and bad management. external events, as a source of operational risk, comprise numerous events that result in physical damages on the bank property such as natural disasters (earthquakes, floods, volcanoes etc.) or catastrophes like wars, robberies or losses incurred by third parties. risk events that are connected with it system are relatively easy to detect although they vary from hardware malfunctioning to abuses of databases. the most difficult to identify and detect are potential operational risks embodied into internal processes and procedures. unlike other mentioned major operational risk drivers, weaknesses of internal processes are still in a way ignored. all improvements in managing operational risk are mostly connected with countable and easily detected events. internal processes weaknesses are less noticeable and strong commitment and willingness of management is required to recognize them and later on to solve. special challenge regarding this type of risk driver is to recognize weaknesses that results from moral hazard problem and some authors propose changes in definition of operational risk in order to include it as integral part (savic ana, 2012, 18). moral hazard is the consequence of existing information asymmetry on the financial markets. it occurs when the lender is subjected to the hazard in which the borrower has an incentive to engage in activities that are undesirable (immoral) from the lender's point of view, that is, activities that make it less likely that the loan will be repaid (mishkin frederic s. 2006). special type of moral hazard risk is principal agent problem which occurs because managers (agents) have more information about investments than principals economic analysis (2013, vol. 46, no. 1-2, 40-52) 42 (owners) so they could have incentives to engage in activities that are not desirable for owners and expose the firm to the higher risk in order to make more profit and personal gains through bonuses for example. there are large number of examples how moral hazard can produce operational risk losses. financial crisis that hit the world in 2008 is the most viable example of that. managers greed for bonuses and profits in large banks that faced biggest problems, led to enormous losses. above mentioned libor scandal also could be regarded as risk event that are coming from moral hazard. still, the question remains would it be possible and feasible for banking management to recognize and admit it. moral hazard, as a source of operational risk is not inherent only to internal processes but it is also source of the risk in events derived from people or externally. for managing operational risk of crucial importance is the fact that risk events originated by people, inadequate internal processes or it system are controllable because they occur within the bank, whereas those coming from external events are not. that is why it is hard to find appropriate strategy to mitigate them. main characteristic of operational risk losses and events is that their frequency and severity are disproportional, which means that events that bear high, severe loss occur very rarely in the life cycle of the bank. in contrast, events that occur with high frequency usually do not produce big losses. these two dimensions of the risk – frequency and severity are key elements that influence its treatment and produce problems for bank management because it is difficult to translate them into risk projections. due to that, loss distribution curve is specific, i.e. it has fat tails, indicating that frequency of high severe risk events is small. figure 1. loss distribution of operational loss events source: osterreichische nationalbank (2006:14) knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 43 for events that occur quite often it is possible to calculate and project potential loss, which is then treated as expected loss and some loss reserves could be formed. on the other hand, unexpected losses refer to events that could not be anticipated as they did not occur within bank in respective period of time, so bank is supposed to have enough capital to cover them. in case of occurring events that produce catastrophic loses it is possible that bank could not survive them. depending on the combination of loss frequency and severity, bank opts for one of the strategies to manage the risk. in case of low frequency, low severity events, banks would usually choose to bear the risk; dealing with high frequency low severity risks assumes proactive risk management actions in order to mitigate its consequence; in contrast, negative effect of low frequency, high severity risks could be mitigated using insurance plans. figure 2. matrix on operational risk management as a function of imact potential and frequency of the related events source: osterreichische nationalbank (2006:15) however, there could not be unique strategies applicable to all banks as operational risk is bank specific, which requires understanding of main drivers that create operational risk profiles. undoubtedly, operational risk is present in all products and services that banks offer, in all internal processes and it could be caused by all employees within bank. in contrast to other business risks, bank is exposed to operational risk in every moment and in every phase of any process from its beginning to its end. that is why operational risk area is broader than area of other business risks. main differences from credit and market risk are: • majority of losses are specific for the certain bank; • higher risk exposure do not assume higher profit but conversely; economic analysis (2013, vol. 46, no. 1-2, 40-52) 44 • exposure to operational risk do not depend on value and volume of transactions or bank portfolio which makes diversification poor technique for risk mitigation; • development of sophisticated hedging instruments for credit and market risk contributed to higher exposure to operational risk; • operational risk exposure are immanent not only to banks but as well to other market participants; • measurement and managing techniques for operational risk are less developed than for credit and market risk. multidimensional nature of operational risk emphasizes necessity of constant improvements risk management techniques because it allows: • early detection of potential problems before their escalation. in that way, it is possible not only to lower loss, but also, to save resources that could be redirected on business volume increase; • enhance quality of capital allocation; • more efficient strategic decision making process because management of the bank is informed about business segment that bear the highest risk; • higher profitability and stability of doing business. recognizing importance of operational risk for modern banking and financial systems, basel committee included in basel ii capital accord capital charge for it. basel ii gave strong contribution for improving risk management function – primarily by standardization of definition, proposing guidelines for loss data collection, introducing methods for calculating minimum capital. new, basel iii regulation imposes improvement in operational risk management indirectly, through guidelines for better management of liquidity and credit risk, thus emphasizing the importance of the most intangible factors of operational risk – internal factor contained in inadequate processes and procedures. after escalation of financial crisis in 2008, it turned out that one of the most important sources of turmoil was insufficient liquidity for covering systemic risk derived from extreme credit losses. capital level in banks that suffered the most was not enough to absorb all potential losses which indicated that risk management process in most of the banks was inadequate (basel committee on banking supervision. 2009). that is why all changes that are implemented in basel iii could be regarded as an attempt to improve internal processes (which are one of the sources of operational risk) that consequently leads to the enhancement in operational risk management. it stresses importance of enhancement risk management function within banks with more active involvement of senior management. by changes in credit risk weights used in internal models and introduction of minimum standards for adequate liquidity level through two new ratios, liquidity coverage ratio and net stable funding ratio, once again failures in internal processes before crisis are confirmed. implementation of new standard should result in lowering operational risk. main drivers of operational risk in serbia management of operational risk in serbia is relatively new discipline. first time it was defined by law on banks in 2006, when banks were obliged to form data bases for collecting operational risk events. that was the first step in the process of basel ii implementation. it knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 45 was the regulation that gave the most important contribution for raising awareness of the importance of managing operational risk. basel ii implementation in 2012 resulted in numerous benefits for the whole banking sector. the most important of them are: • standardization of the operational risk definition; • standardization of risk events and losses collection on banking system level; • development of monitoring system; • development of operational risk management process within banks; • basis for implementation of complex quantitative techniques for managing operational risk. still, the process of managing operational risk is in initial phase and there is a lot of work to do in the future in its improvement. analyzing operational risk drivers in serbia assumes that macroeconomic situation and overall business climate should be taken into account as they impose most common risk events. higher level of corruption, weak legal system, and high unemployment rate positively contributes to realization of some risk event such as clients’ frauds and forgeries. that indicates that most of threats for the banks are coming from external events. period of pre-crisis expansion in serbian banking system (from 2001 to 2008) additionally exposed banks to new operational risk threats. multiple increases of placements and assets, development of new products, rise in employees’ number and organizational units accompanied with mergers and acquisitions was faster than improvement and adjustment of working process and procedures. prevailing operational risk events strongly depend on dominant client structure of the bank that on the other hand influences organizational structure, corporate culture and working processes of the institution. majority clients in the banking system in serbia are retail customers – households, private individuals, entrepreneurs and small businesses. according to the data of association of serbian banks, 97% of total clients within sector as of the end of 2012 are retail clients. having in mind that banks are the most important participants on the financial market, operational risk losses either realized or potential can strongly harm the whole system. in the next section key factors of operational risk in retail business is discussed. key factors of operational risk inherent to retail banking offering financial services to retail clients differs from orientation on large corporate clients or investment banking. specifics are following: • labor intensive business model which is demanded by large number of clients that proceeds transactions of relatively small amounts; • high level of decentralized decision making process; • higher operational expenses (personnel and administrative) per product unit; • large outstanding number of loans and active accounts; • widespread branch network and • higher level of loan portfolio diversification. every working process in retail segment is labor intensive, especially in loan activity. credit analyses rely not only on official financial data of the client, but also on soft economic analysis (2013, vol. 46, no. 1-2, 40-52) 46 information that clients confine to loan officers. that, on the other hand, requires adequate number of employees and branch network to serve all potential clients and build up strong relations with clients which at the end results in wide range of threats and challenges from operational risk stand point from all defined sources – people, processes and external events. people as a source of operational risk retail banks on average have more employees than large corporate banks. main characteristics of operational risk events that are driven from employees’ behaviour or their work in retail banking are following: • higher possibility of unintentional errors caused by overtime or tiredness due to the large number of everyday transactions, in order to serve large number of clients, during the period of expansion, accompanied with growing number of employees, risk of insufficient training of employees and consequently higher percentage of accidental errors increases. according to the proposed basel ii matrix, which is adopted by national bank of serbia, this type of risk event would be categorized as execution, delivery & process management, within business line retail banking, originated by human factor. • inadequate level of control large amount of transactions as it requires high expenses, which can open a room for internal frauds, but also for unintentional errors or failure to meet a professional obligation. • internal thefts and frauds due to high level of decentralization in decision making process which is in high correlation with moral hazard risk. business model and working process with this specific client segment basing credit analyses sometimes on informal income sources, lack of verified documentation, but also insufficient control of employees from higher management contribute to higher risk. financial reports of retail business are not audited so it is easier for responsible employees to forge them. this could be also treated as moral hazard problem. it would be ‘higher’ if there is a bonus system based on individual productivity of employees and achieved performances of their organizational unit. in order to mitigate this risk, empirical data shows that banks usually implement following: • determination of time intervals when number of orders reaches peaks; • determination of adequate number of employees for execution volume of transactions; • procedure implementation control; • individual productivity control; • promoting e-banking transactions. one of the methods for mitigation risk of internal frauds is more strict internal controls which have benefits both for detecting internal as well as external frauds and forgeries from clients. it includes checking of credit documentation, client visits and rechecking their financial performances. moral hazard problem from the agency problem point of view could be partially mitigated through long-term promises and bonus systems for employees that during career knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 47 achieve required results. these suppose that employees within banks should anticipate some kind of long-term commitment with shareholders and the bank (myerson roger, 2012). since long-term bonuses and fringe benefits expectations are of crucial importance for motivation and behaviour in line with shareholders interest, investors’ ability to trust them depends on long-term profit expectations. internal processes as a source of operational risk it goes without saying that the most difficult driver of operational risk lies in internal processes and procedures. operational risk inherent to internal processes and procedures is hard to distinguish from the risks that result from people because they actually create them! failures and omissions in processes could be unintentional due to misunderstanding of process essence or intentional with the aim of acquiring more profit by exposing institution to higher risks which is the result of moral hazard. in retail banking, the most important potential factors of operational risk from inadequate or failed internal processes are: • overlapping of responsibilities and fails within processes. labor intensive business model assumes waste number of processes. if they are not set in adequate manner, overlapping of responsibilities or duties can occur which leads to inefficiency and omissions during work. • apart from unintentional failures, procedures can contain those that allow acquiring personal gains or expose bank to higher than accepted risk in order to achieve higher profit. these kinds of fails are more likely to exist if management bonus system is directly dependent on achieved profit in certain period of time. here, we have moral hazard risk, in the form of principal agent problem. • if procedures do not cover all aspects of the process, there is a possibility of breaches the responsibilities. the biggest threat in internal processes comes from moral hazard problem, but still it is not identified in that manner. apart from these, internal processes inadequateness could be present in other processes. systems of internal and external control are the first measure in mitigating risk inherent in bank processes. contribution to it comes also from: • regular monitoring of bank management by shareholders, and monitoring of decentralized organizational structures from top management; • applying restrictive covenants. by this measure investors can define areas and projects that are prohibited for financing; set rules and conditions for loans disbursements, determine acceptable ratios of liquidity, solvency and loan portfolio quality. it is important that proscribed covenants do not include shortterm profitability requirements, but the ones that support long-term sustainable stable business results of the institution. profitability indicators directly support moral hazard problem. faced with high profit targets, managers could be more prone to more risky activities in order to achieve personal gains. • existence of independent operational risk unit within the bank is of crucial importance for identifying these kinds of risks. process of risk identification economic analysis (2013, vol. 46, no. 1-2, 40-52) 48 should be more concentrated on analyzing these hidden risks instead of countable high frequency, low severity risk events. external events as a factor of operational risk external factors, as a source of operational risk are not under bank control. if we exclude catastrophic and events that cause physical damage on bank assets, in retail banking higher exposure to operational risk comes from: • higher possibilities of clients’ frauds and forgeries. in the working environment characterized by high level of corruption, it is easier to forge documentation on clients’ financial results as well as issuance of false certificates on their property. • in entrepreneurial segment, moral hazard problem is more present in comparison to large enterprises. at the same time, entrepreneurs are managers and owners and entrepreneurial personal income is directly dependent on company’s income. that is why there is a higher risk that entrepreneur would misuse borrowed funds from the bank and invest them in more risky ventures in order to maximize own fortune. • furthermore, entrepreneur tendency to misuse borrowed funds in order to increase own fortune is directly dependent on the companies financing choices [wu yan, 2008] and it is higher within those that finance their activity primarily using banking loans i.e. in finance structure have higher share of debt. entrepreneurs follow the well-known economic principle that marginal benefits of effort should equal its marginal cost. higher debt share in finance structure assumes lower marginal benefit of invested effort of the entrepreneur. that is why their motivation for further efforts is reduced and they are more prone either to misuse borrowed funds which mean that higher indebtedness increases moral hazard risk that on the other hand exposes bank to higher risk. in this case moral hazard problem is negatively correlated with chosen financing model. in serbia, most of entrepreneurs are financing their activity through banking loans. that is why this issue is important to risk management within banks. however, these risk factors are not under bank control. in order to mitigate these risks possible solutions could be: • more strict control of used funds including visits to clients; • applying reporting covenants that oblige clients to report banks on used funds on regular basis; • applying restrictive covenants in case clients misuse borrowed funds for purposes other than agreed with the bank; • applying contract clauses that preserve value of collateral during the life time of the loan. in serbia, for example, mortgage value is reestimated and adjusted to market conditions every 3 years. beside that, majority of banks require collateral insurance during life time of the loan, which is additional security in case client do not repay the loan. all these measures increase operational costs of the banks and consequently interest rates that clients pay, so again there is a tradeoff between risk and profit. in the first two years of basel ii implementation and reporting on operational risk events, as it was expected in the beginning of the process, research on operational risk events has knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 49 shown that risk events are mainly driven by human factor (people) as 54% of total number of events is originated from it (knezevic marija, 2010, p. 101). the most common type of risk event is unintentional errors caused by overwork and tiredness. on the other hand, only 16% of total losses are derived from this source. among business lines, payments and settlement line is the most exposed to negative effects of operational risk. in this line, 91% of risk events and 20% of realized losses are caused by unintentional errors. typical risk event is wrong data entry in processing client transactions. these events usually do not result in loss because it is possible to recover payment order, which explains disproportion between number of events and losses volume. that is the example of risk event with high frequency and low severity. moreover, it is countable and easily recognized, so it could be additional reason of domination in first phases of data collection. in contrast to number of risk events, majority of realized and potential losses are coming from external factor – 81% of total and 43% of total risk events! out of that, external frauds contribute with 70%. business line retail banking is the line that is under strongest negative effect of external factor and generally operational risk. figure 3. operational risk events and losses within retail banking business line source: data taken from (knezevic 2010) in this line, 91% of all losses and 49% of all risk events have occurred. majority of them (72%) are coming from external events, that is from frauds. thefts and frauds form clients in most cases are realized through forged documentation on their financial results in loan approval process. common types of false documentation are economic analysis (2013, vol. 46, no. 1-2, 40-52) 50 forged data on overestimated values on mortgages, false documentation on financial result of clients or false income statements. usually, risk event is discovered after certain period of time when client stop to repay loan instalments. time lag between date of risk events and time of discovery vary between few months to several years, which make estimation of potential losses and application of sophisticated quantitative methods very hard and complex. these types of events reflect the real nature of operational risk events – that risk events cause financial effect with time lag, do not have regular intervals and that financial loss could be severe. in retail banking there could be a lot of such cases with individually low amounts of loss. although it can harm single institution it is not likely that it would in short period transfer the loss on the whole banking system. problem for the sector arises when big clients with significant amount of debt at few banks commit such a fraud. in the worst case scenario this could lead to bank bankruptcy. recently, several loss cases caused by clients’ frauds were released with significant amounts of losses. we will mention some of them: group of clients, through ownership in related companies, from 2007 to 2012, have committed series of frauds and forgeries by which hypo bank experienced loss of 15 million chfs. during 2007, based on forged documentation on estimated value of collaterals, they received a loan for the purpose of privatization state companies. after privatization, through mutual trading and decreasing share values of privatized companies, indebted companies bankrupt. hypo bank couldn't recover lended funds and crime investigations against suspected is still in process. the most striking operational risk event in last decade that occurred in serbia is for sure case of agrobanka, that bankrupt in 2012, with the loss of almost 300 million eur. to its end led several events starting from forged documentation on mortgages and other collaterals, misusing of funds, weak procedures and internal controls, to the involvement of senior management in fraud activities in order to acquire personal gains (moral hazard). investigations regarding these fraud cases are still in process. this event sharply unsettled financial market, but still it is the question whether it was recognized as a pure operational risk event that could be realized in any other institution. conclusion in modern banking, operational risk remains one of the biggest challenges that whole industry is facing with, although it does not receive deserved attention. banks are more concerned with rising credit risk caused with still present illiquidity in the system and unsettled market conditions characterized by high inflation, gdp growth stagnation, rising unemployment and sharp exchange rate fluctuations. it is sometimes hard to distinguish risk factors deriving from credit and operational risk as they are interconnected and that is why some risk events wrongly treated. management of operational risk is focused on easily countable and controllable, usually high frequency – low severity risk events and their sources (for example number of unintentional errors). resources are directed to satisfy regulatory requirements – to collect risk events data and determine minimum capital. regulation do have positive impact on improving risk management functions within banks, but itself is not enough to assure stable knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 51 and sound banking system as it cannot substitute importance of proactive risk management in the process of risk mitigation. for the time being, the highest threats are coming from external events that are not controllable. however, single institutions cannot do much in mitigating these risks. in order to mitigate them, joint actions of all participants in the market are needed. one of the possible solutions could be exchange of risk events data between banks within the same system and forming so called black lists of clients. as banks are not reluctant to share in house information, of key importance is the role of regulator that could be kind of intermediary, at least in first phases. the key question in front of banks managers is how to deal with operational risk in the future and how to recognize it among numerous risk events that occur every day? how to put stress on the most important ones hidden in the procedures and processes and motivated by moral hazard? first of all, it is imperative to admit and accept the fact that operational risk is one of the most important risks that institutions are facing with, not the residual. then, redirect resources from countable, controllable and high frequency low severity losses on more sophisticated risk events. enhancing internal models of risk management and independent risk units remain of crucial significance. references basel committee on banking supervision. 2006. “international convergence on capital measurement and capital standards (a revised framework, comprehensive version)“. http://www.bis.org/publ/bcbs128.pdf (accessed march 15, 2013). basel committee on banking supervision. 2009. “strengthening the resilience of the banking sector”. www.bis.org/publ/bcbs164.pdf (accessed march 30, 2013) knezevic, marija. 2010. “operational risk in microfinance institutions”, master thesis. belgrade university mishkin, frederic s. 2006. monetarna ekonomija, bankarstvo i finansijska tržišta. novi sad: data status. myerson, roger b. 2012. “a model of moral-hazard credit cycles”. http://home.uchicago.edu/~rmyerson/research/bankers.pdf (accessed march 30, 2013 ). osterreichische nationalbank. 2006. “guidelines on operational risk management”. www.oenb.at/en/img/operational_risk_screen_tcm16-49652.pdf (accessed march 30, 2013). savic, ana. 2012. opeartivni rizici u bankama. beograd: zadužbina andrejević. wu, yan. 2008. “capital structure and moral hazard within entrepreneurial firms”. citeseerx.ist.psu.edu/viewdoc/summary?doi=10.1.1.192.6708 (accessed march 30, 2013). economic analysis (2013, vol. 46, no. 1-2, 40-52) 52 operativni rizik izazovi za bankarski sektor rezime – operativni rizik pokriva širok spektar događaja koji, ili ne daje nikakave efekte na finansijski rezultat, ili može jako da naškodi finansijskoj instituciji. iako je prisutan u aktivnosti banaka od samog početka, interesovanje bankarskog sektora za operativni rizik je poraslo tek poslednjih decenija xx veka. bazel 2 je dao značajne podsticaje u procesima upravljanja operativnim rizikom u bankama širom sveta. bazel 3 uvodi napredak u indirektnom upravljanju operativnim rizikom, kroz smernice za bolje upravljanje likvidnošću i kreditnim rizikom, čime naglašava značaj najvažnijih faktora operativnog rizika interni faktor u okviru neadekvatnih pocesa i procedura. u bankarskom sistemu srbije najveći doprinos implementaciji bazelskih standarda je imalo podizanje svesti o prisustvu ove vrste rizika, iako je još uvek u početnoj fazi. najveći uticaj na faktore rizika imaju makroekonomsko okruženje, struktura bankarskog sistema i vrsta klijenata kojima se pruža finansijska podrška. imajući u vidu da su banke u srbiji uglavnom orijentisane na sektor stanovništva, ne čudi da je najbitniji faktor operativnog rizika, uzimajući u obzir broj rizičnih događaja, ljudska greška sa 54%. takođe, većina finansijskih gubitka su izazvani zbog prevara klijenata, više od 70%. u ovom radu autor ukazuje na najvažnije faktore i događaje operativnog rizika koji su prisutni u poslovima sa stanovništvom u srbiji, kao i njihovih izvora kao ključnih elemenata u ublažavanju negativnih efekata u budućnosti. ključne reči: operativni rizik, bazelska regulativa, bankarski sektor, faktori operativnog rizika, događaji operativnog rizika, unutrašnji procesi, prevare, ljudski greske article history: received: 31 march 2013 accepted: 20 may 2013 doi: 10.28934/ea.22.55.1.pp12-29 preliminary report state and perspectives of agricultural land acquisitions ana budak11f* 1 advokatska kancelarija dr ana budak / independent researcher, serbia abstract despite being marginal in both the general and scientific public, land acquisitions have brought agricultural land in the unprecedented focus of interest. the causes of these changes are the consequence of, inter alia, the growing world population, which undeniably leads to the increased need for agricultural products. therefore, in this article, the most relevant cause of agricultural land acquisitions is considered – growing food demand. the history suggests that the acquisitions of agricultural lands are not a new phenomenon, but rather a new wave of déjà vu. the latest wave of agricultural land acquisitions, according to the general understanding, started with the global financial crisis. the growing demand for land acquisition began, which led developing countries to realize that the purchase of agricultural land, despite its potentially negative effects, could catalyze economic development. the main goal of this paper is to review and explore the state and perspectives of agricultural land acquisition on a global level. the research uses data from the land matrix database and employs historical method, conceptual analysis of law, classification method, content analysis, synthesis, systematic literature review, and descriptive statistics method. we drew the conclusion that more than a third of all the cross-border land acquisitions were caused by the growing food demand. the results of the research show that the growth of land acquisitions follows the growth of the world population, implying that the demand for agricultural land will not be stagnant for at least three more decades, i.e. land acquisitions undeniably are in continuo. key words: agricultural land acquisitions, agricultural land, agricultural land market, causes of agricultural land acquisitions jel classification: f21, f60, q15 introduction although agricultural land acquisitions are not a new phenomenon, it indeed is significantly accelerated in 2008 by the global food crises when a large number of investors, perceiving a growing food demand, saw great potential for profit in agricultural land. in most cases, investors invest because of the demand for food, biofuels, or, in general, for the sake of making a profit. when they invest in food, they do so primarily because there is no suitable land for agricultural production in their home countries. illustrative in that sense is the example of the countries of the middle east. in addition to growing food demand, the increase in the number of international acquisitions of agricultural land was influenced by policies to attract foreign direct investment. nevertheless, after more than a decade of accumulation of world capital, poverty and hunger remain persistent. faced with the need for rural development, states are seeking assistance in investing in agricultural land. in other words, they are starting to work on attracting foreign direct * e-mail: ana.budak@legis.rs ana budak 13 investment in agriculture. this is because they see it as a means to achieve their goals which include, but are not limited to, the revitalization of the agricultural sector. namely, decades of neglecting agriculture have taken their toll and led to low productivity and stagnation of agricultural production in many countries (sharma, lahiri, neogi & akhter, 2021). some of the notable examples include african countries (mfaniseni wiseman & mfundo mandla, 2018), and transition economies (kuhn & bobojonov, forthcoming). in this regard, as one of the possible solutions, foreign direct investments in agriculture are imposed. this could significantly contribute to filling this financial gap in the agricultural sector. in such circumstances, although agriculture has been at the back of investors' priorities for decades, it has deservedly gained importance in recent decades. however, there are some legal restrictions and specificities in certain countries related to land acquisitions. some of these legislations are motivated by the aim of protecting family farms. namely, family farms are considered to be among the best social tools for poverty reduction in many countries. for example, in poland, there is a restriction which is reflected in the fact that foreign legal entities can acquire agricultural land up to 1,000 hectares (dla piper, 2021), while for natural persons this limit is set at 300 hectares (interlegal, 2021). on the other hand, hungary is the only member state of the european union that completely forbids legal entities to style property rights on agricultural land, which means that the ban applies not only to foreign but also to domestic legal entities. this absolute ban on legal entities acquiring ownership of agricultural land became part of hungarian legislation in 1994 and has been part of the legal system ever since. similarly, in serbia, privately owned agricultural land cannot be acquired by foreign legal entities, while the acquisition of state-owned agricultural land is reserved for domestic natural persons (budak, 2021). the emergence of the interest of world investors in agriculture is seen by many host countries as an opportunity for development and even as a solution to the problem of rural development. in other words, until almost a decade ago, investors were practically not interested in investing in the agricultural sector. notably, it is of interest to know what has changed. we investigated whether this can be partly explained by the emergence of another wave of the "gold rush", where agricultural land is considered a commodity and worth investing in. to illuminate this uncharted area, we examined the crucial causes of modern agricultural land acquisitions. examples of modern acquisitions include chinese companies' increasing investments in agricultural land in african countries or south america (which is in line with its going global policy). other examples include large-scale agricultural land acquisitions by transnational companies, supported by some governments. which is often called neocolonialism in the literature. for example, between 2004 and 2009, ethiopia leased 1.48 million hectares of agricultural land for approximately 1 usd for 2.5 hectares (globalvoices, 2020). the government of mozambique has concluded a contract with the london company and left 30,000 hectares of agricultural land to it for the production of bioethanol. the move has been sharply criticized as the land was originally pledged to local communities involving more than 1,000 families (united nations, 2020) certainly, among the most important investments are the ones that originated from the european union. the member states of the european union are becoming one of the most important actors in the world when it comes to the acquisition of agricultural land. namely, conducted research (antonelli, siciliano, turvani & rulli, 2015) indicates that the member states of the european union have concluded 23% of all concluded land agreements in the world. others (borras jr et al., 2019) state that it is difficult to estimate the exact extent of "land grabbing" committed by european union companies, given that a large number of these transactions are in the "gray zone", which makes it very difficult to establish precise categorizations. this will be the case, for example, when a european union corporation buys goods from a reputable foreign company, and those goods come from a country that has been "grabbed" by peasants. by 2019, 14 economic analysis (2022, vol. 55, no. 1, 12-29) european union companies have concluded a total of 909 land contracts covering 23 million hectares of land worldwide. modern acquisitions of agricultural land differ from those already seen, inter alia, in new causes. moreover, host countries, especially developing ones, have been shown to pursue active policies to attract investment in agricultural land to enable economic development and modernization of agriculture. at the same time, developed countries, driven by the need to meet the demand for food and biofuels, are starting to buy agricultural land in large quantities. the theory has identified several causes that, on a global level, lead to modern acquisitions of agricultural land. as a rule, they are reduced to demand for food, biofuel production, land availability, and prices, weak legal and institutional frameworks and policies of the european union. in this paper, the demand for food will be examined as, in the author's opinion, the most significant cause of agricultural land acquisitions. the perspective we adopt is global in order to maximise the generalizability of our results. in addition to the analysis of the policies of the host countries and the policies of the countries of origin of investments, the paper seeks an answer to the question of the long-term tendency of agricultural land acquisition: whether their number will decrease, increase, or stagnate. furthermore, the paper points out that it should be borne in mind that the causes of the acquisition of agricultural land differ from the so-called "triggers" that led to them, such as the world food crisis. the work is organized as follows. the first part of the paper describes the methodology. in the second part of the paper, we describe general tendencies and causes of agricultural land acquisitions. the third part presents the key causes of agricultural land acquisitions and their relationship with the increase in world population. the fourth part of the paper presents the dynamics of agricultural land acquisition. based on the analysis in these chapters, the relevant conclusions are drawn, as well as their practical implications. data and methodology data the research uses data from the land matrix database, which includes only one transaction with over 200 hectares (land matrix initiative, 2020b). the land matrix initiative prepared two reports that represent a kind of compilation of international land transactions the first one in 2012 and the second one in 2016. these reports show a smoothing of the curve when it comes to international transactions, which would mean that we are witnessing a period of stagnation in the acquisition of agricultural land. as of 2016, a new report has not yet been made. for this reason, the author of this paper decided to do it herself, based on available data on international transactions for the period 2000-2020. year, based on which the dynamics of agricultural land acquisition was presented. the aforesaid limitation of 200 hectares must be borne in mind when drawing conclusions about agricultural land acquisitions and their implications. first of all, it could be rightly pointed out that the figures in this database are underestimated due to such incompleteness of the database. namely, it is very likely that there is a huge number of contracts that individually have less than 200 hectares, but together make up a huge acquired area that has not been recorded. however, the most prominent authors who study the acquisition of agricultural land think that this database is a good basis for research. they state that the mentioned database provides valuable, but approximated information on the scale of this phenomenon, emphasizing that this is the case if readers are warned about weaknesses and limitations related to data (rulli & d'odorico, 2013). although fast data collection is very important, especially when we need fast information, their level of inaccuracy must be acceptable, i.e. their limitations must be clearly stated (scoones, hall, borras, white & wolford, 2013). therefore, the data we have can be the basis for creating an image of this ubiquitous phenomenon, for making political decisions and ana budak 15 initiating social actions, primarily of small farmers, for shaping international politics, but with the restriction that these data must not be taken unreservedly. however, the paper focuses on this database, given that it is the most complete database in this area and that it is, of course, invaluable for monitoring this phenomenon. data are collected using the "snowballing" method, where one data source is the starting point for further research. given the speed with which information changes, as well as the scarcity of information, primary data sources are given priority over publicly available reports, which is achieved, inter alia, by cross-checking available data. data are obtained using a variety of data collection methods, including a network of partners in host countries, through which data are collected from regional and national coordinators, research associates, experts and ngos, public and private actors, individuals (who are allowed to submit available data), peer-reviewed papers, reports of local and international organizations and non-governmental organizations, research papers dealing with this topic, governments of individual countries, companies' websites and other publications, such as annual reports and media reports. it is likely that the figures, in cases where the state has transparent data, i.e. when reports are the main sources of the database, are likely to be underestimated. on the other hand, if there is no transparency of data in the country, i.e. if the media and non-governmental organizations are the main sources of data, it is very possible that the figures will be overestimated. so, having in mind the possibility that various actors, depending on their interests, will "beautify" the data, one gets the impression that, in this way, a kind of balance is created between the data. methodology considering the multitude of facets to this phenomenon, different methods of analysis were applied. in order to review the development of this phenomenon, the historical method was used. to understand the key terms, a conceptual analysis of the law was used. the classification method was used to disentangle the key concepts in the research, while the content analysis and synthesis were used to present the causes of the agricultural land acquisitions. to describe the existing knowledge about the phenomenon, the content analysis was combined with the systematic literature review. in order to understand the magnitudes, patterns, and dynamics of the change to this phenomenon more clearly, in this article we used the method of descriptive statistics. this method was also employed to visually clarify the considered variables and their dynamics over time, which complements the historical method also used in our analysis. such a combination of methods allowed us to draw empirically based conclusions. it should be useful to define the main concepts and definitions we use further in the analysis. land matrix database (land matrix initiative, 2020b), which we use, defines a land deal as “any intended, concluded, or failed attempt to acquire land through purchase, lease, or concession for agricultural production, timber extraction, carbon trading, industry, renewable energy production, conservation, and tourism in lowand middle-income countries”. the data includes deals that: “entail a transfer of rights to use, control, or ownership of land through sale, lease, or concession; have been initiated since the year 2000; cover an area of 200 hectares or more; imply the potential conversion of land from smallholder production, local community use, or important ecosystem service provision to commercial use.”. we think that agricultural land acquisitions could be defined as the establishment of control (purchase, lease, concession, or otherwise) over large areas of land (agricultural or forestry) by investors (foreign or domestic, or investors who are a combination a natural person, a private company, government or investor who is a combination of these actors) for the production of food, biofuels, speculative or other reasons. the general trends and causes of agricultural land acquisitions for the first time in decades, there is consensus among policymakers that the agricultural sector in poor countries urgently needs investment to address hunger and poverty, as well as to ensure 16 economic analysis (2022, vol. 55, no. 1, 12-29) economic growth. (spieldoch & murphy, 2009). with this in mind, the host country should pursue a liberal trade policy in order to attract as many investors as possible and thus contribute to economic growth. on the other hand, how trade liberalization will affect other aspects of the daily life of the average resident of that country is a question that does not necessarily have a positive outcome. in any case, concluding contracts that deal with agricultural land transactions, without an adequate strategy for attracting foreign direct investment, i.e. without previously clearly set goals of the host country (what investments it wants to attract and what it expects from them), often leads to negative effects of such investments. the most common adverse effects are effects on rural development, effects on competition, effects on the environment, effects on food security, and effects on human rights. given the undeniable need for investment, developing countries often pursue an intensive policy of attracting foreign direct investment in agriculture as they see it as one of the main means of economic growth and modernization of the economy. for instance, some research (gerlach & liu, 2010) has shown that sub-saharan african agriculture needs at least 21 billion usd a year to reduce the poverty and malnutrition of its population. it must be admitted that it is a goal that this region will find very difficult to achieve on its own. in such circumstances, host countries, especially developing ones, welcomed the foreign direct investment, considering it a unique opportunity for economic development, infrastructure improvement, development of new technologies, and improvement of know-how in agriculture. (fernández, 2017). therefore, foreign direct investment can be one of the levers of the economic development of these countries. the primary goal of attracting foreign direct investment in agriculture is, for example, to modernize agricultural production, new technologies, access to or better integration into the world market, or increase exports. these and similar goals are set by the state as primary in concluding contracts. simultaneously with the need of developing countries for investments, after the world crisis in 2008, investors saw agricultural land as a means of reducing risk, i.e. a "dam from inflation". in that sense, the acquisition of agricultural land can be motivated exclusively by lucrative goals (cotula, 2013). in addition, agricultural land can be considered an attractive investment not only because of the current prices at which it will be possible to make a profit but also because of the growing trend of demand for agricultural products. hence, as the increased demand for food inevitably leads to an increase in land prices, investors often buy large areas of land to make a profit by reselling. in effect, investors perceive the profit, i.e. the difference between the low price at which they bought the land and the price of its later sale at a much higher price. therefore, it could be said that the cause of modern acquisitions of agricultural land is the "expected reciprocal profit" of investors in relation to the host country that expects economic development from the investment (ojulu, 2013). it is estimated that the projected annual rates of return of investors in agricultural land are 10-40% in europe and up to 400% in africa (grain, 2008). in this sense, the organization "grain" (grain, 2016) concluded that making a profit is the dominant cause of the latest wave of agricultural land acquisitions. land matrix database (land matrix initiative, 2020b) detects a total of 18 causes that lead to the acquisition of agricultural land: biofuel production (contracts concluded for this reason have a total of 4,544,851 hectares), demand for food (7,826,132 hectares), livestock, non-food agricultural products, agriculture (unspecified), tree planting, deforestation/forest management, carbon sequestration, forests (indefinite), mining, oil/gas exploitation, tourism, industry, reserve creation, land speculation, renewable energy, other and many causes. ana budak 17 figure 1. causes of agricultural land acquisitions (% of all concluded contracts) source: (nolte, chamberlain & giger, 2016) for most of the concluded contracts, both in terms of number and acquired areas, agriculture is the dominant cause of the acquisition of agricultural land. figure 1 shows that the demand for food is one of the main causes of agricultural land acquisitions, with a total of 38% of all agricultural land acquisitions. in second place is agriculture (indefinitely), which can include various crops with a variety of applications (for the production of food, animal feed, fuels, and industrial materials, e.g. palm oil, which is used for food, fuel, and cosmetics). in third place are biofuels with 21% of all contracts. however, one should keep in mind that theory (anseeuw, wily, cotula & taylor, 2012b) distinguishes the so-called "triggers" of a certain phenomenon from its causes. in this sense, the "trigger" for the emergence of agricultural land acquisitions would be the global crisis of 2007/2008, while the causes can be numerous. it is very difficult to distinguish the causes of agricultural land acquisitions, given that they are often intertwined and interconnected, especially with the emergence of so-called "flexible crops".2f1 in any case, there are many potential causes that literature and practice have recognized, but also an unlimited number of possible motives that guide each investor when investing. these causes will depend not only on each investor but also on the various factors that shape the local environment in which the investor invests social, economic, or other. the emergence of flexible crops is a logical consequence of multiple crises (borras, franco, gómez, kay & spoor, 2012). consequently, investors were given the opportunity to diversify risk. risk diversification is extremely important from the perspective of profit maximization, as a primary goal of every market-oriented subject. under those circumstances, the farmer will grow the crop and produce from it what is the most profitable for him at that moment (food, animal feed, biofuel, industrial materials). precisely due to the existence of these "flexible crops", it is not easy to separate the causes of food demand and biofuel production, since the same product can be used for both food and biofuel production. in this sense, the investor's investment plan may change as time passes in response to changes in international prices and other incentives (cotula, 2013). this is because investors make a decision on the method of investment based on the legal regime of ownership, control, and management in the given circumstances, based on which they conclude which of the offered 1 the four currently most popular "flexible crops" are corn, oil palm, soybeans, and sugar cane. the increase in world production of these crops has been significant in the last 50 years, with the largest increase in the last two decades. many large-scale investments are located in this sector. more about this: (borras, franco & wang, 2013) 18 economic analysis (2022, vol. 55, no. 1, 12-29) opportunities gives them the greatest opportunity to enter and exit the investment (campanale, 2013). there is nothing new when it comes to reusable crops. for example, in the philippines, coconut is considered a "tree of life" because each part of this plant has its use and value. however, for a single agricultural product with multiple uses to be considered "flexible", it must be possible to change the multiple uses according to profit (borras jr, franco, isakson, levidow & vervest, 2016). however, the infrastructure needed to promptly replace one use with another requires huge investments, so only those actors who possess such technology can benefit from flexibility. in other words, small farmers do not benefit from flexible crops as they do not have the necessary financial capacity (genoud, 2018). for these reasons, it can be said that flexible crops have the potential to worsen already unequal power relations between small and large farmers. in such a state of affairs, large farmers have the opportunity to profit from the production of such crops, while small ones do not have that opportunity. it is also pointed out that flexible crops deepen the commoditization of land through additional standardization and speculation. therefore, it can be concluded that crop flexibility can be an important limiting factor when it comes to small farmers' access to land (genoud, 2018). the crucial causes of agricultural land acquisitions and their relation to the growing world population the key causes of agricultural land acquisitions are primarily driven by increasing world population (which has been shown to lead to rising food prices), policies to attract foreign direct investment in agriculture led by host countries, especially developing ones, and policies pursued by countries of origin of the investment. in addition, since they are persons with predominantly lucrative motives, investors are investing for the reason that they perceived an exceptional increase in the prices of agricultural land. all of the above highlights the demand for food and biofuels as the two most important causes of agricultural land acquisitions, then the difference in prices and availability of agricultural land, as well as the weak legal and institutional framework of the host countries. in addition, european union policies have been shown to be a significant cause of agricultural land acquisitions. in the literature (anseeuw et al., 2012b) the water demand is most often cited as a key cause of agricultural land acquisitions. water scarcity is increasingly one of the main obstacles to agricultural production, leading to increased demand for water sources. first of all, we have in mind the countries of the middle east, in which declining water reserves have led investors to increased demand for agricultural land abroad. for this reason, saudi arabia completely abandoned the production of food for its own needs in 2007. some authors (cotula, 2013) point out that water is the main cause of the modern trend of foreign direct acquisitions, given that "land in arid and semi-arid areas would not be useful without water". the water demand was caused by many factors, but the literature most often mentions the fact that there is no unlimited oil, climate change, growing concern for energy security, and interest in renewable energy sources, which results in increased biofuel production and hydropower (mehta, veldwisch & franco, 2012). such acquisitions are referred to in the literature as water grabbing and green grabbing. data from the non-governmental organization "grain" show that the acquisitions concern water as much as land, considering that, with only a few exceptions, each concluded contract included access to water (grain, 2016). likewise, a general pattern was observed that investors are not interested in land that is not supplied with water for production. this is because there is no point in using the land without water (mehta, veldwisch & franco, 2012). the literature states that agricultural land acquisitions, as a rule, are concentrated in areas with safe water sources and that the demand for food and biofuels will increase the pressure on water sources (anseeuw et al., 2012b). this is because the production of all agricultural goods (excluding fish) requires, directly or indirectly, the use of both land and water. given that about 86% of all known water ana budak 19 sources are used in the production of agricultural products, acquisitions of agricultural land represent, to a large extent, the demand for water sources (rulli, saviori & d’odorico, 2013). the problem is that the quantities of water that will be needed to carry out a particular project are not explicitly stated in the contracts (woodhouse, 2012). therefore, it is necessary to assess the required and available water for each contract (mehta, veldwisch & franco, 2012). it could be concluded that the term "green grabbing" means acquisitions carried out in the name of environmental protection. just like "land grabbing", "green grabbing" has a negative connotation in the literature. however, it does not always have to be motivated by speculative reasons or result in negative effects. in other words, the demand for agricultural land has increased not only due to increased demand for food or biofuels, but also due to the need to reduce environmental degradation, and sometimes this is indeed the only or primary motive of investors. nevertheless, it could be said that water sources have not yet reached the significance of the key cause of the acquisition of agricultural land. in a world in which, according to previous estimates, there will be a gap between supply and demand by 2050, it can be concluded that the demand for food is still more important. as the main cause of the acquisition of agricultural land, it is certainly joined by the production of biofuels, as a ubiquitous reaction to the fight against climate change. such a gap has led many investors to invest in agriculture, since, in the foreseeable future, they perceived an exceptional increase in the price of agricultural land. since investors are persons with predominantly lucrative motives, this was a completely expected scenario. having in mind the above, the author limits her work to studying, in her opinion, the most relevant cause of the acquisition of agricultural land the demand for food. this is because the water demand, although undeniably present, is still subsidiary and accessory in the acquisition of agricultural land in the sense that it appears as a naturally necessary condition for the use of agricultural land, and not as a goal in itself. all things considered, water is a necessary, but not a sufficient factor for attracting foreign direct investment (which does not mean that it will not be the one in the future). world food crisis 2007/2008 convinced many investors that they could not fully rely on the international market, i.e. that it would be increasingly volatile in the future, and that, therefore, it could not be trusted when it came to food security. the united nations special rapporteur on the right to food (de schutter, 2008) pointed out that the increase in food prices on the international market during this period was "unprecedented in its scale and brutality". namely, many countries have become concerned about how they will feed their nations in security. therefore, the interests of low-income countries whose economies are largely based on agriculture have met the interests of high-income countries, which are the largest importers of food and exporters of capital. hiincome countries that lacked agricultural land and water to meet their food needs realized that it was in their interest to transfer food production abroad. so, they realized that it is better to acquire land abroad and produce food themselves than to depend on the supply on the international market (de schutter, 2011). about 38% of all concluded contracts were concluded precisely for food production (nolte, chamberlain & giger, 2016). however, there are different opinions on this issue, namely that most of what is produced on the acquired land is not food (hall, 2011). yet, the facts refute such claims. namely, food production as a cause of acquisitions plays a big role everywhere in the world, and especially in europe. according to data from the database "land matrix" (land matrix initiative, 2020b), food is the main cause of agricultural land acquisitions, leading to a total of 7,826,132 acquired hectares, of which 2,685,887 hectares in eastern europe, 2,572,746 hectares in latin america and the caribbean, 2,123,023 hectares in africa, and 374,222 hectares in asia. acquisitions motivated by food production most often come from china, india, south korea, saudi arabia, and qatar (anseeuw et al., 2012b). situations in these states vary significantly. for example, china is incredibly "self-sufficient" when it comes to food. however, it has a huge population, and its agricultural land is disappearing due to industrial development. with 40% of all farmers in the world and only 9% of the total agricultural land in the world, it is not surprising 20 economic analysis (2022, vol. 55, no. 1, 12-29) that the demand for food is highly ranked among china's political goals (grain, 2008). china and india currently have enough food for the needs of their population. however, both countries have high population growth, so agricultural land and water sources are under great pressure due to increased urbanization and industrialization. these causes lead investors from these countries to invest abroad to meet the future food needs of their people. the same is the case with middle eastern countries, such as saudi arabia, where there is not enough agricultural land to meet the future food needs of its population (friis & reenberg, 2010). moreover, the countries of the middle east face other problems. since they are located in the desert, they are in short supply when it comes to arable land and water, so they do not have opportunities for food production. on the other hand, they own large amounts of oil and money, which gives them enough space to rely on food imports. the global food crisis has negatively affected these countries. namely, given that they depend on food imports from abroad (especially from europe), as well as that their currencies follow the us dollar (except kuwait, but only since 2008), the simultaneous increase in food prices on the world market and the fall of the us dollar meant that these countries were affected by "additional" inflation. their account for imported food jumped rapidly from 8 to 20 billion us dollars. given that the majority of their population are low-paid migrant workers, it is necessary for these countries to provide food at reasonable prices (grain, 2008). their goal is to secure food supply through direct ownership or control of agricultural land abroad and, as far as possible, to exclude traders and other intermediaries in order to reduce the cost of food imports by 20-25% (grain, 2008). under such circumstances, saudi arabia realized that, given the growing scarcity of water, it would make sense to stop producing wheat by 2016 and, instead, produce it and export it back from abroad, ensuring, of course, that the whole process is under their control. the idea was to conclude agreements with islamic states, which would allow their companies access to the land and allow them to export the produced products back to their country. at the same time, as host countries, they would, in turn, receive oil and capital. most affected by this policy were sudan and pakistan, a large number of southeast asian countries (burma, cambodia, indonesia, laos, philippines, thailand, and vietnam), followed by turkey, kazakhstan, uganda, ukraine, georgia (the list is not exhaustive) (grain, 2008). however, the literature states that the allegations of substitution for oil/gas and capital have not been verified, i.e. that there is no evidence for them, but that they are "excessive and uninformed allegations based on secondary sources" (woertz, 2013). it seems that the large increase in demand for agricultural land is mainly the result of the increased need for food due to the growing population. for example, according to research by some authors (faure, 2015), the population of the middle east is expected to double from 30 to 60 million by 2030, and therefore, food imports from these countries, which already are 60%. are expected to increase. namely, the growth of the world's population is one of the basic factors that determine the demand for food.3f2 the relationship between population growth and agricultural land acquisition is presented in figure 2. from figure 2 it can be concluded that the growth of agricultural land is accompanied by world population growth, which indicates a positive impact of world population growth on increasing demand for agricultural land in the world. it is also clear from the aforementioned figure that the linear growth trend of the acquired areas of agricultural land follows the growth of the world population. therefore, we conclude that this trend is likely to continue in the future. the increase in population and food consumption will increase at least until 2050 when it will flatten to about 9 billion people. increased competition for land, water, and energy, overfishing, and the urgent need to reduce the impact of food production on the environment, will affect our ability to produce food. with all this in mind, the world faces a threefold challenge: to combine the 2 due to the increase in world population there is an increase in demand for agricultural land. given that the supply of agricultural land is fixed, this inevitably leads to an increase in agricultural land prices. ana budak 21 rapidly growing demand for food with supply, while taking care to do so in an environmentally and socially sustainable way, and simultaneously ensuring that the world's poorest people are not hungry (godfray et al., 2010). therefore, the question arises how, sustainably, to produce more food? in the past, the primary solution to food shortages was to put new areas of agricultural land into use or find new places to fish. however, since the early 1960s, world cereal production has more than doubled, while, at the same time, agricultural land has increased by only 11% (from 4.5 to 5 billion hectares) and arable agricultural land has increased by only 9 % (from 1.27 to 1.4 billion hectares) (pretty, 2008). it can be concluded that in about 6 decades we have managed to double food production, while for that purpose we have increased the area of agricultural land by slightly more than 1/10. undoubtedly, we have become much more productive, which is, inter alia, a consequence of new technologies and knowledge applied in agricultural production. having in mind that new technologies and knowledge, as a rule, are available to developed countries, the conclusion is that, on the wings of globalization, new technologies and knowledge should be allowed to cross the borders of developed countries and spill over into less developed ones. this should be allowed in order to increase productivity, which would have a positive effect not only within the borders of the host country but, ultimately, in the world as a whole. figure 2. world population growth and the area of acquired agricultural land through international acquisitions over time source: prepared by the author based on data from the land matrix database (land matrix initiative, 2020b) food demand is projected to increase not only due to world population growth but also due to dietary changes4f3, which are associated with the economic development of developing countries. opportunities for food production are limited in many countries around the world, especially due to limited water availability, but also due to reduced productivity and climate change (anseeuw et al., 2012b). many investment institutions, such as deutsche bank, have pointed out that agricultural production can be increased in two ways: by increasing yields and increasing arable land (deutsche bank group, 2009). we should especially keep in mind the fact that the supply of agricultural land is practically fixed, which means that the supply is predetermined and that we cannot increase it in accordance 3 it is interesting to note that 77% of people's caloric intake is derived from only 12 basic foods: wheat, rice, corn, beef, lamb, pork, chicken, soy, palm oil, potatoes, milk, and sugar (anderson, 2014). -1000000 0 1000000 2000000 3000000 4000000 5000000 6000000 7000000 8000000 9000000 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 areas (ha) world population (thousands) linear (areas (ha)) 22 economic analysis (2022, vol. 55, no. 1, 12-29) with the possible growth of demand. however, there are suggestions in the literature by which such an obstacle can be overcome. for instance, having in mind the non-multiplicity as one of the characteristics of agricultural land, it seems that, within the given land fund, it is possible to redistribute it. in other words, it is necessary to take such measures aimed at using the available land as efficiently as possible (keča, 1993). increased demand for agricultural land could have been predicted according to long-term projections of imbalances in the relationship between world supply and food demand (campanale, 2013). according to the estimates of the food and agriculture organization of the united nations, it is assumed that, in order to feed 9 billion people in 2050, the production of agricultural products in the period from 2005 to 2050 should increase by 70% globally and almost 100% in developing countries. therefore, insufficient production growth will lead to higher and more volatile prices (food and agriculture organization of the united nations, 2011). in that sense, the value of owning agricultural land is increasing in the world of growing demand for agricultural products, especially food. it has become clear that agricultural land has turned into a commodity in which investors saw an opportunity to secure profits. the question that arises is whether the acquisition of agricultural land can lead to meeting the increased demand for food while promoting sustainable development. in that sense, it is pointed out that the governments of the host countries generally approve foreign direct investments, even in cases when their population does not have enough food, which is the case of madagascar, sudan, or cambodia. in such circumstances, large-scale agricultural land acquisitions motivated by the food security of richer countries in the poor (where people are starving) are seen as unethical (zoomers, 2010). although such understandings can be justified and even understood, it seems that they are not completely grounded. it seems that such an attitude does not take into account the fact that there was a famine in the mentioned countries even before the arrival of investors. also, it is a fact that investors did not come to the mentioned countries by fraud and took the food previously produced in those countries to their home countries. on the contrary, they came, invested in production, produced it themselves by investing capital, and exported the finished product to their home countries. in addition to the above, the need for food is physiological and therefore not related to the question of where the food producer comes from. in other words, the fact that an investor comes from a rich country should not be discredited as unnecessary and bad. on the contrary, rich countries, as well as poor countries, need a certain amount of food. unlike poorer countries, some developed countries do not have enough (adequate) land for agricultural production. in this regard, there is a need for the proper distribution of natural resources in order to feed all those who live on the planet. of course, the problem of hunger is not related to the rich, but to the poor countries in which investors, as a rule, invest. considering the aforementioned, it should be borne in mind that rich countries would not be able to efficiently produce enough food to meet the nutritional needs of their population. likewise, poor countries would not be able, despite sufficient resources available for their production, to produce enough food for their own needs, due to low yields resulting from outdated agricultural production. in such circumstances, we can conclude that there is a need to reconcile the interests of rich and poor countries, i.e. the need to allow foreign investors access to agricultural land, provided that they contribute to the food security of poor countries or at least not endanger it. the dynamics of agricultural land acquisitions the analysis conducted in this part of the paper aims to review the current state of agricultural land acquisitions and draw relevant conclusions about what we can expect in the future. figure 3 shows that agricultural land acquisitions remained low until 2005, with a slight increase between 2002 and 2006. the sudden increase in acquisitions in the period from 2006 to 2014 can be ana budak 23 explained by the global food crisis of 2007/2008. in any case, the above data could indicate a steady and long-term trend of interest in agricultural land. figure 3. international transactions concluded agreements 2000-2016 source: (nolte, chamberlain & giger, 2016) figure 3 shows a leveling off in the period from 2014, but the authors point out that this does not necessarily mean that fewer agricultural land contracts have been concluded, but that it may also be a consequence of the need for time to reach information on concluded contracts to the public. at this point, we are not able to say with certainty whether the stated stagnation reflects the true picture of things or whether it is just a hoax caused by the need for a certain period to pass for some information to reach the public. however, it should certainly be mentioned that something like this has already happened in the previous report from 2012 (anseeuw et al., 2012a)5f4. this report showed a sharp and steep decline in the acquisition of agricultural land in 2010, which, as the new report showed, was not the case, but probably a consequence of the lack of information about the concluded contracts at the time when the report was made. in fact, the new report from 2016 showed that the report from 2012 did not present the real state of affairs when it comes to 2010. the next and last report to date, and since the land matrix database has existed, shows the leveling of agricultural land acquisitions in the period from 2014. however, the authors are skeptical that we are witnessing a period of stagnation in agricultural land acquisitions and believe that this is because data on international transactions do not reach the public (immediately), which is why there seems to be stagnation. however, this assumption of the author of the aforesaid report from 2016 has not been verified to date, since a new report, which could confirm such an assumption, has not been made yet. for this reason, the author of this paper decided to do it herself, based on available data on international transactions for the period 2000-2020. 4 the comparison with the above report is significant since only two reports of this type exist. namely, land matrix prepared two reports that represent a compilation of international land transactions, the first one in 2012 and the second one in 2016. 24 economic analysis (2022, vol. 55, no. 1, 12-29) figure 4. number of international acquisitions of agricultural land greater than 200 ha in the world source: prepared by the author based on data from the land matrix database (land matrix initiative, 2020b) having in mind the previous knowledge about the acquisition of agricultural land, as well as what they have shown in practice, it seems that the second possibility mentioned by the authors of the 2016 report is more probable. namely, it is likely that it is not stagnation of acquisitions, but only ignorance of the media transactions. this is supported by the results of this research presented in figure 4, from which it can be concluded that in the period from 2014 there was no flattening of the curve. on the contrary, there was a large increase in the number of acquisitions of agricultural land. it can be concluded from figure 4 that from 2001 until the beginning of the global food crisis in 2008, the number of concluded land contracts was relatively negligible. the peak of growth in the number of concluded contracts on agricultural land, which are related to the deals of acquiring over 200 hectares, was recorded in 2013 when there were a total of 114. after 2013, the number of concluded land contracts decreased steadily, to reach a constant 20-40 contracts per year. despite the above data, which show a decrease in the number of concluded contracts on agricultural land, the above should be taken with a grain of salt, since it is possible that a large number of concluded contracts have not been recorded yet. in other words, the true scale of land transactions is likely to be visible only in a few years. from figure 5 it can be concluded that the areas of acquired agricultural land through international acquisitions of agricultural land were at a low level until 2008, i.e. until the beginning of the global food crisis, when a large increase in acquired agricultural land was recorded. the data show that the highest number of acquired hectares was in 2013 when more than 3,500,000 hectares of agricultural land were acquired. as figure 4 shows, the fact that prima facie, the acquired areas in recent years are negligible should not be taken without reservation. this could be, as in the previous case, only a consequence of the delayed data on the acquired areas. 0 20 40 60 80 100 120 number of acquisitions ana budak 25 figure 5. areas of acquired agricultural land through international acquisitions over time source: prepared by the author based on data from the land matrix database (land matrix initiative, 2020b) this small experiment conducted by the author of this article based on available data also speaks about the long-term growth trend of this phenomenon (land matrix initiative, 2020a). by january 2019, over 1,500 international transactions at the global level were completed, which are related to the deals of acquiring a total of 47.3 million hectares of agricultural land. by september 2020, the number of international transactions had increased by 20%, i.e. from cca. 1,500 to cca. 1,800 hectares. simultaneously, the acquired area had increased by 40.35%, i.e. from cca. 47.3 to cca. 79.3 million hectares. to put this figure into perspective, the entire balkan is spread over about 47 million hectares. eight years after the publication of the report "seized!", which has captured the attention of the public, which is still abating, grain has published another report entitled "how big, how bad?" (grain, 2016). this report contains data documenting almost 500 cases of agricultural land acquisitions covering 30 million hectares worldwide. however, the inherent limitation of this database should be borne in mind since, similar to the land matrix database, it includes only certain transactions, i.e. a large number of contracts were not even considered. in other words, it is likely that the scale of the phenomenon is underestimated and that we are talking about much larger areas. the danger is that land deals not included in the database (the ones referring to the land acquisitions of less than 500 hectares) make up a considerable share in total acquisitions. likewise, the reader might wonder how it is possible that the acquisition of agricultural land according to the grain database counts a significantly smaller number of acquired agricultural land than the land matrix. it is only a methodological difference that arises from the different definitions of the term. namely, the land matrix database considers only those land contracts that cover an area of 200 hectares or more, while the farmlandgrab.org platform, which grain uses as a basis for its research, considers only those contracts related to the deals of acquiring over 500 hectares. an additional limitation of the data from the platform is that it takes into account only contracts concluded after 2006, which have not been terminated, in which the investor is a foreigner and which are concluded for food production. from all the above, it can be concluded that the true scale of land transactions (both in number and in the acquired area of agricultural land) is probably much larger than the current data show, but that this will be visible only in a few years, i.e. when data on international transactions made in the last few years will be made public. in any case, it can be concluded that agricultural land acquisitions show a long-term growth trend. 0 500000 1000000 1500000 2000000 2500000 3000000 3500000 4000000 areas (ha) 26 economic analysis (2022, vol. 55, no. 1, 12-29) conclusion bearing in mind that in some developing countries agriculture has been neglected for decades, it is not surprising that states stimulate investors to invest in the agricultural sector since it is seen as one of the efficient and quick solutions to problems that have long been out of the state's financial radar. in this sense, it seems that investment in agricultural land should probably be encouraged rather than hampered, especially given the fact that they can be a lever of economic development. however, the eternal controversy regarding this issue does not abate. particular suspicion regarding investment in this sector stems from the fact that acquisitions bring with them several potentially negative effects. for this to happen, host countries must pursue welldesigned policies to attract foreign direct investment, based on well-designed development strategies. in other words, international transaction agreements must not be concluded on an ad hoc basis if the chances of negative effects of agricultural land acquisitions are to be minimized. it could be said that the recommendations for the policy of attracting foreign direct investment are: to ensure the rule of law and an adequate legal and institutional framework in advance (if they are weak, these countries have a great chance to experience the negative effects of agricultural land acquisitions), as well as to ensure non-discrimination of investors and good business conditions. it turned out that one-third of all concluded contracts on agricultural land acquisitions were concluded for food production. namely, the increased demand for food, i.e. agricultural products, has resulted in increased demand for agricultural land. the result of this increased demand is a large number of investments in agriculture, especially in developing countries where land is often considered underused. investments in these countries are no surprise. on the contrary, they are only a reflection of investors for whom making a profit is always a motive, even if it was a secondary one, as in this case when the main motive is to satisfy the need for food. the research showed that the growth of the acquired areas of agricultural land follows the growth of the world population. this indicates the positive influence of the increase of the world population on the increase of the demand for agricultural land in the world. in addition to the above, it has been shown that the linear growth trend of the acquired areas of agricultural land follows the growth of the world population. therefore, we conclude that this trend is likely to continue in the future, i.e. that it is unlikely that the demand for agricultural land will decrease. world population growth will continue to be the background cause that will manifest itself through, inter alia, increased demand for agricultural products. this is supported by the conservative assessment of the world bank (deininger & byerlee, 2011), that in developing countries, 6 million hectares of agricultural land will be put into use every year until 2030. furthermore, the paper showed that the number of international acquisitions of agricultural land over 200 hectares, i.e. the biggest number of acquired hectares in the world, was in 2013. likewise, it was concluded that the true scale of land transactions (both in number and in the area of acquired agricultural land) is probably much higher than the current data show. furthermore, this will be visible only in a few years when data on international transactions made in the last few years will hopefully be made public. in any case, it can be concluded that agricultural land acquisitions show a long-term growth trend. all things considered, it can be concluded that the acquisitions of agricultural land are in continuo. given the aforesaid, there is a need for policies to attract foreign direct investment in agriculture to be designed to maximize benefits and minimize potential drawbacks. this is because agricultural land acquisitions, on the one hand, have the potential to create new jobs, bring new technologies, knowledge, improve existing or build new infrastructure and improve agricultural production but, on the other hand, they can worsen the existing environmental situation, living standards, food security, rural development, competition, and human rights. in any case, concluding contracts dealing with agricultural land transactions, without an adequate strategy for attracting foreign direct investment, i.e. without previously clearly set goals ana budak 27 of the host country (what kind of investments it wants to attract and what it expects from them), often leads to negative effects of such investments on the host country. for this not to happen, host countries must pursue well-designed policies to attract foreign direct investment, based on well-designed development strategies. in other words, international 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"globalisation and the foreignisation of space: seven processes driving the current global land grab." the journal of peasant studies, 37(2): 429-447. article history: received: november 11, 2021 revised: march 8, 2022 accepted: april 5, 2022 https://landmatrix.org/publications/ https://www.dlapiper.com/en/us/insights/publications/2019/07/real-estate-gazette-35/fewer-restrictions-on-the-acquisition-of-agricultural-land/ https://www.dlapiper.com/en/us/insights/publications/2019/07/real-estate-gazette-35/fewer-restrictions-on-the-acquisition-of-agricultural-land/ doi: 10.28934/ea.20.53.1.pp105-117 scientific review implementation of two – dimensional model of corporate social responsibility in serbian companies saša virijević jovanović1* | tatjana janovac1 | dragana nešović2 1 university business academy, faculty of applied management, economics and finance, departement for management and business, belgrade, serbia 2 university union, nikola tesla, faculty of law, security and management, department for law, niš, serbia abstract the aim of the paper is to point out the possibilities of measuring the effects of corporate social responsibility (csr) on the basis of two dimensional model, developed by quazi ali m. and o’brien d. (2000). the problem of measuring the effects of csr occurs mainly due to the fact that it is difficult to estimate how qualitative factors contribute to competitiveness. the two-dimensional csr model measures the corporate social responsibility from two perspectives. one is the company’s approach towards society, while another represents the cost / benefit ratio of csr. therefore, the model belongs to the category of socio-economic models. in order to make a contribution towards the further researching of the model application, the empirical test have been made on the sample of 33 companies in serbia. according to quazi ali m. and o'brien d., the survey was based on a questionnaire consisting of 25 statements that covered significant issues in the field of corporate social responsibility. factor analysis was used as a statistical method in the research. the survey indicated that the majority of respondents recognize the significance of corporate social responsibility application. however, the respondent’s opinions are divided between two extremes: companies oriented toward long-term goals, which show interest in society and companies that focus on short-term, purely profit-oriented goals, which take a negative stance on csr. key words: corporate social responsibility, two – dimensional csr model, business and society jel classification: a14 introduction corporate social responsibility (csr) in the contemporary economic and social environment has become a critical business function in organization and an “inescapable priority” (porter and kramer, 2006). also, in recent years, the importance of csr is highly recognized by national and regional authorities, who have taken legislative initiatives in order to promote and support practice of socially responsible business. therefore, the scientific public is increasingly considering the possibility of measuring the level of corporate social responsibility, as well as its effects on the social environment and business. over the past years, multiple models of corporate social responsibility have been developed by numerous authors. however, most of the models were descriptive and only a few have been empirically verified. australian authors, quazi and o'brien have defined a wider approach to corporate social responsibility, noting that the organization should strive to build sustainable relationship with * corresponding author, e-mail: sasavirijevic12@gmail.com 106 economic analysis (2020, vol. 53, no. 1, 105-117) social environment. as a result of such approach, the authors have designed the two dimensional csr model, which was the subject of this paper. the main advantage of the model is the possibility of application in different cultures and industries. therefore, it has attracted the attention of other researchers, who have continued to test its validity in different socio-cultural contexts, such as: spain (de la cruz and suarez, 2005), brazil (filgueiras et al. 2012), mexico (ortega et al. 2016) etc. regarding the findings of quazi and o'brien, the aim of the paper is to point out the possibilities of measuring the effects of corporate social responsibility on the basis of two approaches, a social perspective and the cost / benefit ratio. empirical research was conducted in serbian companies from june to august 2019. the sample included 136 managers and ceos from 33 companies. in interpreting the obtained data spss program was used, with its functions of descriptive statistics and factor analysis. corporate social responsibility concept – theoretical background social responsibility as a practice of organizations has existed for several centuries, before the emergence of the first theoretical approaches (schwartz and cragg, 2009). however, the first written records of corporate social responsibility date back to 1899 and are related to the work of andrew carnegie. the scientific study of this concept was introduced by chester barnard (carroll, 1999) in 1938, who analyzed the responsibility of organizations in the publication "the functions of the executive” (chester, 1968). when it comes to the modern concept of csr, many consider that its founder was the prominent american scientist, howard bowen (carroll, 1999). in 1953 bowen published a book “social responsibilities of the businessman” in which he indicated that the private business success will be judged regarding its contribution to the general welfare (bowen, 1953). later, in 1960 keith davis claimed that businessmen have to reexamine their contribution to the society (davis, 1960). the very same year william c. frederick considered that businesses’ resources should be put on disposal for the sake of higher social goals. (frederick, 1960). in recent years, pitter drucker was also a great proponent of the concept. he was well-known by his statement that “leaders in every single institution and in every single sector have two responsibilities. they are responsible and accountable for the performance of their institutions, and that requires them and their institutions to be concentrated, focused, limited. they are responsible also, however, for the community as a whole” (knapp, 2007). within the pages of the new csr theory, there is a special place for archie carol, who linked the concept with the idea of conscious capitalism (carroll, 2015; wagner-tsukamoto, 2019). corporate social responsibility today is an important academic field, which confirms the growing attention to the subject. this is supported by the fact that most successful large companies now publish substantial information on their social and environmental impacts (crane, mcwilliams et al., 2008). furthermore, there have been made great efforts in order to harmonize csr practices globally and to define standards that will guide business actions in social environment. there are many definitions of corporate social responsibility in the current literature. however, there is no single established definition, especially if one consider different theoretical approaches around the world (malecki, 2018). carroll has introduced the following definition: "the social responsibility of business encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time" (carroll, 1979). according to one of the most commonly cited definition, csr is regarded as the responsibility of business sector that has to be aware of its influence on the society (european commission, 2019). in order to meet its social responsibilities, the enterprises and their stakeholders should saša virijević jovanović, tatjana janovac, dragana nešović 107 define business strategies that will integrate environmental, social, ethical and human rights interests (meglio, 2019; rasche, morsing, moon, 2017). some authors emphasize the importance of discretionary business practices in csr definitions (kotler and lee, 2005; sales, 2019; bittar-godinho and masiero, 2019). the word discretionary refers to the fact that there is no law that obliges companies to act socially responsible, but they do so voluntarily. other authors propose normative approach and insist that csr is about managing business operations “in a manner that meets high social and environmental standards” (fisher and lovell, 2003). there are also attitudes that csr definition should involve economic and legal concerns (carroll and shabana, 2010). measuring corporate social responsibility measuring the effects of corporate social responsibility is a demanding process, as it should show how the csr activities of an organization affect society, as well as how it contributes to competitiveness. some studies indicate that the measurement of csr effects is highly dependent on the industry, product type, and social issues in question (mullerat, 2010). considering the problems of measuring the effects of csr, lantos points out that the results of such empirical research are often ambiguous, and does not indicate whether the organizations are better or worse in fulfilling social responsibilities (lantos, 2001). the process of measuring csr is particularly difficult regarding the fact that it is not easy to assume how qualitative factors such as morale of the employees, corporate reputation, public relations, and other contribute to profitability and competitiveness. however, through different periods of csr history, different models have been developed in order to measure the company’s performance in society. in 1979, carroll was the first who introduced the corporate performance model (csp). the model presented four different types of social responsibilities: economic (“make profit”), legal (“obey the law”), ethical (“be ethical”), and philanthropic (“be a good corporate citizen”) (carroll, 1979). the csp model served as a solid base for developing other approaches to measuring csr (schreck, 2009), such as watrick and cochran’s model (1985) and wood’s model (1991). from carroll’s csp model to the present day, csr methodology has enriched its history with different models, which can be classified in many ways. according to the classification, which is widely represented in the literature csr models can be divided into three categories (liangrong, 2009): 1. socio-economic models, 2. the stakeholder model, 3. triple bottom line model. the two – dimensional model of csr the findings in this study are based on a two-dimensional csr model. it was developed by quazi ali m. and o’brien d. (2000) in order to measure the corporate social responsibility from two perspectives. one is the company’s approach towards society, while another represents the cost / benefit ratio. therefore, the model belongs to the category of socio – economic models. when developing the model, the authors defined two goals: 1. to create a corporate social responsibility model that will be applicable across different cultures and 2. to empirically verify the model by examining how managers perceive csr. 108 economic analysis (2020, vol. 53, no. 1, 105-117) the model consists of two axes, horizontal and vertical and four quadrants, shown in figure 1. the company's position in the model depends on how it perceives the csr and its benefits. figure 1. a two-dimensional model of corporate social responsibility source: (quazi and o’brien, 2000) the horizontal axe connects two extremities: “wide responsibility” on the left and “narrow responsibility” on the right. the left position represents a wider social approach to business, which implies that the company should be interested in community development as well as involved in protection of the environment, nevertheless the fact that it does not have a legal obligation. the right position, on the other hand, is in line with the old, classic business approach, which emphasizes that the company should be focused solely on short-term goals, such as to maximize profits. supporters of this concept consider that the company has only one sole social responsibility, which is to provide products for the society, while making a profit and respecting legal regulations. vertical axe of the model represents two extreme positions, regarding the consequences of the company’s social action. the benefits from csr are shown on the top of vertical axe, and costs from csr activity are situated at the bottom. companies that focus on short-term, mainly profitoriented goals show concern about the costs that arise from csr activity, and therefore they are oriented toward the lower, negative positions. unlike the companies that are oriented toward long-term goals and show interest in society. these companies have a position within the upper positive extremes of the model (filgueiras et al. 2012). the intersection of two axe made four quadrants in the model that represent company’s approaches toward csr: the classical view, the socio-economic view, the modern view and the philanthropic view. the classical approach is applied by those organizations whose managers think that there is no reason to invest in social responsibility activities as they do not contribute to profitability. the socio – economic approach recognizes that csr provides some benefits to the organization, such as good customer and supplier relations (liangrong, 2009). the modern view is applied by organizations that are aware of the added value created by responding on societal needs and perceiving net benefits from its csr programs (jamali, sidani, khalil, 2009). saša virijević jovanović, tatjana janovac, dragana nešović 109 the philanthropic quadrant represent the widest approach to corporate social responsibility in which business agrees to show an altruistic and ethical sense of doing something right for society (kaplan, serafeim, tugendhat, 2019). implementing the two – dimensional model of corporate social responsibility in serbian companies – empirical study the aim of this study was to explore the possibilities of measuring the effects of csr on the basis of two dimensional model. the model has been empirically tested on the example of serbian companies in order to demonstrate its application. the survey was conducted from june to august 2019, on a sample of 40 companies in the territory of serbia. the response rate was 82.5% (33 companies). the data were first analyzed by descriptive statistics. then the factor analysis method was applied, which allowed finding simpler data structures. the sample description the sample has included companies with more than 10 employees in the sectors of information and communication, trade, finance and transportation. the respondents in the study were 136 managers and ceos, responsible for csr strategies in the selected companies. regarding the industry of 33 serbian companies that participated in the research, the structure of the sample was the following: finance 19,9% (27 respondents), trade 44,1% (60 respondents), transport 11.8% (16 respondents), information and communication 24,3% (33 respondents), presented in figure 2. frequency percent valid percent cumulative percent valid finance 27 19.9 19.9 19.9 trade 60 44.1 44.1 64.0 transport 16 11.8 11.8 75.7 information and communication 33 24.3 24.3 100.0 total 136 100.0 100.0 figure 2. sample description regarding the type of industry source: author's calculation based on spss the second feature that has described the sample was the number of employees. regarding this feature, the most numerous (28,7%) were the respondents coming from companies that have 30-40 employees (figure 3). frequency percent valid percent cumulative percent valid 10-20 37 27.2 27.2 27.2 20-30 38 27.9 27.9 55.1 30-40 39 28.7 28.7 83.8 40-50 12 8.8 8.8 92.6 >50 10 7.4 7.4 100.0 total 136 100.0 100.0 figure 3. sample description the number of employees in companies source: author's calculation based on spss 110 economic analysis (2020, vol. 53, no. 1, 105-117) instruments and procedures the empirical research was based on the questionnaire, developed by quazi ali m. and o'brien d. it was consisted of 25 statements related to important issues of csr. for each statement, the respondent indicated the degree of agreement, which was presented as a grade from 1 to 5 (meaning: 1 = strongly disagree; 2 = disagree; 3 neutral; 4 = agree and 5 = strongly agree). in interpreting the obtained data spss program was used, with its functions of descriptive statistics and factor analysis. results the survey indicated that the majority of respondents recognizes the significance of corporate social responsibility application. more than 90% of respondents consider (strongly agree 26, 5% and agree 64%) that social responsibility presents and important factor for competing in the market. figure 4 shows the descriptive statistics of respondent’s answers regarding positive statements about csr. the arithmetic means of their answers were higher than 4, which corresponds to the highest grades from likert scale. n minimum maximum mean std. deviation the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution 136 1 5 4.11 .696 social responsibility is an effective basis for competing in the market 136 3 5 4.17 .578 business should realize that it is a part of the larger society and therefore it should respond to social issues 136 3 5 4.26 .561 contributing to the solution of social problems can be profitable for business 136 3 5 4.20 .569 corporate social action programs can help build a favorable image for a business. 136 3 5 4.20 .499 valid n (listwise) 136 figure 4. descriptive statistics of respondent’s answers regarding positive statements about csr source: author's calculation based on spss and quazi and o'brien’s model in general, respondents' answers were ranked between two extremes: managers who see business as a part of the larger society, which is therefore not limited on its economic role, and managers who consider social responsibility acts as a cost disadvantage. however, the majority of respondents had positive attitudes toward the concept of csr, which could be classified within the modern quadrant in two-dimensional model of csr. the greatest heterogeneity in respondent’s answers was obtained in the statements regarding the issues of csr regulation, the role of business in society as well as the costs of csr programs. at the same time, those were the questions on which respondents answered negatively toward the concept of corporate social responsibility. figure 5 illustrates respondent’s answers regarding the statement that business can avoid further regulation by adopting social responsibility programs. saša virijević jovanović, tatjana janovac, dragana nešović 111 frequency percent valid percent cumulative percent valid strongly disagree 13 9.6 9.6 9.6 disagree 24 17.6 17.6 27.2 neutral 37 27.2 27.2 54.4 agree 40 29.4 29.4 83.8 strongly agree 22 16.2 16.2 100.0 total 136 100.0 100.0 figure 5. respondent’s answers on question “business can avoid further regulation by adopting social responsibility programs” source: author's calculation based on spss and quazi and o'brien’s model frequency percent valid percent cumulative percent valid strongly disagree 23 16.9 16.9 16.9 disagree 61 44.9 44.9 61.8 neutral 27 19.9 19.9 81.6 agree 22 16.2 16.2 97.8 strongly agree 3 2.2 2.2 100.0 total 136 100.0 100.0 figure 6. respondent’s answers regarding the statement “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business” source: author's calculation based on spss and quazi and o'brien’s model also, it should not be ignored that 18, 4% of respondents consider that social involvement may be suicidal for the marginal firm advantage (figure 6). in order to analyze attitudes towards csr in more detail, we have selected the variables that had the greatest heterogeneity in answers and subjected them to the method of factor analysis. the data was tested with kaiser-meyerolkin (kmo) test in order to measure the suitability for structure detection. bearing in mind that the result was 0.754, which was higher than the proposed minimum of 0.6, we have concluded that the data was suitable for the factor analysis (figure 7). kaiser-meyer-olkin measure of sampling adequacy. .754 bartlett's test of sphericity approx. chi-square 260.546 df 28 sig. .000 figure 7. kmo and bartlett's test of the selected sample source: author's calculation based on spss 112 economic analysis (2020, vol. 53, no. 1, 105-117) r eg u la ti o n i s n o t su ff ic ie n t to e n su re b u si n e ss b eh a v es i n a s o ci al ly r es p o n si b le w ay a b u si n es s th at i g n o re s so ci al r es p o n si b il it y m ay h av e a co st a d v a n ta g e o v er a b u si n e ss th at d o es n o t s o ci al i n v o lv em en t m ay b e su ic id al f o r th e m ar g in al f ir m , f o r th e h ig h c o st s in v o lv ed m ay t h ro w i t o u t o f b u si n es s b u si n es s is p ri m ar il y a n e co n o m ic in st it u ti o n a n d i t is m o st s o ci al ly r es p o n si b le w h en i t at te n d s st ri ct ly t o i ts e co n o m ic in te re st s it i s u n fa ir t o a sk b u si n es s to b e in v o lv e d i n so ci al r es p o n si b il it y p ro g ra m s as i t is al re a d y d o in g t o b y c o m p ly in g w it h s o ci a l re g u la ti o n s b y t ra n sf er re d t h e co st o f so ci al i n v o lv e m e n t to s o ci et y , b u si n es s m a y w e ak en i ts i m ag e w it h t h e p u b li c t h e in cr e as in g i n v o lv em e n t o f b u si n es s in so ci al r es p o n si b il it y m a y l ea d t o i n cr e as in g ex p ec ta ti o n s o f so ci et y a s to t h e b u si n es s co n tr ib u ti o n b u si n es s ca n a v o id f u rt h e r re g u la ti o n b y ad o p ti n g s o ci al r es p o n si b il it y p ro g ra m s c o rr el at io n regulation is not sufficient to ensure business behaves in a socially responsible way 1.000 -.361 -.318 .223 -.210 -.215 .141 .225 a business that ignores social responsibility may have a cost advantage over a business that does not -.361 1.000 .751 -.208 .512 .428 -.099 -.261 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business -.318 .751 1.000 -.134 .530 .482 -.076 -.158 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests .223 -.208 -.134 1.000 .019 -.032 .152 .235 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations -.210 .512 .530 .019 1.000 .301 .123 -.147 by transferred the cost of social involvement to society, business may weaken its image with the public -.215 .428 .482 -.032 .301 1.000 -.015 -.198 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution .141 -.099 -.076 .152 .123 -.015 1.000 .197 business can avoid further regulation by adopting social responsibility programs .225 -.261 -.158 .235 -.147 -.198 .197 1.000 figure 8. correlation matrix source: author's calculation based on spss and quazi and o'brien’s model in order to find correlation coefficients between variables, we have used correlation matrix from spps program, presented in figure 8. the results indicated significant number of correlation coefficients higher than 0,3. the strongest correlation (0,751) was determined between the variables “social involvement may be suicidal for the marginal firm, for the high saša virijević jovanović, tatjana janovac, dragana nešović 113 costs involved may throw it out of business” and “a business that ignores social responsibility may have a cost advantage over a business that does not”. figure 9 represents the communalities that indicate the amount of variance in each variable that is accounted for. initial extraction regulation is not sufficient to ensure business behaves in a socially responsible way 1.000 .583 a business that ignores social responsibility may have a cost advantage over a business that does not 1.000 .772 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business 1.000 .699 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests 1.000 .654 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations 1.000 .682 number of employees 1.000 .614 by transferred the cost of social involvement to society, business may weaken its image with the public 1.000 .653 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution 1.000 .639 business can avoid further regulation by adopting social responsibility programs 1.000 .405 extraction method: principal component analysis. figure 9. communalities source: author's calculation based on spss and quazi and o'brien’s model the table of total variance explained (figure 10) shows that two factors have eigenvalues greater than 1. together, they account more than 53% of the variability in the original variables. component initial eigenvalues extraction sums of squared loadings total % of variance cumulative % total % of variance cumulative % 1 2.883 36.040 36.040 2.883 36.040 36.040 2 1.387 17.337 53.377 1.387 17.337 53.377 3 .860 10.756 64.132 4 .792 9.904 74.037 5 .721 9.013 83.049 6 .687 8.584 91.633 7 .434 5.424 97.058 8 .235 2.942 100.000 extraction method: principal component analysis. figure 10. total variance explained source: author's calculation based on spss and quazi and o'brien’s model the eigenvalues and component numbers are presented on a scree plot in figure 11. the diagram shows that the last big drop occurs between the two and three components. 114 economic analysis (2020, vol. 53, no. 1, 105-117) figure 11: scree plot source: author's calculation based on spss component 1 2 regulation is not sufficient to ensure business behaves in a socially responsible way -.550 .292 a business that ignores social responsibility may have a cost advantage over a business that does not .864 .079 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business .846 .202 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests -.290 .610 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations .656 .429 by transferred the cost of social involvement to society, business may weaken its image with the public .632 .190 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution -.151 .658 business can avoid further regulation by adopting social responsibility programs -.426 .479 extraction method: principal component analysis. a. 2 components extracted. figure 12. component matrix source: author's calculation based on spss and quazi and o'brien’s model figure 12 shows component matrix with the loadings of eight variables on the two factors extracted. the first factor is highly associated with the statements “a business that ignores social responsibility may have a cost advantage over a business that does not” and “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business”. the second corresponds most strongly to the variables “the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution” and “business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests”. the findings indicate that the variables related to the cost issues of csr programs were grouped into one factor, while the variables related to the social dimension of business were grouped into second factor. these results are in accordance with the basic principles of two dimensional csr model, which implies a social perspective and the cost / benefit ratio. saša virijević jovanović, tatjana janovac, dragana nešović 115 component 1 2 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business .858 a business that ignores social responsibility may have a cost advantage over a business that does not .816 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations .794 by transferred the cost of social involvement to society, business may weaken its image with the public .659 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution .685 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests .680 business can avoid further regulation by adopting social responsibility programs .593 regulation is not sufficient to ensure business behaves in a socially responsible way -.357 .448 extraction method: principal component analysis. rotation method: oblimin with kaiser normalization. a. rotation converged in 5 iterations. figure 13. pattern matrix source: author's calculation based on spss and quazi and o'brien’s model the rotated solution indicated the existence of a simpler structure (figure 13), with both components having significant factors. the interpretation of the components is consistent with the statement that the largest number of respondents' negative answers regarding csr referred to two issues: social perspective of business and the costs of csr programs. conclusion this research has emphasized the importance of using the methodology in measuring corporate social responsibility. therefore, the paper has analyzed the application of twodimensional model of csr that belongs to the category of socio economic models, and represents two approaches towards csr, a social perspective and the cost / benefit ratio. when selecting a model of csr, we have also had in mind its possibility of application in different cultures and industries. the research was conducted in 33 serbian companies on a sample of 136 respondents (managers and ceos). the survey indicated that the respondent’s opinions are divided between two extremes: companies oriented toward long-term goals, which show interest in society and companies that focus on short-term, purely profit-oriented goals, which take a negative stance on csr. the greatest heterogeneity in respondent’s answers was obtained in the statements regarding the issues of csr regulation, along with the stands toward the costs of csr programs. however, the survey indicated that the majority of respondents realizes the importance of creating the added while responding on societal needs and perceiving net benefits from its csr actions. in that terms, the answers correspond with the modern quadrant in two-dimensional model of csr. in order to further data processing, the factor analysis method was applied. the suitability of applying this method was confirmed by kaiser-meyer-olkin test, with a result of 0.754. the analysis included eight variables with the largest differences in responses. the correlation matrix indicated a significant number of positive correlation coefficients. the strongest 116 economic analysis (2020, vol. 53, no. 1, 105-117) correlation (0,751) was determined between the variables “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business” and “a business that ignores social responsibility may have a cost advantage over a business that does not”. by applying the method of principal component analysis two components were identified. the first factor was highly associated with the variables “a business that ignores social responsibility may have a cost advantage over a business that does not” and “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business”. the second corresponded most strongly to the variable “the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution”. finally the research resulted in defining pattern matrix, that presented simpler structure with two components having significant factors. the interpretation of the components is consistent with quazi and o'brien’s approach which is based on two dimensions: social perspective of business and the costs of csr programs. references bittar-godinho, j., and masiero, g. 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(2017). corporate social responsibility: strategy, communication, governance. uk: cambridge university press, 6 quazi, ali m., o’brien, d. (2000). “an empirical test of cross – national model of corporate social responsibility.” journal of business ethics, 25 (1): 33-51 sales, a. (2019). “the institutionalization of the domain of corporate social responsibility” in corporate social responsibility and corporate change, ed. sales arnaud, 3-43, switzerland: springer schreck, p. (2009). the business case for corporate social responsibility. munich: physica verlag heidelberg, 15-16 schwartz, m., cragg, w. (2009). corporate social responsibility. london and new york: routledge, 16 wagner-tsukamoto, s. (2019). "in search of ethics: from carroll to integrative csr economics." social responsibility journal, 15 (4):469-491 watrick, s., cochran, p. (1985). “the evolution of the corporate social performance model.” academy of management review, 10(4): 758-769. wood, d. j. (1991).” corporate social performance revisited”. academy of management review, 16(4): 691-718. article history: received: november 1, 2019 accepted: december 10, 2019 implementation of two – dimensional model of corporate social responsibility in serbian companies saša virijević jovanović115f* | tatjana janovac1 | dragana nešović2 introduction corporate social responsibility concept – theoretical background measuring corporate social responsibility the two – dimensional model of csr implementing the two – dimensional model of corporate social responsibility in serbian companies – empirical study the sample description instruments and procedures results conclusion references doi: 10.28934/ea.23.56.1.pp20-31 first online: march 31, 2023 preliminary report managers’ attitudes on sustainable development concept application in trading companies – evidence from serbia maja staletović11f* | srećko bačevac2 | mirjana stevanović3 | ljubica pantelić4 1 business college of applied studies „prof. phd radomir bojković“ kruševac 2 belgrade banking academy, faculty for banking, insurance and finance belgrade, belgrade 3 the college of academic studies „dositej“, belgrade 4 deposit insurance agency, belgrade abstract trading companies face various challenges brought about by the modern environment. for this reason, trading company managers try to adapt their business to various requirements of the environment. this is supported by the fact that recently there has been a global change in the structure of retail, with evidence in the following examples: new sales formats have appeared, there are new categories of retail companies, sales facilities are modernized, soft information is emphasized, flexibility and innovation in business are encouraged, the role of interest groups is valued, unpredictability is accepted as the norm of functioning, the offer of trade mark products is expanded, etc. however, as economic, environmental and social problems gain more and more importance, another very important topic that captures the attention of business managers is the sustainable development concept application. doing business in accordance with the rules of sustainable development implies that trading companies base their work on ecological and moral principles of sustainable social communities. in accordance with the importance that the sustainable development concept has today, the aim of the paper is based on the analysis of attitudes of employees in management positions in trading companies in the republic of serbia regarding the application of economic, ecological and social dimensions of sustainable development. the research results showed that the application of certain elements of sustainable development basic dimensions in their trading companies has been evaluated by the managers as good. keywords: sustainable development, trading companies, management, changes, environment jel classification: m14, q56 introduction in modern economic conditions, sustainable development is a serious and very important topic. this concept aims to promote equitable and equal development while achieving economic betterment, social well-being and environmental quality. the goal is to satisfy the needs of present generations and not neglect the needs of future generations. thus, it is necessary to develop a comprehensive attitude regarding the sustainable development concept application in all areas and at all levels. in the last few years, the sustainable development concept is increasingly used in the field of trade. proof of this can be found in published sustainable development reports of many successful companies in that area. the above reports differ in the detail of providing data on * corresponding author, e-mail: maja.staletovic@visokaposlovnaskola.edu.rs maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 21 sustainable activities. a more detailed presentation of data on sustainable activities is provided by trading companies that have leadership positions in the market, which is, to some extent, expected from them. these companies are significantly dedicated to the application of various elements of economic, ecological and social dimensions of sustainable development. regarding trading companies in the republic of serbia, this paper aims to analyze certain research results in order to view the application of sustainable development basic dimensions in trading companies in the republic of serbia. the paper is based on the following research hypothesis: trading companies in the republic of serbia operate in accordance with the basic elements of the economic, ecological and social dimensions of sustainable development. accordingly, a theoretical presentation of the importance of sustainable development concept application in trading companies was given at the beginning of the paper. thenceforth, in accordance with the goal and the set hypothesis, the research results were presented and the managers' attitudes regarding the sustainable development concept application in trading companies in the republic of serbia were analyzed. at the end, concluding remarks were given and the contribution of this research was pointed out. theoretical background the importance of sustainable development was recognized as early as 1972, when the club of rome pointed out the „dilemmas“ humanity faced at that time, primarily from the standpoint of accelerated exploitation of the most important natural resources (štrbac et al., 2012). in such conditions, the sustainable development concept was primarily associated with the need to stop further creating unbalanced relations between the environment and society. the goal was based on creating a more harmonious relationship between accelerated economic growth and a significantly degraded environment. the sustainable development concept is conceived as a category that should propagate and encourage economic growth without environmental degradation and with respect for the needs of all social community members. its task is reflected in creating the balance between economic, ecological and social spheres, which in turbulent economic conditions can bring great benefits. the main principle of sustainable development is based on ensuring intergenerational solidarity (withisuphakorn, 2019). it can even be said that sustainable development is the backbone of modern society. it is actually a concept that is gaining importance day by day in various sectors of the economy. the emergence of the sustainable development concept had a significant role in creating a change in global thinking, forcing companies to rethink the way they conduct their business (hami et al., 2015). many, especially companies that have a leadership position in the market, have become aware of the importance of the sustainability concept for their functioning. as trade and retail occupy a significant place in the economy of a country, likewise, the sustainable development concept has its place in retail (sokolov mladenović, 2017). however, with regard to the trade sector, the sustainable development concept application is relatively recent. the need for responsible behavior in trading companies is stimulated by the action of various dynamic environmental trends. firstly, we are talking about the increasingly developed awareness of consumers about the importance of responsible behavior of trading companies, the emergence of information and communication technology that provides the opportunity to transmit information about companies’ irresponsible activities among consumers at an enormous speed, the increasing interest of the media in socially responsible activities of companies, etc. in addition, trading companies, especially those engaged in manufacturing, have a certain contribution to environmental degradation, but also in creating or solving social community problems. today, retail is facing major challenges due to the high mobility of consumers, the need for a strong orientation toward monitoring and analyzing consumer behavior, and the transition to online trade (burilović, 2020). all these factors encourage trading companies to operate in accordance with sustainable development goals and principles. in his work, lazibat (2012) states the research 22 economic analysis (2023, vol. 56, no. 1, 20-31) results according to which consumers notice the following irresponsible activities of trading companies: • large trading companies can be a competition to smaller trading companies, • trading companies can be harmful to the environment when they generate a large amount of waste, • inadequate attitude towards employees, • inadequate attitude towards consumers, • non-compliance with legal regulations, • inadequate promotional material. rahdari et al. (2020) emphasize that the retail industry has a significant responsibility to society because its business model is broadly embedded within society, both in terms of suppliers in its upstream supply chains and downstream with consumers. stefaneska and borusiak (2015) emphasize that retail companies have a special role in implementing the concept of sustainable development. thanks to their position as intermediaries between manufacturing companies and consumers, trading companies are able to encourage responsible behavior of their interest groups, which can be of great importance for improving the quality of life of the entire social community. theoretical-empirical research shows that trade has the ability to influence the production process and the consumption pattern but also to encourage producers to favor the needs of consumers who prioritize the sustainability concept (sokolov mladenović, ćuzović, 2014). at the same time, the sustainable development concept with all its components in retail shows certain specificities, and based on them, companies strive to create and improve their longterm competitive advantage (sokolov mladenović, 2017). thanks to their position as intermediaries between manufacturing companies and consumers, trading companies are able to monitor the responsible operations of their suppliers and also influence the development of consumer awareness of the importance of sustainable development. a trading company can initiate the process of developing awareness among end-users that they are not only consumers but that they can be an important link in the procurement chain that can, by adopting the habit of ecological behavior, return a significant amount of raw materials, now in the role of a supplier (knego, 2012). the management of trading companies is responsible for ensuring the willingness to include a larger amount of organic products in their offer, eliminate the use of plastic bags, respect the principles of "fair" trade and consumption, offer organic products under the brand name, respect ecological principles when building sales facilities, use renewable energy sources, etc. essentially, trading companies are also expected to encourage the creation of new, sustainable habits of their suppliers, consumers and other social community members. business operation according to sustainable development principles and goals is especially expected of large and successful trading companies. according to their financial capacity, they are even expected to have a strategic commitment to sustainable development concept implementation. the foregoing means that sustainable development concept application should be continuous and not occasional. in addition, it is important that sustainable development concept implementation is not unilateral. it is necessary to simultaneously and equally take care of the application and balance of economic, ecological and social dimensions of sustainable development. this is also important because the mentioned areas are somewhat interconnected. zhang and jiang (2019) note that a company’s economic development will affect environmental degradation, but in turn, environmental pollution will also affect the development of companies. in addition, many studies show that consumers do not prefer to buy from socially irresponsible companies and that employees choose fair and responsible employers. it often happens that consumers hold trading companies responsible for the actions of other participants in the supply chain (for example, for product quality). for that reason, it is important that trading companies also encourage their suppliers to behave in accordance with the rules required by the sustainable development concept application. when choosing a supplier, a trading company can ignore those maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 23 who do not respect environmental protection criteria when manufacturing products, who exploit child labor, and who use impermissible technologies and materials in production that are harmful to human health and the environment (knego, 2012). given that an increasing number of stakeholders are showing interest in the responsible business of trading companies, the most successful retail chains regularly publish their sustainability reports, from which it can be seen which sustainable development components or dimensions represent an integral element of their business operation and creation of a long-term and sustainable competitive advantage (sokolov mladenović, 2017). reports on sustainable development provide an overview of realized and planned sustainable activities, as well as the challenges faced by companies during the implementation of their sustainable activities. regular disclosure of data on sustainable activities through sustainable development reports shows a strategic inclination to apply the sustainable development concept. recently, trading companies have been adopting various practices based on sustainable development concept application: eliminating the use of plastic bags, reducing co2 emissions, developing internal codes of good conduct, improving employment practices (e.g., employment of persons with disabilities), etc. (lavorata, 2014). comprehensive and continuous application of sustainable development basic dimensions can have a positive impact on the business performance of a company and thus on its ability to more easily face all the challenges that hinder sustainable functioning. the benefits that trading companies can have from sustainable development concept application are numerous. firstly, in dynamic economic conditions, sustainable development concept application represents a path that can help a trading company to better position itself on the market compared to its competitors. in addition, a sustainable business contributes to higher productivity, lower business costs, improved sales quality and increased sales revenue, improved consumer and employee satisfaction, and thus creates a base of loyal consumers and an image of a desirable employer, safe product quality and reliability, availability of necessary resources, etc. lee (2021) points out that due to the positive effects, social responsibility becomes an important strategic issue for businesses. for this reason, many successful companies view sustainable development not only as a moral issue, but also as their social obligation and, accordingly, become advocates of “solid” sustainable development. research methodology achieving economic, ecological and social sustainability is one of the most pressing goals societies are facing today (brenner, hartl, 2021). in the dynamic and turbulent environment in which retail companies operate, sustainable practices are posited as an opportunity for their progress and survival (marin-garcia, 2021). in line with the importance of sustainable business, this paper’s methodology is based on both theoretical and empirical research. firstly, using the analytical and descriptive method, and based on available sources that deal with the issue of sustainable development and sustainable development concept application in trading companies, the importance of sustainable development concept in modern, very turbulent business conditions was pointed out, followed by the encouraging factors of sustainable development concept application in the trade sector, as well as the importance of sustainable operations of trading companies. in the empirical part of the research, the authors provide the results of a descriptive statistical analysis of respondents' attitudes regarding the application of various elements of economic, ecological and social dimensions of sustainable development. in conditions when environmental pollution issues are becoming more serious and social sphere demands are increasingly high, sustainable development with its basic components becomes one of the unavoidable topics in business decision-making. managers of trading companies are becoming more aware of the importance of sustainable development concepts for the realization of business goals and results. accordingly, the investigated research sample (staletović, 2022) consisted of employees in managerial positions in trading companies in the republic of serbia. therefore, the research was conducted on the territory of the republic of serbia, between october 2021, and 24 economic analysis (2023, vol. 56, no. 1, 20-31) march 2022, with a sample of 103 participants. the research included trading companies of various sizes. the data collected through the questionnaire, which, apart from general questions about gender, the position of the participants, headquarters of trading companies, type of the sales facility, etc., also contained questions about key elements of the economic, ecological and social dimension of sustainable development, where the participants evaluated the application of the aspects of sustainable development basic dimensions using a five-point likert scale. the collected data were analyzed using the statistical program spss version 23. results analysis and discussion the trading sector plays a major role in the operations of the serbian economy. it is also one of its most vital parts. however, characteristics of the modern environment had a significant impact on the functioning of trading companies in the republic of serbia. today, when explaining the sustainable development concept, attention is focused on three aspects, i.e. economic, ecological and social sustainability (sokolov mladenović, 2017). in order to have a high-quality sustainable development concept application, it is necessary for trading companies to simultaneously devote themselves to the application of mentioned sustainable development dimensions. accordingly, the management of trading companies is expected to create economic value, but also to take care of environmental protection and to take into account social community demands. the question arises whether such a situation also exists with the management of trading companies in the republic of serbia. the research conducted by lovre and brankov (2016), related to the sustainability of the retail sector until 2013, showed that the trading sector in the republic of serbia was on the path to doing sustainable business. besides, lukić (2012) also points out that the application of the sustainable development concept in trading companies in the republic of serbia is at a lower level compared to some countries with a more developed market economy, which especially applies to domestic retail companies. for example, lukić (2016) states that energy costs in serbian trade are higher than in countries with a developed market economy. the reasons for this are very low energy management efficiency, insufficient use of modern energyefficient technology and equipment, unsatisfactory improvement of energy efficiency in existing and slowed construction of new energy-efficient office buildings and retail facilities, as well as a slight use of renewable energy sources (lukić, 2016). the results of the conducted research (staletović, 2022), obtained using the method of a direct survey of employees in managerial positions in trading companies in the territory of the republic of serbia, showed that managers believe that their trading companies are committed to implementing economic, ecological and social dimensions of sustainable development, which confirms the hypothesis set in this research. descriptive analysis results regarding the basic dimensions of sustainable development are presented below, for each dimension separately (table 2, 3, 4). primarily, it should be noted that the average value of the years of work of managers in their current position is around 9 years, which indicates that these are managers who are well acquainted with the operations of their companies and, accordingly, with the application of sustainable development concept thereof (staletović, 2022). consequently, they were able to assess with a greater degree of reliability the application of sustainable development basic dimensions in their companies. maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 25 table 1. descriptive statistics for years of work of the manager in the current position minimum maximum arithmetic mean standard deviation how many years have you been working in your current position? 1.00 35.00 9.01 7.20 source: staletović (2022) silvestre and tirca (2019) point out that one gets the impression that the change toward a more sustainable world is frustratingly slow and that organizations need to promote investment in the implementation of innovative approaches aimed at solving current and urgent sustainable challenges. sustainable development refers to the need to simultaneously alleviate poverty/improve standards of living and maintain or enhance vital natural capital necessary for future well-being (polasky et al., 2019). the economic dimension of sustainable development is based on the efficient use of available resources and productivity growth, which would represent an important source of competitive advantage, but all the while taking into account that negative environmental issues are minimized (ostojić, 2020). adequate application of the economic dimension of sustainable development implies that trading companies take into account rational use of available, especially scarce resources, encourage investments in less harmful technologies, improve employment, invest in sustainable training of their employees, in sustainable brands, etc. essentially, by implementing the economic dimension of sustainable development, trading companies should encourage investments in new types of development that would encourage the implementation of sustainable economic activities. the descriptive analysis presented in table 2 shows the assessment of the application of certain elements of sustainable development’s economic dimension. for example, the data show that within the economic dimension of sustainable development, managers have best assessed that the increase of energy efficiency can be productive for the company and that extending direct sales to online sales and monitoring market demands in terms of quality, price and quantity can all have an impact on trading company’s revenues from sale. on the other hand, it has been poorly assessed that the introduction of organic products in a trading company would contribute to the growth of sales revenue, that social responsibility performance affects the company’s financial performance, and that the introduction of ecological innovations can have a positive impact on the increase in sales revenue. however, regardless, the analysis shows that the application of sustainable development economic dimension elements in these companies is still assessed as good, which means that the managers of trading companies assess the application of certain sustainable development economic dimension elements as good or very good (the agreement ranged from 1 to 5, and the arithmetic mean is mostly between 3 and 4). 26 economic analysis (2023, vol. 56, no. 1, 20-31) table 2. descriptive statistics for basic elements of sustainable development economic dimension economic dimension of sustainable development minimum maximum am sd to what extent are the resources available to your trading company used rationally, i.e., in accordance with the rules required by sustainable development concept application 2.00 5.00 3.58 0.90 to what extent do you think a more efficient use of resources would affect the economic performance of your trading company 1.00 5.00 3.61 0.88 to what extent does social responsibility performance affect the financial performance of your trading company 1.00 5.00 3.14 1.00 to what extent is the awareness about the importance of sustainable cost management for achieving sustainable efficiency developed in your trading company 2.00 5.00 3.37 1.00 to what extent is your trading company committed to continuous investment in new jobs 1.00 5.00 3.46 1.13 to what extent would various professional trainings of your employees on sustainable development importance contribute to the growth of your income from the sale of goods 1.00 5.00 3.50 0.98 to what extent do you believe that encouraging your suppliers to behave in accordance with the sustainable development concept would positively affect the economic performance of your trading company 2.00 5.00 3.41 0.81 to what extent would the introduction of adequately marked, high-quality and at the same time affordable private labels in the offer of your trading company contribute to the growth of your sales revenue? 1.00 5.00 3.62 0.93 to what extent is your trading company committed to creating sustainable value for consumers 2.00 5.00 3.62 0.99 to what extent would the use and introduction of organic products in your trading company contribute to the growth of your sales revenue 1.00 5.00 2.94 1.07 to what extent does the need to keep up with market demand for quality, price, and quantity of merchandise affect your sales revenue? 1.00 5.00 3.65 1.03 to what extent can the introduction of eco-innovations in the business practices of your trading company contribute to the growth of your sales revenue 1.00 5.00 3.27 1.00 to what extent can expanding direct sales to online sales affect your sales revenue 1.00 5.00 3.74 1.20 to what extent do you believe the costs of solving environmental issues affect the selling price of your goods 1.00 5.00 3.28 1.02 to what extent can the increase in energy efficiency improve the profitability of your trading company 2.00 5.00 3.98 1.01 am – arithmetic mean sd – standard deviation source: staletović (2022) bojat and rebić (2019) point out that sustainable development should provide long-term economic benefits and reduce the negative effects of business activities on the environment. our planet’s ecosystem is very sensitive, as even small disturbances, such as global temperature changes in larger temporal and spatial scales cause unpredictable effects (nadoveza, pešić, 2020). due to strong pressure from society and stakeholders to reduce negative impacts on the maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 27 environment, companies are forced to focus on nature conservation and ecology (stojanović, 2021). damnjanović et al. (2020) state that large corporations in developed countries must consider the ecological component of sustainable development during every significant project due to extremely precise environmental legislation that very harshly sanctions non-ecological technological processes, used materials and environmentally harmful products. the data presented in table 3 show that the application of certain ecological dimension elements of sustainable development is assessed as good or very good (the arithmetic mean is also between 3 and 4). the exception is one element, i.e. the worst assessment is present regarding the knowledge of the terms "green sales facilities", "green product range", "green price", "green transport", "green technology". on the other hand, it is best assessed that the increase in the trading company’s participation in environmental actions would have an impact on improving the image of the company. in addition, there is a good assessment, for example, regarding the extent to which trading companies have reduced the use of plastic bags, etc. table 3. descriptive statistics for basic elements of sustainable development ecological dimension ecological dimension of sustainable development minimum maximum am sd to what extent do you take into account the requirements of the ecological dimension of sustainable development when making business decisions 1.00 5.00 3.21 1.11 to what extent would increasing the participation of your trading company in environmental actions organized at the local or wider social community level contribute to strengthening the image and reputation of your company 1.00 5.00 3.61 0.95 to what extent are employees in your company informed about the importance of environmental protection 1.00 5.00 3.41 0.99 to what extent are your sales facilities, processes and technologies following environmental sustainability requirements 2.00 5.00 3.27 0.82 to what extent does your trading company respect ecological principles of sustainability when using means of transport 1.00 5.00 3.12 1.04 to what extent would investing in functional and economical equipment which is compliant with ecological standards for storing and displaying goods contribute to the progress of your company 1.00 5.00 3.56 0.86 to what extent would the application and promotion of recycled material in order to preserve nature be productive for your trading company 1.00 5.00 3.52 1.00 to what extent is your trading company committed to designing a more sustainable way of using water throughout the supply chain 1.00 5.00 3.21 1.06 to what extent could adequate solutions for more responsible waste management be developed in your trading company 1.00 5.00 3.47 0.90 to what extent has the use of plastic bags been reduced in your trading company 1.00 5.00 3.58 1.17 to what extent does your trading company pay attention to energy efficiency 1.00 5.00 3.49 1.16 to what extent would the introduction of eco-label into your trading company’s business practices indicate compliance with high environmental protection standards 1.00 5.00 3.35 1.12 28 economic analysis (2023, vol. 56, no. 1, 20-31) ecological dimension of sustainable development minimum maximum am sd to what extent are your suppliers familiar with the importance and need to respect environmental requirements in their business 1.00 5.00 3.02 0.97 to what extent could your trading company work on developing an environmental protection policy with the aim of monitoring, measuring, reducing and preventing the release of pollutants into the environment? 1.00 5.00 3.00 1.16 to what extent are you familiar with the terms "green sales facilities", "green product range", "green price", "green transport", "green technology" 1.00 5.00 2.87 1.16 am – arithmetic mean; sd – standard deviation source: staletović (2022) in addition to the economic and environmental aspects, trading companies must not neglect the importance of the social dimension of sustainable development. pavlović and denčić-mihajlov (2020) state that the concept of a sustainable business causes companies to direct their resources more than ever toward solving important social issues. in accordance with the requirements of this sustainable development dimension, trading companies should be as fair as possible in respecting the needs of all social community members. in order to achieve this, it is necessary for them to include in their operations all basic elements incorporated in the social dimension of sustainable development. the research results shown in table 4 indicate that the best assessed is that trading companies can increase responsible behavior towards their employees in terms of ensuring occupational safety and fairer awarding of employees, as well as that there is an opportunity to work on promoting gender equality. on the other hand, the worst assessment is regarding the degree to which a company is dedicated to providing support to the social community through various activities. however, in this case, likewise, the application of mentioned elements within the social dimension of sustainable development is assessed as good. table 4. descriptive statistics for basic elements of sustainable development social dimension social dimension of sustainable development minimum maximum am sd to what extent could your trading company increase responsible behavior towards its employees in terms of ensuring occupational safety, security and health 1.00 5.00 3.88 1.08 to what extent could your trading company work to respect and promote gender equality? 1.00 5.00 3.72 1.10 to what extent is your business committed to employing people with disabilities 1.00 5.00 2.85 1.17 to what extent is your trading company committed to the professional development and training of its staff 1.00 5.00 3.21 1.12 to what extent could your trading company take care of the system of fair awarding of its employees 1.00 5.00 4.05 1.00 to what extent are the activities organized in your trading company aimed at informing employees about the importance of responsible behavior towards customers 1.00 5.00 3.29 1.14 to what extent could your trading company be more committed to complying with high standards of quality and safety of goods for human health 1.00 5.00 3.61 1.09 to what extent does your trading company support the implementation of projects aimed at involving customers in socially responsible actions 1.00 5.00 4.03 0.99 to what extent does your trading company take care of the safety and security of the storage space 2.00 5.00 4.02 0.97 maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 29 social dimension of sustainable development minimum maximum am sd to what extent is your trading company ensuring that the goods it sells are accessible to the average consumer 1.00 5.00 2.95 0.98 to what extent is your trading company familiar with the terms "fair trade" and "fairtrade goods" 1.00 5.00 3.26 1.31 to what extent does your trading company support its suppliers with the aim of creating a sustainable supply chain 1.00 5.00 3.19 1.13 to what extent does your trading company work to raise citizens' awareness of a healthier lifestyle 1.00 5.00 3.19 0.98 to what extent do you think that the implementation of charitable projects by your trading company would have a positive effect on the trust of consumers and society 1.00 5.00 3.72 1.01 to what extent is your trading company committed to providing support to the local community through various socially responsible activities 1.00 5.00 2.10 1.20 am – arithmetic mean sd – standard deviation source: staletović (2022) dynamic economy, together with social equality and sustainable use of resources, create the foundations of sustainable development (jusufranić et al., 2019). with changing social norms and consumer attitudes, the need for businesses to consider and incorporate sustainability into their core strategies has never been more important (vadakkepatt, 2021). essentially, the analysis of the presented data shows that the application of economic, ecological and social dimensions elements of sustainable development in trading companies in the republic of serbia is assessed as good. it should be kept in mind that the future economy and our future in general largely depend on what we will do and how (mihajlović et al., 2020). accordingly, company managers have the task of making other employees aware of the importance of the sustainable development concept, its essence and the need to establish a balance between economic, ecological and social components of development (staletović et al., 2021). only through such joint effort that quality implementation of sustainable development can be achieved. conclusion the need for sustainable development concept application in trading companies especially gains importance with the emergence of a dynamic environment. in such conditions, simultaneous and equal application of economic, ecological and social dimensions of sustainable development is emphasized. it can be said that the managers of trading companies operating in the territory of the republic of serbia have become aware of the importance of sustainable development concept application in their business. the analysis of obtained results related to the attitudes of managers regarding the application of basic dimensions of sustainable development showed that trading companies respect certain elements of economic, ecological and social dimensions of sustainable development. however, it can also be concluded that some further improvements are still necessary in this regard. the contribution of research results can be viewed from a theoretical and empirical standpoint. the significance of the theoretical part of the research is reflected in the fact that the importance of sustainable development concept application in trading companies has been pointed out. the significance can also be seen in the fact that the factors that encouraged sustainable development concept application in trading companies were highlighted, as well as the benefits that trading companies can have from such application. the contribution of the empirical part of the research is reflected in providing a more detailed insight into the situation regarding the application of various elements of economic, ecological and social dimensions of sustainable development in 30 economic analysis (2023, vol. 56, no. 1, 20-31) trading companies in the republic of serbia. the research limitation is mirrored primarily in the inadequate number of papers dealing with the sustainable development issues in trading companies in the republic of serbia, making it harder to compare findings with similar scientific studies. the reason for this is precisely the existence of a small number of scientific studies that deal with applying fundamental dimensions of sustainable development in the trading sector of the republic of serbia. the limitation can also be reflected in the size of the sample due to insufficient interest of the participants in managerial positions for filling out the questionnaire (due to lack of time, lack of trust in the way in which data is used, then still current covid-19 virus protection measures, etc.) given that this is a very modern concept, which gains more and more significance, the recommendation for further research is to monitor the condition of application of fundamental dimensions of sustainable development in the trading sector in the future and, if possible, on a larger sample. literature bojat, m. rebić, m. 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(2019). discussion on environmental protection and company economic development. in iop conference series: earth and environmental science, 242(5), 1-6. article history: received: 20.12.2022. revised: 5.2.2023. accepted: 16.3.2023. microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp1‐22 original scientific paper business sector innovation and economic growth: a comparative analysis between eu countries cláudia caseiro1 | marta simões1* 1 ceber and faculty of economics, university of coimbra, portugal abstract this paper examines the relationship between innovation carried out by the business sector and economic growth in the 28 member states of the european union, divided into two groups (1 and 2) according to their innovation performance. we use fixed effects panel data methods to test the hypothesis that business sector innovation plays a relevant role in explaining the behaviour of real gdp per capita, estimating two growth regressions according to data availability (1990‐2015 and 2008‐2015; unrestricted/restricted sample). the results indicate that the role of business sector innovation in economic growth not only varies according to the sample of countries and the period under analysis but also the proxy for innovation used. in group 1 (above average innovation performance) the innovation indicators statistically significant in explaining growth also present a positive sign (with a few exceptions). in group 2 (below average innovation performance) on the other hand, the statistically significant business sector innovation indicators present a negative sign. one possible justification for these signs are differences in absorptive capacity so that the growth benefits of innovation activities depend on aspects such as human capital availability, accumulated knowledge, technological and financial support. since group 1 includes countries with higher absorptive capacity, business sector innovation is effectively translated into faster economic growth. in group 2, innovation activities do not translate into productivity increases due to a lack of absorptive capacity. additionally, resources used in innovation activities might compete with other activities more relevant in terms of the stage of the growth process these countries are in so that innovation saps growth key words: business sector innovation, economic growth, eu 28, fixed effects jel classification: c23, o30, o47, o52 introduction there seems to be a consensus in the literature that innovation drives economic growth, supported both by the neoclassical theory of exogenous growth, but especially by endogenous growth models, pointing to technological progress and thus innovation as drivers of economic growth, albeit from different perspectives ((solow, 1956); (lucas, 1988); (romer, 1990); (jones, 1995); (jones, 2005)). at the firm level, several studies examine the relationship between innovation carried out by firms with the respective productivity levels and growth ((oecd, 2009); (mohnen and hall, 2013)). eurostat data show that the intensity of r&d expenditures in the 28 eu member states (eu) increased between 2005 and 2014, with expenditure carried out by the business sector increasing from 1.10 % of gdp in 2005 to 1.30% in 2014. innovation * corresponding author, e‐mail: mcsimoes@fe.uc.pt 2 economic analysis (2019, vol. 52, no. 1, 1‐22) through r&d and investments in technology are considered essential to ensure competitiveness and increase productivity and in this way, sustain economic growth (pece, 2015). innovation is however difficult to measure since it encompasses technological aspects, such as new or significantly improved products/ services, but also includes non‐technological aspects, such as new organisational models, new marketing strategies, or new processes (mohnen and hall, 2013). the aim of this paper is to relate the different aspects of innovation by firms (technological and non‐technological) to a country's long‐term macroeconomic performance (economic growth), grouping the different countries under analysis according to different characteristics/indicators of their business sector innovation activity. in particular, we aim at better understanding the relationship between inputs and outputs of business innovation and the behaviour of output in different groups of countries. following the identification of country groups based on the performance of indicators of inputs and outputs of innovation activities relative to the eu28 average, we estimate two empirical models that correspond to growth regressions where the different innovation indicators are the main explanatory variables taken alongside other relevant growth determinants. depending on data availability, the period under analysis is 1990‐2015 or 2008‐2015, for unrestricted and restricted country samples. the remainder of the paper is organized as follows: after the introduction, the second section contains a brief review of the literature on the relationship between innovation and growth. in the third section, we analyse the average performance of firms’ innovation activity in terms of inputs and outputs, grouping the countries under analysis according to their position relative to the eu28 average. the next section contains the methodology and results. in the final section, we present the main conclusions. innovation and growth: theory and evidence in the 1930s, joseph schumpeter highlighted that economic growth is caused by innovation, in particular, creative destruction, with business innovation fundamental for this change. (solow, 1956) also stresses that technological progress is the driver of growth, but does not provide an explanation how the decisions by economic agents in terms of input allocation between final goods production and innovation activities can influence the pace of economic growth. in the mid‐1980s, endogenous growth theories assign knowledge a fundamental role in the explanation of technological progress. first‐generation endogenous growth models consider innovation as an unintentional by‐product of inputs accumulation, for instance through from learning by doing or learning by studying ((romer, 1986); (lucas, 1988)). second‐generation endogenous growth models, pose that decisions by firms concerning r&d activities increase the respective productivity levels and also generate positive externalities in terms of productivity improvements in other firms, and, consequently, faster growth ((romer, 1990); (jones, 1995)). there thus seems to be a consensus in the literature that technological progress and innovation are at the basis of economic growth, with many empirical studies presenting evidence on this link. for instance, (ulku, 2004), using panel data to study the relationship between economic growth, r&d expenditures and innovation in 20 oecd member states and 10 non‐member countries, concludes that innovations (measured by patents) have a positive growth impact, although only developed oecd countries seem to be able to increase the level of innovation through r&d expenditures. (pradhan et al., 2016) studied 18 eurozone countries over the period 1961‐2013, using time series data. the dependent variable considered was the growth rate of real gdp per capita and the independent variables correspond to five indicators of innovation (number of patents per resident per thousand inhabitants, number of patents per non‐residents per thousand inhabitants, number of patents per resident and non‐resident per thousand inhabitants, real r&d expenditures as a percentage of real gdp and researchers involved in r&d activities per million inhabitants) and eight indicators of financial development. the authors conclude that financial development and innovation are important in determining cláudia caseiro, marta simões 3 economic growth and that long‐term growth depends on countries' ability to innovate in order to remain competitive, which requires adequate (financial) resources devoted to r&d activities. in a recent study, (maradana et al., 2017) examined 19 eu member states and concluded that there is a long‐run equilibrium relationship between the innovation indicators used (resident patents, non‐resident patents, r&d expenditures, r&d researchers, high‐tech exports, and scientific and technical journal articles) and growth. however, despite the consensus on the importance of innovation for economic growth, many authors recognise that it is difficult to measure this concept, which hampers the results from empirical studies. measuring innovation in a precise and rigorous way is critical to correctly assess its effect on growth (hasan and tucci, 2010). often business innovation is not included in the analysis due to data availability and accessibility (microdata) issues (oecd, 2009). in addition, there is no unique and perfect measure of innovation. according to (hong et al., 2012), in practice, companies innovate in different ways: investing in r&d, actively patenting, cooperating with external partners, acquiring technology externally via licensing, through design, marketing and staff training. it is, therefore, crucial to choose the adequate innovation proxies, although previous studies do not all point in the same direction concerning this choice. several authors consider r&d expenditures as a proxy for innovation, e.g. (goel and ram, 1994) and, more recently, (freimane and bāliņa, 2016). but, according to (wang, 2013), since (schmookler, 1966) demonstrated the adequateness of patent data as an indicator of innovation, these have often been the preferred proxy for innovation. similar to other authors, (wang, 2013) considers that r&d expenditures are only inputs to innovation activities and do not measure innovation results/outputs. the literature also distinguishes between two types of measurement of innovation: indirect and direct (hong, oxley and mccann, 2012). according to the authors, r&d expenditures are indirect measures since they only measure inputs to innovation activities, while patents focus on the successful commercial application of innovations. however, (hong, oxley and mccann, 2012) consider that for econometric analysis the best option is to use direct measures, which may be objective (when it comes to the number of innovations or "count of innovations") or subjective. the oecd oslo manual (oecd, 2005) identifies the existence of four different types of innovation: product, process, marketing and organisational. product innovation refers to the "introduction of new or significantly improved goods or services concerning its intended characteristics or uses" ((oecd, 2005), p.57). process innovation refers to the "implementation of a new or significantly improved production or distribution method" ((oecd, 2005), p.58). marketing innovation refers to "implementing a new marketing method with significant changes in product design or packaging, product positioning, promotion or pricing" ((oecd, 2005), p.59). finally, organisational innovation concerns the "implementation of a new organisational method in the company's business practices, in the organisation of its workplace or in its external relations" ((oecd, 2005), p.61). at the firm level, several studies show a positive relationship between productivity and different types of innovation (moreno and surinach, 2014). based on the former oecd classification, (hall, 2011) concluded that there are significant impacts of product innovation on productivity, but, on the other hand, the impact of process innovations is more ambiguous and may even be negative. (tavassoli and karlsson, 2015) analysed the persistence of the innovation behaviour by firms and, similar to (hall, 2011), concluded that the degree of persistence is not the same for all types of innovations, being greater for product innovations: product, process, and organizational innovations have a "true" dependency, that is, the decision to innovate in the next period is influenced by the success of the innovation of the previous period, while marketing innovations have a "false" dependency because the persistence effect does not remain in marketing innovations. (mohnen and hall, 2013) updated the previous research analysing the existing evidence on the effects of technological and non‐technological innovations on the productivity of firms and the existence of potential complementarities between the different 4 economic analysis (2019, vol. 52, no. 1, 1‐22) types of innovation. the authors concluded that all types of innovations contribute to improved productivity performance. (moreno and surinach, 2014) also sought to empirically analyse the relationship between the business sector innovation and productivity growth in 25 eu member states, as well as in iceland, norway and turkey for the period 1998‐2000 and 2002‐2004, concluding that innovation has a positive impact on productivity growth, but this impact is more important in the case of process innovations than output innovations, which can be justified on the basis that by introducing a new production process firms become more efficient, reducing costs and, thus, increasing productivity. to sum up, it is consensual in the literature that innovation boosts economic growth and, from a business sector perspective, the introduction of innovations by firms, whether a product, process, organisational or marketing innovations, leads to an increase in the respective productivity, which should also lead to faster economic growth. the present studies contribute to the existing literature by carrying out a comprehensive analysis of the relationship between firms’ innovation activity and economic growth taking into account a wide array of indicators (technological and non‐technological) to measure business sector innovation (inputs and outputs). business sector innovation in the eu28: a comparative analysis in this section we differentiate the 28 eu member states in terms of the innovation activity carried out by the respective business sector (firms), grouping countries into different sets according to their average performance in terms of inputs and outputs, i.e. differences between innovation efforts/investments and the results of innovation activity for the countries under analysis, relative to the eu28 average. the business sector innovation indicators related to inputs considered in this study are r&d expenditures, innovation expenditures in the business sector, percentage of firms that promote the training of their employees, total staff in r&d activities and researchers in r&d activities. outputs are represented by the following indicators: number of patent applications by the business sector to the european patent office (epo), number of patents granted by the uspto to the business sector, number of registrations of trademark applications, percentage of small and medium enterprises (smes) that introduce product or process innovations, percentage of smes that introduce marketing or organizational innovations, percentage of smes that innovate internally, and percentage of innovative smes that cooperate with others. table a.1 in the appendix summarises the indicators used, as well containing a detailed description and classification of each indicator according to the european innovation scoreboard (eis) 2017. the countries under analysis were grouped based on their average performance in terms of inputs and outputs of business sector innovation relative to the eu28 average for the period 2008‐2015. we started by computing, for each country, the average indicator for the period 2008‐2015. next, we computed the ratios of each of these indicators relative to the eu28 average (eu28=100). finally, in order to analyse the overall performance in terms of either inputs or outputs, we computed the average of the ratios for each of these two categories, based on the relative performance of each indicator. four different groups were identified. the first group of countries (group 1) is made up of countries with average performances above that of the eu28 in terms of both inputs and outputs of business sector innovation. this group comprises ten countries: austria, belgium, denmark, finland, france, germany, ireland, luxembourg, the netherlands and sweden. in the eis classification for 2015, these countries are classified as innovation leaders (sweden, netherlands, luxembourg, finland, denmark, and germany) and strong innovators (ireland, france, belgium, and austria). figure 1 contains information on the relative performance of these member states in terms of inputs and outputs for the period 2008 to 2015 relative to the eu28 average. according to figure 1, all these member states have higher performances in inputs and outputs compared to cláudia caseiro, marta simões 5 the eu28 average, with finland, sweden, denmark, austria, germany and luxembourg recording the highest ratios. however, this aggregate information masks different performances in terms of the various indicators used to measure inputs and outputs. only germany and sweden perform above the eu28 in all indicators. the remaining member states have lower performances than the eu in some indicators. for instance, austria, belgium, denmark, finland, france, ireland, luxembourg and the netherlands show levels of expenditure on innovation by the business sector (excluding r&d) below the eu28 average. on the output side, austria, denmark and luxembourg have performances above the eu28 average in all indicators, especially for registration of trademark applications in luxembourg, an outlier. belgium, finland and france record lower than average trademark registrations applications, while in ireland epo performance is lower than average, as well as the trademark registrations applications1. figure 1. group 1: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. 1 the data for these more detailed indicators are available from the authors. 6 economic analysis (2019, vol. 52, no. 1, 1‐22) figure 2. group 2: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. the second group of countries (group 2) includes member states which, on average, perform worse than the eu28 in terms of both inputs and outputs of business sector innovation. this group includes fifteen countries: bulgaria, croatia, czech republic, estonia, greece, hungary, italy, latvia, lithuania, malta, poland, portugal, romania, slovakia and spain. in the eis typology for 2015, these member states are classified as modest innovators (romania and bulgaria), moderate innovators (croatia, czech republic, greece, hungary, italy, lithuania, latvia, malta, portugal, poland, slovakia and spain) and, in the case of estonia, a strong innovator. figure 2 contains information on the inputs and outputs of this group 2 for the period 2008‐2015 relative to the eu28 average. according to figure 2, overall these countries have a performance in terms of inputs and outputs of business sector innovation below the eu28 average, although romania, bulgaria and latvia stand out with levels of inputs and outputs which are more distant from the eu28 average than the other member states in this group. on the other hand, the czech republic, estonia and malta record levels close to the eu28 average. within this group, there are also substantial differences in the performance of certain indicators. for instance, the czech republic performs above the eu28 average in terms of r&d activities personnel; croatia, slovakia, estonia, greece, latvia, lithuania, malta, poland and the czech republic record higher than average expenditure on innovation in the business sector; and in croatia, slovakia, malta, portugal and the czech republic the percentage of companies promoting employee training is also above average. for output indicators: trademark applications are above the eu28 average in malta; the same applies to product and/or process cláudia caseiro, marta simões 7 innovations and the percentage of smes innovating internally in estonia, greece, italy, portugal and the czech republic and in marketing and/or organizational innovations in greece, italy, portugal and the czech republic2. figure 3. group 3: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. figure 4. group 4: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. the third group (group 3) is characterised by higher than average inputs and at the same time lower than average outputs. this group consists only of slovenia, classified by the eis in 2015 as a strong innovator and its innovative activity is very close to the eu average. according to figure 3, the performance is higher than average for inputs (in three out of the five indicators and very close for the others), but below average for outputs. slovenia performs well in most input indicators but records patent levels and registrations of brand applications well below the eu28 average. finally, the fourth group (group 4) includes countries with inputs below the eu28 average and outputs higher than the eu28 average. two countries, cyprus and the united kingdom, are included in this group. according to the eis in 2015, cyprus is classified as a moderate innovator and the uk as a strong innovator. in figure 4, it is possible to see that in cyprus the performance for inputs is lower than average, while outputs are slightly above the eu28 average. cyprus records high innovation expenditures and percentage of firms that promote the training of officials and above the eu28 average, but low levels of patents (applications and concessions). in the united kingdom inputs are close to the eu28 average, although slightly below, but the uk records a higher than average performance in three out of the five indicators. outputs are below‐average due essentially to trademark applications, the introduction of the product and/or process innovations, and the percentage of smes innovating internally (three out of seven indicators). in the econometric analysis, since slovenia has a large number of output indicators (four in seven) which are close to the eu28 average, this country will be included in group 1. the united 2 the data for these more detailed indicators are available from the authors. 8 economic analysis (2019, vol. 52, no. 1, 1‐22) kingdom will also be considered in group 1 as inputs are close to the eu28 average, while cyprus will be included in group 2 since it performs poorly in inputs. these changes also make the groups more in line with the eis classification. empirical models, methodology and results in this section, we present the two empirical models estimated, the methodology used and the main results obtained for the total sample as well as for the two groups defined in the previous section. empirical models in order to study the relationship between business sector innovation and economic growth, we consider the global sample of 28 eu member states as well as the two country groups, 1 and 2, defined in the previous section. two periods were considered in the analysis due to data availability for some indicators of innovation activities: 1990‐2015 (model 1) and 2008‐2015 (model 2). the first empirical model (model 1) is similar to that of (moreno and surinach, 2014), corresponding to an ad hoc growth regression, with variables measured at 5‐year intervals, and is given by equation (1): , , , _ 1 1 2 (1) where: δ0 – constant; ui,t – error term.; i – countries (i = 1, 2, …, n). t – 5‐years sub periods (t = 5); t‐1 – initial year of each sub period. the dependent variable in the first model, equation (1), is the annual growth rate of real gdp per capita in ppps (purchasing power parity) (δlngdprpc) for 5‐years sub‐periods. the data for this variable are from the penn world table 9.0 (feenstra et al., 2015) and the world bank3. the main explanatory variable of the model is inov1 (proxy for the business sector innovation activity), and the proxies used, alternatively, are six indicators of business innovation (see table a.1 in the appendix) that constitute measures of both inputs and outputs, selected based on their importance in explaining the relationship between business sector innovation and growth, as reported in previous literature ((hasan and tucci, 2010); (hong, oxley and mccann, 2012); (wang, 2013)). we expect a positive sign for all the estimated coefficients, in line with the endogenous growth predictions of (romer, 1990) and (jones, 1995) and the results of studies such as (freimane and bāliņa, 2016), (hasan and tucci, 2010) and (wang, 2013). the control variables included were selected from the theoretical and empirical growth literature (e.g. (romer, 1986); (barro and sala‐i‐martin, 2004); (hasan and tucci, 2010)). initial real gdp per capita (lngdprpc) is expected to deliver a negative estimated coefficient based on the convergence predictions of (solow, 1956) and technology diffusion growth models (weil, 2013) with poorer countries recording higher real gdp per capita growth rates. a positive relationship is expected between investment in physical capital (gcf) and economic growth based on (solow, 1956) and also between investment in human capital (hc) and growth as this allows for higher production of new ideas/projects and the accumulation of knowledge, leading to higher productivity and (romer, 1990)). government consumption (gov_cons) is expected to present a negative sign, assuming that these are non‐productive expenditures: (mitchel, 2005) 3 the data up to 2014 is from pwt 9.0 (feenstra, inklaar and timmer, 2015), the values for 2015 were calculated based on per capita real gdp growth from the world bank. cláudia caseiro, marta simões 9 argues that each monetary unit that the government spends means less money in the productive sector of the economy, which reduces the rate of output growth. the expected relationship between globalisation (glob) and growth is ambiguous. according to (samimi and jenatabadi, 2014), globalisation allows countries to allocate resources more efficiently, as well as benefit from economies of scale and cost reductions, which leads to higher growth. on the other hand, globalisation has negative effects on growth in countries with weaker institutions and with political instability and also in countries specializing in activities that are not effective in the process of globalization. the second empirical model (model 2) is given by equation (2): , , , _ 1 1 2 (2) where: δ0 – constant; ui,t – error term.; i – countries (i = 1, 2, …, n). t – years (2008‐2015). in model 2 the dependent and control variables are the same as those in model 1, although the proxy for human capital now corresponds to the percentage of the population aged 15 to 64 years old with upper secondary, non‐tertiary post‐secondary and higher education (tertiary) due data availability. the frequency of the data used is yearly since the innovation proxies related to smes (inov2) are only available for a limited number of years, from 2008 until 2015. according to the studies reviewed, a positive relationship is expected between the various business sector innovation indicators and output growth ((oecd, 2009); (hall, 2011); (mohnen and hall, 2013), (moreno and surinach, 2014)). however, different types of innovations are expected to have different quantitative impacts. the indicators of the different types of innovation used aggregate product and process innovations into a single indicator and marketing and organisational innovations in another. we thus expect that the former will have a more significant impact than the latter, but may not contribute to the explanation of economic growth due to the inclusion of process innovations, in light of the conclusions of (hall, 2011) and (moreno and surinach, 2014). marketing and organisational innovations might even have a negative impact on growth, according to (tavassoli and karlsson, 2015). in both models 1 and 2 the variables d1 and d2 correspond to time dummies, included to consider the potential impact of the financial crisis on real gdp per capita growth. in model 1, d1 assumes the value 1 for the five‐year period 2005‐2010 and 0 otherwise; and variable d2 assumes the value 1 for the last five years (2010‐2015) and 0 otherwise. in model 2, d1 assumes the value 1 for 2009, 2010, 2011 and 2012, 0 otherwise; and variable d2 assumes the value 1 for 2013, 2014 and 2015 and 0 otherwise. methodology and results the empirical models were estimated using the econometric package gretl version 2017d. as a preliminary analysis to determine the appropriate estimation method in a static panel context, we applied the usual diagnostic tests to choose between pooled ols, fixed effects or random effects: the f‐test, the breusch‐pagan test (breusch and pagan, 1980) and the hausman test (hausman, 1978). the f‐test allows one to choose between the pooled ols and the fixed‐effects methods: the null hypothesis (h0) considers homogeneity in the constant, so the pooled ols method is the most adequate, against the alternative hypothesis (h1) that there is heterogeneity in the constant, so the most appropriate method, in this case, will be fixed effects. the breusch‐ pagan test, in turn, allows to decide between the pooled ols method and the random effects method: h0 considers the homogeneity in the constant, so the most appropriate method is pooled ols; h1 admits heterogeneity between countries (not constant over time), so the random effects method is the most appropriate. finally, the hausman test allows to decide 10 economic analysis (2019, vol. 52, no. 1, 1‐22) between fixed effects and random effects: h0 considers heterogeneity across countries (not constant over time), so the random effects method is the most appropriate; h1 also considers heterogeneity across countries, but constant over time, so that the fixed effects method is the most appropriate. we performed these tests for the baseline specifications given by equations (1) and (2) and the alternative innovation indicators considering the whole sample of 28 eu member states. according to the results for f‐test, the fixed‐effects method is preferable to the pooled ols method. according to the breusch‐pagan test, the random effects is the most appropriate. finally, from the results of the hausman test, we concluded that the fixed‐effects method is preferable to the random‐effects method. overall these diagnostic tests thus indicate that the most appropriate estimation method for models 1 and 2 considering the whole sample is the fixed effects method. we also carried out the diagnostic tests for the sub‐samples, groups 1 and 2, and both empirical models. for model 1, group 1, the most appropriate method is pooled ols for all innovation indicators, except for trademark_app (fixed effects); when group 2 is considered, in model 1 the most appropriate methods are: random effects for rdepc; pooled ols for rd_staff, res_rd and patent_app; and fixed effects for patent_g and trademark_app. for model 2, the fixed effects method is the most appropriate estimation method for groups 1 and 24. main results of the estimation of model 1 table 1 presents the results of the estimation of model 1 for the whole sample using fixed effects. in each column, a different indicator of business sector innovation is considered. table a.2 in the appendix contains the results of the estimation for group 1 and table a.3 contains the results for group 2. regarding the control variables, the results obtained for the whole sample for lngdprpci,t‐1 confirm the predictions, negative and statistically significant coefficients in all columns, and thus the convergence predictions of (solow, 1956) and technology diffusion models. these results also apply to groups 1 and 2. the estimated coefficients for the investment rate also confirm predictions when the eu28 or group 2 are considered, with a positive and statistically significant sign (except column v for eu28 and vi for group 1). the estimated coefficients for human capital for the eu28 are only statistically significant in columns ii and v. in group 1 the estimated coefficients confirm the predictions, positive and statistically significant, except when trademark applications are used. for group 2, we obtain a negative (although not statistically significant) relationship between human capital and economic growth in columns i and vi. in the remaining cases, we get positive coefficients but not statistically significant. as for public consumption, some of the results are not in line with the predictions: for the eu28 the estimated coefficient is negative, but not statistically significant in columns i, ii, iii and v, it is positive but not statistically significant in column iv and negative and significant in column vi. when the sample is restricted to group 1, the results show that an increase in public consumption has a negative and statistically significant impact on the growth rate of real gdp per capita. when the sample is restricted to group 2, the results indicate that the relationship between public expenditure and growth is negative for columns i, ii, iii, iv and vi but not statistically significant. the results found for the eu28 show that the globalisation index has a positive and statistically significant impact on growth, supporting the predictions of (samimi and jenatabadi, 2014). these results continue to apply for groups 1 and 2, with a few exceptions. overall, these results indicate that our growth regression is correctly specified since the majority of the results are in line with evidence from previous empirical growth studies. regarding the time dummy d1 (2005‐2010), for the eu28 and the subsamples the majority of results show a negative (and generally statistically significant impact) on growth. as for the results with the time dummy d2 (2010‐1015), for the eu28 and group 1, in general, the 4 these results are available from the authors. cláudia caseiro, marta simões 11 estimated coefficient is not statistically significant, while for group 2 the coefficient is positive and usually statistically significant. these results indicate that the sovereign debt crisis period did not affect all the eu countries in the same way. turning now to the results for our main explanatory variables, when inputs of business sector innovation are used (r&d expenditure, total r&d staff and r&d researchers), the results obtained with the eu28 (table 1, columns i, ii and iii) indicate that these inputs do not contribute to growth over the period 1990‐2015, since the respective estimated coefficients are not statistically significant. these results remain for group 1, as can be seen from table a.2, columns i, ii and iii. the results obtained for group 2 (table a.3) are different: an increase in total r&d personnel and r&d researchers has a negative and statistically significant effect, contrary to predictions. the lack of statistical significance for group 1 could be because these inputs, in reality, do not result in successful innovations, with economic value, and thus do not lead to productivity increases and faster growth. it could also be the case that there is a time lag between r&d activities and innovations becoming effective (wang, 2013). as for group 25, these countries might be devoting r&d expenditures to the imitation of innovations from developed countries that are not adequate to their reality and thus do not permit faster growth. according to (galor, 2005), the growth process is characterized by different stages in terms of the relative importance of physical, human capital and knowledge accumulation, so countries in group 2 might be deviating scarce resources from more important activities as far as their stage in the growth process is concerned, which results in less growth. when outputs of business sector innovation are introduced as the main explanatory variable (patent applications, patents granted and trademark applications registrations), the results for the eu28 (table 1, columns iv, v and vi) show that there is a positive impact on growth, however, only trademark applications produce statistically significant effects6. for instance, patents do not contribute to the explanation of growth, contrary to the conclusions of authors like (hasan and tucci, 2010). this result can be due to a number of reasons, including that many innovations do not result in patens, in order to effectively remain secret and not be copied, so that technical details are not revealed; and also because some firms use patents to prevent other firms from placing an invention in the market (hasan and tucci, 2010); and finally, because the costs of patenting are high, becoming unfeasible for small firms (wang, 2013). these results remain for group 1, according to table a.2, columns iv, v and vi. when the sample is restricted to group 2, the results obtained, as shown in table a.3, columns iv, v and vi, are in general statistically significant (except patents granted). in the case of patent applications, the coefficient obtained is in line with the findings of (hasan and tucci, 2010): an increase in the number of patent applications produces positive and significant effects on the real gdp per capita growth rate. on the other hand, contrary to predictions, registrations of trademark applications lead to a decrease in growth. trademark application records are not associated with technology and are relevant to the services sector, according to the eis (2017). in countries such as bulgaria, croatia, hungary, poland and romania (transition countries) this indicator does not become relevant and may indicate that trademark registrations do not lead to productivity increases, as evidenced by the results of the estimation of the model leaving out the outliers cyprus and malta. 5 consisting of some of countries considered by the imf as developing countries: bulgaria, croatia, hungary, poland and romania. 6 cyprus, malta and luxembourg represent outliers in the trademark_app indicator and were therefore withdrawn from the sample to check the impact on the results: trademark applications are no longer statistically significant in any of the samples under analysis, which may indicate that if the legal framework does not protect intellectual property, this indicator is not relevant for growth. these results are available from the authors. 12 economic analysis (2019, vol. 52, no. 1, 1‐22) looking at the aic, bic and hq information criteria for the eu28 models in table 1, we can conclude that the model that best explains growth is the model that considers patent applications since the criteria present the lowest value. the same applies for groups 1 and 2 (tables a.2 and a.3, respectively)7. table 1. results of the estimation of model 1 (fixed effects), 28 eu countries, 1990‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi constant 0.7386 *** 0.8976 *** 0.8894 *** 0.948 *** 1.1756 *** 1.1877 *** lngdprpci,t‐1 −0.0932 *** −0.1167 *** −0.1169 *** −0.1249 *** −0.1456 *** −0.1297 *** gcfi,t 0.1891 *** 0.216 *** 0.2292 *** 0.2677 *** 0.0475 0.2278 *** hci,t‐1 0.0042 0.00787 * 0.00755 0.0060 0.00885 * 0.000794 gov_consi,t −0.0744 −0.0552 −0.0434 0.0091 −0.0191 −0.3460 *** globi,t 0.0019 *** 0.0023 *** 0.0024 *** 0.0025 *** 0.0027 *** 0.0018 *** rdepci,t −1.0516e‐5 ‐ ‐ ‐ ‐ ‐ rd_staffi,t‐1 ‐ −3.1771e‐6 ‐ ‐ ‐ ‐ res_rdi,t‐1 ‐ ‐ −3.4140e‐8 ‐ ‐ ‐ patent_appi,t ‐ ‐ ‐ 0.000121 ‐ ‐ patent_gi,t ‐ ‐ ‐ ‐ 0.0001073 ‐ trademark_appi,t ‐ ‐ ‐ ‐ ‐ 4.6620e‐5 *** d1 −0.00995 −0.0111 −0.0120 −0.0146 * 0.000197 −0.00953 d2 0.0143 * 0.0148 0.0135 0.0152 * ‐ 0.0231 ** lsdv r2 0.6097 0.6361 0.6369 0.6649 0.7718 0.6644 r2 dentro 0.4591 0.5561 0.5429 0.6189 0.7437 0.5465 aic (akaike) −635.3512 −623.6562 −605.0257 −648.7218 −554.6305 −536.4121 bic (schwarz) −531.8441 −519.6036 −502.0724 −542.8226 −459.4830 −439.1948 hannan‐quinn −593.2916 −581.3732 −563.1937 −605.6875 −516.0262 −496.9802 notes: column i ‐ r&d expenditures; column ii ‐ total staff in r&d activities; column iii ‐ researchers in r&d activities; column iv ‐ patent applications; column v ‐ granted patents; column vi ‐ registration of trademark applications. ***, **, * indicate statistical significance at the 1, % and 10% levels, respectively. source: own elaboration. taking the results as a whole, we can conclude these differ according to the group of countries and time period under analysis. between 1990 and 2015, in the eu28 and group 1, inputs do not contribute to the explanation of aggregate output behaviour, while only r&d personnel and r&d 7 we also estimated model 1 with data for the period 2008‐2015. the results obtained with the inputs indicators show that r&d expenditures have a relevant role in explaining an increase in the growth rate of real gdp per capita, as predicted. the results with the outputs indicators are different depending on the sample under analysis. for the eu28, registrations of trademark applications are no longer statistically significant, with patents granted explaining economic growth. the coefficients obtained with outputs in group 1 show that patent applications and trademark application have significant negative and positive impacts, respectively. the results with outputs for group 2 show that patent applications in this period fails to explain the behavior of output. these results are available from the authors. cláudia caseiro, marta simões 13 researchers play a relevant role in explaining growth (but with a negative sign) in group 2. on the other hand, restricting the period to 2008‐2015, r&d expenditures present a positive and statistically significant role. as for outputs, between 1990 and 2015 trademark applications contribute to the explanation of growth due to the outliers cyprus, luxembourg and malta (and also patent applications in group 2). between 2008 and 2015, the results relative to the longer period change: for the eu28, patents granted have positive and relevant impacts on growth and brands lose their significance; for group 1, patent applications have negative and significant growth impacts; and for group 2 patent applications lose statistical significance. main results of the estimation of model 2 table 2 presents the results of the estimation of model 2 for the eu28 with fixed effects considering each indicator of business sector innovation alternatively. tables a.4 and a.5 in the appendix contain the results for groups 1 and 2, respectively. concerning the control variables, according to table 2 for the eu28 initial real gdp per capita presents a negative and statistically significant coefficient in all models (at the 1% level of significance), as expected, and the same applies for groups 1 and 2 (tables a.4 and a.5, respectively). the results obtained for the investment rate are also as expected: we obtain a positive relationship and statistically significant for the eu28 and group 2. the relationship between human capital and the real per capita gdp growth rate for the eu28 and both groups 1 and 2 is positive and statistically significant. the results obtained for public consumption are negative and statistically significant for the eu28 and group 2. however, when the sample is restricted to group 1, the results are not statistically significant (some exceptions apply). finally, as far as globalisation is concerned, the results are positive and statistically significant in the eu28 and group 2 as expected, but negative and not statistically significant in group 1. the time dummy d1 (2009‐2012) does not influence economic growth in the eu28 sample, so that the 2007‐08 financial crisis shows no negative growth effects. however, the latter occurs in group 1, while in group 2 (table a.5) the estimated coefficient is positive and statistically significant. the results for the time dummy d2 (2013‐15) for the eu28 (table 2) indicate that this was a post‐crisis recovery period, with a positive and in most cases, statistically significant coefficient for d2. the coefficients obtained for group 1 (table a.4) contrast with the previous ones since negative coefficients were obtained although without statistical significance. turning now to the results of the estimation of model 2 with inputs indicators (innovation expenditure and training of employees), the results obtained for the eu28 (table 2, columns iii and iv) show that only an increase in the percentage of firms that promote employee training contributes positively to growth. the results obtained for group 1 (table a.4, columns iii and iv) remain the same. when the sample is restricted to group 2, the results indicate that no input indicator contributes to the explanation of the growth rate of real gdp per capita, as can be seen in table a.5, columns iii and iv. the lack of statistical significance of innovation expenditure in group 1 can be justified by the relatively small investment in innovation in the form of dedicated machinery and equipment (within this group only germany and sweden have a ratio in this indicator that is higher than the eu average), which is not enough to spark innovation that promotes productivity improvements. for group 2, the lack of significance of innovation expenditure can be justified by the lack of absorptive capacity. this group includes transition countries with a low level of technological and scientific development, and thus, investments in innovation (equipment and machinery) do not translate into successful innovations. additionally, the lack of statistical significance for the percentage of firms that promote training to develop/upgrade the ict skills of employees for group 2 can be justified by the fact that this type of innovation input is more relevant in more advanced economies, according to the eis methodology report 2017, so it does not translate into productivity gains in this second group. 14 economic analysis (2019, vol. 52, no. 1, 1‐22) as for the results with indicators of outputs of business sector innovation (product/ process innovations, marketing/ organizational innovations, smes that innovate internally and smes that cooperate with others), the results reveal that for the eu28 all these indicators present negative coefficients, but only statistically significant for marketing and/or organizational innovations. the results for group 1 are not statistically significant. for group 2 (table a.5, columns v, vi, vii and viii), the results show that outputs have statistically significant negative effects on growth (except the percentage of smes that cooperate with others, without statistical significance). the lack of statistical significance of the outputs indicators for group 1, according to the eis methodology report of 2017 lies on the fact that adoption of product and process innovations is especially relevant to the manufacturing industry and since the present study studies business sector innovation (which encompasses all business sectors, not only manufacturing), it is not enough to explain growth in this group of countries, especially because this is not the most important sector of activity in advanced countries. another possible explanation, this time for the lack of significance of marketing/organisational innovations is that the adoption of new organisational methods requires a period of adaptation that often does not translate into success, because in many firms there is "resistance to change". third, the lack of significance of cooperation activities related to innovation among group 1 firms could be explained by the fact that this type of activity has not enough relevance in the overall activities of the firms. on the other hand, a possible justification for the lack of relevance of cooperation activities between group 2 firms may be due to the fact that many cooperation agreements require complex innovation levels, which in the case of countries such as bulgaria, croatia, hungary, poland and romania may not be successful as these countries lack human capital/more skilled workers. the negative impact of output indicators (product/ process innovations, marketing/ organizational innovations and smes that innovate internally) for group 2 may indicate that the resources devoted to innovation activities, such as skilled workers, may be necessary for other more fundamental activities in terms of the growth process of these countries, resulting in slower growth. we also considered as explanatory variables exports of medium and high‐tech products, exports of knowledge‐intensive services and sales of new‐to‐firm and new‐to‐market innovations. the results for the eu28 countries and both country groups are not statistically significant (tables 2, a.4 and a.5, columns i, ii and ix, respectively). one possible justification for this lack of significance is that exports of these types of products and services are just a small share of total exports, and the same applies to sales of innovations as a share of total sales. from the aic, bic and hq information criteria for the different models using the eu28 (table 4), we conclude that the best model corresponds to the one considering the percentage of firms that promote employees training as the innovation variable. the same is true for group 1 (table a.4). for group 2, the best model is the one using the percentage of smes that innovate internally (table a.5). taking the results as a whole, again, the role of business sector innovation for growth differs according to the group of countries and the innovation indicator considered. in most cases for the eu28 and group 1, the results with inputs show that only employee training has a relevant (and positive) role; while for group 2 inputs do not have a growth effect. in terms of outputs, for the eu28 only marketing/organisational innovations have a significant (although negative) effect; for group 1 outputs do not play a relevant role and for group 2 product/ process innovations, marketing/organisational innovations and internally innovating companies have negative and significant impacts on economic growth. cláudia caseiro, marta simões 15 table 2. results of the estimation of model 2 (fixed effects), 28 eu countries, 2008‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi vii viii ix constant 2.64*** 2.66*** 2.62*** 2.71*** 2.69*** 2.76*** 2.70*** 2.66*** 2.61*** lngdprpci.t‐1 −0.3653*** −0.3736 *** −0.369 *** −0.3839 *** −0.3737 *** −0.3868 *** −0.3753 *** −0.3714 *** −0.3711 *** gcfi.t 0.6476 *** 0.6504 *** 0.6708 *** 0.615 *** 0.6615 *** 0.7029 *** 0.6674 *** 0.6524 *** 0.6389 *** hci.t‐1 0.0094 *** 0.0097 *** 0.0095 *** 0.0096 *** 0.0097 *** 0.0102 *** 0.0099 *** 0.0097 *** 0.001 *** gov_consi.t −1.1774 *** −1.1703 *** −1.081*** −1.218*** −1.124*** −1.149*** −1.1*** −1.16*** −1.19*** globi.t 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007 *** export_hti.t −0.000518 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ export_servi.t ‐ 0.000674 ‐ ‐ ‐ ‐ ‐ ‐ ‐ inov_ei.t ‐ ‐ −0.0121 ‐ ‐ ‐ ‐ ‐ ‐ train_empi.t ‐ ‐ ‐ 0.0032 ** ‐ ‐ ‐ ‐ ‐ prodproc_inovi.t ‐ ‐ ‐ ‐ −0.000554 ‐ ‐ ‐ ‐ markorg_inovi.t ‐ ‐ ‐ ‐ ‐ −0.0011 * ‐ ‐ ‐ ino_sme.t ‐ ‐ ‐ ‐ ‐ ‐ −0.0012 ‐ ‐ coop_inovi.t ‐ ‐ ‐ ‐ ‐ ‐ ‐ −0.0002 ‐ sales_inovi.t ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.0008 d1 0.0106 0.0107 0.0085 0.0102 0.0105 0.0095 0.0095 0.0107 0.0103 d2 0.0279 * 0.0282 * 0.026 0.0267 * 0.0259 0.0251 0.024 0.0277 * 0.0284 * lsdv r2 0.6122 0.612 0.6155 0.6234 0.6127 0.6195 0.616 0.6118 0.6133 r2 within 0.5437 0.5434 0.5475 0.5568 0.5442 0.5522 0.548 0.5431 0.5449 aic (akaike) −765.103 −764.99 −766.73 −770.81 −765.33 −768.79 −766.99 −764.87 −765.64 bic (schwarz) −647.09 −646.98 −648.72 −652.80 −647.32 −650.78 −648.98 −646.85 −647.62 hannan‐quinn (hq) −717.33 −717.2 −718.95 −723.03 −717.56 −721.02 −719.21 −717.09 −717.86 notes: column i ‐ exports of medium and high‐tech products; column ii ‐ exports of knowledge‐intensive services; column iii ‐ innovation expenditures; column iv ‐ training of employees; column v ‐ product/ process innovations; column vi ‐ marketing/ organizational innovations; column vii ‐ % of smes that innovate internally; column viii –% of smes cooperating with others; column ix ‐ sales of innovations. ***, **, * indicates that the coefficients are significant at 1, 5 and 10% levels, respectively. source: own elaboration. conclusion this study investigates the relationship between business sector innovation and real gdp per capita growth in the 28 european union member states using static panel data methods for the estimation of two growth regressions, assessing how inputs and outputs of firms' innovation activities play a role in economic growth and distinguishing between two groups of countries identified according to their innovation performance (above or below) relative to the eu28 average in terms of selected business sector innovation indicators. the results obtained indicate that the role of business sector innovation in economic growth varies according to the sample of countries and the period under analysis, as well as according to the proxy used to measure business sector innovation activities. overall, the innovation indicators that play a relevant role in explaining economic growth for group 1, the group with the highest innovation performance in the eu, have a positive impact on the growth rate of real 16 economic analysis (2019, vol. 52, no. 1, 1‐22) gdp per capita, except patent applications (2008 ‐2015). on the other hand, group 2, characterized by below‐average performances in business sector innovation, mainly presents indicators that have negative growth impacts (r&d personnel, r&d researchers and trademark registrations, product/ process innovations, marketing/ organizational innovations, and smes that innovate internally between), with the exception of patent applications for the 1990‐2015 period and r & d expenditure between 2008 and 2015. one possible justification for this divergence lies in absorptive capacity, which is associated with the level of development of countries, as the success of the innovations in terms of increasing productivity and generating faster growth depends on different aspects, namely human capital availability, accumulated knowledge, adequate infrastructure, technological and financial support/development. group 1 includes the more developed member states (higher real gdp per capita) thus has in principle higher absorptive capacity, and so innovation in this group has more positive impacts, and higher business sector innovation indeed translates into faster growth. on the other hand, group 2 includes less developed/transition member, so that innovations do not translate into productivity increases because they lack the necessary absorptive capacity. the negative growth impacts obtained could also be the result of competition for scarce resources between different types of activities, with different weights in the process of growth of these countries, with business sector innovation activities using resources that would have higher growth returns in other sectors of activity. the findings also allowed us to conclude that not all inputs and outputs of business innovation are relevant to the explanation of the behaviour of output in the 28 eu member states, which again could be explained by the lack of certain types of absorptive capacity so that not all r&d activities carried out translate into successful innovations. in terms of policy implications, public policies can promote innovation through different instruments, e.g. either directly by providing funds, through human capital formation, enforcing patent protection laws, through tax benefits or indirectly through regulatory policies ((griffith, 2000); (oecd, 2007)). also, government policies can also provide incentives for firms to innovate. in light of the results obtained, the policy design should be different depending on the target group of countries. first, the results for the most recent period support policies that allow for an increase in r&d expenditures in the business sector. for group 1, the results suggest that policies that promote the acquisition of machinery and equipment for r&d activities are key to growth. for group 2, the results suggest that 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(2013). economic growth. boston: pearson/addison wesley. 18 economic analysis (2019, vol. 52, no. 1, 1‐22) appendix table a.1. variables in the empirical models: description and sources variables model description source dependent variable lngdprpci,t 1 e 2 average real gdp growth rate per capita at constant 2011 prices (usd) in ppps pwt control variables lngdprpci,t‐1 1 e 2 initial value of real gdp per capita at constant 2011 prices (usd) in ppps pwt gcfi,t 1 e 2 gross capital formation as % of gdp pwt hci,t‐1 1 e 2 average years of total schooling of the population aged 15 and over (barro and lee, 2013) gov_consi,t 1 e 2 public consumption as % of gdp pwt globi,t 1 e 2 globalization index kof investments/ inputs rdepci,t 1 r&d expenditures in the business sector per capita (euros) – source eurostat eurostat inov_ei,t 2 expenditure on innovation (excluding r&d) as % of turnover– source eis eis train_empi,t 2 firms that promote training to develop or upgrade the ict skills of employees, % of total firms– source eis eis rd_staffi,t‐1 1 total staff in r&d activities in the business sector per million inhabitants– source pordata pordata res_rdi,t‐1 1 researchers in r&d activities in the business sector per million inhabitants– source pordata pordata innovation activities/ outputs patent_appi,t 1 number of patent applications to the epo by the business sector per million inhabitants– source eurostat eurostat patent_gi,t 1 patents granted by the uspto to the business sector per million inhabitants– source eurostat eurostat trademark_appi,t 1 number of european union trademark applications (eutm) per million inhabitants– source eurostat eurostat prodproc_inovi,t 2 smes that introduce product or process innovations as % of the total number of smes– source eis eis markorg_inovi,t 2 smes that introduce marketing or organisational innovations as % of the total number of smes– source eis eis ino_smei,t 2 smes that innovate internally as % of the total number of smes– source eis eis coop_inovi,t 2 innovative smes that cooperate with others as % of total smes– source eis eis impacts export_hti,t 2 exports of medium and high‐tech products as % of total exports of products eis export_servi,t 2 exports of knowledge‐intensive services as % of total exports of services eis sales_inovi,t 2 sales of new‐to‐market and new‐to‐firm innovations as % of turnover eis temporal dummies d1 1 e 2 temporal dummy 1 (model 1: 1 for the period 2005‐2010, 0 otherwise; model 2: 1 for 2009, 2010, 2011 and 2012, 0 otherwise) ‐ d2 1 e 2 temporal dummy 2 (model 1: 1 for the period 2010‐2015, 0 otherwise; model 2: 1 for 2013, 2014 and 2015, 0 otherwise) ‐ source: own elaboration based on data from the penn world table 9.0 (pwt), barro‐lee dataset, kof, eurostat, european innovation scoreboard (eis) and pordata. cláudia caseiro, marta simões 19 table a.2. results of the estimation of model 1, eu12 (group 1), 1990‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi constant 0.1878 0.3344 0.2280 0.2510 0.5379*** 1.5891 *** lngdprpci,t‐1 −0.0280 −0.0429 * −0.0318 −0.0330 * −0.0558 *** −0.1572 *** gcfi,t 0.2180 *** 0.1989 ** 0.2118*** 0.2170 *** 0.0284 −0.1266 hci,t‐1 0.0071 ** 0.0076 ** 0.0073 * 0.0074 ** 0.0055 ** 0.0062 gov_consi,t −0.3376 ** −0.3975 *** −0.3541 ** −0.3982 *** −0.4278 *** −0.9902 *** globi,t 0.000759 0.000856 0.000730 0.0006584 0.000858 ** 0.0023 * rdepci,t −7.2578e‐6 ‐ ‐ ‐ ‐ ‐ rd_staffi,t‐1 ‐ 1.6809e‐6 ‐ ‐ ‐ ‐ res_rdi,t‐1 ‐ ‐ −1.2094e‐7 ‐ ‐ ‐ patent_appi,t ‐ ‐ ‐ 2.3588e‐5 ‐ ‐ patent_gi,t ‐ ‐ ‐ ‐ 7.2195e‐5 ‐ trademark_appi,t ‐ ‐ ‐ ‐ ‐ 9.4847e‐5 *** d1 −0.0238 ** −0.0231 ** −0.0238 ** −0.0251*** −0.00999 −0.0044 d2 0.0103 0.0122 0.0104 0.0115 ‐ 0.0406 *** r2 0.3685 0.3703 0.3620 0.3851 0.5481 ‐ adjusted r2 0.2654 0.2675 0.2534 0.2887 0.4690 ‐ lsdv r2 ‐ ‐ ‐ ‐ ‐ 0.8439 r2 within ‐ ‐ ‐ ‐ ‐ 0.8131 aic (akaike) −268.3492 −268.5145 −257.0800 −278.4762 −259.9794 −255.5067 bic (schwarz) −249.8052 −249.9705 −238.8518 −259.6271 −245.0097 −218.0827 hannan‐quinn −261.1260 −261.2912 −250.0129 −271.1033 −254.3223 −241.3641 notes: column i ‐ pooled ols for r&d expenses; column ii ‐ pooled ols for the total staff in r&d activities; column iii ‐ pooled ols for researchers in r&d activities; iv column ‐ pooled ols for patent applications; column v ‐ pooled ols for granted patents; column vi ‐ fixed effects for the registration of trademark applications. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. 20 economic analysis (2019, vol. 52, no. 1, 1‐22) table a.3. results of the estimation of model 1, eu16 (group 2), 1990‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi constant 0.7373 *** 0.766124 *** 0.7719 *** 0.8930 *** 1.2841 *** 1.0914 *** lngdprpci,t‐1 −0.0907 *** −0.0948377 *** −0.0953*** −0.1114 *** −0.1640 *** −0.1247 *** gcfi,t 0.2005 *** 0.179851 ** 0.1692 ** 0.2341 *** 0.1575 * 0.3654 *** hci,t‐1 −0.0013 0.000828091 0.000564 0.000264 0.0072 −0.0066 gov_consi,t −0.0507 −0.103619 −0.0979 −0.0774 0.1050 −0.0822 globi,t 0.0021 *** 0.00226445 *** 0.0023 *** 0.0024 *** 0.0027*** 0.0021 *** rdepci,t 1.0100e‐5 ‐ ‐ ‐ ‐ ‐ rd_staffi,t‐1 ‐ −8.6045e‐6 * ‐ ‐ ‐ ‐ res_rdi,t‐1 ‐ ‐ −1.7627e‐5 * ‐ ‐ ‐ patent_appi,t ‐ ‐ ‐ 0.000463 * ‐ ‐ patent_gi,t ‐ ‐ ‐ ‐ 0.000974 ‐ trademark_appi,t ‐ ‐ ‐ ‐ ‐ −0.000138 *** d1 −0.0078 −0.0076 −0.0053 −0.0116 0.000567 −0.0033 d2 0.0136 * 0.0151 * 0.0176 ** 0.0158 * ‐ 0.0440 *** r2 ‐ 0.5639 0.5829 0.6404 ‐ ‐ adjusted r2 ‐ 0.5111 0.5308 0.5999 ‐ ‐ lsdv r2 ‐ ‐ ‐ ‐ 0.8421 0.7133 r2 within ‐ ‐ ‐ ‐ 0.8256 0.5628 aic (akaike) −355.5393 −348.6601 −344.4415 −370.7207 −311.6848 −313.4456 bic (schwarz) −334.9252 −327.8027 −323.8274 −349.2825 −262.0305 −262.3944 hannan‐quinn −347.3242 −340.3319 −336.2264 −362.1255 −292.1235 −293.4016 notes: column i ‐ random effects for r&d expenditure; column ii ‐ pooled ols for the total staff in r&d activities; column iii ‐ pooled ols for researchers in r&d activities; iv column ‐ pooled ols for patent applications; column v ‐ fixed effects for granted patents; column vi ‐ fixed effects for the registration of trademark applications. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. cláudia caseiro, marta simões 21 table a.4. results of the estimation of model 2 with fixed effects, eu12 (group 1), 2008‐15 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi vii viii ix constant 6.3944*** 6.1876 *** 6.2550 *** 6.6236 *** 5.9766 *** 6.3595 *** 6.1626 *** 6.2453 *** 6.4380 *** lngdprpci,t‐1 −0.6641 *** −0.6421 *** −0.6468 *** −0.6782 *** −0.6270 *** −0.6540 *** −0.6371 *** −0.6451 *** −0.6698 *** gcfi,t 0.1869 0.1768 0.1598 0.1538 0.1521 0.1953 0.1735 0.1632 0.1516 hci,t‐1 0.0134 *** 0.0130 *** 0.0133 *** 0.0121 *** 0.0132 *** 0.0129 *** 0.0130*** 0.0131*** 0.0135*** gov_consi,t −0.7687 −0.8443 −0.8478 −0.8567 * −0.8805 * −0.8466 −0.8339 −0.8067 −0.7162 globi,t −0.0027 −0.0024 −0.00245 −0.0027 −0.0021 −0.0023 −0.0025 −0.0025 −0.0023 export_hti,t 0.000739 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ export_servi,t ‐ 0.000533 ‐ ‐ ‐ ‐ ‐ ‐ ‐ inov_ei,t ‐ ‐ 0.0068 ‐ ‐ ‐ ‐ ‐ ‐ train_empi,t ‐ ‐ ‐ 0.0029 *** ‐ ‐ ‐ ‐ ‐ prodproc_inovi,t ‐ ‐ ‐ ‐ 0.0013 ‐ ‐ ‐ ‐ markorg_inovi,t ‐ ‐ ‐ ‐ ‐ −0.000365 ‐ ‐ ‐ ino_smei,t ‐ ‐ ‐ ‐ ‐ ‐ 0.000327 ‐ ‐ coop_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.000559 ‐ sales_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.0016 d1 −0.0306 * −0.0291 * −0.0294 * −0.0262 * −0.0292 * −0.0287 * −0.0294 * −0.0309 * −0.0318 * d2 −0.0074 −0.0060 −0.0066 −0.0051 −0.0034 −0.0050 −0.0062 −0.0074 −0.0091 lsdv r2 0.6465 0.6457 0.6461 0.6848 0.6517 0.6465 0.6460 0.6466 0.6490 r2 within 0.6284 0.6275 0.6279 0.6686 0.6338 0.6284 0.6279 0.6285 0.6310 aic (akaike) −335.5293 −335.3313 −335.4253 −345.1485 −336.7694 −335.5249 −335.4088 −335.5508 −336.1278 bic (schwarz) −286.9129 −286.7150 −286.8090 −296.5322 −288.1531 −286.9085 −286.7925 −286.9345 −287.5115 hannan‐quinn −315.9859 −315.7879 −315.8820 −325.6051 −317.2261 −315.9815 −315.8654 −316.0074 −316.5844 notes: column i ‐ exports of medium and high‐tech products; column ii ‐ exports of knowledge‐intensive services; column iii ‐ innovation expenditures; column iv ‐ training of employees; column v ‐ product/ process innovations; column vi ‐ marketing/ organizational innovations; column vii –% of smes that innovate internally; column viii ‐ % of smes cooperating with others; column ix ‐ sales of innovations. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. 22 economic analysis (2019, vol. 52, no. 1, 1‐22) table a.5. results of the estimation of model 2 with fixed effects, eu16 (group 2), 2008‐15 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi vii viii ix constant 2.5022 *** 2.4888 *** 2.4548*** 2.5312 *** 2.6043*** 2.4820 *** 2.2812*** 2.5214 *** 2.4941 *** lngdprpci,t‐1 −0.3670 *** −0.3681 *** −0.3675 *** −0.3746 *** −0.3829** * −0.3840 *** −0.3538 *** −0.3716 *** −0.3704 *** gcfi,t 0.7714*** 0.7674 *** 0.7924 *** 0.7502 *** 0.8471 *** 0.8735*** 0.8341*** 0.7757 *** 0.7662 *** hci,t‐1 0.0088 *** 0.0089 *** 0.0089 *** 0.0087 *** 0.0094 *** 0.0109 *** 0.0103 *** 0.0088 *** 0.0090 *** gov_consi,t −1.2168 *** −1.2079 *** −1.1076 *** −1.2289 *** −0.9851 *** −1.1182 *** −0.8771 ** −1.2014 *** −1.2349 *** globi,t 0.0086*** 0.0087 *** 0.0088*** 0.0088 *** 0.0085 *** 0.0092 *** 0.0080 *** 0.0087 *** 0.0087 *** export_hti,t −0.00029 6 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ export_servi,t ‐ −0.00011 8 ‐ ‐ ‐ ‐ ‐ ‐ ‐ inov_ei,t ‐ ‐ −0.0108 ‐ ‐ ‐ ‐ ‐ ‐ train_empi,t ‐ ‐ ‐ 0.0017 ‐ ‐ ‐ ‐ ‐ prodproc_inovi, t ‐ ‐ ‐ ‐ −0.0024 ** ‐ ‐ ‐ ‐ markorg_inovi,t ‐ ‐ ‐ ‐ ‐ −0.0019 ** ‐ ‐ ‐ ino_smei,t ‐ ‐ ‐ ‐ ‐ ‐ −0.0030** ‐ ‐ coop_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ −0.00040 6 ‐ sales_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.000465 d1 0.0297** 0.0295 ** 0.0272 * 0.0292 ** 0.0316 ** 0.0256* 0.0233 0.0301 ** 0.0297 ** d2 0.0415 * 0.0408 * 0.0393 * 0.0417 * 0.0351 0.0312 0.0247 0.0416 * 0.0424* lsdv r2 0.6666 0.6665 0.6704 0.6696 0.6839 0.6845 0.6891 0.6665 0.6670 r2 within 0.5830 0.5828 0.5877 0.5867 0.6046 0.6054 0.6112 0.5829 0.5835 aic (akaike) −440.920 8 −440.866 5 −442.196 1 −441.925 8 −446.8741 −447.105 2 −448.748 6 −440.899 3 −441.063 7 bic (schwarz) −375.676 8 −375.622 5 −376.952 1 −376.681 9 −381.6301 −381.861 3 −383.504 6 −375.655 3 −375.819 8 hannan‐quinn −414.449 2 −414.395 0 −415.724 5 −415.454 3 −420.4026 −420.633 7 −422.277 0 −414.427 7 −414.592 2 notes: column i ‐ exports of medium and high‐tech products; column ii ‐ exports of knowledge‐intensive services; column iii ‐ innovation expenditures; column iv ‐ training of employees; column v ‐ product/ process innovations; column vi ‐ marketing/ organizational innovations; column vii –% of smes that innovate internally; column viii ‐ % of smes cooperating with others; column ix ‐ sales of innovations. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. article history: received: november 8, 2018 accepted: may 30, 2019 doi: 10.28934/ea.19.52.12.pp23-35 original scientific paper comparative analysis of insurance premiums in serbia and bosnia and herzegovina ‐ multiple linear regression analysis model tijana kaličanin1* | sandra kamenković1 | ivana simeunović1 1 university union, belgrade banking academy ‐ faculty of banking, insurance and finance, belgrade, serbia abstract in the last few years, the global insurance market has shown a trend of concentration growth, which was conditioned by the processes of mergers and acquisitions in insurance. the aim of this paper is to make a comparative analysis of insurance premiums in serbia and bosnia and herzegovina. dynamic analysis of market concentration indicators calculated on the basis of absolute amounts of premiums indicates that the insurance market in bosnia and herzegovina is characterized by low concentrated supply, i.e. there is greater equality of market share in relation to high inequality and high concentration among market participants in the insurance sector of the republic of serbia. having applied the multi‐linear regression model in order to analyze the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐2017, it can be concluded that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had the average net salary, households and final consumption expenditure and gross domestic income. key words: insurance premiums, insurance sector, multiple linear regression analysis model jel classification: c30, g22, l19 introduction in the last two decades, countries of central and east europe have experienced tremendous changes in the political, cultural, social and economic environment. central and east european financial system has been rapidly developing during the last couple of years, contemporary regulations have been introduced and new financial institutions have been established contributing to the maintenance of macroeconomic stability in the region. nonetheless, the macroeconomic sector in the region, underdeveloped even before the recession took place, has been a highly risky place for investments and unstable in comparison with western europe (kaličanin & hanić 2016a). the insurance market in the western balkans is characterized by significant changes caused by different economic growth pace. countries preparing to become members of the european union are carrying out faster reforms, and there is also a significant inflow of foreign capital due to a reduction of financial and political risks (novović‐burić et al. 2017). in this paper, the insurance sectors were analyzed in the republic of serbia and bosnia and herzegovina. in addition to the transition process in both countries, these countries have * corresponding author, e‐mail: tijana.kalicanin@bba.edu.rs 24 economic analysis (2019, vol. 52, no. 1, 23‐35) undergone similar political and economic changes in the past decade. both insurance markets have passed through the process of integration and internationalisation. in addition to many similarities characteristic for these two markets, there are substantial differences that are reflected in the number of residents, the number of insurance companies, the market structure, the participation of the market leader, and the number of companies with foreign capital. the market of a country is as developed as its competition is able to function on it. competition has to be constantly stimulated and protected by mechanisms in line with the european integration processes and policy focused on market economy development. competition as such has been a particularly sensitive issue in transitional countries such as serbia and countries in the region. changing the number of insurance companies on the market influenced significantly the formation of a group of leaders in the insurance market as well as strengthening the position and increasing the individual market share of the leader (kaličanin & lazić, 2018). initial structural changes raised an issue and brought about the need for a higher competitiveness in serbia. every country aspiring to join the eu and integration processes ought to develop legal norms and apply the eu regulations (kaličanin & hanić 2016a). in recent years, the insurance sector has become a significant factor in the development of the overall financial and economic system. in the first part of the paper, insurance markets and level of competitiveness were analyzed. competitiveness in the market has led to changes in the balance sheet structure of the entire financial sector as well as the position of individual insurance companies in previous years. the insurance sector is extremely important for the economy of a country, not only from the point of view of security and protection from different types of risks but also from the point of view of the overall economic development and improvements in the functioning of the financial market. in the second part of the paper, the focus is on the analysis of insurance premiums and the impact of selected macroeconomic indicators on premiums using the multi‐linear regression model. literature review there are many analyses which deal with insurance premiums and economic growth. outreville (1990), zhi (1998), beck and webb (2003), webb et al. (2002) have shown a very strong interaction between insurance premiums and gdp despite different periods and country patterns. analyses mainly suggest that higher gdp growth rates have an impact on economic activity growth, which leads to assumptions about a positive correlation between gdp growth rate and demand for insurance. haiss and sumegi presented very extensive research in 2008, which led to the conclusion that there is a correlation between insurance and gdp growth in eu‐15 countries with developed financial markets as well as short‐term linkages between gdp and non‐life premiums on a sample of cee countries. serbia and bosnia and herzegovina are selected for this research because very few authors have analyzed this region from the insurance aspect. novovic‐buric et al. (2017) explored the influence of certain factors on the purchase of insurance products through a panel analysis. western balkan countries were analyzed in the period from 2005 to 2015, and the results show that most of the economic factors affect total life premiums. the demand for life insurance has a significant and positive impact on gdp and wages, while the influence of unemployment and interest rates is negative. dragos (2014) used the fixed and random effects model in the analysis, which entailed 17 countries in asia and central eastern europe. the aim was to compare emerging markets in europe characterised by market economies and emerging markets in asia, which are predominantly planned economies in terms of the impact of economic performance on life and non‐life insurance. it has been noted that the differences certainly exist. the results concerning the cee, taking into consideration the countries which are analyzed in this research have shown tijana kaličanin, sandra kamenković, ivana simeunović 25 that income and education have a positive impact on the insurance demand, while urbanisation has shown a significant impact on non‐life insurance. on the other hand, income distribution negatively influences the demand for insurance. kjosevski (2012) analysed the determinants of life insurance demand in central and southeastern europe by using fixed‐effect panel models in the period 1998‐2010. the results show that in terms of life insurance, the most significant predictors are the following: high gdp per capita, inflation, health expenditure, level of education and the rule of law. mitra (2017) analysed the impact of economic, demographic and cultural factors on life insurance consumption in 28 eu countries. the focus was on the emerging east european economies, given that in the analysed period 2009‐2014, there were significant reforms of the insurance sector in these countries. the results show that the higher gdp is an indicator of higher wages and higher levels of economic activity, the more positive impact on insurance demand. ward and zurbruegg (2002) analysed 37 countries in the period 1987 ‐ 1998 with the intention to point to the links between insurance premiums and various legal and political factors, as well as economic and social factors. the analysis has shown that the consumption of life insurance products is under stronger influence of gdp in asia than in oecd countries, which is an expected result given that in the oecd countries there is a considerably higher average income level and that ‘s curves’ suggest that at higher levels of income the demand for insurance is less susceptible to the revenue growth. bianchi et al. (2011) analysed the insurance market in central, eastern and southeastern europe and both countries which were analyzed in this research are contained in the sample. they used panel regression (a cross section with fixed effects) to examine the impact of gdp growth on insurance premium growth. the results suggest that economic development and catching‐up processes mainly condition premium growth, and that in unstable periods, it shows increased volatility. comparative analysis of the insurance market figure 1 shows the total number of insurance companies operating in the insurance market in serbia as well as in bosnia and herzegovina in the last ten years. the largest number of insurance companies in serbia was present in the period 2011‐2013 when there were 28 companies, followed by the decline in the number of insurance companies, ranging from 25 in 2014 to 21 at the end of 2017. figure 1. number of insurance companies, 2007‐2017 with the number of insurance companies in the market in bosnia and herzegovina, fewer oscillations can be noted in the observed period, ranging from 24 to 27. the largest number of 0 10 20 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 20 24 26 26 28 28 28 25 24 23 21 25 26 26 26 25 25 25 24 24 27 27 number of insurance companies ‐ serbia number of insurance companies ‐ bih 26 economic analysis (2019, vol. 52, no. 1, 23‐35) insurance companies at the b&h market operated in the last two years of the observed period, i.e. 2016‐2017 with a total of 27 companies. in addition to the banking sector with the largest share of the balance sheet total in the total financial sector ‐ about 90%, the balance sheets of the leasing companies, pension funds and insurance companies are included. figure 2 shows a fall in the share of the insurance sector's balance sheet total in the total financial sector, which is notable in both markets in the period 2005‐2008. after 2008, the share of the insurance sector balance sheet total in serbia rose from 4.2% in 2008 to 6.3% in 2017. the same trend is present in the insurance market of bosnia and herzegovina, where the growth of the balance sheet total in the total financial sector increased in the same period for the same percentage ‐ 2.1%, from 3.45% to 5.57% in 2017. figure 2. contribution of the balance sheet total of the insurance sector to the overall financial sector, 2005‐2017 figures 3 and 4 show the ratio of the total number of insurance companies and foreign companies in the period 2007‐2017. it can be concluded that the number of foreign insurance companies in serbia has changed proportionally with the total number of companies present in the market. the number of foreign companies in the insurance market of b&h did not change significantly in the observed period. there were 10 foreign insurance companies in the period 2008‐2014, after which this number increased to 11 and 12 in 2015, 2016 and 2017, respectively. figure 3. relationship between the total number of insurance companies and foreign companies, 2007‐2017, serbia 4,42 3,75 3,46 3,45 3,72 3,86 4,43 4,77 4,86 5,19 5,38 5,57 5,57 5,3 4,3 4,1 4,3 4,2 4,2 4,4 4,5 4,8 5,2 5,8 6,1 6,3 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih serbia 20 24 26 26 28 28 28 25 24 23 21 13 17 19 19 21 21 21 19 18 17 15 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign tijana kaličanin, sandra kamenković, ivana simeunović 27 figure 4. relationship between the total number of insurance companies and foreign companies, 2007‐2017, b&h given that the subject matter of the analysis is the amount of income earned by insurance companies, the companies’ market shares are calculated on the basis of the amount of total premiums at the end of the year taken from the balance sheet of insurance companies. figure 5 shows a comparative analysis of the concentration of the largest companies in b&h and serbia according to the criterion of the total balance sheet. dunav insurance company was the market leader in serbia according to the mentioned criterion and has absorbed about one‐quarter of the entire market in the observed period. by the end of 2015, sarajevo insurance was the market leader in b&h according to the criterion of the total premium. for the next two years of the observed period, uniqa insurance achieved the largest amount of total premiums. the concentration of leader ratio in b&h is much lower than in serbia, so the leader in this market has a share of about one‐tenth of the entire market. figure 5. cr1 according to the criterion of the total premium, 2007‐2017 the number of companies involved in the calculation of this indicator is determined by government agencies that are monitoring the degree of bid concentration in that particular country, provided that this coefficient is used as an official indicator (martin, 2002). cr 1, cr3 and cr5 are most frequently accrued in the reports of the responsible insurance institutions, according to the criterion of total premiums, total non‐life insurance premiums and total life 25 26 26 26 25 25 25 24 24 27 27 9 10 10 10 10 10 10 10 11 11 12 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign 013 012 012 012 013 013 012 011 010 009 008 031 025 028 026 027 029 027 025 027 026 027 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 28 economic analysis (2019, vol. 52, no. 1, 23‐35) assurance premiums. figure 6 shows the concentration ratio of the top five insurance companies with the highest total premium. although there is a mild tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. (as can be seen in lorenz curves 8 and 9). cr5 had fallen from 84.16% in 2007 to 77.19% in 2017. the mentioned concentration ratio in b&h dropped from 45.97% to 39.21%, from 2007 to 2017. figure 6. cr5 according to the criterion of the total premium, 2007‐2017 figure 7 shows the dynamic analysis of the herfindahl‐hirschman index in the period 2007‐ 2017 for both markets. the significance of the index is reflected in the fact that although it respects the individual market share of all companies in the branch it particularly responds to the presence of companies with large market participations, which significantly increase its value (lipczynski & wilson, 2001) given the above and taking into account the high cr5 concentration ratio on the insurance market of the republic of serbia, high values of the herfindahl‐hirschman index are not surprising. figure 7. herfindahl‐hirschman index according to the criterion of the total premium, 2007‐017 with the increase in the number of insurance companies in serbia, this index has declined, so the highly concentrated bid with the index of 2050 in 2007 reached the level of a medium concentrated bid (it is considered thin the market is medium concentrated if the hhi index value 046 045 045 046 046 045 046 045 042 041 039 084 082 079 077 077 077 076 077 076 075 077 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 2050 1820 1654 1520 1551 1595 1495 1496 1558 1495 1543 655 623 622 643 636 640 636 610 585 555 534 0 500 1000 1500 2000 2500 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 serbia bih tijana kaličanin, sandra kamenković, ivana simeunović 29 ranges from 1000 to 1800). it can be concluded that from 2008 until today, the insurance market in serbia is medium concentrated. herfindahl‐hirschman index according to the criterion of the total premium differs significantly in the market of bosnia and herzegovina, where the permanent low‐concentration bid is present in the observed period. although the hhi index fell from 655 to 534, from 2007 to 2017, it can be concluded that the insurance market in b&h is inconsistent, i.e. that there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. figure 8 shows lorenz curves based on the amount of total premiums for the initial and the last year of the observed period, i.e. 2007 and 2017. first, insurance market leaders have reduced their market share, i.e. the top 20% of insurance companies in 2007 had a cumulative 80% of the total market share measured by the total premium, while the same percentage of leaders in 2017 had less than 60%. with the exception of market leaders (the first four companies) of 18 companies in 2007, 14 companies shared 18.85% of the total market, while in the year 2017 some 15 companies shared 18.69%, which suggests that the number of companies increased in the market with smaller market share, primarily due to the appearance of new companies in the market. this finding contributes to the value of the herfindahl‐hirschman index as well as the value of cr5. figure 8. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, serbia constructing lorenz's curve in terms of the degree of concentration of supply in the relevant market, the distribution of the entire market between business entities can be clearly seen. (kaličanin & hanić 2016b). lorenz curves for the insurance market of bosnia and herzegovina constructed based on the premiums shown in figure 9 differ considerably from those presented in figure 8. the distribution of the market share of insurance companies in the stipulated market is characterised by greater equality, which can be inferred from the lorenz curve distance from the equal’s curves (in case of equal distribution of market share among all participants in the market). fewer companies have been able to increase their market share over the observed period, while market leaders reduced their cumulative market share. 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz 30 economic analysis (2019, vol. 52, no. 1, 23‐35) figure 9. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, b&h in 2017 in bosnia and herzegovina, there were 27 companies, i.e. 6 companies more than in the republic of serbia. in addition to the difference in the number of companies, there is greater inequality in the distribution of market shares in the serbian insurance market as well as greater concentration on the supply side compared to the low concentration of the insurance market of bosnia and herzegovina. methodology as emphasised before, the aim of this paper is to analyse the insurance market in serbia and bosnia and herzegovina with reference to certain macroeconomic indicators that play a key role in the development of insurance. in this respect, we investigated the mutual influence of individual variables on the movement of total premium income earned in these countries. in this analysis, a time series is used for the period 2000‐2017, i.e. for a period of 18 years. for the mentioned period, the following independent variables were analysed:  – average net salary (current, rsd/km)  – unemployment, total (% of tthe otal labor force)  – gross domestic income (constant lcu)  ‐ gdp per capita (current us$)  ‐ wage and salaried workers, total (% of total employment)  ‐ households and npishs final consumption expenditure (current us$) while the dependent variable was – total premium (current rsd/km). for this research, multiple regression analysis was carried out using the spss statistical software. the choice of independent variables is based on empirical fundaments that relate to the studied variable, as well as on the information contained in the relevant literature. six independent variables were included in the analysis to identify those that could explain the major part of the variability of the studied (dependent) variables. a model involving variables whose calculated regression coefficient is significant at 5% level is selected. empirical research and discussion usually, the first part of the study contains basic indicators of descriptive statistics. since all variables included in the analysis were measured on the ratio scale, the values of arithmetic mean and standard deviations are presented as indicators of a descriptive statistic (table 1 and table 2). 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz tijana kaličanin, sandra kamenković, ivana simeunović 31 table 1: descriptive statistics for different variables – serbia mean std. deviation n total premium 49372718.5000 24831359.35237 18 average net salary 345729.3333 183811.84680 18 unemployment, total (% of total labor force) 17.6239 3.61340 18 gross domestic income (constant lcu) 2855342777777.7780 458570337497.97485 18 gdp per capita (current us$) 4614.9873 1798.25314 18 wage and salaried workers, total (% of total employment) 69.4582 1.98410 18 households and npishs final consumption expenditure (current us$) 25301236558.1667 9670960437.31504 18 source: authors using spss table 2: descriptive statistics for different variables – bih mean std. deviation n total premium 430206288.0000 141434498.99548 18 average net salary 1035.7778 262.30260 18 unemployment, total (% of total labor force) 27.3079 2.00943 18 gross domestic income (constant lcu) 24073220032.1667 3036558289.97812 18 gdp per capita (current us$) 3848.6667 1366.86275 18 wage and salaried workers, total (% of total employment) 66.5221 6.48730 18 households and npishs final consumption expenditure (current us$) 12811176132.8333 2684992943.38614 18 source: authors using spss below is an output that refers to the multiple regression model which was implemented on the data obtained for both countries involved in the analysis. table 3: model summary along with the values of r and r square – serbia model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .962a .925 .920 7023512.91992 .925 196.491 1 16 .000 2 .981b .962 .957 5152189.94256 .037 14.733 1 15 .002 3 .992c .983 .980 3548389.97989 .021 17.624 1 14 .001 4 .996d .993 .990 2444365.32992 .009 16.502 1 13 .001 a. predictors: (constant), average net salary b. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$) c. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu) d. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu), unemployment, total (% of total labor force) source: authors using spss 32 economic analysis (2019, vol. 52, no. 1, 23‐35) in the case of variables describing the insurance market in the republic of serbia, four models were generated, where the last model was selected having the highest value of the coefficient . the value in this case shows that 99.3% variations in total premium can be explained by selected four variables and this model can be considered appropriate to develop the regression equation. the independent variables selected by the above mentioned model are as follows: average net salary, households and npishs final consumption expenditure, gross domestic income and unemployment, total (table 3). the following table shows the unstandardized and standardised regression coefficients for all models. in the last model, t‐values for all the two regression coefficients are significant as their significance values (p‐values) are less than 0.05. therefore, it can be concluded that the previously selected 4 independent variables significantly explain the variations in the total premium. table 4: regression coefficients of selected variables in different models along with their ‐ values and partial ccorrelations – serbia model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) 4460520.406 3606405.932 1.237 .234 average net salary 129.906 9.267 .962 14.018 .000 .962 .962 .962 2 (constant) 14150355.208 3656718.281 3.870 .002 average net salary 178.058 14.268 1.318 12.479 .000 .962 .955 .628 households and npishs final consumption expenditure ‐.001 .000 ‐.405 ‐3.838 .002 .753 ‐.704 ‐.193 3 (constant) ‐66019515.273 19262250.240 ‐3.427 .004 average net salary 102.779 20.448 .761 5.026 .000 .962 .802 .174 households and npishs final consumption expenditure ‐.002 .000 ‐.640 ‐6.977 .000 .753 ‐.881 ‐.242 gross domestic income 4.254e‐5 .000 .786 4.198 .001 .934 .747 .145 4 (constant) ‐49098413.472 13907538.352 ‐3.530 .004 average net salary 107.565 14.135 .796 7.610 .000 .962 .904 .182 households and npishs final consumption expenditure ‐.001 .000 ‐.550 ‐8.200 .000 .753 ‐.915 ‐.196 gross domestic income 3.880e‐5 .000 .717 5.512 .000 .934 .837 .132 unemployment, total (% of total labor force) ‐783350.327 192833.041 ‐.114 ‐4.062 .001 .250 ‐.748 ‐.097 a. dependent variable: total premium source: authors using spss using the values of the unstandardized regression coefficients of the last model presented in table 4, the following regression model can be shown: 49098413.472 107.565 0.001 0.0000388 783350.327 tijana kaličanin, sandra kamenković, ivana simeunović 33 concerning the same analysis carried out for the data from bosnia and herzegovina, two models were generated, where the second one was selected for which the value of 0.983 was assigned for the determination coefficient (table 5). in this way, a multiple hierarchy model was formulated which combines two independent variables as follows: gross domestic income and wage and salaried workers, total. since the f‐value for this model is highly significant, the model is reliable. also, the regression coefficients in the stipulated model are statistically significant, and it is considered that the selected variables have a great predictive significance in estimating the value of the total premium. table 5: model summary along with the values of r and r square ‐ bih model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .975a .951 .948 32128444.21790 .951 313.443 1 16 .000 2 .992b .983 .981 19491967.96979 .032 28.470 1 15 .000 a. predictors: (constant), gross domestic income (constant lcu) b. predictors: (constant), gross domestic income (constant lcu), wage and salaried workers, total (% of total employment) source: authors using spss the last table contains the values of the regression coefficients for the previously selected model. table 6: regression coefficients of selected variables in different models along with their ‐ values and partial correlations ‐ bih model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) ‐663490820.738 62238137.572 ‐10.661 .000 gross domestic income .045 .003 .975 17.704 .000 .975 .975 .975 2 (constant) ‐827546449.311 48694106.929 ‐16.995 .000 gross domestic income .035 .002 .759 14.452 .000 .975 .966 .483 wage and salaried workers, total (% of total employment) 6110923.803 1145287.155 .280 5.336 .000 .866 .809 .178 a. dependent variable: total premium source: authors using spss regression equation, which can explain the variability of the observed total premium variable analysing trends in selected independent variables goes as follows: 827546449.311 0.035 gross domestic income 6110923.803 wage and salaried workers 34 economic analysis (2019, vol. 52, no. 1, 23‐35) conclusion after 2008, the share of the insurance sector balance sheet total in serbia and bosnia and herzegovina increased in the same period for the same percentage – 2.1%. the number of insurance companies with foreign equity in serbia has changed proportionally with the total number of companies present in the market whereas the number of the foreign insurance companies in bosnia and herzegovina remained almost the same although the total number of the insurance companies increased. the concentration of leader ratio (cr1) in bosnia and herzegovina is much lower than in serbia, so the leader in this market has a share of about 10% of the entire market while in serbia it is about 27%. although there is a moderate tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. it can be concluded that in the last decade the insurance market in serbia is medium concentrated according to herfindahl‐hirschman index calculated by total premium and it differs significantly in the market of bosnia and herzegovina, where permanent low‐concentration bid is present in the observed period ‐ there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. in this paper, the multi‐linear regression model was applied in order to analyse the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐ 2017. we can conclude that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had average net salary, households and final consumption expenditure and gross domestic income. therefore, there is a positive correlation between household income (including salary and other income) and premiums. also, in the periods when household expenditure was higher, the amount of total insurance premium was also higher. both of the selected economies have undergone changes in the financial sector, particularly in terms of recent regulatory reforms. this paper provides information on the determinants of insurance demand in the republic of serbia and bosnia and herzegovina. this research is limited to a macro level analysis of the insurance demand. further, detailed analysis can be performed on individual life insurance products, which may result in more reliable findings. the period 2000‐2017 was analysed, so future studies can further segregate the cee region into developed and developing economies and make a detailed time series analysis incorporating both pre‐crisis and post‐crisis period. acknowledgements this paper is a result of research projects under the code 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonisation with eu requirements) financed by the ministry of science and technological development of the republic of serbia. references beck, t. & webb, i. 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(1998). die nachfrage nach lebensversicherungen: eine empirische analyse für china, mannheimer manuskripte zu risikotheorie, portfolio management und versicherungswirtschaft 112, universität mannheim. www.nbs.rs www.azobih.gov.ba www.data.worldbank.org article history: received: april 1, 2019 accepted: may 29, 2019 microsoft word 2009_3_4.doc note from the editor-in-chief the current volume of economic analysis contains seven articles covering a wide range of topics from monetary strategy to entrepreneurship, knowledge firms and rural development. kallinterakis and lodetti explore association between herding and nonlinearities and market illiquidity: evidence from montenegro. research results suggest that herding is non-existent, irrespective of whether one corrects for thin trading or not. their findings also illustrate that the montenegrin market accommodates significant nonlinearities, which, despite being irrelevant to herding, undergo a substantial depression following the adjustment of returns for thin trading. neupauerová et al.’s article discussed exchange rate targeting as an very useful monetary strategy especially at the beginning of transition process in many countries. they tried to evaluate effectiveness of exchange rate targeting in the slovak republic and in the czech republic using statistic methods. their conclusions can serve as an experience to other countries that are just at the beginning of their transition process. vukotić and stošić in their article compared the rate of inflation in serbia with the rate of inflation in the european union (eu) with intention to find out how much serbia – as a potential candidate country to the eu – diverges from general price tendencies exhibited by eu member states. kapić in her analysis provides relevant information for the evaluation of the companyʹs profitability, assets reconstruction degrees and competitiveness degree in the financial abilities position. additionally, author concluded that many evaluation models use the money in cash flows from the regular business management as they provide the management with motives to record cash inflows as cash inflows from regular business management and outflows developed either by investments or by financing. đogić et al.`s article is focused on importance of entrepreneurship for development of bih economy. they concluded that the entrepreneurship development in bosnia and herzegovina requires the ending of the transition process and whereby the qualification of domestic enterprises to confront with the global market challenges. ending of the domestic enterprise transition process will initiate entrepreneurship as the main lever in the economic development. along with domestic enterprise restructuring, the basis of the entrepreneurship development in the following period, as a good therapy for the consequences of global economic crisis, will be formed by new entrepreneurship ventures mainly expresses via small and moderate enterprises. economic analysis (2009, vol. 42, no. 3-4, 5-6) 6 stefanović et al.ʹs article stresses that life-long learning politics is the basic premise of the company’s market competiveness considering the fact that the knowledge is the only resource that grows with use and not disburse. the main conclusion of the paper states that the most successful companies and national economies are those based on knowledge, or in other words highly educated and trained human resources. ivanović and jeločnik present the results of their empirical study, which provides evidence of previous and in next period expected apple production in the world, europe and serbia. my sincere appreciation goes to technical editor zorica božić. it has been an enjoyable experience working with her. i also wish to thank the contributors of the articles and the associate editors for the excellent work that they have done. thank you again. prof. dr mirjana radović marković editor-in-chief economic analysis ea09_3-4 samo prva strana.pdf page 1 microsoft word 2008_01_02.doc original paper    macrodynamics and pollution in open economy:     an is‐lm analysis    ouyahia emmanuel, nice sophia antipolis university    key words: keynesian cross diagram,  macroeconomic policy, pollution    udc: 502.2:330.101.541          jel: q58, q50, e12, e61    abstract ‐ the economy of the environment is traditionally the field of micro‐economy. yet pro‐ viding an analysis purely macro‐economic  is  from a theoretical and praxeological point of view   possible.  with this in mind, we change the model is‐lm so that it incorporates the pollution. this extension of the  model has allowed us to show the ecological and economic effects of different monetary or budgetary policies  depending on the type of small open economy considered (with or without different kind of control pollution  activities).  introduction  even if there is a debate about the exact meaning to be attached to the term sustainable de‐ velopment, it appears that whatever their opinions underlying theory, the authors involved in this  debate agree that the concept of sustainable development implies managing and maintaining an  inventory of resources with a view to equity between generations and between countries1. indeed  the economics of the environment is traditionally treated as a sub division of the micro‐economy. it  therefore appears to us, after authors like daly2, there is a place also for a macro‐economy of the   environment, where the macro‐economy would be regarded as a sub‐system open to the ecosys‐ tem and totally dependent on the latter, both for the source of inputs into low entropy of matter  and energy, and as a receptacle outputs for high entropy of matter and energy. the macroeconomy  of  environment should focus on the volume of trade that cross the boundaries between the system  and the subsystem. as daly points out if the optimal allocation of a given level of resource flows  within an economy is a micro‐economic problem, the optimal scale of the economy relative to the  ecosystem is an entirely different problem in fact a macroeconomic one.  moreover, to try to establish the foundations of a macro‐economy environment, and measure  their lessons, we will incorporate into the model is‐lm, but in its dynamic form, function pollution  in the form of stock.  a dynamic is‐lm model extended to the case of pollution  in its original version, the  is‐lm  model relies on comparative statics, but the principle of  correspondence of samuelson stipulates that the properties of comparative statics of a model relies  on its dynamic properties3. as we intend to modify the model by adding new variables in order to  introduce pollution, we therefore must study the dynamical properties of the corresponding model  before to make any comparative statics analysis.  1 pearce d, markandya a, barbier e.b  (1989), blueprint for a green economy, london, earthscan publications.  2 daly h. e.,“elements of environmental macroeconomics”, in costanza r , ecological economics, the science and manage‐ ment of sustainability, columbia university press, new york, pp 32‐45  3in fact, in its comparative statics form, the assumption of automatic balancing of the market for goods and services is  made. but in its dynamic form, one wonders about the existence of this equilibrium and the process of adjustment of the  economy toward it.  2007 ‐ 12  •  economic analysis®  in  the  dynamic  model  is‐lm  we  consider  an  economy  in  which  national  income  (y)  re‐ sponds to excess investment (i) on savings (s). thus, the first dynamic equation based on the is  curve is given by the following:   &y i s= −   in case you  introduce budgetary expenditure  (g),  the environmental budget  (ge),  taxation  (t),  productive investment (i) and pollution (ie) and exports (x) and imports (m), the previous dy‐ namic equation becomes:    &y i i g g s t x me e= + + + − − + −   the function of exports of the economy is ( )x x= ω  with the exchange rate ω  = $ / €.we suppose  that when the exchange rate increases ceteris paribus, imports rise, and when the level of house‐ hold  income  increases imports are also  increasing, hence the function of  imports  m my= ( )ω ,  where m is the propensity to import of the economy.   the investment in this economy is divided into a productive investment aimed at increasing  the production capacity of  the economy, i, and investment  in pollution control which does not  have this capacity, ie4. regarding the investment function,  arii −= , the level of productive in‐ vestment depend on the level of interest, r, where the parameter ʺaʺ reflects the incentive to invest  from rate interest and  i  an autonomous level. note that the firm’s calculation of profitability in‐ tegrates expected demand,  through  the assessment of the marginal efficiency of capital and  its  comparison to the rate of interest. this assessment process will take a special importance with the  function of investment in pollution control. in fact we suppose that interest rate  plays a lower role  in the pollution control investment function than in the function of investment in other sectors,  resulting in a coefficient ʺbʺ very low and less than ʺaʺ5. in this case, we write the investment func‐ tion in pollution control  i i bre e= − . thus a fundamental element in our model will be to know if  the expectations of the firms in the sector of the pollution would be resolutely optimistic about the  behaviour of the stateʹs environmental standard.   in this economy public expenditure, is assumed exogenous, with the request of the state in  consumer goods and services and property investment, g, and public investment in pollution con‐ trol, ge, respectively g g=  and g ge e= . with all these assumptions, is equation is rewritten :  (1)  & ( )y s t y ty ct c g g i ar i br x mye e= − − − − + + + + − + − + −1   in our model is‐lm dynamic interest rate (r) responds to excess demand for money (l) on  the money supply determined exogenously (m). but in open economy the money supply will vary  depending  on  changes  in  foreign  exchange  reserves  and  the  in  monetary  base,  h,  [ ] [ ]&r hy l lr h r= + − − + , where  r x m f r= − + ( ) . thus, a fixed exchange rate regime, the lm  curve dynamics is given by the relationship (2) where hy  is the demand for money for purposes of  transactions, and  l lr− is the demand money for purposes of speculation, and finally the mone‐ tary base exogenous:  4 from a strictly accounting on a perfectly entitled to present the overall investment in the form of two sectors since these  equations are equations balance ex‐post. and we know all prices in the economy, since this is the prerequisite for the  aggregation of goods produced for obtaining the equation of balance between accounting income and expenditure.  5 several reasons require that choice. first reason is that firms that invest in clean‐up will do so only if the state has en‐ couraged the market for mitigating pollution by enacting laws requiring in all other sectors the use of new products of  pollution control : the pollution sector can not declare unilaterally an increase of its production unless it has correctly  anticipated a strengthening of pollution standards. the second reason lies in subsidies granted by the government which  are merely transfers therefore making private investment in pollution less dependent on interest rates. finally, in this  case we must also consider the fact that environmental standards, in the first place, determine the use of cleaner prod‐ ucts. once internalized this information the rate of interest takes the second place.  volume 40 • spring 2008 • 13  (2)  [ ]& ( )r hy l lr h x my f r= + − − − − +   we will now introduce the environmental dimension in this model showing the evolution  equation stock pollution widely used in theoretical models of sustainability6. thus strom7 in his  article assumes that the stock waste is the appropriate measure of environmental  the rate of de‐ cline in the density of waste, reflecting the rateδquality. with  of increase in the assimilative capac‐ ity of the natural environment due to capital investment, and w the waste was then the following  equation:  & ~ z w h i zr= − − δ . in transposing this equation to adapt to the dynamic model is‐lm,  we can then write the equation dynamic equilibrium macro‐environment in the form of the equa‐ tion (3), namely:  (3),  & ( ) ( ) ( ) ( ) ( )e y g i br ee e= − − + −α β γ γ δ   where e is the stock of pollution or waste,  αy is the emission of pollution emitted by the  productive activities,  β ge the reduction of the stock of pollution caused by government spending  on pollution, and γ γ( ) ( )i bre −  the reduction of the stock of pollution due to the clean‐up activi‐ ties of the private sector, δ the rate of decline of natural waste stock e. therefore, the dynamic sys‐ tem can be written by the following matrix:  ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ −− −− −+++++ + ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ − +−+ +−−−−− = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ )()( 0)()( 0)()1( ee ee ig xhl tcxcgigi e r y b flmh bamtts e r y γβδγα& & &   in the mathematical appendix, we demonstrate the stability of this model. we can therefore study  its behaviour near of the equilibrium. doing so the previous equations become:     ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ + −− +−++++ = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ − +−− +++− )()( 0)()( 0)())1(( ee ee ig xhl xtccgigi e r y b lfhm bamtts γβδγα   this system is in fact the structural form of a small open economy subject to a pollution problem.  we examine this structural form deducting the reduced form in the next section.  dynamic behaviour analysis of the model   the behavioural analysis of the previous dynamic model is identical to study the behaviour  of the structural form of a keynesian model of a short‐term applied to the local pollution. we will  study the structural form by deducting the reduced form.   with activities for pollution reduction private non‐autonomous  i i bre e= − , and public ex‐ penditure shocks g ge e= , the is curve, in open economy, is given by the relationship (1), i.e.:  y t cy cty ct ty c g i g i ar br x mye e( )1− = − − − + + + + + − − + −   the lm curve is given by the relationship (2), namely:  h x my f r hy l lr+ − + = + −( )    the equation environmental equilibrium, taking into account the public and private spending on  pollution control is given by (3):  6 see for example gradus r., smulders s. (1993), the trade‐off between environmental care and long‐term growth, pollu‐ tion in three prototype growth models, journals of economics, 58(1), pp25‐51.  7 strom s, “economic growth and biological equilibrium”, swedish journal of economics, vol. 75, n°2, june 1973. strom  s, (june 1973)  economic growth and biological equilibrium, swedish journal of economics, 75(2).  2007 ‐ 14  •  economic analysis®  e y g i bre eδ α β γ γ= − − +( ) ( ) ( )    presented in matrix form the previous three equations give us the following system:  ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ + −− +−++++ = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ − +−− +++− )()( 0)( 0))1(( ee ee ig xhl xtccgigi e r y b lfhm bamtts γβδγα    with  the  determinant  ( )[ ]λ = − − + + + + + +δ s t t m f l a b h m( ) ( ) ( )( )1 ,  and  with  ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ + −− +−++++ = )()( ee ee ig xhl xtccgigi m γβ .the structural system  is  written  in  its  reduced  form  in  the  following manner:  m bmttsbalfbhm mttsmh balf e r y ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ λ−++−−++−+− ++−−+− ++− ⎟ ⎠ ⎞ ⎜ ⎝ ⎛ λ = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ δγααγ δδ δδ /))1(()()()( 0))1(()( 0)()( 1   starting from this reduced form model we will deduct the behaviour of this model in the  several cases. to do this we will calculate the various multipliers corresponding to this model.  comparative statics in the simplified case without pollution control  in the simplest case we make the assumption that no expenditure pollution, neither public  nor private, shall be undertaken in the economy ( 0== ee gi  and b=0). in sum, it’s only the assimi‐ lative capacity of the environment  that converts waste produced by the economic process. the  equation of environmental equilibrium is given by:  e yδ α= .  multipliers  the multipliers are obtained by differentiating the reduced form model:   δ δ δ δ δ δ y c y i y g ky= = = >,1 0    and    δ δ y t cky= − >,1 0   δ δ y h ky= − >,2 0    δ δ y l ky= <,2 0   where  ( ) ( )( ) ( )[ ] k f l s t t m f l a m h y , ( ) 1 1 = + − + + + + + , and  ( )( ) ( )[ ] k a s t t m f l a m h y , ( ) 2 1 = − − + + + + +   the monetary and budgetary multipliers are:  δ δ δ δ δ δ r c r i r g k r= = = >,1 0    et    δ δ r t ck r= − >,1 0   δ δ r h k r= − <,2 0     δ δ r l k r= <,2 0   where  ( ) ( )( ) ( )[ ] k m h s t t m f l a m h r , ( ) 1 1 = + − + + + + +   volume 40 • spring 2008 • 15   and  ( ) ( )( ) ( )[ ] k s t t m s t t m f l a m h r , ( ) ( ) 2 1 1 = − + + − + + + + +   the equation of  ecological equilibrium allows us to calculate the environmental multipliers:   [ ] [ ]δ δ δ δ δ δ δe k c i g c t k l he e= + + − + −, ,1 2   δ δ δ δ δ δ e c e i e g k e= = = >,1 0    and    δ δ e t ck e= − >,1 0   δ δ e h k e= − >,2 0     δ δ e l k e= <,2 0  where ( ) ( )( ) ( )[ ] k f l s t t m f l a m h e , ( ) 1 1 = + − + + + + + α δ and   ( )( ) ( )[ ] k a s t t m f l a m h e , ( ) 2 1 = − − + + + + + α δ   the sign of ecological multipliers are the same as monetary and budgetary multipliers com‐ pared to y. this is perfectly normal. indeed in this model no place has been given to expenditure  on pollution control, so the emission level is equal to the difference between the level of gross pol‐ lution and assimilative capacity of the natural environment, assumed fixed. so in this case, emis‐ sions of pollution are only proportional to the volume of production and hence the national in‐ come of the economy and in a linear fashion. therefore, any economic stimulus of income through  budgetary and monetary policies corresponds to an increase in national income and thus and thus  to a proportional increase in the same sense of the level of waste emissions. the main reason is that  any distribution of income, wages, or simply any stimulation of demand creates ceteris paribus, a  stimulation in the same direction of pollution (more wages mean more consumption more invest‐ ment and so on. and therefore more consumption and thus more waste).  graphical representation   the graphic representation of the environmental equilibrium equation is exactly like that of  a balance of payments curve. indeed it is written (3)  0 = −α δy e , iey e= δ α . the status of this  curve is very particular. it brings together all the points which, for a given level of pollution, e, for  a given level of assimilation of natural waste,δ , and finally to an intensity of pollution in the pro‐ duction sector aα,  associates a level of income, y. it is not a worthy that for a given objective pollu‐ tion emitted, e, there is a single level of income, y. thus be is a line parallel to the axis. hence the  graphical representation of the environmental equation is the following:    be(e,α,δ) r y be'(e'>e,α,δ) y=eδ/α y'=e'δ/α   2007 ‐ 16  •  economic analysis®  figure 1. environmental equilibrium curves according to the emission level of pollution  thus you have a family of curves where the  closest to the origin correspond to low levels of  emissions and    the furthest a higher  level of pollution. in the case of this small open economy  where no environmental expenditure  is  implemented,  the environmental  impact of a policy of  budgetary or monetary can only be the same as that exercised by these policies on income level  since we  just verify that the respective multipliers are the same, as can be seen in the following  graphic:  is lm' be bp r y lm is' be' y y'     figure 2. effect of a budgetary stimulus in open economy on the level of income and of pollution.  thus, in open economy and in a fixed exchange rate regime any budgetary policy moves is   to the right, thereby increasing the rate of interest. in fixed exchange rate regime, and with com‐ plete freedom of capital movements, it increases the stock of gold and currency of the central bank,  and it has more than compensate for the fact that imports have increased. the balance of payments  is in surplus resulting in a exogenous creation of money (capital flows). so lm move to the right.  at the equilibrium the  three lines  intercept (isʹ lmʹ and bp, which  in fixed exchange does not  move); national  income has  increased, with yʹ> y. from an environmental perspective,  this  in‐ crease in overall income implies that the level of waste has been raised and therefore the curve be  move to the right in be ʹ. in the new ecological and economical equilibrium, the economy is at a  higher income level, which implies an emission level also higher.  thus, from a macroeconomic view, we get the same results as those of usual is‐lm model  with a fixed exchange rate regime. however all variations in the level of national income reflects a  change in the same sense of the level of emissions. therefore after adjustment we will always be in  equilibrium macroeconomicaly and ecologically speaking. note that in the latter case the notion of  equilibrium should be understood as  the  level of pollution consistent with the level of  income,  given the intensity in pollution of the national economy, and bearing in mind assimilative capacity  of the environmental represented by δ . it’s certainly not the level of emissions that would ensure  an hypothetical ecological ʺparadiseʺ. this is of great importance if one believes, like daly, in the  notion of size or scale of the sustainable economy. indeed, in this case, we can consider that this  ʺsustainable sizeʺ corresponds to a maximum amount of waste that can assimilate the ecosystem in  the short term and in the long term. this leads us therefore to set an upper limit to the evolution of  gnp. as stated daly, the limit depends on the country and a whole range of factors, geographical,  ecological and demographic8. in the next part of this article we introduce environmental public  and private spending allowing more flexibility to reconcile national income and environmental  constraints.   8 in our model, we could introduce it as a theoretical form of a line parallel to the y‐axis.  volume 40 • spring 2008 • 17  comparative statics in the general case   multipliers  using the equation representing the equilibrium on the market products ie is we get the fol‐ lowing multipliers:  δ δ δ δ δ δ δ δ δ δ y c y i y g y i y g k e e y= = = = = >,1 0 and  δ δ y t cky= − <,1 0   δ δ y h ky= − >,2 0    δ δ y l ky= <,2 0   with  ( ) ( )( ) ( )( )[ ] k f l s t t m f l a b m h y , ( ) 1 1 = + − + + + + + +   and  ( ) ( )( ) ( )( )[ ] k a b s t t m f l a b m h y , ( ) 2 1 = − + − + + + + + +   applying the same method to the equation on the money market, we have:   δ δ δ δ δ δ δ δ δ δ r c r i r g r i r g k e e r= = = = = >,1 0  and  δ δ r t ck r= − <,1 0   δ δ r h k r= − <,2 0     δ δ r l k r= >,2 0   where  ( ) ( )( ) ( )( )[ ] k m h s t t m f l a b m h r , ( ) 1 1 = + − + + + + + +    and  ( ) ( )( ) ( )( )[ ] k s t t m s t t m f l a b m h r , ( ) ( ) 2 1 1 = − + + − + + + + + +   regarding be we obtain:  [ ] [ ] [ ]δ δ δ δ δ δ δ δ δ δ δe k c i g g i c t k l h k g ie e e e e e e= + + + + − + − + +, , , ( ) ( )1 2 3 β γ   δ δ δ δ δ δ e c e i e g k e= = = >,1 0  and  δ δ e t ck e= − <,1 0   δ δ e i k k k e e e e= + = − >, , ,( / )1 3 1 0γ γ δ and   δ δ e g k k k e e e e= + = − >, , ,( / )1 3 1 0β β δ   δ δ e h k e= − ,2     δ δ e l k e= ,2    with the multipliers    ( ) ( ) ( )( ) ( )( )[ ] k f l m h b s t t m f l a b m h e , ( ) 1 1 = + + + − + + + + + + α γ δ ,  k e , /3 1= − δ , and   ( ) ( ) ( )( ) ( )( )[ ] k s t t m b a b s t t m f l a b m h e , ( ) ( ) 2 1 1 = − + + − + − + + + + + + γ α δ .  the important point about these multipliers is to note that, from a strictly economic point of  view, nothing changes compared to the usual is‐lm  model without pollution. nevertheless, from  an ecological point of view  the environmental public expenditure multiplier has the same eco‐ nomic  impact  that  another  government  expenditure  (dy/dg=dy/dge),  but  without  having  the  2007 ‐ 18  •  economic analysis®  same environmental consequences, since the multiplier of environmental pollution control public  expenditure is less than that of an usual public expenditure (de/dg>de/dge). thus, while increas‐ ing ge lead to an increase on income identical to that of the same increasing of g but with an emis‐ sion level of pollution corresponding much less important. however, it must be stressed that, for  ge, it has been implicitly supposed that environmental government spending have a real   envi‐ ronmental effect on pollution, symbolized by the coefficient β between zero and one. but one could  imagine the case of environmental public spending that would not impact assessments, adminis‐ trative activities, without significant effect (a part from the distribution of wages to employees of  the ministry of environment or writing reports with non‐recycled paper etc. ..), that is to say a co‐ efficient β equivalent to  zero or very close to zero.   regarding the monetary multiplier, they depend on the sign of  ( ) ( )s t t b a b( )1 − + − +γ α .  this term is only represents the slopes of is and be. we stressed in the previous section that the  coefficient “b” is smaller than ʺaʺ. this means that the normal case is a negative sign of the previ‐ ous term. in the unusual case where the term is positive, it means that the multiplier effect of pri‐ vate investment in pollution control is more important than for the usual investment. this could  happen only in an economy where the expectations of the decision makers in the field of pollution  would be resolutely optimistic on the behaviour of the stateʹs environmental standard. therefore,  any monetary policy has a double effect in lowering the rate of interest: it facilitates investment as  a whole, and hence pollution, but investment in pollution control is also encouraged. thus, an en‐ vironmental point of view, the net effect depends on expectations of the firms and hence rely on  the environmental policy imposed by the state, and, hence, by the respective sizes of the pollution  control sectors  compared to the usual investment sector.  graphical representation  the  graphic  representation  of  the  environmental  equation  is  given  by  (3)  e y g i bre eδ α β γ γ= − − +( ) ( ) ( ) . this equation may be written in the following form:  r b y e g i b e e= − + + +α γ δ β γ γ( ) ( ) ( ) ( )    the status of this curve is consistent with the previous case. indeed it gather all the points  which, for a level of public and private environmental expenditure and for an intensity of pollu‐ tion in the production sector, associates to a couple of income level and  interest rates  a specific   level of pollution e. the reverse of the slope of the curve be is then equal to −α γ ( )b , hence the  graphic representation of figure 3:  y=δe/α y'=y''=(δe'+βge+γie)/α r=δe/(bγ) r'=(δe'+βge+γie)/(bγ) y r be be' be'' r''=(δe'+βge+γie)/(b''γ)     figure 3. curves balances macro‐environment according to the emission level of environmental expenditure  volume 40 • spring 2008 • 19  and the sensitivity of private environmental investment at the rate of interest.  an examination of figure 3 shows us that, when comparing the curve be  and the curve be ʹ,  an increase in the level of environmental private or public expenditure lead to increased pollution  level, income level and interest rates. this is perfectly consistent. a comparison of curves be ʺand  be ʹshows that for identical level of environmental expenditure, for a ratio b different, we obtain  income and pollution levels which are  identical but different interest rates ( the more b decrease in  passing from b ʹ to b ʺ, the more interest rate increases). thus, we conclude that lower is b, i.e. less  private investment in pollution control is sensitive to interest rates, the stronger changes in r have  to be in order to obtain the same level of pollution. moreover this chart  is perfectly consistent with  the definition of be given in the previous section because, when the coefficient b tends towards  zero, ie when private investment becomes independent and indifferent to the rate of interest, then  be becomes vertical.  an important consequence of the shape of the curve be is that, according to the place of the  curve be compared to is, the effect of monetary policy on the emission level will not be the same  (as indicated by the sign of the corresponding multiplier which differs depending on whether one  is in the usual case or not). but this changes nothing with regard to the comparison between the  effect of an environmental public expenditure versus a usual public expenditure, as can be seen in  figure 4:  be(e) is lm bp is' lm' be'(e') e e* e** y y' y ''=y'y lm lm'' bp is is'' be(e ) be''(e'') e e* e** usual public expanditure dg>0, dy=(y'-y)>0, de=(e'-e)>0 environmental public expanditure dge>0, dge=dg , dy=(y''-y)=(y'-y )>0, de=(e''-e)<(e'-e)   figure 4. effects on the level of income and of pollution compared to those of a budgetary environment.  in this figure, we make the assumption that we are in the normal case, ie that the slope of is  is not greater than or equal to that of be (but change this assumption would not into question the  results). in the first case, a budgetary stimulus has the effect of  moving is to the right where it  crosses lm in e *. but this is not a point of equilibrium in open economy. the interest rate has in‐ creased resulting in an influx of foreign capital just inflating the stock of gold and foreign exchange  considering our implicit assumption of high mobility of capital (given the slope of the curve bp).  this largely offsets the decline in the stock of foreign exchange resulting from increased imports.  in total, there is therefore an exogenous creation of money that moves lm to the right where it  crosses is ʹ in e **. this is a point of economic equilibrium symbolized by the intersection of is ʹand  lm. from an environmental point of view, the shift from y to y ʹhas resulted in an increase in same  intensity in the level of emissions from e to eʹ. hence, from the environmental point of view, the  situation has worsened without ambiguity.  this figure, allows us to verify that for an increase in environmental public expenditure of  same  intensity as  the public expenditure of  the previous case,  income y  increases of  the same  amount as in the previous case, and passes from y to y ʺ, where y = y ʹ. the curves fit is and lm is  the same as in the first case. by contrast the level of emissions  even though it has increased com‐ 2007 ‐ 20  •  economic analysis®  pared to its initial level e is at a level eʺ which is less than eʹ. accordingly, a an environmental pub‐ lic expenditure, even if it leads to an increased pollution, is more efficient ecologically speaking  than a usual public expenditure, because it causes relatively less pollution that the latter, for the  same increase in national income.  by contrast, if we look to the environmental impact of a monetary economy open, there is no  such dichotomy ʺusual/ environmentalʺ, but a dichotomy between normal and abnormal as can be  seen on the figures 4 and 5:  is lm' be(e) bp r y lmbe'(e') y y' e e' r r'        figure 4. effect of an active monetary policy in open economies on the level of income and that of emissions  in the normal case.  in the normal case, the sign of the environmental monetary multiplier is positive. an initial  increase of money supply by lowering the level of interest rates going from r to r ʹ, stimulates the  economy whose income goes to yʹ. but, in open economy, e ʹ is a situation of unstable equilibrium  because situated below the curve of the balance of payments. indeed, with a perfect capital mobil‐ ity, the declining interest rate leads to a flight of capital which, coupled with rising imports leads  the stock of gold and currency of the central bank on the decline. so the money supply contracts.  therefore lm go back to its original position. the level of income returns to y, and hence the econ‐ omy returns to its stable equilibrium position, e. from an environmental view situation is identical.  at first, when the income from y to y ʹ, the level of emissions increases since the multiplier mone‐ tary environment is positive, and therefore the curve be moves on the right (where the level of  pollution emissions e ʹ is higher than e). then the lm’ , be’ is ʹcurves intercept in eʹ. this position  being unstable, when the level of income is declining to return to y, the level of emissions is declin‐ ing as well and hence the curve be shift back. indeed, the money supply experienced an exoge‐ nous destruction  of money, so the multiplier monetary environmental operated but with a decline  in money supply. hence the economy  has experienced a reduction in emissions in the normal case,  and therefore a return to the level of emissions at its initial level e after passing through the level e  ʹ: the economy has returned to its initial level of wealth and pollution.   if we turn now to the unusual case, illustrated figure 5, the results are greatly changed.  volume 40 • spring 2008 • 21  lm lm' bpis be(e) be'(e') e'<e e e' r r' y y' y r        figure 5. effect of an active monetary policy in open economies on the level of income and that of emissions  in the unusual case.  in  the unusual case,  the  sign of  the  monetary multiplier environmental  tells us  that  any  change in the money supply reflects a change in direction in the level of emissions, because the  declining interest rate stimulates heavily investing in pollution control that compensates well be‐ yond or even adverse effects on investment usual. as a result, an increase of the amount of cur‐ rency in the case abnormal, leads to lower emissions of pollution. therefore, active monetary pol‐ icy by lowering the level of interest rates going from r to r ʹ, stimulates the economy which income  rise from y to y ʹ. but in the open economy eʹ is a situation of unstable equilibrium because situ‐ ated below the curve of the balance of payments, which is in deficit. indeed with a perfect capital  mobility declining interest rates caused a flight of capital which therefore reduces the lm curve to  its original position. the level of income returns to y, and hence the economy returns to its stable  equilibrium position, e. from an environmental point of view, the situation is reversed. at first,  when the income rise from y to y ʹ, the level of emissions decrease, following the stimulation of  investment in pollution control, and therefore the curve be moves left to beʹ where e ʹ<e. but this  position is an unstable economic equilibrium. when the level of income return from y’ to y the  level of emissions increases in response to the declining investment in pollution control. so the  curve be ʹ leaves back and returned to his original position, be, where the level of emissions re‐ gains its initial level e. hence, after adjustments, the economy has returned to its initial level of  wealth and emission pollution.   note finally that in the unusual case we make the implicit assumption that the private sector  of investment in control of pollution is an extremely important sector of the economy with the con‐ comitant assumption that the firms, when they formulate their expectations, know that the gov‐ ernment is committed to not to relax the laws and standards, and therefore not depress demand  for goods of pollution‐control equipment, explaining the important weight of this sector. it is there‐ fore a very special case which to our knowledge doesn’t exist up to now in the reality  where the  private sector of investment in pollution control is less important than usual private sector:  that’s  why we consider it as an abnormal case.   conclusion   the introduction of pollution in the form of stock in a dynamic is‐lm model, has allowed us  to analyse the environmental consequences of macroeconomic policies. according to the model, an  environmental public expenditure, even if it leads to increased pollution  is preferable to a usual  2007 ‐ 22  •  economic analysis®  public expenditure, because it causes relatively fewer emissions of pollution that the latter, for an  identical increase in national income. the environmental effect of an expansionary monetary pol‐ icy depends on the type of economy involved in.  in the unusual case, where the bulk of invest‐ ment activities would be dedicated to clean‐up, any change in money supply leads to a variation in  the opposite sense in the level of pollution, for the reason that a lower interest rate stimulates in‐ vestment in pollution control that compensates the much more adverse effects of investment in  usual sector. in the normal case where the private sector pollution is smaller than the usual private  sector, any monetary policy induced by the decline of interest rates encourages more the usual  investment ( with environmental standards unchanged), thereby increasing pollution and the in‐ come levels. hence, one of the major lessons of this model is that what is important is the expecta‐ tions  in the sector of the pollution  control and the size of this sector relatively to the rest of the  economy. also, a government anxious to make a sustainable economic growth should give priority  to try to drive the expectations of these pollution control firms through environmental standards  increasingly severe as long as the economy did not have a private sector of pollution control at  least as important in its economic size as the usual private sector. in the meantime, environmental  public policies should be preferred, from an environmental point of view, to any monetary and  budgetary policy, provided that public environmental measures are concrete and truly effective  remediation. thus, our findings reinforce the arguments of post‐keynesians like peter bird9, who  recognized the importance of informational constraints in a state of uncertainty, and prefer main‐ taining standards seeking optimality.  moreover, if one takes as relevant the criterion proposed by daly of ʺcarrying capacityʺ, ie  the optimal scale of the economy compared to the ecosystem behind it, we can conclude that our  model, except in unusual circumstances, show that any monetary or budgetary policy increases the  pollution level and therefore drive the economy a little closer to the sustainable limit. if the econ‐ omy is in an unusual case, one moves more and more of this limit, then there is sustainable devel‐ opment in its fullest sense.  bibliography   bird p. w. n.(1982), neoclassical and environmental post‐keynesian economics, journal of post‐keynesian economics, 4(4),  pp586‐593.  daly h. e.,elements of environmental macroeconomics, in costanza r , ecological economics, the science and management  of sustainability, columbia university press, new york, pp 32‐45.  gradus r., smulders s. (1993), the trade‐off between environmental care and long‐term growth, pollution in three pro‐ totype growth models, journals of economics, 58(1), pp25‐51.  ouyahia e., macrodynamics and international pollution in open economies, thesis  presented nice january 15, 1999.  pearce d, markandya a, barbier e.b  (1989), blueprint for a green economy, london, earthscan publications.  strom s, (june 1973)  economic growth and biological equilibrium, swedish journal of economics, 75(2).  mathematical appendix  the resolution of the dynamic system passes through the calculation of values of the main matrix. the result is the char‐ acteristic polynomial following:  ( ) [ ] ( ) ( )[ ]p s t t l m f s t t m l f h m a bλ δ λ λ λ= − − + − + + + + + − + + + + + + =² ( ) ( ( ) )( ) ( )( )1 1 0     the resolution of this polynomial imposes using the determinant δ where :  9 bird p. w. n.(1982), neoclassical and environmental post‐keynesian economics, journal of post‐keynesian economics,  4(4), pp586‐593.  volume 40 • spring 2008 • 23  δ = − + + − − − + +( ( ) )² ( )( )s t t m l f h m a b1 4 .  if δ  is positive, then the three values, solutions of the previous polynomial equation are three real rootsl:  δλ −=3 and  [ ]λi s t t l m f= = − − − − − − ±1 2 12 1, ( ( ) ) δ .   if  δ  is  zero,  then  the  three  values  of  polynomial  previous  solutions  are:  δλ −=1   and  a  real  double  root  ( )[ ]fmltts −−−−−−= )1(21λ .   if  δ    is  negative,  then  the    three  values  of  polynomial  previous  solutions  are  λ δ3 = −   and  two  complex  roots  ( )[ ]δ±−−−−−−== ifmlttsi ))1((212,1λ    all the real values are strictly negative, the model is stable.    microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp118-132 original scientific paper modeling wealth effect in consumption function based on system of national accounts (sna) data ivana jovanović1* 1 statistical office of the republic of serbia, belgrade, serbia abstract the study explores the influence of housing wealth, as well as other wealth variables, on consumption in the frame of life cycle-permanent income theory. the sample consists of three former socialist countries and the model used was based on models initially developed for advanced economies, most notably norway and the netherlands. the paper, based, where necessary, on a compiled data set, uses a more complete list of variables than similar studies and relies on comparative analysis to come to plausible results and interpret them. the results differ from those obtained in other studies for the same or similar type of countries or even the same economies, and that is that movements in value of housing stock do not influence consumption of households. in addition, the paper explains why housing wealth is not part of consumption function in former socialist countries with certain macroeconomic structure, and that is low part of unpaid mortgage debt in the financing structure of housing wealth. the reason is that mortgage financing causes the price movements of housing wealth to influence consumption, especially in developed countries where workforce is highly mobile and financial innovations are present and mortgage financing dominates housing stock. key words: system of national accounts, wealth effect, consumption function, economic transition, johansen’s procedure jel classification: c01, e01, e21, e37, e60, p1, p2, r20 introduction wealth effect in consumption function is a phenomenon known since as early as the days of keynes, and it means that consumption is influenced not only by current or permanent income but also by wealth. by wealth we mean housing wealth (hw), or value of houses influenced by physical stock and prices, securities or market shares held by households (sec) and other financial assets like savings decreased by financial liabilities most notably mortgage liabilities (fafl). system of national accounts (sna) worldwide, and it counterpart in europe, european system of accounts (esa), as internationally developed accounting framework for macroeconomic statistics is source of data for the wealth effect analysis. while data for other sample countries (slovenia and czech republic) were readily available in the eurostat´s database, serbian data had to be constructed for this study as serbia is still on its way to harmonize statistics with european and world standards. * e-mail: ivanakirovic@gmail.com ivana jovanović 119 is wealth effect present in former socialist and transition countries similar to serbia, as regards their economic history? which components of wealth are statistically significant in their consumption function? are there similarities between sample countries? how is their economic structure different from, for example the netherlands whose macroeconomic model contains all components of wealth (see second part)? the aim of the research was to explore the consumption function in similar countries like serbia, i.e. former socialist (post) transition countries on the basis of system of sna data by sectors and to compare the results within the sample but also with the models of developed countries. comparative analysis was aimed to give answers about the mechanism of influence of wealth effect components on consumption. not only we come to decisive and different result than similar studies, we also offer the explanation of mechanism of influence of the housing wealth on consumption which is original contribution of the study. the paper consists of five parts: literature review, data and the methodology, research results and interpretation, mechanism of impact of housing wealth and other wealth variables on consumption and conclusion and implications. literature review this paper explores consumption modeling based on permanent income-life cycle theory models, in developed countries. according to the life cycle–permanent income hypothesis, consumers estimate their long–term ability to consume (hall, 1978 in jovanovic, 2016) based on wealth (modigliani) or permanent income (friedman). hall (1978) points out that permanent income is unobservable category. the wealth effect – the effect of financial and non-financial asset prices and value on consumption – has been analyzed by several economists, including keynes, as mentioned earlier (“windfall changes in capital values as a major factor capable of causing changes in propensity to consume”, speight 1990, ch.6 in brodin and nymoen 1992, p 433). park (1996, p. 48) points to deaton (1972), who emphasized, in the context of a modified lifecycle hypothesis, that rapid changes in financial assets play a substantial role in determining private consumption. the relevance of physical assets (see park 1996, p. 48), including land and housing, to consumption has been tested only sporadically in the literature. perhaps the irrelevance of physical wealth like land in explaining private consumption behavior in the western hemisphere is due largely to the fact that in recent years the region has experienced little change in physical asset prices compared to far-east asian countries (i.e., japan, korea, and taiwan). deaton (blinder & deaton,1985), points out that consumption depends only on part of gross disposable income which is made up of salaries and not on capital income like dividends and rents, because their discounted value is a part of wealth. we want to stress that other approaches, as regards the consumption function model, in developed countries, like the netherlands (centraal planbureau, 2010, see second part) and norway (brodin, nymoen, 1992; also see rimini model in bårdsen, g. et al, 20101), take wealth as a sum of all the wealth components, housing wealth as well financial saving and liabilities of the households. de bonis and silvestrini (2011) separate housing wealth but take stock market shares together with other forms of financial assets and liabilities and find for eleven oecd countries that all variables are significant. wealth effect in developed countries is, as we have seen from the examples and before mentioned references, taken in models in those countries for the demand projections for conducting monetary policy for example the ecb (jovanovic, 2012), 1 the rimini model is based on quarterly data. the quarterly national accounts are the most important data source together with other statistics from the national accounting system and from norges bank’s database for financial sector balance sheets (findatr). see, kjetil & fredrik, 2001. also, see appendix 2. 120 economic analysis (2020, vol. 53, no. 1, 118-132) norwegian central bank or for other governmenet policies (for example, the netherlands). due to a different structure of the post-communist and post socialist countries, we take housing wealth and financial assets and liabilities separately and stock market shares owned separately as well, as we suppose that components of wealth of households have a different impact on consumption than in developed countries, which make separation of wealth components necessary. other studies of under developed countries include countries from the sample, but also developing asian countries (so called emerging economies). one study apply panel framework of analysis, without financial assets and liabilities component, with only stock market shares as regards financial assets and proves that housing wealth is significant (ciarlone, 2012). some individual studies concerning czech republic (šonje, 2012) prove significance of housing wealth in a model with only two variables, real wage next to the housing wealth, in the short run. in šonje et al. (2014) the authors do not come to decisive conslusion due to short time series for a group of former transition countries in a panel framework of analysis. weyerstrass et al. 2001, in model for slovenia, do not provide conclusion on the significance of the influence of housing wealth on consumption, as the model consists only of gdi and first lag of consumption and do not pass the specification tests (autocorrelation and heteroscedasticity). our study takes in the account the full list of variables, based on developed countries model, but all taken separately. the importance of our study is that wealth components are taken separately and that their list is complete, and we come to the decisive conclusion as regards the influence of housing wealth on consumption, which turned out to be not significant by all three sample countries and the financial assets decreased by liabilities and market shares proved significant. analysis was done on the basis of johansen’s procedure, and error correction model which passed all specification tests. data and the methodology three former transition countries were analyzed: serbia, czech republic and slovenia. until the third quarter of 2008, there was a steady increase in the value of consumption and other macroeconomic variables like housing wealth, gross-disposable income and financial market shares in the world economy, and also in the sample countries, when the effects of financial and economic crises due the read from the mortgage market in the united states started to be visible, and a drop was witnessed in the sample and in the world economy. even before the crisis, slovenia and czech republic reached the level of highly developed countries, whereas serbia is still middle income country. the sample for this research was formed with czech republic and slovenia, because it was presumed that they should be compared due to the relatively similar economic history. as we will see, one of the similarities is the high proportion of fully owned houses by households, which turn out to be a crucial element to explain the result of this study and difference with other highly developed countries with different background, like the netherlands. the model used is compiled based on models in developed countries and differ from the existing models in relevant literature for the sample countries because the list of variables is more complete. it differs from the model of the netherlands (see next section), in that, among others, that all wealth components are taken separately. in the netherlands, the fafl component is highly negative (see table 4), whereas, hw had a steady growth (graph1) so that adding of all wealth components including securities is understandable in case of the netherlands. ivana jovanović 121 econometric model in use in centraal plaanbureau in the netherlands centraal planbureau (cpb) (de jong 2011, centraal planbureau 2010)2 has developed a long term and a short term consumption model ecm, „equilibrium error correction model“. wealth variable is a sum of components in long term model. the idea is that as the wealth of the households as a total rises in the long run, the saving, securities, net housing wealth (housing wealth decreased by mortgage liabilities), consumption rises in the long run. in short run, on the other hand, taking loans, using savings or selling of securities (which leads to decerease of wealth) causes the rise of consumption. in short run, households can decide to refinance their mortgage under more favorable conditions because the rising of house prices is usually followed by the fall of the mortgage interest rate, or, in developed countries they can make use of financial innovation allowed in most developed countries, which is, to get consumption loan based on the overvalue (higher value of dwelling compared to mortgage debt) so that the consumption rises (centraal planbureau, 2010).3. this channel works in the long run as well (see ludwig & slᴓk, 2002)4. in short run, rise of the prices of market shares can result in fall of wealth, due to a selling of the securities, which boosts consumption in the short run. in the ecm model of the cpb, which explains short term variations of consumption, for hw and sec the price variations are taken in the account, next to the term which describes the adjustment to the cointegration relation, because of the explained influence of the prices of dwellings and securities in the short run on consumption and saving. interesting is that, in the long run, increasing wealth leads to increase of consumption, whereas, in the short run, it is vice versa. the short term deviation from the cointegration relation is adjusted to it via the ecm coefficient. in the dutch short run model, the effect of the prices of the dwellings is visible clearly, whereas in the long run model dwellings are part of a total wealth. dutch mortgage debt is substantial, as we have seen before, so that decrease of total wealth with that figure substantially adjusts wealth total, and the correction of saving only, with mortgage liabilities, would yield a negative net financial assets (see table 4, ratio fafl/gdp is negative for the netherlands which also means that fafl variable is negative). in dutch model of cpb (de jong, 2011), two types of households are distinguished: lch households (those who behave in conformity with the „life cycle hypothesis”) and rot (from engl. „rule of thumb“) households. lch households own financial and non-financial assets (dwellings) and are capable to adjust their consumption during the life cycle in accordance to their total life capital or ltw („life time wealth”). this aggregate consists of assets (financial, like stock market shares, savings, decreased by loans, mostly mortgage loans and non-financial i.e. dwellings) and salaries and social benefits. these households invest in houses, save in the form of stocks and other securities and have access to financial market. they take loans and invest to absorb the shocks and smooth the consumption during time. these households adjust their portfolio dependent on the relative performances of stocks and deposits. even probability of death is a presumption which makes aggregate consumption function possible (blanchard 1985, in de jong 2011). rot household, on the other hand, don’t have access to a financial market and spend all their income every month. as a consequence, they don’t accumulate financial assets and shocks in their gdi influences directly their consumption. long term model (cpb 2010)5 is: 2 dutch central bank uses the similar model. see de nederlandsche bank 2011. 3 this possibility is available in the netherlands since 2004. 4 their model comprises of housing and stock market wealth and disposable income as a whole, not only labour income. wealth components are proxied by their prices. 5 first part of model concerns lch and second of rot households. 122 economic analysis (2020, vol. 53, no. 1, 118-132) 𝐶 ß 𝜆 (𝑊𝑔 + (1 𝜙 ) 𝐿𝐷2 + (1-𝜙 𝑂𝐷2 + – + 𝜙 𝐿𝐷2 + 𝜙 𝑂𝐷2 𝑅 = 0.99, time span 1971 – 2008 (annual data) description of variables abbreviation: c – long term level of consumption of households ß– rate of the time preference of money 𝜆 –probability of death 𝑊𝑔– net assets of households (pension capital excluded) 𝜙 – proportion for rot households 𝐿𝐷2 – income of work (without dividends and interest6) 𝑂𝐷2 – social benefits of the households 𝜙 – proportion for rot households 𝑟 – long term interest rate, net (after tax on salaries and social security contributions) 𝑝 – expected rate of net salaries θ – risk premium the fourth element is for discounting of the future flows of work income and social and pension benefits. short term model is (cpb, 2011): ⁼ c1 c2 1-q65 c3 δ𝑟 + c4 + c5𝑤 𝑤 + c6 1-𝑤 𝑤 c7 𝑙𝑛𝑐 – 𝑙𝑛𝑐∗ + c0 𝑅 = 0.88, time span 1973 – 2008 (annual data) description of variables abbreviation: c – short term consumption c* – long term consumption ldc – available work income of households q65 – pressure of ageing of the population (65⁺/20-65years) odc – social benefits of households 𝑤 – housing wealth (mutations concern average price7) 𝑤 – value of securities (shares) of households (mutations concern price movements) 𝑤 binnary variable for shares (take value 1 when rise) 𝑤 – percentage of households that own shares 𝑟 real interest 𝑙𝑛𝑐 – 𝑙𝑛𝑐∗ – ecm term („error correction model”) we can see that in a short consumption function, components of wealth (housing and securities i.e. market shares) are given separately, while, in the long term function they are taken together. reason for this is that in short run price movements of housing stock and stock market 6 dividends are implicitly captured in capital from shares, which is part of total net assets, under presumption that the price of shares is equal to the present value of future dividend flows, idem, pg. 12. interests are present in ltw (life time wealth) ß, 𝑟 , idem, pg. 11. on the contrary to this concept, in model of central bank of the netherlands (de nederlandsche bank, dnb), gdi as a total income is a variable. (dnb, 2011) 7 𝑤 = 𝑝 𝑊 , housing wealth is a product of average change of annual price and average housing stock last year. idem 𝑤 . cpb, 2011, pg.12. ivana jovanović 123 shares influence consumption markedly, presented as variables 𝑤 and 𝑤 . these price movements influence conscious decisions about augmentation and decrease of saving, i.e. consumption, and the measure in which the consumption will deviate from long term cointegration relationship (the level of the ecm parameter). for example, rising of share prices can result in their selling or additional taking of loans so that consumption can rise in comparison to the long term level defined by the cointegrating relation. with time, this decision about decrease of savings (or augmentation of liabilities) brings consumption back to the equilibrium level because lower level of wealth means lower level of consumption in the long run. interest rate in the short run model is interest rate on commercial credits. the model the base for analysing the wealth effect in sample countries` consumption function is the quarterly var model made up of the sna defined variables, c, gdi, fafl, sec, hw and sal where c – household consumption8 gdi – gross disposable income of households (excluding property and gross mixed income n case of serbia) sal – salaries fafl – savings (s) and transaction deposits (d) of the households decreased by financial liabilities or loans (l) by banks, end of period hw – housing wealth, value of household residential property, end of period sec – value of securities (shares) in the hands of households, end of period variable_sa – de-seasonalized variable quarterly data run from q1 2004 up to q2 2014. seasonality was excluded by the use of x12 census model. level data were available for czech republic and slovenia from the eurostat database, and it was somewhat necessary to construct quarterly data as regards hw variable, as quarterly stock data are not, whereas flow data are available on quarterly basis. logarithms of data were used. for serbia, the stock data of all variables were compiled and constructed by the author, based on data of the statistical office of the republic of serbia (sors), the data of the national bank of serbia, financial exchange and the securities commission of the republic of serbia. the data for the gdi were based on household budget survey conducted by sors. in jovanovic (2016), more details are given about the construction of serbian data. the methodology the paper employs cointegration analysis in order to determine the significance of individual wealth components in consumption, and analysis of macroeconomic ratios. in already mentioned paper, jovanovic (2016), we have dealt with the methodology of the johansen’s procedure and all additional testing, on the example of serbian data. the same was applied to two other countries of our sample, czech republic and slovenia. the paper uses the relevant quantitative methods of time series analysis. firstly, the presence of the season component is tested in the time series and the series de-seasonalized where necessary, then the nonstationarity of time series is established, and lastly cointegration and vector autoregression (var) analysis are implemented. next to johansen’s procedure, which resulted in one cointegration vector in cases of serbia and czech republic, augmented dickey fuller unit root and zivot endrews tests of unit root, in cases of structural breaks were applied. specification tests were applied to vecm (vector error correction model). also constrain tests with bartlett 8 institutional household sector as defined in sna 124 economic analysis (2020, vol. 53, no. 1, 118-132) correction helped to establish appropriate model i.e. to determine variables that enter cointegration relation. comparative analysis of macroeconomic ratios which put into relation mortgage loans and housing stock, enabled deeper interpretation of the research results (the netherlands versus sample countries) and to discover the mechanism of effect of housing wealth on consumption. graph 1. the netherlandshousing wealth source: eurostat research results and interpretation vecm passed all specification tests. johansen’s procedure, resulted in one cointegration vector in cases of serbia and czech republic. fafl and sec vaiables are found significant and enter the cointegration relation with consumption in both serbia and czech republic. their sign is positive. in case of fafl variable, the sign can be negative in ecm, and that is the case for serbia (see table 2 in appendix 1). in short run, households can take commercial loans and increase consumption, but after some time, increased loans or decereased fafl will cause consumption to fall (via ecm parameter) to the equilibrium level found by cointegration relation. the more detailed results are presented in anex 1. here, we summarize in short, the research results presented in table 1,2 and 3 and in appendix 1. slovenia: no cointegration found czech republic : c = 0,101fafl + 0,477sec + 4,449 ecm (error correction model) param. = -0,3 (-4,428) serbia: c = 0,098fafl + 0,145sec + 6.340 ecm param. = -0,806 (-8,59) in tables 1, 2 and 3 the results after application of johansen’s procedure and ecm specification tests are summarized and results for slovenia (var of differenced variables): 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 300000 400000 500000 600000 700000 800000 ivana jovanović 125 table 1. results of the johansen´s procedure for serbia results variables serbia level of integration cointegration relation (coeffic.) consumption i(1) 1 gross disposable income salaries i(1) net financial assets i(1) 0,098 securities i(1) 0,145 housing wealth i(1) ecm parameter (t-statitics) ‐0.806 (‐8.59) ecm, jarque bera norm. test 0,92 ecm, breusch godfry autocorrelation test 0,08 ecm r², adjusted 0,64 source: author’s analysis based on application of johansen’s procedure and usual tests table 2. results of the johansen´s procedure for czech republic results variables czech republic level of integration cointegration relation (coeffic.) consumption i(1) 1 gross disposable income i(1) salaries i(1) net financial assets i(1) 0,101 securities i(1) 0,477 housing wealth i(1) ecm parameter (t-statitics) ‐0.28 (‐5.59) ecm, jarque bera norm. test 0,45 ecm, breusch godfry autocorrelation test 0,36 ecm r², adjusted 0,68 source: author’s analysis based on application of johansen’s procedure and usual tests table 3. results of the johansen´s procedure and var of first differences for slovenia results variables slovenia level of integration cointegration relation (coeffic.) consumption i(1) gross disposable income i(1) salaries i(0) net financial assets i(1) securities i(1) housing wealth i(2) ecm parameter (t-statitics) ecm, jarque bera norm. test ecm, breusch godfry autocorrelation test ecm r², adjusted var of first differences: variables commerc. loans interest rate, gdi, sec 126 economic analysis (2020, vol. 53, no. 1, 118-132) var of first differences: normality 0,11 var of first differences: portmanteau autocorrelation test up to lag 12 0.07-0.24 var of first differences, r², adjusted 0,24 source: author’s analysis we see from tables 2 and 3 that ecm models for serbia and czech republic, as well as the var of the first differences for slovenia pass the specification tests. additional variable, interest rate on commercial loans was introduced for slovenia in order that model pass the specification test (autocorrelation and normality of residuals). now, we present the table 4 with comparative macroeconomic ratios, for the sample countries as well as for the netherlands. table 4. macroeconomic ratios comparative analysis fl/gdp fafl/gdp hw/gdp nethw/gdp sec/bdp nethw/ hw fl/hw serbia 14% 6% 5,41 5,27 5% 97% 3% slovenia 23% 14% 1,76 1,53 11% 87% 13% czechia 21% 15% 1,14 0,94 6% 82% 18% netherlands 118% -52% 1,22 0,08 24% 6% 97% source: eurostat and authors calculations we see that relatively high proportion of housing is fully owned by households in former socialist countries (ratio nethw/hw is almost 100 in three sample countries), whereas in the netherlands predominant part of housing if financed by mortgage debt (ratio of financial liabilities of the households, which is predominantly mortgage debt fl/hw amounts to almost 100%). mecahism of impact of housing wealth and other wealth variables on consumption several channels of influence of wealth variables on consumption in developed countries are presented in the relevant literature. campbell & coco (2005) have determined that the saving from precaution changes by households with mortgages when house prices change, and that this channel is insignificant at households with no budget restraint, or which own the house. they found that changes in consumption as a result of change in house prices are the biggest with elderly population and close to zero by young people who rent houses. credit terms become more relaxed when house prices rise. in great part of literature for developed countries the macroeconomic effect of house prices on consumption is linked to financial liberalization which made possible the financing of consumption from the positive difference of the house in comparison to the mortgage value (for example aouki et al., 2014). ludwig & slᴓk (2002) housing wealth is significant variable in the consumption function in the netherlands as well as in other developed countries. if we look at table 4, we see that almost all housing stock in the netherlands is financed through the mortgage financing. the opposite is truth for the sample countries. last column of table 4 shows that the percentage of financing of housing wealth in countries amounts 3 – 18% while in the netherlands it is 97%. it is obvious, then, that here lies the answer how the housing wealth prices fluctuations impact consumption in the long run. the effect of the housing wealth on consumption goes through mortgage financing and workforce relocation. that is why the effect of housing wealth on consumption can be visible only if the proportion of mortgage financing is relatively high in the total of housing wealth, and that is not the case in sample countries, so the housing wealth effect is there not present. ivana jovanović 127 here we go in detail about the mechanism of housing wealth on consumption, next to the effect of financial innovations which we mentioned in the part about centraal planbureau methodology. in the periods when the house prices rise, the possibility to sell the dwelling present no burden to owner household, in a situation of divorce, moving to elderly accommodation (see campbell & cocco, 2005) or relocation for other reasons like work, which is common in the netherlands. in the situation of bursting of big housing bubble like in 2010 in the netherlands, when houses prices dropped by 15% and more, household naturally became more cautious with spending, increased their savings to cover the potential loss of selling the house, and therefore the negative impact on consumption is obvious to explain. the opposite happens when the house prices rise. given that fafl variable is significant in sample countries, and effects positively consumption, mortgage finance that dominates fl obviously influences consumption, because mortgage loans present increase of financial burden on the households. share of securities in comparison to gdp is significant only in the netherlands, so that we conclude that the channel through which securities influence consumption in the sample countries is through the expectations of the public captured on the financial exchange. furthermore, as securities variable is highly correlated with the housing wealth (for serbia, correlation coefficient is 0.57) we can expect that the studies which don’t take into account sec variable could find hw statistically significant (as šonje, 2012). conclusion and implications the main result of the paper is that housing wealth is not significant in the long run in sample countries. effect of the housing wealth on consumption goes through mortgage financing and workforce relocation and financial innovations linked to mortgage financing which are present in developed countries. the insignificance of housing wealth in the sample countries is explained by the fact that relatively high proportion of housing is fully owned by households in former socialist countries, while in the netherlands predominant part of housing if financed by mortgage debt. the effect, of mortgage financing on consumption will be visible on the macro level in countries where mortgages are dominant in the financing of the housing stock, which is not the case in countries from our sample. the effect of stock market shares is most probably captured through the expectations channel. securities enter the cointegrating relation in all sample countries. gdi is not significant except in the var of first differences in slovenia. salaries did not enter the cointegration relation. net financial assets are found significant and enter the cointegration relation in all sample countries. until the mortgage proportion in financing the housing wealth stock is at the relatively low level, quarterly data on housing wealth will not be relevant for modeling consumption in serbia. future research could rely on the sors data, once available, and panel data analysis, but it is not expected that this research avenues will yield relatively different results. some other research study based on sors time series can confirm or disapprove the soundness of compiled data from this study. however, same result for two analyzed countries with similar macroeconomic ratios, serbia and czech republic, could be taken as a proof of soundness of the results and data quality compiled for serbia. this research, starting from models developed for countries like norway and netherlands, added more explanatory variables in the analysis. this way, the paper contributed to the existing literature in the field of studying wealth effect in former transition countries. by adding variables, separately, like net financial assets and stock market shares, anovel result different from those for other panel and individual studies (ciarlone, šonje et al.), emerged – housing wealth does not exert significant influence on private consumption in analyzed former transition economies. 128 economic analysis (2020, vol. 53, no. 1, 118-132) acknowledgements this paper is the result of collaboration with gorana krstic, professor of economic statistics at the university of belgrade who kindly initiated and defined the scope of this research and zorica mladenovic, professor of econometrics at the university of belgrade, who kindly provided expert help in the field of applied econometrics. references55 aoki, k., proudman, j., vlieghe, g. 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(2001). slopol1: “a macroeconomic model for slovenia.” international advances in economic research. february, vol. 7, issue 1, pp 20–37 ivana jovanović 129 appendix appendix 1 more results of johansen´s procedure table 1. results for serbia: testing imposing restrictions ß (1) α (1) variables equations c_sa 1 (na) dc_sa ‐0.806 (‐8.590) gdi_sa 0.000 (na) dgdi_sa -0.467 (-2.682) hw_sa 0.000 (na) dhw_sa 0.000 (0.000) sec ‐0.145 (‐12.518) dsec 0.000 (0.000) fafl ‐0.098 (‐10.734) dfafl 0.000 (0.000) constant -6.340 (-62.911) test of restricted model: χ²(5) = 8.988 [0.110] with bartlett correction: χ²(5) = 5.166 [0.396] source: author´s analysis table 2. ecm model for serbia variable parameter estimate t statistics zᵼ-1 -0.806 -8.59 dc_saᵼ-1 0.31 2.84 dsecᵼ-1 -0.079 -2.133 dsecᵼ-2 -0.152 -3.786 dfaflᵼ-2 -0.043 -2.123 dc_saᵼ-3 0.362 3.035 dfaflᵼ-3 -0.082 -3.961 dfaflᵼ-4 -0.089 -3.673 source: author´s analysis 130 economic analysis (2020, vol. 53, no. 1, 118-132) table 3. matrices for czech republic ß (1) α(1) variables equations c_sa 1 (na) dc_sa ‐0.300 (‐4.428) fafl_sa ‐0.101 (‐1.846) dfafl_sa 0.060 (0.487) sec ‐0.477 (‐18.040) dsec -0.556 (-2.149) constant -4.449 (-8.527) model adequacy: autocoorelation tests: lm(1): χ²(9) = 14.861 [0.095] lm(2): χ²(9) = 4.746 [0.856] normality test: χ²(6) = 5.612 [0.468] source: author´s analysis note: see notes by table 5 table 4. ecm model for czech republic variable parameter estimate t statistics zᵼ-1 -0.28 -4.42 dc_saᵼ-1 -0.33 -1.6 dc_saᵼ-2 -0.5 -2.61 dfafl_saᵼ-1 0.65 5.21 dfafl_saᵼ-2 0.27 1.71 dfafl_saᵼ-3 0.25 1.91 source: author´s analysis ivana jovanović 131 table 5. trace test for var(4) c, fafl, gdi, sec, dhw slovenia i(1)-analysis r p-value p-value* 0 0.000 0.457 1 0.000 0.325 2 0.001 0.278 3 0.009 0.241 4 0.210 0.328 model adequacy: autocoorelation tests: lm(1): χ²(10) = 23.710 [0.536] lm(2): χ²(25) = 23.838 [0.529] normality test: χ²(25) = 11.918 [0.291] source: author´s analysis notes: a) p* is bartlett‐corrected p‐value b) lm(1) is the ljung box test based on the estimated auto‐ and cross‐correlations of the first t/4 lags. see dennis (2006), p.51 c) lm(2) is the test for the nth order autocorrelation, idem d) test for normality is the doornik‐hansen test, idem 132 economic analysis (2020, vol. 53, no. 1, 118-132) appendix 2 interest rate transmission mechanism from rimini model (norway central bank) figure 1. interets rate channels in rimini given constant exchange rate source: bårdsen, g. et al., 2010, pg. 13 article history: received: november 27, 2019 accepted: may 23, 2020 money market rates (3-month euro-nok) bank deposit and lending rates nominal exchange rate households: disposable income wealth loans housing prices expectations enterprises: income wealth loans stock prices expectations private consumption housing investment business sector fixed investments productivity production employment output gap inflation wage-setting unemployment ea_2018_3-4 olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža et al. 81 doi: 10.28934/ea.18.51.34.pp81-94 original scientific paper estimation of tobacco products price and income elasticity using aggregate data olivera jovanović1* | jovan zubović1 | marko vladisavljević1 | duško bodroža1 isidora ljumović1 | ivana domazet1 | mihajlo đukić1 1 institute of economic science, belgrade, serbia abstract the main aim of this paper is to estimate long run and short run price and income elasticity for cigarettes based on aggregate level data for period 2002-2016 using error correction model. in order to estimate elasticity of demand for tobacco products authors of this paper used aggregate level data. because the cigarettes make the largest share in overall consumption of tobacco products in serbia, conducted research is based on approach that 90% of total consumption of tobacco products are cigarettes. this research is unique in the see countries, while research conducted in other low and middle income countries in western balkan region showed similar results. price elasticity among the see countries is in range between -0.44 and -0.78 research among low and middle income countries over the world empirically showed that demand for tobacco products is usually inelastic. analysis conducted in the republic of serbia showed that price elasticity ranged between -0.76 and -0.62 while income elasticity ranged between 0.34 and 0.39. key words: tobacco products, consumption, elasticity, price jel classification: e20, h20, c13 introduction in order to empirically estimate the long-term and short-term effects of increasing cigarettes price on cigarettes consumption in serbia we have used the error correction model (ecm). this model is often used in research among countries with low and middle income to estimate price elasticity using macro aggregate data (ross and al-sadat, 2007). research nalysis aims to present price and income elasticity for tobacco products in serbia using official statistical data for the period 2002-2016. according to official institute for public health “batut” data more than one half of total population consumed tobacco products in a lifetime (health and statistical yearbook for serbia, 2018), while world bank data shows that in 2017 at least 33% population above age 15 in serbia smokes at least one cigarette per day, amounting to about 2,457,000 active smokers (tobacco control fact sheet, serbia). thus, tobacco products’ consumption in serbia should be of high concern to policymakers. results of empirical research shown in this paper can help policy makers (in the field of economics, finance and health) to understand the factors affecting the demand for cigarettes including their prices/taxes, others tobacco control policies, and income so that they can design policies to lower tobacco use in serbia. * corresponding author, e-mail: olivera.jovanovic@ien.bg.ac.rs 82 economic analysis (2018, vol. 51, no. 3-4, 81-94) the main obstacle in this analysis was the lack of data to construct a long time series. given that only a short time series is available, we have carefully defined variables to assure that they are compatible and found the best methodological approach to deal with data deficiency. we opted for a classic linear model of cigarette demand with consumption per adult as a depended variable, while real tobacco price and real income are the primary independent variables. the model tested for the impact of various tobacco policies as well as for a summary index of tested tobacco control policies. other relevant variables that could affect consumption such as tertiary education, life expectancy at birth for male and female, average employment and employment rates for male and female were also tested in the models but not included in the final specification and presentation of results due to concerns related to the degree of freedom. data cigarette demand price and income elasticities were estimated using annual data. we have constructed several linear models of cigarette demand with a maximum of three independent variables to preserve the degree of freedom. cigarettes consumption and cigarette price data in serbia are available only for the period after year 2002. several measures of cigarette consumption and cigarette price have been accounted for and tested their properties to assess their suitability for our models. the dependent variable is the annual cigarette consumption per capita of adult population1. this measure of aggregate cigarette consumption is calculated using retail sales volume as reported by the statistical office of the republic of serbia. since the volume is measured in the sticks, we divided it by 20 to get cigarette consumption in packs (figure 1). we have also considered an estimate of consumption based on the household budget survey data (hbs). however real consumption is underreporting in hbs data by a large amount and was therefore abandoned. another possible measure of consumption can be derived from cigarette production added to net import and export level. this measure resulted in unstable estimates, most probably due to time lags of recording foreign trade, so we excluded it from further analysis. figure 1. cigarettes in packs per adult, 2002-2016 source: statistical office of the republic of serbia 1 population of age 15 and older olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 83 the most important independent variable is the price. we first considered official data on weighted average cigarette price and the price of the most sold brand2, but their values do not exist for all years included in the model. therefore, we opted for real (or relative) tobacco price index3 (real tobacco cpi; figure 2) that we obtained by deflating (using general cpi) nominal tobacco cpi published annually since 2007 by the statistical office. methodology for creating tobacco cpi was implemented in 2007 by statistical office of the republic of serbia. so we extended time series data using official statistical office methodology for calculation and extrapolation of real tobacco cpi. real tobacco cpi in the period 2002-2016 is shown in figure 2. figure 2. tobacco price index (real tobacco cpi), 2002-2016 source: statistical office of the republic of serbia real income was measured by real gross domestic product (gdp) per capita obtained from the statistical office of the republic of serbia. 2 available in official gazette of republic of serbia 3 tobacco price index is official data available in statistical yearbook, published annually by statistical office of republic of serbia. it represents a retail price index of tobacco products, calculated by weights that present structure of household consumption of cigarette and other tobacco products. it is obtained from the data of hbs, national accounts, trade and catering trades statistics, particular ministries etc. note that in serbia, cigarettes are main consumed tobacco product. because this index is available as chained, we converted into base index and extended time series. 84 economic analysis (2018, vol. 51, no. 3-4, 81-94) figure 3. real gdp per capita, 2002-2016 source: statistical office of the republic of serbia tobacco control policies are an essential factor in the demand for cigarettes as well as for all other tobacco products consumption we have analyzed the impact of two policies in our models using dummy variables for the ban on smoking in all public indoor areas (value 0 before 2005, value 1 otherwise) and the ban on tobacco advertising (value 0 before 2010, value 1 otherwise). effects of implementing regulatory policies were measured separately, including one by one variable in the model. we created a tobacco policy index by adding up the two dummy variables which represent the summary measure for tobacco control policies. even though many factors influence the final price of cigarettes, the most essential policy-related determinants of cigarette prices are taxes (chaloupka et al., 2010). chronically poor competitiveness of serbian market during the global economic crisis has become a basic weakness of serbian economy. therefore, the negative effects of the crisis in serbia felt widely, exposing the deep structural problems of serbian economy (domazet, stošić, 2013). those are reasons why we decided to include in analysis several variables more. current socioeconomic environment indicate the importance of employment (male and female) into our study (đuričin, pantić, 2015). we have used other independent variables such as the number of graduates with tertiary education (to measure impact of education on cigarette demand), average level of employment (an alternative measure of income and stress level) life expectancy at birth for male and female (to assess the impact of the return to the investment in health). structural changes lead to changes in the level of employment, especially in the private sector (ognjanović, 2013). in recent decades, women have successfully fought for their equality in society and proved they are capable of great achievements, so we used average level of employment for women in our study (ljumović, pavlović, 2017). however, results of the models including these variables are available upon request. table 1 and table 2 summarized the data used in our analysis. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 85 table 1. data used in the macro model of cigarette demand, 2002-2016 year retail volume (consumption of cigarettes, packs per adult)* real tobacco consumer price index** real gdp per capita*** tobacco control policy index law1 law2 2002 157.11 97.10 2280 0 0 0 2003 187.08 95.45 2505 0 0 0 2004 195.17 97.11 2675 0 0 0 2005 204.24 91.53 2836 1 1 0 2006 193.77 100.00 3297 1 1 0 2007 190.29 118.60 3990 1 1 0 2008 189.42 117.54 4586 1 1 0 2009 201.12 133.44 4187 1 1 0 2010 180.89 141.50 4082 2 1 1 2011 152.96 150.68 4619 2 1 1 2012 133.96 162.75 4400 2 1 1 2013 112.35 195.81 4781 2 1 1 2014 119.55 220.32 4672 2 1 1 2015 116.08 212.42 4720 2 1 1 2016 111.12 230.61 4904 2 1 1 *source: statistical office of republic of serbia, 2017 **source: statistical office of republic of serbia, 2017 ***source: statistical office of republic of serbia, 2017 law 1 is the law on the protection of the population from exposure to tobacco (2004) law 2 is advertising law (2009) table 2. data used in the macro model of cigarette demand, control variables, 2002-2016 year education, graduated students life expectancy at birth, female (%) life expectancy at birth, male (%) life expectancy at birth, total (%) employment level, average employment rate, women employment rate, male employment rate, total 2002 18,709 75 69.7 72.3 2,207,903 40.3 57.5 48.6 2003 19,748 75.1 69.9 72.4 2,168,678 38.7 56.9 47.6 2004 22,047 75.5 70 72.7 2,166,949 36.3 54.9 45.2 2005 27,537 75.6 70.2 72.8 2,171,457 32.9 52.4 42.3 2006 29,406 76.1 70.8 73.4 2,115,135 32.0 49.3 40.4 2007 32,039 76.5 70.9 73.6 2,085,242 33.8 50.3 41.8 2008 34,671 76.6 71.3 73.9 2,081,676 36.5 53.2 44.4 2009 40,330 76.7 71.4 74.0 1,984,740 34.0 49.1 41.2 2010 43,545 77 71.8 74.3 1,901,198 31.1 45.3 37.9 2011 46,162 77.2 72 74.5 1,866,170 29.0 43.1 35.8 2012 47,523 77.5 72.3 74.8 1,865,614 28.7 42.8 35.5 2013 47,797 77.9 72.6 75.2 1,864,783 30.8 45.2 37.7 2014 58,728 78 72.8 75.3 1,845,494 33.0 46.9 39.7 2015 50,501 77.9 72.8 75.3 1,896,000 35 50 43 2016 50,326 77.8 72.8 75.2 1,921,000 38 53 45 source: statistical office of republic of serbia, 2017 86 economic analysis (2018, vol. 51, no. 3-4, 81-94) the model specification tests conventional model in linear form is used to estimate the price and income elasticity of cigarette demand. all variables are used in real values. (1) yt = α + β1 x1t + β2x2t + εt, where t=1, …,15 (1.1) where the following represent: ytcigarette consumption per adult (retail sales volume in packs, per adult) x1treal tobacco price index (real tobacco cpi) x2treal gross domestic product per capita (real gdp per capita) β1price coefficient β2income coefficient model (1) includes only price and income measures as independent variables. therefore, their coefficients represent the upper bound, since the impact of tobacco control variables is not taken into account. model (2) is similar to model (1), but includes tobacco control policy. in this case, we used variable tban (law2) to reflect the adoption of the advertising law (ban on advertising of tobacco products). β3 is a coefficient capturing the impact of advertising law on cigarette consumption. (2) yt = α + β1 x1t + β2x2t + β3x3t + εt, where t=1,…,15 (1.2) we estimated several versions of demand model with tobacco control policies/event to find an adequate specification, but because the analysis is limited with the degrees of freedom, all individual policies could not be included in just one model. besides variable tban which is used in the model (2), variable tlaw1 (law on the protection of the population from exposure to tobacco) is implemented in the model (3). tobacco control policy index (tpi) defined as the sum of the other two indicators is used in the model (4). apart from these variables, we took into consideration life expectancy at birth4 (total) in estimated model 55. because life expectancy at birth of a female is not integrated at the same order as dependent and independent variables, we did not use it in final estimation of cigarette demand. the diagnostics of variables listed in table 1 starts with stationarity unit root tests. the classic analysis of time series is based on the assumption that the data are stationary, which implies a constant mean and a constant variance over time. the time series is stationary if the following conditions are satisfied: 1) e(xt)= const, t=1,2,3… 2) v(xt)= const, t=1,2,3… 3) cov(xt, xt-k)= f(k). t=1,2,3…. k=1,2… in practice, many time series do not meet this requirement. for example, a random shock that would weaken its impact over time in case of a stationary series can have a permanent effect for an indefinite period if the time series is not stationary (or has a unit root). to test for stationarity, we used dickey-fuller (df) statistics for the presence of unit root (mladenović and nojković, 2007). we tested two main hypotheses in the first step: 4 life expectancy at birth is average number of years a newborn is expected to live if mortality patterns at the time of its birth remain constant in the future. 5 dickey-fuller test results are presented in table 2. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 87 h0: time series is not stationary, has a unit root h1: time series is stationary the result for a level order of integration shows that we cannot accept ho hypothesis that the variables are stationary because df statistic is above than all critical values. therefore, we proceeded with the second step and tested hypothesis. the test revealed that cigarette consumption, price and income are stationary in their first differences and are integrated at first order (i) (table 3). table 3. results of df unit root test dickey-fuller variables adf t-test statistic level/first dif. h0: variable has a unit root level z(t) first dif. z(t) decision main variable consumption -0.102 -3.029** i(1) real tobacco cpi 0.988 -3.278** i(1) gdp per capita -1.526 -3.492** i(1) control variable tobacco policy index -1.412 -3.986*** i(1) tlaw1 (regulator policy 1) -2.171 -3.606** i(1) tban (regulator policy 2) 0.857 -3.606** i(1) employment, average -1.411 -2.071 i(2) employment rate, total -1.755 -1.605 i(2) employment rate, male -1.829 -1.385 i(2) employment rate, female -1.650 -1.678 i(2) education-graduated students -1.236 -4.787*** i(1) life expectancy at birth, (male) -1.137 -3.739*** i(1) life expectancy at birth, (female) -1.688 -2.317 i(2) life expectancy at birth, (total) -1.398 -2.979* i(1) note: z(t) is compared with corresponding test critical values;*** indicates rejection of h0 at the 1% significance level, **5% significance level, and * 10% significance level. source: authors own calculation based on the results presented in table 2, we observe that measure of cigarette consumption in serbia is integrated at first order i(1), it is stationary at first differences since the reported value of z(t) test statistic was -3.029, on 5% significance level. real tobacco cpi and real gdp per capita are integrated at first order i(1) at 5% significance level, with reported z(t) test statistic values: 3.278 and -3.429, respectively. tobacco control policy index, and individual regulatory variables tlaw1 and tban are integrated at same order as main independent variables i(1), all significant at 1% and 5% level. different measures of employment in serbia cannot be included in the further analysis, because df test results show integration at second order i(ii). df test statistics for employment rate female is z(t)= -2.695, p=0.023, employment rate male is z(t)= -3.406, p=0.007 and for employment rate total is z(t)= -2.988, p=0.014.6 6 results of df test shows us that variables of employment are not integrated at first difference. 88 economic analysis (2018, vol. 51, no. 3-4, 81-94) to determine the existence of a long-term relationship between our variables of interest, we applied a test for cointegrationdickey-fuller residual tests (dfr). if the time series are cointegrated, then the residual series is stationary, while the non-stationarity of the residual means that the time series are not cointegrated. if a h0 hypothesis is accepted than the residuals are nonstationary and the time series are not co-integrated. the rejection of the zero hypotheses (h0) confirms the stationarity of the residual, and therefore the cointegration of given time series. using the dfr test, we found that the variables in models (1), model (2) and model (4) are cointegrated and thus, they have a long-run relationship. to confirm this result, we applied another test for cointegration, johansen cointegration test (johansen, 2005). table 4 present results of the johansen cointegration test for variables in authors preferred modelsmodel (1), model (2) and model (4). table 4, results of johansen co-integration tests. model 1 null hypotheses eigenvalue trace statistic 0.05 max-eigen 0.05 critical value critical value h0: (r=0)* 0.0000 23.2142 24.3100 14.4272 177.8900 h0: (r≤1) 0.6432 8.7869 12.5300 8.7478 11.4400 h0: (r≤2) 0.4647 0.0392 3.8400 0.0392 3.8400 model 2 h0: (r=0) 0.0000 45.5888 39.8900 25.2938 23.8000 h0: (r≤1)* 0.8358 20.2950 24.3100 13.4566 17.8900 h0: (r≤2) 0.3748 6.8385 12.5300 6.5662 11.4400 model 4 h0: (r=0) 0.0000 57.0688 39.8900 29.1951 23.8000 h0: (r≤1) 0.8757 27.8737 24.3100 17.1833 17.8900 h0: (r≤2)* 0.7069 10.6904 12.5300 10.4773 11.4400 note: johansen, s. 1995. likelihood-based inference in cointegrated vector autoregressive models. oxford: oxford university press. r is the number of the cointegrating equation. *indicates the rejection of the null hypothesis at the 5% level. source: authors own calculation results of max-eigen and trace statistics indicate that h0 of no cointegration vector can be rejected and that there exists one co-integration equation at the 5% significance level in model 1. after stationarity and cointegration tests, we proceed with estimating long-run and short-run relationships. engle-granger two step method is used to estimate long run and short run price and income elasticities. first, long-run relationships between cigarette consumption, price and income is estimated using the classic linear demand model (equations 1.1 and 1.2) because models are specified in linear form, price and income elasticity is calculated multiplying the estimated price and income coefficient β1 and β2 by price and income fitted values, divided by fitted value of cigarette consumption in packs. the use of fitted values instead of actual average values is required to obtain results based on the long run equilibrium (ross and al-sadat, 2007). since cointegration exists in observed models, we estimated the second step of the englegranger method the error correction model (ecm) – to estimate short-run price and income elasticities (ross and al-sadat, 2007). this model used the first difference of all variable and olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 89 lagged residual from the long-run model (mladenović and petrović, 2007). the short-run ecm model can be expressed as follows (mladenović and nojković, 2012): tktktktkt ktktktkttt zzii ppyyuy 141413131 2121111110 ........ ........ εγγγγ γγγγγ +∆++∆+∆++∆+ ∆++∆+∆+∆+=∆ −−−− −−−−− (1.3) where k represents the number of lags; δ is the difference operator; γ ’s are parameters to be estimated; t1ε is the error term; 1−tu is error correction term that represents residuals from the long-run equation, and 0γ measures the speed of adjustment toward equilibrium in long-run. in our specification of ecm model, we choose to use one lag to avoid losing too many degrees of freedom because our time series are short (a small number of observations). ∆ [! = (\'!"# + (#∆�!"# + (]∆ !̂"# + /#! (1.4) ∆ [! = (\'!"# + (#∆�!"# + (]∆ !̂"# + (_∆`ab�!"#c/#! (1.5) ecm model for cigarette demand which includes only measures of tobacco price and income is given with equation 1.4. the equation for cigarette demand model which includes tobacco control policy index or regulatory variables like tban or law1 is given in 1.5. since we are using lin-lin form, price and income elasticities are calculated using lin-lin form of the model: results table 5 presents results of the long-run cigarette demand for several different demand models. table 5. long-run cigarette demand function 1 (basic) 2 (tban) 3 (tlaw1) 4 (tpi) 5 (lifetotal) variables consumption consumption consumption consumption consumption rtobcpi -0.86335 -0.6995449 -0.7958605 -0.8467552 -0.7820187 gdppc 0.01406 0.0150893 0.0046155 0.0161606 0.019342 regulatory 1 (tban) -20.07846 regulatory 2 (tlaw1) 18.38403 regulatory (policy index) -3.70036 life expectancy at birth, total -7.962421 constant 232.7062 214.455 245.1503 226.8379 789.4529 observations 15 15 15 15 15 dickey-fuller test for unit root residuals test statistic test statistic test statistic test statistic test statistic 90 economic analysis (2018, vol. 51, no. 3-4, 81-94) 1 (basic) 2 (tban) 3 (tlaw1) 4 (tpi) 5 (lifetotal) variables consumption consumption consumption consumption consumption adj. r-squared z(t)= -3.323 z(t)=-3.671 z(t)= -3.247 z(t)= -3.419 z(t)= -3.465 dickey-fuller test for unit root residuals hausman test m-statistic ------- --------- m=0.04 m=0.64 m=0.04 note: t-statistics in brackets;*** p<0.01, ** p<0.05, * p<0.1; source: authors own calculation all variables in model 1 are statistically significant. this model is the basic model, because it includes only two independent variables, without any other controls. real tobacco price index has a negative sign, which is in line with the economic theory if the price of cigarettes increases, their consumption will go down. real income has a positive sign which is also in line with the economic theory of normal good – the higher the income, the higher the consumption. r2 value is 0.845, meaning that 84.5% variability in the model is explained with selected variables. real tobacco price index and real income in model 2 are statistically significant with sings similar to model 1. variable tban which represents one tobacco control policy (ban on tobacco advertising) is not statistically significant, but it’s inclusion leads to the improvement in r2 value. the statistical insignificance of the policy variable can be explained by the short length of the time series. in model 3, variable tlaw1 is not statistically significant (p=0.317), and it has the opposite sign. the tobacco policy index (tpi) in model 4 is also not statistically significant (p=0.760), but it has the expected sign. in model 5 we include life expectancy at birth (total), and results show that variable is not statistically significant (p=0.730), but has a negative coefficient sign. it is expected result even if we did not get significant in the model, one of reason can be a very short and limited time-series data. the values of long-run price elasticities for our favorite models are shown in table 6, including the results bootstrapping. table 6. long-term price and income elasticity for tobacco products long-run model 1 model 2 model 4 price elasticity -0.764408 -0.6193687 -0.749707 price elasticity bootstrapped (100 replication) -0.7808978 -0.5985788 -0.7562662 (0.1583772) (0.2150423) (0.1607641) income elasticity 0.3368191 0.3612285 0.3868732 income elasticity bootstrapped (100 replication) 0.3461998 0.3972342 0.4354273 (0.0085674) (0.0085617) (0.0139486) note: se in brackets source: authors own calculation the long-run price elasticity in model 1 is -0.764, which is in line with results obtained in other lowand middle-income countries. this implies that 1% increases in prices of cigarettes lead to a 0.76% decrease in cigarette demand. price elasticity is higher in model 1 than model 2, because this specification does not control the impact of tobacco control policies. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 91 the value of long-run income elasticity coefficient was 0.34 which implies that 1% increases in real gdp per capita lead to a 0.34% increase in cigarette demand. when variable tban is included in the model (model 2), the value of long-run price elasticity coefficient is 0.62 which implies that 1% increases in prices of cigarettes led to a 0.62% decrease in cigarette demand. the value of long-run income elasticity coefficient was 0.36 and implies that 1% increases in real gdp per capita led to a 0.36% increase in cigarette demand. however, this result is not statistically significant. when variable tpi is included in model 4, the value of price elasticity is -0.75 which is almost similar to basic model 1. value of income elasticity is 0.38 but this result also is not statistically significant. table 7. short run cigarette demand function model 1 model 2 model 4 variables d.consumption d.consumption d.consumption d.rtobcpi -0.8802679** -0.8574294*** -0.8563312** -2.67 -3.41 -2.63 d.gdppc -0.0049126 -0.0004975 -0.0012268 -0.45 -0.05 -0.1 d.regulatory (d.tban) -2.107591 -0.17 d.regulatory (d.tpi) 4.280726 0.37 l.residuals -0.7381731** -0.9576962*** -0.8358793** -2.68 -3.67 -2.68 constant 5.581537 4.85751 4.040065 1.13 1.19 0.71 observations 14 14 14 r-squared 0.517 0.7284 0.5679 adj. r-squared 0.3721 0.6077 0.3759 breusch-pagan/ cookweisberg test for heteroskedasticity chi2(1) =0.43 chi2(1) = 0.15 chi2(1) = 0.09 ho: constant variance prob > chi2 = 0.5140 prob > chi2 = 0.7023 prob > chi2 = 0.7612 durbin's alternative test for autocorrelation chi2(1) = 0.0023 chi2(1) = 0.168 chi2(1) = 5.568 h0: no serial correlation prob > chi2 = 9.290 prob > chi2 = 0.6815 prob > chi2 = 0.0174 lags 1 lags 1 lags1 breusch-godfrey lm test for autocorrelation chi2(1) = 0.0077 chi2(1)=0.289 chi2(1)=5.800 h0: no serial correlation prob > chi2 = 7.111 prob > chi2 = 0.5911 prob > chi2 = 0.0160 lags 1 lags 1 lags 1 92 economic analysis (2018, vol. 51, no. 3-4, 81-94) ramsey reset test f(3, 6) = 2.77 f(3, 6)=0.10 f(3,6)=1.43 ho: model has no omitted variables prob > f =0.1205 prob > f =0.9565 prob > f =0.3238 skewness/kurtosis tests for normality adj chi2(2)= 2.97 adj chi2(2)= 3.96 adj chi2(2)=0.87 ho: normality prob>chi2= 0.2264 prob>chi2= 0.1404 prob>chi2= 0.6484 jarque-bera normality test chi(2)=1.084 chi(2)= .6345 chi(2)= .6974 ho: normality prob>chi2= .5817 prob>chi2= 0.9099 prob>chi2= .7209 mean vif 1.19 1.37 1.4 note: t-statistics in brackets;*** p<0.01, ** p<0.05, * p<0.1; source: authors own calculation the results presented in table 7 shows a negative real tobacco cpi coefficient in all models. it means that an increase in cigarette price in the short run will have a negative effect on consumption. income coefficient in all models (models 1, 2 and 4) are negative, but not significant, so in a short-run increase of real gdp per capita leads to decrease in cigarette consumption. estimated parameters for price in all three models are statistically significant at 5% and 1% level, while estimated parameters for income in all three models are not statistically significant. coefficient for a regulatory variable tban has no statistically significant effect on the tobacco consumption, but has a negative sign. same sign has a tobacco control policy index in model 4. negative sign of tobacco control policy variables in models is in line with the assumption that tobacco control policies leads to decrease cigarette consumption in a short run. error correction parameters values are -0.738, -0.957, -0.836 for models 1, 2 and 4 respectively7. interpretation of these coefficients is that 73.8% to 95.7% deviation from long-run equilibrium will be corrected in the following year. the diagnostic test was applied in order to analyze the presence of heteroscedasticity, autocorrelation, multicollinearity and specification of functional form. also, the normality of residuals is checked with jarque-bera and skewness/kurtosis tests (mladenović and nojković, 2012). results of all specification tests are presented in table 7. the short-run elasticities of cigarette demand are presented in table 8. table 8 short run price and income elasticities short-run model 1 model 2 model 4 price elasticity -0.05 -0.05 -0.05 income elasticity -0.01 -0.001 -0.001 source: authors own calculation in the short-run model, real tobacco cpi is statistically significant, and it implies that changes in price have an impact on the demand for cigarettes even in the short run. short-run price elasticity is quite low, which is quite common for addictive products such as cigarettes (ross and al-sadat, 2007) since consumers may need some time to quit. on the other hand, real income does not have a significant impact on cigarettes consumption, so we can conclude that in short-period of time smokers in serbia will change their consumption of cigarettes. the impact of price and income changes in a short run is smaller compared to the long-run, as expected. we were not able 7 error correction parameters are statistically significant on 5% and 1% level, respectively. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 93 to do bootstrap standard errors for the short-term price elasticities, because we have an insufficient number of observations. conclusion tobacco taxes are the most effective measure for preventing initiation and reducing tobacco consumption. studies about tobacco taxation topic provide evidence that higher tobacco prices lead to a significant reduction in tobacco products consumption. these studies estimate the price elasticity of consumption in the range from -0.25 to -0.50, but the estimates for lowand middleincome countries are higher (chaloupka et al., 2010). ross and al-sadat (2007) suggest that in lowand middle-income countries a 10% increase in cigarette prices can reduce cigarette consumption by 4%-8%. the results presented in this study represent the first estimates of the price and income elasticities of cigarette demand in the republic of serbia. we used official data from the statistical office of the republic of serbia for this analysis covering the period 2002-2016. we found that 10% increase in cigarette prices would reduce cigarette consumption by 6.2%-7.6% in the longrun, and by 0.5% in the short-run. this means that the total cigarette demand would decline by 6.7% to 8.1% in response to a 10% increase in price. based on empirical research, price elasticity for cigarettes in serbia is quite similar to other low and middle income countries who estimate price elasticity using the same methodology. even though research was conducted on a small number of observations (short time-series), our results correspond to the results obtained in other lowand middle-income countries. this confirms that higher tobacco taxes that lead to higher cigarette prices have the potential to reduce cigarette use in serbia substantially. this would be desirable given the large toll of tobacco use on both public health and the economy. acknowledgements this paper is a result of international research project "accelerating progress in taxation of tobacco and tobacco products in lowand middle-income countries". this research is funded by the university of illinois at chicago’s institute for health research and policy through its partnership with the bloomberg philanthropies. references chaloupka iv, f. j., peck, r., tauras, j. a., xu, x., & yurekli, a. (2010). cigarette excise taxation: the impact of tax structure on prices, revenues, and cigarette smoking (no. w16287). national bureau of economic research. domazet, i., stošić, i. (2013). “strengthening the competitiveness of serbian economy and the corporate market restructuring”, economic analysis, vol. 46, no ¾, pp. 108-124. đuričin s., pantić o. (2015). “the development of micro-crediting as a factor of promoting women entrepreneurship in serbia”, journal for women entrepreneurship and education (jwee), no1/2, pp. 50-66. hjalmarsson e., österholm p. (2007), testing for cointegration using the johansen methodology when variables are near-integrated, imf working paper, western hemisphere division. johansen, s. 1995. likelihood-based inference in cointegrated vector autoregressive models. oxford: oxford university press. ognjenović k. (2013) “how structural changes affect enterprises’ expectations about employment in serbia”, economic analysis, vol. 46, no ¾, pp. 141-152. mladenović z., nojković a. (2012), primenjena analiza vremenskih serija, centar za izdavačku delatnost ekonomskog fakulteta u beogradu 94 economic analysis (2018, vol. 51, no. 3-4, 81-94) mladenović z., petrović p. (2007), uvod u ekonometriju, centar za izdavačku delatnost, ekonomski fakultet univerziteta u beogradu pavlović d., ljumović i. (2016), “prospects and challenges for female leaders from the balkans”, journal for women entrepreneurship and education (jwee), no1/2, pp. 58-75. ross, h., & al-sadat, n. a. (2007). demand analysis of tobacco consumption in malaysia. nicotine & tobacco research, 9(11), 1163-1169. article history: received: november 20, 2018 accepted: december 13, 2018 microsoft word 2007 3 4.doc 2007 ‐ 58  •  economic analysis®  abstract: after the collapse of communism in 1990, the european union (eu) has immediately  sustained  in  the process of democratization  in  the ex‐communists countries, and has provided necessary  technical and financial assistance in order to place a market economy.  the enlargement was (and always is)  the most significant and the most ambitious european project since the signature of the treaty of rome1: it  reconciles one of the economic projects of the united europe with geo‐strategic vision of the european conti‐ nent, which will allow the important position of the eu in the world. the 1st may 2004 the eu has passed to  the  twenty‐five  member  countries2,  with  accession  of  ten  new  member  states  (nms).  the  process  of  enlargement has continued on january the 1st, 2007 by accessing to the eu of bulgaria and romania. the  “single market”, economic and monetary union (emu) and the process of integration are the major points  of the europe of twenty‐seven member countries. the process of preparation of accession to the eu, has an‐ nounced the preparation in the central and east european countries (ceec) from the 1989, and it marked  some difficulties for the ceec – on the level of political integration but also economic and social. the present  article show us, also, the importance of the introduction of the euro – which present the very important phase  in the evolution of the eu, and the biggest monetary changement in the history of europe…we consider  euro as the concretization of the eu. it represents the success of the “single market” and contributes to the  economic stability of the eu. also, it is important to know that the euros play his important role to the poli‐ tic and economic fields. the new member states (nms) are engaged to enter to the emu in his future3. for  the success of their entrance to the emu, the nms have to align their economies with these of the old mem‐ ber states of  the eu.   this economic alignment, so called “convergence”, constitutes  the supplementary  phase on their aim toward european  integration.   the  latest enlargements represent the most  important  moments in the history of the european continent.  today, the question is also the integration of the balkan  countries to the eu and their future toward european integration.  introduction    the enlargement policy of the european union (eu) is noted in the article 49 of the treaty4 of  the eu5, which dispose that “any european state which respects the principles set out in article  6(1) may apply to become a member of the union…”. the eu is defined the political and economic  1 the treaty of rome, signed by belgium, france, germany, italy, luxembourg and the netherlands on march 25, 1957,  established the european economic community (eec) and came into force on 1 january 1958.  2 cyprus, czech republic, estonia, hungary, latvia, lithuania, malta, poland, slovak republic and slovenia  3 slovenia as the nms has entered the emu the 1st january 2007.  4 the maastricht treaty (formally, the treaty on european union, teu) was signed on february 7th, 1992 in maastricht,  the netherlands after final negotiations on december 9th, 1991 between the members of the european community and  entered into force on november 1st, 1993 during the “delors” commission. it led to the creation of the european union  and was the result of separate negotiations on monetary union and on political union. the maastricht treaty has been  amended to a degree by later treaties.  5 “any european state which respects the principles set out in article 6(1) may apply to become a member of the union.  it shall address its application to the council, which shall act unanimously after consulting the commission and after  receiving the assent of the european parliament, which shall act by an absolute majority of its component members. the  conditions of admission and the adjustments to the treaties on which the union is founded, which such admission en‐ tails, shall be the subject of an agreement between the member states and the applicant state. this agreement shall be  submitted for ratification by all the contracting states in accordance with their respective constitutional requirements.”  the future of the european economy srđan redžepagić, institute of economic sciences, belgrade, serbia  key words: eu, emu, ceec, enlargement, euro, european economy jel : f15, f31 original paper volume 40 • autumn 2007 • 59  criteria for accession. before the accession to the eu, some phases are necessary to be established  for  all  the  central  and  east  european  countries  (ceec).  the  following  phases  are  necessary  (obliged) for each european country which would like to become the member of the eu:  o to candidate: each european country can depose candidature for the membership to the  eu.  o to become candidate: the treaty of the eu precise two conditions, before the country ob‐ tain candidate status: to be european and democratic country. after this condition com‐ pleted, the european commission recognise the statute of the candidate country. it isn’t  the only criteria the one european country obtain the full membership to the eu.  o the strategy of pre‐accession: when the county has become the candidate, the strategy of  pre‐accession is necessary. this strategy has the objective to “familiarise” the candidate  country with the procedure and policy of the eu – giving the possibility to the candidate  country to participate to the programmes “communautaires” and accordant the financial  aid. the opening processes of the negotiations for the accession: to join the eu, each new  member state (nms) must fulfill three criteria:  • political: stability of institutions guaranteeing democracy, the rule of law, human  rights and respect for and protection of minorities;  • economic: existence of a functioning market economy and the capacity to cope  with competitive pressure and market forces within the union;  • acceptance  of  the  community  “acquis”:  ability  to  take  on  the  obligations  of  membership, including adherence to the aims of political, economic and mone‐ tary union.  o signature of the treaty of accession: the results of the negotiations included in the treaty  of the eu are transferred to the european council for confirmation by it and to the euro‐ pean parliament for his agreement.  o accession to the eu: after the signature, the treaty is transferred to the member countries  and to the candidate(s) country(ies) for the ratification,  in some cases, by referendum.  the treaty takes place, and the candidate country becomes the eu member state.   the eight ceec6, and also cyprus end malta, has entered to the eu on the 1st may 2004. bul‐ garia and romania has joined the eu on the 1st january 2007. these two enlargements have had  the biggest effect in the history of the enlargements of the eu. in this article we will pointed to the  economic criteria for the nms of the eu, but also to the effects (after the enlargements) that have  been produced in (and for) the nms and the eu old member states. it is necessary to know that  the latest enlargements have had very positive effects, but also “some negative effects” (less than  positive effects) for the new and old member states of the eu.   the introduction of the euro represents the essential phase in the evolution of the eu, and  the biggest monetary changement in the history of europe7. euro is the concretization of the eco‐ nomic and monetary union (emu). the emu consists of three stages coordinating economic pol‐ icy and culminating with the adoption of the euro, the euʹs single currency. under the copenha‐ gen criteria, it is a condition of entry for states acceding to the eu that they be able to fulfil the re‐ quirements for monetary union within a given period of time. the twelve nms that acceded to the  6 czech republic, estonia, hungary, latvia, lithuania, poland, slovakia and slovenia  7 cf. redžepagić, s. (2006), l’analyse de l’évolution de l’union européenne – les effets économiques d’élargissement, issn 1453‐ 8202, editor: university valahia targoviste, the 17th international conference organized by cedimes, faculty of eco‐ nomics ‐ university of targoviste (xviième colloque fédérateur cedimes), university of valahia, targoviste, romania,  november 2006, pp. 122 – 133  2007 ‐ 60  •  economic analysis®  eu in 2004 and 2007 all intend to join third stage of the emu in the next ten years, though the pre‐ cise timing depends on various economic factors. similarly, those countries who are currently ne‐ gotiating for entry will also take the euro as their currency in the years following their accession  (slovenia has entered to the euro zone the 1st january 2007).  enlargements  the enlargement of the eu represented (and i hope represent also today and for the future)  one of the most important chances for the eu for the 21st century. the enlargements represented  (and probably will represent) the advantages  in the field of stability and the prosperity for the  nms but also for the old members of the eu. the eu summit8 was scheduled to invite ten (twelve)  more countries to join the eu. this enlargement brought the number of eu member states up from  15 to 27. in the past the eu was limited to western europe, but following the impending expan‐ sion it included the whole of eastern europe up to the former soviet border and, in addition, the  two mediterranean island nations of malta and cyprus. in western europe, norway and switzer‐ land are the only countries not to have joined the eu. in the east, only the balkan nations of ex‐ yugoslavia9 (with the exception of slovenia) and albania remain outside the eu. with the latest  enlargements, the population of the eu has grown by 75 million, brought it up to half a billion  people.  with  9,200  billion  euros,  the  eu’s  gross  domestic  product  (gdp)  is  equal  that  of  the  united states of america.   it is important to know, the full timeline of past enlargements (and treaties) were10:  o 23 july 1952 – the treaty of paris entered into force, establishing the european coal  and steel community (ecsc). founding members were the benelux countries (bel‐ gium, the netherlands, and luxembourg), france, italy and west germany.  o 1 january 1958 – the treaty of rome entered into force, establishing the european  economic community (eec), which later becomes the european community (ec).  o 1 january 1973 – (first enlargement); denmark, ireland, and the united kingdom ac‐ cede to the ec (norway signed the treaty but failed to ratify due to a negative opin‐ ion in a national referendum on accession).  o 1 january 1981 – (second enlargement); greece accedes to the ec.  o 1985 – granted home rule by denmark six years earlier, greenland decides to leave  the ec following a referendum. (see member state territories).  o 1 january 1986 – (third enlargement); portugal and spain accede to the ec.  o 1  november  1993  –  the  maastricht  treaty  takes  effect,  formally  establishing  the  european union.  o 1 january 1995 – (fourth enlargement); austria, finland, and sweden, accede to the  eu.  o 1 may 2004 – (fifth enlargement, part i); comprising the largest number of countries  ever admitted at one  time, cyprus,  the czech republic, estonia, hungary, latvia,  lithuania, malta, poland, slovakia and slovenia accede to the eu.  o 1 january 2007 – (fifth enlargement, part ii); bulgaria and romania joined eu.  in june 1993, eu leaders meeting in copenhagen set three criteria that any candidate country  8 being held december 12th and 13th in copenhagen.  9 bosnia and herzegovina, croatia, macedonia, montenegro and serbia  10 for the full explanation see the site official of the european commission.  volume 40 • autumn 2007 • 61  must meet before it can join the eu. in order to become a candidate for entry to the eu, countries  need to fulfil the economic and political conditions known as the “copenhagen criteria”, according  to which a prospective member must:  o have stable institutions guaranteeing democracy, the rule of law, human rights and  respect for and protection of minorities  o have a functioning market economy as well as the capacity to cope with competitive  pressure and market forces within the eu  o take on board all the “acquis” and support the various aims of the eu (especially, the  ability to take on the obligations of membership including adherence to the aims of  political, economic and monetary union).   these three criteria have been fulfilled by all nms. in addition, each nms must have a pub‐ lic administration capable of applying and managing eu laws in practice11. the eu reserves the  right to decide when a candidate country has met these criteria and when the eu is ready to accept  the new member, as this was the cases for each nms before her enter to the eu.  economy in the enlarged eu   according to the international monetary fund, the eu has a large economy, greater than that  of the united states of america with a 2005 gdp of 12,865,602 usd million vs. 11,734,300 usd  million (usd figures). the enlargements have always some significant economic consequences on  the economy of the eu12. so the reason is because the bigger market which stimulate the economic  growth in the nms. the euʹs member states account for 30.3% of the worldʹs total gdp in 200513.  after the signature of the treaty of rome14, one of the most important objectives for the eu  consists to maintain the economic and social progress in order to assure the health, prosperity and  better future for the europeans. economic performance varies from state to state, as presented in  the table 1.  table 1: eu member states economic indicators  member states  gdp (ppp*)  2006  millions of  euros  gdp (ppp*) per capita  2006  euros  % of eu27  average gdp (ppp*) per  capita  gdp (ppp*)  2007  millions of  euros  gdp (ppp*)  per capita  2007  euros  percentage of  eu27  average gdp  (ppp*) per capita european union  11,557,853  23,500  100%  12,172,536  24,600  100%  austria  250,247  30,200  129%  264,472  31,900  130%  belgium  302,570  28,700  122%  319,867  30,200  123%  bulgaria  66,799  8,700  37%  71,714  9,500  39%  cyprus  16,849  21,900  93%  17,773  22,900  93%  czech republic  191,080  18,600  79%  207,174  20,100  82%  denmark  161,613  29,700  126%  171,298  31,200  127%  estonia  21,170  15,900  68%  23,919  17,900  73%  finland  143,818  27,300  116%  153,595  28,900  117%  france  1,673,128  26,500  113%  1,744,444  27,800  113%  11 for more precisely explanations see the official web site of the european commission.  12 gauthier a. (2005), “la construction européenne : étapes et enjeux”, forth edition, bréal, paris.  13 source: world bank  14 the treaty of rome, signed by france, west germany, italy and benelux (belgium, the netherlands and luxembourg)  on march 25, 1957, established the european economic community (eec) and came into force on 1 january 1958.  2007 ‐ 62  •  economic analysis®  germany  2,184,612  26,700  114%  2,340,372  28,200  115%  greece  230,659  20,800  89%  246,671  22,100  90%  hungary  154,358  15,300  65%  166,031  16,200  66%  ireland  143,475  33,700  143%  157,070  35,700  147%  italy  1,432,261  24,300  103%  1,500,475  25,500  104%  latvia  29,971  13,100  56%  33,630  14,900  61%  lithuania  46,015  13,600  58%  50,241  15,000  61%  luxembourg  30,183  65,300  278%  31,376  69,900  284%  malta  7,289  17,700  75%  7,824  18,600  76%  netherlands  500,762  31,000  132%  530,564  32,800  133%  poland  473,774  12,400  53%  525,277  13,600  55%  portugal  185,083  17,500  74%  190,882  18,200  74%  romania  190,657  8,800  37%  208,220  9,700  39%  slovakia  79,339  14,700  63%  88,602  16,400  67%  slovenia  40,867  20,400  87%  44,040  21,800  89%  spain  1,053,600  24,000  102%  1,121,961  25,400  103%  sweden  256,327  28,200  120%  274,499  30,000  122%  united kingdom  1,688,660  27,900  119%  1,847,105  29,400  120%  *purchasing power parity  source: eurostat – 21 april 2007, percentages recalculated manually to eu‐27  according to the literature15, and analyzing economic situation of the eu, the enlargement  has provoked the supplementary economic growth of 1% per year in the nms16. the supplemen‐ tary economic growth registered by other member states is less, but always significant.  table 2:  gdp per capita: distribution of the richness    country  %    luxembourg  189    ireland  125    denmark  115    netherlands  113    austria  110    belgium  108    finland  104    france  103    united kingdom  103    germany  103    italy  103    sweden  102    average of the eu‐15  100    spain  84    slovenia  74    cyprus  72    portugal  69    15 farvaque e. et g. lagadec (2002), “l’élargissement à l’est : risques, coûts et bénéfices, intégration economique  européenne : problèmes et analyses”, edition : de boeck university, 2002.  giuliani j‐d. (2003), “quinze plus dix : le grand élargissement”, foundation robert schuman, paris : albin michel,  2003.  16 and by previsions, will continue to present during the first ten years after the accession of the nms!  volume 40 • autumn 2007 • 63  greece  66    czech of republic  60    hungary  57    malta  55    slovakia  47    estonia  42    poland  39    lithuania  39    latvia  35            source: eurostat; european commission   euro and economic and monetary union    on the march 13th 1979, the european monetary system (ems) was created. the ems has  created a zone of monetary stability in europe, encouraging growth and investment. it was based  on the “ecu”17, on the exchange rate and intervention mechanism18 and the credit mechanism19. in  order to remove the non‐tariff barriers to the free movements of good, capital, services and per‐ sons, the ems wasnʹt anymore enough and so the single currency became a necessity. the euro‐ pean monetary union was established during the treaty of maastricht which entered into force in  1993. its formation spanned three stages:  1. stage one: 1 july 1990 to 31 december 1993 – at this initial the member states drew up  convergence program designed to promote improvements in the convergence of eco‐ nomic performance, thereby making it possible to establish fixed exchange rates.  2. stage two: 1 january 1994 to 31 december 1998 – this was a transitional period during  which a determined effort was made to achieve economic convergence. the european  monetary institution (emi) was set up in frankfurt to strengthen the coordination of  member statesʹ monetary policies, promote  the creation of a european central bank  (ecb) in stage three.  3. stage three: 1 january 1999 and continuing – at the beginning of this third stage a ecb  was set up and the exchange rates among the participating currencies were fixed once  and for all. the bank was made independent of the national governments and would  manage the monetary policies of all the participating countries.  during the madrid european council the member states decided to call the single currency  ʺeuroʺ. to be able to join, every member state had to accomplish the following criteria:  o deficits – national budget deficits must be close to or below 3% of gross national prod‐ uct (gnp).  o debt – public debt may exceed the 60% of gnp only if the trend is declining towards  this level.  o price stability – the rate of inflation may not exceed the average rates of inflation of the  three member states with the lowest inflation by more than 1.5%.  o interest rates – long‐term interest rates shall not vary by more than 2% in relation to the  average interest rates of the 3 member states with the lowest interest rates.  17 a basket of the currencies of the member states  18 based on that each national currency had a central exchange rate linked to “ecu” and bilateral rate exchanges were  allowed to fluctuate within a band of 2.25%, or up to 6%, increased finally at 15%  19 when the bilateral exchange rates are approaching the 15% limit, the banks have unlimited liability to intervene to not  pass the limit of 15%  2007 ‐ 64  •  economic analysis®  o exchange rate stability – a national currency shall not have been devalued during the  two previous years and must have remained within the ems 2.25% margin of fluctua‐ tion.  on may 3rd, 1998, the member states decided which of the 15 nations achieved the five crite‐ ria to join the single currency:  o austria, belgium, finland, france, germany, ireland, italy, luxembourg, netherlands,  portugal and spain all qualified.  o greece and sweden did not achieve all the five criteria.  o denmark and the united kingdom took the “opt‐out” choice but could join it anytime  when the inner political conditions would allow it.  on january 1, 1999, the third stage of emu began. the euro became a currency on its own  right and the exchange rates were definitely fixed. until january 1st, 2002, the national currencies  were used with the banks with businesses completely transferring to euro and the euro coins and  notes were introduced and are circulating beside the national currencies.  the european exchange rate mechanism (erm)20 is based on the concept of fixed currency  exchange rate margins, but with exchange rates variable within those margins. before the intro‐ duction of the euro, exchange rates were based on the ecu, the european unit of account, whose  value was determined as a weighted average of the participating currencies.        source: european commission (2007)    20 the erm was a system introduced by the european community in march 1979, as part of the ems, to reduce ex‐ change rate variability and achieve monetary stability in europe, in preparation for emu and the introduction of a single  currency, the euro, which took place on january 1, 1999.  volume 40 • autumn 2007 • 65  table 3: respect the criteria of convergence in the ceec – “maastricht criteria”  measured crite‐ rion    price stability    public fi‐ nances  results for  public fi‐ nances   durability of  convergence    stability of con‐ vergence    how this criterion  is measured  inflation rate  (consumption  prices)  budget defi‐ cit (% of  gdp)   public debt  (% of gdp)  interest rate  (long term)   stability of ex‐ change rate  criteria of conver‐ gence    < 1.5 % three  member states  which have the  lowest rate  not more  than 3 %    not more  than 60 %   < 2 % three  member states  which have the  lowest rate  participation to  the erm ii dur‐ ing two years   czech republic     1.8 %     12.6 %     37.8 %     4.7 %     during accession  to the erm ii   estonia     2.0 %     – 3.1 %     5.3 %     4.6 %     accession  28.6.2004     latvia     4.9 %     1.5 %     14.4 %     5.0 %     accession  2.5.2005     lithuania     – 0.2 %     1.9 %     21.4 %     4.7 %     accession  28.6.2004     hungary     6.5 %     6.2 %     59.1 %     8.1 %     during accession  to the erm ii    poland     2.5 %     3.9 %     45.4 %     6.9 %     during accession  to the erm ii   slovenia21     4.1 %     2.0 %     29.4 %     5.2 %     accession  28.6.2004     slovakia     8.4 %     3.7 %     42.6 %     5.1 %     accession 28.11.   2005    reference values for  the euro zone  < 2.4 %     < 3.0 %     < 60 %     < 6.4 %         source: european commission (2006), calculated by author  as of 1 may 2004, the ten national central banks of the nms became party to the erm ii  central bank agreement. the national currencies themselves will become part of the erm ii at  different dates, as mutually agreed.  table 4: declarations of the member states concerning their entrance to the emu   country  declaration 2004  declaration  2006  entry to  erm ii  czech republic  2009  2010  2007  estonia  2007  2008  june 28, 2004  lithuania  2007  2010  june 28, 2004  latvia  2008  2010  may 2, 2005  hungary  2009  2014  without declaration  poland  2009  2013  without declaration  slovenia  2007  2007  june 28, 2004  slovakia  2009  2009  november 28, 2005  cyprus  2008  2008  may 2, 2005  malta  2008  2008  may 2, 2005      source: the world bank  21 slovenia has become the member of the euro zone the 1st january 2007.  2007 ‐ 66  •  economic analysis®  the estonian kroon, lithuanian litas, and slovenian tolar were included in the erm ii on 28  june 2004; the cypriot pound, the latvian  lats and the maltese  lira on 2 may 2005; the slovak  koruna on 28 november 2005. the currencies of the three largest countries which joined the eu on  1 may 2004 (the polish zloty, the czech koruna, and the hungarian forint) are expected to follow  eventually. plans for bulgaria are to apply for erm ii membership in 2007 and to commit to its  rules regardless of the european commission decision, while romania plans to join erm in 2010‐ 2012. eu countries that have not adopted the euro are expected to participate for at least two years  in the erm ii before joining the euro zone. as slovenia adopted the euro in 2007, the slovenian  tolar was removed from the erm ii and from circulation. the same will happen to the maltese lira  and the cypriot pound on 1 january 2008. sweden is expected to participate in erm ii in order to  meet the convergence criteria required for switching currency, but has deliberately chosen to stay  out of  the mechanism,  thus maintaining  their currency swedish krona. this choice  is currently  tolerated by the ecb, but it has been warned it wonʹt be tolerated for newer union members.  conclusion   this study22 makes use of the recent analyse for the eu new member states. “enlargement is  both a political necessity and a historic opportunity for europe. it will ensure the stability and se‐ curity of the continent and will thus offer both the applicant states and the current members of the  union new prospects  for economic growth and general well‐being. enlargement must serve  to  strengthen the building of europe in observance of the acquis communautaire which includes the  common policies.” this is declared to the european summit of madrid from december 199523. eco‐ nomic integration in general and enlargement of the eu to the east of europe in particular created  a wider european single market, thereby stimulating structural adjustment and economic speciali‐ zation. this study analyzed economic situation in the enlarged eu with a special focus on the new  eu member states and the monetary union. finally, it is important to know that the policy (eco‐ nomic, social, political, etc.) options for the new eu member states played (and still play) the im‐ portant role for the nms but also for the eu‐15 states (old member states).   literature  1. aristovnik, a. and berčič, b. (2007), fiscal sustainability in selected transition countries, munich personal repec  archive paper no. 122, posted 9th january 2007, university of ljubljana, faculty of administration, slovenia, 17  p.  2. budina, n. and van wijnbergen, s. (1996), inflation stabilization, fiscal deficits and public debt management in poland,  tinbergen institute discussion paper, ti 96‐179/4  3. chauveau s. (2004), élargissement de l’union européenne : les dix nouveaux entrants – opportunités dans la filière,  edition : fédération de la maille, 2004.  4. european central bank (2002), review of the international role of the euro, december 2002  5. farvaque e. et g. lagadec (2002), l’élargissement à l’est : risques, coûts et bénéfices, intégration economique eu‐ ropéenne : problèmes et analyses, edition : de boeck university, 2002.  6. gauthier a. (2005), la construction européenne : étapes et enjeux, forth edition, bréal, paris, 2005.  7. giuliani j‐d. (2003), quinze plus dix : le grand élargissement, foundation robert schuman, paris : albin michel,  2003.  22 for more precisely study, cf. redžepagić, s. (2007), les politiques économiques comparées et les coûts d’intégration pour les  pays de l’est candidats à l’adhésion à l’union européenne, doctoral dissertation under direction of professor j.‐p. guichard,  university of nice sophia‐antipolis, cemafi (centre d’etudes en macroéconomie et finance internationale), march  2007  23 this summit held on 15 and 16 december 1995 in madrid.  volume 40 • autumn 2007 • 67  8. green, c. j. et al. (2000), poland: a successful transition to budget sustainability?, economic research paper no.  00/5, loughborough university  9. redžepagić, s. (2006), l’analyse de l’évolution de l’union européenne – les effets économiques d’élargissement, issn  1453‐8202, editor: university valahia targoviste, the 17th international conference organized by cedimes,  faculty of economics ‐ university of targoviste (xviième colloque fédérateur cedimes), university of vala‐ hia, targoviste, romania, november 2006, pp. 122 – 133  10. redžepagić, s. (2007), les politiques économiques comparées et les coûts d’intégration pour les pays de l’est candidats à  l’adhésion à l’union européenne, doctoral dissertation under direction of professor j.‐p. guichard, university of  nice sophia‐antipolis, cemafi (centre d’etudes en macroéconomie et finance internationale), march 2007  11. rinaldi‐larribe m‐j. (2004), l’élargissement de  l’union économique et monétaire européenne à  l’est et  l’euro, paris,  edition : harmattan, l’esprit économique : le monde en questions, 2004.      doi: 10.28934/ea.23.56.1.pp57-68 first online: may 15, 2023 preliminary report is there a relationship between country development and citizens’ level of digital skills? marija antonijević14 f* | aleksandra bradić-martinović1 | jelena banović1 | đina ivanović1 1 institute of economic sciences, belgrade, serbia abstract this paper examines the relationship between citizens' level of digital skills and country development. country development is measured by gross national income per capita (gni p.c.), while digital skills are measured by the world economic forum. data were gathered from the world bank databases for 2019 from 135 countries worldwide. correlation analysis was used for the analysis. the results of the correlation analysis show a significant strong positive linear relationship between digital skills and gni p.c., indicating the importance of country development in developing adequate levels of the crucial skills of the 21st century – digital skills and vice versa. keywords: digital skills, development, gross national income per capita, correlation analysis jel classification: f63, j24 introduction globalization and technological innovations have contributed to a change in the way how individuals and the economy function. james (2021) states that most innovations are created in developed countries. the same author notes that digital technologies are primarily developed in and for the usage of affluent countries concerning their socio-economic conditions, including attitudes, skills, income, and infrastructure. regarding this, citizens in developing countries, especially rural areas, lack digital skills. developed countries are usually the setters in innovations, so developing countries lag in their adoption (bara, 2016). in this regard, comin & mestieri (2018) state that despite reducing lag, developed countries are ahead in the diffusion of technology. according to baliamoune-lutz (2003), time lag and diffusion of innovation depend on the level of the country’s income. regarding this, in developing countries, income per capita constraints ict diffusion. also, karjaluoto et al. (2002) and lee et al. (2002) state that an increase in income is positively related to the adoption of innovation. kolaković et al. (2009) indicate that success in using digital resources depends on the level of development. bradić-martinović & banović (2018) confirm differences between developed and developing countries regarding accessing ideas, knowledge, and modern ict. oecd points out that in developing the digital economy in countries, the crucial roles play the following elements: ict infrastructure, ict skills, finance, and regulation, as well as the interplay * corresponding author, e-mail: marija.antonijevic@ien.bg.ac.rs 58 economic analysis (2023, vol. 56, no. 1, 57-68) between them (dahlman et al., 2016). the coronavirus accelerated the adoption of digital products/services and highlighted the importance of digital channels and, consequently, the possession of required digital skills. the committee for the coordination of statistical activities (2020) states that developing countries are less equipped to use information and communication technologies to minimize the disruption due to coronavirus. regarding this, it can be concluded that developing countries should improve their position since there is a possibility that another similar event will occur in the future. in the fourth industrial revolution era, it is crucial to understand how to use digital tools and communicate through digital channels. regarding this, it is significant to possess the appropriate level of digital skills in the digital world when performing everyday activities. thus, digital skills are needed for daily digital communication, doing a job, executing digital banking transactions, etc. european parliament & council also highlights the importance of digital competencies, considering they represent lifelong learning competencies (european parliament & council, 2006). individuals can acquire the required skills in this digital world by learning and experiencing them in practice (ivanović & simović, 2020). also, all individuals should continuously develop digital skills in every stage of life (ivanović & antonijević, 2022), so it is a never-ending process. those who are digitally skilled have more success in finding a job. also, the international telecommunication union itu (n.d.a) points out that digital skills are required for the future since nine out of ten jobs need these skills in europe. therefore, digital skills have become essential for individuals who want to be a part of the labor market, considering that around 90% of jobs require an appropriate level of digital skills. lazić et al. (2023) emphasized the significance of digital competencies, especially for people with disabilities, considering the opportunities for their employment through freelance platforms. possessing proper digital skills is significant, especially in developing countries, since billions of the young will participate in the labor market (unctad, 2018). individuals who lack digital skills are threatened to lose their job due to their lower competitiveness in the labor market (banović & pavlović, 2021). according to domazet et al. (2018), developing cooperation between three sectors—ict, education, and private—can help generate a synergy effect and be advantageous to all parties. no recent literature explores the relationship between the level of digital skills and development. given that developed and developing countries differ in terms of digital infrastructure (center for strategic and international studies csis, 2022; james, 2021) and education (wiley, 2021; oecd et al., 2020), authors expect that there is a relationship between development, measured by gross national income per capita, and citizens' level of digital skills, measured by a 7-point likert scale determined by the world economic forum. this paper is structured as follows. after analyzing the relevant literature, the authors examined the association between the level of digital skills and gni per capita. the results of the correlation analysis indicate that the country's development plays a vital role in the citizens' digital skills and vice versa, considering that the authors found a strong positive relationship between the level of digital skills and the gni p.c. the last part of this paper includes suggestions and directions for further research. literature review and hypotheses eshet (2004) indicated the crucial role of digital skills in the twenty-first century. all industries have been exposed to changes under the influence of digital technologies, which consequently underlines the need for possessing the appropriate level of digital skills. thus, digital skills have become essential in an individual's everyday activities. different terms correspond to skills related to ict and digital technologies, such as ict skills, it skills, digital literacy, information literacy, technology skills, 21st-century skills, and digital skills, so all mentioned terms are synonyms (bejaković & mrnjavac, 2020). unesco defined digital skills as "a range of abilities to use digital devices, communication applications, and networks to marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 59 access and manage information. they enable people to create and share digital content, communicate and collaborate, and solve problems for effective and creative self-fulfillment in life, learning, work, and social activities at large" (unesco, 2018). according to eurostat, there are four levels of digital skills. these levels are based on the european digital competence framework (digcomp) and individuals’ digital activity in the last three months. regarding this, the following individuals’ levels of digital skills are identified by braun et al. (2020): 1. individuals with above-basic digital skills “individuals who have performed all of the following activities: sending/receiving emails, participating in social networks, installing software and applications, using online banking, using word processing software, using advanced spreadsheet functions to organize and analyze data such as sorting and filtering”. 2. individuals with basic digital skills “individuals who have sent/received emails, installed software and applications, and used spreadsheet software (without advanced functions such as sorting and filtering)”. 3. individuals with low digital skills “individuals who have sent/received emails, installed software and applications, but have neither used word processing, nor spreadsheet software nor have used software to edit photos, videos or audio files”. 4. individuals with no digital skills individuals who “have not performed any relevant activities, despite declaring having used the internet at least once during the past three months”. international telecommunication union itu (2018a) identifies three types of digital skills: basic, intermediate, and advanced. an explanation of all these types is given in detail below in table 1. table 1. types of digital skills type explanation basic “elementary skills for executing basic tasks. include “hardware (for example, using a keyboard and operating touch-screen technology), software (for example, word processing, managing files on laptops, managing privacy settings on mobile phones), and basic online operations (for example, email, search, or completing an online form)”. intermediate “enable us to use digital technologies in even more meaningful and beneficial ways, including the ability to critically evaluate technology or create content. these are effectively job-ready skills since they encompass those skills needed to perform work-related functions such as desktop publishing, digital graphic design and digital marketing”. advanced “those needed by specialists in ict professions such as computer programming and network management. these include artificial intelligence (ai), big data, coding, cybersecurity, internet of things (iot), and mobile app development”. source: international telecommunication union itu. (2018a). digital skills toolkit. available on https://www.itu.int/en/itu-d/digital-inclusion/documents/itu%20digital%20skills%20toolkit.pdf. accessed september 25, 2022. oecd (2004) differs the following three categories: basic users, advanced users, and ict specialists, while cedefop (2015) points out basic, moderate, and advanced ict skills. international telecommunication union itu (2021) differs three types of digital skills: 1. basic: “copying or moving a file or folder, using copy and paste tools to duplicate or move information within a document, sending emails with attached files, and transferring files between a computer and other devices”; https://www.itu.int/en/itu-d/digital-inclusion/documents/itu%20digital%20skills%20toolkit.pdf 60 economic analysis (2023, vol. 56, no. 1, 57-68) 2. standard: “using the arithmetic formula in a spreadsheet, connecting and installing new devices, creating electronic presentations with presentation software, and finding, downloading, installing and configuring software”; 3. advanced: “writing a computer program using a specialized programming language”. paset et al. (2021) identify the following digital skills levels: basic/foundational, intermediate, advanced, and highly specialized. digital skills are becoming central for developing and developed countries (international telecommunication union itu, 2018a). the results of the international telecommunication union itu (2018b) research showed that the digital skills divide existed between developing and developed countries since the average percentage of individuals with basic digital skills amounted to 46% and 65%, respectively. furthermore, the gap was higher in terms of standard skills (20% in developing countries and 49% in developed countries). the least developed countries characterized the highest gap between access to the internet and the actual use of the internet. the vast digital skills gaps are often associated with less wealthy economies due to inappropriate digital education and training (wiley, 2021). insufficient skills were identified in developing countries, especially in the case of the poor (international telecommunication union itu, 2021). according to oecd et al. (2020), there was a digital divide between the more vulnerable and less educated on one side and the rich and more educated on the other. additionally, the same authors indicated that new technologies must be incorporated into education to develop digital skills. therefore, teachers have a crucial role in digital transformation by including ict in teaching. information telecommunication union itu (n.d.b.) data showed that overall digital skill levels should be enhanced in numerous countries. this conclusion is based on the fact that less than 40% of respondents worldwide reported engaging in basic digital skills activities in 76 countries for which data were available in 2021. also, less than 40% of respondents reported performing some of the activities comprising standard digital skills in 70% of countries. additionally, more than 10% of respondents reported carrying out activities involving advanced digital skills in 15% of observed countries' information telecommunication union itu (n.d.c). according to eurostat data, 54% of the eu population (age range 16 – 74) had at least basic digital skills in 2021. the top 3 countries with the highest scores were the netherlands, finland, and ireland, while the lowest had romania, bulgaria, and poland (digital skills & jobs platform, 2022). in serbia, bradićmartinović & banović (2018) found that slightly lower than 50% of respondents had no or had a low level of digital skills in 2017. however, the study's results did not differ significantly from the eu average (42.8%), i.e., more precisely, 17.3% had no digital skills, while 25.5% had a low level of digital skills. one key factor determining ict access is income level (dewan et al., 2005). thus, the authors indicated that ict's affordability increases with income. nipo et al. (2014) also supported these findings. vicente & lopez (2008) stated that countries with higher education and income levels express better ict access. maji & laha (2021) also highlighted the crucial roles of income, education, economic openness, and urbanization in overcoming the digital divide. results of recent studies showed that the digital divide was determined primarily by income level, educational level, internet affordability, freedom of the economy, citizens’ gender and age, urbanization, and foreign direct investments (aikins, 2019; cruz-jesus et al., 2018; fang et al., 2019; huxhold et al., 2020; otioma et al., 2019; pachis, 2018; song et al., 2020). in 2021, there was still a digital divide between developing and developed countries, considering that 96% of 2.9 billion offline people lived in developing countries (international telecommunication union itu, 2021). according to the latest data from the international telecommunication unionitu (n.d.b), around 4.9 billion individuals worldwide used the internet in 2021. when the pandemic started, the number of internet users in developing countries increased by 13.3% (international telecommunication union itu, 2021), indicating the importance of being online. regarding country development, 90% of people used the internet marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 61 in developed countries and 57.1% in developing countries (international telecommunication unionitu, 2021). regarding this, those who are unconnected need to develop appropriate skills to become connected. wiley (2021) stated that those economies that lead to digital skills development were considered the most resistant. moustakas et al. (2018) also highlighted the importance of a skilled labor force for improving economic productivity and growth. due to the pandemic, the demand for workers with digital skills is still increasing. the pandemic indicates the significance of reducing the digital skills gap. also, it has underlined the critical role of an adequate level of digital skills (eu4digital, 2021). additionally, the pandemic has disclosed the gaps between developed and developing countries in adopting digital technologies (misra, 2022). misra (2022) has pointed out that the main obstacles to achieving digital inclusion in developing countries are ineffective implementation and investment approaches related to digital skills. olczyk & kuc-czarnecka (2022) revealed that the digital economy and society index (desi), which measures the eu's digital performance, was an important predictor of changes in gdp per capita in eu countries. furthermore, rozite et al. (2019) found that digital skills statistically impact gdp per capita in the eu. additionally, aniela et al. (2019) stated that in 2015, eu countries can be classified into four clusters (very high level, high level, medium level, and low level) based on their gdp and the percentage of individuals who have basic or above-level digital skills, indicating similarities within groups and dissimilarities among groups. by analyzing the literature, the authors have identified a lack of studies that examine the association between digital skills and development, especially on a global level. based on all the above, two hypotheses were formulated: h1: there is a significant positive relationship between the level of digital skills and gni p.c. the following section presents a detailed insight into the characteristics of the sample and the statistical tools the authors used to test the defined hypothesis. methodology world bank databases were used to examine the presence of a linear relationship between the level of digital skills and development. since the most recent digital skills data available was from 2019, the authors conducted the analysis using data from that year. the study included 135 countries worldwide, 52 developed (38.52%) and 83 developing countries (61.48%). data for some african and asian countries were missing, and they were excluded from the analysis. table 2 presents the summary of the variables used in the analysis. table 2. summary of the variables variable explanation data source digital skills in your country, to what extent does the active population possess sufficient digital skills (e.g., computer skills, basic coding, digital reading)? [1 = not all; 7 = to a great extent] https://govdata360.worldbank.org gni per capita gni per capita, atlas method (current us$) https://data.worldbank.org the world bank classification for 2019 was used, which classifies countries into four income groups (low, lower-middle, upper-middle, and high-income) based on the thresholds determined by the amount of gni p.c. in usd. it is important to note that on july 1 each year, the world bank updates the classification of countries, considering that changes in population, inflation, income https://govdata360.worldbank.org/indicators/he6227f5e?country=bra&indicator=41400&viz=line_chart&years=2019,2019 https://data.worldbank.org/indicator/ny.gnp.pcap.cd https://data.worldbank.org/indicator/ny.gnp.pcap.cd 62 economic analysis (2023, vol. 56, no. 1, 57-68) growth, and exchange rates influence gni p.c. and that the thresholds must be adjusted for inflation (world bank, 2019). according to nielsen (2011), high-income countries are considered developed, while low, lower-middle, and upper-middle countries are considered developing countries. gni per capita in u.s. dollars was used to express the level of development as proposed by paulozzi et al. (2007). table 3. presents the summary of income groups, countries' classification by development level, and the codes used in the analysis. table 3. classification of countries by income group and development income group gni per capita (usd) the codes of the income group level of development low income < 1,026 1 developing lower-middle income 1,026 3,995 2 upper-middle income 3,996 12,375 3 high income > 12,375 4 developed source: world bank, available on https://blogs.worldbank.org/opendata/new-country-classificationsincome-level-2019-2020 16.9.2022 and nielsen, l. (2011). imf working paper–classifications of countries based on their level of development: how it is done and how it could be done. international monetary fund. the level of digital skills was measured using publicly available 7-point likert scale data from the world economic forum, which were based on assessments made by research teams from each country's institute on a scale ranging from 1 to 7. based on the available data, the authors calculated the global average digital skills score to be 4.22. considering that the maximum score is 7, it can be concluded that there is a space for improving the level of digital skills globally. from the aspect of development, developed countries had, on average, a higher level of digital skills (4.81) compared to developing ones (3.86). table 4. descriptive statistics – digital skills income group n mean std. deviation std. error 95% confidence interval for mean min max lower bound upper bound 1 13 3.33 .42933 .11908 3.0752 3.5941 2.74 4.03 2 33 3.84 .54702 .09522 3.6433 4.0312 2.45 5.06 3 37 4.07 .62451 .10267 3.8602 4.2766 2.91 5.37 4 52 4.81 .55497 .07696 4.6557 4.9647 3.52 5.83 total 135 4.22 .75070 .06461 4.0992 4.3548 2.45 5.83 source: authors' calculation in income group 1, mozambique had the lowest score for digital skills, while the gambia had the highest score. in income group 2, the lowest score was recorded in angola, while the philippines had the highest score. the lowest and the highest values in income group 3 had paraguay and malaysia, respectively. in income group 4, panama had the lowest, while finland had the highest digital skills score. in serbia, the score for digital skills was 4.09. this score is slightly above the average of serbia's income group (upper-middle income). the descriptive statistics for gni per capita are presented in table 5. https://blogs.worldbank.org/opendata/new-country-classifications-income-level-2019-2020 https://blogs.worldbank.org/opendata/new-country-classifications-income-level-2019-2020 marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 63 table 5. descriptive statistics – gni per capita in usd income group n mean std. deviation std. error 95% confidence interval for mean min max lower bound upper bound 1 13 701.54 196.505 54.501 582.79 820.29 240 950 2 33 2223.03 947.841 164.998 1886.94 2559.12 1070 3980 3 37 7007.03 2414.146 396.883 6202.11 7811.94 4010 12120 4 52 37003.46 20030.484 2777.728 31426.94 42579.98 12620 84260 total 135 16784.59 20416.586 1757.180 13309.20 20259.99 240 84260 source: authors' calculation in income group 1, burundi had the lowest gni p.c., while guinea had the highest. in income group 2, the lowest gni p.c. was recorded in angola, while the philippines had the highest value. the lowest and the highest gni per capita income group 3 had sri lanka and costa rica, respectively. finally, in income group 4, romania had the lowest, while switzerland had the highest gni p.c. gni per capita in serbia was 7040 usd in 2019. this amount was slightly above the average of the upper-middle income group serbia belongs to. correlation analysis was used to test the defined hypothesis and examine the relationship between two variables, i.e., development (measured by gni per capita) and the level of digital skills (measured by a seven-point likert scale). considering the presence of the outliers, we applied spearman correlation analysis. results analysis of the association between the level of digital skills and gni p.c. shows that a higher level of digital skills corresponds to a higher gni p.c. dots on the graph (figure 1) represent pairs of digital skills and the income level with the belonging code of the income group above the dot. figure 1. scatter plot for the level of digital skills and gni p.c. (us$) source: authors based on world bank data 332 3 3 4 4 3 4 2 4 4 22 33 3 4 3 1 1 22 2 4 1 4 3 3 3 4 4 4 4 3 3 22 4 1 4 4 3 1 3 4 2 4 3 12 2 4 4 233 4 4 4 3 4 3 3 2 44 2 2 4 3 2 4 4 3 11 3 1 4 2 4 3 32 3 21 3 2 4 4 2 2 4 4 2 4 3 3 2 4 4 4 4 3 1 4 2 3 4 4 4 4 3 4 3 4 4 22 3 4 2 3 1 2 44 4 4 212 20 10000 20000 30000 40000 50000 60000 70000 80000 90000 0 1 2 3 4 5 6 7 g n i p er c ap ita digital skills 64 economic analysis (2023, vol. 56, no. 1, 57-68) even though a positive relationship between these two variables is identified, it should be pointed out that there is an influence of some other factors, such as the development of digital infrastructure, quality of the educational system, availability of the latest technology, etc. a correlation analysis was applied using the spearman coefficient to examine the presence of a statistically significant association between digital skills and gni p.c. considering the presence of outliers, the authors used spearman's correlation. a statistically significant (p<0.01) strong positive linear relationship was found between the level of digital skills and gni per capita, i.e., development, considering that the value of the correlation coefficient is 0.72 (table 6). therefore, the null hypothesis that there is no linear relationship between the level of digital skills and gni per capita was rejected. table 6. results of the spearman's correlation total sample digital skills gni per capita digital skills 1 .720** sig. (2-tailed) 0 0 gni per capita .720** 1 sig. (2-tailed) 0 0 n 135 135 ** correlation is significant at the 0.01 level (2-tailed) source: authors' calculation this result shows a strong link between development and digital skills, i.e., the higher level of gni per capita corresponds to a higher level of digital skills, and vice versa. due to the lack of literature examining the relationship between digital skills and development, particularly globally, there was a limitation in comparing research results. our findings support the previous studies conducted in the eu by rozite et al. (2019) and aniela et al. (2019). therefore, the results of our analysis highlight the significant role of income in developing citizens' appropriate level of digital skills. furthermore, digital skills play an important part in driving economic development. this study contributes to the expansion of the literature in this scientific field, given that it provides for the first time an insight into the relationship between the development and the level of digital skills on a global level. conclusion digital transformation is rapidly changing the way how society and the economy function. in the 21st century, all individuals need digital skills to interact, study, work, access online services, and find necessary information (european commission, n.d.). the development of digital skills significantly contributes to overcoming poverty and empowering the poor (urvashi et al., 2017). since there are differences between developing and developed countries, it is significant to explore the relationship between country development and the citizens’ level of digital skills. in this regard, this paper aims to examine a positive linear relationship between the level of digital skills and country development measured by gross national income per capita (gni p.c.). the analysis covered 135 countries worldwide, considering that the data for predominantly african and asian countries were unavailable. the data were collected from the world bank databases for 2019. to test the formulated hypothesis, correlation analysis was used. a strong positive relationship was found between the level of digital skills and gni p.c. considering that the correlation coefficient amounts to 0.720. this result indicates a higher level of gni per capita. i.e., country development corresponds to a higher level of digital skills, and vice versa. thus, the results of our analysis highlight the important role of country development in enhancing citizens’ marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 65 level of digital skills, and the significance of citizens’ level of digital skills in improving country development. based on the findings of the study, there are several implications and policy recommendations. firstly, the study highlights the importance of increasing access to digital technologies and infrastructure in promoting country development. governments should invest in expanding access to high-speed internet, computer hardware, and software, especially in rural and underdeveloped areas, to ensure citizens can access the digital resources necessary to develop their digital skills. secondly, the study suggests that digital skills education and training investments can effectively enhance the development of the country. thus, governments should prioritize the higher incorporation of digital skills in their education systems and provide training programs to the workforce to ensure that citizens have the necessary skills to thrive in the digital economy. finally, policymakers should consider the findings of this study in their efforts to close the digital divide and promote digital inclusion. even though this study contributes to expanding the scope of the literature related to this scientific field, this research has some limitations. firstly, the data for predominantly african and asian countries were unavailable, which could limit the generalizability of the study's findings. secondly, the study only examined the correlation between the level of digital skills and country development, which does not imply causality. thirdly, other factors that may affect a country's development and the level of digital skills were not considered. the above limitations suggest the need for further research to better understand the complex interplay between digital skills and country development. future studies should aim to expand research by incorporating more countries into the analysis. furthermore, researchers should include other relevant variables, such as the development of digital infrastructure, availability of the latest technology, quality of the educational system, etc. additionally, they should consider using more precise and reliable measurements of digital skills, such as observing the percentage of the population with the respective level of digital skills (e.g., above-basic, basic, low, and no digital skills). moreover, further research should focus on examining causality and developing more sophisticated statistical models and techniques to analyze and identify causal relationships. acknowledgments this paper is supported by the ministry of science, technological development and innovation of the republic of serbia. references aikins, s.k. 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https://blogs.worldbank.org/opendata/new-country-classifications-income-level-2019-2020%2018.9.2022 https://govdata360.worldbank.org/indicators/he6227f5e?country=bra&indicator=41400&viz=line_chart&years=2019,2019 https://data.worldbank.org/indicator/ny.gnp.pcap.cd%2018.9.2022 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp109-120 scientific review western balkan countries as an attractive investment destination darko marjanović1* | mihajlo đukić1 1 institute of economic sciences, belgrade, serbia abstract foreign direct investments are potentially very important for each country as they could significantly contribute to its economic development. the importance of foreign direct investments reflects in their ability to contribute to development of comparative advantages and competitiveness. in the last 20 years, wb countries have tried to attract as many foreign investors as possible using various policy incentives. foreign direct investment inflows followed the pace of economic transformation and reforms towards a market economy, leading to economic growth. the aim of this paper is to analyse characteristics of the inflow of foreign direct investments in the western balkans (wb) countries, as well as the impact they might have on their economic growth and development. in order to determine the amount of foreign direct investments, but also the position, i.e. competitiveness of each of the observed countries, there have been used secondary data from the official unctad reports. the paper will also present an analysis of the greenfield investments for selected economies, as a very important type of foreign investments that probably have the largest positive spillovers. the time period covered by this research was from 2010 to 2019. the results of the conducted research indicate that serbia is the most attractive investment destination, considering that in the observed period, more than 60% of the total amount of foreign direct investments that were directed to the countries of the western balkans ended up on its territory. key words: foreign direct investments, western balkans, investors, economic development jel classification: f21, p33, p45 introduction in the single european union market, characterized by fierce competition and free movement of capital, labor, goods and services, member states and international organizations strive to create the most competitive economic environment. in that context, tax policy instruments are very important. the realization of comparative advantages by using tax policy instruments was especially obvious at the beginning of the 21st century, when the new members from eastern europe joined the european union, and the „race“ in attracting foreign investments additionally intensified. in line with the accession of these countries to the european union, the issue of tax competitiveness shifts to the countries of the western balkans (albania, bosnia and herzegovina, montenegro, north macedonia and serbia) that remained outside the european union. all these countries generally do not have sufficient domestic capital, and therefore not enough investments to stimulate economic activity. this is one of the main reasons to explain * corresponding author, e-mail: darko.marjanovic@ien.bg.ac.rs 110 economic analysis (2020, vol. 53, no. 2, 109-120) why these countries strived to be as much competitive as possible, since they will be in a position to attract foreign investors not only from europe, but from all over the world as well. the competitive economic environment of a country is a clear investment signal for multinational companies. favourable environment results with larger amount of investments and consequently leads to the opening of new production facilities as well as the employment of the local labor force. factors often present in transition and less developed countries and particularly beneficial for the foreign capital are, above all, the high unemployment rate as well as privatization which has led to the closure and restructuring of a large number of companies. high unemployment rate sometimes leads to lower labor costs, whereas destroyed local companies cannot be enough strong competition for large multinational businesses. all of the aforementioned favours foreign capital. countries that have gone through the transition towards market economies are in a position to attract foreign capital with low tax rates, trying at the same time to eliminate high unemployment rate, increase gdp, etc. (feld, 2005). the most important factors that guide multinational companies in deciding which country to invest in are lower income tax and income tax rates (donath & slavin, 2009). fdi accumulation in the western balkans has been associated with an increase in production given that multinational companies usually have better operational solutions and know-how that transfer to the targeted economies. in this case, multinational companies can benefit not only from the increased revenues but also from increased production and efficiency. fdi are often based on the new innovative technologies educating employees for the particular business, and bridging the gap between developed and developing countries. fdi contribution often results in the promotion of foreign trade, given that increased efficiency, economy of scale and product quality will contribute to greater export opportunities for domestic companies, previously unable to participate in foreign markets. a favorable investment climate is very important for all investors in these countries, given that the state, when creating an adequate investment climate for foreign investors, also provides domestic companies with additional opportunities and support. literature review foreign direct investments are very important form of international capital movements, significantly influencing national economic development (musabegović et al., 2015). the western balkans could be an attractive investment destination in the following period (sanfey et al., 2016). for that to happen, it is necessary for these countries to increase their production, export and achieve overall economic stability (domazet & marjanović, 2017a). foreign direct investments might significantly contribute to the economic growth, reduce unemployment and result in inflow of new technologies (zdravković et al., 2017). foreign direct investments are one of the factors of success of the national economy in the global market (marjanović & domazet, 2018). although decisions related to fdi inflows/outflows are primarily an economic consideration driven by market forces, they are also deeply shaped by the economic, political, and legal rules governing investment in the host country (meunier, 2017). one of the main tasks for the western balkans countries is to attract as much foreign direct investment as possible. it is very important that there is available, but not limitless capital on the world market, which lead to countries competing with each other for investors and their capital (marjanović, 2018; stošić et al., 2011). the country features such as size, openness, skill levels, and institutional stability not only set the pace of fdi, but that they also influence both the network structure and the power positions of each node (bolivar et al., 2019). the findings of research paul & jadhav (2019) indicate that infrastructure quality, trade cost measured by tariff and non-tariff barriers, institutional quality measured by effective rule of law, political stability, regulatory quality and control on corruption are significant determinants of fdi in emerging markets. darko marjanović, mihajlo đukić 111 if state aims to be an attractive destination for foreign investors, it is necessary for tax policy makers to pay special attention to tax rules. precisely these rules and the adopted measures in the field of tax policy will significantly influence the decision of investors to invest capital (domazet & marjanović, 2018). tax incentives tend to attract efficiency-seeking fdi motivated by lowering production costs than other types of investment. developing country governments can take unilateral steps to use tax incentives in a more targeted and cost-efficient manner by (1) targeting incentives at those investors whose decision to invest is most likely swayed by incentives and (2) improving the design, transparency, and administration of incentives to reduce indirect costs and avoid unintended consequences (andersen et al., 2018). in the process of globalization, states are trying to reduce tax rates and / or expand tax bases with an aim to attract foreign capital. this is also called a "race to the bottom", which is based on two predictions: (a) multinational companies invest in countries that do not have high standards and grant additional benefits to investors, (b) countries undermine each other's standards to achieve the main goal and that is attracting foreign capital (olney, 2013). according to cazzavillan & olszewski (2012), non-financial fdi is positively affected by financial services fdi and by market potential and fdi crowds out domestic investment in the manufacturing sector. according to li & tanna (2019) fdi has a strong and positive impact on tfp (total factor productivity) growth after accounting for the roles of human capital and institutions. institutions are found to be more important than human capital in realizing productivity gains from fdi. if the western balkans countries succeed in attracting foreign investors, it will automatically mean that the state has provided a safer and more favorable economic environment in the country compared to competitors (domazet & marjanović, 2017b). however, it does not necessarily mean that the fdi will result in economic development. western balkan countries generally have a certain level of skills and knowledge, which might contribute to a higher inflow of foreign direct investment in these countries. this could also lead to the growth and development of the host countries and result in increase of the country's competitiveness as well (redžepagić & richet, 2008). corruption is one of the major issues the western balkans is facing, challenging both domestic and foreign companies in doing business. according to zeneli (2015), high levels of corruption negatively affect the economic development of the western balkans countries. corruption is negatively correlated with the level of income, given that a higher level of corruption affects the reduction of per capita income. it also negatively affects the current account balance, stimulate tax evasion, reduce competitiveness, also discouraging innovation activities. analyzing the inflow of foreign direct investments, đukić and bodroža (2011) come to the conclusion that all western balkan countries should invest more efforts in solving potential problems that might negatively affect the attraction of greenfield investments, since these investments can significantly contribute to the development of these economies. data analysis and findings western balkan countries still lag behind developed eu economies in terms of their overall economic development. they cannot obtain sufficient capital from the internal sources of their own accumulation. therefore, fdi represent very important channel of capital accumulation for these countries. one of the main goals for these countries is to attract as much foreign capital as possible bridging the gap between available and desired amount of investments. inflow of the new investments is supposed to have significant impact on their economic growth. 112 economic analysis (2020, vol. 53, no. 2, 109-120) fdi in the western balkan countries over the last ten years, fdi in the western balkan economies has been mainly focused on the manufacturing sector, which recorded significant improvement in productivity and the profitability if compared to the previous period. this is one of the reasons behind the transfer of resources from the industrial sector with small comparative advantages, towards industrial sectors that may have comparative advantages comparing to more competitive regions, primarily neighbouring balkan countries. there are numerous reasons why companies seek to expand their business to other countries, with particular emphasis on (a) lower operating costs, (b) availability of raw materials, (c) cheaper labor, (d) avoidance of customs and other export costs when exporting to targeted markets, (e) lower transport costs, (f) takeovers of companies direct competitors operating in targeted markets, etc. fdi has had a significant impact on catch-up processes in developing countries. western balkan countries (albania, bosnia and herzegovina, montenegro, north macedonia and serbia) are also the ones that might experience economic benefits from the fdi inflow. the aim of this paper is to present recent trends in the fdi inflow, as well as to explore the impact of fdi on the development of selected economies. in addition, the paper will present an analysis of greenfield investments (amount and total number of implemented projects). the analysis covered the period from 2010 to 2019. data from the official united nations conference on trade and development (unctad) were used. table 1. fdi inflows in western balkan countries, 2010-2019. (millions of us dollars) country 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 albania 1 050 876 855 1 265 1 111 945 1 100 1 148 1 289 1 281 bosnia and herzegovina 406 496 394 276 550 361 349 449 472 528 montenegro 760 558 619 447 497 699 226 558 489 452 north macedonia 212 478 142 335 272 240 374 205 725 365 serbia 1 686 4 932 1 298 2 053 1 998 2 347 2 352 2 878 4 127 4 280 source: unctad (2020) over the period from 2010 to 2019, about $ 51,805 million of foreign direct investments entered the western balkan region. the main sources of the attracted investments are the eu countries, china, russia and the usa. table 1. shows that 2012 was extremely unfavorable in terms of attracted investments. as a result of the reduced fdi inflow, it was hard to achieve strong economic growth in the period after 2012. however, since 2013 it could be noticed relatively favorable trend in fdi, particularly in serbia and albania. by conducting stimulative fiscal policy towards foreign investments, serbian authorities have created a relatively competitive economic environment, which resulted in positive results measured in the amount of attracted foreign capital. if we consider the overall level of investments in the western balkans, it could be noted that serbia has significantly larger inflows of foreign direct investment if compared to other countries in the region. if per capita fdi are taken into account, montenegro takes the first position followed by serbia and albania. however, the western balkans region lags significantly behind eu countries in terms of fdi inflows per capita. average fdi stock per capita in the western balkans is around €2,600 while in the european union it is around €14,300 (sanfey et al., 2016). darko marjanović, mihajlo đukić 113 figure 1. fdi inflows in western balkan countries, 2010-2019. (millions of us dollars) source: authors based on the unctad (2020) the largest single recipient of the regional fdi is serbia, which received about $27,951m in the analysed period, which is 54% of the total amount of foreign direct investment that ended up in the western balkans. it is followed by albania with $10920m (21%), montenegro with $5305m (10%), bosnia and herzegovina with $4281m (8%) and north macedonia with $3348m (7%). at first glance, it can be concluded that in the observed period, out of the total amount of fdi attracted, more than half arrived in serbia. this is not surprising, since besides the fact that serbia is the largest economy in the region, serbian policy makers put special emphasis on creating conditions for attracting foreign investors. other countries received much less fdi in relative terms if compared to serbia. figure 2. share of fdi attracted by western balkan countries (2010-2019), in % source: authors based on the unctad (2020) in the first half of 2019, compared to the same period 2018, fdi fell by 1 percentage point. however, we inflow of fdi to the countries of the western balkans is still solid, mostly due to the favourable geographical location, relatively cheap and skilled labour as well as lower labour costs. the contributions of foreign direct investment (fdi) to the western balkan economies have been relatively important over the last years, providing support for economic growth, job creation, innovation and technological progress. eu companies are the biggest investors in the western balkans: over €10 billion of foreign direct investments in the past five years. 114 economic analysis (2020, vol. 53, no. 2, 109-120) western balkan countries are not yet members of the european union which, to a certain extent, can be a limiting factor for attracting foreign investors. if the total fdi inflow in the eu countries with the total fdi inflow in the western balkans is compared, we can derive conclusion that western balkan countries significantly lag behind in terms of fdi inflow compared to eu. table 2. fdi inflows, 2010-2019. (millions of us dollars) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 european union 394082 488712 397392 366738 312030 645445 591331 465076 415116 446896 wb countries 4114 7340 3308 4376 4428 4592 4401 5238 7102 6906 source: unctad (2020) although the share of fdi in the western balkans has increased significantly in the recent years, it is still insufficient compared to other eu countries. if the inflow of fdi in eu countries is compared over the same period, it could be noted that the western balkan countries receive between 0.7 and 1.8% of the total fdi recorded in the eu countries. figure 3. foreign direct investment in western balkan countries, net inflows (% of gdp) source: world bank data url: https://data.worldbank.org/indicator/bx.klt.dinv.cd.wd the contributions of foreign direct investment (fdi) to the western balkan economies have been relatively sizeable over the last years (figure 3), providing support for economic growth, job creation, innovation and technological progress. greenfield investments in the western balkan countries one of the most important sources of business development of multinational companies refers to investing in other regions, i.e. other countries. it is motivated by a legitimate interest aimed at ensuring economic benefits and increasing profits. by entering foreign markets, they have the opportunity to invest capital in one of the following ways: (a) greenfield investments, (b) m&a (merger and acquisition) and (c) joint ventures. the most common form of foreign investment is through greenfield investments. this form of investment is typical for companies that invest their own capital in a foreign country, where they do not have pre-built infrastructure, space or labor force for their business. therefore, to have the characteristics of a greenfield investment, the company has to build completely new plants and facilities, and agreed darko marjanović, mihajlo đukić 115 location in the specific market, to activate a new business as a new market player, to enrich the offer of products and services in the target market, as well as to hire new workers. table 3. number of announced greenfield fdi projects in western balkan countries, 2010-2019. country 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 albania 6 8 12 4 6 5 2 3 6 5 bosnia and herzegovina 23 30 29 31 21 25 16 26 29 28 montenegro 10 6 7 9 8 4 3 2 17 10 north macedonia 15 26 31 27 32 20 20 11 13 10 serbia 79 111 113 125 79 75 86 112 157 114 source: unctad (2020) over the period between 2010 and 2019, the largest share of greenfield investments arrived in serbia. other western balkan countries have recorded significantly lower share of greenfield investments. the reason for this lies in the fact that serbia has significantly improved its policy towards greenfield investments, which has been also recognized by foreign investors. figure 4. share of greenfield investments in western balkan countries (2010-2019), in % source: authors based on the unctad (2020) out of the total number of greenfield investments attracted by the western balkan economies, serbia leads with 64%, whereas in other countries there were significantly lower amount of this type investments. serbia is followed by bosnia and herzegovina (16%), and by north macedonia (12%), while the other two countries have a very small number of these investments (montenegro 5%, albania 3%). table 4. value of announced greenfield fdi projects, by destination, 2003-2019. (millions of us dollars) country 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 albania 58 431 302 62 51 139 36 12 188 183 bosnia and herzegovina 291 1 235 1 210 888 975 3 140 936 552 701 558 montenegro 510 388 343 850 1 136 44 615 47 1 988 582 north macedonia 414 811 966 555 854 342 291 111 855 237 serbia 3 710 3 785 4 387 4 006 1 977 4 470 2 068 3 842 6 699 4 172 source: unctad (2020) 116 economic analysis (2020, vol. 53, no. 2, 109-120) many companies have recognized the western balkans as an ideal place to invest their capital. hence, it is not surprising that a significant amount of greenfield investments in the last decade arrived in these countries, where serbia stands for the largest recipient. during 2018, the western balkans recorded the largest inflow of greenfield foreign direct investments over the observed period 2010-2019, amounting to approximately $ 9 billion. although western balkans have attracted significantly fewer greenfield fdi projects than other countries in central, eastern and western europe, the region's performance has been relatively solid if the share of global gdp is considered. serbia attracts almost 12 times more foreign investments compared to similar economies of its size. the main reasons for such a significant attraction of fdi lies in the economic incentives, solid labor force and relatively generous tax policy, but also trade agreements and other political agreements signed with other countries. discussion western balkan countries use different strategies aiming to attract fdi. it is very important to create a good investment climate, and one of the prerequisites for creating favorable business environment is the adequate tax policy. the establishment of investor support agencies as well as the conclusion of bilateral agreements related to capital investment can significantly contribute to the opening of the market for foreign investors resulting in capital inflows. therefore, fdi could be a significant source of economic development, modernization, growth of production, exports and employment. since the early 1990s, albania experienced a steady inflow of the fdi. choosing albania as an investment destination provides foreign investors with significant competitive advantages over the neighbouring balkan countries geographical location, low tax burden, very cheap labor as well as natural resources (oil, gas, copper, iron, chromium), including solid penetration of the regional market. in recent years, the albanian government has aimed to increase the inflow of fdi through tax reform. measures have also been taken to improve the overall business climate in the country by improving business procedures as well as undertaking comprehensive structural reforms, primarily in legislation while reducing the fiscal burdens. albania offers equal treatment to foreign and domestic investors, but has also signed bilateral agreements aiming to promote and protect investments. the focus of the policy makers in the future period should be to attract foreign direct investments in sectors where the potential of the albanian economy has not been exploited, particularly in exploitation of the natural resources, development of tourism and the agribusiness sectors. although bosnia and herzegovina has competitive tax rates compared to other western balkan countries, the level of foreign direct investment is still far from the expected level. the authorities aim to improve their competitive position by introducing numerous tax and other incentives for foreign investors. one of the problems for business development, being also a significant barrier for the fdi inflow, is the complex state administration and several levels of governance. inadequate and inefficient administration as well as the complex legal framework are coupled with non-transparency of the state policy. foreign investors are particularly concerned about of political instability, high levels of corruption, the gray economy and inadequate workforce skills. in order to attract fdi and improve competitiveness, it is important for bosnia and herzegovina to carry out the necessary political reforms, reduce corruption, improve administrative efficiency, and develop a strategy for attracting fdi. one of the steps towards creating a system for attracting fdi refers to the strategic decision about the country's development priorities that could result in advantages over neighboring countries. foreign direct investments are one of the important factors in achieving sustainable economic development and increasing the competitiveness of montenegro. the legal framework in montenegro is very liberal and favors the fdi attraction. however, it should be borne in mind that fierce competition in the world market and the presence of liberal regulations are typical darko marjanović, mihajlo đukić 117 for almost all countries worldwide that aspire to attract foreign investments. it is important to note that an attractive legal framework has been created in the country, i.e. foreign investors have the national treatment and there are no restrictions on profit repatriation. additionally, montenegro has very simple legal procedures for establishing a company. montenegro has an extremely high potential for attracting fdi, but in the following period, the implementation of major projects will largely depend on the economic situation at the global level. in the forthcoming period, the inflow of foreign direct investments could be negatively affected by lower interest of foreign investors in the implementation of large projects in the field of tourism, outflow of foreign capital, slow administrative procedures and delays in privatization. therefore, it is very important for montenegro to complete the privatization process in the coming period (through simplification of procedures and acceleration of the privatization process) and change the investment structure in terms of increasing the share of greenfield investments. it is also very important to increase investment in new production programs that will inevitably lead to job creation. one of the main goals of the macedonian government in the coming period is to attract as much as foreign direct investments as possible, which will contribute to the creation of a safer and more favorable economic situation in the country, resulting in creation of new jobs. in addition to low tax rates, northern macedonia has made efforts in other segments of the economic policy in order to be competitive with neighboring countries. this is reflected in various benefits for starting a business, reducing costs and time for a company registration, strengthening regulations and investors' protection, simplifying the process of obtaining building permits and electricity, etc. all these efforts have been rewarded by increasing foreign direct investment in macedonia over the last decade. after 2012 and the recorded sharp decline of fdi in serbia, the period that followed led to significant economic stability in the country, which resulted in an increase in fdi inflows from both eu countries and china. greenfield investments in serbia have grown over the past 6 years, where 2018 stands out, in which over 100 individual projects have been implemented. it should be particularly emphasized that serbia, according to the fdi intelligence list for 2019, is ranked first in the world as a country receiving greenfield investments, taking into consideration the level of gdp. with a score of 11.92 serbia attracts almost 12 times the amount of greenfield fdi compared to the amount that could be expected given the size of its economy. the implemented reforms have significantly contributed to the fact that foreign investors are increasingly interested in serbia as an investment destination, with eu countries (germany, italy, the netherlands and austria) leading the way. economic perspectives of serbia in the following period will dominantly depend on its readiness to deal with high level of corruption and strengthen rule of law which have been stressed as the main challenge in most of the reports of the international institutions and organizations (i.e. european commission report, 2020). to summarize, it is obvious that the western balkan countries are favourable investment locations for foreign investors. all these countries have implemented economic reforms and greatly simplified the criteria for attracting foreign investors. well-implemented tax reform is also crucial for attracting foreign direct investment, which primarily refers to tax incentives that will largely determine the future strategies of multinational companies and their choice to invest capital. however, it is important to note that fdi should not be considered only as a whole, since the structure of the attracted fdi is also important. fdi that bring new technologies, and result in producing higher added value products are particularly important for the sustainable economic development. conclusion size of the market and the market growth rate are the key parameters that investors are taking into consideration when entering the particular market. if the market is large and the 118 economic analysis (2020, vol. 53, no. 2, 109-120) growth rates are high, management will seriously consider diverting resources to the particular market, analysing possibilities to establish its own branch or acquire a majority stake in a joint firm. the decision about entering enter a new market also depends on other market conditions such as trade barriers (tariffs, quotas, customs duties). fdi are very important for those countries where there are underdeveloped regions, as they could significantly change the business conditions helping these regions to grow and develop much faster if compared to regions relying only on their own resources. the positive impact of fdi is often pronounced in industry, service development, trade, trade relations and the transfer of new technologies. industries in developing countries which succeeded in attracting foreign capital, often achieve good business results. foreign capital plays a stimulative role in the overall economic recovery of a country. western balkan countries have established investment agencies in charge of promotion of their economic potentials, so that the number of concluded bilateral agreements, agreements on avoiding double taxation as well as free trade agreements are increasing every day, aiming to improve the investment climate in these countries. bilateral agreements typically involve developed countries on the one hand and developing countries on the other, with the aim of protecting companies from developed countries from political risks while helping developing countries to attract fdi. double taxation agreements are essential to prevent a multinational company from being taxed twice on the basis of the same business activity. it is very important for investors to have adequate conditions for unlimited and equal participation in the market. when making a decision on investing in a certain country, special attention is paid to the index of economic freedoms, which serves to measure economic freedoms in world economies. according to the results for 2020, on a scale of 0 to 100, where the maximum value represents a perfectly free country, western balkans countries score 65.3 on average. according to the index of economic freedom, all the countries of the western balkans are classified in the third level moderately free. the effects of potential foreign investments on the western balkan economies are mainly positive, and the key evidence lies in their dynamic growth over the last 10-15 years. western balkans is experiencing an increase in fdi during the european union accession process. it is important for all the western balkan countries to ensure an adequate environment in the following period creating an appropriate investment policy framework and providing political stability and favourable business climate. the competitiveness of the western balkan economies has significantly improved in the previous period, since countries are competing to each other when applying specific measures offered to potential investors. macroeconomic stability, strategic geographical position, favorable tax regime as well as low labor costs are important determinants of the attractiveness of particular country for the fdi inflow. in order to attract investors, it is very important to provide investors with attractive fiscal incentives. one of the benefits is the establishment of economic zones, business parks, trade zones and other similar measures, through which countries offer tax exemptions as a significant benefit. in the following period, it is very important for the western balkan countries to design adequate investment and tax policies, so to be even more oriented to the attraction of free capital, which could significantly contribute to their economic 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foundations of inflation targeting with special emphasis on the experience of serbia milena lazić1* | ivana domazet2 1 belgrade banking academy faculty of banking, insurance and finance, university union, belgrade, serbia 2 institute of economic sciences, belgrade, serbia abstract compared to the 1970s when the inflation rate in most countries reached double digits, nowadays we are facing low inflation rates globally. inflation targeting, as a monetary policy strategy, appeared in late 1980s in the period when other strategies proved to be insufficiently effective. the first country to apply inflation targeting in 1989 was new zealand. since then, 64 countries have implemented the inflation targeting as a monetary policy regime. the concept of inflation targeting as a strategy for conducting monetary policy in serbia was introduced in august 2006. when choosing the appropriate strategy to ensure price stability, the nbs relies on the experiences of other countries, especially central and eastern european countries. accordingly, the paper aims to present the genesis of the development of the inflation targeting, as well as the impact of applying this strategy on reducing global inflation. a special segment of this paper is devoted to the analysis of the experiences of serbia in terms of applying the inflation targeting. key words: inflation targeting, small open economy, transmission mechanism of monetary policy, pass-through effect, dollarized economy, serbia jel classification: e4, e5, e6, n1 introduction contemporary central banking faces numerous challenges. in this regard, the authors kozaric and fabris (kozaric & fabris, 2012) stated in their paper that the key problems that central banks are facing today are the followings: • choosing monetary policy goal; • choosing monetary policy regime and • selecting the key monetary policy instruments. as far as the goals are concerned, friedman (friedman, 1968) states that there is a consensus among the general public regarding the basic objectives of economic policy in terms of high employment, low inflation (price stability) and economic growth. the author, however, considers that there is no such consensus to their mutual consent. however, the findings of numerous empirical studies have confirmed the existence of a positive link between price stability (stable economic environment) and economic growth. it is therefore not surprising that the large number of modern central banks as the main goal (or one of the basic goals) of * corresponding author, e-mail: milena.lazic@bba.edu.rs milena lazić, ivana domazet 153 monetary policy management emphasize the establishment and maintenance of price stability, i.e. the preservation of the purchasing power of the national currency. in addition, most contemporary central banks implement their monetary policy within the framework of some of the current regimes. generally, monetary policy regimes provide a framework for the decision-making process implemented by monetary authorities in the country (in the form of a set of more or less rigid rules and procedures). in this regard, the authors bordo and schwartz (1997) in their paper made a distinction between monetary regimes and monetary standards. according to these authors the monetary policy regimes imply ".... a set of monetary arrangements and institutions accompanied by a set of expectations expectations by the public with respect to policymakers’ actions and expectations by policymakers about the public’s reaction to their actions.... ". contrary to that, and according to these authors, monetary standards refer only to institutions and arrangements which are in the function of managing money supply. historically, over time, two basic categories of monetary policy regimes have been singled out. the first category includes regimes that have implied convertibility of currency into goods (usually gold). the second category includes contemporary regimes that function within the framework of the so-called fiat money. these are as follows: • exchange rate targeting; • monetary aggregates targeting (monetary targeting); • monetary policy regime with an implicit nominal anchor and • inflation targeting. as with homogeneity of the perception of the basic goals of monetary policy, there is a certain consensus regarding the trend of the application of different monetary policy regimes. eugenio domingo solans, the member of the executive board of the european central bank1, believes that in recent years the tendency towards the "standardization of the monetary policy regimes" has become more prominent at the global level. namely, in the last few decades, there has been a shift in the way monetary policy is conducted. in other words, many countries have abandoned various forms of fixed exchange rate regimes that they applied until then, adopted a free (or managed) floating of their currencies, or implemented a strategy of inflation targeting. with that regard, one of the key findings presented in the work of the author pesakovic (2017) was the importance of historical perspective when conducting a policy which was often ignored in past. the first country which applied inflation targeting in 1989 was new zealand. since then, 64 countries2 have implemented the inflation targeting as a monetary policy regime. the concept of inflation targeting as a monetary policy regime in serbia was introduced in august 2006. when choosing the appropriate regime/strategy to ensure price stability, the nbs relies on the experiences of other countries, especially central and eastern european countries. with that regard, the subject of this paper is the analysis of our country's experience regarding the implementation of inflation targeting regime. the paper aims to illustrate the basic effects of inflation targeting implementation in the case of serbia as a small open emerging market economy with recent hyperinflation past. the paper consists of four parts. after the introductory remarks, the second part provides an overview of the literature which deals with the inflation targeting strategy and points to the main advantages and disadvantages of this monetary policy regime. in the third part the experience of serbia regarding the application of inflation targeting strategy was analyzed. within the fourth, i.e. final part, concluding observations and recommendations for further research in this area have been provided. 1 more on: https://www.ecb.europa.eu/press/key/date/2000/html/sp001201_1.en.html 2including the european union, usa and south african countries, see more on: http://www.centralbanknews.info/p/inflation-targets.html 154 economic analysis (2019, vol. 52, no. 2, 152-162) literature review compared to the 1970s when the inflation rate in most countries reached double digits, today we are facing low inflation rates globally (with the exception of underdeveloped countries in south america, africa and asia). inflation targeting, as a monetary policy strategy, appeared in late 1980s in the period when other strategies proved to be insufficiently effective. bernanke, laubach, mishkin and posen (bernanke et al., 2001) in their paper defined inflation targeting as the monetary policy framework whose main characteristics are public announcement of numeric target (or fluctuation zone) for the selected inflation rate for one or more time periods, as well as a clear determination of monetary authorities that stable and predictive inflation rate is the main goal of the monetary policy. inflation target is mostly connected with the consumer price index, i.e. some variances of this index which occur by exclusion of some price categories (food price, energy, mortgage loans interest rates, etc.). heenan, peter and roger (heenan, peter & roger, 2006) selected the four pillars which they consider to be the basis of inflation targeting: • explicite determination of the central bank to proclaim price stability the main goal of the monetary policy, as well as a high degree of central bank independence in its everyday operational procedures; • defining explicite numeric target for the selected rate of inflation; • responsibility of central bank for implementation of the proclaimed goal which is reflected through a high level of transparency in conducting monetary policy; • implementing policy based on pro-active approach, i.e. anticipation of factors which can contribute to the growth of inflationary pressures and accordingly undertaking appropriate measures. complementary to the above mentioned, in his paper svensson (2010) emphasized the following basic characteristics of the inflation targeting: • the public announcement of the numerical target or the fluctuation zone of the targeted inflation rate measured mainly by the consumer price index (it is also important to note that the inflation rate is previously defined for the midterm goal); • high level of transparency and responsibility of monetary authorities which is accomplished through continuous communication with the public regarding plans and goals along with making public reports on inflation and its determinants; • goals regarding stabilization of economic activity are not ignored, although these goals are considered in the long run; • a certain (justified) deviation from a defined target is tolerated in order to prevent sudden shocks in the short run. inflation targeting should be considered primarily as a framework for conducting monetary policy, rather than as a set of rigid rules that the monetary authorities in the country must adhere to (hammond, 2012). implementation of the inflation targeting implies that the central bank sets an explicit target in terms of the level of inflation rate, which necessarily affects the increase in the level of transparency, i.e. the establishment of the credibility of the monetary policy process. generally, central banks usually opt for a "more flexible" form of inflation targeting strategy, that is, instead of explicit numerical value for the target rate they determine the fluctuation zone and the probability of realization of each scenario. in this way, the emphasis is placed on the medium-term (most often two to three years) the fulfillment of the set goal, i.e. justifiable deviations are allowed in the short run. according to some authors (gürkaynak et al., 2006), this allows monetary authorities to manage inflationary expectations more easily, while at the same time it represents an efficient method for controlling the level of inflation in the long run. in fact inflation targeting is a milena lazić, ivana domazet 155 strategy based on two contradictory elements: defining a precise numerical value for the targeted inflation rate in the medium term and responding to sudden and unforeseen shocks in the short run (king, 2005). the inflation targeting defines a framework for conducting monetary policy which is based on the rule which speaks in favor of the potential rigidity of the regime itself. the regime basically consists of defining the operational target for the nominal short-term interest rate of the central bank that functions in the inflation targeting framework. in his book, woodford (2003) states that decision made by monetary authorities almost always involves determination of the level of the short-term interest rate that is in the function of an operational target, as well as increased transparency in decision-making and reaching the ultimate goal. in this context, it is not surprising that dedication to achieving the ultimate goal implies the definition of a specific procedure when deciding on the amount of the short-term interest rate. however, what gives some flexibility to the regime is the fact that the central bank never actually fixes the interest rate completely. in addition, within the defined framework, the central bank has discretion to respond to sudden shocks. regarding the aforementioned stipulations, in practice there are two basic ways in which the central banks achieve defined operational target in terms of the numerical value of the selected nominal short-term interest rate. the first way involves conducting open market operations in the form of regulating the amount of money in circulation. the other way represents the corridor system and is applied, among other things, in our country. the corridor system involves determining the amount of the selected key interest rate and the basic money market interest rates deposit facilities interest rate and lending facilities interest rate. the interest rate corridor system has proven to be highly efficient in countries such as canada, australia and new zealand. the most famous practical example of the rule for determining the level of the short-term nominal interest rate was defined by john taylor in 1993 (taylor rule). in its basic form, taylor rule was defined by the following equation: it = 2 + πt + 0,5 (πt – 2) + 0,5 (yt yt p) where πt stands for the current inflation rate and yt and yt p represent gross domestic product and potential gross domestic product, respectively. taylor’s rule is defined according to the available empirical data for the american economy. as the optimal inflation rate, the rate of 2% has been selected. compared to other strategies, the inflation targeting strategy provides the wider public with the clearest explicit goal, places more emphasis on the transparency of central bank operations and the growth of their credibility (obradović, dinić, & pivašević, 2014). in addition, some authors (arestis & sawyer, 2008) believe that the application of the inflation targeting as a monetary policy regime reduces the importance of fiscal policy, due to the reduction of the possibility of deficit budget financing from the primary emission. svensson (2002) stated that the strategy of inflation targeting proved more efficient in the domain of reducing the growth rate of the general level of prices compared to the strategy of monetary aggregates targeting. apart from that, in addition to reducing the inflation rate, it has been proved empirically that the huge number of countries managed to increase credibility and transparency in conducting monetary policy by applying the inflation targeting as a monetary policy strategy (obradović, dinić, & pivašević, 2014). the first country which applied inflation targeting in 1989 was new zealand. inflation targeting was most often applied in situations where another monetary policy regime gave a bad results. thus, a large number of european countries accepted the concept of inflation targeting 156 economic analysis (2019, vol. 52, no. 2, 152-162) after a sudden collapse of the erm system in 1992 (fabris & galić, 2016). today, almost all central banks in the world are legally required to declare price stability as one of their primary goals (laurens et al., 2015). the panel of countries that implement inflation targeting is very heterogeneous. analyzing figure 1, it can be noted that the average level of inflation in developing countries has drastically decreased as the number of developing countries which started to apply this strategy increased (from the initial 60% in 1995 to less than 10% in 2014). when it comes to developed countries, the growth in the number of developed countries that implemented inflation targeting has also contributed to lowering the average inflation rate of developed economies, though to a far lesser extent. figure 1. the level of the world inflation (for developed countries and developing countries) and the begining of implementation of the inflation targering strategy source: (hale & philippov, 2015, p.2) the imf study supports the aforementioned (international monetary fund, 2005), showing that in the period 1990-2004 in the countries that implemented the inflation targeting, the inflation rate was 4.8 pp lower on average in comparison with the inflation rate of countries that applied some of the alternative monetary policy strategies. in addition, the implementation of the inflation targeting also contributed to lowering the inflation rate variability (declining variability by 3.6 pp versus countries that used alternative monetary policy strategies). advantages and disadvantages of the inflation targeting strategy are shown in table 1. table 1. advantages and disadvantages of implementation of inflation targeting strategy advantages disadvantages central bank focused on domestic shocks rigid regime with too much discretion it is not necessary to have stable and predictable link between inflation and monetary aggregates. controlled prices make implementation of the regime more difficult the strategy is comprehensible to general public underdeveloped financial markets make implementation of the regime more difficult milena lazić, ivana domazet 157 advantages disadvantages high level of transparency and communication with the general public interest rates growth increases the burden of debt servicing responsibility of the central bank in case of long time delays it is difficult to reach annual targets the central bank is focused on things it can influence – price stability risk of huge oscilations of the exchange rate lower costs in case of failure in conditions of informal dollarization it is difficult to implement the regime source: (fabris & galić, 2016, p. 345) although it has many advantages, the inflation targeting regime has some drawbacks as well. in the last few years, the question of the applicability of this regime in the presence of informal dollarization has been increasingly raised in the professional public. informal dollarization implies a situation where the economy and the population choose to use a foreign currency as a value keeper (which implies the high share of deposits denominated in foreign currency in total deposits). this resulted in a significant weakening of the key policy instrument (domestic short-term interest rates) to the achievement of the final target (targeted inflation rate / fluctuation zone). in their paper, fabris and galic (2016) state that countries with two currency systems which are characterized by a high level of fluctuations in the exchange rate cannot apply the conventional inflation targeting regime. namely, the high level of fluctuations in the exchange rate in the conditions of high dollarization significantly determines the level of prices in the country. regarding that, there is a consensus in the literature that the pass-through effect is higher in highly dollarized countries compared to those in which dollarization is not present (reinhart, rogoff, & savastano, 2014). experience of serbia in implementing inflation targeting over the past two decades serbian economy has been characterized by price volatility and high inflation rates, inadequate monetary policy and a very weak and underdeveloped financial system (vilaret, pješčić, & đukić, 2009). in order to increase the credibility of the central bank, for the last two decades domestic monetary authorities have been trying to build an environment with low and stable inflation rates. with that regard, numerous empirical studies have found that a low, stable and predictable inflation rate is positively correlated with the economic growth. currently and according to scores assigned by the two most prominent rating agencies, serbia has stable outlook, but there is a possibility for change in economic environment and a high credit risk, mostly due to slow economic grow and high share of public and foreign debt in gdp (brkić and pijalović). the problem of price instability, which culminated in hyperinflation in the first half of the 1990s, with the existence of high degree of pass-through of the exchange rate on prices, was the main reason why foreign exchange rate was used as a nominal anchor for a long time in the suppression of inflationary pressures (tasić, 2008). consequently, the inflation rate was reduced from 111.9% in 2000 to 15% in 2002. after the official exchange rate became equal to the market rate, the national bank of serbia abandoned the fixed exchange rate regime and introduced the managed floating as the exchange rate regime. all that resulted in decline of inflationary expectations in the forthcoming period. the concept of inflation targeting as a monetary policy regime in serbia was introduced in august 2006, although formal implementation of the regime did not start before january 2009. 158 economic analysis (2019, vol. 52, no. 2, 152-162) when choosing appropriate strategy to ensure price stability, the nbs relies on the experiences of other countries, especially central and eastern european countries. as a measure of inflation, the annual percentage change in the consumer price index is taken, which at the same time represents the most reliable numerical indicator of the direction of monetary policy conduct in the country. however, the inflation projection cannot be made without assuming direction of monetary policy conducting during the period covered by planning. the assumption of direction of monetary policy conducting is a critical aspect of the inflation projection because it can be interpreted as a statement of the intention of the central bank in the medium term (đurđević, 2007). the basic instrument that the nbs uses to achieve its goal is the key policy rate. other monetary policy measures are an auxiliary instruments whose main goal is to make the monetary transmission process more efficient. inflation projections are based on the assumptions about the movement of the interest rate on which they are based. with that regard, the literature provides three basic models for the projection of the inflation rate in the following period (đurđević, 2007): • constant key policy rate; • the key policy rate based on market expectations; • the key policy rate which central bank intends to follow. table 2 shows the monetary policy regime conducted by the national bank of serbia since the year 2000. apart from that, the main characteristics of these regimes are explained. table 2. monetary policy regimes implemented by the nbs in the period 2000 2015 monetary policy regime operation target exchange rate regime monetary policy instruments control of capital monetary targeting (20002006) net domestic assets (top); net foreign assets (bottom) managed fluctuation interventions on the foreign exchange market; the rate of mandatory reserve; open market operations yes (short term) inflation targeting (september 2006) short-term interest rates managed fluctuation with a tendency towards free fluctuation two-week (one week) repo rate as the main instruments; auxiliary instruments: interventions on foreign exchange market; prudential measures; mandatory reserve rate yes (short term) source: (vilaret, pješčić & đukić, 2009), p. 60 in the new monetary policy framework, the target for inflation is determined as a unique value with the allowed deviation for several years in advance. for the period from january 2018 to december 2019, the memorandum on targeted inflation rates of the national bank of serbia foresees a targeted rate of total inflation of 3% with a tolerance of +/1.5 p.p (see figure 2). milena lazić, ivana domazet 159 figure 2. realized inflation rate and its deviation from the predicted target for the period 2009 q1– 2019 q2 (year-on-year rates), % source: national bank of serbia official website taking into account that serbia is highly euro-oriented economy, in the conditions of applying the inflation targeting, the fact that the monetary policy in our country is far less effective and precise in comparison with other countries in which foreign currency is not dominant should be taken into consideration. the change in the key policy rate by the central bank should theoretically influence the cost of the loan and, consequently, the aggregate demand in such a way that any increase in that rate also increases the cost of borrowing, reduces the aggregate demand and lowers the inflation rate. in addition, the growth of interest rates simultaneously discourages consumption (aggregate demand), i.e. has a stimulating effect on the economy and savings. however, in highly dollarized economies operating in the inflation targeting regime, the change in the key policy rate only affects the cost of loans and deposits denominated in domestic currency, which implies higher volatility and far more significant changes in this instrument in absolute terms in order to achieve the desired effect. in support of the above mentioned, the results of the research conducted by rajkovic and urosevic (rajkovic & urosevic, 2016) point out that when faced with a negative external shock (under which the mentioned authors imply an increase in foreign interest rates), central banks operating in two-currency monetary systems tend to be more restrictive compared to central banks that do not function in dollarized economies. besides that, on the global level the global economic crisis led to the use and development of new tools for risk management in banking sector (abdesslem, pascal, 2014). in the case of our country, the fact that the dominant part of the loan is denominated or indexed in euro makes the direction of the ecb's monetary policy more likely to affect the cost of the loan (and therefore the aggregate demand) than the change in the key policy rate of the nbs. moreover, the success of the inflation targeting in serbia depends on comprehension and assessment of the impact of pass-through of the exchange rate on prices. numerous researches have shown that the classical channels of monetary transmission do not work in the financial system of our country which is highly euro oriented, that is, that the exchange rate channel becomes dominant channel of influence on the level of inflation and even 160 economic analysis (2019, vol. 52, no. 2, 152-162) the goal itself (šoškić, 2016). in his study šoškić noticed that for a more efficient monetary policy, i.e. a lower and more stable inflation rate, which is also within the defined inflation target, it is necessary to influence the reduction in level of dollarization (euroization), which would contribute to the smooth functioning of the traditional monetary transmission channel. conclusion experience of a great number of countries has shown that ensuring price stability, in the medium term, is a prerequisite for achieving other important macroeconomic goals stable and sustainable economic growth, employment growth and improvement in the living standards. it is therefore not surprising that a large number of modern central banks emphasize the establishment and maintenance of price stability as one of the basic goals of monetary policy implementation, i.e. the preservation of the purchasing power of the national currency. central banks of many countries around the world function in some of the contemporary monetary policy regimes. depending on the specificity of the particular economy, the chosen regime may prove to be adequate or inadequate. compared to other strategies, inflation targeting provides the wider public with the clearest explicit goal, and places more emphasis on the transparency of central bank operations, the improvement of their credibility and accountability in monetary policy management. the strategy proved to be more efficient in lowering the rate of inflation compared to the strategy of targeting monetary aggregates. moreover, apart from lowering the inflation rate, it has been empirically confirmed that a large number of countries have managed to increase the credibility and transparency of monetary policy in general through the implementation of inflation targeting. taking into account that serbia is an import dependent highly dollarized economy characterized by recent inflationary past and, in general, public mistrust in domestic currency, in addition to choosing the appropriate monetary policy regime the monetary authorities in our country have to pay special attention to the foreign exchange rate mechanism. consequently, comprehension and assessment of the impact of pass-through of the exchange rate on prices is crucially important for the success of inflation targeting in serbia. this is supported by the fact that, immediately prior to the implementation of the new monetary policy regime, the exchange rate was used as a nominal anchor in our country. in this regard, future research in this field should focus on the impact of the pass-through of the exchange rate on prices in the serbian economy. acknowledgments this paper is written as a part of the research projects oi179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements) and iii47009 (european integrations and social and economic changes in serbian economy on the way to the eu), financed by the ministry of education, science, and technological development of the republic of serbia. references arestis, philip, & sawyer, malcolm. 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(2003). interest and prices foundations of a theory of monetary policy. new jersey: princeton university press. article history: received: july 18, 2019 accepted: august 19, 2019 ea_2015_3-4 udc: 005.941 005.57 cobiss.sr-id: 220027916 preliminary reports knowledge management as imperative for economic growth and development baltezarevic vesna1, faculty of culture and media, belgrade, serbia baltezarevic radoslav, alma mater europaea, belgrade, serbia jovanovic dragana, faculty of culture and media, belgrade, serbia abstract – we are now living in times of global business activity and the knowledge economy. knowledge-based resources represent the organizational know-how as the knowledge of employees, organizational production processes, and overall knowledge of one collective. knowledge management has long been recognized as a factor necessary for the development of business organizations. only those managers that embrace knowledge as the most important resource can expect to be better positioned than the competition. know-how is very important segment of overall knowledge that is deposited within the organization. the value of knowledge is much more important than all other forms of assets that an organization possesses. but knowledge cannot be communicated without the interested employees. so, managers have to create the business environment which uses adequate business communication. good communication stimulates ideas and creativity of employees. management must be able to manage business information and achieve active participation in communication with employees and exchange the intellectual capital values with them. key words: knowledge economy, know-how, knowledge management, intellectual capital, communication introduction the human society as a whole is exposed to constant change. contemporary economy is facing the values of intellectual capital. however, often a huge part of the intellectual potential of employees is not available to the organization. employees who are not positively stimulated do not want to share their knowledge and experience with others. such knowledge remains hidden in their consciousness. hidden knowledge’s transfer from implicit to explicit knowledge is possible only when employees feel belonging to the collective. the creation of such an organizational culture where employees understand that they are important for business is only possible with a good business communication. 1 vesnabal@gmail.com baltezarević, v., et al., knowledge management, ea (2015, vol. 48, no. 3-4, 62-68) 63 in today’s knowledge-based, high-tech environment, education, experience and skills become outdated very quickly, sometimes even before they are ever put to use (luthans, 2004). the ability of individuals and groups to quickly adapt to new demands and evergrowing range of constant challenges, determines their position in society. the accelerated pace of life and new technology still cannot affect the human need to interact with other people, because man possesses constant urge to communicate. competitive advantage indicates the power of a company, product or an economy in relation to others. the modern economy is directed more towards knowledge and latest technologies. therefore, the traditional concept of organization has been increasingly orienting towards ‘intelligent organization’, ‘virtual organization’, ‘organization based on the knowledge’, and so on. the idea of the new organization is dating back to the distant 1937. when ronald kouzea, in his theory of organizations, argued that “... bound to investigate and explain the causes and consequences of these changes in order to understand that a major transformation is due to the introduction of new economic organization” (fukuyama, 2007, p.57). nowadays, many organizations are aware that the only way to win and keep a competitive advantage is to learn faster than the competition. only those companies that embrace knowledge as the most important resource can expect to be better positioned than the competition. the ability to think quickly, the ability to collect and channel the knowledge available within the collective and thus consolidate that knowledge in the right way is a list of skills required of today's managers. the concept of ‘intelligent organization’ is based on knowledge that is deposited in the minds of talented individuals. such knowledge, in the theory, is called tacit knowledge. “tacit knowledge cannot be bought in the market in a form that would be appropriate for direct use” (zack, 1999. p.128). the transfer of tacit knowledge requires a certain amount of confidence and contacts. “tacit knowledge is a combination of cultural, emotional and psychological background that is on the margins of human consciousness” (tuomi, 19992000). today's business trends, the global crisis and the brutal struggle for survival in the market, are directing the organization towards a ‘new’ concept that is increasingly becoming based on ‘intangible capital’ and not on tangible assets. such an approach demands a new form of organization that is facing the intellectual capital. know how is what creates value, but also leads to new knowledge. modern technology facilitates the transfer of knowledge. reconciliation of businesses with the challenges of the modern era increasingly indicates interaction with the progress of science and technology, but it can be done only with people (baltezarevic, v. et al., 2013, p. 265). learning and adapting to new communication and business methods is imperative for the survival in a business environment. the management must know first how to get an answer if knowledge currently exists and what kind of knowledge is missing. in western literature we are faced with a new field of the economics, which, is referred to as knowledge-based economy or knowledge economy and information-based economy or information economy. economy of knowledge is recognized as the processes of creation, and use of knowledge. new economists who promote knowledge-based economy argue that such economy is a key determinant of development. knowledge, innovation and new ideas 64 economic analysis (2015, vol. 48, no. 3-4, 62-68) are pushing the boundaries of social and economic growth. “european social model, with its developed systems of social protection, given the transformations that lead to the knowledge economy” (baltezarević, v. & baltezarević, r. 2013, p. 431). knowledge management knowledge management is the ability to creating profits and leading position in the market with placement of collective knowledge. knowledge assets created computerized collection, storage, distribution and direction of corporate knowledge. modern technology contributes to the incorporation of knowledge into new products. development and use of knowledge within the organization must be under the control of management, which must ensure that conditions are created not only to make knowledge base, but also for its codification and transfer. generating knowledge includes all activities that convey new knowledge. successful society is defined as a learning society. this new society demands employment and personal development of every individual (baltezarevic, v. et al., 2013, p. 264). new demands are: achieving efficiency with the use of knowledge and innovative solutions in all areas of business. managers must create the conditions that employees have to possess large scale of skills both for individual and team work. it means that the corporate environment creates opportunities for the development of organizational intellectual potential, involvement of employees in the social network and facilitating the exchange of knowledge in the decision-making process. these requirements can be fulfilled only if the people are satisfied with their business position. knowledge is necessary for the individual’s personal and professional development. only lifelong learning can ensure that employees follow and apply new technology and new knowledge. knowledge managers have to create successful knowledge strategies related to the fact that the value of accumulated knowledge is sharing with employees because it is the only way to newly created values. people must be informed about all strategies and all aspects of a new added knowledge. but, managers must take into account the needs of the employees if they wish their positively respond to organizational changes. most important is to establish a knowledge base of their needs, relationships and opportunities. people will determine organizational success and knowledge must be a systematic process (skyrme & amidon, 1997). if managers want knowledge to be an organization resource that guarantees success in the market, it means the overall functioning of the management in order to recognize the needs of employees, service users and of all potential business partners. the sharing of knowledge is possible only with people. through contact with other people we fulfill both our individual and collective needs (walters, 2000), this is why ‘relationship management’ represents an important aspects of work. modern business challenges for a competitive position in the market modern business is facing challenges that require quick and adequate response to all challenges. however, the speed of response depends on the ability to absorb change better and faster than the competition. so-called baltezarević, v., et al., knowledge management, ea (2015, vol. 48, no. 3-4, 62-68) 65 ‘intelligent’ organizations are standing out with their ability to adapt to the demands of the fourth revolution. such organizations have their strategic objectives clearly definite: motivation, training of employees and creating a better organizational climate. knowledge-based resources include both tacit and organizational know-how stored in personnel, organizational manufacturing processes, and relationships (baltezarevic v., et al., 2013, p. 264). the management style and attitudes towards employees affect the ability of creating an organization based on knowledge. partnership approach to governance, which is characterized by involving employees in the decision-making process and creating business strategies affect the cohesion of employees and commitment to achieving business goals of the organization. that effect, stemming from the management modality, to a large extent, depends on the personal values and attitudes of group members (rot, 2006, p. 143). factors of external and internal environment, biological, psychological and social nature, have a constant effect on humans and lead to the disruption of the harmonious inner balance. a man is perceived as a product of society represented by the environment, as the cultural and behavioral contexts of an individual are the consequences of the society and the culture that person was born into and is living within. human capital can be a key source of competitive advantage because it is so difficult for competitors to replicate (barney 1991). psychological capital is not only concerned with “who you are” but also, in the developmental sense “who you are becoming”, your “best self” (luthans, et al., 2007:20). positive psychological capital consists of self-efficacy, hope, optimism and resilience, and is associated with a number of favorable outcomes for employees. employee attitudes affect their business behavior and their contribution to the work. role of social groups man is a social being with a potent desire to belong, both at the individual and larger social group levels. one needs organization to feed the need for social connection with shared beliefs and expectations, as well as to have someone to communicate one’s ideas to, and to share the dualistic satisfaction of one’s own life within a group, while being accepted as an equal member of the team, and as an individual. how successfully is the modern man coping with a globalized, alienated world where there is less and less time for face-to-face contact? usually only a small group of people can successfully cope with the unstoppable current of daily changes. they are able to build their own social capital. however, individuals continue to be social beings in a formal workplace with their needs as the individual beings within the organizations (haslam, 2001). social capital is precious for any organization because of its impact on the actions of individuals in the organization structure: “the actual and potential resources embedded within, available through and derived from the network of relationships possessed by an individual or a social unit” (nahapiet & ghoshal, 1998, p. 243). members of social groups to feel satisfied and to freely engage in a deeper interaction need to feel safe and accepted in the organizational system they have joined. for the creation of such business environment, the managers are most responsible. if management does not understand the importance of employment relationship within the social networks that will 66 economic analysis (2015, vol. 48, no. 3-4, 62-68) negatively affects the functioning of the organization and achieving the projected goals (krackhardt, 1990). through establishing of social relations with other people, feelings, needs and knowledge are shared. social networks coexist and influence each other (monge & eisenberg, 1987). social capital facilitates the development of intellectual capital and exchange of knowledge within the social group. consequently, social capital can impact not only economic transactions, but also production, loyalty and risk taking (nahapiet & ghoshal, 2000). employees transferred their social model from private life in the business sphere. they connect with other employees in order to build such social chain. at the beginning of this process people must gain trust in each other and establish the communications channel with the two-way flow. trust and social capital are closely related. trust as cooperative behaviors is important in a range of organizational activities and processes such as team work, leadership and goal setting (mayer, et. al, 1995). the goal of successful organizational culture must be based on the needs of human capital. employee satisfaction is important for their integration and acceptance of business strategy in the organization. this means that managers must achieve good opportunity for business communication, socialization and integration of each employee. recognizing of their individual goals and needs ensures the creation of trust between employees and management and facilitates achieving the leadership position of the organization. conclusion a modern organization is an interaction of visionary abilities of a leader, and skills and know-how of the management. however, knowledge must “abandon” the individual framework and become a shared resource. knowledge is best utilized within a group, because people who know each other converse more intensively than strangers. members of a group must share the same vision, and become well acquainted in order to establish mutual trust. knowledge managers must first establish the same kind of positive relationship with its employees. the social life is focused on communication contacts which are realized within the organization; communication is still considered a central component of effective business processes with priority given to the respect of the personality of each employee which discourages any form of psychological harassment. communication and organizational culture together are necessary for a good organizational climate. only those employees who feel as respected members of the collective wish to contribute to the success of the organization. such organizational environment is possible only if management applied good system which is based on open communication, knowledge, confidence and business skills related to leadership positions in the market. companies that embrace knowledge 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"social capital, intellectual capital, and the organizational advantage". academy of management review, 23(2): 242-266. nahapiet, j. & ghoshal, s. 2000. “social capital and the organizational advantage.” in knowledge and social capital, ed. eric lesser, 119-157. oxford and boston, butterworthheinemann. rot, n. 2006. psihologija grupa, (psychology of groups). beograd: zavod za udžbenike i nastavna sredstva. skyrme d. j.&. amidon d. m. 1997. business intelligence http://www.skyrme.com/pubs/knwstrat.htm tuomi, i. 1999-2000. “data is more than knowledge: implications of the reversed knowledge hierarchy for knowledge management and organizational memory.” journal of management information systems 16, 3. 103-117. walters, d. 2000. “virtual organizations: new lamps for old?” management decision, 38,5/6, 420-436. zack, m.h. 1999. “developing a knowledge strategy.” california management review, 41(3), 125-145, p.128. 68 economic analysis (2015, vol. 48, no. 3-4, 62-68) upravljanje znanjem kao imperativ za ekonomski rast i razvoj rezime – mi sada živimo u vremenu globalnih poslovnih aktivnosti i ekonomije zasnovane na znanju. resursi zasnovani na znanju predstavljaju organizacioni know-how (znati kako) kao znanje zaposlenih, organizacioni proizvodni procesi, odnosno celokupno znanje jednog kolektiva. upravljanje znanjem je odavno postalo neophodno za razvoj poslovnih organizacija. samo oni menadžeri koji prihvataju znanje kao najvažniji resurs mogu očekivati da će biti u boljoj poziciji od konkurencije. know-how je vrlo važan segment celokupnog znanja koje je deponovano unutar organizacije. vrednost znanja je mnogo značajnija od svih ostalih oblika imovine kojima organizacija raspolaže. ali znanje ne može da se razmenjuje bez zainteresovanih zaposlenih. tako menadžeri moraju da kreiraju poslovno okruženje u kome je zastupljena adekvatna poslovna komunikacija. dobra komunikacija stimuliše ideje i kreativnost zaposlenih. menadžeri bi trebalo da budu u stanju da upravljaju poslovnim informacijama i da obezbede aktivno učešće u komunikaciji sa zaposlenima sa kojima razmenjuju vrednosti intelektualnog kapitala. ključne reči: ekonomija znanja, know-how, upravljanje znanjem, intelektualni kapital, komunikacija article history: received: 14 november, 2015 accepted: 17 november, 2015 ea_2014_3-4 udc: 005.332:005.322 005.51 jel: l29, o31 cobiss.sr-id 211782924 original scientific paper a leaders’s influence on the definition and implementation of strategy in organizations vujičić slađana1, faculty of business economics and entrepreneurship, belgrade, serbia radović marković mirjana, institute of economic sciences, belgrade, serbia faculty of business economics and entrepreneurship, belgrade, serbia ivković dragan, nikitović zorana, faculty of business economics and entrepreneurship, belgrade, serbia abstract – in modern business conditions, the success of an organization is connected to the leader skills and abilities. leadership becomes more important every day due to the requests of a turbulent and variable environment which can be satisfied only by organizations led by leaders able to harmonize the leading of the organization with the real situation within it. thus leaders, through their behavior and skills influence, define and implement organization strategy to a large extent. key words: leaders, leading process, strategy, organizational changes, transformation. introduction the business activities of modern organizations are trailed by great changes and dynamics. these changes bring difficulties to the large number of organizations, as on a daily basis, the market becomes more unpredictable, with more demanding customers. organizations know that they must gain an understanding of the presence and way of changing in order to succeed in the future (mcmillian, 2012). the survival of organizations in these business conditions is possible only if the leaders of the organizations are ready to face the occurring changes, as they are the basis and key of the success of modern organizations because their role is to create organizations which are flexible enough not only to adapt to changes but also to their executors. aware of the need to strategically plan the future of their organization and the process of implementing the chosen strategies, leaders today tend to lead their organizations in a better and more effective way and to accomplish the given goals. achieving goals is the characteristic of efficient leadership. leader effectiveness is perhaps most obvious when the organization changes its strategy. to implement a new strategic initiative, leaders at subordinate levels must reinforce it; that is, they must allocate resources for it, deal effectively with resistance, and convince employees that the new initiative is important and in their interest (cannella, monroe, 1997; rotemberg, saloner, 1993) 1 corresponding author: sladjana vujičić, email: sladjanakonto@gmail.com vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 91 review of literature the strategy used during the last years can be defined as the main concept of management. due to constant and rapid changes, strategies must be planned and implemented in the right way. xenophon (cummings, 1993), an ancient greek writer, defined strategy as ‘knowledge about the business which is supposed to be done’. from this definition, it can be concluded that knowledge is necessary for implementing strategy and here there is a connection between leadership and strategy formulation. chandler (1962) observed strategy as ‘a defining of the basic long term goals and tasks of the company and defining the course of action and allocation of resources necessary for accomplishing these goals’. asnof (1987) gave the following definition: ‘strategy is the rule of decision-making’. coulter (2010) defines strategy as the cluster of decisions and activities directed toward accomplishing the goals of the organization. the strategy of a certain company is as a rule a mix of the following effects: 1) the proactive actions of managers for improving market position and the financial results of the company, and 2) the reactions to unpredictable happenings and new market conditions (figure 1) (thompson et al., 2008). figure 1 shows the external and internal factors which impact the defining of an organization’s strategy. figure 1. the external and internal factors which impact the strategy of an organization. source: adapted from thompson, a. strickland a. j. iii, gamble j.e. “strategic management – in searching for competitive advantage – theory and practice cases”, complete 14th chapter, zagreb economy and management school, mate, zagreb, 2008, pp. 5-7. today leaders are the key elements for defining and implementing strategy. the leader is to decide what to do and how to do it (hornsby, 2000). the attempt of a leader to change the economic analysis (2014, vol. 47, no. 3-4, 90-103) 92 way of thinking can be considered as the strategy forming process. leaders should adopt a realistic approach to identify the strategic gaps so that proper strategies can be formulated (fairholm, 2009). in fact, leaders are those which influence the behavior of their followers within organizations. they have key role in the decision-making process in order to provide an efficiency and effectiveness of modern organizations. the best leaders need to be attentive, motivational, and supportive (radović-marković, 2007). however, which role they would play and to what extent they will succeed in the realization of the given goals depends on multiple factors, which includes factors from the environment in which an individual was raised, his or her family situation, and his or her personality traits (radovićmarković, 2007a). rauch and bealing (1984) see leadership as ‘the process of influence on the activities of an organized group for accomplishing goals’. howard (2005) defines leadership as the process of communication (verbal and nonverbal) which includes teaching, motivating, leading and supporting others. figure 2 can help us understand leaders and the leading process. the leading process can be envisioned as a dynamic and complex process of exchange. figure 2. the leadership process source: dunham r.b., pierce j. l. (1989) management, glenview, il: scott, foresman, p. 556. figure 2 shows five crucial components and their connections (leader, followers, context, leading process and the results). leadership is a dynamic process which includes a constant exchange between the leader and the followers. leadership in modern organizations brings great responsibility. according to covey (1996), there are three major leader roles: finding a goal, influencing and training. kouzes, posner (1997) promote the attitude that leaders hold the following roles: 1) initiating the process – leaders are capable of noticing good quality ideas, supporting them and accepting the challenge to implement the ideas. leaders are ready to make vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 93 steps into unknown territory and they initiate the innovation processes and are ready to accept innovations. 2) they inspire others with a vision – namely, their associates, as leaders do not motivate by command but with enthusiasm and vision, due to the fact that leadership assumes following without coercion. 3) they provide the possibility for others to act – one of the major leader roles is to give support and help all those which must accomplish a certain business goal. due to rapid changes in the business environment, today’s leaders mostly try to create more flexible organizations and to respond to changes with a good strategy. leader influence on the decision-making process is the core of the strategic management process. figure 3 shows us the influence of certain components which characterize strategic leadership and have a positive influence on the implementation of strategy in organizations: determining a strategic direction, establishing balanced organizational controls, effectively managing the organization’s resource portfolio, sustaining an effective organizational culture, emphasizing ethical practices. figure 3. the role of selected strategic leadership actions in strategy implementation. source: adapted from hitt et al. ,2007 each of these strategic leadership actions positively contributes to effective strategy implementation (hitt et al., 2007). the leader’s role in implementing strategy in organizations leaders and the leading process are key factors for formulating and implementing strategy because they represent the core of strategic management. leaders influence decision-making processes because effective decision-making impacts the implementing of the strategy. also, leaders must be conscious of what is perceived by others and develop strategies that are proactive in building success (radović-marković, et al. 2013). to ease the economic analysis (2014, vol. 47, no. 3-4, 90-103) 94 development of certain strategies and to implement them easily is a very important job of the leaders. in figure 4 we can see strategic leadership and the strategic management process. strategic leader skills culminate in strategic competitiveness and above-average returns. figure 4. strategic leadership and the strategic management process source: hitt et al.,2007 basically, leaders in organizations influence three areas of organization. on the first place, they influence vision, strategies and values. these three components together create the culture of the organization. before strategy formulation, leaders have to identify the need for change by proper care and a full scanning of the environment within which organizations exist (jon, 2008). strategy formulation is all about planning for the future (chatman, 2010). to implement a formulated strategy, all the employees of one organization must take part. each employee should understand the need for change and give his or her own contribution to an effective implementation of the strategy. the leaders must motivate the employees to accept changes because it is known that people always reject them. thus, successful strategy implementation depends on leadership skills of working through others, organizing, motivating, culture building, and creating strong links between a strategy and how the organization does things (thompson et al., 2008). vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 95 the challenge of leadership is the commitment to people within an organization and to embrace change and implement strategies intended to position the organization for this. leaders incite commitment to embrace changes and an effective implementation of strategy through various interrelated strategic leadership roles which include clarifying strategic intent, building an organization, and shaping organizational culture, to mention only a few (pearce, robinson, 2005, 2008). research methodology the aim of the research in this paper is to verify a leader’s role in defining and implementing strategy in organizations. empirical research was conducted by a testing method in which a questionnaire is the chosen instrument. the research was conducted in a random sample of 40 organizations from the territory of the republic of serbia at the beginning of 2014 in a direct interview. the research included 480 employees from the mentioned organizations of different genders and education levels. 0 5 10 15 20 25 shops small enterprises medium enterprises large enterprises number 15 22 2 1 figure 5: structure of the surveyed organizations male 58% female 42% figure 6:surveyed by gender 13% 34% 36% 15% 2% 0% 10% 20% 30% 40% 50% <31 31-40 41-50 51-60 >60 figure 7: surveyed by age economic analysis (2014, vol. 47, no. 3-4, 90-103) 96 for the purpose of the questionnaire, the leader was defined as ‘a person who influences the behavior of employees or a group of people, or an organization as a whole in the aim of carrying out the strategy of an organization’. the strategy of an organization was defined as a cluster of goals, policies and plans for accomplishing an organization’s set targets. the questions in the questionnaire were formulated in such a way that an analysis of the leader’s influence on strategy implementation in organizations could be carried out based on the given answers. the questionnaire was made from three different parts: 1. data about the organization. in this part of the questionnaire, the questions referred to the type of business system, the name of the organization, the address of the organization, business activities and the total number of employees. 2. data about the respondent. this part of the questionnaire contained provided answers, and referred to information about the respondent. 3. the third part of the questionnaire referred to the role of strategy in organizations and to the role of the leader in its conducting. 4. considering all the mentioned, the general hypothesis in the research was the following: h0: leaders in organizations have a key role in defining and implementing the organization’s strategy. based on this general hypothesis we developed separate hypotheses: h1: defining and implementing of strategy are key factors which influence the results achieved by an organization. h2: the business results of an organization depend on the strategy with which an organization responds to external and internal changes in their wish to accomplish results. for each question in the questionnaire, there was an offered answer by which the respondents estimated how much they agree with the given assertion in the form of a fivepoint likert scale (1-very small, 2-small, 3-average, 4-significantly, 5-very significantly). 0.80% 5.20% 13.20% 19.80% 35.40% 25.60% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% phd ma university degree bachelor's degree graduated other figure 8: surveyed by education level vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 97 the key results of the research and discussion after the collecting of data, we began data processing. below are the results of the empirical research based on the survey conducted in organizations on the territory of the republic of serbia. the respondents have answered eight questions which are significant in determining the leader’s influence on organization strategy (annex). table 1. statistical indicators the arithmetic mean the standard deviation coefficient of variation how much is the organization strategically oriented? 3.9792 1.099045 0.276200 how much does organization strategy influence its success? 4.1292 0.851459 0.206206 how much are employees in an organization aware of the vision and mission of the organization? 4.0438 0.950966 0.235169 how much does a leader influence an organization’s strategy? 4.0583 0.915568 0.225602 how much do leader characteristics influence the defining of an organization’s strategy? 4.0563 0.925879 0.228260 how much does a leader influence strategy implementation? 4.0896 0.874581 0.213856 how much does a leader use modern concepts in defining and implementing a strategy? 4.2667 0.846398 0.198374 how much does applied strategy influence the improvement of the performances of the organization? 4.0167 0.983051 0.244743 the given answers give results which produce reliable conclusions. the survey has shown that leaders influence on the successful implementation of strategy in organization is very large. conclusion leaders are the key for accomplishing the given business targets and carrying out organizational changes, and thereby, conduct strategy in organizations. the research conducted on a random sample of 40 organizations from the territory of the republic of serbia at the beginning of 2014 by direct interview included 480 workers from various organizations has shown that a leader’s influence on defining and implementing strategy is very large. the conducted survey confirmed major and separate hypotheses. for example, to the question ‘how much does a leader influence an organization’s strategy?’ 37.08% respondents replied with a very significant influence, and 38.54% said significant. to the question, ‘how much does a leader influence strategy implementation?’ 38.33% respondents answered very significantly, and 37.8% significantly. economic analysis (2014, vol. 47, no. 3-4, 90-103) 98 the main hypotheses in the paper ‘leaders in organizations have a key role in defining and implementing organization strategy’ is confirmed by the series of positive answers. among the questions used for checking the major hypothesis, the answers given which vary from ‘significant’ and ‘very significant’ are between 30% and 100%. it is especially significant to know that the largest number of respondents recognizes that leaders in organizations have a clear vision about defining and implementing the strategy in the right way. with this paper we tried to show the role of the leader in defining and implementing strategy in organizations and to give a basis for further research. references asnof, h.i. 1987. corporate strategy rev. ed. london: penguin. cannella, a.a., & monroe, m.j. 1997. „contrasting perspectives on 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(2013). „women in business and leadership: critiques and discussions.“ the second international scientific conference on employment, education and entrepreneurship, belgrade, serbia, pp. 19-31. available at ssrn: http://ssrn.com/abstract=2349488 radović marković, m. 2007a. entrepreneurship for women. belgrade: magnus, pp.157. rauch, c.f., behling, o. 1984. functionalism: basis for an alternate approach to the study of leadership. in leaders and managers: international perspectives on managerial behavior and leadership, ed. j. g. hunt, d. m. hosking, c.a. schriesheim, and r. stewart, 45-62. new york: pergamon press. rotemberg, j.j., & saloner, g. 1993. „leadership styles and incentives.“ management science, 39: 1299−1318. thompson, a., strickland a.j.iii, gamble, j.e. 2008. strateški menadžment – u potrazi za konkurentskom prednošću – teorija i slučajevi iz prakse. četrnaesto cjelovito izdanje. zagreb: mate, 5-7. vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 99 annex to the question ‘how much is the organization which you are working for strategically oriented?’ 20 respondents answered very little, 35 little, 70 average, 165 significantly and 190 very significantly. figure 9: the strategic orientation of organization 4.17% 7.29% 14.58% 34.38% 39.58% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does an organization’s strategy influence its success?’ 2 respondents answered very little, 15 little, 90 average, 185 significantly and 188 very significantly. figure 10: influence of strategy on success 0.42% 3.13% 18.75% 38.54% 39.17% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much do you think employees are aware of the vision and mission of the organization?’ 12 respondents answered very little, 19 little, 78 average, 198 significantly and 173 very significantly. economic analysis (2014, vol. 47, no. 3-4, 90-103) 100 figure 11: vision and mission of the organization 2.50% 3.96% 16.25% 41.25% 36.04% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much do you consider leaders influence an organization’s strategy?’ 5 respondents answered very little, 23 little, 89 average, 15 significantly and 178 very significantly. figure 12: leader’s influence on organization strategy 1.40% 4.79% 18.54% 38.54% 37.08% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much do leader characteristic influence the defining of organization strategy?’ 4 respondents answered very little, 24 little, 97 average, 171 significantly and 184 very significantly. vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 101 figure 13: leader characteristics and organization strategy 0.83% 5.00% 20.21% 35.63% 38.33% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does a leader influence the implementation of a strategy?’ 0 respondents answered very little, 23 little, 95 average, 178 significantly and 184 respondents answered very significantly. figure 14: leader influence on strategy implementation 0.00% 4.79% 19.79% 37.08% 38.33% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does a leader use modern concepts in defining and implementing a strategy?’ 7 respondents answered very little, 9 little, 56 average, 185 significantly and 223 respondents answered very significantly. economic analysis (2014, vol. 47, no. 3-4, 90-103) 102 figure 15: leader and modern concepts 1.46% 1.88% 11.67% 38.54% 46.46% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does a strategy influence the improvement of an organization’s performances?’ 6 respondents answered very little, 30 little, 102 average, 154 significantly, and 188 respondents answered very significantly. figure 16: strategy and organization performances 1.25% 6.25% 21.25% 32.08% 39.17% 0% 10% 20% 30% 40% 50% very small small average significant very significant uticaj lidera na definisanje i implementaciju strategije u organizacijama rezime – u današnjim uslovima poslovanja uspeh organizacija je usko povezan sa liderskim sposobnostima. liderstvo svakim danom sve više dobija na značaju jer zahteve promenljivog i turbulentnog okruženja mogu da zadovolje samo organizacije koje na svom čelu imaju lidere koji mogu da usklade način vođenja organizacije sa realnom situacijom u njoj. lideri svojim ponašanjem i osobinama u velikoj meri utiču na definisanje, ali i na implementaciju strategije organizacije. vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 103 ključne reči: lideri, liderski proces, strategija, organizacione promene, transformacija article history: received: 7 june 2014 accepted: 23 november 2014 doi: 10.28934/ea.22.55.1.pp1-11 original scientific paper crowdfunding response to the covid-19 pandemic: evidence from kickstarter isidora ljumović10f* | aida hanić1 | slavica stevanović1 1 institute of economic sciences, belgrade, serbia abstract the aim of this paper was to explore the impact of covid-19 on crowdfunding using data from the kickstarter platform. the study period covers the covid years from march 2020 through 2021 and three years before the pandemic. we crawled data from kickstarter.com with custom-made software, a scraper robot. the research was based on a sample of a total of 43.977 campaigns, of which 29.5% were started during the covid era and 70.5% were launched previously. to test our expectation that the characteristics of the campaigns during covid-19 have changed, we applied a t-test. the results show that crowdfunding created an early response to the covid crisis, manifested as differences between campaigns initiated during and before the pandemic period. campaigns initiated during the covid-19 pandemic had lower goals, much higher amounts of funds pledged, a higher number of backers, higher chances for success, and a shorter blurb description, while they were more frequently chosen as favorites by the kickstarter staff. the coronavirus is a huge economic burden, particularly for start-ups, entrepreneurs, and small and medium-sized businesses (smes). as a result, the findings of this study suggest that crowdfunding, as an online option, might help fill in the finance gap during times of crisis. key words: crowdfunding, covid-19, kickstarter jel classification: o16, g23, d26 introduction the pandemic of covid-19 had a huge impact on different aspects of people’s life and behavior, causing health and economic problems worldwide leading to the conclusion that existing economic and societal patterns are insufficient in times of crisis (petkovska mirchevska et al., 2021; hanić, 2020). it resulted in the greatest recession since world war ii (world bank, 2020), with 114 million people losing their jobs because of temporary and permanent company closures (ilo, 2020). at the same time, mckinsey estimates that the banking sector will suffer a loss of cumulative revenue of $1.5 trillion to $4.7 trillion between 2020 and 2024 (mckinsey's global banking annual review, 2020). in practice, the pandemic has resulted in an economic contagion that is spreading at the same rate as the disease (carlsson-szlezak et al., 2020). a tool that can be critical in minimizing the harmful consequences of crises like covid-19 is social enterprises because it can address the financial needs of individuals and communities (farhoud et al., 2021). in that aspect, our focus is on crowdfunding. mollick (2014) defines * corresponding author, e-mail: isidora.ljumovic@ien.bg.ac.rs 2 economic analysis (2022, vol. 55 no. 1, 1-11) crowdfunding as "the efforts by entrepreneurial individuals and groups—cultural, social, and forprofit-to fund their ventures by drawing on relatively small contributions from a relatively large number of individuals using the internet, without standard financial intermediaries". in practice, crowdfunding is an initiative proposed by someone to raise financial sources from the capital providers or the "crowd" to fund innovative new ventures (ordanini et al., 2011; moritz & block, 2016; moysidou & hausberg, 2020). although there are other different online techniques for raising funds, crowdfunding has become an "umbrella" term for all forms of social entrepreneurship. there are four different types of crowdfunding: donation-based, reward-based, equity-based, and lending-based (wang et al., 2018). the major difference is in the desired outcome (mollick, 2014). for instance, vismara (2019) notes that in a reward-based model, proponents seek financial contributions from backers in exchange for rewards or products. donation-based crowdfunding refers to charitable giving with no return, while in the lendingbased model, there are fixed interest rates for lenders. on the other hand, in an equity-based model, entrepreneurs make an open call to sell a specific amount of equity in their company. no matter the type, every crowdfunding process includes four basic elements. the project creator is an individual that launches the crowdfunding campaign, the second element is the campaign itself, to be funded, the supporters are investors that back the project with a small amount of funds and finally, there is a crowdfunding platform as an intermediary between the project creator and its supporters (jovanovic, 2019). one of the major advantages in the context of crowdfunding is reducing the obstacles related to the lack of financing. according to moysidou and hausberg (2020), crowdfunding gave a chance to startups that had no access to traditional capital markets, considering not just the financial aspect but the feedback from potential customers (bernardino & freitas santos, 2020) as a signal of approval or disapproval (vasileiadou et al., 2016). crowdfunding can be effective for both immediate and long-term responses in times of crisis. for instance, berliner and kenworthy (2017) note an increase in the use of crowdfunding to cover extra costs of health care in the us after the financial crisis in 2008, while nagui saleh et al. (2021) state that crowdfunding created the early response to the covid-19 pandemic. this is consistent with saleh et al. (2021), who found a significant spike in overall crowdfunding efforts in march 2020, owing in part to the covid-19 pandemic. in this regard, the aim of this paper was to explore the impact of covid-19 on crowdfunding since it can be considered as a tool that can help the community in an emergency (farhoud et al., 2021) because “if many people contribute small amounts, even costly projects can happen” (bone and baeck, 2016). to explore how the advent of covid-19 impacted the character of crowdfunding, authors used data from the kickstarter platform with custom-made software, a scraper robot, covering the covid years from march 2020 through 2021 and three years before the pandemic. this paper is structured as follows. section 1 reviews the relationship between entrepreneurship and crises in terms of understanding how crisis can lead to better understanding of how the crisis can lead to the creation of alternative ways to solve the financial problems of individuals and societies, since covid-19 has shown certain shortcomings in the social systems of some countries. section 2 presents the empirical model and data used while section 3 contains the discussion of the results obtained. finally, the section 4 concludes. literature review the relationship between entrepreneurship and crises is influenced by the way we define crisis or threat. in general, it is a process that develops over time, or in phases, and it leads to disjunction in normal functioning (williams et al., 2017). in that aspect, doern et al. (2018) emphasize that crisis management and resilience are the two concepts important to understand. considering this, herbane (2010) stands four reasons why should entrepreneurs be interested in crisis management: isidora ljumović1, aida hanić, slavica stevanović 3 • the use of technology brought new forms of threats; • losses from the crisis, particularly revenue, are not the only ones that should be observed but mostly damage to customer service, reputation and availability; • local and national public authorities are concerned with business resilience and • entrepreneurs should ensure the continuity of their operations. regarding the way people (entrepreneurs) deal with the crisis, muñoz et al. (2019) conducted a two-stage exploratory study before and after calbuco volcano eruptions in 2015 and 2016 in chile and found four resilience strategies: anchored reflectiveness, situated experience, breaking through, and reaching out. in the case of covid-19, farhoud et al. (2021) analyzed crowdfunding for social entrepreneurship in crisis based on the uk's social enterprise crowdfunding platform, upeffect. when considering the intersection of social entrepreneurship and crowdfunding, the authors suggested three perspectives: social enterprise, funding crowd, and institutional perspective. this is presented in figure 1. figure 1. strategies of how can crowdfunding contribute to serving social issues in times of crisis source: farhoud et al. (2021) these methods mean that crowdfunding platforms must support social entrepreneurs as clients, engage the community as a source of funding, and ensure consistency in funding social enterprises, particularly when emphasizing the "togetherness" aspect of crowdfunding campaigns. according to bernardino et al. (2016), using crowdfunding in social entrepreneurship is based on “common social causes” or the “collective cooperation of people”. in that aspect, social fundraising has become important, especially for the young or y generation that is more socially and environmentally oriented (ming-li et al., 2020; calic & mosakowski, 2016) and because of the accessibility and outreach that crowdfunding provides. building on this research, crowdfunding models perform particularly effectively in situations when funding decisions are influenced by a mix of social motives and local ties, and money is required quickly. in the aspect of the use of crowdfunding during covid-19, igra et al. (2021) use the term coronavirus-related crowdfunding (ccf). according to the authors, there were more than 175,000 gofundme campaigns in the us for covid-19 between january 1 and july 31, 2020. in this period, more than $416 million from over 4,750,000 individual donations were raised. 4 economic analysis (2022, vol. 55 no. 1, 1-11) in similar research, elmer et al. (2021) analyzed launched campaigns on gofundme (between 27 march and 27 april 2020). on a sample of 500 campaigns, results show that matters of business, family, health, and community constituted 72% of all campaigns, which can be considered as a “call for help” or call for community fundraising on issues related to individuals. this is consistent with wang et al. (2021), who found that categories related to individuals were more funded after than before the outbreak of covid-19. on the other hand, in a research done by raywa et al. (2020), on a sample of 1579 campaigns that were created on gofundme.com between march 3 and 20, 2020, almost 83% of non-u.s. campaigns, directed at italy, focused on hospitals and healthcare workers (54.6%), which emphasizes the differences between the u.s. and europe in terms of healthcare but also financial stability. in general, the crowdfunding market is predicted to grow by $ 196.36 bn during 2021-2025, progressing at a cagr of 15% (global crowdfunding market 2021-2025, 2021). regarding countries that are considered the largest, us and canada are top performers since they generated $74 billion in p2p lending in 2020 while the uk generated $12.6 billion followed by asia pacific (apac) at almost $9 billion with the notice that china was not included in this data (cambridge centre for alternative finance report, 2021). when we exclude the best performers, the top 20 include both developed and emerging economies but also small economies and countries that just started to practice crowdfunding as presented in the following table. table 1. top crowdfunding national markets in 2017 rank country total volume in us 4 australia $1,148,515,565.00 5 south korea $1,129,918,098.00 6 canada $867,577,549.42 7 france $747,274,513.52 8 germany $672,751,878.90 9 japan $348,650,302.00 10 netherlands $316,287,611.90 11 israel $295,455,044.29 12 italy $271,919,936.14 13 india $268,579,820.00 14 new zealand $261,621,933.00 15 finland $222,314,696.19 16 sweden $221,890,190.29 17 brazil $216,357,244.21 18 georgia $195,784,289.95 19 singapore $190,821,714.00 20 spain $181,620,894.27 source: ziegler t., shneor r., zhang b.z. (2020). the global status of the crowdfunding industry. in: shneor r., zhao l., flåten bt. (eds) advances in crowdfunding. methods in may 2021, we used custom-made software, a scraper robot, to collect data on projects and funders from kickstarter.com for our empirical analysis. it crawled projects from the kickstarter homepage (kickstarter.com, last entry 6 may 2021) and collected data for each campaign. kickstarter is one of the most popular reward-based platforms. crowdfunding platforms like kickstarter are becoming more popular for analysis because they can provide documentation and isidora ljumović1, aida hanić, slavica stevanović 5 analysis of new financing mechanisms while also offering substantial information on entrepreneurs, investors, funding attempts, and other related elements that are typically not disclosed to outsiders in other financing mechanisms like banks and venture capitalists. we were able to collect data on 43,977 campaigns between march 2017 and may 2021, with a focus on the period of the covid-19 pandemic; hence, the study period covers covid years from march 2020 through 2021, and three years before the pandemic. we found 12,970 (29.5%) campaigns that were started during the covid era and 31,007 (70.5%) campaigns that were launched previously. variables we have collected several variables from kickstarter's campaigns: campaign id, the id of the creator, a short, concise, effective introduction and description of the campaign, so-called blurb, goal of the campaign ($), blurb length, currency, time of launching the campaign, duration of the campaign, number of backers, the status of the campaign (active, succeeded, suspended, cancelled, or failed), pledged funds ($), category and subcategory, and country of the creator. we tested how selected factors of crowdfunding campaigns altered during the covid-19 pandemic, following mainstream academic literature. the variables related to the crowdfunding campaign include goal, pledged funds, and duration of the campaign, blurb length, and the creator's country of origin. we define the campaign goal as the amount of money the creator of the campaign wants to raise. there are no upper or lower limitations on the goal on the kickstarter. the amount of money received from investors is referred to as pledged funds. due to the high skewness of the distribution data related to the target and pledged value, we used the logarithm of the target capital (log_goal). we excluded all campaigns from the sample with a goal of below $5,000 and over $5,000,000. campaigns with minimal aims are easy to achieve, and it has been confirmed that they are not serious fundraising efforts (mollick, 2014). they also frequently target family and friends (cumming et al., 2017). campaigns with high amounts set as a goal have different characteristics from the majority of campaigns in the sample. the duration of the project campaign is the period in which the campaign is active, and it can last from 1 to 60 days. blurb is a project's brief description, and we calculated its length by counting the number of letters in it. it is one of the metrics used to assess the complexity of a project campaign. individuals from 25 countries can create projects, including the united states, the united kingdom, canada, australia, 16 european nations, new zealand, hong kong, singapore, mexico, and japan. in that aspect, for this research, we categorized countries into 6 categories: the us, uk, canada, australia, european countries, and others. the stage of the campaign and the number of backers are variables that show the campaign's outcome. the campaign's status can be successful, failed, active, cancelled, or suspended. the campaign is successful if the project creator has raised the amount of money specified in the objective; otherwise, the campaign fails if he has not met the goal. at the time of this research, active projects were underway, and we had no way of knowing how they would turn out. cancelled projects were terminated by the creator before the end of the duration, for an unknown reason. if a campaign violates platform rules, it will be suspended. all active, suspended, and cancelled projects were left out of the sample. the variable state is a dummy variable that takes the value of 1 if the campaign goal was successful, or zero elsewise, meaning that the campaign is treated as failed. backers are people (the crowd) who support an idea in the crowdfunding world. they invest a particular amount of money in someone's idea. to distinguish projects that are designated by kickstarter team members as "favourite" while active, we used the staff-pick variable. the variable is a dummy, taking the value of 1 if the kickstarter team marked it as a favourite, after an endorsement process in which platform staff assesses a campaign's quality (wessel et al., 2016), zero elsewise. to test our expectation that the characteristics of the campaigns during covid-19 have changed, we applied a t-test. the analysis was performed using spss v.25. table 2 shows descriptive statistics. the sample consists of 6 economic analysis (2022, vol. 55 no. 1, 1-11) 43,977 projects, with a success rate of 51.9%. the average amount of money a campaign creator may raise is about $37,000 with the sample's minimum and maximum set at $5,000 and $5,000,000. the average pledge amount is $31,455 which is lower than the average goal amount. the greatest sum collected was $11,386,449. however, only 164 of the projects in the sample received more than $1 million. the typical project lasts 35.51 days, with an average of 301.13 backers per project and a blurb length of 104.80 words. table 2. descriptive statistics of the sample characteristic sample no. of projects 43,977 successful projects (%) 22,844 (51.9) minimum maximum mean std. deviation goal for collecting ($) 5,000.00 5,000,000.00 37,069.97 148,253.70 amount pledged ($) 0 11,386,449.10 31,455.46 177,746.39 duration (days) 1 60 35.51 12.09 backers (no.) 0 88,887 301.13 1394.69 blurb length (no. of words) 4 140 104.80 31.61 country number of campaigns (% of campaigns) us (%) 28,563 (64.9) uk (%) 4,266 (9.7) ca (%) 1,848 (4.2) european countries (%) 5,871 (13.4) au (%) 919 (2.1) other (%) 2,509 (5.7) source: authors results using t-test statistics, table 3 reveals statistical differences between campaigns launched during the covid-19 phase and those launched prior to that period. the results show significant differences among all analyzed characteristics. the campaigns initiated during the covid-19 pandemic have lower goals ($33,974 against $38,365, p-value < 0.05), much higher amounts of funds pledged ($54,714 opposed to $21,726, p-value < 0.05) and number of backers (517.40 compared to 211.02, p-value < 0.05) and, most importantly, higher chances for success (0.62 against 0.48, p-value < 0.05). the wide range of standard deviations for specified goals, pledged funds, and number of backers indicates that the most and least successful campaigns have vastly different outcomes. the campaigns during the covid-19 period have a somewhat longer duration (35.69 to 35.42, p-value 0.015), while the blurb description, as a measure of project complexity, is shorter (95.29 to 108.78, p-value 0.05). finally, during the covid-19 epidemic, campaigns were more frequently chosen as favourites by the kickstarter staff (0.22 against 0.16, p-value 0.05). crowdfunding is primarily a us phenomenon, and the vast majority of campaigns, not only on kickstarter but also on other platforms, originate in the united states. to see how the covid-19 pandemic period changed the origins of campaign creators across countries, we transformed a variable pointing out the country or origin of the campaign creator. the new variable has a value of 1 if the creator is from the united states, 2 if from the united kingdom, 3 if from canada, 4 if, from a european country, 5 if from australia, and 6 if from any other country in the sample, zero elsewise. for all countries except australia, the t-statistic reveals statistically significant differences. we interpret these results as a fact that the number of campaigns from the us area decreased during the pandemic caused by covid-19. in parallel, the number of campaigns coming from other countries increased during the pandemic. european countries have seen the greatest increase in the number of campaign creators. specifically, during the pandemic, the number of campaign creators from isidora ljumović1, aida hanić, slavica stevanović 7 european countries increased by 3%, followed by a 2% growth in the group of other countries. during the covid-19 period, the number of campaign creators from the united kingdom and canada increased by 1% each. table 3. differences between campaigns initiated during and before the covid-19 pandemic covid-19 period 12,970 obs pre-covid period 31,007 obs 95% ci for mean difference t df m sd m sd goal for collecting 33,974* 140,945 38,365* 151,190 -7,429 -1,352 -2.83 43,975 pledged funds 54,714* 259,065 21,726* 128,126 29,358-36,618 17.81 43,975 duration 35.69* 12.45 35.42* 11.93 0.02-0.51 2.08 43,975 backers 517.39* 2050.27 211.02* 987.55 277.92-334.83 21.10 43,975 blurb length 95.29* 34.03 108.78* 29.64 -14.12--12.85 -41.61 43,975 staff pick 0.22* 0.41 0.16* 0.37 0.05-0.06 13.71 43,975 failed or succeed 0.62* 0.49 0.48* 0.50 0.14-0.15 28.01 43,975 us 0.60* 0.49 0.67* 0.47 -0.07--0.05 -13.00 43,975 uk 0.10* 0.31 0.09* 0.29 0-0.02 3.18 43,975 ca 0.05* 0.21 0.04* 0.19 0-0.01 4.12 43,975 european countries 0.15* 0.36 0.13* 0.33 0.02-0.03 7.73 43,975 au 0.02 0.15 0.02 0.14 0-0 0.73 43,975 other countries 0.07* 0.25 0.05* 0.22 0.01-0.02 7.31 43,975 * significance level: 0.05. source: authors discussion the problem of financial constraints for start-ups and small and medium-sized enterprises (smes) is well known in contemporary literature. this issue is even more pronounced in the external disruptions and extreme uncertainty caused by crisis events. the negative consequences of the covid-19 crisis have been demonstrated in the financial industry, where the stock market has experienced crashes and high volatility, and the banking system is under pressure to maintain liquidity (zhang et al., 2020). in such circumstances, it is debatable whether new technologies, such as online video pitches used in equity crowdfunding, might mitigate the effect of the crisis (brown & rocha, 2020). in this paper, we provide an empirical analysis of how the advent of covid-19 impacted the character of crowdfunding by using data from the kickstarter platform. we discovered statistical disparities between campaigns launched during the covid-19 period and those before, as those who start campaigns (i.e., entrepreneurs) and those who finance them (i.e., the crowd) have changed dramatically (chandler et al., 2021) following the covid-19 pandemic. campaigns started during the covid-19 pandemic have lower targets, considerably higher quantities of funds contributed (as in saleh et al., 2021), a significantly higher number of backers, and most importantly, an increased probability of success. we argue that such an increase is related to several reasons. it is commonly recognized that social media allows for rapid dissemination of information in emergency situations such as natural disasters and large-scale crises. given that crowdfunding is a type of social investing platform, embracing new technological trends by using the online sphere to connect people with entrepreneurs, growth in 8 economic analysis (2022, vol. 55 no. 1, 1-11) the number of people willing to invest on the platform is reasonable. during the pandemic, communities were shut down, financial systems were only available online, government assistance programs were halted or delayed, and a large number of people turned to crowdsourcing to satisfy their needs. campaign creators were looking to get funding for their project and investors to find opportunities in the scarce market. increased interest in the platform has resulted in an increase in the number of investors and campaign creators, as well as an increase in the amount of money pledged. crowdfunding reflects the community’s response, and the novelty of action likely influenced a larger number of campaigns and their success. moreover, the increased rate of success proves that natural disasters and large-scale crises unite people. campaigns ran for a little longer during the covid-19 period; the blurb description, as a measure of project complexity, was a bit shorter; campaigns were more frequently chosen as favorites by the kickstarter staff. during the epidemic triggered by covid-19, the european countries have seen the greatest increase in the number of campaign creators, whereas the percentage of us crowding campaigns has decreased. our results on the sample of campaigns from kickstarter in the period between march 2017 and may 2021 coincide with the general finding from popper and lorenz (2020), who claim that there was an unexpected boom of activity in the midst of the global pandemic with the number of campaigns increasing by over 60% and with rajwa et al. (2020), who found that the number of active campaigns rapidly increased with the spread of covid-19 on the gofundme crowdfunding platform. the findings from the research correspond to those of saleh et al. (2021), arguing that crowdfunding created an early response, where covid-19–related campaigns were created more frequently, raised more money than other campaigns and had longer narrative descriptions. the results are in line with moine and papiasse (2020), who found that the covid-19 crisis led to an upsurge in crowdfunding activity across france, with a proactive attitude towards accompanying emergency demands. we can argue that even though the crowd’s disposable income may be reduced, considering the economic recession, we have witnessed an extraordinary growth of crowdfunding in a relatively short time, mainly due to the harsh economic realities of the pandemic caused by covid-19 and massive delays in government relief (fairlie, 2020). for many existing and successful entrepreneurs, crowdfunding provided financial relief for their businesses (farhoud et al., 2020; saleh et al., 2021), while in contrast, many entrepreneurs have leveraged crowdfunding as an exit strategy (chandler et al., 2021). this research adds to the existing body of knowledge about crowdfunding because it is one of the first to look at how covid-19 altered the nature of crowdsourcing. the consequences of covid-19 on the nature of crowdfunding will demand a more detailed consideration in future research and policy. to do this additional research with data from other platforms such as gofundme, indiegogo, patreon and similar is needed. conclusion the covid-19 pandemic has drastically altered human civilization, causing a disturbance in the functioning of the current socio-economic norms. during the crisis (comparably with the financial crisis of 2008), the spread of the coronavirus represents a significant economic burden, particularly for start-ups, entrepreneurs, and smes. it is critical to keep them alive and prevent them from going bankrupt on a massive scale during this time of crisis. in the economic crisis, financial resources are scarce and expensive, investors postpone their investments and access to finance becomes particularly limited for innovative smes. to address those needs, many turned to the use of crowdfunding. crowdfunding, as an online solution, can provide support and fill in the financing gap in a time of crisis. one of the main advantages of crowdfunding is that it can be effective for immediate and long-term responses in terms of helping the community in a time of crisis. in that aspect, this paper aimed to explore the impact of covid-19 on crowdfunding using the kickstarter platform. isidora ljumović1, aida hanić, slavica stevanović 9 research results suggest that crowdfunding created an early response regarding the covid crisis since we discovered major differences between campaigns initiated during and before the pandemic. in other words, campaigns initiated during the covid-19 pandemic had lower goals, much higher amounts of funds pledged, including the higher number of backers and higher chances for success. at the same time, results show that the pandemic influenced the use of crowdfunding regarding the country of origin, where there was a great increase in the number of campaign creators in europe, contrary to the us. the present covid-19 crisis is likely to have offered much-needed assistance to local communities by promptly responding to local needs and mobilizing financial resources. european citizens are not as accustomed to using crowdfunding to respond to social issues in the way americans are, particularly in the case of health care (berliner & kenworthy, 2017), since the european institutions pay more attention to social issues than in ones in the united states. in the first month of the pandemic, most european countries did not provide for an adequate policy response to the crisis, pushing for the individuals to turn to crowdfunding for requiring financial support. as crowdfunding showed to be effective in situations influenced by a mix of social motives and local ties, where money is required quickly, local government support mechanisms should be more flexible and better-suited for financing for innovative projects. even though crowdfunding does not have geographic barriers, the local solutions must be custom-made and adjusted to the local economic and social entrepreneurial environment. future research will require a more in-depth examination of crowdfunding patterns. although the covid-19 pandemic boosted the appeal of all internet technologies, including social lending networks, crowdfunding systems evolved organically over time as well. it's possible that the findings are related in part to this expansion and in part to the covid-19 pandemic. acknowledgments this paper is a result of the research financed by the ministry of education, science and technological development of the republic of serbia. references berliner ls, kenworthy nj. 2017. “producing a worthy illness: personal crowdfunding amidst financial crisis”. soc sci med. bernardino, s., freitas santos, j. 2020. “crowdfunding: 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101528. ziegler t., shneor r., zhang b.z. 2020. the global status of the crowdfunding industry. in: shneor r., zhao l., flåten bt. (eds) “advances in crowdfunding”. palgrave macmillan, cham. https://doi.org/10.1007/978-3-030-46309-0_3 article history: received: july 27, 2021 revised: march 25, 2022 accepted: april 1, 2022 ea_2018_1-2 notes from of new editor-in-chief as of september 2017 i am privileged and honored to take over the position of editor-in-chief of the economic analysis. on behalf of all the members of our new editorial board (ivana domazet, vladimir simović, jelena minović, sonja đuričin, duško bodroža), i would like to point out that we want that this change will mark the beginning of a new stage of journal development as we seek to position economic analysis among leading journals in the field economic analysis with special focus on emerging countries. as part of our future strategy the mission of the journal has been created: the economic analysis mission is to introduce the scientific and professional public with the original research results in the field of economic sciences, as well as with public policies proposals that are aimed at overcoming the identified challenges. the main thematic areas, which will be in the focus of the journal, are: sustainable economic development and resilience, business economy and management, labor economics and human capital and the international economy. accordingly, we invite academicians, professors, researchers, phd and master students which are connected to these topics to publish their work in our journal. the new editorial board decided that the quality of the editorial processes should be improved and that our publications should follow the international standards. therefore, starting from the end of 2017 open journal system (ojs) has been introduced to facilitate the development of entire editorial management workflow, including: article submission, multiple rounds of peer-review, and indexing. the new editorial board took the steps in indexing economic analysis in international databases such as central and eastern european online library (ceeol), central & eastern european academic source (ceeas), research papers in economics (repec), erih plus, doaj... last but not least, all the members of the international and local editorial board are entirely aware of upcoming challenges and high-level goals related to further improving the quality of the journal. however, over the next few years we shall work hard to build up a journal with a successful international reputation, publishing high quality research data, which will be abstracted and indexed in the main journal databases. in order to obtain this, i look forward to receiving your high quality submissions, general feedback and suggestions or criticisms for improving the journal. editor-in-chief ivan stošić, phd ea_2014_3-4 udc: 330.341.1(4-672eu) 005.591.6:334.012.63/.64 jel: o1, l26 cobiss.sr-id 211779852 original scientific paper european growth: a crisis exit strategy ben abdesslem amel1, larefi, university of bordeaux, france kauffmann pascal, crdei, university of bordeaux, france abstract – while the european union (eu) is facing a further aggravation of the recession, accompanied by the consequences of the 2008 global financial crisis, the support for economic activities is proving to be more than necessary. primary concerns of member states must be based on increased efforts in competitiveness, employment, innovation, and assistance for small and medium-sized enterprises (sme), to boost economic growth on a short-term basis or on a longer-term horizon. in this regard, this article firstly suggests that the temporary support for economic activities is absolutely necessary and the possible arrangements are examined in detail. in addition, more emphasis must be put on innovation, as it plays a crucial role for economic growth. particular attention is also drawn to smes, their potential impact on the productive fabric and their financial constraints. the concluding remarks are focused on the european market size, and the antagonism between competition policy and industrial policy is highlighted. key words: economic growth, european union, innovation, small and medium-sized enterprises, industrial policy introduction in the light of some historical macroeconomic results that are deemed unsatisfactory and the current economic policies, one can confirm that growth is not a high-priority for european union (eu) and its member states. the evidence is obvious for them, especially since it is within the competence of the countries themselves to reduce unemployment, as stated in the treaties. spain, greece, italy and portugal illustrate the singular and important obstinacy of fiscal orthodoxy among most southern european countries (as well as france), leading them to a vicious circle of recession, and even depression. concerning the eu (the level at which we are developing the following reflection), the situation is similar. in the framework of financial assistance mechanisms, and more generally the stability and growth pact (sgp), the balancing of public accounts has become a central obsession for both the european commission and the european central bank (ecb). however, the union and its member states have not always been as little concerned about economic growth, both at the cyclical level as well as the structural level. 1 avenue léon duguit, 33608 pessac, france, e-mail: amel.ben-abdesslem@u-bordeaux.fr economic analysis (2014, vol. 47, no. 3-4, 3-19) 4 firstly, at the time of the great recession of 2008-2009, the necessity of an economic boost in europe was shared by nearly all members. the commission, clearly convinced that the poor economic circumstances resulted from a shortfall in demand, wanted to promote fiscal policies inspired by keynesian thought. conscious that the eu budget, in terms of financial means (capped at 1.27% of eu gdp), was not adapted to a quick and massive economic recovery effort through demand, the commission worked on coordinating national economic stimulus plans and ensuring their consistency in all member states. by avoiding free riding behaviors, the commission will also modestly contribute to the overall endeavor in terms of expenditures. secondly, at the structural level, the commission has been the lynchpin of the lisbon strategy since 2000. with very high ambitions in terms of competitiveness, research and development (r&d), employment and growth in europe2, the failure of the lisbon strategy has been sufficiently explored to not dwell on it3. however, european authorities have deemed necessary to give it a direct continuation in the early years of this decade through the europe 2020 strategy. even though we cannot explain why the new initiative would ignore its predecessor's mistakes (lack of cohesion between the national policies, inadequate range of incentive and coercive tools, weak governance), it is a laudable desire. concerns related to growth potential in the union seem unquestionably well founded. the following work is based on the belief that economic growth must take the priority in european public policies, both for the union and its member states, at the cyclical level as well as the structural level. furthermore, we are of the view that there is no inherent incompatibility between supporting aggregate demand in the short-term and strengthening growth potential in the mediumto long-term. to support these beliefs, we emphasize that it has become an absolute necessity to quickly bolster economic activity in europe (section 2). we recall that a growth strategy can also be an effective process for a public-sector deleveraging. in a third section, we discuss the possible modus operandi of a demand stimulus, which leads us to favor some forms of public investment. in a fourth section, we emphasize the role of innovation as a key driver of economic growth. we will then focus on the incorporation of small and medium-sized enterprises – following the example of the german mittelstand – within the productive fabric of europe (section 5). lastly, as concluding remarks, we will focus on the european market size and the exploitation of possible scale effects. a temporary support to economic growth the analysis of the eu macroeconomic path since the outbreak of the 2007 financial crisis is relatively easy. this is particularly true in the euro area. what is intriguing is the incapability of main economic policy actors (member states, european commission, ecb, 2 this strategy has been agreed upon following the lisbon summit of 2000. its aim was to make the eu the most competitive economy in the world, and the most efficient in terms of innovation as well as information and communication technologies. 3 the midterm “kok report” (2004) had already provided a severe and worrying conclusion regarding the ambitious objectives of the lisbon strategy and the efficiency of the “open method of coordination”. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 5 imf for countries under financial assistance) to make the proper diagnosis and to find the appropriate remedy. table 1. gdp growth 2005 2006 2007 2008 2009 2010 2011 2012 2013 eu 2.2% 3.4% 3.2% 0.4% -4.5% 2.0% 1.6% -0.4% 0.1% france 1.8% 2.5% 2.3% -0.1% -3.1% 1.7% 2.0% 0.0% 0.2% germany 0.7% 3.7% 3.3% 1.1% -5.1% 4.0% 3.3% 0.7% 0.4% united kingdom 3.2% 2.8% 3.4% -0.8% -5.2% 1.7% 1.1% 0.3% 1.7% finland 2.9% 4.4% 5.3% 0.3% -8.5% 3.4% 2.8% -1.0% -1.4% spain 3.6% 4.1% 3.5% 0.9% -3.8% -0.2% 0.1% -1.6% -1.2% greece 2.3% 5.5% 3.5% -0.2% -3.1% -4.9% -7.1% -7.0% -3.9% ireland 6.1% 5.5% 5.0% -2.2% -6.4% -1.1% 2.2% 0.2% -0.3% portugal 0.8% 1.4% 2.4% 0.0% -2.9% 1.9% -1.3% -3.2% -1.4% united states 3.4% 2.7% 1.8% -0.3% -2.8% 2.5% 1.8% 2.8% 1.9% japan 1.3% 1.7% 2.2% -1.0% -5.5% 4.7% -0.5% 1.4% 1.6% source: eurostat the great recession of 2008-2009 is undoubtedly a demand-side crisis, and not a supplyside problem, as krugman (2009) underlined at an early stage. banking and financial problems raised by the subprime mortgage crisis have spread to the mainstream economy, through a credit crunch and negative wealth effects caused by the collapse of some asset markets. from these observations, fairly consensual, keynesian stimulus plans have emerged, as mentioned in the introduction. these plans to support aggregate demand have produced the expected effects. on one hand, economic activity did not decline dramatically as it did during the 1930’s great depression and on the other hand, the early stages of economic recovery have appeared in 2010 (see table 1). however, the turning point concerning fiscal policies has proved to be disastrous in the eu, and particularly in the euro area. these policies have prematurely prioritized a return to equilibrium of public accounts, with the aim of reducing sovereign debt. the consequences were immediate. deprived of the support of public expenditure, the economic activity slowed down and declined nearly the entire euro area. this was particularly true in countries under the troika’s supervision (greece, ireland and portugal). because of market pressure and european budgetary rules, this also occurred in other countries, which were hoping for a budgetary consolidation (spain, italy). the turning point concerning fiscal policy stance in europe naturally coincides with the outbreak of the greek crisis at the end of 2009 and the beginning of 2010. at that time, the historical high level of public debt in the european monetary union (emu) appeared to be an invalidating phenomenon that prohibits maintaining expansionary economic policies. this argument is a red herring in several ways. the average debt (as a percentage of gdp) is higher in the united states or in the united kingdom than in europe, not to mention japan. the problem stems less from the debt itself than its cost, largely determined by mimetic capital markets, and the institutional structure economic analysis (2014, vol. 47, no. 3-4, 3-19) 6 of the euro area, which is not a federal government. in this context, it needs to be taken into consideration that emu member states acquire debt in a currency other than their domestic currency. furthermore, the euro area countries are under the auspices of a central bank other than their official lender of last resort, unlike the federal reserve in the united states or the bank of england in the united kingdom. table 2. unemployment in europe, percentage moreover, from a macroeconomic perspective, the well-known fact that a growth initiative might be a valuable debt reduction strategy is neglected by european authorities. the historical example of the united kingdom's experience after the second world war proves it. the country had emerged from the worldwide conflict with a massive sovereign debt (more than 200% of gdp) but had succeeded to reduce it through three steps – that are ignored by contemporary mediterranean europe. the first element is moderate inflation (4 to 8% per year) that erodes the real value of the debt4. the second one is time frame: the public debt of the uk returned to acceptable levels not after a few years, but several decades later. finally, the strong growth registered during the post-war economic boom had led decisively to reduce the sovereign debt ratio. the famous equation that links this ratio (dt) to the primary government balance (bt as a percentage of gdp), gdp growth (g) and to the average interest rate on debt (it) sums up itself the macroeconomic debate in the euro area (see box 1). those krugman (2012) calls “the austerians” seek to reduce in priority the primary budget balance (bt), while hoping that capital markets will approve this – orthodox – choice with lower interest rates (it). the italian – and even further the spanish – experience demonstrates that the success of this policy is by no means guaranteed. in addition, these countries have exacerbated unemployment (see table 2) and, by doing so, they have reduced their growth potential, as a long period out of the job market plays a strong role in de-training and de-motivating employees. conversely, a policy to exit the debt crisis would offer a twofold advantage. it would seek to reduce the debt-to-gdp ratio without depending excessively on global finance – nor be limited to future fiscal balances with a deadly policy spiral of “austerity-recession-reinforced 4 germany refuses to consider it (even in the writings of the imf’s chief economist olivier blanchard). 2005 2006 2007 2008 2009 2010 2011 2012 2013 eu 9.0 8.2 7.2 7.0 9.0 9.6 9.6 10.4 10.8 france 8.9 8.9 8.0 7.5 9.1 9.3 9.2 9.8 10.3 ge rmany 11.3 10.3 8.7 7.5 7.8 7.1 5.9 5.5 5.3 unite d kingdom 4.8 5.4 5.3 5.6 7.6 7.8 8.0 7.9 7.5 finland 8.4 7.7 6.9 6.4 8.2 8.4 7.8 7.7 8.2 spain 9.2 8.5 8.2 11.3 17.9 19.9 21.4 24.8 26.1 ire land 4.4 4.5 4.7 6.4 12.0 13.9 14.7 14.7 13.1 unite d state s 5.1 4.6 4.6 5.8 9.3 9.6 8.9 8.1 7.4 japan 4.4 4.1 3.9 4.0 5.1 5.1 4.6 4.3 4.0 source: eurostat ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 7 austerity” – and it will help to provoke demand stimulus that is requested by a majority of macroeconomists. box 1. the dynamics of the debt-to-gdp ratio let dt denote a country's public debt at year t. yt refers to its gdp, it stands for the interest rates on debt and bt is the primary budget balance (excluding interest expenditure and with b>0 indicating a surplus). by construction, public debt is as follows: dt = dt-1 + it . dt-1 – bt the evolution of the debt-to-gdp ratio is given by: = (1 + it) – we use lowercase letters to refer to gdp ratios and g represents growth rate. dt = dt-1 . bt all other things remaining equal, the debt ratio decreases in case of primary surpluses (bt > 0). however, its dynamic is also governed by the comparison between the economy's growth rate and the interest rate on debt. as long as it is less than g, the debt ratio may decrease, even without primary surpluses. conversely, when the cost of debt is below the growth rate, the ratio can increase even with an equilibrium on the primary budget balance (known as the snowball effect). the necessary surpluses to simply stabilize dt become increasingly higher. in the following discussion, we examine in what extent a strategy in favor of economic growth could be organized in the euro area. we also demonstrate how it should be accompanied by a structural policy designed to enhance potential growth. a growth strategy coordinating short and long term objectives the first obstacle, unfavorable to keynesian policies in europe, is the weak macroeconomic governance system in the euro area. ineffective during normal times, it becomes a tremendous handicap when a serious crisis occurs. it should be noted that there is an apparent lack of authority and reactivity of the economic and financial affairs council (ecofin) and the eurogroup. the macroeconomic decision-making process itself is lacking in the euro area. this is a serious concern, and it is perceived as such by main partners5. the total absence of exchange rate policy illustrates this fact ably (kauffmann 2013). more fundamentally, the fiscal policy framework of member states is problematic. concerning the sgp, even though it requires an appropriate monitoring of sovereign debt 5 the famous remark attributed to h. kissinger “who do i call if i want to speak to europe?” still applies today, especially for the euro area. t t y d t t y d 1− t t y b g i + + 1 1 economic analysis (2014, vol. 47, no. 3-4, 3-19) 8 ratios, it has capped public deficits at 3% of gdp in a caricatural manner. in addition to the fact that this threshold percentage has no serious macroeconomic justification, it applies to a balance that is not adjusted for the cyclical position of an economy. as we currently observe, this may lead countries near recession to reduce their public expenditure or to raise their taxes to comply with the pact, which is procyclical. far from correcting these problems, the 2011 reforms, which are referred as the “six-pack”, have reinforced the disciplinary function of law as well as the threat of sanctions in the event of failure. in addition to the stability pact, the member states of the euro area have adopted in 2012 a new fiscal compact. the treaty on stability, coordination and growth (tscg) introduces two new rules imposed on the member states, which are likely to cause deleterious effects on public expenditure. the first constraint is the debt brake, with a maximum structural deficit of 0.5% of gdp imposed on the signatory countries. the second constraint is the introduction of a form of automatism concerning the reduction of sovereign debt, once it exceeds the threshold of 60% planned by the sgp. the combined effects of the sgp and the tscg on fiscal policies have been devastating in the euro area: the first one prevents the free play of automatic stabilizers in case of severe cyclical downturns; the second prohibits any feasible discretionary stimulus. it is evident that a european growth strategy will have to overcome these inconsistent constraints. the invocation of exceptional circumstances would temporarily suspend the application of these laws, as it has been done for the sgp during the great recession. it should be recognized that the second obstacle to a european growth policy is germany itself, for several reasons. first of all, for the euro area, this country has demonstrated some of the highest macroeconomic performance. therefore, the need for an economic stimulus through demand is less important than elsewhere. however, this situation is evolving since germany’s economic growth continues to slow down, driven by weak economic conditions in most of its neighboring countries, which are also its export customers. this leads to the second reason why germany appears as a problem: its growth strategy is based on exports and is regularly held up as a model. the “internal devaluation” strategy (reduction of production costs and prices, especially through lower wages) has been recommended to southern european countries – through the so-called hartz reforms – as it is supposed to be germany’s cornerstone to its current success. this kind of statement contains a twofold error, which can ironically be analyzed as a kantian approach. firstly, an internal devaluation strategy has more chance to succeed if it is performed in isolation, and in a context of sustained growth, as it was the case for germany in the early 2000s. the current situation is different: a race to the bottom in costs is simultaneously prescribed to several countries, and in a recessionary environment. secondly, if all euro area countries had based their growth strategy on exports like germany, we would have to wonder where the net importers are. this is the reason why, in the following discussions, we rule out the crisis exit strategy based on the “germanization” of the euro area, which is an unfounded fallacy. the different components of aggregate demand that need to be supported are neither final consumption expenditure nor exports, but public and private investment6. 6 the important question of the exact funding arrangements is further discussed below (project bonds, new european credits, eib loans, etc). ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 9 these measures to support economic activity are first and foremost, by their very nature, short-term measures, designed to strengthen effective growth. from a medium-term perspective, priority should be given to investment for several reasons. the first one is that investment will ensure future economic gains, as long as selected and financed projects are productive. the second reason – which is at least as fundamental – is that the impact of this demand component will directly combine short-term objectives to boost economic growth with long-term objectives. the last one is related to the proven existence of sectors that lead to a public stimulus for structural reasons. the commission has identified several potential areas of intervention (railway networks, digital economy, energy, etc.) with a view to support growth and the internal market (european commission, 2012). rather than perceive them – like european authorities – as a way to reinforce competition and to lower internal borders, we believe that collective investments and private investments – and consequently short-term demand – should be explicitly supported, as well as, through them, other key factors for future growth such as innovation. innovation, a key driver for economic activity highlighted by several studies, we consider innovation a major source of economic development in modern times (veblen, 1898; schumpeter, 1911). evolutionary economists have understood this in a comprehensive manner, through the concept of innovation systems (freeman,1987), as a network of organizations that creates new processes, subsequently used socially and economically, thereby promoting growth, employment, competitive positions of nations, and business development. a theoretical approach of innovation the new endogenous growth theories, developed in the 1980s, have given to innovation a central role in their models (romer,1986; lucas, 1988; aghion et al., 1998). technological adaptation and innovation are presented as the key drivers for the long-term growth of an economy, and productivity growth is explained by schumpeter's “creative destruction” phenomenon, as innovations have the capacity to accelerate the obsolescence of existing technologies and to implement more efficient processes. these new theories have offered a better understanding of innovation and its role on a country's economic performance, even though their interpretations are often considered simplistic by some economists. among those expressing criticism is jones (1995), who noticed that although the number of scientists and engineers involved in r&d has strongly increased, the productivity growth had not been significant. endogenous growth approaches present a basic vision of the innovation process, but have nevertheless highlighted its role within an economy. many studies of the technological frontier as well as of imitation and innovation schemes have been substantially extended and have provided us with a better understanding of innovation as a whole, combining both institutional and innovation dynamics. the relationship between institutions and new processes affects a country's economic performance (north, 1998). structural policies may vary according to whether growth regimes are characteristic of a catching-up economy or not, and their impacts on productivity economic analysis (2014, vol. 47, no. 3-4, 3-19) 10 growth depend on the distance from the technological frontier, usually symbolized by the united states. for an economy that is lagging behind technologically, growth sources are indeed capital accumulation and imitation; while more advanced countries enjoy economic growth where innovation is the main driver, with intense competition, a flexible labor market and a sustained investment in higher education (acemoglu et al. 2006). an economy that is near the technological frontier – like european union – needs to exploit its innovation potential and to invest more in higher education to put the economy back on the path of growth (aghion, cohen 2004). a supply of skilled labor may induce companies to invest more in r&d; conversely, an increase in innovative activities and in the r&d sector generally encourages further efforts in education and qualification (romer,2001). the complement between higher education policy and innovation policy could fuel economic growth and increase the low level of r&d expenditures in the eu. insufficient incentives to innovate after the post-world war ii economic expansion, the eu has registered poor macroeconomic performance. while it is considered a key to a sustained and sustainable growth, the low innovation capacity partly explains these disappointing results. the united states and japan have invested considerably in r&d, while europe has lagged behind. in the 1990s, the united states had intensified their efforts to enhance new technological knowledge and japan had invested in basic research, whereas a paradox had emerged among european countries. for many years, member states focused on a rather archaic division of labor and had been limited to an imitation role, while public authorities should have promoted fundamental research in specific centers, and the role of companies should have been to innovate, with more organic cooperation between the different actors (cohen & lorenzi 2001). in 1993, the european commission has highlighted the problems related to innovation. europe has had difficulties to “convert scientific breakthroughs and technological achievements into industrial and commercial successes.” table 3. gross expenditure on research and development, gdp ratio 2005 2006 2007 2008 2009 2010 2011 2012 eu 1.82% 1.84% 1.84% 1.91% 2.01% 2.01% 2.05% 2.06% france 2.11% 2.11% 2.08% 2.12% 2.27% 2.24% 2.25% 2.26% germany 2.51% 2.54% 2.53% 2.69% 2.82% 2.8% 2.89% 2.92% united kingdom 1.70% 1.72% 1.75% 1.75% 1.82% 1.77% 1.78% 1.72% finland 3.48% 3.48% 3.47% 3.70% 3.94% 3.90% 3.80% 3.55% spain 1.12% 1.20% 1.27% 1.35% 1.39% 1.40% 1.36% 1.30% united states 2.49% 2.55% 2.62% 2.76% 2.81% 2.73% 2.67% na japan 1.32% 1.39% 1.40% 1.47% 1.70% 1.76% 1.84% na source: eurostat,2005-2012. empirical studies have indicated that investments in r&d that lead to patents result in significant growth of productivity gains in developed economies (edworthy,wallis 2006). under the europe 2020 initiative, an objective of 3% of gdp to invest in r&d must be achieved to reduce the lag behind main competitors. despite a satisfactory scientific basis, ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 11 the innovation capacity remains insufficient in europe. for years, gross expenditure on r&d (gerd) has paled in comparison to principal partners without any member state being able to reverse the trend. even though the eu has registered a slight increase of its gerd, the effort has not been sufficient to reach the same level of japan or the united states (see table 3). public and private expenditure in higher education has also been relatively low compared the united states7, where 41% of the american population aged 25 to 64 have higher education degrees, against 44% in japan and only 25% in the eu11. however, these data should be qualified, as there are some disparities between european member states. significant efforts in terms of education, research and innovation have been undertaken in scandinavian countries. finland, sweden and denmark have indeed invested in r&d, at higher levels than the united states. according to the oecd, to achieve the objectives of the lisbon strategy, seven hundred thousand more researchers were needed in europe. the gap between the eu and its main competitors is essentially due to the fact that the european economy is specialized in the medium-high technology sector, but not in the promising new high-technology sectors such as information and communication technologies (ict), electronics, nanotechnologies or biotechnologies. the united states has strong capital accumulation in the ict sector, whereas europe has been focused on employment policies that encourage low-skilled labor, especially through reductions in social security contributions on low wage earners. this partly explains low gains of labor productivity in europe relative to the united states. the rapid diffusion of ict across the atlantic is also due to the important fall in the relative prices of these goods and services. since the 1990s, it appears that the ict investment has been an important determinant of productivity gains. between 1995 and 2000, ict investments have induced a gdp growth per capita of 0.3% to 1%, according to empirical studies (jorgenson et al. 2002; cette et al. 2002). information and communication technologies are tightly linked to innovation and help to accelerate the diffusion of information, to encourage networking among companies, to reduce geographical distances and to improve communication. the eu could benefit from a stronger investment in ict. this also applies to nanotechnologies, biotechnologies and more generally to high technologies. the challenge facing the eu remains to redirect and reinforce the innovation system, especially through the increase in r&d expenditure and a major effort to invest in high technologies and higher education. the economic crisis has created financial obstacles for many companies and has led to a decline in r&d investment. it is essential to counteract this tendency and to stimulate technical progress in the most promising sectors, as innovation can contribute to boosting the economy. while the eu has considerable scientific potential, the economic recovery should be accompanied by a more intense diffusion of ict and by a higher level of education, to increase productivity gains. public support could play a key role to reinforce the innovation process among european countries, which have more and more difficulties to access sources of funding. 7 18% of private expenditure are reserved to educational institutions in the eu-15, as against 66% in the united states and 68% in japan. economic analysis (2014, vol. 47, no. 3-4, 3-19) 12 the financing of innovation and public intervention the financing of innovation presents particular challenges. the difficulty of obtaining a complete return on investment is holding investors back from investing in innovation. information asymmetry and moral hazard have a tendency to increase the costs of obtaining external financing. even if this is true for all firms, it is especially so for innovative companies (hall 2005; hall & lerner 2010). the financing of innovative companies can be provided by standard forms of investment. however, the specific characteristics of innovation make it more difficult to access finance, whether they use internal resources or financial intermediaries. this is the reason why the intervention of public authorities to encourage innovation is essential. more than 35% of gerd in europe come from the public sector. the challenge is the articulation of public and private funding. the public sector should primarily finance projects that could not find investors through private funding, especially at the beginning of the growth cycle. public intervention should be digressive with the development of the project and the authorities cannot be the only actor to finance innovation because unintended consequences might appear. direct support provides immediate financial benefits to a company's income statement. such is the case of eu funds operating on two separate budget lines: the framework program for research and technological development (fp) and the regional policy (via the european regional development fund, the european social fund and the european agricultural guarantee fund). indirect support also encourages a company's development while improving its environment (via r&d tax credits, seed funds, business incubators, etc.). the european commission has proposed an investment of 88 billion euros for research and innovation, as part of the new community framework program “horizon 2020” which assembles all eu funding programs, including the current framework program for research and technological development (fp7), the competitiveness and innovation framework program (cip), and the eu contribution to the european institute of innovation and technology (eit). the objective is to stimulate growth and employment, as well as reducing administrative burdens. the european investment bank (eib) and the european commission have implemented in 2012 a joint initiative to stimulate investment in the sectors of transport, energy and ict. the europe 2020 project bond initiative is fundamentally different from the so-called eurobonds. project bonds are private debt and are issued by project companies to finance large-scale infrastructure projects. neither the european commission nor the member states will therefore issue such bonds. capital markets are considered to be an alternative source of funding and a useful long-term financial instrument to trigger innovation in these specific sectors. through financial supports, public intervention promotes and encourages private investors, and even more so during an economic decline. even if the economic literature does not help to evaluate the efficiency of public authorities' activities for innovation, the revival of economic growth should be facilitated by a public reinforcement on promising sectors such as high technologies. some financial supports – especially direct – should be reassessed. however, many public interventions contribute to the development of european small and medium-sized enterprises (smes), which stimulates economic growth and the diffusion of innovation. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 13 the contribution of small and medium-sized enterprises in the face of globalization and the acceleration of technological change, businesses with fewer than 250 employees are considered key actors in the productive structure and contribute substantially to the eu's economic growth. almost 21 million european companies are smes – more than 99% of all businesses (apart from the financial sector). europe's future prosperity depends, among other things, on the growth potential of these companies. the economic role of smes in europe small and medium-sized enterprises lead to a process that replaces incumbent firms by new market entrants, potentially more innovative and efficient. this process contributes to the productivity growth attributable to technical progress and essentially stems from the existing sustainable smes. this incumbent-entrant dynamics have an impact on the overall productivity. the creation of more productive smes that replace the least efficient firms largely explains the american productivity growth in the 1990s (foster et al., 2002). these “creative destructions” that can be generated by economic crises help to strengthen the productive fabric. even though there is a less important impact during a recession, reinforcing assistance to the creation of innovative smes and encouraging the growth of existing startup companies could assure a positive result on productivity growth. the situations in europe and the united states do not differ by the number of new startups but by their fate (bartelsman et al., 2005). the establishment of a support plan for french smes during the 2008 global crisis has improved their financial health. the economic stimulus plan helped more than twenty thousand companies and their survival rate has reached 89% at the end of june 2011. despite the considerable growth potential of european smes, liquidity constraints undeniably lead these startups to bankruptcy. smes have also helped to provide long-term employment, jobs creation being negatively associated with a firm’s size (birch, 1981; storey & johnson 1987; davis et al., 1998). they account for around two thirds of industrial employment in europe and the commission has estimated that they provided 85% of jobs created between 2002 and 2010. employment creation justifies why smes should be supported. however, despite growth potential and job creations, european smes are facing many challenges. barriers to sme growth structural barriers to the development of smes are numerous. one of the most difficult obstacles remains the struggle to access external financing sources. this impediment should be considered as important as labor market rigidities. indeed, smes play a key role to the diffusion of technical progress but have to face the difficulties inherent to financing of innovation. venture capital is often chosen to overcome the problem. the financial capital is provided to risky investments and should have a positive impact on companies’ growth prospects (engel, 2002). the sme is partly financed out of its own resources and the remaining part is provided by a special fund, maintained by external investors and managed by venture capitalists, who are supposedly able to reduce information asymmetry. based on his own economic analysis (2014, vol. 47, no. 3-4, 3-19) 14 business network and his technical as well as market knowledge, the venture capitalist will help the company to grow. its intervention is primordial during the early-stage of the company. on the informal market, some intermediaries can finance these startups, such as business angels who invest in innovative smes with a strong potential. these high net worth investors intervene during the seed and start-up stage or during the launch of new products, they are particularly motivated by the return on investment and are relatively keen to take higher risks. europe is lagging behind concerning the financing of its early-stage companies and smes’ monitoring. there are near 75 thousand business angels in the eu, as against 265 thousand in the united states. american smes were given the necessary capacity to finance and secure their development. their business angels have rapidly expanded thanks to fiscal incentives and deductions of investment losses. in europe, given the particularly heterogeneous nature of the region in terms of capital gains taxes, the efforts concerning fiscal incentives for venture capital investments must be accentuated. a reduction in capital gains tax would reward investors, at least cost to the government. in the united states, the reduction in capital gains has generated a positive and decisive impact on venture capital investments and on the degree of risk-taking by business angels (lerner 1998). tax credits should be limited to more risky investments and oriented towards early-stage smes, to encourage investors and further venture capital investments. the european commission has tried to support such financing by the establishment of a european system in december 2011, to help managers commercialize venture capital funds on a european basis. they will raise additional capital and the obstacles related to cross-border transactions will be reduced. crowd-funding could provide an alternative source of financing. this participatory approach, which involves individuals with relatively small amounts of money to invest, is only an epi-phenomenon in the world of venture capital financing. while american congressmen have passed a law to facilitate this type of financing (through the jumpstart our business startups act), european smes are facing restrictive national regulations to the development of crowd-funding. however, crowd-funding could be inefficient in selecting potential entrepreneurs and could also lead to fraud and misuse. as signals of project quality are weak and information asymmetry is exacerbated, investors’ potential returns are unlikely to justify the risk taken. other instruments and initiatives could help smes to access financing. examples include – but are not limited to – mezzanine capital (subordinated debt) that facilitates access to bank credits and supports intangible investment projects, but are poorly developed in europe. some joint european resources initiatives for smes such as “jeremie” could also improve access to financing through structural funds. these initiatives allow member states to invest in venture capital funds, guarantee funds or loan funds. given these financial constraints, european smes barely reach the critical size to export, and only one in five is operating internationally. challenged by the fierce foreign competition, an expansion abroad would support the long-run viability of a business, but would also boost economic growth and strengthen competitiveness. exportation is often considered as too expensive or risky and many smes do not expect to internationalize their activities. however, german smes have the capacity to reach the critical size required. the german mittelstand – and its many medium-sized smes – is frequently perceived as a model ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 15 to follow and has enhanced the reputation of the “made in germany” seal of quality thanks to the enviable performance of its industries. while french and british smes were affected by the global financial crisis, germany’s prosperity owes a great deal to the mittelstand and to the strength of its large number of medium-sized enterprises. without actually leading to a german-inspired model based on export-dependence, public and private investments would enable more european smes to internationalize their activities. because several asian countries have experienced an economic take-off, german smes has become highly specialized, especially in high value-added capital goods, in sectors such as automotive, chemistry, precision engineering and electrical engineering. the mittlestand is also notable for – and is playing a pioneering role in – the transition to a resource-efficient and lowcarbon economy. therefore, these smes have become the essential suppliers of major industrial groups and have benefited from a strong international demand. think small first: an sme-friendly environment to tackle the obstacles impeding the development of european smes, a more suitable environment must be provided. because growth potential and employment creation in the european industry depends on the dynamism of its companies, more efforts are required to encourage the establishment, development and internationalization of smes. in this regard, the adoption of the “small business act” for europe in december 2008 was undoubtedly a useful action plan. taking its inspiration from the american small business act, the recent initiatives aim to contribute to the achievement of ambitious objectives targeted by the europe 2020 strategy. to boost economic growth, the european commission and its member states are committed to establish several political and legislative measures of which one of the main goals is to support smes and reduce the obstacles that hinder their development and restrict job creation. with a 1.1 billion euros budget over the 2007-2013 period, the competitiveness and innovation framework program (cip) facilitates venture capital investments and provides loan guarantees for smes. according to the commission, each sme with a guaranteed loan could create an average of 1.2 jobs, and 300,000 smes have benefit from the cip financial instruments by 2013. the european investment bank (eib) has contributed to the development of smes by releasing 40 billion euros of loans to 210,000 companies between 2008 and 2011, to help innovative enterprises and to implement the lisbon strategy. the central role of the eib in raising funds to finance european smes – and by extension innovative companies – needs to be strengthened to meet the objectives of the europe 2020 program. special emphasis should be given to small business investment companies (sbics) to finance smes in their startup and growth phases. by implementing a european supervisory board (with a public-private team) and with some help from the eib, business angels and the financial market, it should be possible to raise enough funds to invest over several years in the most dynamic smes. some improvements have been observed in public procurement. smes have less administrative burdens since the introduction of the small business act (sba) and are encouraged to work together in order to offer joint bids. the main challenge for smes lies in the diversity of national and local environments and on the principle of subsidiarity. even though all eu member states recognize the importance economic analysis (2014, vol. 47, no. 3-4, 3-19) 16 of the sba and its rapid implementation, the countries have chosen various methods of implementation and obtained different results. access to financing and to public procurement is generally facilitated but the future of the sba will depend on the determination of european countries to follow the commission’s initiatives. an enhanced governance of the sba should provide the expected results. the global economic environment has dramatically changed in the past few years and the efforts to encourage the creation, development and internationalization of smes must form the heart of the new integrated industrial policy of the eu. member states should take into account the needs of smes in their economic policies in order for the european industry to remain a driver of economic growth. concluding remarks: european union must take advantage of its market size europe does not have a true top-down industrial policy such as the one endorsed by france in the 1980s. the union is pursuing instead a bottom-up industrial policy inspired by the german standortpolitik8. its initiatives towards smes provide an eloquent illustration. however, sectoral actions to strengthen the productive fabric in europe remain exceptional. galileo is one of the few industrial projects that are truly supported by the eu. by contrast, the union does not interfere in sectors where the combined effect of increasing returns (or spatial externalities) and the size of the european internal market could be a decisive advantage for the competitiveness of manufacturers. indeed, in productive activities where economies of scale are real (besides aeronautics, some energyrelated sectors, railway equipment, some aspects of the new green economy, etc.), a policy of “european industrial champions” could succeed. given its importance – often among the main international priorities – the single market can transform a european champion into a worldwide industrial leader. if not, it will still be a significant player on markets that are only allowing a few large competitors. the european pusillanimity is often involved and blamed, in several matters. firstly, europe’s major competitors – and especially china – are using this type of leverage. the chinese case and its numerous successes have even largely contributed to the recent rehabilitation of the industrial policy, at least in emerging countries (rodrik,2004). secondly, as pointed out by aghion et alii (2011), the question is no longer to know whether or not the industrial policy should have a sector-based component, but to understand how to implement it with a maximum efficiency and a minimum of detrimental effects. finally, the structural economic phenomena are undoubtedly related to the classical economics idea that the market is better than the state at making the right investment choices. the environmental crisis or the issues of energy mix are significant examples. in europe, the competition policy has so far taken precedence over the industrial policy. the merger control policy is indeed occasionally constraining the creation of large companies. the concern to limit market power prevails over the development of the productive apparatus. similarly, public procurement cannot be used selectively within the eu, as was the case in france and as it is still occurring among the major competitors (united 8 literally “industrial production policy”, dealing with the competitiveness of the “made in germany”. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 17 states, japan, china, etc.). submitted by the european commission, the recent request for international reciprocity concerning the opening of public procurement cannot hide the naivety (related to neo-liberal beliefs) that is characteristic of the eu policy in this matter over the past twenty-five years. to a certain extent, a similar idea is behind the state aid control. state aid is indeed prohibited by the treaties, but can be compatible with the logic of the internal market (article 107 tfeu). the real circumstances authorized by the commission remain unclear. the article 107-3 stipulates that the “aid to promote the execution of an important project of common european interest” and the “aid to promote the economic development” are potentially permissible. it seems that a legal uncertainty could be found to promote an active industrial policy, with sectoral state aid. moreover, industrial policy and competition policy are less antagonistic than what the consensus of the past twenty-five years was suggesting (aghion et al., 2011). in particular, some state aid could target specific sectors, without favoring one company over another, as long as the sector concerned has not reached a high degree of concentration. the risk of “cherry picking” (where incumbent companies are favored by the political action) is therefore limited. the eu has also identified – as part of the europe 2020 strategy – several promising sectors, considered as decisive for the future competitiveness. this includes, in particular, the digital economy, biotechnologies, photonics, nanotechnologies, etc. consequences still have to be drawn from state aid issues, particularly when fixed production costs are high (and therefore important scale effects). these state aid measures would benefit from a european approach, because all attempts by member states to give advantage to a local company will be avoided, while the pertinent scale is the internal market as a whole. references acemoglu, d., aghion, p. & zilibotti, f. 2006. 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"why is economics not an evolutionary science?" the quarterly journal of economics, 12(4): 373–397. evropski rast: kriza izlazne strategije rezime – dok se evropska unija suočava sa sve jačom recesijom, propraćenom posledicama globalne finansijske krize iz 2008. godine, pokazuje se da je više nego potrebna podrška privrednim aktivnostima. primarne brige zemalja članica se zasnivaju u nastojanju da povećaju konkurentnost, zaposlenost, inovacije i pomoć malim i srednjim preduzećima, kako bi podstakle ekonomski rast u kratkom ili dugom roku. u tom smislu ovaj rad najpre ukazuje na to da je apsolutno neophodna privremena podrška privrednim aktivnostima, a detaljno su i razmotreni mogući aranžmani. pored toga, treba staviti akcenat na inovacije jer one igraju ključnu ulogu za povećanje ekonomskog rasta. posebna pažnja je usmerena na sektor malih i srednjih preduzeća, njihov potencijalni uticaj na produktivnost i finansijske poteškoće. u zaključnom delu smo se fokusirali na veličinu evropskog tržišta i istakli smo netrpeljivost između politike konkurentnosti i industrijske politike. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 19 ključne reči:. ekonomski rast, evropska unija, inovacije, mala i srednja preduzeća, industrijska politika article history: received: 5 september 2014 accepted: 30 november 2014 ea_2016_3-4 udc: 336.77/.78 336.76(4-12)"2007/2014" jel: f39, g24 cobiss.sr-id: 228330252 scientific review correlation between credit rating and macroeconomic indicators: case study of south-east european countries brkić snježana1, school of economics and business sarajevo, bosnia and herzegovina pijalović velma, school of economics and business sarajevo, bosnia and herzegovina pjanić elma, eurorisk systems, ltd. abstract – credit rating, as one of country risk indicators, plays an exceptionally important role in international capital markets – for creditors and investors as much as countries, industries and companies which require loans and investments. it is connected with a wide range of different factors, both of economic and non-economic nature. the goal of this paper is to provide insight in trends of credit ratings of south-east european countries and to compare their ratings, bringing them into relation with macroeconomic situation of given countries. the research takes into account ratings provided by three the most significant rating agencies – standard & poor's, moody's and fitch, as well as eight macroeconomic indicators, for albania, bosnia and herzegovina, montenegro, croatia, macedonia and serbia in period between 2007 and 2014. results of this research have shown that credit ratings of these countries ranged within the non-investment speculative grade. croatia has the highest credit rating, followed by macedonia, then serbia and montenegro, while b&h scores the lowest. trend of the credit rating often does not sufficiently match the macroeconomic situation of the countries observed through main macroeconomic indicators. by using scatter diagrams and spearman’s rank correlation coefficient, it has been discovered medium strong positive correlation between credit rating on one side and gross domestic product, external debt and exports, on the other side, while correlation with other analysed macroeconomic indicators has been extremely low. key words: country risk, credit rating, macroeconomic indicators, spearman’s rank correlation coefficient, south-east european countries introduction the problem of country risk has been one of the most significant research topics in the international business and finance field in the past several years. the impact which risk assessment can have on a country, especially in context of international business and investments, keeps the focus of many authors on this particular topic. most authors share the opinion that globalisation of the world financial market and financial crises in the 1980s and 1 e-mail: snjezana.brkic@efsa.unsa.ba address: snježana brkić, ekonomski fakultet u sarajevu, trg oslobođenja alija izetbegović br. 1, 71 000 sarajevo, bosna i hercegovina 2 economic analysis (2016, vol. 49, no. 3-4, 1-19) 1990s, from the collapse in chile in 1982 to the russian crisis in 1998, brought the analysis of country risk in focus of interest of not only banks and international financial institutions, but also governments and wider public. (pjanić, 2015) country risk analysis requires extensive and comprehensive knowledge of international economics and macroeconomics, socio-political institutions and history of the country which is being analysed. however, most market participants are not capable of carrying out their own deep analysis, so the number of specialized institutions doing country risk assessment is growing. among these institutions, credit rating agencies play an especially important role. rating agencies provide credit rating assessment, which symbolises the level of risk to which investors are exposed when purchasing bonds and other securities. in today’s financial world, it is almost impossible to borrow money without credit rating – credit rating scores serve as guidelines for investors indicating where and how much to invest, they are therefore of crucial importance for economies of countries which rely on external financing. since transition countries belong to the countries which have been relying on foreign financing sources for years, this paper will examine credit ratings of the group of south-east european transition countries – albania, bosnia and herzegovina, montenegro, croatia, macedonia and serbia in period between 2007 and 2014. this research covers the dynamics of credit ratings of the above listed countries, comparison of their credit rating scores, and review of major macroeconomic indicators of these countries in context of their correlation with credit rating. theoretical considerations for a long time, country risk belonged to the category of complex and incomprehensible topics, mainly because of lack of access to information as well as their incompleteness. due to the extraordinary complexity of this term, there are many different definitions. bouchet, clark and groslambert (2003) analysed the literature related to country risk in the past four decades, and they established that each country risk definition contains a wide range of different situations, but they always refer to specific risks which are caused by international business and which are not present in local business, regardless of the cause of the risk or nature of the given industry. some authors emphasize the economic character of this term. bhalla (2006) country risk from the point of view of creditors as exposure to cross-border credit loss caused by economic movements within a country. madura (2006) defines country risk as potentially negative influence of a country’s environment on the cash flow of multinational corporations. however, such observation of country risk can be considered incomplete, because it does not emphasize the wider context and multidimensional character of the term. the economic dimension of country risk, according to mondt and despontin (1986), reflects only the ability of a country to pay its debt, but not its willingness to fulfil its obligations. in their opinion, this indicates the necessity to examine the political environment as an inevitable factor in country risk analysis. a more comprehensive definition of country risk was provided by calvaerley (1990), who defined country risk as potential economic or financial loss caused by difficulties a country is facing on macroeconomic and/or political scene. country risk defined in this way brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 3 takes into account relevant factors such as economic, financial, social and political ones. shapiro (2006) provides a brief definition of country risk as general level of political and economic uncertainty which influences the value of loans and/or investments in a country. according to meldrum (2000), all business transactions involve a certain level of risk, but when they are carried outside of borders of one country, they include additional risk which arises due to different features of each country, be it economic structure, politics, sociopolitical institutions, geographic position or currency. the goal of country risk analysis is to identify the possibility of occurrence of such risks, as well as they impact on potential return of cross-border investment. berg and guisinger (2003) claim that country risk represents the most comprehensive category of international business risk, and that includes the overall risk of business environment of the host country. perry (2010) defines country risk as economic, political and business risks which are specific for a certain country, and which can result in unexpected loss for an investor. so, country risk includes all sources of potential difficulties, from political and social risk, to macroand microeconomic risk. two basic components of country risk are most frequently mentioned in literature: socio-political and economic-financial component. political risk occurs due to internal or external conflicts, disputes related to territorial division, revolutions aiming at change in power, terrorist attacks and so on. according to hoti and mcaleer (2005), political risk can also occur due to political instability or conflicts in the region to which a country belongs, although the country in question is not involved. social risks include collective actions launched and led by trade unions, non-governmental organizations and other informal groups which are trying to influence the local government and/or directly influence the business policies of foreign corporations (bouchet, clark and groslambert, 2003). scientist buckley (2004) links economic risk to events in national economy which might influence the outcome of international economic transactions, whereby the definition includes both present and potential economic situation in a country. economic risk is divided into macro risk which applies to all foreign corporations, and micro risk which applies only to certain sectors or individual corporations. macroeconomic risk entails shift in certain variables within economic system, such as economic activity growth rate, prices, interest rates, currency exchange rates and so on. microeconomic risk purports all negative events which take place at the level of an industry or corporation. sovereign risk is risk related to crediting of a state. it occurs when a government cannot or will not fulfil its obligations abroad, and/or when a government does not allow residents (corporations or individuals) to pay back their foreign debt. a. shapiro (2006) divides sovereign risk into direct and indirect risk. direct sovereign risk occurs in the situation when a government is not willing or not able to fulfil its international obligations. indirect risk occurs when measures undertaken by a government influence the ability of individual debtors to pay back their debt to foreign creditors and investors. (ghose,1988, as cited in hoti and mcaleer, 2002). in both cases, foreign investors and creditors are exposed to risk caused by decisions of the government in the country in which they are investing. the first attempts to define a unique system of country risk analysis were made by banking institutions. these were simple systems focusing only on economic variables (saini, krishnan and bates, philip, 1978, as cited in kosmido, doumpos and zopounidis, 2008). today, institutions which make country risk assessments use different methodologies, 4 economic analysis (2016, vol. 49, no. 3-4, 1-19) depending on type of investment and source of risk. these institutions are generally divided in two categories. the first category consists of institutions which take all possible kinds of risk into account. the second category focuses on credit rating of a country. these are credit rating agencies. based on a detailed analysis of information, and in line with predefined standards, rating agencies determine the credit rating, i.e. the score which symbolises the level of risk to which investors are exposed when purchasing bonds and other securities. credit rating can be described as an assessment of present situation in a country, based on which investors can predict the success of their potential investment in the country, or based on which investors can predict the credit ability of the country (bouchet et al, 2003). in order to enable a better understanding of risk, agencies analyse and interpret a large number of information about investors and debtors, market and changes in economic and political circumstances. also, they give opinion on credit ability of institutions and their financial obligations. in many cases, countries request rating not because they need to borrow, but because they want to show the international market their tendency for adequate, transparent and pro-market governance; in other words, governments insist on having a (positive) credit rating score so that the market can see their economic policy as acceptable and suitable (pjanić, 2015). due to intense development of the financial system, the role, significance and range of activities of rating agencies changed over time. today, renowned agencies do not only provide the service of credit rating assessment, but they also provide consulting service, manage important international indexes and engage in other highly profitable activities related to international borrowing and investments. there are more than 70 credit rating agencies in the world. the most famous ones are moody's, standard & poor's and fitch, which are recognized by all members of the basel committee and almost all non-member countries. the structure of the rating agency industry is extremely oligopolistic. from the very beginning, the industry has been dominated by the triumvirate of agencies – moody's, standard & poor's and fitch – which cover over 95% of the market. this triumvirate is further divided with “the big two” – moody’s and standard & poor’s, each holding market share of 40%, and fitch which holds 15% of market share and is specialized in distinctive niches which it dominates (begić, 2013) standard & poor's (s&p's) was established in 1941 through merger of standard statistics which was established in 1860 and poor's publishing. today, the agency operates in 26 countries throughout the world. s&p lists several key parameters which are used for assessment of credit risk: political risk, revenues and economic structure, economic growth perspective, fiscal flexibility, obligations of the state, external and potential obligations, monetary flexibility, external liquidity and foreign debt (bouchet, clark and groslambert, 2003). according to methodology applied by s&p's, huljev (2013) specifies the following key determinants: gdp growth rate, gdp per capita, currency stability, fiscal equilibrium, public debt and especially external debt, foreign reserves level, inflation and current account of balance of payments. moody's investor service, daughter company of moody's corporation, issued its first rating report in 1909. today, moody's investor service belongs to the most famous and most renowned world agencies specialized in credit ratings and risk analysis. it operates in 35 brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 5 countries. according to moody’s, the essence of credit rating assessment lies in analysis of three basic factors: structure of social interactions, social and political dynamics, and economic basis. experts also research foreign debt, calculate net debt, compare the burden of debt among countries and analyse short-term debts (bouchet, clark and groslambert, 2003). fitch publishing company was established in 1919. fitch did not play any significant role as a rating agency. however, in perod from 1997 to 2000, after a series of successful mergers with other companies, fitch ratings became recognisable as an agency specialised in risk management, financial “training” and data distribution. the criteria which support the risk assessment methodology defined by this agency can be grouped in following subgroups (bouchet, clark and groslambert, 2003): demographic, educational and structural factors, labour market analysis, production and trade structure, private sector dynamics, balance of payments, macroeconomic policy, trade and foreign investment policy, banking and finances, external property, foreign debt, international position and government policy. details of the methodology framework used by credit agencies are not fully known. if they were known, investors themselves would be able to calculate values of certain determinants and set the credit rating score, and decide based on that whether to invest or not. what is known is that the methodology used by agencies to assess credit rating is very complex. analysts do not only use publicly available information on issuers of financial instruments, they also use information not available to the public. this means that on top of the objective assessment of financial and economic indicators, analysts must also make a subjective assessment. all of this indicates that there is no single, universal formula to determine the credit rating score. methodology differs not only from agency to agency, but also from analyst to analyst. regarding macroeconomic factors connected to credit rating, research done by borenszstein and panizza, (2006) as cited in huljev (2013) indicated that credit rating was significantly correlated with gdp growth rate and gdp per capita. in the given research gdp per capita explained around 80% fluctuations in credit rating. some studies (bucur, andreea dragomirescu, simona, 2014) emphasize that unemployment rate should be part of credit rating analysis, as higher unemployment rate is in negative correlation with country risk assessment. huljev (2013) argues that foreign debt is also significantly and positively correlated with default risk. in that sense analysts consider relation between foreign debt and gdp especially relevant. however, rating agencies take into account the whole context of a country in analysis of the given variable, making it relevant for less developed countries only. methodology remarks this paper takes into account the credit rating scores of the three most significant rating agencies – standard & poor’s, moody’s and fitch, for selected countries of south-east europe in period 2007-2014. the south-east european countries selected for this analysis are albania, bosnia and herzegovina (bih), montenegro, croatia, macedonia and serbia. it is necessary to note that the three agencies did not rate all observed countries in the entire period. only croatia was rated by all three agencies in the entire observed period. bosnia and herzegovina and serbia were given credit rating scores for the first time in 2004, 6 economic analysis (2016, vol. 49, no. 3-4, 1-19) macedonia in 2005, albania in 2007 and montenegro in 2008. fitch does not rate bosnia and herzegovina, montenegro and albania at all, and the remaining countries are rated in some years only (serbia and macedonia starting with 2005). similarly, moody’s rated serbia for the first time only in 2013, and it is still not rating macedonia (table 1). these facts influenced the selection of the observed period, and this is why the period in which a comparative analysis of credit ratings of these countries is possible is limited to eight years, from 2007 to 2014. table 1. periods of assignment of credit rating, per country and agency country/agency moody's standard & poor's fitch albania 2007-2014 2010-2014 bosnia and herzegovina 2004-2014 2008-2014 montenegro 2008-2014 2010-2014 croatia 1997-2014 1997-2014 1997-2014 macedonia 2009-2014 2005-2014 serbia 2013 2004(2007)-2014 2005(2007)-2014 source: prepared by authors based on data published by credit rating agencies. a new derived numeric scale with score range from 1 to 20 was created for the purpose of comparative analysis. it is based on the existing rating scales used by agencies. (annex table 1) for each of the observed countries, we also provide and explain annual data on macroeconomic indicators. the analysis uses eight macroeconomic indicators which are, basing on existing literature about country risk analysis and methodology of rating agencies, assumed to have the greatest impact in the system of assessment by credit rating agencies: economic growth expressed through rate of real gross domestic product, gross domestic product (gdp) per capita, inflation (as consumer price index), savings as share of gdp, foreign debt as share of gdp, unemployment rate, export and import of goods and services in relation to gdp. the aim of this part of the research is to contribute to better understanding correlation between macroeconomic indicators and credit rating score. for that purpose, spearman’s rank correlation coefficient and scatter diagrams which indicate form, strength (degree) and direction of correlation between selected variables, are used. research results credit rating score and macroeconomic indicators by country albania moody’s is the only agency which published credit rating scores for albania throughout the entire observed period. s&p’s provided rating scores in the last five years. moody’s assigned albania the score of b1 with stable outlook (similar to the score assigned by s&p’s), which puts albania in the non-investment speculative category, with high credit risk. (table 2) brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 7 table 2. credit rating of albania (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s b1/ stable outlook b1/ stable outlook b1/ stable outlook b1/ stable outlook b1/ stable outlook b1/ stable outlook b1 / stable outlook b1 / stable outlook standard & poor’s n/a n/a n/a b+ / stable outlook b+ / stable outlook b+ / stable outlook b / negative outlook b / stable outlook fitch n/a n/a n/a n/a n/a n/a n/a n/a source: prepared by authors based on data published by credit rating agencies albania’s credit rating remained stable throughout the observed period – constantly at the level of score 7 on the derived numeric scale of credit rating (graphs 1 and 2). at the same time, the country experienced gradual worsening of macroeconomic situation. according to information published by websites of the global economy, world bank and national bank of albania, albania had the lowest gdp per capita of all the analysed countries (usd 4,564.39 in 2014). albania’s gdp grew throughout the observed period, but at a decreasing rate in recent years, significantly lower (as much as four times lower) than in the years before the global crisis. along with positive albeit slow economic growth, maintenance of monetary stability characterised by a relatively low and declining inflation rate (2.65% in average during the observed period and under 2% in recent years) and positive lek to euro exchange rate remains the only positive achievement. share of savings in gdp was in decline, while the share of external debt had a continuous strong growing trend, tripling during the observed period (57.7% of gdp). unemployment rate also grew from 13.5% to 16.10%. strong trade deficit was also maintained throughout the entire period bosnia and herzegovina as in case of albania, fitch does not assign credit rating to bosnia and herzegovina. moody’s has been assigning credit rating to bih since 2004, and standard and poor’s only since 2008. table 3. credit rating of bosnia and herzegovina (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s b2 / stable outlook b2 / stable outlook b2 / stable outlook b2 / stable outlook b2 / negative outlook b3 / stable outlook b3 / stable outlook b3 / stable outlook standard & poor’s n/a b+ / stable outlook b+ / stable outlook b+ / stable outlook b+/ negative outlook b / stable outlook b / stable outlook b / stable outlook fitch n/a n/a n/a n/a n/a n/a n/a n/a source: prepared by authors based on data published by credit rating agencies. 8 economic analysis (2016, vol. 49, no. 3-4, 1-19) moody’s and s&p’s credit rating score for bih remained within the non-investment speculative grade throughout the entire period. however, it is interesting that the score assigned by s&p’s, although in the same grade, was always slightly better than the score assigned by moody’s. the score assigned by the two agencies in period between 2007 and 2011 did not change (b2 with moody’s and b+ with s&p’s), but it went down in the last three years – it remained at the non-investment speculative level, but dropped down by one unit on the derived numeric scale, from 7 to 6 for s&p’s (from b+ to b), and from 6 to 5 for moody’s (from b2 to b3). (table 3, graphs 1 and 2) according to information published by websites of the global economy, world bank, b&h ministry of foreign trade and economic relations and central bank of b&h, the significant economic growth which b&h experienced in 2007 and 2008 (5.98% and 5.59% respectively) stopped in 2009, when growth rate became negative for the first time in the observed period, dropping to -2.72%. although growth rate has been positive since 2013, gdp per capita has not yet reached its value from 2008, and in 2014 gdp per capita was usd 4,790.05. inflation is low, around 1.92% in average. except in 2008 when foreign debt share in gdp dropped by one percentage point, bih’s foreign debt in post-war period has been constantly growing. still, with foreign debt share in gdp of 30.40%, bih is the least indebted among the analysed countries. unemployment rate is very high, the highest among the analysed countries except macedonia. the highest unemployment rate was registered in 2007 with 29.7%. the lowest rate was 23.9% in 2008. at the end of the observed period it was 27.9%. although export share in gdp has been growing from 27.11% in 2007 to 33.90% in 2014, significant trade deficit remain present due to growing import. there is a decreasing trend in savings-to-gdp ratio which went from 13.15% in 2007 to 9.6% in the last analysed year. trade deficit and chaotic public finances along with political instability and inefficient institutions are listed in reports of credit rating agencies as main problems in bih. montenegro of all three agencies, only moody’s assigned credit rating to montenegro in throughout the entire analysed period. s&p's published its first rating for montenegro in 2010. in 2010 and 2011, these two agencies assigned different rating scores to montenegro, although in the same category of credit ability with speculative elements and significant credit risk: moody’s assigned montenegro the score of ba3, and s&p’s the somewhat higher score of bb. the scores remained the same in the following years. (table 4) table 4. credit rating of montenegro (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s n/a ba2 / negative outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook standard & poor’s n/a n/a n/a bb / negative outlook bb / negative outlook bb/ stable outlook bb/ negative outlook bb/ negative outlook fitch n/a n/a n/a n/a n/a n/a n/a n/a source: prepared by authors based on data published by credit rating agencies. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 9 according to the derived numeric scale, the rating score was 9 in the first two years, after which it dropped by one unit, and remained at that level for the rest of the period (graphs 1 and 2). montenegro’s credit rating was quite stable throughout the entire period, according to moody’s. according to information published by websites of the global economy, world bank and ministry of finance of montenegro, the country, like other analysed countries except albania, experienced negative economic growth rate in 2009 and 2012 (-5.66% and -2.72% respectively), and there was also a decline in credit rating in these two years. full economic recovery after the crisis did not happen – gdp real growth rate was 10.7% in 2007, and only 1.78% in 2014. montenegro achieved gdp per capita usd 7,378.45 in 2014 that is only slightly higher than in 2008. the common characteristic of montenegro and other observed countries is the growing trend of foreign debt, as well as trade deficit. montenegro also experienced a growing trend of savings which grew from the negative -10.55% of gdp in 2008 to more than 5% of gdp in the most recent analysed years. unemployment rate was relatively stable at around 19%, except in 2008 when it dropped to 16.8%. average inflation rate was 2.86%, but in final year the inflation rate was negative with -0.7%. croatia croatia is the only one among the observed countries which in period between 2007 and 2011 was, according to all three agencies, in the investment category with medium credit ability and moderate credit risk. from 2011 to 2014, s&p’s agency reduced its credit rating score (the other two agencies followed the suit as of 2012) from lower medium grade (highest b level) to the highest grade in the speculative category which is described as “credit ability with speculative elements and substantial credit risk”. (table 5) table 5. credit rating of croatia (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s baa3 / positive outlook baa3 / positive outlook baa3 / stable outlook baa3 / stable outlook baa3 / stable outlook baa3 / negative outlook ba1 / stable outlook ba1 / negative outlook standard & poor’s bbb / stable outlook bbb / stable outlook bbb / stable outlook bbb-/ negative outlook bbb-/ negative outlook bb+ / stable outlook bb+/ negative outlook bb / stable outlook fitch bbb-/ stable outlook bbb-/ stable outlook bbb-/ negative outlook bbb-/ negative outlook bbb-/ negative outlook bbb-/ negative outlook bb+/ stable outlook bb / stable outlook source: prepared by authors based on data published by credit rating agencies. the derived numeric scale provides better insight into decrease of credit rating from 12 points in period 2007-2009 to 10 points (moody’s) and 9 points (s&p’s) in 2013 and 2014. (graphs 1 and 2) it is obvious that the 2008 economic crisis hit croatia most severely. according to information published by websites of the global economy, world bank and ministry of 10 economic analysis (2016, vol. 49, no. 3-4, 1-19) finance of republic of croatia, the country was in recession in the last 6 years – with continuously negative economic growth rates and decline in gdp per capita which dropped from usd 15,893.86 in 2008 to usd 13,475.26 in 2014. inflation was relatively low and stable in the post-crisis period, ranging from 1 to 3.4%, and even had negative value in the last analysed year (-0.2%). unemployment rate also displayed a constantly growing trend from 2008, when it was 8.4%, to 2013 when it was 17.3%. in the final analysed year, there was a slight decline in unemployment rate to 16.7%. unlike other countries, croatia mostly had relatively well-balanced import and export of goods and services. with foreign debt which exceeded debt-to-gdp ratio of 100% as of 2009 (108% of gdp in 2014), croatia is most indebted of all the analysed countries. macedonia macedonia had stable credit rating assigned by two agencies for almost the entire observed period (moody’s does not assign credit rating to this country), within the speculative grade, but mostly with score of bb+ by fitch and bb by s&p’s (table 6). on the derived numeric scale, macedonia had 10 points with fitch in all years except in 2007 when it had 9 points, which makes macedonia country with the second highest credit rating score among the observed countries. table 6. credit rating of macedonia (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s n/a n/a n/a n/a n/a n/a n/a n/a standard & poor’s n/a n/a bb / stable outlook bb / stable outlook bb / stable outlook bb / stable outlook bb / stable outlook bb-/ stable outlook fitch bb / positive outlook bb+/ stable outlook bb+/ negative outlook bb+ / stable outlook bb+/ stable outlook bb+/ stable outlook bb+/ stable outlook bb+/ stable outlook source: prepared by authors based on data published by credit rating agencies. the 2008 crisis had a negative impact on macedonia’s economic growth which was negative in 2009. according to information published by websites of the global economy, world bank and ministry of finance of republic of macedonia, growth rate has not managed to reach the pre-crisis level even today (in 2007, it was 6.47%, and in 2014 it was 3.77%). inflation was low throughout the observed period (it oscillated slightly between 1.5% and 3.9% with the exception of 2008 when it hit 8.3%), but in 2009 and 2014 it was negative. savings-to-gdp ratio was constantly growing, from 15.88% in 2007 to 29.46% in the final analysed year. on the other hand, unemployment rate is highest in the region (around 32% in average). foreign debt increased significantly from 47.60% of gdp in 2007 to 66.01% in 2014. similar to other analysed countries, macedonia experienced trade deficit in the observed period. despite the low economic growth rate, high unemployment and increase of foreign debt, its credit rating score remained unchanged for most of the observed period. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 11 serbia moody’s assigned credit rating score to serbia for the first time only in 2013, and it was b1. the other two agencies assessed serbia’s credit rating throughout the observed period. according to scores assigned by two agencies, serbia has stable outlook (table 7), but there is a possibility for change in economic environment and a high credit risk, mostly due to slow economic grow and high share of public and foreign debt in gdp. table 7. credit rating of serbia (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s n/a n/a n/a n/a n/a n/a b1 / stable outlook b1 / stable outlook standard & poor’s bb/ stable outlook bb/ negative outlook bb/ stable outlook bb/ stable outlook bb / stable outlook bb/ negative outlook bb/ negative outlook bb/ negative outlook fitch bb/ stable outlook bb/ negative outlook bb/ negative outlook bb/ stable outlook bb / stable outlook bb/ negative outlook bb/ negative outlook b+ / stable outlook source: prepared by authors based on data published by credit rating agencies. as in most other observed countries, according to information published by websites of the global economy, world bank and national bank, serbia also experienced negative economic growth in 2009, 2012 and 2014, as well as modest economic growth after the economic crisis (2.57% in 2013). gdp per capita in 2014 still had not reached the level achieved in 2008. serbia had highest inflation of all the observed countries, and in all years of the observed period it showed significant oscillation in interval between 6.1% and 12.4%. savings-to-gdp ratio ranged between 10.58% and 13.66%. foreign debt grew and reached its peak in 2012 with 87.9% of gdp, but in 2014 it dropped to 77.1% of gdp. the unemployment rate in the observed period ranged between the lowest 13.6% in 2008 and 23.9% registered in 2012. unemployment rate in the final observed year was 22.2%. although we saw an increase in exports from 28.36% in the beginning to 44.34% of gdp at the end of the observed period, serbia is still experiencing trade deficit. comparative analysis of credit rating scores in order to conduct comparative analysis of credit rating scores of the countries, we used a derived numeric scale (annex table 1), as well as graphs which allow easier interpretation of the dynamics of credit rating. because some countries were assigned different credit rating scores by different agencies in some years, we use two approaches in the comparative analysis: (1) single rating is higher rating and (2) single rating is lower rating, as depicted in graphs 1 and 2. the numeric scale showed that credit ratings of sampled countries ranged between 5 and 12. the highest credit rating (12) was registered for croatia, followed by macedonia with one or two points less on the numeric scale. the lowest credit rating among the observed 12 economic analysis (2016, vol. 49, no. 3-4, 1-19) countries was registered for bih – in some years, bih’s rating dropped to 5 points. albania is in a somewhat better position, although in some years its credit rating matched the one of bih. compared to other countries, serbia and montenegro are in the middle, with credit rating between 8 and 9. graph 1. comparative analysis of credit rating of south-east europe countries (higher credit rating) 7 7 7 7 7 7 7 76 7 7 7 7 6 6 6 9 9 8 9 9 8 8 8 12 12 12 11 11 11 10 109 10 10 10 10 10 10 108 8 8 8 9 8 8 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 2007 2008 2009 2010 2011 2012 2013 2014 albania bosnia and herzegovina montenegro croatia macedonia serbia source: prepared by authors based on data published by credit rating agencies. the comparative analysis of higher credit rating shows a decline in credit rating scores for most of the observed countries after 2011, except for albania and macedonia. the scores of these two countries show most visible stability. croatia has the highest credit rating throughout the period, but at the same time it has the rating which changes most from the beginning to the end of the period. graph 2. comparative analysis of credit rating of south-east europe countries (lower credit rating) 7 7 7 7 7 7 6 66 6 6 6 6 5 5 5 9 9 8 8 8 8 8 8 11 11 11 11 11 11 10 99 10 9 9 9 9 8 88 8 8 8 8 8 7 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 2007 2008 2009 2010 2011 2012 2013 2014 albania bosnia and herzegovina montenegro croatia macedonia serbia source: prepared by authors based on data published by credit rating agencies. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 13 the comparative analysis of lower credit rating shows stability of scores for all sampled countries up to 2012. in that year, and all subsequent years, all countries except montenegro experienced lower credit rating. correlation between credit rating and macroeconomic indicators in order to test if there is a correlation between credit rating and macroeconomic indicators, we used the spearman’s rank correlation coefficient and scatter diagrams for each of the analysed macroeconomic indicators. credit rating is shown on a derived numeric scale from 0 to 20, based on higher credit rating scores presented in the previous chapter. table 8. values of rank correlation coefficient macroeconomic indicators coefficient values description gdp growth rate -0.078 very weak positive correlation gdp per capita 0.66 medium strong positive correlation inflation (consumer price index) 0.17 weak positive correlation savings-to-gdp ratio 0.44 weak positive correlation unemployment rate -0.17 weak negative correlation external debt-to-gdp ratio 0.63 medium strong positive correlation exports-to-gdp ratio 0.62 medium strong positive correlation imports-to-gdp ratio -0.07 very weak negative correlation source: authors’ own calculation spearman’s rank correlation coefficient between economic growth and derived numeric value of credit rating is negative, and is -0.078, which indicates a negligible negative correlation. scatter diagram shows that there is no unambiguous trend, which also indicates a weak correlation. weak correlation of negative sign also exists between credit rating on one side, and unemployment rate and share of import in gdp, on the other side, while weak correlation but of positive sign has been registered between credit rating, and inflation and savings-to-gdp ratio. medium strong correlation exists between credit rating and gdp per capita, exports-to-gdp ratio and external debt-to-gdp ratio. spearman’s rank correlation coefficient is highest in case of correlation between credit rating and gdp per capita with value of 0.66, which means that countries with higher gdp per capita also have a higher credit rating. (table 8 and graphs in annex) conclusion this research shows that credit rating scores for south-east europe countries in the observed eighth-year period oscillated within the non-investment, speculative b grade (except croatia in the first three years), the grade which is for most of these countries described as “credit ability with speculative elements and substantial credit risk”. according to moody’s, the credit rating scores range from baa2 to b3, and according to s&p’s and fitch from bbb to b-. this means that the countries are still able to pay their due liabilities, although there is a relatively high risk for investments. 14 economic analysis (2016, vol. 49, no. 3-4, 1-19) the numeric scale, created for purposes of comparative analysis, shows that the countries ranged between 5 (bih in recent years) and 12 (croatia in the beginning of the period). the highest credit rating was experienced by croatia – according to all three agencies, the rating of this country in the beginning of the period was classified in the investment grade (although at the lowest level). however, croatia’s credit rating changed the most during the observed period compared to ratings of other countries – from the lowest investment grade it dropped to the highest and medium level of b grade of speculative investment (from 12 to 10 on the numeric scale). macedonia had the second highest rating score, followed by serbia, montenegro and albania. bih had the lowest credit rating among the observed countries. in 2014, moody’s put bih at the lowest level of grade b which borders to grade c – extremely speculative grade. the analysis did not show any significant changes in scores or any major oscillations. a more apparent decreasing trend of credit rating is visible only in the example of croatia. in context of macroeconomic situation, it is obvious that the countries are slowly recovering from the global crisis. absence of any significant economic growth had an impact on increase of unemployment, maintenance of trade deficit and growing foreign debt, which generally indicates a growing country risk and therefore this does not represent a business environment which would be attractive for investors. decrease in credit rating of croatia is in line with changes in basic macroeconomic indicators of this country, especially with absence of gdp growth and enormous increase in foreign debt. however, the trends of credit ratings of other countries do not sufficiently match their macroeconomic situation observed through the selected macroeconomic indicators, and we can assume that some noneconomic factors, such as political and social ones, have a more significant influence on their credit rating scores. the strongest correlation between credit rating and analysed macroeconomic indicators has been discovered in case of gdp per capita, exports-to-gdp ratio and external debt-togdp ratio – medium strong correlation of positive sign, while correlation between credit rating and other macroeconomic indicators is almost negligible. finally, we must underline that although problems of these countries are well-known to the public, they are additionally increased by their dropping credit ratings. since most of these countries do not have a sufficiently developed capital market, or they do not issue bonds on the international market, they depend on other external sources of financing. lower credit rating will mean a more difficult access to foreign capital under favourable conditions, and it will even prevent foreign loans and cause less attractiveness of the countries for foreign investors. it will be increasingly difficult to break the vicious circle of insufficient availability of financing sources and weak economic growth under such circumstances. references bhalla, b. 2006. “how corporations should weigh up country risk.” euromoney publ. issn 0014-2433, pp. 66-72. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 15 begić, j. 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fitch short description of rating category investment grade 20 aaa aaa highest credit quality, the lowest credit risk 19 aa1 aa+ very high credit quality, very low credit risk 18 aa2 aa 17 aa3 aa 16 a1 a+ upper-medium credit quality, low credit risk 15 a2 a 14 a3 a 13 baa1 bbb+ medium credit quality, moderate credit risk 12 baa2 bbb 11 baa3 bbb speculative grade 10 ba1 bb+ low medium credit quality, with speculative characteristics, substantial credit risk 9 ba2 bb 8 ba3 bb 7 b1 b+ relatively low credit quality, high credit risk 6 b2 b 5 b3 b 4 caa1 ccc+ low credit quality, very high credit risk 3 caa2 ccc 2 caa3 ccc 1 cc very low and the lowest credit quality, with prospect of non-payment of financial obligations, selective bancruptcy, bankruptcy ca c c sd d source: prepared by authors based on data published by central bank of bih http://www.cbbh.ba/print.php?id=549 legend: a – with no risk or with low risk; b – with moderate credit risk; c i d – with medium or high credit risk; symbols + and – show trend of change of credit rating (outlook); 18 economic analysis (2016, vol. 49, no. 3-4, 1-19) graph 1. correlation between credit rating and economic growth graph 2. correlation between credit rating and gdp per capita source: authors' own calculation graph 3. correlation between credit rating rating and inflation rate graph 4. correlation between credit and unemployment rate source: authors' own calculation y = -0.079x + 8.6657 r² = 0.0273 0 2 4 6 8 10 12 14 -10 -5 0 5 10 15 derived numeric value of credit rating economic growth (gdp growth) y = 0.0004x + 6.0649 r² = 0.5575 0 2 4 6 8 10 12 14 0 5000 10000 15000 20000 derived numeric value of credit rating gdp per capita y = 0.0292x + 8.4203 r² = 0.0028 0 2 4 6 8 10 12 14 -5 0 5 10 15 derived numeric value of credit rating inflation rate (cpi) y = -0.0398x + 9.3379 r² = 0.0285 0 2 4 6 8 10 12 14 0 10 20 30 40 derived numeric value of credit rating unemployment rate brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 19 graph 5. correlation between credit rating rating and savings as % of gdp graph 6. correlation between credit and external debt as % of gdp source: authors' own calculation graph 7. correlation between credit rating rating and exports as % of gdp graph 8. correlation between credit and imports as % of gdp source: authors' own calculation article history: received: 15 september, 2016 accepted: 20 september, 2016 y = 0.0617x + 7.0089 r² = 0.2658 0 2 4 6 8 10 12 14 0 20 40 60 derived numeric value of credit rating savings-to-gdp ratio y = 0.0418x + 6.2002 r² = 0.4481 0 2 4 6 8 10 12 14 0 50 100 150 derived numeric value of credit rating external debt-to-gdp ratio y = 0.1559x + 2.8334 r² = 0.3511 0 2 4 6 8 10 12 14 0 20 40 60 derived numeric value of credit rating exports-to-gdp ratio y = -0.023x + 9.8033 r² = 0.0218 0 2 4 6 8 10 12 14 0 20 40 60 80 100 derived numeric value of credit rating imports-to-gdp ratio microsoft word 2010_1_2.doc note from the editor-in-chief i am pleased to be able to present this special issue of economic analysis which is devoted to scientific conference “economic prospect in the second decade of the 21st century” (14. – 15. april 2010), organized by belgrade banking academy and institute of economic science in belgrade. furthermore, i am glad to announce that almost articles for this issue have been collected by dr jozef glova from faculty of economics, technical university in košice, slovakia whom i invited to be our guest editor and help me in selecting articles for the first issue of economic analysis in 2010. it is another step forward in strengthening cooperation between our partner institutions. at the same time, work on this issue is more closely connected us with colleagues from other faculties of economics within v4 and countries of south eastern europe who provided special contributions to our peer journal with their high quality papers. thanks to everyone for their cooperation with the hope that it will continue in the future. prof. dr mirjana radović marković editor-in-chief economic analysis microsoft word 2010_1_2.doc original scientific paper the upsurgence of clusters in the light of globalization matray myriam*, institut d’administration des entreprises iae université jean moulin lyon 3 centre de echerche magellan equipe euristik, france udc: 005.44 jel: o21 abstract – clusters, as system of companies anchored in a region, contribute and ensure the long-term world competitiveness of national production. the object of this paper is to demonstrate that globalization opens restrictions on growth potential, which can be exploited by the clusters in order to position themselves on the world markets by maximizing on the benefits of global competition. thus, clusters use the advantages of globalization (including a myriad of networks), channeling the negative effects the latter may cause (taking as an example industrial espionage which has become increasingly prevalent). clusters can therefore be a means for firms to be competitive at a time of globalization and, at the same time, be integrated in the process. portraying a policy of growth, most european countries – such as france have adopted this new industrial policy, which is being introduced in its turn in some mediterranean countries (like morocco for instance). key words: cluster, globalization, competitiveness, knowledge sharing, networks introduction globalization has released potential for growth; this process is conducive to the accumulation of skills, knowledge sharing, the intensification of the networks (via information and communication technology ict), the synergy companies... yet it puts the companies in a new competitive “playground”. in the light of this, businesses adapt themselves, and new industrial policies are put in place to maximize on the process of globalization without being caught out by the competition it may generate. the clusters development policy comes into the framework of. the challenge of these clusters is to geographically group together firms, public and private research, laboratories and training organizations engaged in a partnership approach to create synergies in order to build innovative cooperative projects recognized nationally &/or globally. the potential benefit of grouping together companies is not a new invention. marshall1 described this process as “industrial district” and used the term “industrial atmosphere” to describe the dynamism generated by cooperation and exchange of know-how within the district. since then, local productive systems (spl) have been organized following the concept of the industrial district in prato, near florence in tuscany, which constitutes the first empirical study2 on this type of industrial concentration by g. becattini3 at the end * address: roanne 42 300 (france), e-mail: myriam.matray@gmail.com 1 marshall, a. (1890), principles of economics, london: macmillan. 2 in italy this type of territorial industrial concentration was highlighted by g. becattini, usa by a.scott and france by c. courlet. economic analysis (2010, vol. 43, no. 1-2, 9-24) 10 1970s. bories-azeau and loubès4 highlight that there is a difference between the concept of local productive systems spl and clusters. spls were identified in 1997 by the ciadt (interministerial committee for regional development) as “a group of companies and institutions geographically close who work together in the same field.” the afore mentioned authors write: “unlike the centered networks, dominated by one or more large enterprise and clusters5, which are subject to a new industrial government strategy, the spls are closely linked local networks, where power is shared amongst their members and consist primarily of small and medium size enterprises smes”. they also distinguish by their branch. an spl is more oriented toward more traditional industries (textile...), unlike a cluster which specializes in industries with high added value requiring heavy investment (micro-nano technologies...). figure 1. definition of a cluster6 the purpose of this paper is to underline the paradox that the cluster is an industrial policy to maintain national competitiveness arising from the adverse effects of globalization (relocation, the race for innovation, increased competitiveness, industrial espionage...), whilst wishing to position itself to face competition in the global market. therefore the clusters adapt their development to globalization: first they take globalization to the advantage of their development, to then be integrated into the globalization to meet international competition. for these reasons, the “cluster industrial policy” is bolstered. it has been 3 becattini, g. (1992), “le district marshallien : une notion socio-économique”, in benko, g. and lipietz, a. (1992), les régions qui gagnent, paris, puf. 4 bories-azeau, i. and loubès, a. (2007), “emergence d’un acteur collectif territorial et réseau d’entreprises : l’exemple de camdib”, revue recemap, october 2007. 5 // http://www.competitivite.gouv.fr. or: // http://www.observatoiredespoles.com/ and // http://polescompet.canalblog.com/ 6 source figure 1 : carel, s. (2005), “la politique française de développement de réseaux d’entreprises localisés, technopôles, spl, pôles de compétitivité : quels enjeux pour les territoires ?”, la politique française de développement de réseaux d’entreprises localisés, septièmes rencontres de théo quant, january 2005. // http://thema.univ-fcomte.fr/theoq/pdf/2005/carel-theoquant05.pdf joint by 3 common goals: innovative projects partnership approach international renown public &/or private research training centers firms matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 11 established in europe and is developing in mediterranean countries because it is an alternative to international competition companies face daily. globalization, the strength of clusters according to michalet7 c-a, “globalization is a multidimensional phenomenon, which encompasses three main elements: the development of trade and the relocating of production and financial movements. these three elements are interdependent.” globalization releases growth potential, yet is causing positive and negative effects. increased competitiveness is particularly favorable to consumers but it can also cause the collapse of a company which fails to stand up to the adversity of competition. globalization allows to increase the panel of knowledge fostering innovation, but it can facilitate industrial espionage, fires the race for innovation and diverts traditional consumer goods in exchange for increasingly more high tech goods. globalization has no borders; it is a-territorial which may cause an issue as to identification of territory. the list of positive and negative impacts of globalization is exhaustive. in our article we will put forward the core elements of globalization in clusters. the a-territoriality of globalization and the anchor-hold of clusters paradoxically national &/or global clusters attach importance to the territory in which they are implanted; it reconciles the global and the local. this new industrial policy, which has been created to further global competitiveness, thinks “global” but acts “local”. thus, the cluster will use the benefits of globalization advantageously to the extent of the networks, by applying “trade flows”8 beyond borders, to develop itself. the agglomeration of enterprises businesses in the field of information technology stand to gain by being able to access technological networks. the advantages constituted by network outsourcing increase by the number of users. marshall defined this as non-pecuniary outsourcing which increases profit. this network outsourcing may explain a paradox: in general, information and communication technology ict allows to decentralize the relationship between producers and buyers, which should allow them to use the means of television as a more comprehensive tool of communication for instance video conferencing through webcams. yet, ironically the tendency is for clusters to concentrate in agglomeration; taking as example operators, they will tend to seek zones where the demand is strongest and these are invariably high-density areas. the implantation of clusters takes into account these “centripetal forces”9 to facilitate their integration into the territory in which they are to be located and for quicker development. in this sense, the network does not exclude the notion 7 michalet, c-a. (2003), “comptes rendus d’auditions, mondialisation: une chance pour l’environnement ?”, 12 march 2003. // http://www.senat.fr/rap/r03-233/r03-23355.html 8 term used to define an aspect of globalization by michalet, c-a. 9 reference to the ʺcentripetal forceʺ on the location of economic activity, analysis developed by krugman, p. economic analysis (2010, vol. 43, no. 1-2, 9-24) 12 of proximity. colletis10, the specialist in geographical economics, highlights the fact that the connection of networks is not automatic between the different actors if they do not know each other, as they need to be built on trust between them. there is in fact no need, indeed, to be close to innovate: the development of communities of shared practices around the free software is an illustration, but it facilitates cooperation. the identity of a cluster whereas globalization comes along with a decline of the idea of nation state, the cluster integrates into a dynamics of co-construction between the territory which it is implanted and itself. however, it is not sufficient for the cooperation of the organization of the cluster, it must be perceived as a process in the construction of an identity so that each member feels totally integrated in the project. this identity is primarily based on the construction of social links through reciprocal exchange of rules and values. this sharing of rules and values in an entrepreneurial environment is particularly reflected in the third part of the following sections of the economic intelligence which encompasses: • industrial espionage with the aim to gain pertinent strategic information, • the protection of storage of information heritage. • and the manner of expression which influences the propagation of information or rules of conduct. the latter can be referred to as “formal capital” as defined by y. bertacchini and l. oueslati, which they describe as a set of rules and common procedures (published in “entre information et processus de communication: l’intelligence territorial”, 2003. // http: // www.isdm.org). this third point highlights the role of the formal structure, actually the efficient functioning of a cluster requires: • common opportunities: the ability to work on a common project being the underlining condition to be integrated as a member of the community, • the ability of the members to cooperate determined by the capacity of the members to organize themselves, • and common rules. the adoption of common rules will allow a high level of reliability favorable to collective research, which will consequently lead to the competitiveness of the cluster. the communal territory plays its role within the pole, in the following quotation thoenig j-c. and waldman c.11 bring to light the importance of the common values passed on by the specific geographical area: “the success and the survival of a company lie in its capacity to conquer, to define and to develop a territorial and economic community. a territory is established by multiple stakeholders (customers, suppliers, employees, civic associations, circles of experts, etc.) whom the company federates around its project, by means of common values and interests, shared identities, and lasting partnerships. the reference to its territory constitutes its code of conduct”. everyone identifies with their own roots; the expression of 10 colletis, g. (2005), “entreprises et territoires : proximités et développement local”, published in: entreprises, réseaux et territoires, 22 march 2005. 11 thoenig, j-c. and waldman, c. (2005), de l’entreprise marchande à l’entreprise marquante, editions d’organisation. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 13 blaise pascal, “the truth lies on this side of the pyrenees, the wrongs beyond”, or another common expression, “to each their own truth”, both reflect this territorial culture and illustrate the relativism which is a doctrine according to which no one opinion is absolutely true, each bearing meaning solely with regards to an active point of reference. this point of reference which can be an individual, a company, a culture, an industrial branch (chemistry, textile, toys & games...), a place. these traditional forms of territorial anchoring seal the future in such way that the crisis of a company becomes the crisis of the territory, and the decline of an organization rhymes with social drama (perrat, and zimmermann, 2003) such as the decline of the textile spl in roanne. as has been noted through the notion of identity, rules, and skills specific to the cluster, its identity shapes itself by ʺthe identification with the internal environment and the differentiation with the external environmentʺ (bouchet y., bertacchini y., noël l.). thus, the adherence to the cluster can be explained by the shape of the social networks it is made up of. between a-territoriality and territoriality the cluster can be assimilated to a specific territory, a place. the place becomes a pole, a center connected with other centers. jean-louis guigou, a delegate to land settlement and to regional function datar (from 1997 till 2002), highlighted the role of the territory faced with globalization by quoting: ““if globalization imposes itself on us, territorialisation depends on us”. this quotation, which i often used, is somewhat simplistic.” but it underlines this powerful dialectic between the global and the local that some american academics illustrated through the concept of “glocalization”. if our societies have indeed considerably increased their interdependence and their flow of exchange, and if companies have become more and more international and sometimes have given the impression of nomadism, territories are nevertheless becoming more and more strategic supports of the contemporary economic development, if they know how to organize themselves.”12 in this way, the cluster integrates this notion of territory. its location is carefully chosen and is proportional to its renown. it is also assimilated to the city in which it is to be implanted. so the cluster will gradually be made reference to by the city of the pole and vice-versa. the success of the pole will also be assimilated to the success of the city in which it is implanted as the latter benefits from positive externalities. thus, the cluster channels globalization by offering it a specific space. this territorial anchorage allows it to build up a physical and moral reason in order to eventually project itself on the global markets. the accumulation of skills in globalization and the sharing of knowledge within the cluster according to the latest work of michalet13 the traffic of goods, capital and technology is more and more intra industrial and intra enterprise. that is to say outer market. the cluster integrates this idea and favors the collaborative research. 12 foreword by guigou, j-l., in loinger, g. and nemery, j-c. (1998), “recomposition et développement des territoires, enjeux économiques, processus, acteurs”, l’harmattan. 13 michalet, c-a. (2007), mondialisation, la grande rupture, la découverte. economic analysis (2010, vol. 43, no. 1-2, 9-24) 14 cluster: factor for uniting agents this bringing together of actors, companies, researchers... is made all the easier as globalization allows a stake in their network, their research (with the example of the portals of information) and even if they come from different countries. it is the materialization of “brainstorming”, making to unite a diversity of agents coming from different backgrounds with the objective to create common motor driving innovative projects through the clusters. actually, one of the first factors of success of a cluster is the joint presence on a common geographical location with public or private research centers and companies specialized in high technologies as well as local economic actors. the aim being to facilitate the exchange of information between these actors in order to set up a process of communication by appropriate networks with the intention to transferring of skills and diffusing innovation. the pole functions with a logic of collective intelligence14, catalyst of collective wealth, sharing of knowledge: essential elements to facilitate and to activate research upon which this entrepreneurial culture is founded. this collaborative research generates innovation aiming for competitiveness on a national or international level. however, it is to be emphasized that the collective intelligence is a perpetual process15 and the information passed on in this way is the conveyor of competitiveness because it represents the strategic information, which belongs to the pole in question and to none other. the challenge is to constantly try to acquire new information in the advent of scientific breakthroughs. the sharing of the knowledge in the lap of the cluster globalization and in particular ict globalization gives everyone access to the required data bases, but these latter ones will only become information once they have been treated and they will only constitute knowledge once they have been assimilated and retranscribed by way of strategic decisions for the future of the pole. amongst the advantages of a cluster is the sharing of information. zimmermann puts forward the following characteristic within firms: the greater the degree of sharing (intervention of a large number of groups in the same scheme), the better is the ʺalchemyʺ of the functioning of the pole. the creation of the network is not immediate; trust is indispensable between the members all the more as not the whole of the information can be passed on by ict. as a matter of fact, explicit knowledge can be transmitted by distance, whereas the implicit knowledge can only be conveyed face to 14 collective intelligence “is specifically to enhance the diversity of knowledge, skills and ideas which are in a community and to organize this diversity of knowledge, skills and ideas which are present in a community and to organize this diversity in a creative and productive dialogue”. quote of zara, o. (2005), “le management de l’intelligence collective: vers une nouvelle gouvernance”, m2 éditions, 2005, in knauf, a. (2006), “le rôle des acteurs dans un dispositif régional d’intelligence économique: la place de l’informédiaire en tant que médiateur et animateur du dispositif” 2006. // http://hal.inria.fr/docs/00/10/73/12/pdf/knauf_numeroie2006_corrige.pdf 15 zartarian, m., centraliens, november 1998, in carayon, b. (2003), intelligence économique, compétitivité et cohésion sociale, la documentation française, p. 111 : “economic intelligence has fundamentally three main vocations: control and protection of scientific, technological and competitive storage of information heritage detention of threats and opportunities that the company may face constitution of influence strategies for the companies. the process is continuous, permanent and heuristics, with the aim to improve the competitiveness of the company by giving it the means to know and understand its environment to illuminate its decisions.” matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 15 face. whilst ict, ie tools, should logically amplify the functioning of a virtual economic system, the reality is quite the contrary: interpersonal communication or “face to face” remains essential as is apparent in the structure of a pole. it begs the question as to how to allow the exchange of strategic information in this competitive environment? ict networks are easily seen through, “pirated”, by the same token “face to face” remains an ie tool in the same way as ict. in that way the interest in a neutral public space contributes to the process of the ie: restaurants, cafeteria... often in these places, described by i.n. fisher as “social spaces” for informal meetings with implicit exchanges. the paradox of the “ie is to be immaterial and remote and yet close to all”16. the most expressive example remains that of “the city” (london’s financial center) where bankers and traders daily exchange strategic information (economic surveillance...). this process, as long as it continues, ensures the life of london’s financial market. neutral public areas are indispensable just like trust, which has to reign between the agents. information, knowledge and inventions have to be brought together and protected; therefore trust is fundamental within the cluster (bertacchini y., bouchet y., and noël l.) 17. according to bertacchini y. and herbaux p.: “a territorial intelligence is an organizational culture based on sharing and treatment of the signals from the economic actors who are destined to supply decisive information to the leaders, at the appropriate time”. mohellebi d. and dou h. (2007) highlight that the passing on of information springs from a corporate culture, that is to say to sensitize and motivate the members. the clusters shape strategic places of exchanges of information, thanks to the neutral spaces where trust reigns and gradually establish a business atmosphere and a corporate culture resting on exchange and cooperation. these phenomena mobilize the exchange of decisive information in the clusters which constitute a “competitive advantage” (porter, 1990). the storage of information heritage of the cluster and globalization the clusters are connected to other places via ict. in fact, with globalization, not to be marginalized, the adoption of icts is fundamental. the ict, the main tools of economic intelligence ie, are defined as all the techniques applied in the treatment and the transmission of information, mainly computing, internet and telecommunications. just as the pole benefits from a national and international renown by appropriation of the ict. the clusters need broadband telecommunication networks and all other contributions of the icts in order to function and develop themselves. icts also allow potential market expansion (electronic commerce). the globalization of icts has nevertheless its limits as far as safety and ethical terms are concerned. in the event ie intervenes to protect storage of information heritage. thus, the icts are limitated as regards to the exchange of information in competitive environment. indeed, bouchet y., bertacchini y., and noël l., note that trust is a process built without experience and consequently is contingent upon the safeguard of information. furthermore, authors like ivan samson, observe that smes implanted in a 16 author’s quote 17 bouchet, y. and bertacchini, y. and noël, l. (2008), “construire la confiance dans les échanges numériques, cas dans un pôle de compétitivité”, isdm informations, savoirs, décisions & médiations, 3rd quarter 2008. economic analysis (2010, vol. 43, no. 1-2, 9-24) 16 territory which is holder of positive externalities continue to develop strategies for competition and cooperation18 amongst themselves. these lines of thought demonstrate the interest of clusters which wisely use globalization to maximize on its own development. the cluster channels the negative effects globalization may cause (absence of identity status due to the a territoriality; the skepticism of the exchange of strategic information via ict, hence the interest of face to face; the fear of espionage hence the need for the pole to restore confidence and security of information) and uses the benefits globalization provides (a myriad of networks, globalization of ict and its absence of virtual borders). gradually the new industrial policy of clusters has proven its strength in the light of globalization and plays the role of a policy for growth to gain the required competitiveness to integrate itself in the stream of globalization. the industrial policy of a cluster the objective of this policy is twofold; internal development of the territory in which it is located and external development namely: • disseminate innovation (f. perroux) in the territory in which the cluster is located, develop territorial economic activity • promote competitiveness national and worldwide renown. thus, in order to achieve the objectives of the pole what matters, according to j. savatier19, is the will for putting in place networking actors, yet this will is evolutionary, just like social networks which make up the pole. thus, according to edward s. et al (2004) “networks experience endogenous development related to the transformation of links, objectives and members [...] but also changes in the external environment.” to adapt to these changes and promote cooperation ei is fundamental as it maintains the renewal of information on a daily basis in order to have data updated through the process of spying being conducive to research. ei also maintains the notion of trust through the protection of storage of information heritage. as an extension to the first part, the emphasis will be on the cluster as a component of integration into the globalization process. the objectives of an industrial policy of clusters as illustrated in france thus, in order to assimilate these economic changes associated with globalization an industrial policy focused on the territory was established by the ciact (interministerial committee for planning and competitiveness in territories). from 2005 to 2007, 71 clusters were officially recognized as such in france, amongst which 7 were distinguished as world clusters and 10 as potential world ones. 18 bouchet, y., bertacchini, y. and noël, l. (2008), “construire la confiance dans les échanges numériques, cas dans un pôle de compétitivité”, isdm informations, savoirs, décisions & médiations, 3rd quarter 2008. 19 savatier, j. (2007), “ table-ronde d’ouverture “l’innovation et l’anticipation des mutations économiques et sociales : perspectives européenne”” in “innovation et anticipation des mutations économiques et sociales”, seminar organized by the european commission, diact and dgefp, bordeaux, 22-24 october 2007. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 17 history of the establishment of clusters; new industrial strategy of government. figure 2. history of the establishment of clusters 2002 implementation of a strategic committee by jean-pierre raffarin ciadt of 13 december 2002. 2003 establishment of an ʺindustrialʺ working group 2004 datar report – “france, an industrial power”february blanc report ʺfor an ecosystem of growthʺ march financial bill for 2005 presented by nicolas sarkozy (art. 24) ciadt of 14 september 2004 call for presentation of projects of ʺclustersʺ november 2005 closure of the call for presentation of projects 28 february 2005 completion of inquiry by technical experts of projects may 9 establishment of the group of qualified actors may 16 proposal of the interministerial working group to government end june ciadt of 12 july 2005 – official recognition of the 67 cluster projects ciadt of 14 october 2005 validation of draft contracts and field of r & d. decree of 14 october 2005 – “interministerial committee for planning and development of territories” ciadt is renamed “interministerial committee for planning and competitiveness in territories” ciact. 2007 5 july 2007, 71 clusters are officially recognized source: jacquet, n. and darmon, d. (2005), “les pôles de compétitivité. le modèle français”, documentation française, coll. etudes n°5225. criteria of quality selected for agreement of cluster f. leroy20, head of mission, member of the working group ʺclustersʺ, management of entreprises, minefi, outlines the main objectives of clusters namely: • strengthen competitiveness of the national territory, • boosting economic development, • create or maintain jobs in industry, • and attracting investment and expertise at european level and globally. in view of this, in order to be recognized as a cluster, a draft project of pole must meet the specified criteria defined in november 2004 by the government. the following four criteria are decisive: • a development strategy consistent with the economic development of the territory of the pole, • a development strategy consistent with the local dynamism and performance of the economic fabric in the light of international competition, • sufficient international recognition, both industrially &/or technologically. the projects submitted must eventually pave the way to a leading position worldwide in their specific fields. the second criterion refers to a distinction between the poles with the 20 leroy, f. (2005), “pôles de compétitivité : de l’appel à projets à la labellisation”. entreprises, réseaux et territoires, 22 march 2005. economic analysis (2010, vol. 43, no. 1-2, 9-24) 18 main focus on technological research activities and the strength of interactions between research centers and companies working on the development in a field of technology by comparison to the dominant industrial poles which cluster companies with more concretely applied r & d and consequently is closer to the immediate market. • a partnership between actors and a structured, operational management. • in actual fact, the quality and efficiency of r & d partnerships between agents (industrials, researchers, lecturers...) are the main criteria for official recognition of a cluster. • the ability to create synergies in research and development and bring new wealth with high added values. the ultimate goal is to improve the competitiveness of the french offer on international markets. in europe, the lack of competitiveness persists and is worsening specifically in view of a stronger euro. the new policy allows to draw benefits from this situation with companies benefitting from the disinflationary effect of the strong euro on the cost of raw materials in particular. europe places high value on quality, this being the only way it can face competition dominated by cost. the purpose of the clusters is to accentuate europeʹs competitiveness with the desire to achieve the goals set in 2000 by the lisbon summit21. the initiative of clusters in the mediterranean countries via the euromediterranean partnership with the example of morocco mediterranean countries having specialized in low cost production for a long time, are feeling the brunt from competition, especially in traditional sectors (e.g. textiles), from india, from asia or eastern countries. they are also faced with the dumping of international monetary exchange. the cluster policy is at its initial stages. it is in their interest to integrate this new perspective to update and show off the advantages of their know-how through globalization. the challenge is to assert themselves in gathering their expertise to give a quantitative and qualitative added value to production, a competitive advantage in order to revitalize the mediterranean economy on the international market. hence the establishment of support plans with the financial aid of the european union. since the autumn of 1995, the barcelona process, provides a framework for relations between the eu and the countries of the southern shores of the mediterranean and with the objective to work towards building a euro-mediterranean shared prosperity and progressive introduction of free trade. it is a turning point in the relations between eu and its 21 this strategy of clusters puts forward the regional appeal. it was highlighted at the lisbon summit in 2000, at which the heads of states set the objective to make europe the leading world region for its competitiveness by 2010, « the most dynamic economic knowledge and the most competitive in the world able to sustain a lasting economic growth » by investing 3% of the gross domestic product gdp. seven years on, it has severely fallen behind as none of the countries have stuck to the set objectives except finland (in particular with the development of nokia, the renowned telecommunication cluster) and sweden. the only two countries having honored their engagement to dedicate 3% of their gdp to r&d activities. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 19 mediterranean neighbors. through this process, the european commission supports specific projects to sustain development through an expansionary fiscal policy. thus, the launch of a european neighborhood policy to support the euro-mediterranean partnership, has been initiated for numerous projects amongst which the meda projects (acronym for measure adjustment). similarities of local policies with europe appear as the emergence of the policy initiative of clusters combining endogenous growth, territorial economic intelligence leading to world renown. the trend of “glocalization” is gradually becoming a widespread policy of regional development for global competitiveness. the barcelona ii conference, held in november 2005, led in particular to a stronger political partnership. thus morocco manages to do the bulk of its trade with the european union, which, on 13 october 2008, awarded it the “advanced status”, setting it halfway between partnership and membership. morocco is the first of the mediterranean partner countries to have been awarded this status which strengthens the partnership: the opportunities for cooperation with the european union are providing a broader and more liberal trade, an enhanced political dialogue, exchanges relating to foreign and internal security policy issues and allowing access to certain programs and community agencies with budgetary support as of 2013. initiation by mediterranean countries to engage partnerships since 2004, the mediterranean partners and libya except turkey who began negotiations with the european union on 3 october 2005 are also included in a new set up: the european neighborhood policy started in march 2003 for the countries not belonging to the union. the following tables highlight the positioning of the mediterranean countries compared to the eu. table 1. economic indicators of the mediterranean countries and the eu economic indicators algeria morocco tunisia european union population (2007) 33 333 216 33 757 175 10 227 157 490 426 060 rate of growth (2006) 3 % 7.3 % 5.2 % rate of growth of the 27 (2007) countries 2.9 % unemployment rate (2006) 9.7 % 1 13.9 % 8.5 % source: http://www.statistiques-mondiales.com/index.html 1 http://www.imf.org/external/np/ms/2007/fra/061107af-1.gif table 2. progression of growth rate of the mediterranean countries growth rate progression 2002 2 2005 3 2006 2007 2008 3 algeria 4.1 % 5.3 % 3 % 6.5 % 5.4 % morocco 3.2 % 1.8 % 7.3 % 3.2 % 4.9 % tunisia 1.7 % 4.2 % 5.2 % 5.8 % north african countries 5.2 % source: http://www.statistiques-mondiales.com/index.html 2 statistics of the world bank. // http://www.worldbank.org/data/countrydata/ countrydata.html 3 according to the fmi report, “les perspectives de l’économie mondiale”. economic analysis (2010, vol. 43, no. 1-2, 9-24) 20 table 3. mediterranean countries and their trade volume 2002 algeria morocco tunisia balance of payment (% of gdp) 7.7 % 2.9 % -3.5 % trade volume with the eu (mio €) 22 377 13 992 13 629 eu balance of trade (mio €) -6 201 1 402 1 539 direct foreign investment (mio usd) 1 100 428 794.8 source: statistics of the world bank http://www.worldbank.org/data/countrydata/ countrydata.html the levels of development of the partner countries are very unequal, particularly in terms of population and gdp. with the extension of the eu on 1 may 2004, the eu has integrated two out of the twelve mediterranean partners22 namely cyprus and malta. the mediterranean countries with the highest population have been statistically identified (algeria, morocco, tunisia) in order to establish a comparison with the european union. in 2002 these countries had already recorded trade with the eu with growth rates of 4.1% for algeria, 3.2% for morocco and 1.7% for tunisia respectively. now set in a growing phase, the mediterranean countries continue to increase their growth rates with 3% for algeria, 7.3% for morocco and 5.2% for tunisia in 2006; the drops being mainly due to drought and rising oil prices. thus the north african countries have an estimated growth rate of 5.2% for 2008 while the 27 european union countries stagnated with a growth rate of 2.9%. the euromediterranean partnership is of equal importance to each. it allows the eu to expand its markets and formally establish constructive partnerships, as in the field of textile following the dismantling of multi-fiber agreement mfa in 2005. as for the mediterranean countries the barcelona process allows to uphold past relations with the eu, to position themselves as partners with the eu in the face of competition from new entrants from eastern countries into the eu, which increasingly monopolize the eu budget, and can to acquire new markets by teaming up with the eu as united front facing up to competition from emerging countries. this partnership now englobes thirty-seven countries of which twenty-seven being eu member countries and ten being mediterranean partner countries. the cluster policy: the emergence of a new strategy in mediterranean countries through the meda program… in order to further optimize the euro-mediterranean partnership, the agreement provides tools for financial cooperation to support the economic move within the mediterranean partner countries. it revolves around various support plans such as the meda projects, projects from the femip (facility for euro-mediterranean investment and partnership)... the interest in this research focuses on the meda projects in morocco. the meda program, agreed by the european council of cannes in june 1995, is one of financial instruments for the implementation of the euro-mediterranean partnership. through this program, the 22 the twelve mediterranean partners are algeria, cyprus, egypt, israel, jordan, lebanon, malta, morocco, syria, tunisia, and turkey. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 21 european union provides financial and technical assistance to mediterranean partners to enable them to achieve the objectives set out in the barcelona declaration bearing three components: political, economic and social. the main focus being on the economic element which has as its objective to progressively establish a free trade. the economic component has facilitated financial cooperation through various support projects such as the meda program and loans from the european investment bank. thus, a global budget is granted by project not by country. it is the european commission which, in collaboration with each individual mediterranean partner, is developing programs to aid the economic transition, funded under meda. these programs can take different forms including “private sector development support, economic transition support, sustainable socio-economic development support and structural adjustment programs support”23. the beneficiaries of funding by the meda program are the states, the regions, the local authorities, government agencies and non-governmental organizations within eu countries and mediterranean partner countries. the role of meda program in morocco the meda program aims to adapt to the new dynamics of competitiveness through sustainable development, job creation and wealth. it allowed the establishment of support project units (uap), meda project management entities. in morocco, they focus in particular on human resources development24 (education, training), of which three specifically selected fields of activity drive its economy: tourism, textiles, the new information technologies and communication (ntic). these projects emphasize (vocational training, skills-based approach) and develop these fields in order to meet the needs of social and economic development in view of international expansion. what is the relation with the cluster policy? the importance of the role of training. this method involves the process of economic intelligence in companies in a given geographical territory. the capital of human training &/or else the presence of appropriate infrastructures are the first phase of emergence to initiate a cluster policy. the governance aspect may also intervene in such instances as uneven geographical location of information and communication technologies (icts) in a territory and a country (importance of the role of clusters regarding the distribution of innovation and transmission of knowledge). in this context y. bertacchini stresses the utter importance of ict territorial integration with an initiative of information and communication “at risk of being marginalized nationally and internationally” 25. as a result governance can cover all or part of the draft economic development, hence the importance of integrating the functioning of a cluster in mediterranean countries. expected results for 2010 results forecast for 2010 would be: 23 “union européenne et méditerranée”, la documentation française. // http://www.ladocumentationfrancaise.fr/dossiers/europe-mediterranee/index.shtml 24 some projects have also focused on the development of infrastructures, trunk roads, and other fields of activity. 25 bertacchini, y. and oueslati, l. (2003), “entre information et processus de communication: l’intelligence territoriale”. // http://www.isdm.org economic analysis (2010, vol. 43, no. 1-2, 9-24) 22 • “in tourism, training of 72 000 young people, including 18 000 through apprenticeships and upgrading of human resources; • in textile, training of 75 000 young people, including 30 000 through apprenticeships, the achievement of a basic literacy skills program for the benefit of 50 000 workers and upgrading of human resources; • in ict, training of 63 000 young people and upgrading of human resources”26 the interest to define these objectives is to emphasize the achievement of training in these three driving fields. these support plans, including the meda program, constitute the beginnings of an industrial policy of clusters for the mediterranean countries. according to michalet ca., globalization is not yet a global phenomenon. only some countries are concerned: in addition to the countries of the triad eu, north america and japan there are fifteen emerging economies: china, india, the newly industrialized countries (the dragons) and the asian tigers in asia, mexico, chile and brazil in latin america, poland, hungary, slovenia and the czech republic in central europe. thus, countries on the sidelines of globalization seek to attract foreign investment (one of the four objectives of the cluster policy) because they fear marginalization. in this way the mediterranean countries wishing to become more industrialized, to increase their export in order to better position themselves vis-à-vis competition and therefore to be able to be integrated in the flow of globalization. conclusion the cluster is defined as “a system of enterprises rooted in a region where interactivity helps to secure long-term global competitiveness of national production” 27; this quotation reflects the fact that the pole is a territorial representation of globalization. so, it was demonstrated in the first part that the cluster, in order to develop, incorporates in its functioning that which globalization brings with it. furthermore, this policy was created to be consistent with market expectations, which are ever more demanding, and its everincreasing race for innovation. consequently this policy is reflected in relation to these new conditions, which are becoming relentlessly more difficult to fulfil (importance of innovation, importance of investment in research and training, particularly in higher education, complexity of innovative processes...). this policy proposes development prospects. with this logic, competitiveness clusters gradually become a model of industrial performance. in effect, changing technology and accelerating markets have brought about the change. what is now required is to combine expertise in the diverse fields of technology with a speedy and well-timed reactivity on the market of innovations. these two major issues make the process of “collaborative innovation” unavoidable. accordingly the clusters have permitted to put in place those conditions imposed by globalization and, paradoxically, in order to remain or to be integrated in the globalization process, to allow the country in which they are implanted optimum competitiveness. the cluster is primarily a policy of growth hence the interest to continue to support this policy in european countries and to introduce it in mediterranean countries so that everyone can take a stand in the light of 26 meda website of morocco. // http://www.meda2-fp.ma/ 27 samson, i. (2008) under the direction of., l’économie contemporaine en leçons, dalloz. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 23 competition and confirms their position in global markets. the dominant overall configuration of the financial profitability is fragile, the industrial policy of clusters might therefore become the basis for a “new governance”, to correct, to channel the excesses of globalization. as the term “governance” highlights, it is also important to clarify the role of institutions for the implementation of poles. the author colletis mentions the need for institutional agents for the creation and sustainability of the pole, whether it be in infrastructure, equipment, funding research programs, partnerships with the region, department, local organization or chambers of trade and industry. european funds for the establishment of clusters in france or government aid through projects such as meda programs in mediterranean countries show how imperative involvement of institutional bodies is for the credibility of a project, for its launch and for its sustainability over time. references angelier, j-p. 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(2005), le management de l’intelligence collective : vers une nouvelle gouvernance, m2 éditions. received: 30 march 2009 article history: accepted: 19 october 2009 ea_2016_3-4 udc: 005:336 658.115:656.2(497.11)"2014/2015" jel: g30, g39 cobiss.sr-id: 228332556 scientific review problems of financial management in the public sector anđelić slavica1, gajić aleksandar2, ilić djordje3 high business school "prof. dr radomir bojković "kruševac, srbija abstract – the paper discusses the financial management in the enterprise serbian railways. the construction of the first railroads in our country began back in the mid of the last century, when a large part of our territory ruled by the austro-hungarian monarchy and the ottoman empire. the development of railway transport in the region saw the expansion of the late nineteenth and early twentieth century, twisting in the territory of the then country: serbia, montenegro, austriahungary and turkey. today serbian railways railway network is 4.347km, 1.387km of which electrified (32%). the main activity of eating the transport of passengers and goods, hauling the trains and maintenance of traction units, trains and rolling stock, track maintenance and control over them, control over other lines and station structures and installations, maintenance and construction of equipment and installations. the significance of this research is the promotion of modern methods of financial management and for pointing out the importance of the same for efficient business operations. using modern methods of financial management it is possible to identify and monitor the needs for financial resources and their sources. it is de facto one of the central category of financial management. the main objective of this study is to monitor and analyze the financial resources of the company "serbian railways", that they are optimal from the viewpoint of the situation and trends, and to the short and long term. financial management includes compliance tools and resources in the process of business where revenues are greater than expenses. it is therefore important that in addition to the scope, structure and resources to be covered by the method of determining the necessary financial resources. key words: finance, management, financial ratios, results, financial plan 1 slavica anđelic, high business school "prof. dr radomir bojković "krusevac, srbija, e-mail: slavica.andjelic@indmanager.edu.rs 2 aleksandar gajic, high business school "prof. dr radomir bojković "krusevac, srbija, e-mail: alaksandar.gajic@indmanager.edu.rs 3 djordje ilic, high business school "prof. dr radomir bojković "krusevac, srbija, e-mail: djordje.ilic@indmanager.edu.rs anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 49 introduction modern approach to financial management emphasizes the continuous earning ability of the company, ie the ability to make a profit through the implementation of strategic objectives (growth, development and market share). modern methods of financial management assume that the assessment of the financial situation must be based on the correlation of the balance sheet and income statement. the necessity of using both reports originating from their character as balance sheet and income statement are connected parts of one whole. these changes in the economy have contributed to the increasing responsibilities of financial managers, which includes: • determining the amount of funds that should be engaged, depending on the size of the company and growth rates, • raise funds on favorable terms and determining duties, • allocation of funds in the form of determination means, • management of working capital. (ljutic, 1995, pp. 308). the responsibility of managers for the contemporary theory is focused on internal and external stakeholders of enterprises (shareholders, creditors, state, employees, suppliers and customers). these responsibilities of managers imposed the application of modern scientific methods in making financial decisions, which contributed to the development of the theory of financial management as a scientific discipline. businesses initially used traditional methods in making financial decisions. however, the modern theory of financial management contains a systematic approach to making decisions about the optimal use of financial resources, aimed at achieving the goals of the company. it can be said that modern scientific conceptions emphasize the need to adapt ways of managing the implementation of the strategic and financial objectives of the company in accordance with the principles of productivity, profitability and competitiveness. this means that modern methods of financial management attach importance to the competitive position and competitive advantage of companies in the market. competitiveness indicators rooted in the different levels of customer satisfaction. inclusion of customer satisfaction is expanding the number of indicators of operating performance in the modern financial management. there are basically the following six performance indicators, strategic financial management companies: • the performance indicators in relation to competition, such as market share, participation in a particular segment of consumers, growth, etc., • the financial performance indicators, such as profitability, liquidity, capital structure, etc., • the quality of services, such as availability, reliability, acceptability by consumers, accessibility, etc., • the flexibility of the "package deal", such as flexibility of scale, flexibility in delivery of goods, flexibility in size range, price, etc., • the usefulness of the assets, such as productivity and efficiency and • the effects of the process of innovation in all areas of activity of the company. (lovreta, 2014, pp. 324). 50 economic analysis (2016, vol. 49, no. 3-4, 48-68) the exposed elements of business success boil down to competitive and financial indicators. between these elements there is a high degree of interdependence. financial indicators to measure the success factors that determine the success and competitive position of companies in the market. their interdependence is coming to the fore in the harmonization of short-term financial goals related to "yield" and long-term goals related to the competitive position of the company. in the "package deals" there is a link between productivity and efficient use of resources and quality of services. modern management is expanding the number of indicators of effectiveness and efficiency. special attention was given to indicators of productivity and profitability, which play a central role in the integrated management of the company. modern approach to financial operations, thus actualize the need for integrated management of productivity and profitability of the company. (lovreta, 2014, pp. 325). results financial management in the case of company "serbian railways" the scope of activities for 2014.: company "serbian railways" jsc in 2014. realized around 3.7 billion dinars, which is about 3.5% less than in the year 2013. and the gross income from the transport conveyor of about 10.9 billion dinars, which is about 2.8% more than in the year 2013. passenger transport: the suspension of traffic on many lines caused by snow drifts in february and floods in may, resulted in a significant reduction in the number of passengers carried. a large number of canceled trains caused the reduction of passengers in international traffic, while in beovoz fall transported passengers caused by the transition of some trains on the application of tariffs from local traffic, which is why passengers are recorded as travelers from local traffic. only in the domestic traffic recorded the carriage of passengers at last year's level. transport of goods: difficult traffic conditions on certain lines due to severe flooding in may, significantly affected the functioning of the transport of goods. in such conditions, increased transport of goods in domestic traffic, import and export turnover was mainly due to increased transport fiat cars and spare parts, then gravel and other aggregates, increasing the transport of oil and oil products, as well as the increase in production in "smederevo steelworks" etc. financial indicators for 2014.: according to balance sheet positions for 2014.., basic indicators of liquidity, or short-term financial balance are unsatisfactory, and amount to 0.21 (general liquidity ratio), followed by 0.14 (current ratio) and 0 03 (current liquidity ratio). "serbian railways" jsc in 2014.. realized a total income in the amount of about 26.3 billion. dinars (of which around 10.9 billion related to net transportation revenue with income from the use of foreign cars), total expenditures in the amount of about 34.5 billion and a net loss of about 8.1 billion. at the height of the most affected by the loss of accrual of expenses (amortization in the amount of about 5.7 billion and exchange rate differences in the amount of about 2.3, billion). in 2014. on account of the company, after all receipts and payments of cash, remains an amount of 1,223 million dinars, which is about 462 million dinars more than at the end of anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 51 2013. (mostly balance in the account referred to eurofima investment funds that are spent in 2014.). the scope of activities for the year 2015.: directorate for infrastructure: network railways of the republic of serbia is more than a century, and over 55% of all stripes have been built in the 19th century. regulation on categorization of railways made the categorization of the main, regional, local and handling lines. permanent lack of funds for maintenance caused a drastic reduction in the length of repaired lines, as well as the lack of capacity on the revitalization of electrical lines and increasing the difference between the actual average and the projected average speed. given the level of revenue in 2015. it is possible to provide for these purposes around 1,297 million. these funds are sufficient, especially for the already initiated procurement procedures, as well as for the rehabilitation of the flood-damaged sections of lines and plants for a minimum volume of new works. organization of transport timetable 2014/2015: according to the planned timetable for the 2014/2015., in traffic every day should be 500 trains to transport passengers. bearing in mind that the design of the railway timetable begins a year before the entry into force, due to the material support of rolling stock for its implementation, are set timetable will be adjusted depending on the availability of railway trains. transport capacity: in 2015. expressed the high rate of immobilization of certain series of towed vehicles (diesel locomotives and carriages dezelmotorni), as well as passenger cars. for 2015. average was 158 correct towing vehicles, 52 passenger and 4,000 freight cars. based on the average number of correct towing vehicles by series, asserts that for driving the execution of the order 2014/2015. lacking five electric locomotives, two electric trains, one diesel locomotives, while the towed trains lacked 20 passenger cars. according to estimates by the directorate for transport, the necessary funds to maintain capacity in 2015. amounted to 4.8 billion dinars. in assessing the funds needed have been taken into account the technical condition and capacity deadline for implementation of repair of vehicles, in accordance with the applicable rules on maintaining of railway vehicles. (rules 241 "sl. glasnik rs" no. 2/84, 2/88, 5/88, 7/88, 9/88 and 13/98) necessary financial resources for services amounted to about 3.33 billion pounds, with the following the structure: • to maintain traction vehicles 1,507 million dinars • to maintain the trucks 1,200 million dinars • to maintain passenger cars to 300 million dinars • for cleaning and car washing 136 million dinars • to maintain the other assets of 110 million dinars • to maintain warehouses and buildings 109 million dinars in addition, the necessary funds for the purchase of materials, spare parts and repair amount to 1.44 billion dinars. 52 economic analysis (2016, vol. 49, no. 3-4, 48-68) given the level of revenue in 2015, it is possible to provide for these purposes around 1.333 million. most of the funds spent on the already started procedures for procurement of services and spare parts for maintenance. volume of transportation: after the economic downturn caused by large floods in the future he felt a gradual economic recovery, so that the serbian railways ad in 2015. with an increase in the workload of approximately 15.6%. for 2015. achieved the transport of about 18.8 million passengers, compared to the execution in 2014. an increase of 8.7%. no bg trains for 2015. achieved the transport of about 7.9 million passengers, an increase of 23.6% of the number of passengers carried in 2014. the increase in transport volume is based, inter alia, the effects of the importation into service of new emus, as well as increased passenger transport operations to restore traffic on the belgrade-vrbnica-border. in 2015. increase revenue by about 22.1%. within the revenues from passenger transportation achieved revenues from bg train in the amount of 361 million dinars. these revenues are not correlated with the number of passengers carried, but depend on the actual driving kilometers. in 2015. to complete the delivery of all emus train "stadler" from the ebrd loan funds iii and the beginning of delivery dizelmotornih trains from the project loan of the government of the russian federation, while the funds secured from eurofima, carry out activities for the supply of used passenger cars, which allows successive replacement of old and nonperforming capacity for the transportation of passengers and contribute to significant improvement of quantitative and qualitative indicators, and thus income, the passenger rail transport and allows for more competitive performance on the transport market. in 2015. achieved the transport of about 12.5 million tons of cargo, which is in relation to the assessment of the implementation of transport in 2014, year, 14.7% more. the increase in transport volume is based on the recovery of economic activity after the may floods and the establishment of traffic on the damaged lines, the expected new transport services zelezarz smederevo, rtb bor, then, cosco transport trains from the port of piraeus to european destinations, as well as increased transport of stone, grain, concrete sleepers, iron and others. in order to reduce costs, take over the activities on the development of direct cooperation with other railway companies in the region, to the international commercial contracts for the transport of goods to avoid intermediaries in freight transport and thus reduce transport costs and increase the competitiveness of the railways, and thus the economy, etc. started investments in rolling stock for the transport of goods in the form of procurement of new multi-system electric locomotives from the ebrd loan funds iv in the coming years should contribute to increasing the quality and quantity of work in cargo traffic. estimated financial highlights for 2015 positions in the balance sheet are planned starting from the estimated states and the sources of funds at the end of 2014. as well as the investment plan. implementation of the investment plan or cip, depends, among other things, the level and dynamics of providing anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 53 necessary funds for financing and indirect variable costs, as well as the participation, for the realization of these projects. expected characteristics of the planned balance sheet as at 2015.years are: • the high share of fixed assets, primarily property, plant and equipment of 97.3%, conditional on the realization of investments, • there is still high share of stock from 28.5% in the total assets of the rotation, • the degree of self-financing, as seen through the share capital in liabilities, decreased from 72.5% to 65.6% due to the cumulative loss, • of the total liabilities, long-term liabilities relating to 45.7% maturities of the principal debt on long-term obligations and the creation of short-term liabilities arising from the repayment of part of credit commitments from the state budget, leading to an increase in short-term liabilities and the difficulty of improving the liquidity of the underlying indicators: table 3.1. liquidity ratio 31.12.2014. 31.12.2015. 1. the general liquidity ratio (the ratio of turns assets and current liabilities) 0.21 0.21 2. current ratio (ratio of working assets and current liabilities excluding inventories) 0.14 0.15 3. the ratio of current liquidity (coverage short-term cash commitments) 003 0.04 in the income statement for 2015. are planned for the following positions: within operating income, net transportation revenues (including revenues from the use of kola) refers to 12.8 billion dinars. although the planned increase in net transport revenues of over 17%, the projected income at the level estimated in 2014. due to a significant decrease in revenues from the budget, primarily, regular subsidies, as well as dedicated revenue of the ministry of finance to finance the cost of maintenance and modernization of railway vehicles, or on arrival by management largely can not be influenced. it is planned that its own operating income per unit of work (rtkm) in 2015. stay at the level of 2014., to a nominal operating expenses fell by over 11% (from 7.9 on the 7.0 pounds). table 3.2. structure of total income, expenses and loss (in millions of dinars) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 i total revenues 26.740 26.324 25.542 97,0 1. business income 24.954 24.331 24.373 100,2 1.1 revenues from sales 10.788 11.396 13.272 116,5 1.2 other operating income 14.166 12.935 11.101 85,8 2. financial income 582 486 447 91,9 3. other income 1.040 1.134 591 52,1 4. revenues from value 164 373 132 35,3 54 economic analysis (2016, vol. 49, no. 3-4, 48-68) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 adjustments of assets ii total expenditures 34.438 34.453 31.512 91,5 1. business expenses 29.199 28.816 29.457 102,2 2. financial expenses 1.966 3.594 1.157 32,2 3. other expenses 2.461 1.771 702 39,7 4. expenses from value adjustments of assets 608 41 55 132,5 5. net loss from discontinued operations 25 230 141 61,4 deferred tax expense 179 iii net profit / loss -7.698 -8.129 -5.970 73,4 the structure of operating revenues illustrates the following display: table 3.3. operating income (in millions of dinars) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 i business income 24.054 24.331 24.373 100,2 1. own income 11.215 11.813 13.679 115,8 1.1 transportation revenues 10.497 10.886 12.752 117,1 passenger transportation 1.823 1.726 2.049 118,7 transport of goods 8.674 9.160 10.703 116,8 2. income from commercialization 453 452 595 131,7 2.1. other income 265 475 332 70,0 2.2. subsidies 13.739 12.518 10.694 85,4 2.3. ordinary subsidies 13.065 12.221 10.376 84,9 2.4. the funds from the development fund 581 103 2.5. funding for projects 61 318 519,1 4. funds for construction 41 5. other 93 93 the structure of operating expenses illustrates the following display: table 3.4. structure of operating expenses (in millions of dinars) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 i business expenses 29.199 28.816 29.457 102,2 1. cost of materials 4.135 4.327 4.441 102,6 1.1. spare parts 897 869 1.108 127,6 1.2. energy costs 3.022 3.179 3.001 94,4 anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 55 serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 1.3. protective clothing and footwear 61 140 180 128,4 1.4. the cost of oil and lubricants 61 58 60 104,4 1.5. other materials 94 81 92 112,6 2. wages 15.442 15.177 14.718 97,0 2.1. gross earnings 11.845 11.534 10.674 92,5 2.2. contributions 2.275 2.215 2.040 92,1 2.3. other fees 1.322 1.428 2.004 140,4 2.4. business travel costs 486 354 286 80,7 the costs of transport workers 597 582 582 100,0 impairment earnings 153 927 605,2 other fees 239 338 208 61,7 3. amortization 5.377 5.726 5.687 99,3 4. other operating costs 4.290 3.613 4.697 127,9 4.1. production services 2.641 2.289 3.468 151,5 4.1.1. maintenance services 946 566 1.833 323,8 from its own resources 467 419 1.521 362,8 4.1.2. costs of common use 788 742 747 100,6 4.1.3. research costs 12 111 106 95,8 4.1.4. communal services 321 223 232 104,2 4.1.5. fire protection 190 219 201 92,1 4.1.6. other production services 384 429 348 81,3 4.2. immaterial costs 1.650 1.384 1.229 88,8 4.2.1. non-production services 525 531 435 81,9 4.2.2 representation 14 15 6 40,0 4.2.3 insurance 102 96 94 98,6 4.2.4. payments 348 289 251 86,8 4.2.5. membership fee 37 47 49 106,3 4.2.6. tax expenses 545 317 305 96,2 4.2.7. other expense 79 89 88 98,9 4.2.7.1. fees 51 63 69 110,0 4.2.7.2. professional literature 11 12 13 110,0 4.2.7.3. other 18 15 6 42,2 5. revenues 46 86 86 100 in the context of the position 4.1.3. column 5 shows the costs of which are financed from earmarked funds of the ministry of construction, transport and infrastructure in the amount of about 5.8 million for the cost of services for the development of project documentation on relocation of capacities in the area of the railway station in belgrade, as well as funds for the development of spatial plan special purpose infrastructure corridor railway belgrade-stara pazova-novi sad-subotica-hungarian border, with two stripe track. serbian railways are already in the year 2013. took over and continued continue to implement actions to reduce costs, especially predominantly fixed expenses: cost of compensation (per diem), costs of production services, insurance, payments, taxes, costs, etc. 56 economic analysis (2016, vol. 49, no. 3-4, 48-68) plan profit / loss for 2015: the law on budget of the republic of serbia for 2015., subsidies for "serbian railways" jsc was reduced by about 2 billion dinars, which will neutralize the effects of the planned growth in transportation revenue and internal undertaken austerity measures. how to be to alleviate the shortage of funds for current operations in 2015. in terms of the cumulative increase in prices of production inputs railway services, numerous operating expenses in the program for 2015. the maximum planned restrictive. the consequences of the natural disaster in may 2014.., which caused major damage to the building and electrical engineering infrastructure of railways, will be continuously transmitted and in 2015. the final training for all parts of lines for railway traffic. also, the effects caused by the floods to infrastructure capacity will also be financed in 2015. exclusively from its own funds. company, which is one of the main reasons for the absence of the possibilities of providing adequate resources for the work of the new procurement of goods, services and works for the maintenance of railway capacities. the company will in 2015. to deal with the loss, but the loss will be generated primarily as accounting depreciation expense category. coverage of loss is possible after resolving the causes of unprofitable operations, of which the most important are: • the lack of compensation for ojp funding, • high level of transportation revenue, due, still present effects of the global economic crisis, as well as the consequences caused natural disasters (floods) • low level of resources to cover infrastructure costs (subsidy can cover 62% of the total expenditure of the directorate of infrastructure). cash flow statement: in 2015., as part of cash flows from operating activities is planned inflow collected transport and other operating income, plus prepayments received subsidies from the budget of the republic of serbia and other inflows. from operating activities are planned payments to suppliers, payments to employees, outflows from other public revenues, etc. in the area of investment is planned for the negative balance (net outflow). financing the investment will be carried out to the extent that funds are secured. in the area of financing planned inflows and outflows from financing activities. given that the net change in short-term and long-term loans (ie the amount of inflow of long-term and short-term loans, net of repayment of these loans) is positive, the amount is shown as part of the cash inflows from financing activities. subsidies: the most significant sources of funding current operations as its own operating revenues, which account for about 56% of the total projected operating revenues and subsidies from the state budget. the law on budget of republic of serbia for 2015. defined the budgetary funds or subsidies, "serbian railways" jsc in the amount of 10.4 billion dinars. until the establishment of a new way of funding infrastructure, and the full establishment of financing obligations of public transport, distribution and use of budget funds will be made pursuant to a special act of the government. starting from the year 2013. significantly reduced the amount of current subsidies, as well as a percentage share of gdp, so that the company in anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 57 all the difficult economic situation because despite the growth of transportation revenues is not able to replace the reduction of subsidies and to finance the costs necessary amount. in addition to subsidies for current operations, the budget of the republic of serbia are provided funds amounting to 1,419 million dinars earmarked for the participation of "serbian railways" ad in the project loan agreement, which serbia received from the government of the russian federation, which will be used to deliver the goods, performance of works and provision of services in the field of railways, in accordance with the law on ratification of the agreement between the government of the republic of serbia and the government of the russian federation on the approval of the national export credit to the government of the republic of serbia. revenues of railways exercise alone are sufficient to cover only one third of operating expenses. in the last five years of income without subsidies amount to about 10-11 billion, while operating expenses about 30 billion dinars. were it not for government subsidies amounting to about 14 billion pounds per year, net loss from operations amounted to about 20 billion. (rs, fiscal council, pp. 44) direct annual budget expenditures (subsidies and guaranteed loans paid) for railways amount to as much as 18 billion pounds. railways are the largest recipient of subsidies from the state budget, with about 13 billion pounds a year. the amount of subsidy is reaching a higher value (15.5 billion in 2011) and gradually reduced in the period 2012-2014. the nominal decline in subsidies to the gdp growth led to a decline in the relative importance of subsidies (in gdp), but it should be borne in mind that the goods resulting from the reduction of subsidies to budgetary problems and not from the restructuring and savings in salaries in the railways. in other words, there is a risk that the reduction of subsidies resulting in redirection of other expenditure on wages, less expenditure on maintenance and the like, which would further aggravate the situation in the railway transport. subsidies from the budget complement operating income, are used to cover part of the operating expenses (less than the annual wage bill) and can not be used for maintenance or new investment. in addition to subsidies, the state pays activated guaranteed loans instead railways. this amount is in the period 2014-2016 is projected at more than 5 billion pounds per year (about 6 billion of total credit commitments in 2014). (rs, fiscal council, p p. 44) earnings and employment policy total staff costs in 2015. amounted to 14.7 billion dinars, which is 3% less than the costs of employees in 2014.. and the same account for about 50% of operating expenses. as part of the cost of employees, the largest amount refers to the weight of earnings amounting to 12.7 billion dinars, which is 7.5 less than in 2014. within other employee benefits expenses and other personnel expenses, which amount to about 2 billion pounds, is the planned amount of funds to be paid into the budget of the republic of serbia on the basis of the law on the regulation of temporary base for the calculation and payment of salaries, wages and other regular income in public funds. total planned mass for earnings with contributions paid by the employer amounts to 12,714 million dinars from the stated amount of contributions paid by employers is planned to be directed to 2.040 million, while the remaining 10.674 million dinars includes the costs of 58 economic analysis (2016, vol. 49, no. 3-4, 48-68) gross earnings (10,650 million dinars) and cost per the basis of conduct or use of benefits, amounting to about 23.8 million dinars, around 3.8 million dinars for subsidies that have the character earnings (net amount, including taxes and contributions paid by employee) and 20 million dinars based on privileged driving employees and goods on international agreements (taxes and contributions paid by employee). operating revenues are not sufficient to cover the wages, since earnings amount to about 15 billion pounds annually. all sizes listed are fairly stable in the last five years, which shows that there is no change and progress in the business model and results. and in the program of operations for 2014 is estimated to be basically unchanged dynamics and structure of revenues, expenses and net results. in doing so, such as a stable revenue categories (own and subsidies), so they are stable and categories of expenditure salary costs, so make up between 15 and 16 billion dinars during the whole period. number of employees at the end of 2013 is approximately 18,000 and the five-year period was reduced by about 1,500 people (the largest decrease in the number of employees in 2010; in 2014 the reduction applies only to the number of employees who retire). (rs, fiscal council, p p. 44) the dynamics of employment, "serbian railways" jsc have extremely unfavorable structure of employees, dominated by old, with insufficient and outdated skills, with which they are unable to accept and implement the effects of modernization of railway capacities on the basis of current investment projects and market orientation that has to be built through restructuring "serbian railways" jsc employees have a need for specialized professions of all kinds, especially engineering, and certainly for the young and modern educated people. the reception staff in the "serbian railways" ad will be aligned with the arrangement of the "serbian railways" ad permanently reduced to 2018.god. the planned structure of employees: on 31.12.2014.god. structure of employees in the "serbian railways' ad shows the following characteristics: vice employees with secondary education (42.7%), while employees with higher education relations 10.2; the average age of employees is approximately 47.7 years and the largest number of employees by length of 3135 years, about 23%. wages paid in 2014 and the plan of payment of wages for 2015: funds for salaries have been planned in accordance with the law on the regulation of temporary base for the calculation and payment of salaries, wages or other income and other in public funds. mass of earnings for all employees (management and other employees) is planned starting from the average salary paid to this category of employees in november 2014.., estimated the number of employees at the end of 2014.. and in accordance with the planned schedule of employment. planned mass of salaries can be adjusted in accordance with the principles of fiscal management and policies of the government. the monthly value of food during the work and value of one twelfth of recourse for annual leave are contained in the value of a working hour. "serbian railways 2" ad is paid 13 salaries. planned charges union members: the amount of compensation for the chairman and members of the assembly of "serbian railways" jsc, which are paid monthly, determined on the basis of resolution of the government 05 no. 120-4780 / 2008 of 6.11.2008. in the amount of a single net average salary in the republic paid in october 2014., plus projected inflation anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 59 of 4.2%; compensation for the work of the president of the assembly has increased by 50 percent. assembly of the "serbian railways" jsc has 15 members. investments as a consequence of these results, the total investment is financed from the loan. country or issuing guarantees for borrowing railways or directly debited to the needs of railways. railways have received loans from the development fund. the state guaranteed the loans granted railways is about 300 million euros, while the approved (not revoked) a total of about 750 million euros. setting priorities for investment (and debt) stems from the fact that the budget will continue to finance these expenditures. (rs, fiscal council, pp. 44) in 2015. investment projects were funded primarily from loans and other arrangements of the international financial institutions. capital projects that were started in the past and whose financing will be continued in 2015. as well as new capital project of reconstruction and modernization of the railway line niš-dimitrovgrad-jredita phase i of the czech export bank, which has provided a guarantee of the republic of serbia, presented are attached to point 7.1., and include the following projects: 1. railway rehabilitation project ii a loan from the european investment bank (eib iv) in the amount of 80 million euros. the project includes three components, namely the reconstruction and modernization of batajnica-golubinci railroad belgrade-sid-state border, section gilje-cuprija-paracin railroad belgrade-nis and cele kula-section stanicenje of nisdimitrovgrad-bulgarian border (the last component will be financed from the credit of the czech export bank, with the approval of the eib. the modernization of batajnica-golubinci is completed. in 2015., on the section giljecuprija-paracin, expected completion of all contracted to build a new bridge across the velika morava river in the length of 322,5m, construction of new double-track line in the length of 10,2km and procurement of equipment and works the reconstruction and modernization of electrical installations (the work had begun 06.11.2013.god., and the deadline for completion of all work on completing the new electronic signaling and safety equipment for cuprija station is 730 days, ie november 2015.). after reviewing all the necessary papers, physical and financial implementation of reconstruction and modernization of the section ginje-cuprija-paracin, propose funding for new components from the remaining part of the loan and in cooperation with the bank take appropriate decisions 2. project rolling stock electromotive multipart sets a loan from the european bank for reconstruction and development (ebrd iii) in the amount of 100 million euros. the project includes the purchase of 30 electric multiple furniture. in 2014.. realized the delivery of trains 5 of the agreed procurement of 21 new emus with swiss company "stadler bussnang ag". in 2015. planned delivery of the remaining trains and completion of the project. 3. project corridor h a loan from the european bank for reconstruction and development (ebrd iv) in the amount of 100 million euros. the project includes three components: 1) the rehabilitation of railway lines along corridor h, including the purchase of machinery for track maintenance and 2) the purchase of approximately 15 multi-system 60 economic analysis (2016, vol. 49, no. 3-4, 48-68) electric locomotives. in 2015., as part of the rehabilitation component lines along corridor h, involved the delivery of new material for the permanent rehabilitation of six sections along the corridor h, whose works will be financed from the russian loan, and delivery of new machinery for the maintenance of the building infrastructure. 4. project rehabilitation of railway line a loan from the european bank for reconstruction and development (ebrd v) in the amount of 95 million euros. the project includes the reconstruction of sections of the belgrade-rakovica-resnik and rehabilitation sections along corridor h. at the beginning of the project "belgrade on water" 2014., there was a necessity of correction of the first component, or change the length of the section to be implemented under this component. ebrd officially informed that due to define new priorities of the republic of serbia in connection with the belgrade railway junction, railways rehabilitation project to be amended for the component beograd-rakovica-resnik (will be done the overhaul on a smaller scale than originally envisaged). serbian railways board of directors has made in december of 2013. the decision on the redefinition of the components to be financed from the loan in the ebrd, which is a bank and a list notified redefined komponemti submitted to the bank for information 2013. in accordance with the above, reference were developed for all planned components and the drafting of project documentation. after devastating floods, which occurred in late may 2014. the government of the republic of serbia has conducted a needs assessment in training and reconstruction of infrastructure affected and in september submitted to the ebrd to consider partial reallocation of the loans, which became effective and which implementation at the moment has not yet begun. the proposed components of the project are as follows: • program updates, due to the damage caused by the floods on the lines of serbian railways, • the reconstruction and modernization of facilities for the purposes of the system bg voz, • program updates on streaks along the corridor h and ebrd loan v (in accordance with the previously planned project). by the end of 2014. were not adopted appropriate decisions, which causes postponement of implementation of other components of the loan for 2016. 5. project railroad station belgrade center-stage i a loan from the kuwaiti fund for arab economic development in the amount of 10 million kuwaiti dinars. the project includes the construction of missing track, construction and equipping of the platform, the reconstruction of stable electric traction facility, contact network and telecommunications facilities with the installation of new pieces of equipment and construction of access roads. in 2014.. the contract was signed with a consortium led by "energoprojekt". with the works began on 3 december 2014., the deadline for completion of works is 420 calendar days, so during 2015. expected to be the largest part of the works. 6. project procurement of new multipart dizelmotornih furniture eurofima loan in the amount of chf 43 million. the project includes two components 1) the purchase of 12 multi anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 61 part dizelmotornih furniture (delivered to all 12) and procurement of major components, equipment and special tools necessary to equip the capacity to maintain as well as parts and components for the maintenance of diesel trains series 711 and 2) the purchase of additional equipment, tools, parts and components in the amount of unused part of the loan. 7. project procurement of used passenger cars eurofima loan in chf equivalent to the amount of 5 million euros. the purchase of used passenger cars will create conditions for improving the supply of passenger transport, both in quantitative (number of available passenger cars) and qualitatively (by types of car, car interior, etc.) and create conditions for realization of the planned arrival of the passenger traffic, ie, its increase. in december 2014.. launched a public procurement procedure ten rounds with five beds and sleeper. 8. the project of reconstruction and modernization of the railway line nis-dimitrovgradphase i czech export bank loan in the amount of 51 million euros. the loan is not agreed whether the guarantee provided by the budget law of the republic of serbia for 2015. 9. infrastructure projects and rolling stock project loan government of the russian federation, the republic of serbia in the amount of $ 800 million. with the participation of the republic of serbia of 15% of the total value of the project amounts to 941 million dollars. for the realization of the project is planned to conclude contracts annex 5 (annex 1 construction of the second track of the belgrade centre pancevo main, annex 2 reconstruction of 6 sections on corridor h, annex 3 reconstruction and modernization of the section stara pazova novi sad, annex 4 reconstruction of the belgrade-vrbnica (bar) and annex 5 delivery dizelmotornih trains. annex 1 covers the financing of the reconstruction and modernization of the section pancevo bridge pancevo main, 15km in length, on the line bg centar-pancevo-vrsac-main border. at this section, includes construction of the second track, as well as construction and reconstruction of existing track capacity and infrastructure in the cells krnjaca, ovca, pancevo bridge, and stop sebešs krnjaca bridge and a new bridge on the tamis in the length of 241,90m and the new lower bridges and engineering structures. the contractor is the russian company "rzd international" doo. earth-moving sub-contractor was selected domestic "energoprojekt engineering" sd belgrade. annex 2 for the reconstruction of 6 sections on koriddoru h concluded 03.2014.years between "serbian railways" jsc and "rzd international". in may 2014.. russian contractor "rzd international" doo has received from "serbian railways" ad proposal that a contract for annex 2 separated into two parts, "north" and "south" as it is only three so-called. "north" section of corridor h building permit and provided funds for the down payment, which is a prerequisite for the commencement of works. serbian railways and "rzd international" doo, signed in october 2014.. contract for the reconstruction of three "northern" sections of the trans-european railway corridor h: golubinci-ruma (oko17,9km), sopot kosmajski-kovacevac (about 18,4km) and mala krsnavelika plana (about 29,5km), and the total value of the contract is about 56 million dollars. "serbian railways" at the end of december 2014. paid the russian company "rzd international" amount of approximately $ 7.3 million on behalf of the serbian state participation of 15% in the project, thus creating conditions for the start of works. 62 economic analysis (2016, vol. 49, no. 3-4, 48-68) in 2015. work began on three 'n' shares and the completion of the preparation of project documentation for three "southern" section. annex no. 5 provides for the acquisition of dizelmotornih trains. "serbian railways" and "rzd international" doo, signed in october 2014.. contract for delivery of 27 new diesel trains, which will be manufactured in the russian company "metrovagonmaš". the value of this contract is $ 100 million. law on budget of the republic of serbia for 2015. are provided earmarked funds of the republic of serbia on behalf of the serbian state participation of 15% in the project in the amount of 1.4 billion dinars. at the end of 2015. it is expected that the first delivery of the new trains dizelmotornih. signing of other annex in 2015. (2.2, 3 and 4) will depend on the moment of providing funds for participation in the amount of 15% of the contract value, as well as the completion of the necessary project documentation and land expropriation. financing of capital projects in 2015. is planned in the amount of 29.2 billion dinars, and to 27.7 billion dinars (94.9%) from international funding sources 1.4 billion (4.8%) from the budget of the republic of serbia and 0.05 billion dinars (0.2%) of the company's assets. the condition for realization of the planned investments is to provide the means for financing and indirect variable costs. for the preparation of technical documentation, participation and other indirect costs and dependent plans funds in the amount of 1.5 billion dinars, of which the largest part relates to the funding of participation, and the participation of the russian loan. law on budget of the republic of serbia for 2015. provided 1.4 billion earmarked for the participation of jsc "serbian railways" the russian loan. part of the funds for these purposes, in accordance with the financial capabilities, the company financed, so as not to jeopardize further implementation of the project, while providing the necessary funds for the participation of countries expected to participate. in addition to the above, to finance the project documentation has been provided and donor funds ipa funds of the european union, for. the project of reconstruction and modernization of the railway novi sad subotica, the value of the donation is 3,95 million; project of the railway bypass around nis, the value of the donation is hinjada 900 euros and the project of reconstruction and modernization of the existing track and the construction of the rest track of the belgrade-nis, shares stalac-djunis the value of the donation is 1.5 million. the donation from the ipa funds of the european union, by means of ap vojvodina and the city of novi sad financed the project of building a new "zezel bridge" over the danube in novi sad. preojekta value is 45.4 million euros. in addition to resources for indirect and attributable costs that are provided from the budget of the republic of serbia or its own funds railways (provided funds are presented in the form 7.1., attached to the program of operations), have not yet been provided, or did not plan the necessary resources for indirect and associated costs the following projects: memorandum of understanding and cooperation on the project hungarian-serbian railways between the people's republic of china, hungary and the republic of serbia 2014. the realization of the project of reconstruction and construction of the belgrade-budapest, "serbian railways" jsc were called to the authorized organization of the republic of serbia on the preparation of the feasibility study of the project, with the task of joint action with the other two parties in the preparation of the study. since the decision of the government of the anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 63 republic of serbia on education working group to find a model of financing the project of reconstruction and construction of the belgrade-budapest in 2015. is defined by the model of financing, both for the preparation phase of the project (preparation of project documentation and expropriation), as well as for the implementation phase of the project, and the start of implementation of activities whose defining also expected. indebtedness capital projects are largely financed loans from international financial institutions. on the day 2014. total liabilities of "serbian railways" jsc amounted to 40.5 billion dinars, of which 40.4 billion to foreign creditors and 121 million dinars to domestic creditors. the total credit obligations are liabilities arising so far exploited or withdrawn, and the outstanding amount of foreign loans for which the republic of serbia has given guarantee (eib, ebrd, the kuwait fund for arab economic development), as well as loans contracted without guarantee (meinl bank). given that "serbian railways" ad are not able to service all obligations, expected assistance of the republic of serbia in the settlement of liabilities arising from loans that were given guarantees and loans eurofima while credit obligations to meinl bank and domestic creditors (bank intesa development fund and the rs fund of solidarity) "serbian railways" ad settled from its own funds. in 2015. matured for payment of total liabilities in the amount of 7.9 billion dinars, of which 7805.6 million dinars based on foreign loans and 104.4 million dinars on the basis of domestic credit. outstanding debts and unpaid claims: estimated-outstanding receivables as at 2014. amounted to 4.3 billion dinars (amount without value adjustment). estimated outstanding obligations as at 2014. amount to about 11 billion dinars. railways the main problems arise from the ordinary course of business, not of debt. the largest enterprises imbalances resulting from the loss from operations. operating loss determines the lack of funds for maintenance and investments and, consequently, the borrowing company. however, the standard indicators of indebtedness are still not alarming (for example, the debt to capital ratio to about one quarter). liquidity is not at a high level (current assets are about one-quarter of current liabilities), and it contributed to the small claims (about 2 billion), and moderately high short-term liabilities (primarily trade payables, about 11 billion dinars). it appears that the road to better results is based on solving the cause of the problem income and expenses. (rs, fiscal council, p p. 44) prices the last price increase in cargo traffic was realized in the first quarter of 2008. (25% in domestic traffic), and in passenger traffic in the first quarter of 2010. (16% in domestic traffic), where the railway is facing a constant increase in cumulative cost of inputs in the production of transport services. in domestic passenger traffic in the second half of 2015. possible activities are ashamed of initiating procedures for obtaining the approval of the government of the republic of serbia for the adjustment of prices only to the level of inflation according to the latest official data of 64 economic analysis (2016, vol. 49, no. 3-4, 48-68) the republic institute ua statistics of the republic of serbia. in domestic freight traffic for 2015. not provided price increase. the company will, if the need arises, the transport of passengers, certain measures of tariff policy (through possible correction commercial privilege or correction of the borders of tariff zone) affect the level of transportation revenue, present activities towards market orientation towards the business model. according to all users who have completed the interview credited carriage of goods in internal traffic, apply the same principle of price levels for the same, or similar transport conditions (quantity and type of goods, transport relations, etc.). the international freight traffic (implementation of agreements on the central billing of transport), the price level to be contracted will be in line with market is acceptable, what is needed to define the prices in accordance with the intensity of competition, seasonal fluctuations, quantities and types of goods offered the transport, the degree of capacity utilization, organization of transport (individual journeys, groups of circuits, block trains), in accordance with the mode of payment and other criteria. expected foreign share of revenues from the international traffic amounts to about 47.5 million. risk management in its normal course of business the company is exposed to a different extent certain financial risks, the risk of reduction in state benefits, changes in exchange rates of foreign currencies, the risk of changes in interest rates, the risk of price changes and liquidity risk. risk management in the company is aimed at minimizing the potential negative impact on the financial position of the company's operations. the risk reduction of state fees: in 2015. government subsidies for "serbian railways" jsc have been reduced by about 2 billion dinars. this reduction leads to the risk of payment to creditors, then the risk of technical readiness for the transport of goods and passengers because of the very difficulty of securing the necessary funds to maintain, and therefore leads to risks in the context of road safety. price risk: given that prices for domestic services controlled and subject to the approval of the government of the republic of serbia, in the circum exposure avoid the risk of disapproval price increases, an increase in transmission revenues in passenger traffic for 2015. not based on the increase in the price of transport. credit risk: a) the risk of changes in interest rates: interest calculation is carried out every six months and the interest rate is equal to six-month euribor-a + 1% fixed percentage. the main credit risk arises from the possible variations euribor and its changes. b) the risk of paying rates on the undrawn portion of the loan in accordance with the opposition on the loan, the borrower pays the fee on the undrawn portion of the loan, which is part of the standard procedures of the ebrd and calculated the total available amount of the loan as well as any amount of the loan which is subject to debt payment but has not yet been withdrawn and amounts to 0.5% of the 'year' level. this fee is calculated and paid twice a year. the main risk for the "serbian railways" ad on this basis, is untimely loan anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 65 disbursements, delays in project implementation, causing a large amount of commission payments, and therefore a longer period of payment of the same. c) the risk of repayment of loans: for loans to "serbian railways" ad repaid independently from its own resources, there is a risk of untimely repayment of the loan due to lack of funds. the risk of changes in foreign exchange rates: the company is exposed to risk from changes in foreign exchange rates arising out of future business transactions, as well as from significant foreign currency liabilities, primarily borrowings, but also to foreign railway administrations, as well as foreign suppliers. on the one hand, the change of course in terms of depreciation of the dinar, especially against the euro and the swiss franc, the cost increases through increased foreign exchange losses and higher credit and other commitments are translated into dinar amount. on the other hand, the change of course in terms of strengthening the dinar's value, especially against the euro, may affect the lower income denominated in dinars in the income statement than planned, given that the company realizes a significant amount of foreign currency earnings. liquidity risk: liquidity management aims to ensure that the company of its obligations on due dates. despite the fact that due to operating losses and long-term financial imbalance of liquidity risk management is difficult, the company regularly pay taxes and contribute to the state. risk management is more difficult when it comes to borrowings, foreign railway governments and foreign suppliers, due to the aforementioned credit risk and the risk of changes in exchange rates and foreign currencies. management reform program public finance 2016 – 2020 the government of the republic of serbia signed a memorandum of economic and financial policies (mefp) with the imf in early 2015, in which he presented the economic policy of the government of the republic of serbia intends to implement in the context of stand-by precautionary arrangement (sba) in the period from 2015 to 2017 in order to solve existing economic imbalances. mefp determined based and provides a framework in which to implement the reform of the management of public finances in the medium term as part of the overall reforms of public administration, while it contains some of the key themes and elements that occur in all the sub-systems of public finance management. (rs, ministry of finance, pp. 5) the program of reform of public finance management strongly relies on a number of previous analyzes undertaken by the european commission and carried out during the screening process in the accession negotiations in the period from 2013 to 2015 as part of a number of negotiation chapters which include, among others, chapter 5 public procurement, chapter 11 agriculture and rural development, chapter 16 taxation, chapter 17 economic and monetary policy, chapter 19 social policy and employment, chapter 22 regional policy and coordination of structural instruments, chapter 23 judiciary and fundamental rights chapter 29customs union chapter 32 financial control, and chapter 33 financial and budgetary issues. these estimates are further supplemented by an annual report on the progress of the republic of serbia, as well as the reports arising from the assessment conducted by sigma program in the period from 2012 to 2015, with special emphasis on the estimates of the management of public finances from 2014 to april 66 economic analysis (2016, vol. 49, no. 3-4, 48-68) 2015, in relation to the principles of public administration throughout the relevant horizontal level management system. (rs, ministry of finance, pp. 6) displaying the current situation in public finance management, report of sigma on the management of public finances for 2015 states a slight improvement over the 16 observed the principle of public finance management, pointing to a weak commitment to transparency in the state budget for 2015, the lack of new programming plan for the development internal financial controls in the public sector (ifkj) in the future, low level of awareness about the importance of internal audit in public funds, low percentage of implemented recommendations of the state audit institution in the published annual audit reports for 2013, certain inconsistencies in the regulatory framework for public procurement, although it is largely harmonized with the eu acquis, as well as the poor quality of the result 7 (rs, ministry of finance, pp. 6) further recommendations arising from the report of sigma on the assessment of the legal framework and organizational and institutional capacity building to consolidate the financial management and control and indirect management of eu funds under the ipa ii, which requested the ministry of finance in early 2014, are incorporated into the program of public administration reform finances in an effort to consolidate the management of all public funds in the republic of serbia, regardless of the source, the harmonization and integration of financial planning, control and execution of eu pre-accession assistance into the national budget system, to ensure the highest level of coordinated and effective planning and programming of public investment and establish a meaningful and unique system of financial control of public funds in the republic of serbia. imf report on the assessment of fiscal risks, reporting and budget preparation from 2015 is one of the cornerstones of the program of reform of public finance management. at the same time, it provides a vital link with the mefp by the government of the republic of serbia signed with the imf in early 2015 for economic reforms that it intends to apply under the sba as a precaution in the period from 2015 to 2017, and supports its implementation. the report of the imf from 2015 on the assessment of fiscal risks, reporting and budget preparation states that serbia made significant progress in the implementation of public finance reforms, while emphasizing that a large fiscal deficit and the need for fiscal consolidation in order to preserve fiscal sustainability increases the importance of continuing the reform of governance public finance. faults as indicated in this report include the limited credibility of the budget because of the focus on an annual budget in the budget process, limited includes the national budget due to the fact that significant parts remain outside the budget of the republic, the lack of reliable estimates of fiscal risks and liabilities, what is the answer spreads a work program to improve fiscal reporting and the expansion of the current cash to accrual accounting in the medium term. finally, the report repeated the assessment of public expenditure and financial accountability of the world bank provides the basis for the preparation of the current reform program of public finance management as it provides a comprehensive and detailed assessment of the current situation in all subsystems of public finance management with a comparison with the results of that assessment, which was carried out in 2010. therefore, the reform program of public finance management relies heavily on inputs obtained from the anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 67 pefa assessment of 2015 in order to eliminate deficiencies therein. (rs, ministry of finance, pp. 7) conclusion imf report on the assessment of fiscal risks, reporting and budget preparation from 2015 is one of the cornerstones of the program of reform of public finance management. at the same time, it provides a vital link with the mefp by the government of the republic of serbia signed with the imf in early 2015 for economic reforms that it intends to apply under the sba as a precaution in the period from 2015 to 2017, and supports its implementation. as an example of a public company, this paper presents the company railways of serbia, which is already in the year 2013. took over and continued continue to implement actions to reduce costs, especially fixed expenses: costs of fees (per diem), costs of production services, insurance, payments, taxes, costs, etc. revenues of railways exercise alone are sufficient to cover only one third of operating expenses. in the last five years of income without subsidies amount to about 10-11 billion, while operating expenses about 30 billion dinars. were it not for government subsidies amounting to about 14 billion pounds per year, net loss from operations amounted to about 20 billion. the government of the republic of serbia signed a memorandum of economic and financial policies (mefp) with the imf in early 2015, in which he presented the economic policy of the government of the republic of serbia intends to implement in the context of stand-by precautionary arrangement (sba) in the period from 2015 to 2017 in order to solve existing economic imbalances. mefp determined based and provides a framework in which to implement the reform of the management of public finances in the medium term as part of the overall reforms of public administration, while it contains some of the key themes and elements that occur in all the sub-systems of public finance management. references ljutić, b. 1995. financial management in agribusiness. belgrade lovreta, s. 2004. a shopping and management. faculty of economics, belgrade rules 241 ("sl. glasnik rs" no. 2/84, 2/88, 5/88, 7/88, 9/88 and 13/98) vidakovic, s. 1999. analysis of the operating companies. belgrade: megatrend university. vunjak, s. 2005. fundamentals of financial management. belgrade dedović, m., milačić, s. 2005. financial management. leposavic ćirović, m. 2000. foreign direct investment, trends and strategies. belgrade ivanisevic, m. 2008. business finance. belgrade cidef james c. van horne. 2006. fundamentals of financial management. belgrade: data status. karavidić, s. ivkovic, d., kvrgić, g. 2012. financial management. belgrade: faculty of business economics and entrepreneurship. kovačević, r. 2000. forms and mechanisms of investment. beograd ostojic, s. 2010. working capital in small business. belgrade: megatrend university. radosavljević, g., tomić, r. 2006. management in the modern business. novi sad. 68 economic analysis (2016, vol. 49, no. 3-4, 48-68) ristić, g., komazec, s. 2000. financial management. belgrade. stakic, b., stanković, m. 2003. financial leasing and leasing. belgrade: university singidunum – ffmo. www.zeleznicasrbije.com, access to the site 20.07.2015., access time 11:30:00 www.fiskalnisavet.rs/analiua preduzeca u drzavnom vlasnistvu, access to the site 04.09.2016., access time 17:30:00 www.mfin.gov.rs/program reforme upravljanja javnim finansijama, access to the site 06.09.2016., access time 08:45:00 article history: received: 17 november, 2016 accepted: 15 december, 2016 doi: 10.28934/ea.21.54.2.pp118-127 preliminary report information and communication technology’s skills among the working population of serbia jelena banović1* | dejana pavlović1 1 institute of economic sciences, belgrade, serbia abstract major social shifts in the economy conditioned by information and communication technology (ict) have led to equal shifts in the labor market. in this paper, the use of ict skills in serbia is presented through an analysis of the microdata from the survey “the usage of information and communication technology on individuals/households in the republic of serbia for 2020”. results showed that internet users have increased in the last five years. according to results, in 2020, 78.4% of people between 16 and 74 used computers in the last three months. the number of unemployed who used a computer in 2020 was 83.6%, and the number of employed who used a computer was 92.7%. students used computers 99.8% in 2020. on the other hand, 96.3% of employed used the internet in 2020, while 89.2% of unemployed used internet at the same period. the use of e-government web services is almost present to the same extent among students, the employed and unemployed. unlike online shopping, students are most likely to use e-government services, even though the employed and unemployed both use online shopping equally. however, comparing statistical data, serbia is not at the european level in ict usage , which can significantly jeopardise individuals' position in the labor market. there are substantial distinctions between youth and older individuals, especially regarding advanced skills. this affects the creation of digital exclusion, which increases the lack of resources that can be employed in better-paid jobs. the main solution for solving the digital divide is education to ensure equal competitiveness for all individuals on the labor market. key words: ict skills, working population, serbia, labor market jel classification: j40, j64 introduction information and communication technology (ict) and digitization have led to rapid changes in all spheres of society – education, trade, international economy, and health, including significant changes in the labor market. ict skills are essential for every individual to learn and work while accessing information on the internet and finding reliable data. considering its role in the process of social transformation, ict creates new business opportunities and employment possibilities. the development of ict has conditioned faster changes in the labor market to which the working-age population must adjust. many authors say that the development of ict skills is one of the most critical factors for the growth of the european labor market (postula et al., 2021; herman 2020). the impact of ict on the labor market is primarily reflected in evolving business dynamics, changes in working conditions, and the skill requirements an individual must possess to perform a particular job. having ict skills allows individuals to carry out a manifold of work * corresponding author, e-mail: jelena.banovic@ien.bg.ac.rs jelena banović, dejana pavlović 119 related tasks. it enables them to communicate over online channels, find information and use a computer in general. since the internet assists with decision-making and problem-solving skills, multiple european countries are developing strategies to help individuals in the labor market to develop basic and advanced ict skills and internet and computer skills. ict skills have become a mandatory requirement for employment in today’s job market. moreover, possessing ict skills allows individuals to become more competitive in labor market. in contrast, a lack of these skills can reduce employment opportunities or result in a potential job loss. ict skills provide an opportunity to create new jobs and improve existing ones. still, they also undoubtedly have had an impact on the obsolescence of numerous positions and professions which ict has made redundant. despite its low-barrier access, benefits from information and communication technologies can remain untapped if the user does not have the needed skills and competencies to use ict. according to eurostat report, general developments in the labor force for people with an ict education (2021) labor force in eu that had an ict education was more than 2 million persons, and by 2020, this number increase to 2.9 million. around 2.7 million persons aged 15-74 in the eu were employed and in possession of an ict education, and 219.000 persons with ict education were unemployed. if we observe this situation according to the gender of respondents, eurostat report employed persons with an ict education by sex (2021) stated that men accounted an 82.8% of the 2.7 million persons in the eu who were employed and in possession of an ict education. women accounted for only 17.2% of labor force who were employed and with an ict education. if we observed the age of the respondents, 65.7% of employed individuals in the eu with ict education were aged from 15 to 34 years. a number of young populations with ict education from 2010. to 2020. was growing 2.7% per annum. if we observe a level of internet usage in the households in 2020, national statistical centers of different countries conduct a questionnaire created according to the eurostat methodology using of ict in households. data shows that that the highest percentage is in scandinavian countries, that are considered as a leader in using of ict and digital technologies – island has the biggest score – 98% of using the ict in households, the netherlands with 97%, finland 96%, sweden 94%. also, the united kingdom with 97%, slovenia, austria and lithuania and poland 90%, hungary on annual basis noted 88% and turkey 91%. surrounding countries shows that montenegro stated 80% in using of ict by household, north macedonia 79%, and bosnia & herzegovina 73% (eurostat, 2021). on the other hand, data for using of the internet by individuals in 2020. shows that dominant are scandinavian countries – island has 99% of using the internet by individuals, norway 98%, sweden and finland 97%. also, croatia noted 80% of individuals who use the internet, italy 81%, the czech republic 89%, bulgaria 74%, austria 89% and romania 85% of individuals. balkan countries have a lower percentage – north macedonia 84%, montenegro 79%, and bosnia & herzegovina 74%, and serbia 80%. (eurostat, 2021). the aim of this paper then is to analyze ict skills among all those active or inactive of working age in the labor market of the republic of serbia, with a focus on active and passive individuals on the labor market, by applying the results of cross-tabulation on microdata from survey ict usage by individuals. this survey is conducted annually by the statistical office of the republic of serbia, according to the eurostat methodology. data covers the territory of the republic of serbia, without ap kosovo & metohija. the reference period was three months before the telephone interview (yearbook of sors, 2021). the results of this paper will be useful for the implementation of future strategies in the field of employment and ict usage in the republic of serbia. literature review the digital economy is vital for innovation, economic growth, and employment. the spread of ict has had a major impact on the labor market as well as what digital skills are essential to 120 economic analysis (21, vol. 54, no. 2, 118-127) function in the workplace and in society. the impact of ict on the labor market is not universally the same by economy or sector (picatoste et al., 2018). according to valsamis et al, scandinavia is a world leader in digital development, while newer eu member states and southern european countries lag far behind. according to the european commission’s digital agenda for europe (2014), there has been a rapid rise in those who are online, yet almost 50% of all internet users have insufficient ict skills necessary to be competitive employees. the digital agenda also states that ict skills must be treated as a priority. therefore, a number of international strategies, policymakers and politicians have stressed the importance of digital skills to achieve competitiveness and sustainable goals (agenda 2030). according to an oecd 2014. report, ict skills among adults are of great importance as lacking such skills poses the biggest risk of losing one’s jobs in the current workforce transformation (oecd, 2014). the same report states that adults are most at risk, as a significant number of them do not have computer and internet skills, while youth are generally familiar with computers and have wider access to the internet at home (oecd, 2014). this highlights the potential skills mismatch between those who possess the strongest ict skills, namely young people, and those who use them in the workplace. according to bejaković and mrnjavac (2020), digitalization of the economy causes market polarization, which has thus caused an increase in demand for those who have digital skills to successfully perform tasks dictated by new technologies. in 2006, sung and ashton (2006) in their study of 294 employers in the uk, pointed out that the adoption of ict was vital in forming new work practices to allow for better communication, innovation, and support in the development of new products and services. murawski and bick (2017) pointed out that many authors have highlighted the impact of ict and digital transformation on external factors while neglecting the role of digital skills of the workforce in this process of change. in 2011, brynjolfsson and mcafee concluded that the pace of technological innovations is proliferating, along with the use of advanced software technologies, thus turning workers without basic digital skills obsolete. in 2000, the uk government launched a life-learning program to increase the employment rate by acquiring and improving digital skills (brown, 2000). however, it must be noted that although there is the strive for every individual to possess ict skills that is not always possible. there are significant gaps in maintaining basic or advanced skills, and they are most often related to the age, gender, demographic characteristics, and education of individuals in the labor market. this situation creates a significant digital exclusion. according to bejaković & mrnjavac (2020), it could also increase social exclusion due to a lack of technological resources to teach digital literacy to the poor or marginalized groups. in this case, these groups of people risk remaining unemployed or losing jobs because they are becoming uncompetitive in the labor market. when it comes to young people, authors state that they gain digital skills during formal and non-formal education (van dorsen, van dijk, 2014) and they manage well in the digital environment. however, youth employment is a global challenge. although they are a part of the digital environment, not all young people have the skills needed in the digital economy. young people in countries such as norway, finland, sweden, denmark, and canada record a high level of use of ict at home, but when it comes to using these technologies at work, the percentage is less than average (oecd, 2014). therefore, it is necessary to strengthen their capacities through education and training for them to enter the labor market as ict literate as possible. on the other hand, if we consider the gender of the individuals in the labor market, numerous studies have shown a large gap in ict literacy between the genders (hafkin, huyer 2007; moghaddam, 2009; wamala, 2012; perifanou, economides, 2020). women had less access to the internet and fewer internet skills than men, while their reasons for using the internet and computers were completely different (fallows, 2005). of course, this gap has narrowed over the years in developed countries, with slighter differences among the younger female population than the older female population. however, the majority of the 3.7 billion people that are not online are jelena banović, dejana pavlović 121 female. the digital gender gap is still present in developing countries, thus creating a strong need for addressing the digital gender divide. according to itu, on the global level, women and girls use the internet 12.5% less than men and boys. in underdeveloped countries, only 15% of women used the internet in 2019, compared to 86% of women in developed countries (itu, 2021). methodology our research is based on the microdata of the survey “the usage of information and communication technology on individuals/households in the republic of serbia for 2020”. the data is provided by the statistical office of the republic of serbia (sors) that carried out the first of such surveys in 2004. through a pilot survey. from 2006. to 2020, the survey was conducted annually following eurostat methodology. the usage of ict is performed either by telephone or in-person interview. the aim is to provide data on the usage of information and communication technologies among individuals/households and enterprises in the republic of serbia. the statistical office of the republic of serbia (sors) carried out the same survey in 2020, splitting it into two forms: one on individuals/households and another on enterprises. the target population consists of households in which at least one member is between 16 and 74 years of age who are collected in a two-phase, stratified sample.1 the three months preceding the telephone interview were taken to be the reference period, wherein the sample included 2800 households and 2800 individuals. furthermore, the survey was conducted based on a representative sample of 2800 households in the republic of serbia and whose response rate was 91.9% (2.574 households). the interview was done both by telephone but would allow for a third party to answer questions should the original interviewee be unavailable. there were a total of 2574 respondents, 1605 of whom were women and 969 men. by age, the majority were over the age of 55 (between 65 and 74 36.7% and between 55 and 64 22.2%). the smallest share was those between 16 to 34 years of age (roughly 13%). from all respondents, only 50.5% achieved a secondary-level education. of the total number of respondents, approximately 32% were employed and 16.7% unemployed (table 1). table 1. descriptive statistics number % income up to 300 euros 755 36.7% 300-600 euros 731 35.5% more than 600 euros 573 27.8% region belgrade 611 23.7% vojvodina 735 28.6% šumadija and western serbia 701 27.2% south and eastern serbia 527 20.5% age 16-24 151 5.9% 25-34 181 7% 35-44 319 12.4% 45-54 408 15.8% 55-64 571 22.2% 1 the data does not account for any representation from the autonomous province of kosovo. 122 economic analysis (21, vol. 54, no. 2, 118-127) 65-74 944 36.7% gender female 1,605 62.4% male 969 37.6% education level lower than secondary 432 16.8% secondary 1,300 50.5% tertiary 842 32.7% employment status employee 818 31.8% unemployed 430 16.7% student 52 2% other 1,274 49.5% total 2,574 100% source: statistical office of the republic of serbia (sors), 2020. since 2015, the usage of ict survey consists of on a comprehensive questionnaire grouped according to the following modules (statistical office of the republic of serbia-sors, 2015): ● module a: access to information and communication technologies; ● module b: use of computers and internet; ● module c: use of e-government; ● module d: use of e-commerce; ● module e: privacy and protection of personal data; ● module f: trust, security and privacy; ● module g: internet of smart devices; ● module h: respondent‘s socio-demographic background information. in our paper, through implementing a cross-tabulation, the data gathered was used to analyse differences in the ict compared against those who were actively employed and those who were officially unemployed. we are focused on the usage of computers, mobile/cellular phones and the internet (module a and b). module c of the same survey tabulates e-government usage, e-trade and e-skills. results according to the date of sors from 2020, the number of internet users increased in comparison with last 3 years. additional, in 2020 more than 3.800.000 people aged between 16 to 74 used computers in the last three months or 78.4% of them. comparing with last year, it is increased by more than 6.500 of individuals. in 2020, 72.4% of individuals used a computer, which is about 2 p.p. more than 2019. also, since 2018, the number of active internet users has increased among all regardless of whether the respondent was employed (both employee and self-employed), unemployed or a student. the most significant rise in usage may be noted among the unemployed, whose computer use grew from 74.6% in 2018 to 83.6% in 2020. and their active internet use grew from 79.0% to 89.2% in the same time. nevertheless, active internet use saw a substantial increase among the employed as well, growing from 89.7% to 96.3%. jelena banović, dejana pavlović 123 table 2. computer and internet users by employment status, 2018-2020. working population 2018 2019 2020 computer users (in the last 3 months) [%] total 70.7 71.9 72.4 employed 86.8 90.3 92.7 unemployed 74.6 77.1 83.6 students 100.0 100.0 99.8 other 44.0 45.3 52.3 internet users (in the last 3 months) [%] total 73.4 77.4 78.4 employed 89.7 93.3 96.3 unemployed 79.0 83.4 89.2 students 100.0 100.0 100.0 other 45.5 53.6 60.4 source: statistical office of the republic of serbia (sors), 2020. in serbia, according to the data from 2020 (sors, 2020), 81.3% of individuals never carried out learning activities over the internet, 6.5% of them doing online courses and 4% of individuals had communication with instructors or students using websites or portals. it can be seen in table 3 that unemployed are most likely to neither seek any online learning materials nor to do an online course. while the overall percentage remains high for all groups as relates to their ever having carried out learning activities on the internet, it remains lowest for students (60.2%). both employed and unemployed are also most likely to have never carried out learning activities on the internet (76.4%-employed and 84.5%-unemployed). table 3. use of the internet, 2020. questions of use of the internet employment status which of the following learning activities have you carried out over the internet for educational, private or professional purposes in the last three months? employee unemployed student other total doing an online course 8.1 5.7 17.1 4.3 6.5 finding online learning materials (audiovisual materials. online learning software. electronic textbooks...) 22.7 13.5 37.2 12.7 17.4 communication with instructors or students using websites or portals 4.9 3.0 9.6 3.3 4 never carried out learning activities over the internet 76.4 84.5 60.2 86.1 81.3 source: statistical office of the republic of serbia (sors), 2020. the unemployed are also the least likely to purchase items online, where 34% have never done so. on the question “which of the following activities did you perform over the internet for private purposes?” in the sample, 83.3% of unemployed stated that they are using the internet for telephoning/video calls, or 88% of unemployed sending messages via whatsapp, viber, skype. unemployed are not interested in selling a good or product online or within e-banking. while about 30% of students and employed individuals are using e-banking for private purposes. 124 economic analysis (21, vol. 54, no. 2, 118-127) according to data, 97% of students telephoned over the internet/video calls and 89.4% of students participate in social networks. students are the most likely to use the internet and other it as they have the highest percentage overall of use which may also be evidenced by their frequency of purchasing items online (table 4). this may be biased due to the fact that students skew younger, and youth has been raised in an environment in which online purchasing is a norm in the target country as opposed to purchasing in person or through other means. table 4. use of e-commerce, 2020. questions of use of the e-commerce employment status when did you last (for private purpose) buy? employee unemployed student other total in the last three months 47.7 36.7 61.5 21.5 36.1 more than three months ago (less than a year) 14.5 13.6 6.8 8.3 11.8 more than a year ago 7.4 15.8 11.8 5.9 9.1 never used it 30.3 34.0 19.8 64.3 43.0 source: statistical office of the republic of serbia (sors), 2020. according to the data 2020, more than 1.415.000 individuals use websites/apps of public authorities to obtain information. or to be more precisely, 34% of individuals obtain information from public authorities’ websites, 25.2% downloading/print official forms and 23.9% send completed forms. if we focused on individuals by employment status, both employed and unemployed benefit equally. according to data from 2020, 44.6% employed and 39.3% unemployed obtained information from public authorities’ websites, while in downloading/printing official forms and sending completed forms employees are larger users than students and unemployed persons (table 5). table 5. use of e-government, 2020. questions of use of the e-government employment status for which of the following public authorities’ services have you used the internet in the last 12 months? employee unemployed student other total obtaining information from public authorities websites 44.6 39.3 49.9 18.1 34 downloading/printing official forms 35.5 27.5 26.7 12.9 25.2 sending completed forms 33.9 26.7 25 11.7 23.9 source: statistical office of the republic of serbia (sors), 2020. discussion and conclusions most authors have adhered to the conclusion that developing digital skills is the most important indicator for both european and global labor market development, which might improve economic growth and macroeconomic factors. accordingly, international strategies, policymakers and politicians emphasize the importance of digital skills in order to achieve competitiveness and sustainable goals (agenda, 2030). our research conducted in the paper has focused on the characteristics of employed, unemployed and students, as well as to what extent they are users of ict skills. according to the micro-data (2020), students (i.e. youth), are more likely to be beneficiaries of the ict sector than either the employed and the unemployed. in serbia there is not a large number of studies focusing on usage of ict among the working population. one of them jelena banović, dejana pavlović 125 is research conducted in 2012. research on digital literacy evaluation was conducted within pharmacy based on a sample size of 1077 respondents (68% of them were employed within pharmacy and 32% were students) (lakic et al., 2012). the research indicated that digital literacy among students was significantly higher than that of the employed. when removing students from the data set and then comparing the employed and unemployed, there is no substantial difference found in computer and internet use. use of e-government web services is almost present to the same extent among students, the employed and unemployed. however, unlike online shopping, students are most likely to use egovernment services, even when the employed and unemployed both use online shopping equally. compared to eu countries, serbia lags behind them in using ict skills. regardless of their status in the labor market, there are substantial distinctions between youth and older individuals, especially when it comes to advanced skills. this affects the creation of digital exclusion, which in turn increases the lack of resources that can be employed in better paid jobs. those lacking digital skills are at a higher risk of remaining unemployed, or, when they do have a job, becoming unemployed, as not possessing digital skills makes them less competitive in the labor market. similar to the rest of the world, the ict sector is considered to be the most promising and fastest growing industry in serbia which sets the trend for competencies required from university graduates in serbia (anđelković-labrović et al. 2020). ict companies tend to recruit graduates who possess specialized knowledge in ict, management and economy, which calls for the implementation of multidisciplinary educational courses (fren 2020). accordingly, the digital serbia initiative states that careers in digital business require specialized knowledge in "data analysis, bioinformatics, cloud computing, the internet of things, machine learning, artificial intelligence, virtual reality, as well as management, finance, accounting, marketing and entrepreneurship" (dsi 2020). similarly, smes in serbia look for candidates with compound skills. these include ict skills, technical and social skills, foreign language skills, communication and negotiation skills as well as the willingness to work in a team and continuously improve one’s knowledge. therefore, in order to be competitive in the digital labour market, young graduates should develop a complex set of ict and soft skills which conform to employers' requirements. technological innovation has been growing in pace with the use of advanced software technologies, making those who do not have basic digital skills more likely to become redundant in a competitive labour market. life-learning programs have long been launched in developed eu countries in order to increase the employment rate through the acquisition and improvement of digital skills of individuals. therefore, in order for digital skills to be advanced, especially among the unemployed, training needs to be introduced by the government of the republic of serbia to ease entry into the labor market for the unemployed. acknowledgment this paper is a result of the research financed by the ministry of education, science and technological development of the republic of serbia. this paper is a result of the project “impact of ict on unemployment factors in spain and serbia a comparative analysis for practical recommendations” funded the science fund of the republic of serbia. references bejaković, p., mrnjavac, ž. 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(2007). women and gender in ict statistics and indicators for development. women’s empowerment and the information society: special issue, (4), 2. pp. 2541 moghaddam, g.g. (2009). information technology and gender gap: toward a global view. the electronic library, (28), 5. pp. 722-733. wamala, c. (2012). empowering women through ict. spider ict4d series no. 4. stockholm university. https://www.diva-portal.org/smash/get/diva2:506080/fulltext01.pdf anđelković-labrović, j., milinković, i., petrović, n., & kovačević, i. (2021). expected competencies from university graduates for employment in serbia. management: journal of sustainable business and management solutions in emerging economies. perifanou, m., economides, a. (2020). gender gap in digital skills in greece. proceedings of the 20th international rais conference on social sciences and humanities. pp. 21-26 fondacija za razvoj ekonomske nauke fren. (2020). analiza perspektivnih zanimanja u sektoru ikt-a. https://fren.org.rs/publikacija/analiza-perspektivnih-zanimanja-u-sektoru-ikta/ digital serbia initiative. (2020). master studies 4.0. https://www.dsi.rs/master-40-itbiznis/programi/ article history: received: december 9, 2021 accepted: december 28, 2021 https://www.diva-portal.org/smash/get/diva2:506080/fulltext01.pdf https://fren.org.rs/publikacija/analiza-perspektivnih-zanimanja-u-sektoru-ikt-a/ https://fren.org.rs/publikacija/analiza-perspektivnih-zanimanja-u-sektoru-ikt-a/ https://www.dsi.rs/master-40-it-biznis/programi/ https://www.dsi.rs/master-40-it-biznis/programi/ information and communication technology’s skills among the working population of serbia jelena banović10f* | dejana pavlović1 introduction literature review methodology results discussion and conclusions acknowledgment doi: 10.28934/ea.22.55.2.pp49-65 first online: december 6, 2022 original scientific paper does the increase in the number of registered patents affect economic growth? evidence from romania and bulgaria ivana domazet16f* | darko marjanović1 | deniz ahmetagić2 | marija antonijević1 1 institute of economic sciences, belgrade, serbia 2 faculty of economics in subotica, serbia abstract the goal of this paper is to determine whether the increase in the number of registered patents per million inhabitants, as a measure of market verification of the results of r&d activities, affects economic growth and the increase in the country's innovation index. the empirical research covered two countries romania and bulgaria. given that the main task of the research was to accurately measure the investigated phenomena and discover the connection between them, the analysis was based on a quantitative research design. the analysis used secondary data from the international databases of the world bank and world intellectual property organization, covering the period from 2008 to 2018. the results of the empirical research showed that no correlations were found, which means that in the cases of romania and bulgaria, there is no dependence between the increase in the number of registered patents per million inhabitants and the growth of the innovation index and gdp per capita. key words: innovation, patents, innovation index, gdp per capita, development jel classification: o3 introduction economic growth is a key element for improving living standards, reducing poverty and achieving common progress (world bank, 2022). countries that generate new technologies and encourage their adoption, as well as those that create innovations, grow faster than those countries that do not promote these activities (domazet et al., 2021). the same authors state that patenting in certain industries is recognized as an important tool for protecting intellectual property and creating a sustainable competitive advantage. according to oecd (2004), patents have an important role in achieving innovation and economic performance. the changes that occurred in the last two decades regarding the patent policy of the oecd member countries encouraged the creation of patents to initiate investments in innovation and improve wedge. the oecd publication also points out that patents are intended to boost innovation in the private sector by enabling their inventors to profit from the invention. moser (2013) argues that policies aimed at spreading ideas and modifying patent rights to stimulation could be an adequate way to encourage innovation. the important role of patents in stimulating innovation and economic growth was emphasized in 2012 by the then-president of the european patent * corresponding author, e-mail: ivana.domazet@ien.bg.ac.rs 50 economic analysis (2022, vol. 55, no. 2, 49-65) organization (epo), benoît battistelli, during his speech at the bulgarian inventors of the year event (epo, 2022). it is important to understand that for patents to have a positive impact on economic growth, it is necessary to apply them in practice (atun et al., 2007). since the goal of every country is to achieve economic progress, numerous authors have examined the nature of the relationship between patents and economic growth. in this regard, some researchers have determined the existence of a positive relationship (wurster, 2021; maradana et al., 2017; pelinescu, 2017; nae & grigore, 2014; hasan & tucci, 2010; akçomak & ter weel, 2009; sinha, 2008; blind & jungmittag, 2008; crosby, 2000), while others identified the existence of a negative relationship between the mentioned variables (silaghi & medeşfălean, 2014; domazet et al., 2022). on the other hand, myszczyszyn (2020) and blind et al. (2021) argue that there is no relationship between patents and economic growth in the long run. bearing in mind that bulgaria and romania are countries that acceded to the eu at the same time (2007) and that they are characterized by similar issues concerning patents – long-term process, high costs, as well a lack of incentives (silaghi & medeşfălean, 2014; world bank, 2010), it is important to determine the nature of the relationship between patents and (a) economic growth and (b) innovation. in accordance with all the above, this paper aims to examine the relationship between the number of registered patents and economic growth and innovation in bulgaria and romania. the paper is structured as follows: the results of relevant studies concerning the relationship between patents, economic growth and innovation are presented in the literature review section. the methodology and results section describes the sample and applied statistical tests used to examine the nature of the relationship between patents, economic growth and innovation, and then presents the research results and their explanation. the last part of the paper deals with the conclusions of the conducted study. literature review analyzing the nonlinear effect of r&d, patents and exports of high-tech products on economic growth in 35 oecd countries for the period 1992-2006, ersin et al. (2022) have determined that there are significant marginal effects of economic growth rates, which are followed by threshold effects dominated by the participation of research and development in gdp. according to the research results of pelinescu et al. (2019) there is a positive and significant impact of growth in r&d expenditure on gdp growth per capita. however, the authors point out that each country should adjust patent rights according to the country's development, as well as the development of the respective industry. in addition, they determined that stronger patent protection is not desirable in underdeveloped countries. depending on the development of the economy, the contribution of patents to economic growth can differ (eliasson et al., 2004). pradhan et al. (2020) point to the role of intellectual property as one of the key drivers of economic growth. bearing in mind that developed countries are characterized by a significant fund of technological knowledge and human capital (alnuaimi et al., 2012), as well as appropriate institutional frameworks related to the protection of patents, that is, intellectual property rights (candelinpalmqvist et al., 2012), it can be concluded that developed countries may have better abilities to maximize utility from patents. based on the analysis of data from 99 countries in the period 1996-2018, rubilar-torrealba et al. (2022) claim that the more developed a country is, the more patents it tends to have. the increase in the number of patents can contribute to the development of innovations that can have a positive impact on economic growth (marjanović et al., 2019; caseiro & simões, 2019; pradhan et al., 2019). the number of patents is considered to be an adequate indicator for evaluating the success of innovative activities (dang & motohashi, 2015). patents can be used as a proxy for innovation crosby (2000) or as an indicator of innovation (blind et al., 2021). patent data are more closely related to innovation than research ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 51 and development data. in addition, patent data are more widely available since they cover a longer period and can be used in time series analysis crosby (2000). the research results, which in 1998-2016 included 43 countries (26 developed economies and 17 developing countries), showed that the number of new patents in the field of information and communication technologies (ict patents) has a positive one-way impact on economic growth. it is important to note that this type of patent has a positive long-term impact. also, the authors of the study identified a significant positive impact of patents on economic growth in developed countries. in contrast to developing countries, the impact of patents on economic growth is negative (nguyen & doytch, 2022). analyzing 4 european countries and 12 sectors, blind & jungmittag (2008) found that patents contribute to economic growth. likewise, the study points to the conclusion that patents are more important for growth in r&d-intensive industries. a positive impact of the number of patents on economic growth in the long term was identified in the study of josheski & koteski (2011), which covered the g7 countries in the period 1963–1993, while a negative impact was found in the short term. sinha (2008) examined the relationship between the number of patents and economic growth in japan and south korea over the period 1963-2005. in the case of japan, a two-way causal relationship was identified between the number of patents and real economic growth. in contrast to south korea, there is a one-way relationship between real gdp growth to the growth in the number of patents. the results of the regression analysis showed that a 1% increase in key technological patents leads to an average increase in gdp per capita by 0.108% (wurster, 2021). maradana et al. (2017) determined the existence of a significant connection between patents and economic growth per capita in the long term based on data for 19 european countries in the period 1989–2014. in romania, portugal, belgium, italy, germany, finland, greece, the netherlands and the uk, it was found that there is unidirectional causality from the number of resident patents to gdp growth. additionally, the results point to the conclusion that there is unidirectional causality from economic growth per capita to the number of patents of residents in hungary, norway, the czech republic, denmark and ireland. in addition, a two-way causality was established between the number of resident patents and economic growth per capita. in the case of the number of non-resident patents in romania, belgium, the czech republic, france, the netherlands, spain and sweden, there is unidirectional causality from the number of non-resident patents to economic growth per capita. unidirectional causality from economic growth to the number of non-resident patents was identified in norway, greece, finland and germany. bidirectional causality was found in portugal, the uk, denmark, ireland and hungary. the results of the research conducted by crosby (2000) based on the data on the number of patent applications in australia in the period 1901-1997 showed that the increase in patents leads to the economic growth of the country. crosby (2000) established the existence of a positive relationship between patents and economic growth in the short term; however, schmookler (2013) claims that this relationship should be negative in the short term, while it should be positive in the long term. akçomak & ter weel (2009) claim that there is a positive impact of the number of patent applications per population on the growth of gdp per capita based on the analysis of data from european countries in the period 1990 2002. hasan & tucci (2010), based on data for 58 states in the period 1980 2003, revealed a positive influence of the ratio patents / r&d expenses on the growth of gdp per capita. the existence of a positive relationship between patents and economic growth was established in romania (nae & grigore, 2014). similar conclusions were obtained in a study conducted by (pelinescu, 2017) based on data from unesco and eurostat databases for the period 2000-2015. a negative correlation between the number of patent applications and the gdp growth rate was identified in malaysia, china and indonesia based on the data from the period 2000-2009 (saini & jain, 2011). a study conducted by silaghi & medeşfălean (2014) based on the data for the period 1990-2010 in romania shows that patents have a statistically significant negative impact on economic growth. in addition, it was determined that an increase in the number of 52 economic analysis (2022, vol. 55, no. 2, 49-65) patents by 1% leads to a decrease in gdp by 0.089%. the authors claim that technologies in romania are most often imitated from abroad. it is also worth mentioning that companies that carry out r&d activities patent their products where they will sell them, which is usually outside the country. the biggest issues are considered to be the time required to obtain a patent, high costs and an underdeveloped market for trading the patented product. iwaisako & futagami (2013) explain the negative impact as a result of a high level of patent protection that significantly reduces the demand for capital, which consequently has a negative impact on output. myszczyszyn (2020) claims that in the long run, there is no relationship between the number of patents and economic growth in germany based on data from 1872–1913. similar are the conclusions of blind et al. (2021), who analyzed data related to the period 1981 2014 for 15 eu countries and found that there is no significant impact of patents on economic growth in the long term. data analysis and findings patents represent the product of innovative knowledge and facilitate the spread of technology, thereby stimulating economic growth. the main goal of the work was to determine whether the increase in the number of registered patents per million inhabitants affects economic growth, measured by gdp per capita, and the growth of innovation, measured by the innovation index of a country. the analysis was based on a quantitative research design (comparative approach). the empirical research covered two countries (romania and bulgaria) in the period from 2008 to 2018. the analysis used secondary data from internationally recognized databases on the phenomena that were the subject of research in this paper: 1. world bank and 2. world intellectual property organization. the secondary data used in the paper were based on several advantages that these data contain, and for that reason, were taken as relevant. the main reasons for choosing these databases are the ability to access identical data, their immediate availability, and the mutual comparability of data for romania and bulgaria. keeping in mind the aspiration to avoid the possible existence of different measuring instruments for the same phenomena in the national statistics of the countries included in the analysis, the data of international organizations were chosen (table 1) rather than the data of national statistics. table 1. number of patents, innovation index and gdp per capita country romania variable / year total patents total population number of patents* gii** gdp *** 2008 20,537,875 2.44 6,730 2009 1,150 20,367,487 56.46 2.92 6,410 2010 1,501 20,246,871 74.13 3.22 6,190 2011 1,599 20,147,528 79.36 36.83 6,350 2012 1,244 20,058,035 62.02 37.80 6,510 2013 1,241 19,983,693 62.10 40.33 6,760 2014 1,252 19,908,979 62.88 38.08 7,020 2015 1,235 19,815,481 62.32 38.20 7,330 2016 1,255 19,702,332 63.70 37.90 7,720 2017 1,452 19,587,491 74.13 39.16 8,320 2018 1,501 19,473,936 77.08 37.59 8,700 country bulgaria 2008 7,492,561 2.12 5,140 2009 397 7,444,443 53.32 2.85 4,990 2010 391 7,395,599 52.87 3.26 5,050 2011 395 7,348,328 53.75 38.42 5,300 ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 53 2012 371 7,305,888 50.78 40.70 5,350 2013 500 7,265,115 68.82 41.33 5,400 2014 467 7,223,938 64.65 40.74 5,530 2015 512 7,177,991 71.33 42.16 5,790 2016 427 7,127,822 59.91 41.42 6,050 2017 425 7,075,947 60.06 42.84 6,310 2018 459 7,024,216 65.34 42.65 6,550 notes: *number of patents per million inhabitants; **gii = global innovation index; ***gdp per capita source: wipo (2019), country profile – romania, bulgaria, available at: https://www.wipo.int/ipstats/en/statistics/country_profile/; world bank (2019), total population by country romania, bulgaria, available at: https://data.worldbank.org/indicator/sp.pop.totl since the secondary data available in international databases had the character of time series, appropriate econometric models for time series were used in the analysis. statistical testing of correlations between the variables shown in table 1 was performed through simple linear regression for each pair of independent and dependent variables individually. this was performed because the small sample size (n < 30) and the nature of the formulated hypothesis (only one independent and two dependent variables) did not allow the application of a more complex regression technique such as multiple regression or multivariate multiple regression, which require the existence of at least two independent variables and significantly a larger number of observations (hair et al., 2014). given that no data were available on the total number of registered patents for romania and bulgaria for 2008, it was not possible to calculate the number of patents per capita. if you look at the data on the innovation index from table 1, you can see that the data for the first three years (2008, 2009 and 2010) were presented using a different methodology compared to the other observation periods. for the results of the statistical analysis to be precise and clear, the research used data for the period from 2011 to 2018. statistical testing of relationships between variables was performed through simple linear regression for each pair of independent and dependent variables individually for romania and bulgaria. in the first case, in the example of romania, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (the dependent variable is the innovation index; the independent variable is the number of patents per million inhabitants). the results of the simple linear regression are presented in table 2. table 2. verification of fulfillment of assumptions case i (romania) variable / assumption number of patents per million inhabitants (n = 8) innovation index (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 2.558 d = 1.539 54 economic analysis (2022, vol. 55, no. 2, 49-65) variable / assumption number of patents per million inhabitants (n = 8) innovation index (n = 8) histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 2). the assumptions are not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 2, it was determined that there is no independence of observations when it comes to the number of patents per million inhabitants (d=2.558). the assumption is not met. ass. 4b. based on the conducted durbin watson statistic and the obtained results shown in table 2, it was determined that observations are independent when it comes to the country's innovation index (d=1.539). the assumption is fulfilled. ass. 5. and ass. 6. based on the performed analysis and obtained results shown in table 2 (histograms and p-p diagrams of normality), it was determined that there is no absence of heteroskedasticity and normal distribution of residual errors. assumptions are not made. in the second case, in the example of romania, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (dependent variable = gdp per capita; independent variable = number of patents per million inhabitants). the results of the simple linear regression are presented in table 3. ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 55 table 3. verification of fulfillment of assumptions case ii (romania) variable / assumption number of patents per million inhabitants (n = 8) gdp per capita (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 0.258 d = 1.140 histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 3). assumptions are not met. ass. 4. based on the conducted durbin watson statistic, it was determined that (a) there is no independence of observations when it comes to the number of patents per million inhabitants (d=0.971), (b) there is no independence of observations when it comes to gdp per capita (d=1.052). the assumption is not met. ass. 5. and ass. 6. based on the performed analysis and the obtained results shown in table 3. (histograms and p-p diagrams of normality), it was determined that in the case of the independent variable (number of patents per million inhabitants) there is an absence of heteroscedasticity and normal distribution of residual errors. in contrast, in the case of the dependent variable (gdp per capita), this was not the case. the assumptions are partially fulfilled. given that the obtained results showed that these assumptions were not met or only partially met, the next task was to transform the data based on the logarithm (table 4). 56 economic analysis (2022, vol. 55, no. 2, 49-65) table 4. results of linear regression model summaryb variables the number of patents per million inhabitants and the country's innovation index r r square adjusted r square se of the estimate 0.417a 0.174 0.036 0.01177 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita r r square adjusted r square se of the estimate 0.329a 0.108 -0.041 0.05052 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf anovab variables the number of patents per million inhabitants and the country's innovation index sum of squares df mean square f p regression 0.000 1 0.000 1.260 0.305a residual 0.001 6 0.000 total 0.001 7 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita sum of squares df mean square f p regression 0.002 1 0.002 0.726 0.427a residual 0.015 6 0.003 total 0.017 7 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf coefficientsa variables the number of patents per million inhabitants and the country's innovation index unstandardized coefficients standardized coefficients t p b std. error beta (constant) 1.777 0.174 -0.417 10.225 0.000 patent_transf -0.107 0.095 -1.122 0.305 a. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita unstandardized coefficients standardized coefficients t p b std. error beta (constant) 3.228 0.746 0.329 4.326 0.005 patent_transf 0.347 0.408 0.852 0.427 a. dependent variable: bdp_i_transf source: authors' research in the simple linear regression model for the variables number of patents per million inhabitants and the country's innovation index, a correlation coefficient of r = 0.417 was determined, which, according to cohen's criteria, can be considered a medium. based on the ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 57 obtained results, r2 = 0.174 (coefficient of determination) and adj.r2 = 0.036 (corrected coefficient of determination), it is concluded that a total of 17.4% and 3.6% of changes in the dependent variable, the country's innovation index, can be explained by changes in the independent variable, the number of patents per million inhabitants. based on the results of the anova test (f (1,6) = 1.260 and p = 0.305), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for changes in the country's innovation index. the obtained results showed that the value of the ordinary regression coefficient is b = 1.777 (se b = 0.174), while the value of the standardized regression coefficient is β = -0.417. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the country's innovation index in the case of romania. in the simple linear regression model for the variables number of patents per million inhabitants and gdp per capita, a correlation coefficient of r = 0.329 was determined, which according to cohen's criteria, can be considered as large (significant). based on the obtained results r2 = 0.108 (coefficient of determination) and adj.r2 = -0.041 (corrected coefficient of determination), the conclusion is that a total of 10.8% of changes in the dependent variable gdp per capita can be explained by changes in the independent variable number of patents per million inhabitants. however, this result should be taken with a grain of salt, while the entire explanatory power of the regression model should be assessed as insignificant. based on the results of the anova test (f (1,6) = 0.726, p = 0.427), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for changes in the gdp per capita. the obtained results showed that the value of the ordinary regression coefficient is b = 3.228 (se b = 0.746), while the value of the standardized regression coefficient is β = 0.329. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the gdp per capita in the case of romania. in the first case, using the example of bulgaria, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (dependent variable = innovation index; independent variable = number of patents per million inhabitants). the results of the simple linear regression are presented in table 5. 58 economic analysis (2022, vol. 55, no. 2, 49-65) table 5. verification of fulfillment of assumptions case i (bulgaria) variable / assumption number of patents per million inhabitants (n = 8) innovation index (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 1.220 d = 2.029 histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 5). the assumptions are not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 5, it was determined that there is no independence of observations when it comes to the number of patents per million inhabitants (d=1.220). the assumption is not met. ass. 4b. based on the conducted durbin watson statistic and the obtained results shown in table 5, it was determined that observations are independent when it comes to the country's innovation index (d=2.029). the assumption is fulfilled. ass. 5. and ass. 6. the results shown in table 5 (histograms and p-p diagrams of normality) were intended to show the absence of heteroskedasticity and the normal distribution of residual errors in the dependent and independent variables. the assumptions are partially fulfilled. in another case, using the example of bulgaria, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (dependent variable = gdp per capita; independent variable = number of patents per million inhabitants). the results of the simple linear regression are presented in table 6. ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 59 table 6. verification of fulfillment of assumptions case ii (bulgaria) variable / assumption number of patents per million inhabitants (n = 8) gdp per capita (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 0.322 d = 1.711 histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 6). assumptions are not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 6, it was determined that there is no independence of observations when it comes to the number of patents per million inhabitants (d=0.322). the assumption is not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 6, it was determined that observations are independent when it comes to gdp per capita (d=1.711). the assumption is fulfilled. ass. 5. and ass. 6. the results shown in table 6 (histograms and p-p diagrams of normality) were intended to show the absence of heteroscedasticity and the normal distribution of residual errors in the dependent and independent variables. the assumptions are partially fulfilled. given that the obtained results showed that these assumptions were not met or only partially met, the next task was to transform the data based on the logarithm (table 7). 60 economic analysis (2022, vol. 55, no. 2, 49-65) table 7. results of linear regression model summaryb variables the number of patents per million inhabitants and the country's innovation index r r square adjusted r square se of the estimate 0.560a 0.313 0.199 0.01349 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita r r square adjusted r square se of the estimate 0.319a 0.102 -0.048 0.03583 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf anovab variables the number of patents per million inhabitants and the country's innovation index sum of squares df mean square f p regression 0.000 1 0.000 2.739 0.149a residual 0.001 6 0.000 total 0.002 7 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita sum of squares df mean square f p regression 0.001 1 0.001 0.680 0.441a residual 0.008 6 0.001 total 0.009 7 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf coefficientsa variables the number of patents per million inhabitants and the country's innovation index unstandardized coefficients standardized coefficients t p b std. error beta (constant) 1.320 0.179 0.560 7.395 0.000 patent_transf 0.165 0.100 1.655 0.149 a. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita unstandardized coefficients standardized coefficients t p b std. error beta (constant) 3.370 0.474 0.319 7.106 0.000 patent_transf 0.219 0.265 0.825 0.441 a. dependent variable: bdp_i_transf source: authors' research in the simple linear regression model for the variables number of patents per million inhabitants and the country's innovation index, a correlation coefficient of r = 0.560 was ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 61 determined, which according to cohen's criteria, can be considered large (significant). based on the obtained results r2 = 0.313 (coefficient of determination) and adj.r2 = 0.199 (corrected coefficient of determination), it is concluded that a total of 31.3% and 19.9% of changes in the dependent variable, the country's innovation index, can be explained by changes in the independent variable, the number of patents per million inhabitants. based on the results of the anova test (f (1,6) = 2.739 and p = 0.149), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for the changes in the country's innovation index. the obtained results showed that the value of the ordinary regression coefficient is b = 1.320 (se b = 0.179), while the value of the standardized regression coefficient is β = 0.560. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the country's innovation index in the case of bulgaria. in the simple linear regression model for the variables number of patents per million inhabitants and gdp per capita, a correlation coefficient of r = 0.319 was determined. according to cohen's criteria, it can be considered a medium. based on the obtained results r2 = 0.102 (coefficient of determination) and adj.r2 = -0.048 (corrected coefficient of determination), the conclusion is that a total of 10.2% of changes in the dependent variable gdp per capita can be explained by changes in the independent variable number of patents per million inhabitants. however, this result should be taken with a grain of salt, while the entire explanatory power of the regression model should be assessed as insignificant. based on the results of the anova test (f (1,6) = 0.680, p = 0.441), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for changes in the gdp per capita. the obtained results showed that the value of the ordinary regression coefficient is b = 3.370 (se b = 0.474), while the value of the standardized regression coefficient is β = 0.319. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the gdp per capita in the case of bulgaria. conclusion the national innovation system of romania includes numerous institutions, organizations and agencies that have a highly developed organizational structure. however, the developed organizational structure in the case of the national innovation system of romania does not imply its efficiency because the system is excessively fragmented and needs to provide equal access to all actors in terms of financial support. financial investments in the field of research, development and innovation in romania in the analyzed period (2008-2018) are very low, the results of the policy in this area are modest, the demand for innovation is low while the supply of human resources is inadequate. in 2014, a new law on innovations was adopted with the task of interpreting private property rights and improving the development of patents, which was supposed to have a direct impact on the economy. nevertheless, there was still a low interest of companies in activities in the field of research, development and innovation, and the majority of companies justified their attitude with large allocations, the riskiness of the venture and the uncertainty of the results. a small number of innovations derive from the structure of the romanian economy itself, in which low and medium technologies prevail. 62 economic analysis (2022, vol. 55, no. 2, 49-65) on the other hand, during the analyzed period, bulgaria's innovation system, although institutionally developed, suffered from two pressing challenges inefficiency and the absence of significant financial resources that would ensure its development. in addition, the main problems faced by bulgaria in the field of research, development and innovation are their small application in the business sphere, weak demand for innovations, and poor cooperation between the academic community and the economy. however, despite all the developments that have taken place in the previous 10 years or so, bulgaria's innovation system is still facing major challenges, among which are the basic ones: how to ensure the continuity of a satisfactory intensity of investment in research and development, how to improve cooperation with the business sector; and how to create a climate and framework for the introduction of publicprivate partnership in the research and development system. of all the forms of intellectual property and technological innovation, patents are most often associated with them since they protect the essence of technological innovation. to create innovations to introduce new and improved products or services to the market, or to introduce new and improved production processes, companies must invest in research and development. therefore, the conducted research aimed to determine whether the increase in the number of patents per million inhabitants affects economic growth and the increase in the innovation index of romania and bulgaria. based on the obtained coefficients of correlation and determination and the absence of statistical significance of the regression model, the obtained results of the empirical research showed that in the case of romania and bulgaria, the following applies: (a) there is no statistically significant correlation between the number of patents per million inhabitants and the innovation index (b) there is no statistically significant correlation between the number of patents per million inhabitants and gdp per capita. if the national innovation systems of romania and bulgaria were to be compared, it could be concluded that there is an evident lack of cooperation between the business sector and the academic community. in addition, innovation in the economy is at a very low level. this is reflected in the entire system, which is inefficient and underfunded. all this supports the fact that the results obtained through this research are not a big surprise. in the analyzed countries, there are still many open dilemmas regarding cooperation between science and business. thereupon, there is little demand for innovation, but also an open question of the success of applying for patents in the business sector. based on all of the above, it is highly debatable whether romania and bulgaria would have more significant results if: • there was an increase in the number of patents per capita, • they invested more funds in the area of research and development, and • they hired a significantly larger number of better-quality researchers. the results of the conducted research, to a certain extent, can be of importance to decisionmakers in romania and bulgaria through certain recommendations, which refer to the efficiency of national innovation systems and the level of demand for innovation within each national economy. therefore, it is very important that policymakers in the field of innovation adequately present the impact that innovation has on the country's economy. an increase in the number of patents per million inhabitants does not guarantee that in these countries, there will be an increase in the innovativeness of the economy and an increase in well-being. for this to happen, it will be necessary for patents to have their application and for all actors in that process to understand that only the application of patents can enable significantly better results in business. the conducted research also has several limitations. the first drawback is the relatively small sample, considering that the analysis was performed only for two countries romania and bulgaria. for subsequent research, it is proposed to increase the sample to four or more countries, with the recommendation that they are countries of the european union or countries ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 63 of one region. the small number of indicators analyzed is another limitation of this research. given that the focus of this paper was on determining the impact of the number of patents on innovation and economic growth of the country, the recommendation for future research is to expand the list of indicators to be analyzed (e.g., production growth, employment growth, competitiveness). in this research, the analysis was performed for the period 2008-2018, which represents the third limitation of this work. in some future research, it is recommended to use data from as long a time series as possible (e.g. 30 years). acknowledgements this paper is financed by the ministry of education, science and technological development of the republic of serbia. references akçomak, s., & ter weel, b. 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(2004). simulating the new economy. structural change and economic dynamics, 15(3), 289-314. ersin, ö., ustabaş, a., & acar, t. (2022). the nonlinear effects of high technology exports, r&d and patents on economic growth: a panel threshold approach to 35 oecd countries. romanian journal of economic forecasting, 25(1), 26-44. european patent office (epo). (2022). bulgaria marks 10 years of membership in the european patent organisation. https://www.epo.org/news-events/news/2012/20121022.html hair, j.f., black, w.c., babin, b.j., & anderson, r.e. (2014). multivariate data analysis. harlow: pearson education. hasan, i., & tucci, c.l. (2010). the innovation–economic growth nexus: global evidence. research policy, 39(10), 1264-1276. http://ebooks.ien.bg.ac.rs/1613/ http://ebooks.ien.bg.ac.rs/1613/ https://www.epo.org/news-events/news/2012/20121022.html 64 economic analysis (2022, vol. 55, no. 2, 49-65) iwaisako, t., & futagami, k. (2013). patent protection, capital accumulation, and economic growth. economic theory, 52(2), 631-668. josheski, d., & koteski, c. (2011). the causal relationship between patent growth and growth of gdp with quarterly data in the g7 countries: cointegration, ardl and error correction models. https://mpra.ub.uni-muenchen.d /33153/1/mpra_paper_33153.pdf maradana, r.p., pradhan, r.p., dash, s., gaurav, k., jayakumar, m., & chatterjee, d. (2017). does innovation promote economic growth? evidence from european countries. journal of innovation and entrepreneurship, 6(1), 1-23. marjanović, d., ahmetagić, d., & beraha, i. (2019). comparative analysis of high technology exports and selected innovation indicators for serbia and cee countries. economic analysis, 52(2), 93-103. moser, p. (2013). patents and innovation: evidence from economic history. journal of economic perspectives, 27(1), 23-44. myszczyszyn, j. (2020). the long-run relationships between number of patents and economic growth. european research studies, 23(3), 548-563. nae, g.g., & grigore, c. (2014). economic growth at regional level and innovation: is there any link? global journal of business, economics and management, 4(1), 16-21. nguyen, c.p., & doytch, n. (2022). the impact of ict patents on economic growth: an international evidence. telecommunications policy, 46(5). oecd. (2004). patents and innovation: trends and policy challenges. oecd publishing. pelinescu, e., pauna, c., saman, c., & diaconescu, t. (2019). human capital, innovation and economic growth in the eu countries. romanian journal of economic forecasting, 22(4), 160173. pelinescu, e. (2017). the impact of human capital on innovation and economic growth in romania. internal auditing & risk management, 12(2), 44-50. pradhan, r.p., arvin, m.b., nair, m., & bennett, s.e. (2020). sustainable economic growth in the european union: the role of ict, venture capital, and innovation. review of financial economics, 38(1), 34-62. pradhan, r.p., arvin, m.b., nair, m., bennett, s.e., & hall, j.h. (2019). the information revolution, innovation diffusion and economic growth: an examination of causal links in european countries. quality & quantity, 53(3), 1529-1563. rubilar-torrealba, r., chahuán-jiménez, k., & de la fuente-mella, h. (2022). analysis of the growth in the number of patents granted and its effect over the level of growth of the countries: an econometric estimation of the mixed model approach. sustainability, 14(4). saini, a.k., & jain, s. (2011). the impact of patent applications field on sustainable development of selected asian countries. international journal of information technology, 3(2), 358-364. schmookler, j. (2013). invention and economic growth. harvard university press. silaghi, m.p., & medeşfălean, r. (2014). some insights about determinants of economic growth in romania. an empirical exercise. theoretical & applied economics, 21(6), 23-36. sinha, d. (2008). patents, innovations and economic growth in japan and south korea: evidence from individual country and panel data. applied econometrics and international development, 8(1), 1-23. word bank. (2010). bulgaria's hidden growth potential lies in research, innovation and technology. https://www.worldbank.org/en/news/press-release/2010/06/21/bulgariashidden-growth-potential-lies-research-innovation-technology world bank. (2022). charting a path to future prosperity with the long term growth model. https://www.worldbank.org/en/news/feature/2022/02/15/charting-a-path-to-futureprosperity-with-the-long-term-growth-model/ https://mpra.ub.uni-muenchen.d/ http://ebooks.ien.bg.ac.rs/1402/ http://ebooks.ien.bg.ac.rs/1402/ https://www.worldbank.org/en/news/press-release/2010/06/21/bulgarias-hidden-growth-potential-lies-research-innovation-technology https://www.worldbank.org/en/news/press-release/2010/06/21/bulgarias-hidden-growth-potential-lies-research-innovation-technology https://www.worldbank.org/en/news/feature/2022/02/15/charting-a-path-to-future-prosperity-with-the-long-term-growth-model/ https://www.worldbank.org/en/news/feature/2022/02/15/charting-a-path-to-future-prosperity-with-the-long-term-growth-model/ ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 65 wurster, m. (2021). intellectual property – how key technology patents stimulate economic growth. https://globaleurope.eu/globalization/intellectual-property-how-key-technologypatents-stimulate-economic-growth/ article history: received: 26.9.2022. revised: 28.11.2022. accepted: 5.12.2022. https://globaleurope.eu/globalization/intellectual-property-how-key-technology-patents-stimulate-economic-growth/ https://globaleurope.eu/globalization/intellectual-property-how-key-technology-patents-stimulate-economic-growth/ ea_2014_3-4 udc: 005.332.8:339.56(497.6) 336.143.232 jel: h60, h62, h63, h68 cobiss.sr-id 211784972 original scientific paper effects of foreign trade on budget equilibrium case study of bosnia and herzegovina alihodžić almir1, university of zenica faculty of economics, bosna and herzegovina đonlagić dženan2, school of economics and business university of sarajevo, bosna and herzegovina abstract – the analysis of economic trends in bh in 2012 recorded further weakening of economic activity. primarily, this is a result of stagnant economies of the eu and the region. in the first trimester of 2013 year, exports grew in real terms by 19% and imports by 13%, which led to the real growth in the trade deficit to about 7%. the given deficit significantly reduced the earlier estimate of economic growth for the first trimester in which the strong export growth, coupled with an increase in industrial production represented a very important step forward compared to the previous year. the main objective of this paper is to discuss the global financial crisis, the movement of the budget deficit in bh for the period 200 2012, as well as monitor the constraints set by the maastricht treaty that the amount of the budget deficit should not exceed 3% of the gdp and the interdependence of imports of goods and nominal gdp. key words: imports of goods, exports of goods, indicators of foreign trade, budget deficit, criteria of convergence introduction fiscal policy is a modern financial policy that contains a component of social economic policy implemented by public finance management measures of restrictive or expansionary fiscal policy. it is also associated with the economic and political dimensions of social policy, which permanently loses neutrality effects on reproduction (kešetović et. al., 2012, pp. 26). one of the most important tasks of fiscal policy is to manage the budget deficit – i.e. manage its excess of expenditures over revenues. in an open economy, it ultimately must balance the net saving in the private sector, as well as the balance of current account payments with the rest. therefore, properly defining and then measuring the budget deficit is one of the main tasks of the fiscal policy but there is no single perfect measure and deficits but for different purposes using different definitions and define its different measurement. the most commonly used definition of the deficit is the conventional deficit and it measures the difference between the cash total government revenue and total cash 1university of zenica – faculty of economics, email: almir.dr2@gmail.com, almir_alihodzi@yahoo.com 2 school of economics and business university of sarajevo, email: dzenan.djonlagic@efsa.unsa.ba economic analysis (2014, vol. 47, no. 3-4, 121-135) 122 expenditures, which must be financed by new borrowing. this measure is also called the deficit and the need for the public sector borrowing public sector borrowing requirement. a surplus (deficit) budget represents the excess of government expenditures over tax revenues in a given period, usually one year, while on the other hand the budget surplus occurs when tax revenues exceed government expenditures (mishkin, 2010, pp. 12). budgetary expenditures include salaries of public servants, purchase of goods and services, government investments, interest on the public debt, transfers and subsidies. on the other hand, the budget revenues include the obligations, duties, interest on state property, transfers, surpluses of public enterprises and proceeds from the sale of public assets. the given concept of deficit measures government expenditure and lending taken for the implementation of public policies, with revenues from taxes, grants and payment of the loan, and without future borrowings or impaired state of liquid reserves. the advantage of this concept is a comprehensive view of the overall financial condition of state and its impact on monetary conditions, domestic demand and external accounts. in practice, it is difficult to find conventional deficit on purely cash basis. typically, a combination of cash and budget deficit is used. the budget deficit on a cash basis is the actual result of budgetary funds assets and liabilities, while the budget deficit on an accrual basis arises when assets and liabilities are recorded at the time of issuance of an order, not at the time of occurrence of actual cash flow. a delay in the performance of its obligations to suppliers and creditors or default on budget revenues results in arrears whose size can significantly affect the budget deficit. financial indiscipline or high inflation contributes to the increased occurrence of arrears increasing the difference between conventional, cash budget deficit and the calculation of the budget deficit (institute of public finance, 2013). in most countries, poorly managed fiscal policy is the main cause of many problems such as high inflation, high budget deficits and low economic growth. the way out of this situation requires an appropriate fiscal adjustment. therefore, if the current government spending is not financed from the current tax and non-tax state revenues, it can quickly lead to the growth of aggregate demand, and ultimately inflation. this is particularly true in countries where the state has allowed funding from the primary issue of the central bank. therefore, it is necessary that the state, as well as all other participants borrow only on the market. in addition, in excessive government borrowing from banks, it is often the main factor affecting the overall monetary expansion, and appropriate fiscal adjustments are also needed to stop the expansion (golomejić raspudić, 2011, pp. 144). the total trade deficit in bh in 2012 increased by of 1.3% compared to the 2011. negative economic growth was reflected in real decline in domestic demand and exports, decreased investment financing by local banks and the fall in industrial production (bh directorate for economic planning, 2013). the paper is structured in three parts. the first section describes the basic settings of the budgetary convergence and opportunities of deficit financing, and impact of global financial crisis on the budget deficit of individual eu countries and the western balkan countries. the second part is devoted to the analysis of the budget deficit in bh and opportunities for sustainability in the long term. the third part describes the possible application of regression model, where it will be determined by strength and direction of relationship between alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 123 variables such as: (1) the importation of goods in bh, and (2) the movement of nominal gdp. at the end of the study, concluding remarks are given. justification for budgetary convergence and deficit financing deficit financing has proved so far to be insufficiently effective means of increasing economic growth and modernization of economy, but on the other hand it is quite effective in supporting the overall demand in the economy, particularly in terms of demand when the economy shows a tendency of sharp decline. first, this deficit financing involves the realization of a long-term economic program, which comes to the fore, where deficit financing and public debt is becoming an important factor for the program. increase of budget deficit in all economies followed by an ongoing growth of the public debt for its coverage is the reality of modern market economies (komazec, ristic, 2011, pp. 107-108). candidate countries for joining the monetary union had a lot of problems in reaching the set convergence criteria. in fact, most problems occurred in achieving the criteria of budget deficit and public debt, which has forced the country to a very strict fiscal discipline and caused a number of social protests in the member states. the reasons for this situation should be look for in the method for covering the budget deficit. the budget deficit of candidate countries mainly covers the real financial income/tax, which directly affects the living standards of population and ultimately can cause serious social protests. similarly, reducing the budget deficit to a level of 3% of gdp means savings that can influence the level of flexibility and efficiency of fiscal policy and employment. therefore, these facts were the main reason for many economists to criticize the proposition for which the budget deficit should amount to 3% and public debt 60% of gdp. these figures were obtained in a manner based on the principle that determines the amount of the budget deficit, which is needed to stabilize the public debt. the budget deficit is expressed as follows: � = � ∙ � �1 where: � − the level at which public debt is stabilized (steady state) expressed as a% of gdp; � − the growth rate of nominal gdp; and � − government budget deficit expressed as a% of gdp – a. in order to stabilize public debt at 60% of gdp and the budget deficit must be brought to a level of 3% of gdp provided that the nominal gdp growth rate is at 5%. the suggestion that was put in this way of calculating refers to the fact that it came to the conclusion that the public debt stabilizes at 60%, not to say 50% or 70%. as a justification, it is stated that the maastricht agreement specified percentage of 60%, as well as the fact that at that time most of the relationship between public debt and gdp ratio was 60% (furtula and marković, 2010, pp. 30-31). the second reason is based on future nominal growth rate of gross domestic product. if the nominal growth rate of gdp is greater than (less than) 5%, the budget deficit that stabilizes the public debt to 60% increases above (decreases) 3% (đonlagić, 2006th, pp. 48). economic analysis (2014, vol. 47, no. 3-4, 121-135) 124 the question that deserves attention relates to why the budgetary convergence was insisted on? the most important reason should be sought in connection with the budget deficit rate of inflation, as a country in which there is a high percentage of public debt to gdp and urges the government of the country to adopt measures that will cause unexpected inflation. the situation has a negative impulse to the owners of the state, i.e. long-term bonds, which leads to a significant reduction of their real value. on the other hand, the government of such countries realizes gains with respect to the real value of debt decreases. using the sudden inflation to reduce the real value of government debt in a high charge state reflects negatively on the country's low charge. under the circumstances, the convergence criteria was set, which provides an optimal relationship between government debt and gdp. for example, when a highly indebted country achieves a debt reduction to the required level, it will not have to use the mechanism of a sudden inflation, where its association with poor indebted countries will not pose a threat in terms of an increase in the inflation rate in the eu. unlike defined convergence criteria, there is a legitimate question: what criteria are missing, which can be considered very important? santini (2011) considered that the criterion of missing long-term relationships is a balanced relationship with the rest of the world, i.e. the requirement for a balance of payments. the following table illustrates the movement of tax revenues based on the surplus / deficit on the current account of balance of payments. table 1. movement of tax revenue on the basis of deficit / surplus in the current account balance the share of indirect taxes in total taxes tax revenues in the event of a deficit in the current account of balance of payments tax revenues in the event of a surplus in the current account 0 0 there is no reduction in tax revenues >0<1 the increase in tax revenues in proportion to the share of indirect taxes l (credit) increase in tax revenue in the present and the reduction of the tax capacity in the future reduction in tax revenue in proportion of indirect taxes s savings reducing tax revenue in the present and increasing tax capacity in the future 1 increasing the taxable amount of deficit l increase tax revenue in the present and the reduction of the tax capacity in the future reducing the size of taxable surplus s reduction in tax revenue in the present and increasing tax capacity in the future source: santini, g. (2011). a possible approach to the reform of tax system of republic of croatian, journal: economics, year 18, no. 1, zagreb, pp. 121 depending on the extent to which the tax system is of an expendable type with the clause ceteris paribus, the budget deficit is reduced/increased. thus, the classification of tax revenues based on the division of tax according to the criterion of time allows the quantification of tax revenues based on the deficit/surplus of the current account balance, that tax revenues from domestic and disposable domestic product. therefore, identification of tax revenue on the basis of the current account balance, as well as certain future tax corrects the size of the public debt. in addition, santini (2011) considers that the criteria of the alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 125 budget deficit and public debt should be supplemented by the following criteria: (1) marginal tax presses matched with income per capita to countries with lower income per capita had a smaller share of the state in the final distribution of gdp and, that is, with the growth of income per capita share of the state in the final distribution of gdp a progressively growing, and (2) agree on the maximum difference in the total indirect tax revenue of individual members of the eurozone, where countries with less income per capita had a higher proportion of indirect in relation to the direct taxes, which in extreme instances contributed to the increase in export competitiveness of less developed countries. influence of debt crisis on the budget deficit in the eu cumulative current account deficits over a longer period demanded constant sources of funding, such as the net inflow of foreign direct investment, portfolio investment, credit transactions on the account to reduce the foreign exchange reserves of the country. any borrowing abroad has its limits, i.e. the creation of net foreign debt, creates an obligation in the future. the table below illustrates the tendency of movement of current account deficit of some eu countries for the period 1992 2008. t a b le 2 . t h e te n de n cy o f cu rr en t a cc o u nt d ef ic it o f so m e e u c o u nt ri es a nd t he w o rl d f or t h e p er io d 1 9 9 2 2 0 08 s ou rc e: f ab ri s, n ., k il ib a rd a , b . ( 20 08 ). a n al ys is o f th e su st ai n ab il it y o f cu rr en t ac co u n t d ef ic it o f m o n te n eg ro , m o n te n eg ri n c en tr al b an k d iv is io n o f r es ea rc h , s ta ti st ic s an d i t , p od go ri ca , p . 1 0 , a va il ab le a t: ht tp :/ /w w w .c bcg .o rg /s li ke _i _f aj lo vi /f aj lo vi /f aj lo vi _p u bl ik ac ij e/ ra dn e_ st u di je /a n al iz a_ od r% c 5% b e iv os ti _d ef ic it a. pd f c o u n tr y 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 a rm en ia -4 6, 3 -6 ,0 -3 ,8 0 -1 7, 0 -1 8, 2 -1 8, 7 -2 2, 1 -1 6, 6 -1 4, 6 -9 ,5 -6 ,2 -6 ,8 -4 ,5 -3 ,9 -1 ,4 -4 ,0 -4 ,2 a u st ra li a -3 ,5 -3 ,1 -4 ,8 -5 ,2 -3 ,7 -2 ,9 -4 ,8 -5 ,3 -3 ,8 -2 ,0 -3 ,8 -5 ,4 -6 ,0 -5 ,8 -5 ,5 -5 ,7 -5 ,6 a ze rb ai ja n -1 6, 6 -1 2, 2 -5 ,5 -1 3, 2 -2 5, 9 -2 3, 1 -3 1, 9 -1 3, 1 -3 ,5 -0 ,9 -1 2, 3 -2 7, 8 -2 9, 8 1, 30 15 ,7 0 31 ,4 39 ,9 b u lg ar ia -4 ,4 -2 4, 7 -0 ,4 -0 ,2 0, 2 4, 1 -0 ,5 -5 ,0 -5 ,6 -5 ,6 -2 ,4 -5 ,5 -6 ,6 -1 2, 0 -1 5, 8 -2 0, 3 -1 9, 0 e st o n ia n /a 1, 2 -6 ,8 -4 ,2 -8 ,6 -1 1, 4 -8 ,7 -4 ,4 -5 ,4 -5 ,2 -1 0, 6 -1 1, 3 -1 2, 3 -1 0, 0 -1 5, 5 -1 6, 9 -1 5, 9 g eo rg ia n /a n /a -3 3, 8 -1 8, 3 -1 2, 6 -1 2, 8 -1 2, 8 -1 0, 0 -7 ,9 -6 ,4 -8 ,4 -9 ,3 -1 2, 2 -9 ,8 -1 3, 8 -1 5, 7 -1 5, 2 k az ak h st an -5 1, 6 -8 ,6 -7 ,8 -1 ,3 -3 ,6 -3 ,5 -5 ,5 -0 ,2 3, 0 -5 ,4 -4 ,2 -0 ,9 0, 8 -1 ,8 -2 ,2 -2 ,2 -1 ,1 m al ay si a -3 ,7 -4 ,6 -7 ,6 -9 ,7 -4 ,4 -5 ,9 13 ,2 15 ,9 9, 4 8, 3 8, 4 13 13 15 17 14 1, 3 m o ld o v a -6 ,9 -1 6, 7 -3 ,1 -4 ,6 -1 ,7 -6 ,2 -4 ,1 -1 3, 4 -8 ,2 -9 ,4 -5 ,6 -4 ,6 -1 6, 5 -3 5, 8 -4 0, 7 -4 0, 5 -3 6, 6 m al ta n /a n /a n /a -1 1, 9 -1 2, 6 -6 ,7 -6 ,5 -3 ,7 -1 2, 5 -3 ,8 -2 ,7 -2 ,8 -6 ,3 -8 ,0 -6 ,1 -9 ,4 -8 ,2 p o rt u g al -0 ,2 0, 3 -2 ,3 -0 ,1 -3 ,5 -5 ,8 -7 ,1 -8 ,5 -1 0, 2 -9 ,9 -8 ,1 -6 ,1 -7 ,7 -9 ,7 -9 ,4 -9 ,2 -9 ,2 r o m an ia -7 ,8 -4 ,7 -1 ,7 -4 ,5 -6 ,7 -5 ,4 -7 ,1 -4 ,1 -3 ,7 -5 ,5 -3 ,3 -5 ,8 -8 ,4 -8 ,7 -1 0, 3 -1 3, 8 -1 3, 2 se rb ia n /a n /a n /a n /a n /a n /a n /a n /a -1 ,7 -2 ,4 -7 ,9 -7 ,0 -1 1, 7 -8 ,5 -1 1, 5 -1 4, 7 -1 5, 0 sl o v ak ia n /a -6 ,3 4, 3 1, 9 -9 ,8 -9 ,1 -9 ,5 -4 ,8 -3 ,3 -8 ,3 -8 ,0 -6 ,0 -7 ,8 -8 ,6 -8 ,3 -5 ,3 -4 ,5 sp ai n -3 ,5 -1 ,1 -1 ,3 -0 ,3 -0 ,2 -0 ,1 -1 ,2 -2 ,9 -4 ,0 -3 ,9 -3 ,3 -3 ,5 -5 ,3 -7 ,4 -8 ,6 -9 ,8 -1 0, 2 t u rk ey 0, 1 -3 ,1 3, 1 -0 ,3 -1 ,2 -1 ,1 1, 0 -0 ,7 -5 ,0 2, 4 -0 ,8 -3 ,3 -5 ,2 -6 ,2 -7 ,9 -7 ,5 -7 ,0 u k ra in e -3 ,0 -2 ,9 -3 ,2 -3 ,1 -2 ,7 -2 ,7 -3 ,1 5, 3 4, 7 3, 7 7, 5 5, 8 10 ,6 2, 9 -1 ,5 -3 ,5 -6 ,2 u sa -0 ,8 -1 ,3 -1 ,7 -1 ,5 -1 ,6 -1 ,7 -2 ,4 -3 ,2 -4 ,3 -3 ,8 -4 ,4 -4 ,8 -5 ,5 -6 ,1 -6 ,2 -5 ,7 -5 ,5 alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 127 from the table above it is clear that the united states, turkey, estonia, slovakia, romania, bulgaria and other countries, have had for years a balance of payments deficit above 5% of gdp. based on the analysis, it can hardly be concluded that some of the observed countries were on the verge of an economic crisis. some advocates believe that countries can have years of current account deficits, and the economy does not suffer because of this if the deficit is used to finance private investment. on the other hand, the budget deficit could lead to the inability of the state to remit abroad. some analysts cite for example the case of russia from 1998, when the russian government was unable to pay the outstanding balance to abroad. the fact that the current account deficit does not matter if it is a result of private sector deficit lowson doctrine1 proved to be wrong, when the asian financial crisis occurred between 1997 and 1998, where in spite of budgetary imbalances there was still the crisis due to the high external indebtedness of the private sector (central bank of montenegro, 2008). measures taken by the governments of the member states in 2008, 2009 and 2010 were primarily aimed at supporting the financial system and mitigating the effects of the crisis that affected the real sector. the measures meant increase of insured deposits, issuing guarantees for liabilities of banks and recapitalisation of financial institutions. table 3. basic monetary and fiscal indicators in euro zone and eu for 2008 -2011 parameters 2008 2009 2010 2011 euro zone gdp (millions of euro) 9.241.541 8.922.208 9.176.138 9.420.834 budget deficit (millions of euro) -196.366 -566.498 -569.469 -390.708 (%gdp) -2,1 -6,3 -6,2 -4,1 public expenditure (%gdp) 47,1 51,2 51,0 49,5 public revenues (%gdp) 45,0 44,9 44,8 45,4 public debt (millions of euro) 6.489.962 7.135.458 7.833.349 8.227.833 (%gdp) 70,2 80,0 85,4 87,3 european union gdp (millions of euro) 12.472.988 11.754.729 12.278.824 12.650.044 budget deficit (millions of euro) -303.470 -806.992 -800.906 -560.834 (%gdp) -2,4 -6,9 -6,5 -4,4 public expenditure (%gdp) 47,1 51,1 50,6 49,1 public revenues (%gdp) 44,7 44,2 44,1 44,7 public debt (millions of euro) 7.763.975 8.764.582 9.826.981 10.433.926 (%gdp) 62,2 74,6 80,0 82,5 source: erić, d., djukić, m. (2012),financial markets in times of crisis, the institute of economic sciences, belgrade banking academy – faculty for banking ,insurance and finance, belgrade, pp. 382. greece had the highest deficit in 2009, i.e. 15.8%, and later in 2010, after severe austerity measures, it was reduced to 10.6%. the level of public debt in greece at the end of 2010 amounted to 144.9% of gdp (erić and djukić, 2012, pp. 382-383). as it can be seen, in 1 this doctrine was named after nigel lowson and it clarifies the extent to which the current balance deficits reflect the decisions of private savings and investment, and there are no disturbances and expectations are rational and there is no reason that the government operates. economic analysis (2014, vol. 47, no. 3-4, 91-135) 128 relation to 2010, budget deficit of the euro zone and eu in 2011 was reduced, while the public debt recorded an upward trend. in the euro zone, the deficit ratio to gdp decreased from 6.2% in 2010 to 4.1% in 2011, while in the eu it dropped from 6.5% to 4.4%. the public debt to gdp in the euro zone increased from 85.4% to 87.3% in late 2011, while in the eu it recorded growth of the indicator from 80% to 82.5% only one year later. at the time of joining the emu, greece shows a high level of budget deficit, which it sometimes seems to be the only country that has not met any of the fiscal conditions of eligibility for the monetary union. in addition, apart from fiscal conditions, greece basically did not meet any of the criteria for convergence, where the range in long-term interest rate in relation to the three countries with the lowest interest rate always showed a higher value than any other member state of the emu. likewise, the inflation rate was at a satisfactory level, only at the time of entry into the union. table 4. the current account deficit as % of gdp in the european union for the period 2011 2012 no. country currency 2011 2012 in mil./currency % of gdp in mil./currency % of gdp 1. belgium euro -13.777 -3,7 -14.852 -3,9 2. bulgaria bgn -1.492 -2,0 -624 -0,8 3. czech republic czk -124.943 -3,3 -169.003 -4,4 4. denmark dkk -33.018 -1,8 -72.470 -4,0 5. germany euro -20.230 -0,8 4.090 0,2 6. estonia euro 186 1,2 -46 -0,3 7. ireland euro -21.268 -13,4 -12.461 -7,6 8. greece euro -19.834 -9,5 -19.360 -10,0 9. spain euro -100.402 -9,4 -111.641 -10,6 10. france euro -105.392 -5,3 -98.196 -4,8 11. italy euro -60.016 -3,8 -47.633 -3,0 12. cyprus euro -1.132 -6,3 -1.127 -6,3 13. latvia lvl -509 -3,6 -187 -1,2 14. lithuania ltl -5.848 -5,5 -3.666 -3,2 15. luxembourg euro -98 -0,2 -359 -0,8 16. hungary huf 1.194.947 4,3 -531.585 -1,9 17. malta euro -183 -2,8 -226 -3,3 18. netherlands euro -27.009 -4,5 -24.405 -4,1 19. austria euro -7.385 -2,5 -7.684 -2,5 20. poland pln -76.094 -5,0 -62.698 -3,9 21. portugal euro -7.543 -4,4 -10.596 -6,4 22. romania ron -30.911 -5,6 -16.822 -2,9 23. slovenia euro -2.298 -6,4 -1.418 -4,0 24. slovakia euro -3.498 -5,1 -3.107 -4,3 25. finland euro -1.539 -0,8 -3.662 -1,9 26. sweden sek 7.160 0,2 -18.307 -0,5 27. uk gbp -118.632 -7,8 -97.794 -6,3 average: 2011 2012. -118.217 -7,8 -86.510 -5,6 alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 129 source: http://epp.eurostat.ec.europa.eu/cache/ity_public/2-22042013-ap/en/2-22042013-ap-en.pdf (access to date: 10.8.2013. at the end of 2011, the lowest ratio of the budget deficit and gdp was recorded in luxembourg (0.3%), finland (0.6%) and germany (0.8%), while hungary, estonia and sweden recorded a surplus of 4.3 %, 1.1% and 0.4% of gdp individually. also, according to eurostat data, the seventeen member countries had a deficit in excess of 3% gdp and to ireland (13.4%), greece (9.5%), spain (9.4%), united kingdom (7, 8%), slovenia (6.4%), cyprus (6.3%), lithuania (5.5%), romania (5.6%), france (5.3%), poland (5.0% ), slovakia (5.1%), the netherlands (4.5%), portugal (4.4%), italy (3.8%), belgium (3.7%), latvia (3.6%) and czech republic (3.3%). thus, one can conclude that, with respect to 2010, all eu member states in 2011 reduced the ratio of the budget deficit and gdp. also, at the end of 2012 the positive percentage of gdp was recorded in germany (0,2%), while all other observed countries of the european union had a negative value of percentage of gdp. the largest negative percentage of gdp recorded in the following countries: spain (-10,6%), greece (10,0%), ireland (-7,6%), portugal (-6,4%), cyprus and uk (-6,3%). management and potential for sustainability of budget deficits in bh bosnia and herzegovina has certain advantages in terms of movement of macroeconomic stability criteria, such as price stability and exchange rate stability, which are secured based on managing monetary policy through currency board arrangement since 1997. however, there are some delays in the fulfilment of structural reforms, among which a slow development of financial markets stands out, particularly money market and government securities market. the main challenges for the near future in the integration of bosnia and herzegovina into the european monetary union are expected in the area of public finance, with a focus on reducing the budget deficit and stabilizing the public debt as a segment of the implementation of effective fiscal policy in state of bosnia and herzegovina. the most important criteria in the context of integration of bosnia and herzegovina can be divided into two categories: first, the conditions arising from the feasibility study and the stabilisation and association agreement, which have been designed by the european union for all candidates for membership in the european union and, secondly, the conditions arising from the copenhagen criteria applicable for all candidates. on the other hand, the conditions arising from the maastricht treaty, known as convergence criteria, refer to the european monetary union and they need to be met by each member state of the european union prior to the introduction of euro as a common currency and accession to the european monetary union. the main goal of the fulfilment of the convergence criteria is to create a stable macroeconomic environment for the introduction of the common currency of euro and for the integration of the monetary system of bosnia and herzegovina into the european monetary union (đonlagić, 2006th, pp. 197-198). the maastricht criteria established boundaries of sustainability of the budget deficit to gdp which amounts to 3%. a legitimate question is whether the set boundaries are the condition for sustainability of the economic activity? in the continuation, we will use the regression model to test the interrelatedness of movement between imports and nominal gdp. economic analysis (2014, vol. 47, no. 3-4, 91-135) 130 stopping the growth of expenditures in relation to revenue decline was indeed insufficient to prevent further escalation of primary deficit, which in 2009 amounted to 3.9% of gdp. in fact, the deficit projection that the government did was much higher than that which actually occurred. consolidated bh has achieved a deficit of around 1 billion bam, as measured by the gdp amounts to 3.9% (expenditure approach), i.e. 4.4% of gdp a (production approach). implementation of these measures has had the greatest impact in 2010, where for the first time a decline followed by stagnation of social benefits compensation of employees. restrictive expenditure policy is continued in 2011, despite the significant growth of social welfare, which is largely achieved through savings in the area of material costs and subsidies. therefore, with revenue growth of 4.6%, primary deficit has been reduced to only 0.6% of gdp in 2011 (bh directorate for economic planning, 2012). in 2012, the trend of limiting spending continued with the primary objective of reducing the fiscal deficit. according to the fiscal rules adopted by the imf and the plan is that the fiscal deficit is at the level of 2011. in 2012, the same as the year before, the trend of deficit financing through the issuance of government treasury bills and bonds was continued with the aim to primarily regulate debts on various grounds. in 2012, the government of the federation of bosnia and herzegovina issued treasury bills in five emissions in the total value of 120 million bam. in addition, the republic of srpska issued bonds in three emissions in the total value of 112.8 million bam (cbbh, 2012). the table below illustrates the foreign trade indicators in bh for the period 2008. 2012. table 5. trends in foreign trade indicators for the period 2008 2012 indices 2008 2009 2010 2011 2012 total (2008 – 2012) index 1 2 3 4 5 6 7 8(6/2) export of goods 6.711.690 5.530.377 7.095.505 8.222.112 7.857.962 35.417.646 117,07% growth/export (of %) (17,60) 28,30 15,88 (4,43) import of goods 16.286.056 12.348.466 13.616.204 15.525.428 15.252.942 73.029.096 93,66% growth/import (of %) (24,18) 10,26 14,02 (1,75) balance of trade (export – import) (9.574.366) (6.818.089) (6.520.699) (7.303.316) (7.394.980) total trade 22.997.746 17.878.843 20.711.709 23.747.540 23.110.904 108.446.742 100,49% coverage of import by exports 41,2% 44,8% 52,1% 53,0% 51,5% source: http://www.dep.gov.ba/dep_publikacije/ekonomski_trendovi/archive.aspx?langtag=bsba&template_id=140&pageindex=1 (adaptation by author) from the table above, it is clear that the total value of imports for the period 2008 2012 amounted to bam 15.252.942, while the total value of exports for the same period was bam 35.417.646. maximum coverage of imports by exports was recorded in 2011 of 53%, whereas in 2012 there was a slight decline amounting to 51.5%. in 2012, imports were valued at 15.2 billion bam, which resulted in a decline in imports of about 1.8% over the previous year, alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 131 while exports declined by 4.4% in 2012, and reached a value of 7,8 billion bam. in all countries of the region except croatia, rates of decline in the value of imports were recorded, while in the export, positive growth rates were achieved by croatia and slovenia. most notably, the decline in exports was recorded in macedonia and serbia of about 10% compared with the previous year. the export-import ratio was reduced in all countries except slovenia, where slovenia has the highest export-import ratio that exceeds 95%. in countries with lower levels of per capita income, it is obviously a higher share of foreign trade in gdp. the graph below illustrates the change in import-export and export-import ratio for the year 2012 in the countries of the region. according to the central bank of bh (cbbh), the current account deficit balance of payments recorded a slight nominal increase of about 21 million bam or 0.9%, where in 2012 it amounted to 2.45 billion bam and represents a trend of increased deficits. therefore, in relative terms, the current account deficit in 2012 amounted to 9.5% of gdp which is the same level as in 2011. the increase in the deficit current account was primarily affected by the foreign trade deficit and decrease of the surplus in the services account (graph 1). graph 1. the current account deficit and merchandise account deficit as participation in gdp in bh for the period 2007 2012 source:// http://www.dep.gov.ba/default.aspx?langtag=bs-ba&template_id=139&pageindex=1 report on development of bh, 2012, economic planning, 2013, p. 10 (adaptation by author's) analysis of the interdependence of imports of goods and nominal gdp in bh regression equations are based on empirical data, where by the solution of the equation we can see that the change in imports of goods have a direct impact on nominal gdp in terms of increases or decreases. a simple linear regression model expresses a relationship between the two parameters as follows: �� = � ��� � �� � = 1,2,……�, �1 where: � dependent variable, � � unknown parameters that need estimate, and �� stochastic variable (error distances) economic analysis (2014, vol. 47, no. 3-4, 91-135) 132 in the regression model, which will be the subject of analysis, we will follow the mutual dependence of the movement of imported goods in bh and nominal gdp sector of the government of bh for the period 2008 2012. also, in this paper we will provide the analysis of variance, and hypothesis on the significance of the regression variables, the null hypothesis, which is the independent variable contention that does not significantly affect the dependent variable, and hypothesis 1, which assumes that the independent variable has a significant effect on the dependent variable. �� ….�� = 0 �� ….�� ≠ 0 based on the scatter diagram, i.e. the coefficient of correlation (r = -0.11513) it can be concluded that among these variables there is a statistical correlation of negative direction, i.e. that the increase in the value of imports of goods will affect the reduction in the value of nominal gdp. the chart below illustrates the interrelationship between imports of goods and nominal gdp for the period 2008 2012. graph 2. simple linear regression line between the imported goods in bh and nominal gdp for the period 2008 2012 source: calculation by author the empirical ratio f = 3.53 (table 5) certainly shows that the regression model is statistically significant. the coefficient of determination is ��= 0,013256, i.e. the model is interpreted to 1.32% deviation. based on these parameters, as well as indicators of the regression analysis, it can be concluded that the applied model with the statistical point of view has rather good features. y = -0.0005x + 24162 r² = 0.0133 0.00 5,000.00 10,000.00 15,000.00 20,000.00 25,000.00 30,000.00 0 5,000,000 10,000,000 15,000,000 20,000,000 n o m in al g d p imports of goods in b&h alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 133 table 6. pearson product moment correlation between imports of good and nominal gdp of government of bh variable 1 variable 2 mean 14185760 15770,5 variance 2,21e+12 30535723 observations 4 4 df 3 3 pearson correlation -0,798766 covariance -917571721 correlation -0,1151353 determination 0,013256145 t – test 19,00186 simple linear regression ungrouped date value s.e. t – stat beta 57878,22 22518,84 2,570213 elasticity -0,00297 0,001581 -1,87758 regression analysis of variance anova df sum of squares mean square regression 1 58447985 58447985 residual 2 33159184 16579592 total 3 91607169 f test 3,525297 sorce: calculation by author the regression equation is equal: � = 0,0005 � � 24162 "� = 0,0133 according to the above equation, if the value of imports of goods increased by one percentage point, indicator of nominal gdp will be reduced by an average of about 0.0005 percentage points. parameter estimation is statistically accurate. therefore, the analysis of relationships between the parameters imports and nominal gdp sectors of bh government on the basis of model adopted and data showed that among the above parameters there is a strong statistical linear relationship in the opposite direction. this confirms the null hypothesis that imports of goods and services, has no significant impact on gross domestic product. economic analysis (2014, vol. 47, no. 3-4, 91-135) 134 conclusion an analysis of macroeconomic indicators in bh in 2012 recorded a trend of weakening economic activity. first of all, the results of this situation should seek the stagnant economies of eu and the countries of the region. negative economic growth is manifested through a real drop in domestic demand and exports, the decline in investment funding and the decline in industrial production. this situation is reflected in the bh economy in terms of public finance statistics. as you can notice, the current account deficit in bh has overrun the limits set by the convergence criterion of 3% of gdp in the last few years, which will inevitably decline in gross domestic product, and ultimately to a deepening decline in economic activity. in order to reduce the deficit by the end of the year, certain levels of governments have already implemented certain measures designed to reduce total expenditure, and thereby reduce the deficit, and for the purpose of approving the new. in line with all above, there is still the problem of financing the deficit. in the early years, the deficit financing was achieved through borrowing, both domestic and foreign. entity governments for this purpose performed bond emissions. to achieve sustainable growth model in bh, attention must be paid to the level of reduction of the trade deficit, work on increasing the level of exports, reduce the level of consumption and higher levels of investment and employment. the only current assumption of deficit financing, which of course is not justified, is in part an increase in public debt. bh should certainly continue to implement restrictive fiscal policy measures and cuts in public spending in order to improve the fiscal position. specifically, in addition to the nominal convergence criteria, bh should seek to achieve real convergence criteria in terms of creating the environment for foreign direct investment, harmonization of labour market and the proper transformation and homogenization of the real sphere of economy. references bh directorate for economic planning. 2012. http://www.dep.gov.ba/default.aspx?langtag=bsba&template_id=139&pageindex=1, economic trends, annual report bh directorate for economic planning. 2013. http://www.dep.gov.ba/default.aspx?langtag=bsba&template_id=139&pageindex=1 bh directorate for economic planning. 2012. http://www.dep.gov.ba/fiskodr/archive.aspx?langtag=bs-ba&template_id=140&pageindex=1 central bank of bosnia and herzegovina. 2012. annual report, http://www.cbbh.ba/index.php?id=31&lang=bs the central bank of montenegro. 2008. analysis of the sustainability of current account deficitmontenegro,http://www.cbcg.org/slike_i_fajlovi/fajlovi/fajlovi_publikacije/radne_studije/anali za_odr%c5%beivosti_deficita.pdf đonlagić, dz. 2006. evropska monetarna unija i bosna i hercegovina. sarajevo: ekonomski fakultet u sarajevu univerzitet u sarajevu. erić , d., and đukić, m. 2012. finansijska tržišta u uslovima krize. beograd: institut ekonomskih nauka, beogradska bankarska akademija – fakultet za bankarstvo, osiguranje i finansije. european commission – eurostat. 2013 http://epp.eurostat.ec.europa.eu/cache/ity_public/222042013-ap/en/2-22042013-ap-en.pdf alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 135 european commission – eurostat 2013 eurostat. 2013. pocketbook on the enlargement countries, no. ks – 30 – 12 – 129 – en – c. furtula, s., and marković, d. 2010. monetarni sistem evropske unije. kragujevac: ekonomski fakultet u kragujevcu. kešetović, i., đonlagić, dž., and rička, ž. 2012 javne finansije. sarajevo: ekonomski fakultet u sarajevu. komazec, s., and ristić, ž. 2011. monetarne i javne finansije. beograd: etnostil. mishkin, f.s. 2010. ekonomija novca, bankarstva i finansijskih tržišta. zagreb: mate doo. golomejić, r. z. 2011. “koordinacija monetarne politike i politike upravljanja javnim dugom u hrvatskoj: stanje i izazovi”, zbornik radova s konferencije, institut za javne finansije, zagreb, 2011, pp. 143 – 170, http://www.ijf.hr/upload/files/file/knjige/javni-dug-2011.pdf santini, g. (2011). “mogući pristup reformi poreznog sustava rrepublike hrvatske”, časopis za ekonomsku teoriju i politiku, godina 18, (1): 99 – 130, zagreb.. institute of public finance. http://www.ijf.hr/hr/korisne-informacije/pojmovnik-javnihfinancija/15/proracun/266/proracunski-deficit/268/. efekti spoljne trgovine na budžetsku ravnotežu studija slučaja bosne i hercegovine rezime –.analizom kretanja ekonomskih trendova u bih u 2012. godini zabeležen je nastavak slabljenja ekonomskih aktivnosti. pre svega, ovakvo stanje rezultat je stagnacije ekonomije zemalja eu i regiona. u prvom tromesečju 2013. godine, robni izvoz je realno porastao za 19%, a uvoz za 13% što je dovelo do realnog rasta vanjskotrgovinskog deficita za oko 7%. dati rast deficita bitno je umanjio ranije procene ekonomskog rasta za prvo tromesečje u kome je snažan izvozni rast praćen rastom industrijske proizvodnje predstavljao jako bitan iskorak u odnosu na prethodnu godinu. osnovni cilj u ovom radu je razmatranje uticaja globalne finansijske krize na kretanje budžetskog deficita u bih za period 2008. 2012., kao i praćenje ograničenja koje je postavljeno mastrihtskim ugovorom da visina budžetskog deficita ne smije preći 3% gdp-a kroz međuzavisnost uvoza roba i nominalnog gdp-a. ključne reči: uvoz roba, izvoz roba, spoljnotrgovinski indikatori, budžetski deficit, kriteriji konvergencije article history: received: 18 february 2014 accepted: 14 june 2014 microsoft word 2011_3_4_finalna ver.doc proffesional paper    tax incentives as a stimulant of r&d activities in  enterprises with the special review on their accounting  framework in b&h  vukmirović nikola, university of banja luka, faculty of economics,   udc:  336(497.63)   jel: o1; h25     poreski podsticaji kao stimulansi r&d aktivnosti   u preduzećima sa posebnim osvrtom na   računovodstveni okvir u bih        abstract – in the centre of attention of recovery plan of the eu for period 2010‐14 are, so  called, “smart investments” which, during long‐term, should ensure higher growth and sustainable  prosperity.  ʺsmart  investmentsʺ  mean  investments  in  research  and  development  (r&d)  and  investments in education from both public and private sources of funding. in order to stimulate higher  investments in r&d activities by private sector it is recommended to use public – private innovation  partnerships (direct way) as well as wider usage of r&d tax incentives (indirect way). as r&d tax  approach has a strong policy impact, this paper will deal with different r&d tax (accounting) schemes  and their impacts on financial performances of enterprises.   as  bosnia  and  herzegovina  admitted  international  accounting  standards  (ias)  and  international financial reporting standards  (ifrs)  for  its accounting  framework,  this paper will  examine relevant ias and ifrs in order to find out “positive” or “negative” effects of each r&d tax  accounting scheme for proper financial treatment of r&d activities in enterprises.   the overall aim of this paper is to answer the question: which r&d tax subsidy model would be  the most appropriate one for b&h, respecting the present legal and accounting framework, as well  as cost and benefits of each recommended model?    key words: accounting treatment of r&d activities, accounting analysis, r&d tax plans and  incentives,  volume  and  increment  based  r&d  subsidies,  corporate  tax  as  a  stimulant  of  r&d  activities.  the principles of the r&d tax incentives design   the basic question that arises when designing fiscal mechanisms friendly to research and  development  (r&d)  activities  is  to  which  companies,  sector(s)  or  technology(ies)  will  be  addressed  these  stimulants.  in  this  sense,  it  is  possible  to  develop  general  approach  to  stimulating, or such tax environment that would not make any differences among companies  according  to  their  size  (micro,  small,  middle  and  large  enterprises),  innovation  history  (innovation active or innovation inactive), sector’s affiliation or technology that is used or     economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   60 developed.  this  approach  has  a  number  of  benefits  which  mainly  come  from  a  wide  coverage of enterprises (greatest potential for the growth of total investment activity in r&d)  as well as minimal negative effects on market mechanisms and doing business conditions.  nowadays, about half of current tax schemes for encouraging r&d activities are general. [1]  on the other hand, certain countries within the general tax system, or as a single part, can  be encouraged on extra development of certain group of companies ‐ e.g. small and medium  enterprises (sme) and/or development of particularly technologies, through permanent or  temporary  programs,  which  usage  depends  on  whether  they  are  defined  by  national  strategic goals or even by the regional aims. by using this approach, greater focus on specific  sector  or  territory  can  be  achieved,  and  thus,  faster  development  of  the  specific  area.  however, these so‐called selective tax schemes cause significantly higher costs in terms of  operating and administration of such schemes, additional harmonization efforts and analysis  of its impacts, in order to avoid undue preference of certain groups of enterprises.   although in the literature can be found information on coverage and goals of different  r&d  tax schemes across  the eu and oecd countries, over time, a number of modalities  were  developed  within  tax  systems,  either  through  the  creation  of  temporary  funds  and  programs (e.g. for development of small innovative enterprises, enhancement of cooperation  between universities and private sector, overcoming the negative effects of the global crisis  etc.) or throughout the systematic  legal changes, and as a result  it  is hard to asses which  approach is better nowadays1. actually, the current practices of developed countries as well  as evolution of their systems show us  that r&d  tax system needs to be aligned with  the  strategic aims and fully and exclusively used to accomplish those goals.   when  designing  r&d  tax  incentives  is  extremely  important  to  take  into  account  the  simplicity  (the  level  of  administrative  and  operational  costs  for  private  enterprises),  consistency (the equal rights for all enterprises, the same interpretation of law by the officers  as well as inspectors, etc.) and system’s stability (so that enterprises can plan benefits that  will be reaped). therefore, these principles are necessary to bear in mind when choosing any  of  the  tax alternatives,  in order  to ensure efficiency and effectiveness of established r&d  friendly  tax  environment.  in  the  following  chapters,  already  used  r&d  tax  schemes  –  throughout  mechanisms  of  corporate  tax  and  wage  tax  and  contributions  (as  the  most  commonly  used  indirect  instruments  for  stimulating  innovative  activities  in  the  private  sector) will be presented.   corporate tax as a stimulant of r&d activities    through the institute of corporate tax, member states of oecd and eu have developed  the several incentives which may be divided into several groups: a) tax deferral ‐incentive in  the form of delayed tax payments, b) tax credits ‐ reduce tax liabilities and c) tax allowances ‐  on the amount of the current r&d costs before taxation. [2]                                                         1 for example, italy and uk stimulated the development of these activities only in smes until 2002.  after  that  the  scheme  was  extended  to  large  companies  but  with  a  lower  preferential  rate.  also  norway in 2002 introduced a tax scheme for smes for r&d which included the purchase of r&d  services from universities and public research institutes. japan, spain, denmark and the uk did the  same.       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   61 tax deferral means delay  in  the payment of corporate  tax based on  the  level of r&d  costs, which typically takes the form of accelerated depreciation of internally generated fixed  assets  (material  and  immaterial).  at  this  place  it  is  necessary  to  make  a  difference  in  accounting treatment of r&d activities. expenditures incurred in the research stage (research  activities) are treated as costs in period when they incurred while expenditures incurred in  the  development  stage  (if  they  fulfil  conditions  for  recognition  under  ias  38)  they  are  recognized  as  an  asset  (material  or  immaterial)2.  therefore,  these  subsidies  can  be  implemented through the accelerated depreciation method of internally generated assets3 (at  a higher rate than for externally generated assets) or even by 100% (and higher) write‐off in  the  first year of use of qualified asset4. through  this method of depreciation,  innovation‐ active companies will have higher depreciation costs, and thus a lower liability for corporate  tax (in the amount of the value of the asset ‐ for 100% write off in the first year x corporate  tax  rate  or  the  amount  of  depreciation  x  corporate  tax  rate).  in  this  way  government  ʺrewardsʺ innovative effort of a given company by reducing its corporate tax liability in the  first year of exploitation of internally generated innovation. if the government requires the  payment of corporate tax in the following years, previously deducted from the tax liability  (in the first year of exploitation), then such a tax incentive has the character of the tax credit  or  tax  asset  (because  the  amount  of  the  costs  in  the  income  statement  is  lower  than  the  amount of the liability for corporate tax). afterwards, the previously calculated tax asset will  be  “consumed”  as  a  result  of  lower  costs  reported  in  the  income  statement  and  higher  calculated  liabilities for corporate tax in the tax statement. it is important to note that the  listed benefits result primarily from the accounting policy ‐ under international accounting  standards (ias) and international financial reporting standards (ifrs), which usage and  ʺstrongerʺ positive effects release on r&d activities are stimulated through the tax system.   tax credits allow direct reduction of tax liability while the tax allowances are deduction,  above normal  ‐ 100% of r&d costs of the amount of taxable  income. therefore, the basic  difference between these two mechanisms  is that tax allowances reduce the gross  income  while the tax credits directly reduce the amount of liabilities for corporate tax. common is  that both reduce the real amount of r&d costs5. [3]                                                         2at this point is important to emphasize the major difference between the accounting regulations in  the eu (ias and ifrs) and accounting regulations in the u.s. (gaap) which is essential to bear in  mind when analysing r&d  tax schemes across  the oecd member states.  in  the usa  there  is no  capitalisation of any r&d costs, either for the cost incurred in the research or development phase.  3 belgium and greece allow depreciation of fixed assets (r&d property, plant and equipment) in 3  years, portugal in 4 years and the netherlands in 5 years.  4 this is case in canada, denmark, ireland, spain and united kingdom.  5 by  investing  in research, a company creates a positive tax savings  in the amount of: the costs of  research (r) x corporate tax rate (1), which lead to the fact that the real amount of research costs is: r x  (1-corporate  tax rate)  (2).  if we  treat expenditures  inccured  in  the stage of development as capital  expenditures  that will affect  the balance statement – will  increase  the value of  total assets.  in  the  depreciation  period  of  given  assets,  amount  of  gross  and  net  income  will  be  reducted  and  consequently the amount of corporate tax paid. if the company at the same time has active research  projects, gross profit for the period will be additionally burdened. total amount of tax savings in that  case will be: (depreciation costs + r) x corporate tax rate (3). this makes an open space for ʺinternally     economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   62 in countries that use the mechanisms of tax allowances, about ¾ of these countries set the  limits or caps on the annual amount of costs deductable for the tax purposes. through the  analysis we found the existence of two types of limits: upper limit on the amount of r&d  cost that can be recognized for tax purposes and the maximum amount of tax deduction that  can be approved. [4]  in the tax credit systems, some countries (e.g. australia and canada6) allow transfer of  credits  (reduction  of  liabilities  for  corporate  taxes)  in  the  next  tax  period.  in  this  way,  especially in small businesses, it is possible, for the periods when their taxable income is not  high  ‐  not  to  take  a  tax  credit  and  than  in  periods  when  they  are  more  profitable  ‐  implementation of a patent, new technology etc. to use it.    another innovation in the r&d tax schemes, in the eu and the oecd countries, is the  use of so‐called volume and increment tax schemes, which differ in the way that r&d costs  are recognised for tax purpose. in the first (volume) or scheme based on volume, all incurred  r&d costs are recognized  in  the tax statement while  in  the other (increment scheme)  the  amount  of  r&d  costs  above  a  certain  (base  level)  are  recognized  as  a  tax  deductable.  therefore, schemes based on the level of r&d costs are useful to stimulate r&d activities in  economies where stable market demand  for  innovation and r&d activities exist either  in  certain  sectors  or  generally.  schemes  based  on  the  increase,  which  are  obviously  more  difficult  to  administer,  are  used  in  cases  where  the  strategic  aim  is  to  support  (only  or  especially)  innovation‐intensive  enterprises  or  certain  sectors  or  specific  technologies.  among countries a  tendency of more  frequent use of volume based r&d  tax schemes  is  present because of lower administrative costs. the disadvantage of this scheme lies in the  fact that it does not only stimulate new r&d activities but also those that would be done  anyway. incremental incentives on the other hand reward extra effort and investment, but  the problem to define the base for comparison occurs [5]. having in mind the structure of eu  economies  and  their  innovation  policies,  both  mechanisms  meet  their  needs  and  are  therefore often combined. however, combined option of volume and increment based r&d  tax schemes is possible and we will call it a hybrid option7.  therefore,  tax credits and  tax allowances occur  in  three  forms depending on whether  they are based on a) the level of r&d costs, b) incremental change in r&d costs or c) the  combination of volume and incremental change in r&d costs. in the volume based r&d tax                                                                                                                                                                         generated sources of financeʺ for r&d activities. in other words, the actual cost of investment in r&d  is: the cost of r ‐ (3). [4]  6 in 2001 australia introduced a system allowing (only) small businesses to transfer a tax discount to  the periods when they have greater corporate tax  liabilities instead in the periods when they have  very litle or none tax liabilities. canada also refund unused tax credits and back to a period of three  years or forward to 10 years.  7 for  example,  in  2001,  australia  introduced  175%  tax  allowance  for  the  amount  of  incremental  increase in r&d costs versus a rate of 125% on the all r&d costs. companies can use this “extraʺ rate  for additional investments in the r&d if increases the volume of r&d investments above the average  amount of r&d investment over the past three years. austria also made some changes and now has  both types of incentives so that companies can reduce their liabilities to 25% on r&d investment and  an additional 10% (35%) if the investment is higher than the average amount of investments in the last  3 years. hungary increased the rate from 8% to 20% of the level of r&d costs and from 30% to 50% of  the incremental increase in investment.       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   63 scheme, companies that spend a monetary unit on r&d will be able to reduce the amount of  taxable income (1+w) (where w is greater than 0). in the case of incremental incentive, the  company can reduce a certain percentage ‐ w on the amount of increase to the base level of  r&d  costs.  in  the  tax  credit  system,  if  certain  scheme  is  volume  based  we  have  direct  deduction  of  tax  liability  in  given  percentage  of  the  annual  investments  on  r&d.  in  incremental form of r&d tax scheme, reduced amount of tax liability will depend on the  nominal change in the cost of r&d, in comparison to the base level of costs in a base period.  income tax and contributions on wages as stimulants of r&d activities   having  in  mind  the  typical  structure  of  the  research  costs8,  significant  effects  can  be  achieved decreasing the amount of gross wages for r&d staff that employers pay. although  the amounts of taxes and contributions on r&d wages have the character of costs and thus  already reduce the amount of liabilities for corporate tax, their reduction will have positive  impact on company’s cash flow which is extremely important for small innovation intensive  enterprises,  especially  in  the  initial  stages  of  research  when  revenues  are  low  and  investments in intellectual and human capital high. additionally, subsidies on r&d staff will  have positive effect on the employment in general, in the first line of highly skilled workforce  and  will  create  an  additional  positive  pressure  on  the  education  system  consequently.  however, the amount of net wages does not need to be reduced. that  is actually a fiscal  relief of employer by reduction of the amount of tax and contributions on r&d wages. from  the aspect of government, these tax incentives are much easier to administer and control as  opportunities for possible accounting manipulations are minimal.  it is interesting to point out that experience has shown that if the number of scientists and  engineers is stable over time (or the labour supply is inelastic), increased volume of r&d  activities (as a result of incentives through the tax system) will result in the increase of r&d  wages instead of raise in innovative activities [7]. this effect is known as ʺearnings effectʺ  which can be and enlarged if the only qualified costs of research activities are r&d wages, as  it was the case in traditional systems of tax subsidies. furthermore, it would be interesting to  determine does the “earnings effect” have the positive effect on the quality of r&d activities  (in  terms  of  better  scientists’  education,  a  higher  degree  of  commercialization,  quality  of  work experience, etc.). however, the results of these studies are not known yet.   also,  the  design  of  tax  incentives  through  taxation  of  r&d  wages,  like  corporate  tax  subsidies, arise the question of the level (volume) and selectivity (in all sectors and/or e.g.  newly employed in r&d) in the application of these tax incentives. the decision will depend  on the objectives and the balance and of the cost/benefit analysis of proposed tax subsidies.   examples of the practices used in eu and oecd countries  the most commonly used scheme in the eu and the oecd countries is volume based tax  scheme (the united kingdom, czech republic, norway and denmark) or schemes which in  addition  to  volume  based  recognise  and  capitalised  expenditures  (asset)  invested  in  the  purchase of r&d fixed assets (e.g. canada, australia, austria, france and italy). generally,                                                         8 it is estimated that 90% of each r&d cost relates to the cost of r&d wages. [6]     economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   64 these  countries  provide  greater  support  to  smes  through  the  system  of  higher  rate  of  deduction for the qualified research costs and capitalised expenditures. based on a display  (figure 1 and figure 2) we can see that e.g. a small company in the uk can reduce its liability  for corporate tax from 0.169 for each eligible r&d cost, while in canada, a tax credit of 35%  will reduce the sme’s corporate tax liabilities by 0.35 for each corresponding r&d cost and  so to a level of 3 million cad after which companies have a right of reduction of 0.2 per unit  r&d cost.     figure 1. examples of simple tax schemes, united kingdom (left), and canada (right) [8]          countries like the usa or e.g. ireland prefer a increment based system while countries  such as portugal, japan and spain use some kind of mixed ‐ hybrid system.  also  there  are  different  practices  regarding  the  consideration  of  qualified  r&d  costs,  eligible for recognition as a deductable in the tax statement. for example, belgium and the  netherlands as qualified r&d costs consider only r&d wages (gross amount). in addition,  belgium through the institute of corporate tax stimulates and capital investments in scientific  research  and  innovative  assets,  while  the  netherlands  additionally  stimulate  self‐ employment in s&t sector – for those who have at least 500 working hours per year spent in  r&d work.                                                           9 in the uk, in the system of “extra” reduction, regular corporate tax rate must be kept in mind. a  small company in the uk, with a corporate tax of 21%, will reduce its corporate tax liability for (175% ‐ 100% ‐ which is a normal deduction) x 21% = 0.1575 per each unit of the corporate tax liability.       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   65 figure 2. examples of common modifications of r&d tax schemes, portugal (left) and the netherlands  (right) [9].      financial analysis of the existing system of corporate and income taxation in b&h  from the aspect of r&d activities  according  to  the law  on corporate  tax  in rs corporate  tax rate  is set at 10%. by  the  regulations on the implementation of this law is determined which revenues and the costs,  in  what  amount,  are  deductable10.  r&d  costs  are  fully  recognized  as  corporate  tax  deductable if they meet the criteria listed in the regulations. also, it is noticeable that the  criteria  in  defining  and  determining  the  qualified  r&d  costs  match  definition  and  accounting treatment of r&d costs under ias 38 ‐ intangible assets, what is desirable from  the  point  of  consistency  in  applying  the  accounting  regulation  given  by  ias  and   harmonization  with  eu  legislation.  also,  the  regulations  require  documenting  the  r&d  activities and corresponding costs either  in  the  form of annual operating or project plan,  analysis, reviews, results of research projects, etc.  in order to avoid any possible abuse  in  terms  of  tax  evasion.  however,  according  to  the  pre‐exposed  practices  of  developed  countries, we can conclude that these activities are not sufficiently stimulated, but that there  is a good foundation for further development and stimulation.  under the law on corporate tax in federation of b&h (fbh), corporate tax rate is also  10% and r&d costs are fully recognized as deductable in the tax balance. unlike the law in  rs,  in  addition  to  expenditure  in  the  research  stage,  total  development  expenditures  (immaterial) are recognized as tax deductable in the period when such expenditure incurred.  at this place we need to have in mind that the already used tax allowances for the amount of  depreciation,  impairment  and  write‐off  costs  in  the  following  years  will  increase  the  tax  liabilities. so, we see that the fbh has established the stimulation that corresponds to a.m.  tax deferrals, and in that sense, the relevant law in fbh is more competitive than one in rs.  but, neither by the law nor by the regulations in fbh is further defined the coverage of  r&d activities and  it  is  leaved  to  the  ias and  ifrs. also, law  in fbh do not explicitly  require documentation of r&d costs. due to, abuse or subjective interpretation of ias and  ifrs might occur either by accountants or inspectors.                                                         10 b&h  is  a  complex  state  ‐  consist  of  two  entities,  where  each  entity  independently  create  and  implement taxation policy, in the domain of corporate and income tax.      economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   66 analysing  the  tax  system  in  the  domain  of  wage’s  taxation,  there  are  no  explicit  incentives for staff working on r&d activities, according to applicable regulations  in  this  area. we say explicit because the relevant laws in rs and the fbh do not provide possibility  for  reduction  of  income  tax  for  the  regular  work  (full‐time  contract  or  as  extra  work  contract). however, the personal income without contract of employment, specifically in the  case of authorship, provides  the possibility  for exemption of contributions on wages  (for  health,  pension,  unemployment  and  other)  if  the  author  of  such  services  is  previously  insured (has an employment contract in other company or on other types of services). in this  way, contractor of those services is required to pay (only) the amount of income tax on the  gross compensation of  the author’s service. those benefits can be used only  if  they meet  criteria set up by the law on copyrights and related rights in b&h. however, if we take a  look  from  the  other  perspective,  permanent  employment  in  r&d  is  conditionally  discouraged and/or companies whose main activity is r&d are not stimulated to deal (only)  with  those activities, and we note there is an additional space for further improvement in  this field.  instead of a conclusion ‐ recommendations for b&h and other western balkans  countries  having in mind current doing business conditions in b&h and administrative and tax  burden of companies, when designing a r&d tax friendly environment is essential focus on  the principles of simplicity, consistency and safety, which were discussed in the first part of  this paper. also, given the current level of total spending (public and private sector) in b&h  for the innovative activities (the estimation for the rs is 0.1% of gdp, the level of b&h about  0.07% of gdp) and a condition for joining eu (1% of gdp), the trends of other countries in  eu (3%of gdp by 2020.with the respect to the countries that already achieved that level), the  structure of b&h export and current level of industrial development, it is necessary to ʺrise  upʺ the general level of investments in the activities of r&d and by the example of ʺgood  practiceʺ to show and prove to businessmen and policy makers the importance of innovation  for society as a whole. this leads to conclusion that a general, volume based approach would  respond to b&h case. regarding to the possibility for 100% write‐off of internally developed  assets and innovations, we would recommend the implementation of the practice of fbh in  rs  with  the  possibility  for  the  extension  for  externally  generated  intangible  assets  (as  opposed to the current estimated depreciable life of 15 years). also, given that the existing  legal  regulations  in  fbh  and  rs  have  included  but  ʺhiddenʺ  r&d  incentives,  stronger  promotion of existing (hidden) r&d tax incentives is necessary. therefore, in short term we  would suggest the implementation of previously given recommendations which due to the  low  corporate  tax  rate  of  10%  in  this  post‐crisis  period  will  not  significantly  affect  the  diminish of the public revenues but may attract ʺcritical massʺ.  for the medium term, the suggestions would be related to the institutes of corporate and  income tax. in this regard, we would recommend the increase in recognition of current r&d  costs for the tax purpose and exemption of the contributions on r&d wages (at least partial,  either for authorships or for full/part‐time contracts) in order to encourage employment of  highly skilled workers and as a result a better education of youth. the above measures can  be initially implemented through a fund system ‐ as a temporary programme(s) and thus no       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   67 system and  legal changes will be required. at  the same  time,  this would have a positive  impact on the supervisory authorities and inspectors, because they will have an open space  for preparation and professional  improvement. after a pilot period, based on cost‐benefit  analysis of those measures, a permanent introduction may be discussed.   in  the  long  run,  in  line  with  the  development  of  innovation  sector  in  b&h  the  introduction of the special incentives for highly innovative enterprises based on the principle  of incremental increases would be reasonable. additionally, difference between ʺrewardʺ on  externally and internally generated innovative products and services may be reduced, but  only  for  innovations  purchased  from  local  companies.  in  this  way,  bigger  innovative  company  would  make  a  significant  positive  push  to  small,  resourceful  and  flexible  enterprises and may stimulate the set up of new enterprises and businesses. in this sense, by  acquiring  the  experience  of  public  administration  and  enterprises,  it  may  be  discussed  creation of such tax environment that would stimulate r&d activities of innovation active  enterprises at the expense of those ʺinactiveʺ through the all elements of tax environment  (taxation of corporate  profit,  personal  income  tax,  the contributions on  wages,  vat,  real  estate taxation, a system of tariffs, taxes, etc.). in this way we would create a significantly  more  objective,  fairer  and  more  transparent  means  of  motivating  (because  it  is  based  on  market mechanisms),  instead of grants, subsidies and donations of  local and  international  institutions, which are very limited, especially after the great economic crisis.  references   details: bloom, n., griffith, r., klem, a., ʺissues in the design and implementation of an r & d tax  credit for uk firmsʺ(2001). briefing note no.15, institute for fiscal studies, london  goolsbee,  a.  “does  government  r  &  d  policy  mainly  benefit  scientists  and  engineers?”,  (1999),  american economic review 88 (2). pp. 298‐302.  hall, b. (1995), ʺfiscal policy towards r&d in the united states: recent experienceʺ, oecd  r&d tax incentives: rationale, design, evaluation (2010),oecd  supporting  growth  in  innovation:  enhancing  the  r  &  d  tax  credit,  (2005),  hm  treasury,  united  kingdom  tax incentives for research and development: trends and issues, science and technology industry,  (2002). oecd  towards  a  more  effective  use  of  tax  incentives  in  favour  of  r  &  d,  (2006),  commission  of  the  european communitiescommission staff working document, brussels.  vukmirovic,  n.,  turkanovic,  d.  “the  impact  of  intangible  assets  investments  on  the  financial  stability and profitability of enterprises”,(2010). ii international scientific conference: technology  innovations a generator of economic growth, association of inventors of republic of srpska         economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   68 apstrakt  ‐  u  centru  pažnje  plana  oporavka  eu  za  period  2010.‐2014.  su,  takozvane,  ʺpametne  investicijeʺ,  koje  treba  dugoročno  da  obezbede  veći  rast  i  održivi  razvoj.  ʺpametna  investicijaʺ znači ulaganja u istraživanje i razvoj (r&d), kao i ulaganja u obrazovanje iz javnih i  privatnih  izvora  finansiranja. u cilju podsticanja  investicija u aktivnosti  istraživanja  i razvoja od  strane  privatnog  sektora,  preporučuje  se  korišćenje  javno‐privatnog  inovativnog  partnerstva   (direktan način), kao  i šire upotrebe poreskih podsticaja za  istraživanje  i razvoj (indirektan način).  kako poreski pristup istraživanju i razvoju ima jak uticaj na donošenje odluka, ovaj rad će se baviti  različitim  r&d  poreskim  (računovodstvenim)  modelima  i  njihovom  uticaju  na  finansijske  performanse preduzeća.  kako  je  bosna  i  hercegovina  prihvatila  međunarodne  računovodstvene  standarde  (mrs)  i  međunarodne standarde finansijskog izveštavanja (msfi) kao svoj računovodstveni okvir, ovaj rad  će ispitati adekvatne mrs i msfi u cilju identifikovanja ʺpozitivnihʺ ili ʺnegativnihʺ efekata svakog  r&d poreskog modela, radi pravilnog finansijskog tretmana ovih aktivnosti u preduzećima.  opšti cilj ovog rada  je da odgovori na pitanje: koja model poreskih subvencija za  istraživanje  i  razvoju bi bio najprikladniji za bih, poštujući sadašnji pravni i računovodstveni okvir, kao i troškove i  koristi svakog preporučenog modela?    ključne reči – računovodstveni tretman aktivnosti r&d, računovodstvena analiza, r&d  poresko planiranje i stimulansi, obim i porast r&d baziran na subvencijama, korporacijski porez kao  stimulans r&d aktivnosti.        article history:  received:  15 july 2011 accepted:  21 september 2011          microsoft word 2008_01_02.doc   original paper    development of small and medium enterprises:     b&h compared to other western balkans countries    zijad džafić, faculty of economics, university of tuzla    adnan rovčanin, faculty of economics, university of sarajevo    nermin klopić, indirect taxation authority b&h    key words: governmental policies, smes, transition process, unemployment, entrepreneurship    udc: 334.012.64:338.24.021.8(497.6)         jel: o18, r11, e65    abstract  ‐ experiences of many countries that were very successful in transition process like slo‐ venia, czech republic, hungary and poland show that special attention has been given to the development  of a powerful smes sector in order to change the economic structure and initiate economic development.  small and medium enterprises make 99,8% of the total number of enterprises and they create 60% of the  gdp and 50% of all investments in eu. smes were the main source for increasing employment in last ten  years. the eu has a goal that it will be the most competitive region in the world before the end of 2010, and  for achieving that goal it will count on the development of small and medium enterprises. if we look at smes  and their development in that regard, in light of making the whole region of the western balkans closer to the  european union, it is clear that smes in this part of europe must develop faster and become a dominant  form of income for the region. smes contribute significantly to decreasing unemployment, but only with the  presence of a powerful government and a consistent industrial policy in which a business environment for  entrepreneurships can develop. the significance of this research is in the need of selection of decisions on:  essential elements of entrepreneurial environment in western balkans; identification of main obstacles for  the development of smes  in these countries, and analysis of  institutional support to the development of  smes and entrepreneurship in these countries  small and medium enterprises (smes) and   entrepreneurship in bosnia and herzegovina  bosnia and herzegovina is one of the countries in the region that experienced such extensive  war destruction in the least decade of the 20th century that has been seen in the area since the sec‐ ond world war. before the war conflict in former yugoslavia started,  bosnia and herzegovina was  more developed by its economic performances than some transition countries that are now full eu  members. presently, bh gdpp/c is only 60% of the pre‐war level.  the starting economic position of bosnia and herzegovina in the environment shifted a few  decades back consequent to the war, and the forthcoming processes and phenomenon characteriz‐ ing the present time – transition, liberalization, globalization, trans‐nationalization – have taken on  a special dimension in such an environment. this is the reality that cannot be ignored. neverthe‐ less, one thing is certain: the new priority mission in bosnia and herzegovina is full membership  in european union.   development of smes and entrepreneurship in b&h is in its initial stage, even though this  sector of economy could become the initial force of development of the country. the government  still has no strategy of the development of entrepreneurship and smes, and furthermore, there are  even government‐imposed barriers for the development of smes and entrepreneurship.   volume 40 • spring 2008 • 89  there is no policy and there are no specific objectives of the development of smes in b&h.  there is also lack of specific legislation, which leads to a lack of measures, instruments, and har‐ monized organization for the support of smes development.   the structure of b&h economy by the number of employees is given in the following table:      table 1 structure of b&h economy by the number of employees  federation b&h (fb&h)  republic of srpska (rs)  up to 10 employees  84%  up to 50 employees  85.5%  11‐50 employees  11%  51‐250 employees  12.8%   51 ‐ 250 employees  4%      smes sector   99%  smes sector   98.3%  large companies  1%  large companies   1.7%     source: dafić. z., preduzetnička ekonomija, denfas, tuzla, str. 45.      b&h devoted itself to strategic development of sme sector in order to reduce the rate of unemployment. there is over half a million people without jobs, and 90,000 young people have already left b&h because of lack of perspective. high unemployment rate stresses the need to encourage, activate and direct the population to business start ups and the development of entrepreneurship as a means of employing family members and other people. an entrepreneurship continually finds himself between the goal to maximize profits and minimize losses, which requires innovativeness and rationality in decision making. looking at entrepreneurship from the human resources perspective, it is cruvial to approach it in an organized fashion, i.e. to encourage and redirect entrepreneurial practives, increase the efficacy and effectiveness of managers and entrepreneurs. finally, the results should be implemented, which would then lead to economical revitalization and strengthening of entrepreneurial and sme sectors in post-war b&h. research on the given topic is in accordance with mid‐term development strategy of b&h  (prsp), 2004‐2007. in this strategy, clear‐cut goals have been defined, and they are: to encourage  the development and growth of micro and small business, to encourage companies to move from  the gray economy into the formal sector and to create new jobs in the private sector.   the economy of bosnia and herzegovina, as well as that of other developed countries and  those  in  transition,  has  turned  to  strategic  development  of  the  small  and  medium  enterprises  (smes) sector in order to decrease the rate of unemployment, which is the highest in europe (43%).  an  increased number of  the unemployed  imposes  the need for encouragement, activation and  guiding people  to start  their own businesses and entrepreneurships  in order  to stimulate self‐ employment and employment of family members and others.  economy of the 20th and 21st century has different rules than smith’s economy of the 19th cen‐ tury. the new ideology of neoliberalism apostrophes the role of smes as promoters of a “healthy”  business climate, economic efficiency and power for economic growth, especially in small, devel‐ oped countries, and even more so for countries in transition.   these statements and theories contribute to increasing the awareness of governments and  businessmen  that smes are crucial for economic development  in  the region. large  interest  for  smes was aroused in countries of the western balkans in the last decade when it was realized that  smes could play a key role in the process of transition.   2007 ‐ 90  •  economic analysis®  western balkans – key economic indicators   the term western balkans is a political one. it expresses the strategy (ie. a clearly set external  policy) of the eu towards the region of ex‐yugoslavia minus slovenia plus albania1. even in the  document the process of stabilization and accession of south‐east european countries (brussels, 26 may  1999) in the context of issues of regional accession, there is a mentioning of „joint strategy“ for  western balkans. in the joint report of the eu titled the role of the union in the world, in the 7th sec‐ tion, countries of western balkans are precisely determined: „croatia, bosnia and herzegovina,  albania, fyr macedonia and serbia and montenegro“.  the  region  of  western  balkans  consists  of  relatively  small  economies.  while  the  biggest  country, population‐wise, is fry (now serbia and montenegro) with 8,6 million people, croatia is  the biggest, economy‐wise, with over 22 billion euros. the total population of the region is 25 mil‐ lion people, which is equal to 6,5% of the eu population, or a third of the ten countries which  joined the eu in may 2004. the total gni of the region is 50 billion euros, which is about 0,6% of  gni of eu or 40% of gni of portugal. gni per capita, according to current nominal rates of ex‐ change in the region is about 1800 euros, with significant difference between gni in croatia (5100  euros) and other countries of western balkans, which is below 1,90o euros. according to criteria of  the world bank, b&h, together with serbia and montenegro, macedonia and albania, is in the  group of 54 countries with  lower‐medium  income per capita  ($736‐$2,935). of all  the analyzed  countries, only croatia belongs to those in the higher‐medium income ($2,936‐$9,075). the follow‐ ing table represents the comparison of economies of western balkans:  table 2. compare economies by income p/c, informal sector, and population.    countries:    b&h    albania    croatia    macedonia    serbia and  montenegro  income cate‐ gory:  lower mid‐ dle income  lower  middle  income  upper mid‐ dle income  lower middle  income  lower middle  income  population:  4,1 million  3,2 million   4,4 million    2.1 million    8.1 million  gni per capita  (us$):  2,040    2,080     6,590    2,350  2,620    informal econ.  estimate (%  gnp):  34,1  33.4  33.4  not available  29.1  source: http://doingbusiness‐org/ 2006  the directorate for western balkans is set up by the european commission for the negotia‐ tions for accession of western balkans countries2. even though the eu has started the negotiations  on stabilization and accession with other countries much earlier, the negotiations with b&h have  started just recently, on 25/01/2006.  the main challenges of transition facing the countries of western balkans in the following  period are3:  o privatization and restructuring of companies and removing of barriers for businesses,  in order to strengthen the flows of private capital and decrease the donation support,  1 milardović, a., zapadni balkan – pojam, ideje i dokumenti o rekonstrukciji balkana u procesu globalizacije, pan liber, osijek –  zagreb – split, 2000., pg.26  2  the agreement of stabilization and accession, www.dei.gov.ba  3 ebrd document, strategy for bosnia and herzegovina, 2005., pg. 2  volume 40 • spring 2008 • 91  o decrease the size of public sector, bureaucracy and administration  o structural and institutional reforms in key infrastructural sectors, such as: transport,  energy, telecommunications and communal infrastructure, as well as financial sector,  o strengthening of state institutions and creation of unifies economic territory in b&h.  the following table (transition report, 2004) shows the realized transitional indicators in the  mentioned segments of economy. this index is between 1 (showing little or no progress) and 4+  (4.33 – showing the standards which are similar to advanced economies of the industrial market)    table 3. indicators of transition for western balkans countries    albania  bosnia and  herzegovina  fyr of mace‐ donia  serbia and  montenegro  liberalization of prices  4,33  4,00  4,00  4,00  liberalization of trade and  currency  4,33  3,67  4,33  3,33  small‐scale privatization  4,00  3,00  4,00  3,33  large‐scale privatization  2,33  2,33  3,33  2,33  company reforms  2,00  2,00  2,33  2,00  competition policy  2,00  1,00  2,00  1,00  infrastructure  2,00  2,33  2,00  2,00  banking sector  2,33  2,67  2,67  2,33  non‐banking financial institu‐ tions  1,67  1,67  2,00  2,00  source: ebrd transition report, 2004.god.  defining smes in eu and countries of western balkans4  the european commission has adopted a recommendation (commission recommendation of  3 april 1996 concerning the definition of small and medium‐sized enterprises (smes), oj l 107 of  30.4.1996, p. 4.) concerning the definition of smes which now provides a clear global framework  for all the measures directed towards micro‐, small and medium‐sized enterprises. it will be ap‐ plied to all new community programmes, whereas existing programmes which use different crite‐ ria will continue to be implemented to the benefit of the enterprises which were considered smes  when these programmes were adopted.         table 4. newly adopted eu definition of smes  criteria  micro enter‐ prises  small‐ sized  enterprises medium‐sized   enterprises  max. number of employees  < 10  < 50  < 250  max. turnover in million ecus  ‐  7  40  max. balance sheet total in million euro   ‐  5  27    to be classed as an sme or a micro‐enterprise, an enterprise has to satisfy the criteria for the  number of employees and one of the two financial criteria, i.e. either the turnover total or the bal‐ ance sheet total. in addition, it must be independent, which means less than 25% owned by one  4 according to: united nations economic commission for europe, small and medium‐sized enterprises in  countriesin transition, united nations, new york and geneva, 2003  2007 ‐ 92  •  economic analysis®  enterprise (or  jointly by several enterprises) falling outside the definition of an sme or a micro‐ enterprise, whichever may apply. the thresholds for the turnover and the balance sheet total will  be adjusted regularly, to take account of changing economic circumstances in europe (normally  every four years).   comparative analysis of level of development   of smes in countries of western balkans  in all transition countries, among which we certainly include countries of western balkans,  the process of political and economic transformation is based on the development of the private  sector and entrepreneurship, as well as the creation of favourable business environment for the  development of smes. some countries have gained a significant progress in these activities, while  others are less successful. as a result, in almost all economic analyses, all transition countries are  divided into two groups.  picture 1. index of development of smes in transition countries    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2005.    the first group consists of the advance transition countries, and the second group includes  the less advanced transition countries. all the countries that belonged to the first group, except  croatia, became members of eu in 2004. other countries of western balkans belong to the second  group. the data that follows relates to the period before this eu expansion. the following picture  volume 40 • spring 2008 • 93  shows the share of private sector in the economy, the share of sme sector in gdp and employment,  the amount of gdp, and finally, the index of smes development in the analyzed countries.   the previous picture shows that b&h has a very low share of private sector in the overall  economy, which is only 45% of gdp. the share of private sector in overall economy which is lower  than this one is characteristic only for the following countries: belarus 25%, turkmenistan 25%,  uzbekistan 35%.  index of development of sme sector  index of development of sme sector in advanced and less advanced transition countries is  shown  in  the  two following pictures. all  the countries of western balkans belong  to  the  latter  group.  picture 2. index of development of smes (advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003.    picture.3. index of development of smes (less advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003   2007 ‐ 94  •  economic analysis®  in b&h, index of development of smes is very low – only 118,2, while in slovenia, which has  the greatest index of all the former and current transition countries it is amazing 2534,9. index of  development of smes, lower than the one of b&h, have only the former members of ussr and  serbia and montenegro. it is indicative that albania has a significantly higher index of develop‐ ment of smes than the most of less advanced transition countries.  sme sector share in gdp  the following pictures show the share of sme sector in gdp, in both advanced and less ad‐ vanced transition countries. countries of western balkans are shown in picture 3.5. with a rela‐ tively low share of smes in the total gdp.    picture 4. share of smes in gdp (advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003    picture 5. share of smes in gdp (less advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003.  volume 40 • spring 2008 • 95  thus, it is evident that the share of sme sector in gdp is low, and it amounts to only 36% in  b&h, which confirms the fact that our economy is still dominated by large companies, which are  mostly state owned.  share of employment in sme sector    the following pictures 6 and 7 show the share of employment in sme sector in advanced  and less advanced transition countries.    picture 6. share of employment in sme sector (advanced transition countries)    source: unece, ibidem    picture 7. share of employment in sme sector (less advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003    the share of employment in sme sector is the highest in the check republic, which is now a  member of eu, while in b&h it is very low, even lower than the total unemployment. this data  confirms the existence of informal economy in our country in a great percent. only serbia and  montenegro are in a more alarming state. in all other less advanced transition countries the share  of employment in sme sector is greater than that of the overall unemployment, and in armenia  this percentage is the greatest.  2007 ‐ 96  •  economic analysis®  comparison of index of development of smes in western balkans countries  based on the previous charts, we can calculate the index of development of smes in these  countries and perform benchmarking of countries of western balkans in relation to croatia, as the  most successful country in the region.     table .4. benchmarking ‐ index of smes development in western balkans countries5  country    share of the  private sector in  total economy  (%)  share of the  sme sector in  total gdp  (%)  share of number  in employees in  all smes  gdp/  (usd/capita)  index of smes  development  albania  75  40  58,4  1.565  274,2  bosnia and  herzegovina  45  36  53  1.376  118,2  croatia  99  56  65  5.053  1.820  the fyr of  macedonia  60  42  65,1  1.866  306,1  serbia and mon‐ tenegro  55  46,6  32,4  1.879  156,0    we can conclude that only serbia and montenegro have a lower index of development of  smes than b&h, while all other members of western balkans have a higher index. in comparison  to the countries of the region it is evident that b&h is lagging behind, in regards to the institu‐ tional support to the development of smes. also, the share of private sector in gdp is quite low  (40%) which confirms the thesis that the process of privatization of state‐owned sector is very slow,  but also it confirms the fact that the rate of establishment of new smes in b&h is on a very low  level.   comparison of the development of institutions for support of sme sector  the unsatisfactory institutional support in relation to the region is shown in the following  table as well:    table 5. a comparison with the surrounding countries – institutions for the support of smes     minist.  for  smes  law  on  smes  agency  fund sme  strategy  internat.  organiz. chamber  agencies  for smes  centres  and incu‐ bators  education spec. instit. albania  +  +  +  +  +  +  ‐  +  +  +  croatia  +  +  +  +  +  +  +  +  +  +  macedonia  +  +  +  +  +  +  ‐  +  +  +  scg  +  +  +  +  +  +  +  +  +  +  b&h  ‐  ‐  ‐  ‐  ‐  +  +  +  +  ‐  b&h is the only country that has no ministry for smes on a state level, it has no law on  smes, it has no sme agency, no sme funds, no strategy for the development of the smes sector,  5 this document is prepared on the basis of the unece questionnaire on small and medium ‐ sized enterprises in economies in  transition and emerging market economies in 2001. printed at united nations, geneva (switzerland), 2003.      volume 40 • spring 2008 • 97  no specialized institutions that exist in other countries. the previous statements and a very com‐ plicated business environment for the development od the smes and entrepreneurship are con‐ firmed and according to the research of the world bank, conducted in 155 countries.   table 6.  benchmarking – doing business on each of the  ten topics (out of 155 countries)    b&h  albania  croatia  macedonia  smn  best  per‐ former  worst per‐ former  simplicity of  doing business  87  117  118  81  92  new  zealand  congo,  dem. rep.  business start  up  123  108  103  114  35  canada  angola  licence acquir‐ ing  141  131  148  64  130  palau  tanzania  worker em‐ ployment  95  127  109  123  61  palau  burkina  faso  registration of  property  132  66  99  73  103  new  zealand  nigeria  credit acquir‐ ing  9  41  131  53  99  united  kingdom  cambodia  investor protec‐ tion  77  136  135  30  45  new  zealand  afghanistan  tax payment  46  132  85  58  74  maldives  belarus  foreign busi‐ ness operation  122  100  109  96  123  denmark  iraq  contract obedi‐ ence  72  113  43  111  110  norway  timor‐leste  business shut  down  58  73  66  109  90  japan  west bank  and gaza  source: doing business, the world bank, 2006    based on table 6 we can conclude that b&h is in 87th place out of 155 countries, which is,  compared to other countries of western balkans, a weaker position than that of fyr of macedonia,  but better than that of albania, croatia and serbia and montenegro. however, as far as conditions  required to start up business in bosnia and herzegovina are concerned, our country is in the low  123rd place, and serbia and montenegro is in the 35th. property registration places b&h in the  132nd place, and albania in 66th. conditions needed for getting credit in b&h place it in the high‐ ranking 9th palce, which is a significantly better position than other countries in western balkans.  it can be concluded here that obstacles for the quicker development of sme sector come mostly  from government, because the market and its mechanisms function well enough.  based on the data from the table 7 it can be concluded that entreoreneurs go through 10 dif‐ ferent procedures when starting up a business in serbia and montenegro, 11 procedures in alba‐ nia, 12 in b&h, 13 in fyr macedonia, which takes about 15 days in serbia and montenegro, 41  days in albania,  48 days in fyr macedonia, and 54 days in b&h. during registration, entrepre‐ neurs face costs of 6% gni per capita i serbia and montenegro up to amazing 40,9% in b&h. as a  consequence of a complicated procedure during business registration in b&h, our registration has  a total of 7 smes/1000 inhabitants, which is significantly below all other countries in the region.  number of smes per capita is shown in the following picture.    2007 ‐ 98  •  economic analysis®  table 7. time required for business registration in western balkans countries  company registration  2005.  number of  steps  days  costs  (% gdp p/c)  alb  b&h  mkd  sim  11  12  13  10  41  54  48  15  31,1  40,9  11,3  6,0  see‐4  oecd  11,8  6,0  39,5  19,0  22,3  6,5    the key obstacles of faster development of smes in bosnia and herzegovina  the most visible obstacles have been elaborated in the following nine bullets. in some cases  we give some recommendations and possible solutions, based on results of our exploring, and on  our own experience. i hope that our suggestions will be of use to the creators of economic policy of  bosnia and herzegovina, because in the worse case, obstacles to the development of the smes can  also slow down the process of transition and to block the transfer to the market economy.  although the current situation of the smes in bosnia and herzegovina we can not character‐ ized as satisfied for many reasons, as  inadequate financial support, non‐supporting tax system,  complex  and  long  lasting  process  of  registration  of  entrepreneurship,  insufficient  institutional  support, smes are the only economic structure that worked with positive results in the past pe‐ riod. with relatively small initial capital, sme sector achieves over 40% of gdp of the country and  it gives needed job to over 250 000 employees, or in the other words, around 654%.  the structure  of smes by economy activity is not satisfied because out of total number of smes, 45 % of them are  involved in trade, 18 % in the production, and 9%, in building projects, 12 % in service and 16% in  other activities. that is the reason why smes are involved export only with 39%. based on stated  data, we can conclude that sme sector could give a job to a larger number of people in this coun‐ try, in the case of decreasing of tax load on them, establishing of stable business environment, mak‐ ing deregulation of certain regulations, liberalization in the field of foreign‐market economy, and  in the case of easier access to the initial capital with better conditions.     research that we made showed us that smes in bosnia and herzegovina are facing many  obstacles, on daily basis but the major one is lack of finances. considering that the system of finan‐ cial support is inadequate in bosnia and herzegovina, majority of companies is financed by its  own capital and with loans from the customers and suppliers. the biggest number of companies  (apx. 93% out of total number of smes) is defined as micro‐companies (up to 10 employees) and  the amount of capital is limited. if we are talking about economic effects of working of smes, the  majority of them is on the edge of surviving – they achieve economic sustainability very hardly  (approx. 50%), while approx.. 20% of them do not want to increase number of employees and ca‐ pacity of business because of fear of failure. cases of complete ruin of companies are often and not  because of market circumstances but because of high obligations toward the state. newly estab‐ lished smes have the largest problems with lack of capital, and banks see them as very risky cate‐ gory of applicants for loans, and often banks insist on very high measures of risk‐protection (mort‐ gage is approximately 200‐300% of measure). beside that, rates are mainly very high and they are  between 11% and 13%, and in a case of micro‐credit organizations they are between 20% and 25%.  volume 40 • spring 2008 • 99  these mentioned loans are strictly oriented, short lasting (up to 12 months) and with the grace  period 6 to 12 months. this is the reason why financing externally is still inadequate for smes.   the next obstacle to the faster development of smes in bosnia and herzegovina is tax system  that  is  primarily  in  the  function  of  covering  high  public  expenses.  with  a  current  high  ratio  tax/gdp,  the economy of bosnia and herzegovina  is one with  the highest  taxes  in  the central  europe, where the taxes are one of the reasons of slow development of private sector and smes  and leads to transition to the grey economy and induces avoiding of tax payment. besides that,  valid tax regulations are often complicated and complexity is additionally increased by their often  changing. luckily, current inefficient tax regulations will be changed with new and more efficient  laws. following measures that would lead to the faster development of smes are:  o abolition of income‐tax in total amount or up to certain amount in the first year of  work   o abolition of taxes on newly employed personnel of specific type of profession and  age, tax credits for research and development  the procedure for registration of company is really complicated in the administrative way.  there are no regulations in the legal system of the bosnia and herzegovina that strictly define spe‐ cially for smes, and their state and business could be seen only as companies in general. one of  the key institutional measures has to be simplifying of registration procedure. this procedure at  this moment is really complicated, complex and long lasting, and costs are very high. for the start  up of new business in bosnia and herzegovina, a person will need 12 steps and 54 days, and costs  are double than in the countries in transition, and around four times higher than in the countries of  oecd. in bulgaria, businessmen for the start up need only 11 steps and 20 days.   smes in bosnia and herzegovina in the past period did not have support of the leaders in  the economic development. similar to the other countries that have been in the transition period,  smes in b&h have shown a constant growth in the last decade. at the same time the environment  is also in the process of transformation through the bringing up new regulations, finalizing the  process of privatization but also starting with the first planned activities by the state toward devel‐ opment of smes and business. however, this is only the beginning and a lot of time will be needed  for creating good conditions for the faster development of this sector. the owners of smes should  hope that the support to this sector will be less declarative, and more concrete, and also that the  atmosphere for the development of internationally oriented sector. to achieve this it is necessary  that the state make influence on more positive environment for the smes by measures of direct  and indirect policy. the government has to provide political, legal and economic stability of the  country in order to develop smes. until now, there is no one institution for the monitoring and  support of the smes on the state level in bosnia and herzegovina, there is no regulations, nor pro‐ grams of support of the development of smes, neither on state nor entity, cantonal, regional nor  municipality  level.  besides  this,  on  economic  faculties,  departments  for  entrepreneurship  and  management have been opening  just recently. professionals should be educated in these depart‐ ments, and they would later on direct the development of smes, but there are still no sme centres,  that would function in universities, and that would be connected with sme agencies. in regards to  them the centres would be in the expert’s role. also, the universities still have not established even  a single incubators, as we can see in other countries. there is not even a joint definition of smes.  therefore, making a comparison of the level of development of institutions crucial for the devel‐ opment of smes in b&h with highly developed countries, and with the transition countries, we  have pointed at our distance from those countries clearly and unambiguously.   2007 ‐ 100  •  economic analysis®  having in mind the importance of smes in the market structure of the developed countries  and the advanced transition countries, b&h should secure support and help to the development of  smes, by using the legal system and setting up the appropriate institutions to:  o establish a stable policy of support to the development of smes on all levels of terri‐ torial organization in b&h, which would not oscillate depending on the changes in  power on all levels;  o making programs of support for smes.  o supporting the creation of centres in non‐governmental institutions that would give  special and immediate support to smes in all stages of their development  o the local authorities should support the development of technological parks, clusters,  incubators etc.   o the local authorities should improve legislation, and especially practices, of registra‐ tion of companies based on principle: „everything in one place – faster, easier and  cheaper“.  o establishing funds for the development of smes, which would stimulate activities of  companies on:  improving current and creating new products and services,  developing competitive advantages of smes in domestic and foreign markets,  securing the level of quality in accordance with the requirements of iso stan‐ dard,  faster implementation of modern technologies,  introducing information systems and e‐commerce,  preparation and execution of ecological projects, etc.  o establishing euro‐info centre state‐wide and including it in the european network of  euro‐info centres. these centres today have the status of official it network of the eu  and besides the member countries they also include over 20 countries of central and  eastern europe, as well as the mediterranean. these centres give answers to all the  questions regarding the operations of smes in the european union. this computer  network would provide employment for a large number of young experts of various  profiles.  o leasing has been proven as an effective tool of supporting smes in many countries  and, therefore, legislation in this area could be a priority for the authorities in bosnia  and herzegovina. the government can influence the leasing market as it is very sen‐ sitive to tax treatment and the protection of rights of retailers in order to be able to ex‐ tract money in case that the customer does not pay.   one of the basic results of the analysis conducted in this paper is that the creation of a spe‐ cific model of a  successful transition in b&h is a task with no alternative. this is not surprising,  because under the influence of events that are gaining speed ever so quickly (and these event are  mostly external – globalization) there is no possibility of a stationary condition; either there is eco‐ nomic growth, or there is recession, with all the consequences of such a process. this is especially  true for b&h, which, as a late participant in the process of globalization, which is caused by war,  must put in additional effort. the economy of bosnia and herzegovina must get institutional sup‐ port on national  (and more and more even on the  international)  level,  in order not  to  lose  its  chance in regards to those countries that have gone quite far down that road. besides this, the pro‐ gram of restructuring of the economy and the development of the sme sector is unimaginable  volume 40 • spring 2008 • 101  without the necessary infrastructure. first of all this relates to: highways, railroads, telecommuni‐ cation systems, securing cheap and safe sources of electric power, creation of industrial zones, etc.  only such a modern infrastructure, ready for investments of commercial investment capital can be  the answer (the countermeasure) for opportunity attractiveness of investing in other, mainly transi‐ tion countries in which there is a low price of workforce. if these things do not happen, investment  capital will not come to b&h.  although the sme sector was expected to expand and grow so that it creates enough jobs, to  absorb the fired workers in the process of restructuring and privatization of large companies, and  to create jobs for those that are new in the labour market, this has not happened in many transition  economies, especially in south‐east europe. in our country too, the sme sector neither grew fast  enough to prevent the growth of unemployment, nor it realized its potential as the initiator force.  even though a large number of new smes entered the market, because of market liberalization  those smes did not grow as fast as it was expected based on the experiences of the developed  market economies. a possible reason might be in the obstacles to development that we listed ear‐ lier on. such obstacles to development stunt a quicker transfer of workforce from the old, non‐ productive large companies to the newly formed private sector. as a consequence, this can result  in less‐than‐possible growth of a given economy, as well as a significantly greater unemployment  that the one that is necessary.   in the end we can conclude that the most evident obstacles to the development of smes in b&h  are the following:  o the divided economic space,  o insufficient legislation,  o lack of financial support,  o high tax rates and a complicated tax system  o non‐existence of a central registry of a bank account holder in banks in b&h,  o non‐existence of a financial market and non‐banking credit institutions,  o non‐existence of advisory and financial support for start‐ups,  o no possibility for securing the requested collaterals,  o big technological backwardness,  o non‐sufficient present on foreign markets,  o non‐sufficient education of the management,  o lack of managerial skills,  o big share of informal economy  o no networks between the existent smes,  o a very long period of time is required to register a firm, also a lot of documentation is  required etc..  conclusions  more than a decade after the end of war in b&h, when it comes to the private sector, three  things can be concluded:  first – there are still numerous obstacles for its development.    2007 ‐ 102  •  economic analysis®  second –  that development  is still a crucial precondition  for  the progress of economy  in  b&h.  third – the economic space in b&h is still divided in two parts.  in order for the sme sector to develop faster, and thus decrease unemployment, it is neces‐ sary to crate a unified economic space and than conduct a significant deregulation, as this area is  regulated with too much legislation. then, it is necessary to make access to financing easier for  smes, to pass a leasing law, to privatize state firms and to increase the share of sector in gdp. sim‐ ply, the number of smes must be significantly greater in the following period, because without the  new companies there will be neither new employment  nor the reduction of the huge deficit. there  is no positive trend while the growth of new firms in b&h is 30‐40%. it is thus needed to crate the  presumptions for the increase in number of start‐ups. also, it is necessary to increase the number  of medium sized enterprises because the share of micro smes with less than five employees is cur‐ rently too big.   the situation is somewhat better in serbia. in this country there is around 50 thousand active  private smes, and their number has not increased significantly in the last ten years. there are 600  medium enterprises and only 83 large enterprises. in comparison with hungary, which has around  the same population, the number of smes is too small. namely, hungary has got over 500 thou‐ sand smes. the basic obstacle to faster development of smes in this country is, similarly to other  countries of western balkans „undercapitalization“. on the average, smes in serbia have 20,000  euros at their disposal, and under current conditions they can be in credit of up to 6,000 euros.   finally we can conclude, that in comparison to other countries of western balkans, b&h is  lagging behind both in institutions and in lack of support for smes. the ground laws for smes in  bosnia and herzegovina have not been passed yet, there is no state‐wide sme strategy, there is no  agency for smes, which is a unique case in the whole region. the government not only does not  have the strategy for the development of smes, but many obstacles, as we have seen, also come  from government. however, we consider that the philosophy on which the market structure in  bosnia and herzegovina should be established is the following:  5 firms with 200 employees is  safer than  1 firm with 1000 employees,  and  100 firms with 10 employees are  more flexible than  10 firms with 100 employees.    one of the primary results of the analysis undertaken in this paper is that the sme sector  has not created enough jobs, that it absorbs the fired workers in the process of restructuring and  privatization of large companies, and that it has not created  jobs for new workers in the labour  market. the possible reason is in obstacles that we have mentioned earlier on, which can result in  growth under possibilities, and a significant unemployment. in the worst case, the obstacles to the  development of smes can block the transition of bosnian economy to market economy. besides  this, the set goals and tasks of research have been realized.  literature  blanchard, o.: the economics of post‐communist transition, clarendon, 1997.  volume 40 • spring 2008 • 103  milardović, a., zapadni balkan – pojam, ideje i dokumenti o rekonstrukciji balkana u procesu globalizacije, pan liber, osijek –  zagreb – split, 2000., pg.26  strategy for bosnia and herzegovina, ebrd document, 2005., pg. 2  united nations economic commission for europe, small and medium‐sized enterprises in countriesin  transition, united nations, new york and geneva, 2003  bašić, m.: ekonomija b&h, ekonomski fakultet univerziteta u sarajevu, sarajevo, 2005.   unece,  small and medium ‐ sized enterprises in economies in transition and emerging market economies in 2001.  printed at united nations, geneva (switzerland), 2003.  džafić z.: pretpostavke razvoja malih i srednjih preduzeća u b&h, tempus projekti u funkciji razvoja malog biznisa, faculty  of economics, sarajevo, sarajevo, 2004.  džafić z.: značaj i uloga malih i srednjih preduzeća u razvoju zemalja centralne i istočne evrope, legal advisor, center for  promotion of civil society, sarajevo, number 4, may 2004.   džafić z.: mala i srednja preduzeća u funkciji restrukturiranja tranzicionih privreda sa posebnim osvrtom na b&h, doktorska  disertacija, ekonomski fakultet, tuzla,  2005.   džafić z.: ruolo ed importanza delle piccole e medie imprese nella fase di ristrutturazione e sviluppo dell economia di  bosnia ed herzegovina, specialist paper, bologna university, italy, 1997.    rovčanin, a., džafić z.:  franšizing – partnerstvo uz sinergetske efekte, collection of papers of faculty of economics in sara‐ jevo, number 24, september 2004  rovčanin, a., džafić, z.: institutional changes ‐ assumption for development of small and medium‐sized enterprises in bosnia  and herzegovina”, international conference of university of rijeka, entrepreneurship and macroeconomic  management, april, 28‐30. 2005. pula, croatia,   www.eppu.ba/pdf/unapredjenje poslovnog okruzenja/pdf.  www.unece/indust/sme/smepub/2003/  www.www.dei.gov.ba‐ the agreement on stabilization and accession          ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp60-78 original scientific paper marketing of public services: the impact of service quality, reputation and consumer engagement on customer perceived value, satisfaction and loyalty sanjay k parahoo1* | heather lea harvey2 | madhavi ayyagari3 1 business school, hamdan bin mohammed smart university, dubai, united arab emirates 2 hashemite university, school of medicine, zarqa jordan 3 murdoch university, dubai, united arab emirates abstract public services are provided by government and have been traditionally supply-oriented. changing citizen expectations put pressure on government agencies and public sector organizations to be accountable for efficiency and effectiveness. further, the quest to enhance international competitiveness by ranking high in the echelons of world’s best governments, led to the adoption of proven marketing philosophy and methodologies in the domain of public service as well. the present study aims at examining the impact of service quality, reputation and consumer engagement on customer perceived value, satisfaction and loyalty for an important public service viz., dubai metro which operated in an intensely competitive market. the study developed and empirically tested a structural model of travel behavior which hypothesized that reputation, quality and customer engagement are major drivers of value and value in turn leads to satisfaction and loyalty. the findings supported the model with reputation having a stronger impact than quality. a positive association was found between value, satisfaction and loyalty. however, consumer engagement was not found to have a significant influence on customer perceived value. key words: marketing of public services, service quality, reputation and consumer engagement, customer perceived value, satisfaction and loyalty jel classification: d4, h0 introduction citizen expectations from public services have registered a significant shift during the recent decades resulting in growing demands for transparent, accessible, and responsive services from the public sector. traditionally, governments have functioned with a supply-orientation, focusing on their own requirements and processes instead of the needs of the people they serve (dudley et al., 2015). the disenchantment with government performance, characterized by the bureaucratic public administration approach, gave way to the new public management paradigm which embodies a result oriented, entrepreneurial and citizen-centric management style (gaebler and osborne 1993). public sector was encouraged to draw from the experience and lessons learnt by the private sector in ensuring effective service design and delivery. gash et al., (2013) exhort: “government must urgently professionalize its approach to commissioning and overseeing public service markets, embracing what we call a ‘market stewardship’ approach.” * e-mail: s.parahoo@gmail.com sanjay k parahoo, heather lea harvey, madhavi ayyagari 61 moreover, governments face competition from other countries for attracting foreign direct investment. countries are vying with each other to enhance their competitive advantage and are rated on a number of indices related to government excellence. these challenges made transformation imperative. some government agencies have successfully adapted themselves and implemented a customer-oriented approach to service design and delivery. they also regularly evaluate customer satisfaction levels and aim at effecting continuous improvements. if marketing of services is more complex than that of goods due to their intangibility (e.g., parasuraman et al., 1988; zeithaml et al., 1985), the challenge is even greater in the case of public services which are complex value propositions that serve multiple publics (osborne et al 2013). data driven insights about citizen satisfaction and its determinants helps public service providers address the key elements for improving service design and delivery. in this context, the present study aims at examining the impact of service quality, reputation and consumer engagement on customer perceived value, satisfaction and loyalty for an important public service viz., dubai metro. the service chosen is highly competitive since mass rapid transport (mrt) faces intense competition from other modes of transport including personal vehicles. the government is encouraging residents to move from personal transport to the use of public transport as part of its sustainability strategy (uae state of green economy 2014). therefore, the objective of this study was to develop and empirically test a structural model of travel behavior based on variables such as satisfaction, value, quality, reputation and engagement that have been found to drive loyalty in various industry settings. it would therefore be useful to determine the pertinence of these variables in motivating riders to select mrt as their mode of transport, particularly for local authorities engaged in promoting the use of their mrt services. an understanding of the drivers of satisfaction would also contribute to the government’s aim of delivering services that rival the best in the private sector (mckinsey 2016). further, the study contributes to the neglected public service context in the service management literature (hodgkinson 2017) and captures insights that help the shift to servicedominant thinking within the public sector. literature review and development of conceptual framework public services public services are the services provided by the government (or its agencies) to those residing within its jurisdiction. unlike their private sector counterparts, public service delivery carries the mandate of ensuring universal access often associated with the fundamental rights of citizens and hence the service context is significantly different (van de walle 2016). for example, provision of healthcare and education is the responsibility of the government towards its citizens. another unique characteristic is ensuring justice involving fair and equitable treatment of all sections of society. the private sector firms can choose which segments they want to target, but the public services often have little choice in targeting segments that are accessible and profitable. public services are targeted at all segments and have to offer value propositions to various stakeholders and not just the users, making it a complex service (osborne et al 2013). mrt services and dubai metro mass rapid transit systems (mrts) are collective urban or suburban passenger services operating at high levels of performance, particularly with regard to travel times and passenger carrying capacity (cdm, 2010). they are more efficient time-wise for consumers and have numerous environmental benefits as compared to private transportation, leading to many cities adopting strategies to encourage this shift in ridership (fouracre, 2003). dubai metro, launched in 2009 to cater to the transport needs of a modern city (pr 2.0, 2011), was chosen as the 62 economic analysis (2018, vol. 51, no. 1-2, 60-78) empirical context of this study. dubai metro is a fully automated system with a total length of 74.7 km, and the longest driverless metro network in the world. furthermore, summer weather conditions in dubai serve as a conduit to the posh air conditioned malls being a social space where residents and visitors spend considerable time. the linkage of the dubai metro to the city’s major shopping malls therefore helps in reducing traffic congestion since the malls generate 4 000 to 10 000 vehicles per hour (maitha, 2011), while the connection of the metro network to the international airport provides tourists with increased mobility. the monthly number of metro users has increased from 1.8 million passengers in october 2009 to 5.5 million passengers in october 2011, with the cumulative total number of passengers crossing 275 million in the first half of 2017 accounting for 36.4 percent of all public transport ridership (dubai metro, 2017). financially, the metro project cost the rta approximately us$ 7.6 billion, but authorities are expecting the metro to generate us$ 4.9 billion in income over the next 10 years (wikipedia, 2012). dubai shares a profile similar to other metropolitan hubs and expanding urban centers in the region, consequently making the findings generalizable to other regional cities that are launching mrt projects, including abu dhabi, riyadh and doha. even though there are considerable advantages to draw consumers to mrt usage, many mrt schemes have experienced severe financing and debt repayment problems due to poor financial returns, resulting in public authorities inevitably being involved in financially supporting the projects (fouracre, 2003). for this reason, it is crucial for management of mrt services to develop passenger loyalty to motivate maximum ridership so as to maximize revenue from the mrt operations to help recoup the large investments associated with launching and operating mrt projects. hence, loyalty is chosen as the output variable of the study model and its drivers and their relationships are next discussed through a review of the extant literature. dependent variables customer loyalty customer loyalty, or one’s intention or predisposition to purchase from the same firm again is a key construct within the service industry (edvardsson et al., 2000). the motivation for understanding and improving loyalty emerges from empirically validated studies linking customer loyalty and profitability (turel and serenko, 2006; and oliver, 1997). in practice in the mrt context, this translates into commuters in a city adopting the service on a regular basis ahead of other transportation alternatives. industry experience shows that has not always been easy to achieve with seoul mrt initially reporting half of the forecast occupancy (chang and lee, 2008), while for chennai’s mrt the corresponding occupancy was only 10 % (madhavan, 2010). loyal customers also act as prescribers, spreading positive word-of-mouth (reichheld and teal, 1996) which may increase the utilization of the service. since, the mrt is a perishable service, unoccupied capacity on a train journey cannot be inventoried and sold later, thereby representing lost revenue. further, while operating a train journey involves high fixed costs increasing the number of passengers transported represents only marginal cost increases. given the inherent flexibility in transportation capacity of mrt by accommodating standing passengers in a train compartment, it would be desirable from purely profitability considerations that mrt trains operate ideally near maximum capacity or in factoring in passenger comfort, near optimum capacity. customer satisfaction customer satisfaction has been identified as a key determinant of customer loyalty (e.g. deng et al., 2009; liang et al., 2009; ha and john, 2010), and as a key global construct for predicting consumer behavior (garbarino and johnson, 1999). it represents the core construct of sanjay k parahoo, heather lea harvey, madhavi ayyagari 63 marketing, and has been defined as “a judgment that a product or service feature, provides a pleasurable level of consumption-related fulfillment” (oliver, 1997). the pertinence of satisfaction as a driver of loyalty is well recognized in the mrt industry illustrated for example by melbourne mrt where performance figures have been linked to customer satisfaction ratings (metro, 2012). in dubai, serco, the dubai metro management company stated: “the dubai metro is similar to a railway system we run in the uk that has customer satisfaction levels of at least 90% and close to 100% availability for services such as ticket machines, escalators and information displays” (www.joindubaimetro.com/serco.asp). the preceding discussion leads to the following hypothesis: h1: passenger satisfaction with dubai metro is positively associated with customer loyalty. perceived value satisfaction is often conceptualized through its key antecedent perceived value (e.g. mc dougall and levesque, 2000; butcher et al, 2001; cronin et al., 2000), and has been defined as the consumer’s overall assessment of the utility of a product based on their perceptions of what is received and what is given (zeithaml, 1988), or a cognitive trade-off between quality and sacrifice (lee, 2010). value has been proposed to be the core purpose and central process of economic exchange (vargo and lusch, 2008), and as a stable construct to predict loyalty (nguyen, et al., 2018; trasoras et al., 2009; pura, 2005; and hellier et al., 2003). but while traditional models of value creation have focused on the firm's output and price (e.g. kleine et al., 2009), vargo and lusch (2008) have shown that value is fundamentally derived and determined by use rather than in exchange. this leads to the following two hyotheses: h2: value perceived by passengers of dubai metro is positively associated with their satisfaction. h3: value perceived by passengers of dubai metro is positively associated with their loyalty. independent variables service quality one’s cognitive evaluation of the service experience (ha and john, 2008) or “judgment about the superiority or excellence of a product” (parasuraman et al., 1988), is known as service quality. it may be influenced by consumer preferences such as utilitarian benefits (roy and ng, 2012). in the airline industry, service quality has long been considered as key to supporting a differentiation strategy (bamford and xystouri, 2005; rhoades and waguespack, 2008), between what might otherwise be considered as a homogeneous service. therefore, service quality has become an expectation of customers that businesses strive to meet or exceed, including the rta who as part of their mission seeks to provide ‘quality service’ of the highest standard to all dubai metro passengers (rta, 2011). value represents a cognitive trade-off between perceptions of quality and sacrifice (lee, 2010), with quality identified as what one gets, whereas sacrifice is seen as what one gives up (drew and bolton, 1987). under constant gives, when higher service quality is perceived by customers, this will lead to an increase in benefits derived from the product or service, indicating that value is also increased. this perceived service quality-perceived value relationship has been empirically demonstrated by many authors (e.g. butcher, et al, 2001; parahoo, 2012; lee, 2010;). therefore, the following hypothesis emerges: h4: service quality perceived by passengers of dubai metro is positively associated with the value perceived 64 economic analysis (2018, vol. 51, no. 1-2, 60-78) reputation reputation is important to a service organization as it represents a valuable intangible asset (vidaver-cohen, 2007). three related terms have been used interchangeably: in the reputation literature: organizational identity, organizational image, and corporate reputation (barnett et al, 2006). but in actuality, the three constructs may be differentiated in terms of whether they refer to internal or external stakeholders, or both. helgesen and nesset (2007) state that organizational identity refers solely to internal stakeholders, organizational image to only external stakeholders alone, while corporate reputation to refers to both internal and external stakeholders, particularly employees and customers. corporate reputation has therefore been defined as the collective judgments of a corporation based on assessments of the financial, social, and environmental impacts attributed to the corporation over time” (barnett et al, 2006, p 34). furthermore wang et al. (2004) acknowledged the critical role of reputation, where an organization’s reputation is based on its past actions (nguyen and leblanc, 2001). and as expected, developing a good reputation is crucial to a business as it leads to value creation (roberts and dowling, 2002). in the transportation industry, the influence of corporate reputation on consumer behavior is well documented, with airline passengers developing a reputation judgment of a service which then influences their consumer behavior in the service (graham and bansal, 2007; parahoo, harvey, and radi, 2014). in mrt industry, public authorities setting up mrt schemes have consequently focused on positioning their service to reflect a positive image and reputation illustrated by singapore’s mrt representing a symbol of “smart singapore” (richmond, 2008), by dubai metro with its aesthetically designed modern stations, and having the longest driverless metro system in the world (gulf news, 2012), and with chennai’s mrt having “15odd futuristically-designed stations” each having parking spaces (madhavan, 2010). the appeal of metro services, particularly for passengers who have an alternative choice for transportation, therefore depends on its reputation. branding and reputation development are prominent in the marketing strategies of firms, as customers prefer not to patronize a service that does not have a good reputation, as this affects their self-image (kwak, and kang, 2009). it has been argued that a good reputation is crucial as it leads to value creation (roberts and dowling, 2002). therefore it was important to effectively incorporate the effect of reputation of mrt services in the study model, particularly since consumer reputation studies in the field have been scarce (graham and bansal, 2007); mostly concentrating on theoretical reasoning, and lacking empirical research designs (jarvinen and suomi, 2011). the above discussion leads to the following hypothesis: h5: reputation of dubai metro is positively associated with perceived value. consumer engagement finally, traditional consumer behavior models have considered passengers of public transport passive consumers, while management created ‘value-in-exchange’ (lovelock et al., 1987) using methods such as improving efficiency and punctuality of traffic services, and enhancing travel comfort (knutsson, 2003). however, the emerging service-dominant logic literature has shifted to operant resources, which are considered as core competences or organizational processes, with customers acting as active participants in relational exchanges and as co-producers of the service. within the service-dominant logic paradigm, management involves social and economic processes largely based on operant resources with which the firm is striving to make better value propositions than its competitors. it is often debated as to whether an enterprise may create value independently, or may only do so collaboratively following acceptance of its value propositions by customers (vargo and lusch, 2008). in the present study, the construct of engagement adopted an ongoing emotional, cognitive and behavioral activation state in sanjay k parahoo, heather lea harvey, madhavi ayyagari 65 individuals (wefald and downey 2009), for the engagement of passengers in public-transport has been shown to be a major driving force behind consumer behavior and decision making (vargo and lusch, 2008), and to be proactively co-created as value-in-use by engaging customers in the service process (gebauer et al., 2010). therefore, it is proposed: h6: customer engagement in service co-creation is positively associated with perceived value these hypotheses are represented by the structural model below (see figure 1). figure 1. conceptual structural model source: developed based on literature review above the conceptual model incorporates the hypothesized drivers of loyalty and their interrelationships in an mrt setting. in the next section, an empirical study is designed to determine the influences, if any, of two specific constructs, reputation and engagement, which have rarely been investigated quantitatively in driving passenger loyalty in mrt service, thereby filling a gap in the literature. methodology to develop measures for the six study constructs, a pool of items was constituted by sourcing from literature validated measures that matched the conceptualization of each of the related constructs in the present study. to supplement and contextualize this pool of items, 20 openended interviews were conducted with passengers at 4 different metro stations, followed by indepth interviews with the managers at the stations. the resulting draft questionnaire (40 items) was discussed with industry experts, and pilot tested with seven passengers which led to some minor refinement of question wording. all items were measured on a seven point semantic differential scale from strongly disagree to strongly agree. an overall measure of each study construct was also included in the questionnaire to assist with item purification. the sampling frame was designed after consultation with industry experts to constitute a representative sample of passengers using the metro. it involved selection of seven stations (out of 28) on the red line and four stations (out of 18) on the green line. personal interviews were conducted as it enabled clarification of any queries, and the data collection was completed during a one week period at various times of day and on multiple days to capture different categories of passengers. a total of 520 passengers were interviewed by a trained interviewer with 511 represented usable responses, and the data analysis was derived using spss (questionnaire purification and descriptive analysis) and lisrel (modeling) software packages. purification of questionnaire the measures for the study constructs were purified using item-to-total correlations (churchill, 1979), as well as correlation with an overall measure of the related construct (e.g overall how would rate the service quality of the metro?). at this stage, items having loadings greater than 0.7 on their associated construct were retained (fornell et al, 1982). this process purified the 40-item pool to 18 items (see table 1). 66 economic analysis (2018, vol. 51, no. 1-2, 60-78) a necessary condition for assigning meaning to estimated constructs is that the measurement items postulated as alternate indicators of each construct must be unidimensional (gerbing and anderson, 1988). the retained 18 items were therefore subjected to a confirmatory factor analysis (cfa) to establish the unidimensionality of the measurement scales. while the p value associated with the chi-square statistic was significant, it is known to be sensitive to sample size. therefore, other fit indices were investigated which pointed to an good fit of the model according to prescribed criteria (e.g. hu and bentler, 1999): chi-squared to degrees/ degrees of freedom (322.68/120) =2.69; ifi=0.99; gfi=0.93; srmr=0.033; rmsea=0.056. the measurement models reflecting the study constructs were confirmed to be one-dimensional and each measurement item having a path loading exceeding 0.70 on its associated latent variable, with the loading being statistically significant at p<0.05. reliability of the model was determined using cronbach alpha with each of the 6 scales having alpha values generally > 0.70, indicating excellent reliabilities (see table 1 below). in addition to reliability, a measurement scale must demonstrate validity and hence several forms of validity were next measured. concurrent validity was measured by correlating the composite score of a construct scale with the overall measure of the same construct, and construct validity was captured by the correlation of the composite score of a construct scale with a related measure (their outcome variable as per figure 1). the high values of the pearson correlation coefficients and their statistical significance (p<0.01) for both concurrent and construct validity confirmed the validities of the six study constructs (see table 1). table 1. summary characteristics for scales of constructs construct initial no. of items final no. of items after purification cronbach alpha concurrent validity: correlation construct validity: correlation. quality 17 3 0.81 0.535 0.698 reputation 4 3 0.82 0.584 0.728 engagement 4 2 0.71 0.434 0.529 value 7 3 0.80 0.429 0.729 satisfaction 3 2 0.77 0.606 0.727 loyalty 5 5 0.91 0.626 0.727 (*all correlations are significant at 1 percent levels with p<0.001) source: constructed from data analysis statistics in spss one final measure was further undertaken to determine discriminant validity by constructing a 95% confidence interval (± two standard errors) around the correlation estimate (φij) among each of the exogenous latent variables (anderson and gerbing, 1988). none of the confidence intervals included unity, with values of 0.77-0.89 for quality-reputation, 0.49-0.65 for qualityengagement and 0.62-0.78 for reputation-engagement, thereby confirming discriminant validity among the constructs. having ascertained reliable and valid unidimensional measures for the study constructs, data analysis was undertaken followed by modeling to test the study hypotheses. data analysis and discussion descriptive analysis and discussion of findings it was observed that the metro passengers represented a mix of different age groups, however nearly 84% were 40 or younger (see table 2). in terms of gender, males (57.3%) slightly outnumbered female passengers, while there were approximately equal proportions of singles sanjay k parahoo, heather lea harvey, madhavi ayyagari 67 (49.7%) and married respondents. the respondents came from a wide range of occupational types, with well over 65% holding administrative positions and above (see table 3). table 2. age distribution source: primary data table 3. type of occupation source: primary date dubai’s cosmopolitan profile was reflected in the nationalities of the respondents as shown in table 4. arabs constituted the most common users of the metro (35.4%), followed by europeans (28.8%), and asians (25.8%) comprising indians, pakistanis and philipinos. in addition, nearly a third (33%) of the users identified themselves as tourists. table 4. nationality of respondents source: primary date among all dubai mrt riders, 28.1% reported owning a vehicle, moreover 32% of local residents were car owners. further analysis to make sure non-resident riders were not a 68 economic analysis (2018, vol. 51, no. 1-2, 60-78) confounding variable was analysed but not found to be significant. but frequency/usage status showed that among riders just over half were heavy users (50.8%, with a metro usage rate of 11-30 days per month), while 19.5 % used the metro more moderately (1-9 days/month), with the rest using the metro even less frequently. thus management needs to identify a means to motivate casual riders to use the metro more regularly. on a more positive outcome more than three-quarters (77%) of passengers reported having used metros in other countries, and 91% of these respondents rated dubai metro better than the metro they used elsewhere. but while the majority had a positive rating for the mrt, passengers had mixed feelings regarding accessibility of feedback mechanisms. there was considerable room to increase forums for interactions with customers. finally, the respondents’ ratings on the six study variables were generally quite high, (see table 5) with one exception, engagement. while this is a very positive signal for metro management and reflective of current success in their operations, it does not preclude continuous improvement efforts as customer needs are known to be dynamic. table 5. mean ratings on study constructs quality value reputation engagement satisfaction loyalty mean 6.2050 6.0049 6.2162 5.6833 6.0078 6.2537 std. deviation .98711 1.10001 1.02355 1.31868 1.15212 1.08217 source: constructed from data analysis in spss testing of hypotheses by structural equation modeling the conceptual model depicted in figure 1 along with the measurement models associated with each of the latent variables were tested using lisrel 8. an inspection of the measurements models confirmed that the measurement variables were good indicators of the constructs, with statistically significant loadings over 0.70 and much smaller corresponding error terms. further, an evaluation of the structural model confirmed that all model paths were statistically significant (p<0.05), except for the path from engagement to value (t = 1.47, and path loading= 0.08), indicating that the postulated relationship between engagement and value based on theoretical considerations was not empirically supported by the data. as a result the model was reformulated by deleting engagement as well as its two associated measures, and a path analysis was again run with the revised model. the new output files showed that all the paths in the measurement and structural models were now significant at p<0.05 (see figure 2). the chi-square statistic was non-significant (p<0.000) and too sensitive to sample size to be used in the present study having a large sample size. the path loadings in the structural model were as postulated by the six study hypotheses (see figure 3). therefore other fit indices were examined and they supported a good fit of the model to the data (chi-square/df = 258.45/98=2.64; gfi= 0.94; agfi=0.92; rmsea= 0.057; srmr=0.032; nnfi= 0.99; cfi=0.99). it may therefore be concluded that the study hypotheses (h1-h5) proposing quality and reputation as drivers of the hierarchical marketing chain represented by variables valuesatisfaction-loyalty could be accepted, while the relationship between engagement and value (hypothesis 6) was not supported. in this regard, it was noteworthy that reputation and quality exerted strong indirect effects of 0.67 (t=9.11) and 0.15 (t=2.24) respectively on loyalty, thereby emphasizing the major influence of reputation as the primary driver of loyalty. sanjay k parahoo, heather lea harvey, madhavi ayyagari 69 figure 2: t-values of paths in structural and measurement models source: lisrel output figure 3: paths in the structural and measurement models source: lisrel output discussion and implications theoretical as a result of the study analysis, the passenger behavior model in mrt services – which posited that reputation and quality are the major variables that drive the marketing chain valuesatisfaction-loyalty for passengers using dubai metro was empirically validated, with the 70 economic analysis (2018, vol. 51, no. 1-2, 60-78) exception of passenger engagement, which was not found to have a significant influence on value perceived by passengers. while the positive association between value, satisfaction and loyalty was expected having been determined in studies in other industry contexts (e.g. cronin et al., 2000; lee, 2010), the major contribution of this study was in identifying reputation and quality as drivers of loyalty for dubai metro passengers. the study model explained 85%, 76%, and 64% of the respective variance in the three dependent variables: value, satisfaction and loyalty, which was encouraging particularly in view of the model’s parsimony. the role of service quality in influencing consumer behavior in various services is well documented in literature (e.g. lee, 2010; parahoo, harvey, and tamim, 2013, ahrholdt, gudergan, and ringle, 2016). specifically, in the transport industry, various studies have identified service quality as a major determinant of airline positioning (rhoades and waguespack, 2008), and in influencing demand for public transport (paulley et al., 2006). therefore, the present study confirms the influence of service quality in driving passenger behavior in the context of dubai metro as well. what was more unforeseeable however was that reputation exerted a much stronger effect on the value-satisfaction-loyalty chain than quality, demonstrated by an indirect effect of 0.67 (t=9.11) for reputation on loyalty compared to quality on loyalty 0.17 (t=2.24). this overriding influence of reputation in influencing travel behavior in a mass public transport service is not common, with the influence of reputation being previously associated with more exclusive transport services such air travel. in fact, anecdotal evidence shows that in commuting between cities business executives generally opt for air rather than rail travel (a mass public transport) even if the journey time differential between the two travel modes is practically the same. the study findings that reputation is the key variable driving passenger loyalty in what could be considered as a less exclusive transport modemetro services -is therefore innovative, particularly that mass public transport is a visible service likely to affect its passengers’ selfimage. the reasons for this shift in consumer attitude and behavior therefore needs to be investigated further. at this stage, it may be proposed that a shift in traveler expectations towards a “smart way to travel” is illustrated by one indicator of the reputation construct (see annex). this seems to be supported by several mutually reinforcing underlying factors. first of all, in an era of growing environmental consciousness, using a cleaner and more efficient mode of transport becomes a lifestyle statement likely to boost a traveler’s self-image. further, dubai metro is based on stateof-the art infrastructure and facilities, with aesthetically designed stations, excellent functional passenger flow, and a good network of connecting allied transport services, which reinforces its image and reputation, making it desirable for various passenger segments. finally, the image of the metro with its futuristic design and image mirrors that of the emirate of dubai projecting global standards of modernity and excellence, thereby motivating its use. a parallel could be drawn here with the mrt service in singapore, a city state to which dubai is often compared, with singapore being described as having a “reputation as a well-oiled city-state, replete with a peerless transport system” (mahtani and wong, 2011). as a conclusion, enhancing the reputation of the metro is the factor that will motivate its enhanced patronage. the lack of empirical support for the influence of engagement on the value-satisfaction-loyalty chain warrants further discussion, for it contrasts the emerging literature on service-dominant logic, as well as recent studies (e.g. gebauer, 2010, edvardsson et al., 2011). it is recognized that consumers increasingly wish to act as active participants within relational exchanges with the service firms to cocreate value for themselves (vargo and lusch, 2008). instead of concluding that engagement of passengers is not a driver of their loyalty, it is proposed that the conceptualization of engagement measures in the study may be a cause for its weak non– significant effect in the study model. in hindsight, this lack of support for engagement as a driver for value may have been linked to the fact that engagement was measured in the present study sanjay k parahoo, heather lea harvey, madhavi ayyagari 71 on the ability (e.g. “i play an active role in my travel by using self-service equipment at dubai metro stations”) rather than the willingness of customers to co-create the service (see item details at annex). for 41.9 % of passengers reported they did not have easy access to a feedback system, thus their engagement was not readily facilitated by management, implying they could not effectively participate in value co-creation, reflected by engagement scoring the lowest average rating among study constructs (see table 5). to rectify a similar situation in future studies, it would be appropriate to measure customer engagement by customer willingness rather than their ability to co-create the service, for the ability to be engaged is moderated by the design of the service process by its provider. the empirically validated travel behavior model in public transport services in dubai, identified and highlighted the major role of reputation as a driver of passenger loyalty, contributes a new insight to the sparse literature of public transport usage which has so far emphasized mainly service quality and passenger satisfaction to drive usage. the multiethnic profile of residents and economic development stage of dubai make the study findings generalizable to public services being offered in highly competitive contexts. managerial the major decision problem that operators of an mrt system face is how to increase their ridership to maximize revenue generation in order to recoup their investments in infrastructure and operational costs, as well as to achieve environmental benefits associated with clean, safe and efficient travel. the present study has demonstrated that to achieve enhanced ridership on the metro, management must focus on developing its reputation and enhancing the service quality offered, for these two variables had significant effects on driving the value-satisfactionloyalty chain with path loadings (gamma) on value of 0.77 (t=9.01) for reputation and 0.17 (t=2.24) for quality. the validated measurement model for reputation (see wording of items at annex) also demonstrates that dubai metro management should focus on image or brand development as well as positioning the metro as a “smart way to travel” by highlighting its lower cost of travel, its associated environmental benefits, and its stress free travel experience (e.g. no traffic jam, comfortable journey). while, for service quality, metro management needs to maintain their emphasis on the quality of infrastructure, pleasant design and excellent passenger amenities at the stations, the quality of service at stations, enhance the passengers’ experiences through the ambience created through interior design, signage and a sound system that matches the positioning of the metro as representing global standards of modernity and excellence. in actual practice, dubai metro management has been successful in increasing its ridership and has opened up new lines and stations since 2009, by precisely focusing on image development and offering a quality service both through human intervention (ticket counters) as well as automated ticketing machines. this is confirmed by the overwhelming majority of passengers of various nationalities (see table 4) who have used metro services overseas, and who rate dubai metro as a better service. while this is an encouraging and motivating situation, in perspective of continuous improvement, efforts must be sustained to maintain the reputation of the metro. for example, the pr campaign of (free) public transport day on november 1, where national leaders, top executives, and private transport users are encouraged to swap their cars for the metro, is a good approach for building the metro’s reputation. targeted advertisement campaigns to car owners, emphasizing the environmental benefits of the metro, as well as its stress free riding experience, may encourage even more residents to swap their cars for the metro, for currently only 32% of the local transit riders reported owning a vehicle. in addition, there is an opportunity to engage the senior managers (among the 41.4 % of users in managers/directors category) in a long-term relationship by proposing monthly 72 economic analysis (2018, vol. 51, no. 1-2, 60-78) passes for first class travel. this service may be leveraged through value added services such as provision of reserved car parking spaces at the park and ride stations, and incorporating free wi-fi in the first class compartment. other services may be offered to these high-end passengers resulting in a win-win partnership, based on qualitative research, for with more executives being encouraged to use the service, the process would enhance the reputation of the metro, and, this could have a multiplier effect on other segments of passengers as well. in a perspective of continuous improvement, metro management should focus on continual feedback from their customers both through visible suggestions boxes at stations as well as electronic means in an attempt to track their expectations, which may then be considered for implementation which would enhance their satisfaction. for example in the present study, certain passengers willingly contributed numerous valuable suggestions: proposing that passengers should be educated to keep clear of the train entrance and to be prepared to exit before reaching their destination; requesting for seats on platforms; and better directional signs to dubai mall. such comments from passengers, if effectively implemented, could lead to higher value and satisfaction. limitations and future research although this research was carefully designed, there were inevitably some limitations: for safety reasons it was not possible to conduct the survey inside the trains, which may have provided a more relaxed atmosphere for the interviews. in addition, while the findings may be generalizable to other cities in the region that are launching metro services with which they share similarities including: customer demographics, economic development stage, and state of infrastructure, it may not be extended to metropolitan hubs in the west (european and us markets) where the higher gas prices may be a driving factor for use of mrt in the western cities. since very few academic studies have investigated passenger behavior in mrt services, there are various future research directions. confirmatory studies should be conducted in other metropolitan cities to determine generalizability of the study findings in other markets, and it would be pertinent to use in-depth studies to delve deeper into the reasons why reputation plays such a key role in influencing consumer behavior in dubai. in addition qualitative techniques may be used to determine how customer engagement may be further enhanced in metro services. such techniques may also shed light on the unexpected lower effect of quality on value, as compared to reputation. further research can also aim at understanding customer journey and customer experience as a source of innovation for enhancing customer delivered value in public service management. conclusion the present study has validated a model of travel behavior in dubai mrt industry demonstrating that a good reputation associated with the metro as well as delivering a quality service were the factors driving passenger loyalty, with the effect of reputation on value being over 4 times that of quality on value. the travelers considered a good reputation to be primarily associated with a positive image as well as the metro representing a smart way to travel. 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open transportation journal, 2:29-46. zeithaml, v., a.parasuraman and l.berry. 1985. “problems and strategies in services marketing.” journal of marketing, 49(2), 33-46. doi:10.2307/1251563 zeithaml, v.a. 1988. “consumer perceptions of price, quality and value: a means model and synthesis of evidence.” journal of marketing, 52 (july): 2-22. 78 economic analysis (2018, vol. 51, no. 1-2, 60-78) annex: measurement items customer loyalty 1. i intend to continue to use dubai metro in future. 2. if i have the opportunity, i intend to increase the use of dubai metro in future. 3. i say positive things about dubai metro. 4. i recommend dubai metro to my friends. 5. as far as possible, i consider dubai metro as my choice for travel. customer satisfaction 1. i am very satisfied with the services provided by dubai metro. 2. dubai metro has fulfilled my needs. value 1. dubai metro represents a convenient means of transportation to me. 2. considering the price i pay and the benefits i get, using dubai metro represents a good option to travel. 3. dubai metro is accessible to me. service quality 1. i find that dubai metro has excellent stations. 2. the physical appearance of dubai metro and its infrastructure is visually appealing. 3. i like the ambience at dubai metro stations. reputation 1. dubai metro has a good reputation. 2. the image associated with dubai metro is positive. 3. dubai metro represents a smart way to travel. engagement 1. i play an active role in my travel by using self-service equipment at dubai metro stations. 2. i have good interactions with dubai metro in self-managing my transport service. article history: received: may 13, 2018 accepted: june 13, 2018 microsoft word 2009_3_4-korigovano.doc original scienfitic paper inflation in serbia and in the european union* vukotić-cotič gordana, institute of economic sciences, belgrade stošić ivan, institute of economic sciences, belgrade udc: 339.745(497.11:4) jel: e31, f31 abstract – administration cannot be practiced in isolation of the culture of the society. this assertion implies that the knowledge, attitude, societal norms and orientation which people hold epitomize their administrative philosophy and the way it is practiced. key words: serbia, eu, emu, inflation, real exchange rate of the serbian dinar introduction in this paper we shall compare the rate of inflation in serbia with the rate of inflation in the european union (eu), to find out how much serbia – as a potential candidate country to the eu – diverges from general price tendencies exhibited by eu member states. we shall also examine the real exchange rate of the serbian dinar to the euro, the single currency within the european economic and monetary union (emu), bearing in mind the role it plays in serbia’s trade policy. finally, we shall observe the structure of inflation by main items of household consumption in both serbia and the eu – to contrast the standard of living in serbia with the standard of living in the eu. the rates of inflation will be derived from the index of consumer prices in serbia and the harmonized index of consumer prices in the eu1. the index of consumer prices in serbia is methodologically compatible with the harmonized index of consumer prices in the eu. the statistical office of the republic of serbia has been releasing data on this index since january 2007. this is the reason why our analysis will cover the period from january 2007 to april 2009, the latter being the last month for which we have collected final data on the harmonized index of consumer prices in the eu from the website of the statistical office of the european communities (eurostat)2. * this paper is a part of research project 159004 “the integration of the serbian economy into the european union – the planning and financing of the regional and rural development, and the enterprises development policy”, financed by the ministry of science and technological development of the republic of serbia. 1 the rate of inflation – as the rate of growth of the general level of consumer prices in a country, or region – is obtained by subtracting one hundred from the index of consumer prices in serbia, or the harmonized index of consumer prices in the eu. consumer prices are retail prices of goods and services purchased by households. 2 for the month for which the eurostat has posted its most recent data on the harmonized index of consumer prices at its website, data for some countries may have been provisional or unavailable. economic analysis (2009, vol. 42, no. 3-4, 29-37) 30 the eu will comprise the twenty-seven countries of which it has been actually constituted throughout the period under observation. these countries, listed in alphabetical order, are: austria, belgium, bulgaria, cyprus, the czech republic, denmark, estonia, finland, france, germany, greece, hungary, ireland, italy, latvia, lithuania, luxembourg, malta, the netherlands, poland, portugal, romania, slovakia, slovenia, spain, sweden and the united kingdom. the emu is actually composed of thirteen countries from january to december 2007, fifteen countries from january to december 2008, and sixteen countries from january 2009. the emu13 included: austria, belgium, finland, france, germany, greece, ireland, italy, luxembourg, the netherlands, portugal, slovenia and spain. the eu15 contained the emu13 plus cyprus and malta. the emu16 encloses the emu15 and slovakia. to accomplish analytical comparability, however, we shall deal with the emu16 over the entire period from january 2007 to april 2009. inflation and the real exchange rate of the serbian dinar chart 1 shows the annual rates of inflation in both serbia and the eu3. annual inflation was higher in serbia than in the eu throughout the period under observation. as a rule, the discrepancy between annual inflation in serbia and annual inflation in the eu was large. this suggests that a reference interest rate of the central bank should not be regarded as an almighty means of combating inflation in serbia. it is the growth of factor productivity, along with a rational public spending, that strengthens the ability of a nation to stabilize prices and to increase its share in world trade. but, the fact is that serbia is significantly lagging in this respect. prominent institutions often exclude serbia from their analyses of national competitiveness. in its most recent annual report on the competitiveness of nations, the institute for management development, located in lausanne (switzerland), included only slovenia and croatia of the ex-yugoslav republics. among the fifty-seven countries observed by three hundred and twenty-nine criteria, slovenia was ranked thirty-second, whereas croatia was ranked fifty-third4. on the other hand, the course of annual inflation in serbia was similar to the course of annual inflation in the eu. yet, the acceleration of annual inflation started earlier and lasted longer in serbia than in the eu: annual inflation was speeding up from may 2007 to june 2008 in serbia, and from august 2007 to july 2008 in the eu. 3 the annual rate measures the growth of a given variable between the current month and the same month of the previous year. thus, the annual rate of inflation – or, annual inflation – measures the growth of the general level of consumer prices over a twelve-month period. 4 institute for management development (2009), word competitiveness yearbook 2009 vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 31 chart 1. inflation in serbia and in the eu, january 2007 – april 2009: annual rates (%) 0 2 4 6 8 10 12 14 16 01 ,0 7 02 ,0 7 03 ,0 7 04 ,0 7 05 ,0 7 06 ,0 7 07 ,0 7 08 ,0 7 09 ,0 7 10 ,0 7 11 ,0 7 12 ,0 7 01 ,0 8 02 ,0 8 03 ,0 8 04 ,0 8 05 ,0 8 06 ,0 8 07 ,0 8 08 ,0 8 09 ,0 8 10 ,0 8 11 ,0 8 12 ,0 8 01 ,0 9 02 ,0 9 03 ,0 9 04 ,0 9 inflation in serbia inflation in the eu27 sources: eurostat, statistical office of the republic of serbia chart 2. inflation in serbia and in the eu member states, april 2009: annual rates (%) -0.7 -0.6 -0.3 -0.2 0.1 0.5 0.6 0.6 0.7 0.8 0.9 1.1 1.1 1.1 1.2 1.3 1.3 1.4 1.8 1.8 2.1 2.3 3.2 3.8 4.0 4.3 5.9 5.9 6.5 8.8 -2 0 2 4 6 8 10 ireland portugal luxembourg spain france austria cyprus emu16 belgium germany estonia denmark greece slovenia italy czech rep. eu27 slovakia netherlands sweden finland uk hungary bulgaria malta poland lithuania latvia romania serbia sources: eurostat, statistical office of the republic of serbia economic analysis (2009, vol. 42, no. 3-4, 29-37) 32 chart 2 depicts the annual rates of inflation in serbia and in the eu member states for april 2009. in this month, annual inflation accounted for 1.3% in the eu, and only 0.6% in the emu. four countries of the euro zone recorded annual deflation, ranging from 0.2% (spain) to 0.7% (ireland). in contrast, serbia registered an annual inflation rate of 8.8%, thus failing to keep up even with top-ranking romania (6.5%). while the reference interest rates of central banks in the eu were particularly low in april 2009, as a response to the current economic crisis, the reference interest rate of the national bank of serbia was 16.5% per year at the beginning, and 14% per year at the end of that month5. but, in spite of such a high reference rate, serbia’s annual inflation rate remained high. this clearly shows that monetary policy alone cannot suppress inflation in a country with a low level of productivity and a high level of budget deficit. chart 3 displays inflation in the emu per unit of inflation in serbia and its determinants – inflation in the emu, and inflation in serbia – as annual rates. the course of annual inflation in the emu per unit of annual inflation in serbia was influenced, as it might have been expected, by the course of annual inflation in serbia rather than by the course of annual inflation in the emu. at the same time, the course of annual inflation in the emu did not differ from the course of annual inflation in the eu: annual inflation in the emu was stagnant from january to august 2007, increasing from august 2007 to july 2008, and decreasing from july 2008 to april 2009. in all the months, however, the emu recorded a lower annual rate of inflation than the eu. the difference between annual inflation in the eu and that in the emu was especially large in march and april 2009, when four countries of the euro zone had an annual deflation (ireland, portugal, luxembourg and spain), while three countries outside the euro zone had a high annual inflation (romania, latvia and lithuania). chart 3. inflation in the emu per unit of inflation in serbia and its determinants, january 2007 – april 2009: annual rates (%) -10 -5 0 5 10 15 20 25 01 ,0 7 02 ,0 7 03 ,0 7 04 ,0 7 05 ,0 7 06 ,0 7 07 ,0 7 08 ,0 7 09 ,0 7 10 ,0 7 11 ,0 7 12 ,0 7 01 ,0 8 02 ,0 8 03 ,0 8 04 ,0 8 05 ,0 8 06 ,0 8 07 ,0 8 08 ,0 8 09 ,0 8 10 .0 8 11 .0 8 12 .0 8 01 ,0 9 02 ,0 9 03 ,0 9 04 ,0 9 inflation in the emu16 inflation in serbia inflation in the emu16 per unit of inflation in serbia sources: eurostat, statistical office of the republic of serbia 5 the reference interest rate of serbia’s central bank was lowered from 16.5% to 15% per year on the 6th of april 2009, and from 15% to 14% per year on the 22nd of april 2009. vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 33 chart 4. real exchange rate of the serbian dinar to the euro and its determinants, january 2007 – april 2009: annual rates (%) -15 -10 -5 0 5 10 15 20 01 ,0 7 02 ,0 7 03 ,0 7 04 ,0 7 05 ,0 7 06 ,0 7 07 ,0 7 08 ,0 7 09 ,0 7 10 ,0 7 11 ,0 7 12 ,0 7 01 ,0 8 02 ,0 8 03 ,0 8 04 ,0 8 05 ,0 8 06 ,0 8 07 ,0 8 08 ,0 8 09 ,0 8 10 .0 8 11 .0 8 12 .0 8 01 ,0 9 02 ,0 9 03 ,0 9 04 ,0 9 nominal exchange rate of the serbian dinar to the euro inflation in the emu16 per unit of inflation in serbia real exchange rate of the serbian dinar to the euro sources: eurostat, statistical office of the republic of serbia, national bank of serbia chart 4 presents the real exchange rate of the serbian dinar to the euro and its determinants – the nominal exchange rate of the serbian dinar to the euro, and inflation in the emu per unit of inflation in serbia – in the form of annual rates6. the annual growth of the nominal exchange rate of the serbian dinar to the euro exhibited a clear downward tendency only from february to august 2008. only in this interval were fewer units of the serbian currency being exchanged, from month to month, for one unit of the emu currency than a year earlier. this means that the serbian dinar was experiencing an accelerated annual appreciation to the euro in nominal terms only from february to august 2008. on the other hand, the annual growth of the real exchange rate of the serbian dinar to the euro was decelerating not only from february to august 2008, but also from july to october 2007. in these intervals fewer units of commodities produced in serbia were being exchanged, from month to month, for one unit of commodities produced in the emu than a year earlier. this means that the serbian dinar was undergoing an accelerated annual appreciation to the euro in real terms not only from february to august 2008, but also from july to october 2007. in these intervals, therefore, the real exchange rate of the serbian dinar, as a relative price of home-produced and foreign-produced goods and services, was demonstrating annual changes that were not in favour of the serbian net exports to the emu. 6 the index of the real exchange rate of the serbian dinar to the euro, rer, is computed as: rer = ner x p*/p where ner is the index of the nominal exchange rate of the serbian dinar to the euro, p* the harmonized index of consumer prices in the emu, and p the index of consumer prices in serbia. (let us recall that the rate of growth is obtained by subtracting one hundred from a given index.) the nominal exchange rate of the serbian dinar to the euro refers to the monthly average of daily midpoint exchange rates released by the national bank of serbia. it is directly quoted, for instance: 1 euro = 93.0588 serbian dinars. economic analysis (2009, vol. 42, no. 3-4, 29-37) 34 chart 5. real bilateral exchange rates of the serbian dinar to the euro, april 2009: annual rates (%) 6.1 6.2 6.5 6.7 7.0 7.4 7.5 7.5 7.6 7.7 8.0 8.0 8.2 8.4 8.8 9.1 11.1 0 2 4 6 8 10 12 ireland portugal luxembourg spain france austria cyprus emu16 belgium germany greece slovenia italy slovakia netherlands finland malta sources: eurostat, statistical office of the republic of serbia, national bank of serbia chart 5 shows real bilateral exchange rates of the serbian dinar to the euro as annual rates for april 2009. in this month, serbia registered annual changes of its currency in real terms that favoured its net exports to each country of the euro zone, ranging from 6.1% (in bilateral trade with ireland) to 11.1% (in bilateral trade with malta). on average, the serbian dinar depreciated to the euro in real terms by 7.5% in april 2009 over april 2008. the structure of inflation in april 2009, as in many other months of the period under observation, two categories – among the twelve main categories of goods and services of household consumption7 – stood out by their contributions to the overall annual growth of consumer prices, in serbia as in the eu. these categories were food and non-alcoholic beverages, on the one hand, and goods and services required for housing (actual rentals; the maintenance and repair of the dwelling; water supply and other services relating to the dwelling; electricity, gas and other fuels), on the other. the first category was more important than the second one in serbia, whereas the second category was more important than the first one in the eu. 7 the classification of goods and services of household consumption, being used for the computation of consumer price indices, has the following main categories: 1) food and non-alcoholic beverages; 2) alcoholic beverages and tobacco; 3) clothing and footwear; 4) goods and services required for housing; 5) furnishings, household equipment and the routine maintenance of the house; 6) medical products, out-patient and hospital services; 7) transportation equipment and services; 8) postal services, telephone equipment and services; 9) goods and services required for recreation and culture; 10) education services; 11) catering and accommodation services; 12) miscellaneous goods and services. vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 35 in april 2009, the annual growth of consumer prices of food and non-alcoholic beverages was predominantly due to the annual growth of consumer prices of food in both serbia and the eu. the annual growth of consumer prices of food – which accounted for 6.4% in serbia, and 2.2% in the eu – was lower than the overall annual growth of consumer prices in serbia (by nearly 30%), and higher than that in the eu (by nearly 70%)8. yet, the proportion in which it contributed to the overall annual growth of consumer prices was almost the same in serbia and in the eu (25%). such a result stemmed from a remarkably high share of food in the consumption of households in serbia (35%), in comparison with that in the eu (14.5%). chart 6. indices of consumer prices of food in serbia and in the eu member states, 2009: weights (%) 9.7 10.4 10.8 11.7 11.7 12.3 12.7 14.2 14.3 14.5 14.8 14.9 15.0 15.5 16.1 16.2 16.2 16.5 16.7 16.8 17.1 17.4 17.6 19.8 20.3 21.6 21.9 23.1 34.8 35.0 0 5 10 15 20 25 30 35 40 luxembourg uk germany denmark austria netherlands ireland sweden emu16 eu27 czech rep. france finland slovenia belgium slovakia cyprus italy malta greece spain hungary portugal estonia poland latvia bulgaria lithuania romania serbia sources: eurostat, statistical office of the republic of serbia chart 6 depicts the weights for the indices of consumer prices of food in serbia and in the eu member states for the year 2009. the chart reminds us of engel’s law: as income rises, the proportion of income spent on food falls (and the other way round). the share of food in total household expenditure is much the same in serbia (35%) as in top-ranking romania (34.8%). at the opposite end stands luxembourg, with only 9.7% of household income being spent on food. we may conclude that the living standard in serbia is low. 8 let us recall that the overall annual rate of growth of consumer prices accounted for 8.8% in serbia, and 1.3% in the eu in april 2009. economic analysis (2009, vol. 42, no. 3-4, 29-37) 36 conclusion the annual rate of inflation was persistently higher in serbia than in the eu from january 2007 to april 2009. this suggests that a reference interest rate of the central bank should not be regarded as an almighty means of combating inflation in serbia. it is the growth of factor productivity, along with a rational public spending, that strengthens the ability of a nation to stabilize prices and to increase its share in world trade. but, the fact is that serbia is significantly lagging in this respect. the annual growth of the real exchange rate of the serbian dinar to the euro was decelerating from july to october 2007, and from february to august 2008. in these intervals fewer units of commodities produced in serbia were being exchanged, from month to month, for one unit of commodities produced in the emu than a year earlier. this means that the serbian dinar was experiencing an accelerated annual appreciation to the euro in real terms from july to october 2007, and from february to august 2008. in these intervals, therefore, the real exchange rate of the serbian dinar, as a relative price of home-produced and foreign-produced goods and services, was undergoing annual changes that were not in favour of the serbian net exports to the emu. in april 2009, annual inflation accounted for 1.3% in the eu, and 8.8% in serbia. in that month, as in many other months of the period under observation, two categories of goods and services of household consumption stood out by their contributions to the overall annual growth of consumer prices, in serbia as in the eu. these categories were food and nonalcoholic beverages, on the one hand, and goods and services required for housing, on the other. the first category was more important than the second one in serbia, while the second category was more important than the first one in the eu. in april 2009, the annual growth of consumer prices of food and non-alcoholic beverages was predominantly due to the annual growth of consumer prices of food in both serbia and the eu. the annual growth of consumer prices of food – which accounted for 6.4% in serbia, and 2.2% in the eu – was lower than the overall annual growth of consumer prices in serbia (by nearly 30%), and higher than that in the eu (by nearly 70%). yet, the proportion in which it contributed to the overall annual growth of consumer prices was almost the same in serbia and in the eu (25%). such a result stemmed from a remarkably large share of food in the consumption of households in serbia (35%), in comparison with that in the eu (14.5%). this fact completes the picture of a low living standard in serbia. references bulíř a., hurník j. (2006), “the maastricht inflation criterion: how unpleasant is purgatory?”, economic systems, vol. 30, no. 4, pp. 385-404 coricelli f., jazbec b. (2004), “real exchange rate dynamics in transition economies”, structural change and economic dynamics, vol. 15, no. 1, pp. 83-100 de broeck m., sløk t. (2006), “interpreting real exchange rate movements in transition economies”, journal of international economics, vol. 68, no. 2, pp. 368-383 kim j., ruge-murcia f. j. (2009), “how much inflation is necessary to grease the wheels”, journal of monetary economy, vol. 56, no. 3, pp. 365-377 vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 37 krause s., méndez f. (2008), “institutions, arrangements and preferences for inflation stability: evidence and lessons from a panel data analysis”, journal of macroeconomics, vol. 30, no. 1, pp. 282-307 leitemo k. (2004), “a game between the fiscal and the monetary authorities under inflation targeting”, european journal of political economy, vol. 20, no. 3, pp. 709-724 mishkin f. s. (2007), monetary policy strategy, mit press, 549 p. reynard s. (2007), “maintaining low inflation: money, interest rates, and policy stance”, journal of monetary economy, vol. 54, no. 5, pp. 1441-1471 vukotić-cotič g., stefanović s. (2008), “inflacija u srbiji u svetlu koncentrisanog tržišta 2008” (pp. 295-303): drašković b., vuković v. (eds.), tržišne strukture i zaštita konkurencije: iskustva zemalja u tranziciji, institute of economic sciences, belgrade banking academy, 303 p. živković b., stamenković s., vučković v. (2007), “novi model monetarne regulacije”, ekonomika preduzeća, vol. 55, no. 1-2, pp. 46-56 received: 24 july, 2009 article history: accepted: 15 august, 2009 ea_2015_1-2 udc: 330.322.3:37 338.1 jel: h52, j24, i21, i22 cobiss.sr-id: 216162828 original scientific paper analysis of the impact of public education expenditure on economic growth of european union and brics tomić zoran, faculty of economics, university of niš, serbia12 abstract – knowledge is one of the key factors for the development and progress of each of the world economies. starting with the industrial revolution, more attention and resources are invested in the development of the education system. economies need to invest effort and resources in the education system that would allow for population to prepare for participation in the economic life of their country. this means that investing in youth education and training for work in the economy and development of young people in research, development and science would contribute to the development of new technologies and knowledge. development of new technologies and knowledge contributes to increased competitiveness of country in the global market. this paper presents a comparative analysis of investment funds in the education systems of the european union and brics, and it is shown that there is a positive correlation between public expenditure on education and the value of gdp of the country. key words: education, economic growth, regression analysis, european union, brics introduction education is the process of personality change in the desired direction by adopting different content depending on the age and needs of individuals. education includes teaching, in addition to educational facilities, depending on the age and needs of individuals. education is the process by which society transmits accumulated knowledge, skills and values from generation to generation. in the old societies, only a small number of people, especially those who had the money or the time, were educated. then the religious dignitaries were often the only literate group, who used the knowledge to read and interpret religious texts. education in its modern form involves teaching in specially constructed buildings. this form of teaching began to grow gradually, especially after the industrial revolution. the process of industrialization and urban expansion has caused the need for special education. people today are working in many professions and use a variety of expertise, so it is not possible to transfer knowledge from parent to child, as it was in old times. 1kralja petra prvog num.3, 37000 kruševac, zoranzoca@gmail.com 2scholarship holder from the ministry of education, science and technological development of serbia 20 economic analysis (2015, vol. 48, no. 1-2, 19-38) knowledge is now the main source of long-term economic growth of each of the world economies. modern tendencies of development in market economies show that education and investment in human resources are among the priorities of the national strategy and national policy, economic and technological progress. trends in investment in human capital and knowledge lead to a revision of economic theory and models. economists are still looking for the basics of economic growth. the traditional "production function" focused on labor, material, capital and energy as the main factors. knowledge and technology are external factors that impact on production. now analytical approaches have been developed so that knowledge can be included directly in the production function. investment in knowledge may increase the production capacity more than any other factor of production and to transform them into new products and processes. because these investments in knowledge characterized by an increase (rather than decrease) in rate of return on investment, they are the key to long-term economic growth. the state plays a very important role in the field of education. education is a big item in the expenditure budget of modern states. jadranka đurović-todorović and marina đorđević (2010) note that in some countries even though the state is able to provide funds for educational institutions, most of the education is provided by private schools, especially those belonging to churches. education is subject to permanent change. the sudden change of paradigm leaves little time to adjust. however, there are a few problems in education changes, mostly relating to how to preserve the good values from the previous education system and how to align the education system with the needs of the modern economy and society. today in serbian education system a major challenge by đurović-todorović and đorđević (2010) is harmonizing the educational profiles curricula with labor market needs. the aim of this paper is to find an empirical relationship between the values of gdp and public expenditure on education and to what extent public spending on education to economic growth in the example of the european union and brics and to compare. education as an important factor for economic growth and development of countries the importance of education for economic development was first spotted by father of economics, adam smith. adam smith represented the idea of specialization of labor. according to smith, the amount of annual products of a nation depends on two factors: the amount of labor employed in the production and productivity of labor. according to smith, the first factor is of lesser importance than the other factors, as can be seen from the fact that people in earlier times lived much poorer than modern people, even though the percentage of the employed labor was much higher. smith primarily indicates the importance of the division of labor, as well as first-rate factor increase in national wealth. obrad blagojević and marko sekulić (1990) note that many economists believe that the idea of division of labor is one of his greatest contributions to economic science. from the above it can be concluded that it is necessary to invest resources to people who are employed to train and educate to work in certain professions. therefore, it is very important to invest in education. even in some texts, lectures or videos on the internet we tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 21 can hear that the modern school was specifically made for the needs of industrialization. in fact, if you compare schools have classrooms that are like production facilities in the factories, the bell that marks the beginning and end of classes, such as in factories that marks the beginning and end of the work shift, the students are divided by grade, as in factories for the production facilities, and students in schools are doing exactly what their task is, as in factories where each plant has a specific role in the production process. adolph wagner was probably the first economist to recognize the positive correlation between economic growth and the growth of government activity. as magnus henrekson (1993) pointed out, wagner saw three major reasons for the increasing role of the state. first, industrialization and modernization would lead to an increase in private activity. expenditures for law and order, as well as contractual enforcement should be increased. second, the increase in real income will lead to the expansion of income elastic of "cultural and social welfare" expenses. wagner said that the education and culture are two areas in which the government is a better controller and executor than the private sector. dipendra sinha (1998) note that natural monopolies like railroads must be controlled by the government, because private companies are not able to run these monopolies effectively. for private companies it is impossible to raise huge finances that are necessary for the development of natural monopolies. problem of the impact of public expenditure in education many theorists have dealt with, and this topic now occupies one of the main topics in economic research. a lot of empirical studies have attempted to examine the relationship between human capital investment and economic growth. sayantan ghosh dastidar, sushil mohan and monojit chatterji (2013) in their work present that relationship is tested in countries such as the united states (jorgenson and fraumeni), and pakistan (aziz khan and aziz), tanzania and zambia (jung and thorbecke), nigeria (ogujiuba and adeniii) and india (chandra) and that results from these papers suggest that expenditure on education affects economy growth positively. fiszbein and psacharopoulos conducted a study to assess the effects of educational investment in venezuela and found that investments in primary education had the largest impact on growth and investment in higher education yields the lowest among the three levels of education. distidar,mohan and chatterji (2013) found in india that investing in education is a necessary but not a significant condition for achieving economic growth. other factors have a significant impact on economic growth in addition to education. oluwatobi stephen and ogunrinola oluranti (2011) for nigeria found that there is a positive relationship between the growth of expenditures for education and economic growth using an expanded model of economic reproduction, where they add to the analysis impact of costs of education and health care. dipendra sinha (1998) found in malaysia that there is a long-term relationship between the cost of education and economic growth, but that there is no mutual relationship between the increase in the cost of education and economic growth. avina sabah idrees and muhammad wasif siddiqi (2013) based on panel analysis found that there is a positive relationship between the rising cost of education and economic growth, and there is the effect of reaching the developed economies based on the investment in education. in their analysis they observed countries uk, usa, canada, germany, france, italy and japan, on the one hand, and pakistan, india, china, turkey, russia, poland and south africa, on the other hand. abhijeet chandra (2010) found that india’s boom in software industry experienced probably due to the huge investments in the 1950s and 1960s 22 economic analysis (2015, vol. 48, no. 1-2, 19-38) in education, particularly in technical sciences. there are also works like and nurudeen usman and belgrave and craigvell, which found that the impact of education expenditures on growth is negative. in addition to studying the impact of the increase in public expenditure of education to economic growth, there are works such as michel beine et.al. (2001) dealing with the problem of brain drain and its impact on economic growth. this is one of the big problems for the growth of the economy of countries like serbia. theories of economic growth and lucas' model dragan kitanović and nataša golubović (2006) define economic growth as the increase of the potential products of an economy, and moving to the right of its production possibilities curve. economic growth can be quantified, primarily by calculating the growth rate of gross domestic product, growth rate of gdp per capita, national income per capita and etc. the theory of economic growth has occupied an important place in classical economic theory. within the classical aproach there are three main factors of economic growth: labor, land and capital. economists of classical school did not take in account technological progress, as well as the development of human capital, which is one of the main objections to their theory. according to marxist school on economic growth was influenced by a number of variables, but chief among them was the rate of profit. for marx it was the constant tendency of capital accumulation and a steady increase in the organic composition of capital, which is not accompanied by a corresponding increase of workers income. neoclassical growth model is based on the model of the economy in which production is carried out with the use of capital and labor. also taking into account the progress of technology, but which has been conditioned by exogenously. this theory has experienced criticism primarily by post-keynesians, but the biggest criticism was the observation of technological progress as exogenous factors of economic growth. schumpeter was particularly emphasized the importance of investments to improve the quality of capital goods, ie. innovation. the implementation of "new combinations" of resources is the primary force that encourages economic growth. keynes represented the view that public expenditure as an exogenous factor can be used as a policy tool to promote economic growth. public expenditure can positively contribute to economic growth. thus, the increase in government spending is likely to lead to increased employment, profitability and investment through multiple effects on aggregate demand. as a result, government spending increases aggregate demand, which causes increased production depending on the expenditure multiplier. the new theory is "endogenous growth theory" which differs from the neoclassical theory, because assuming that the technological change endogenously conditioned, able to explain the continued growth of per capita income in some countries, on the one hand, and persistent survival disparity in the level of pre capita income among countries, on the other hand. the basic model of "endogenous growth" according to kitanović and golubović (2006) includes human capital as a separate factor in the production function. investment in education by the state, participating in the creation of an adequate educational program surely is a key factor for improving human capital, which leads to increased productivity and getting the necessary technological innovation to further economic growth. tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 23 lucas, along with romero, is one of the creators of the theory of endogenous growth. in lucas' model, human capital is seen as a factor of production and knowledge is central to accelerating economic growth. according to lucas' model engine of economic growth is human capital. people can use their time for work and training (i.e., research and practice). the relationship between these activities to individuals in an economy to make depends on the institutional structure and characteristics of the labor market and the economy. in this paper we performed a quantitative analysis of the impact of public spending on education in the economic growth of the economy in the example of the european union, usa and japan, as the largest economies in the world. model in research is used a model that is derived from the classical production function. in this case, the movement of the value of production in the economy depending on the cost of public education is observed. f(edu) =y (1) where y is a production function of one of the country, and edu represents public expenditure on education in the country. when this model is transformed into logarithmic from (1): µββ ++= )log( )log( 10 edugdp (2) where 0β is constant intercept term, 1β slope coefficient and µ is error. slope coefficient tells us how much it will increase the value of gdp if we increase the value of public spending on education. this paper uses costs of the public sector, because the private sector costs difficult to measure and obtain the necessary data, and because in most countries the greatest interest in investing in education is the state, and it bears most of the costs. in this paper, the analysis is performed on the european union and 28 member states, for brics countries and serbia. it also provides an overview of information on investing countries in different levels of education. the regression analysis was applied, which was made in the program origin 9. analysis of the model the analysis of public expenditure on education in the eu member states and the european union as a whole in the countries of the european union knowledge-based economy is a strategic task. the bologna declaration on higher education from june 1999 marked the beginning of a new enhanced european cooperation. đurović-todorović and đorđević (2010) say that educational system of each country can be divided into three main sectors: 24 economic analysis (2015, vol. 48, no. 1-2, 19-38) • public education • private education in which the state participates with 50% and • private education (independent schools) in the european union education is the responsibility of the member states. eu institutions have importance in supporting of education. according to article 165 of the treaty on the functioning of the european union, the community will contribute to the development of quality education by encouraging cooperation between member states, through activities such as promoting the mobility of citizens, designing joint study programs, establishing networks, exchanging information or teaching languages of the european union. the contract includes a commitment to promote lifelong learning for all citizens of eu. the eu funds educational, professional and public construction programs that encourage eu citizens to seize the opportunities offered by the eu to its residents to live, learn and work in other countries. the most famous of these is the erasmus program, under which more than two million students have participated in the inter-university exchanges and mobility in the last 20 years. since 2000, awareness of the importance of education and training in order to exercise economic and social objectives, the eu member states have started to work together to achieve a series of 13 specific objectives in the field of education. this is called the education and training 2010 program. sharing good practices by participating in peer education activities, by setting benchmarks and monitoring progress of key indicators, the 28 member countries aim to respond to coherent common challenges, while retaining their individual sovereignty in the area of educational policy. the european union is also a partner in a variety of intergovernmental projects, including the bologna process which aims to create a european higher education area by harmonizing academic degree standards and structures, as well as academic quality assurance standards across the eu member states and in other european countries3. main education priorities of the eu countries are: • strengthening vocational education and training, • increase transparency of professional education and training through the implementation and rationalization of information networks, • improving policies, systems and practices in the approach to learning, the professional education and training, • promote cooperation in assurance of quality in education, • supporting the professional development of staff, etc. for the analysis of the european union we used the data obtained from euro stat of the gdp values for the period from 2002 to 2011, as well as the amount of public expenditure on education for the period 2002 2011 expressed as a percentage of gdp. the used data are shown in table 1. 3 tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 25 table 1.gdp and public expenditure on education for eu, 2002 2011 year gdp (in mil €) public expenditure on education (% gdp) public expenditure on primary education (% gdp) public expenditure on secondary education (% gdp) public expenditure on higher education (% gdp) 2002 9,983,702.30 5.00 1.13 2.27 1.12 2003 10,151,451.90 5.03 1.15 2.29 1.11 2004 10,658,018.60 4.95 1.14 2.23 1.10 2005 11,128,703.00 4.92 1.13 2.20 1.12 2006 11,764,657.30 4.91 1.15 2.17 1.10 2007 12,473,648.90 4.92 1.15 2.17 1.11 2008 12,548,545.70 5.04 1.17 2.22 1.14 2009 11,815,746.60 5.38 1.24 2.39 1.21 2010 12,337,150.70 5.41 1.23 2.37 1.25 2011 12,711,206.20 5.25 1.19 2.23 1.27 source: euro stat http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/, data processed by author (accessed october 1, 2014) based on the obtained data it can be concluded that by 2008 the average of 5% of gdp for education was used to finance in 28 countries members of the european union. since 2009, after the economic crisis, eu has increased the allocation of funds for education, which may be related to the importance of education to obtain the competitive advantage of the eu member states in relation to the rest of the world economy to recover from the economic crisis. in addition that is the period when there was an increase in the unemployment rate in all eu member states. most of the funds were allocated for secondary education (2.17 to 2.39%), which indicates the importance of this level of education. at the secondary level of education young people gain expertise in areas that will be in their professional career to deal with, but also in that period they become capable of working. for basic and higher education almost the same amount of fund is used. the largest expenditure on secondary education can be explained by the fact that the present system of private financing of education of young people and that higher education is not compulsory. eu aims to reach by 2020 40% of the population are higher educated, and therefore should not be surprising that there is a growing trend when it comes to public funding of higher education. 26 economic analysis (2015, vol. 48, no. 1-2, 19-38) figure 1. graphic of gdp amount and cost of education in the eu 28 per year 2002 2004 2006 2008 2010 2012 0 140000 280000 420000 560000 10000000 12000000 14000000 16000000 18000000 20000000 gdp public education expenses public primary education expenses public secondary education expenses public higher education expenses m ill io n € year application of the model in case of the european union and the member states of the european union the analysis starts from the null hypothesis, which states that the total value of public education spending does not significantly affect the value of the observed gdp of the country. the analysis used the logarithmic values of the gdp of the european union and the logarithm of the absolute value of the principal amount of expenditure for the period 2002 2011. by applying multiple regression analysis of the model (2) we obtained the following values of the parameters: table 2. the parameter values of the regression analysis for eu 28 parameter value error t-statistics probability 0β 2.58353 0.52380 4.93232 0.0012 1β 0.77645 0.09082 8.54894 0.0000 r 0.94939 source:data processed by author from eurostathttp://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/, (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of investments in education significantly affects the value of gdp for the eu28. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country; in this case we reject the null hypothesis. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of the eu 28 to 0.77%. the coefficient of determination further confirms the high correlation between the observed size and degree of correlation observed data. the following table gives a presentation of the obtained values of parameters for each member country of the european union observed individually. we apply the same method tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 27 and logarithmic values for the amount of the gdp of the public expenditure on education. analysis was carried out in the program origin 9. table 3. the values of the parameters of the regression analysis for the member states of the european union country/period parameter value error t-statistics probability austria (1995-2011) 0β 2.42007 0.59208 4.08741 0.0001 1β 1.04697 0.06244 16.76707 0.0000 r 0.97260 belgium (2001 2011) 0β 5.17062 0.48839 10.58709 0.0000 1β 0.75814 0.04947 15.32444 0.0000 r 0.95899 bulgaria (1992 2011) 0β 3.81162 0.38295 9.9532 0.0000 1β 0.91115 0.05495 16.58232 0.0000 r 0.98403 czech republic (1996 2011) 0β 3.41425 0.31093 10.98091 0.0000 1β 0.97075 0.03766 25.77397 0.0000 r 0.98963 denmark (1995 2011) 0β 3.60350 0.44676 8.06584 0.0000 1β 0.88539 0.04627 19.13432 0.0000 r 0.98012 estonia (1993 2011) 0β 2.57688 0.18457 13.96168 0.0000 1β 1.05423 0.03076 34.27395 0.0000 r 0.99284 finland (1991 2011) 0β 2.02215 0.49168 4.11274 0.0006 1β 1.07870 0.05435 19.84583 0.0000 r 0.97672 france (1991 2011) 0β 2.63329 0.39265 6.70644 0.0000 1β 1.01830 0.03456 29.46617 0.0000 r 0.98923 greece (1995 2005) 0β 5.53809 0.28939 19.1369 0.0000 1β 0.74186 0.03426 21.65679 0.0000 r 0.99054 netherland (1991 2011) 0β 4.41575 0.29019 15.21652 0.0000 1β 0.85233 0.02900 29.38867 0.0000 r 0.98918 croatia (2002 2011) 0β 4.83044 0.21221 22.76285 0.0000 1β 0.77851 0.02882 27.01407 0.0000 r 0.99456 28 economic analysis (2015, vol. 48, no. 1-2, 19-38) country/period parameter value error t-statistics probability ireland (1995 2011) 0β 4.67164 0.66186 7.05836 0.0000 1β 0.80914 0.07614 10.62638 0.0000 r 0.93954 italy (1991 2011) 0β 0.91832 0.90234 1.01771 0.3216 1β 1.19519 0.08236 14.51145 0.0000 r 0.95773 cyprus (1995 2011) 0β 5.05524 0.13218 38.24534 0.0000 1β 0.65173 0.01991 32.72912 0.0000 r 0.99307 latvia (1992 2011) 0β 2.90361 0.19899 14.59143 0.0000 1β 0.99763 0.03223 30.95326 0.0000 r 0.99074 lithuania (1993 2011) 0β 2.95616 0.18844 15.68783 0.0000 1β 0.99680 0.02856 34.90756 0.0000 r 0.99310 luxembourg (1995 2011) 0β 0.99767 0.46843 2.12981 0.0546 1β 1.33602 0.06783 19.69685 0.0000 r 0.98488 hungary (1992 2011) 0β 2.70274 0.42606 6.34349 0.0000 1β 1.02995 0.05301 19.42903 0.0000 r 0.97698 malta (1998 2011) 0β 5.83850 0.30448 19.17522 0.0000 1β 0.47900 0.05441 8.80325 0.0000 r 0.93055 germany (1999 2011) 0β 6.89314 0.86364 7.98151 0.0000 1β 0.66907 0.07465 8.96261 0.0000 r 0.93785 poland (1995 2011) 0β 3.42800 0.27239 12.58510 0.0000 1β 0.95149 0.02926 32.51554 0.0000 r 0.99298 portugal (1995 2011) 0β 2.29273 0.42223 6.93282 0.0000 1β 1.00085 0.04746 21.08611 0.0000 r 0.98355 romania (1999 2011) 0β 4.40787 0.39950 11.03346 0.0000 1β 0.86593 0.05117 16.92169 0.0000 r 0.98465 slovakia (1993 2011) 0β 2.57600 0.25723 10.01422 0.0000 1β 1.08452 0.03613 30.01596 0.0000 tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 29 country/period parameter value error t-statistics probability r 0.99070 slovenia (2001 2011) 0β 1.94547 0.63310 3.07294 0.0133 1β 1.12505 0.08501 13.23465 0.0000 r 0.97526 spain (1992 2011) 0β 3.21737 0.41869 7.68433 0.0000 1β 0.98837 0.04041 24.46054 0.0000 r 0.96917 sweden (1991 2011) 0β 1.56319 0.42933 3.64099 0.0017 1β 1.10939 0.04369 25.38963 0.0000 r 0.98558 united kingdom (1991 2011) 0β 3.80688 0.57116 6.66518 0.0000 1β 0.92427 0.05102 18.11455 0.0000 r 0.97225 source: data processed by author from eurostathttp://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ (accessed october 1, 2014) based on the analysis, it can be concluded that the conclusions that are valid for the european union apply to the eu's member states. the correlation coefficients (r) range in values of 0.95 to finding indicating a high correlation observed data and the positive value of correlation suggests that changes in the value of public expenditure on education has a positive impact on the change in gdp observed countries. the values for all the countries under consideration are statistically significant because the probability of t-value is less than 0.05.for countries such as italy, luxembourg probability value of t-value for the parameter βo is greater than 0.05. analysis of public spending on education and model in the brics countries brics is the english abbreviation and economic term that refers to the growing development of the economic potential of brazil, russia, india, china and south africa. implicitly, concerns the economic alliance of these complementary economies. the term was introduced by jim o'neill of the corporation for the global financial research goldman sachs, and was quickly accepted by the public, especially the media, to the extent that the majority of news sources from global finance used without much explanation. the meeting of officials of these countries, held in the summer of 2008 in yekaterinburg, called the bric summit. the group originally consisted of brazil, russia, india and china. south africa is a member of this group of 13 april 2011. below will be analyzed for each country individually. in the analysis of the contribution of public expenditure in the case of brazil was observed period from 2004 2011. 30 economic analysis (2015, vol. 48, no. 1-2, 19-38) table 4. gdp and public expenditure on education in brazil, 2004 2011 year gdp (in mill. $) public expenditure on education (% gdp) 2004 663,760.34 4.0 2005 882,185.70 4.5 2006 1,088,916.82 5.0 2007 1,366,824.00 5.1 2008 1,653,508.56 5.4 2009 1,620,188.06 5.6 2010 2,143,067.87 5.8 source: the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure 2. graphic of gdp amount and cost of education in brazil by year 2004 2005 2006 2007 2008 2009 2010 0 20000 40000 60000 80000 100000 120000 500000 1000000 1500000 2000000 2500000 m ill io n $ year gdp public education expenses in percentage terms, brazil set aside 5.06% of gdp for education, which is the average of the european union. in the reporting period it can be observed upward trend in expenditures for education, both in absolute terms and in percentage values of the gdp of brazil. it can be said that investment in education is certainly one of the key factors that led brazil to the sixth position in the development of economy in the world. the analysis used the logarithmic values of the gdp of brazil and the logarithmic values of absolute principal amount of expenditure for the period 1995 2010. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. table 5. the values of the parameters of the regression analysis for brazil parameter value error t-statistics probability 0β 5.61954 0.15202 36.96493 0.0000 1β 0.76147 0.01425 53.46357 0.0000 r 0.99808 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 31 the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for brazil. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of brazil by 0.76%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of india was observed period from 2003 2006. table 6. gdp and public expenditure on education in india, 2003 2006 year gdp (in mill. $) public expenditure on education (% gdp) 2003 618,356.47 3.6 2004 721,585.61 3.3 2005 834,215.01 3.1 2006 949,116.77 3.1 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure 3. graphic of gdp amount and cost of education in india by year 2003 2004 2005 2006 0 10000 20000 30000 600000 700000 800000 900000 1000000 m ill io n $ year gdp public education expenses in percentage terms, india set aside of 3.3% of gdp for education, which is below the average of the european union and brazil. in the reporting period it can be observed upward trend in the expenditures for education in absolute terms. in the analysis of the applicability of the model were used logarithmic values of gdp india and logarithmic values of absolute principal amount of expenditure for the period 1997 2011. by applying multiple regression analysis and the model is presented by (2) in the above examples are obtained the following values of the parameters. 32 economic analysis (2015, vol. 48, no. 1-2, 19-38) table 6. the values of the parameters of the regression analysis for india parameter value error t-statistics probability 0β 3.18113 0.85151 3.73588 0.0047 1β 1.01915 0.08348 12.20772 0.0000 r 0.97111 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of the gdp of india. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of india for 1.02%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of south africa was observed period from 1999 2011. table 7. gdp and public expenditure on education in south africa, 1999-2011 year gdp (in mill. $) public expenditure on education (% gdp) 1999 133,183.58 6.0 2000 132,877.64 5.6 2000 118,478.99 5.3 2001 111,100.86 5.2 2002 168,219.32 5.1 2003 219,092.94 5.3 2004 247,051.56 5.3 2005 261,007.04 5.3 2006 286,171.83 5.2 2007 273,141.75 5.1 2008 284,183.10 5.5 2009 365,208.43 6.0 2010 403,894.32 6.2 2011 133,183.58 6.0 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 33 figure 4. graphic of gdp amount and cost of education in south africa by years 1998 2000 2002 2004 2006 2008 2010 2012 0 5000 10000 15000 20000 25000 100000 150000 200000 250000 300000 350000 400000 450000 m ill io n $ year gdp public education expenses in percentage terms, south africa invests 5.5% of gdp for education, which is the average of the european union. in the reporting period it can be observed upward trend in the expenditures for education in absolute terms. in the analysis of the applicability of the model were used logarithmic values of the gdp of south africa and the logarithmic values of absolute principal amount of expenditure for the period 1991 2011. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. table 8. the values of the parameters of the regression analysis for south africa parameter value error t-statistics probability 0β 3.04033 0.25257 12.03774 0.0000 1β 0.98389 0.02680 36.70966 0.0000 r 0.99448 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for south africa. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of south africa by 0.98%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of russia was observed period from 2000 2006. 34 economic analysis (2015, vol. 48, no. 1-2, 19-38) table 9. gdp and public expenditure on education in russia, 2000 2006 year gdp (in mill. $) public expenditure on education (% gdp) 2000 259.708,50 2.9 2000 306,602.67 3.3 2001 345,110.44 3.5 2002 430,347.77 3.4 2003 591,016.69 3.5 2004 764,000.90 3.8 2005 989,930.54 3.9 2006 259,708.50 2.9 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure 5. graphic of gdp amount and cost of education in russia by years 2000 2001 2002 2003 2004 2005 2006 0 5000 10000 15000 20000 25000 30000 35000 200000 400000 600000 800000 1000000 m ill io n $ year gdp public education expenses in percentage terms in russia 3.4% of gdp is allocated for education, which is well below the eu average. in the observed period upward trend in the allocation of funds for education in absolute terms can be seen. in the analysis of the applicability of the model were used logarithmic values of gdp of russia and the logarithmic values of absolute principal amount of expenditure for the period 2000 2008. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. table 10. the values of the parameters of the regression analysis for russia parameter value error t-statistics probability 0β 4.70764 0.19903 23.65263 0.0000 1β 0.86191 0.02010 42.89189 0.0000 r 0.99837 source:data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 35 the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for russia. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of russia by 0.86%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of china was observed period from 1992 1996. table 11.gdp and public expenditure on education in china, 1992 1996 year gdp (in mill. $) public expenditure on education (% gdp) 1992 422,660.55 1.7 1993 440,501.21 1.7 1994 559,224.20 2.0 1995 728,007.55 1.9 1996 856,084.63 1.9 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure6.graphic of gdp amount and cost of education in china by years 1992 1993 1994 1995 1996 0 2000 4000 6000 8000 10000 12000 14000 16000 300000 400000 500000 600000 700000 800000 900000 m ill io n $ year gdp public education expenses in percentage terms in china allocates an average of 1.84% of gdp for education. in the observed period can be observed upward trend in the allocation of funds for education in absolute terms. in the analysis of the applicability of the model were used logarithmic values of the gdp of china and the logarithmic values of absolute principal amount of expenditure for the period 1992 1999. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. 36 economic analysis (2015, vol. 48, no. 1-2, 19-38) table12. the values of the parameters of the regression analysis for china parameter value error t-statistics probability 0β 4.98414 0.42257 11.79476 0.0000 1β 0.89458 0.04467 20.02555 0.0000 r 0.99382 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for china. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of russia by 0.89%. the coefficient of determination confirms that there is a positive correlation between the observed data. it is necessary to get to the more recent data and do further analysis to confirm the existing result. in a previous paper zoran tomic (2014) found for usa and japan that null hypothesis is rejected, i.e. there is a positive correlation between public expenditure on education and gdp growth. in the case of the us 1% increase in the cost of education is achieved gdp growth of 0.78% and japan with increasing the amount of expenditures of 1% leads to an increase in gdp by 0.81%. based on this, we can see that the highest growth has india (1.02%). if we take into account the individual eu member luxembourg has the highest growth of 1.33% to 1% of the additional costs in education. brazil has the smallest growth with 0.77%, and from the eu is malta with 0.47% growth. conclusion knowledge is a key factor for the improvement and development of each of the world economy. the significance of knowledge and education was spoken by adam smith, who represented need to divide the work among the people. today, an important question arises about all these activities, education and the education system to economic growth and development of each country. education and the education system helps and contributes to empower people to work in the economy, but also with the knowledge that they have and the resources contribute to the technological development that will allow the country's economy to develop and to have competitive an advantage. also a big problem today is the problem of brain drain which is also a challenge for new research in this area. based on the analysis for european union, usa, japan and briks, it was found that there is a positive correlation between the amount of public expenditure on education and economic growth in these countries. it was found that among india in briks group, italy, luxembourg and slovenia within the eu, achieved the highest economic growth, because a 1% increase in public expenditure on education comes up more than 1% growth in the value tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 37 of log (gdp). observed between groups of the european union, usa and japan, the largest growth is achieved in japan with 0.87% growth in log (gdp), while the lowest growth is achieved in eu (as a group), where the increase in expenditure on education by 1%, the growth of log (gdp) for the 0.77%. in subsequent research should expand the number of countries that will be covered by the panel and perform analysis among the countries themselves on the contribution of public expenditure on education to economic growth. it was also found that most funds allocated for secondary education, which can be explained by the fact that post-secondary education young people are trained to work in the economy or for further education. among the surveyed countries malta achieved the lowest growth which can be best explained by the very size of economy, the structure of the economy, population size and so on. to further confirm the above results it is necessary to include additional information in the analysis (the period after 2011 and the period before 1991), which will provide direction for further research into this issue, as well as the inclusion of other factors that lead to economic growth of countries (health care costs, the costs of science, etc.) and thus further develop the model. references beine, michel, docoquier frederic and rapoport hillel. 2001.“brain drain and economic growth: theory and evidence.”journal of development economics, 64, 275-289. blagojević, obrad and sekulović marko.1990. ekonomske doktrine. beograd: privredni pregled. chandra,abhijeet. 2010.does government expenditure on education promote economic growth? an econometric analysis, munich personal repec archive, http://mpra.ub.unimuenchen.de/25480/ (accessed december 23, 2014). đurović-todorović, jadranka and đorđević marina. 2010. javne finansije.niš: ekonomski fakultet u nišu. idrees, alvina, sabah and siddiiqi muhammad wasif. 2013.“does public education expenditure cause economic growth? comparison of developed and developing countries.”pakistan journal of commerce and social sciences, 7(1): 174-183. henrekson, magnus.1993.“wagner’s law a spurious relationship.” public finance, 48(2): 406-415. oluwatobi, stephen and ogunrinola oluranti. 2011.“government expenditure on human capital development: implications for economic growth in nigeria.”journal of sustainable development, 4(3): 72-80. sinha, dipendra. 1998.“government expenditure and economic growth in malaysia.”journal of economic development, 23(2): 71-80. sayantan, ghosh, dastidar et. al. 2013. relationship between public education expenditures and economic growth: the case of india, http://repo.sire.ac.uk/bitstream/10943/435/1/sire-dp2013_07.pdf (accessed december 23, 2014) kitanović, dragan and golubović nataša. 2006.osnovi ekonomije.niš: ekonomski fakultet u nišu. tomić, zoran. 2014.analysis of the impact of public education expenditure on economic growth of european union, usa and japan, proceedings from 7th international 38 economic analysis (2015, vol. 48, no. 1-2, 19-38) conference science and higher education in function of sustainable development, business and technical college of vocation studies, užice, serbia. analiza uticaja javnih troškova obrazovanja na privredni rast u evropske unije i briks zemalja rezime – znanje je jedan od ključnih faktora za razvoj i napredak svake odsvetskih ekonomija. počevši sa industrijskom revolucijom, više pažnje i sredstava ulaže se u razvoj obrazovnog sistema. ekonomije trebaju da ulože napor i sredstva u obrazovni sistemu koji bi omogućio stanovništvu da se što bolje pripremi za učešće u ekonomskom životu svoje zemlje. to znači da će ulaganje u obrazovanje i obuku za rad u privredi i razvoj mladih ljudiza istraživanja, razvoj i bavljenje naukom doprineti razvoju novih tehnologija i znanja. razvoj novih tehnologija i znanja doprinosi povećanju konkurentnosti zemlje na globalnom tržištu. ovaj rad predstavlja uporednu analizu ulaganja u obrazovnim sistemima evropske unije i briks-a, i takođe je pokazano da postoji pozitivna korelacija između javne potrošnje za obrazovanje i vrednost bdp-a zemlje primenom regresione analize. ključne reči: obrazovanje, ekonomski rast, regresiona analiza, evropska unija, briks article history: received: 26 march, 2015 accepted: 3 april, 2015 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp109‐127 scientific review a literature survey of the environmental kuznets curve petar mitić1* | milena kresoja1 | jelena minović1 1 institute of economic sciences, belgrade, serbia abstract since the 1970s, the issue of environmental degradation has received considerable attention. environmental kuznets curve is one of the most well‐known hypotheses that explains the relationship between economic growth and environmental pollution. it represents an important model that enables policymakers to deliver quality information‐based decisions. in this paper, we provide the theoretical framework of the environmental kuznets curve and examine existing literature on the ekc hypothesis. the systematic literary survey includes studies conducted for single countries as well as for groups of countries. most of the studies were empirically testing the existence of an inverted u‐shaped relationship between economic growth and carbon dioxide emissions. due to the different periods, sets of independent variables and methodological frameworks, the results are inconclusive, which is consistent with previous literature surveys on the same topic. key words: environmental kuznets curve, environmental degradation, income, economic growth, co2 emissions jel classification: q50, q56 introduction environmental degradation and lowering the quality of the environment has become a global problem attracting considerable attention. although it is not a generally accepted point, authors such as tietenberg & lewis (2016) state that in the field of environmental economics the natural environment is viewed as commodity or asset with many qualitative attributes. the natural environment can be used as a source of renewable resources, but also as aesthetic consumer goods. even today, there are ongoing discussions between economists and ecologists about a desirable or acceptable level of environmental pollution. the point that most economists and ecologists see as common is that zero pollution is neither desirable nor sustainable. ecologists emphasise that the environment has limited waste processing power and that environmental pollution occurs only when waste is deposited in the environment outside its assimilation capacity, i.e. beyond its ability to timely decompose waste. accordingly, the discharge and disposal of waste must not exceed the renewable assimilation capacity of the environment. economists often try to challenge, or better say, extend this view, stating that it is completely rational that society pollutes outside the assimilation capacity of the environment to the extent that it collectively benefits from increased pollution through the added value of goods and services produced (hussen, 2000). * corresponding author, e‐mail: petar.mitic@ien.bg.ac.rs 110 economic analysis (2019, vol. 52, no. 1, 109‐127) simon kuznets set up a model in 1955 that shows that relationship between income per capita and income inequality exhibits an inverted‐u shape curve. as the per capita income increases, inequality of income also increases initially and then begins to decline after a certain turning point. in other words, the income growth in the initial stages has unequal income distribution, and then, income distribution gains greater equality with economic growth (kuznets, 1955). this empirical phenomenon is known as the kuznets curve. from the 1990s, this curve gets a novel interpretation. empirical evidence that both the level of environmental degradation and income per capita follow the same inverted‐u shape has been found. therefore, the environmental kuznets curve (ekc) now becomes a means of describing the relationship between the level of environmental quality and income per capita (dinda, 2004). before creating the concept of ekc, the limited ability of the environment to absorb waste has been in the focus of scientific and professional discussions. after establishing the theoretical model of ekc, the focus shifted to the necessity of achieving and maintaining economic growth to overcome the problems of environmental pollution. high economic growth rates are the basis of all developing countries’ policies, resulting in extremely high environmental costs, primarily in terms of urban and industrial waste accumulation, deterioration of air, land and water quality, loss of biodiversity, climate change and global warming (gill, viswanathan, & hassan, 2017). thus, economic growth in developing countries will produce more pollution than economic growth in developed countries due to the level of technological progress and innovation. this systematic relationship between economic development and the environment is an assumption on which the ekc hypothesis has been developed. webber & allen (2010) have taken the view that ekc has important implications, primarily that developing countries should direct their policies to achieve rapid economic growth, rather than adopting and implementing environmental policies. they state that "economic growth ultimately leads to the achievement of both ecological and economic goals, while pro‐environmental policies only slow down economic growth" (webber & allen, 2010). the term “environmental kuznets curve” was coined by panayotou (1993). the first studies that empirically tested and demonstrated the existence of the inversed‐u shape of the ekc between income and environmental pollution were carried out by grossman & krueger (1991) and shafik & bandyopadhyay (1992). studying the interdependence between air quality and economic development, grossman & krueger (1991) found the inversed‐u shape curve between so2 and smoke and income per capita. this is the first formal confirmation of the ekc validity. these results indicated that the concentration of air pollutants increase with the income level at first, and then decrease at higher levels of income. the ekc was further popularised in the 1992 world bank development report, which states that as revenues increase, the demand for improving the quality of the environment will increase along with the resources available for investment (ibrd, 1992). this position is also supported by beckerman (1992), who states that although economic growth usually leads to environmental degradation in the early stages, it ultimately represents the best and possibly the only way to achieve an adequate quality of the environment in most countries. thus far, a vast number of papers have been published which empirically investigate and analyse the issues of interdependence between environmental quality and economic growth, using diversified tools of econometric analysis. it is important to point out that the hypothesis of environmental kuznets curve was, and still is today, particularly interesting in this type of research. according to mitić, munitlak ivanović, & zdravković (2017), empirical models that analyse the environmental kuznets curve most often observe the indicator of environmental degradation as a dependent variable in relation to the indicators of economic development and their squares as the independent variable. the remainder of this paper is organised as follows. in the next section, the theoretical framework of the ekc is presented. special emphases are given to the factors of influence on the shape of the ekc curve, and econometric specification of the model. rest of the paper provides petar mitić, milena kresoja, jelena minović 111 an overview of ekc research for both individual and groups of countries. last part of the paper gives several concluding remarks. theoretical framework of the environmental kuznets curve the intuition behind the ekc is intuitively attractive (dinda, 2004). "environmental kuznets curve represents a hypothetical link between different indicators of environmental degradation and income per capita" stern (2004). this curve postulates that in the early stages of economic development, industrialisation and urbanisation greatly exhaust natural resources and create industrial and urban waste. at this stage, economic growth and pollution are interconnected, in the sense that economic growth also increases environmental pollution (gill, viswanathan & hassan, 2018). dasgupta et al. (2002) confirm this view, stating that pollution is rising rapidly in the early stages of industrialisation, as the main goal is to increase material production, and people are more interested in business and earning revenues rather than having clean air and water. rapid achievement of economic growth implies increased use of natural resources and emissions of pollution, which creates greater pressure on the quality of the environment. people at these stages of economic growth are too poor to invest in improving the quality of the environment and most often neglect the consequences that growth makes to the environment. it is said that multi‐dimensional poverty is often high in the initial stages of economic development, and environmental conservation is often ignored (asumadu‐sarkodie & strezov, 2019a). therefore, at this stage, there is a positive linear link between economic growth and environmental pollution. reduction of pollution comes with the advancement of the process of industrialisation, technical and technological improvements and growth of the service sector (panayotou, 1993). in other words, pressure on the environment is growing faster than income in the early stages of development and slows down with gdp growth at higher levels of income. “green economy and especially renewable energy are crucial for reducing poverty, a particularly significant problem for developing countries” (todorović, 2018). only in the later phases of economic development, there is a significant increase in income levels which, in combination with an increase in institutional quality, awareness of environmental sustainability and high diffusion of technology and innovation, causes a decrease in environmental degradation (asumadu‐sarkodie & strezov, 2019a). therefore, it is evident that ekc represents a well‐established relationship between the level of economic activity and the pressure on the environment. “in brief, environmental kuznets curves are statistical artefacts that summarise a few important aspects of collective human behaviour in two‐ dimensional space.” dinda (2004). as it is stated above, at higher levels of income, people start to value the environment more. therefore, there are more requirements for environmental quality in the advanced stages of economic development. at higher levels of economic development, structural changes towards information‐intensive industries and services, together with increased environmental awareness, implementation of environmental protection regulations, better technology and higher environmental costs, result in a gradual reduction in environmental degradation. when income per capita crosses the turning point of ekc, it is assumed that improving the quality of the environment begins to grow. therefore, this could be an overview of the natural process of economic development from an agrarian and industrial economy to a clean economy based on information‐intensive activities and services sector (arrow et al., 1995). all this speaks in favour of the fact that the environmental indicator is a reversed function of income per capita. precisely this systematic relationship between income per capita and environmental quality is the core of ekc hypothesis. pollution increases with an increase in revenues in the early stages of economic development and is reduced with an increase in revenue in the later stages of economic development, as shown in figure 1. 112 economic analysis (2019, vol. 52, no. 1, 109‐127) figure 1. environmental kuznets curve source: authors the conceptual framework of ekc may imply that environmental problems that arise as a result of economic growth are automatically solved in later stages of economic development. in a dynamic economic environment, with technological advances and increase in population preferences toward a better environment, economic growth does not pose a threat to environmental quality, but rather a condition for raising its’ quality. under the assumption of the truthfulness of the ekc hypothesis, economic growth should not be viewed as a threat to the quality of the environment, but as a means for eventual improvement of the environment. this idea also underwent an administrative embodiment in the new idea of sustainable economic development in our common future report published by the world commission on environment and development in 1987 (stern, 2004). lapshina, bakaeva & sotnikova (2017) claimed that a transition to the sustainable development concept is a necessity, especially for the urban territories. ekc had a significant impact on the economic policies of both developing and developed countries alike. even the priorities of the international monetary fund and the world bank have been focused on supporting policies for growth. therefore, economic growth has become the primary goal of developing countries without proper consideration of environmental issues. according to van den bosch & telenius (2016), changes in the environment are evident all over the world and take place at a faster pace than previously thought. for this reason, it is imperative that governments now take steps to reverse and adapt to the damage already done. the empirical results of the ekc indicate that economic growth can support environmental improvements if appropriate policies are taken. however, the consensus is that effective environmental policy can only be achieved in terms of income growth. however, before adopting a policy, it is important to understand the nature and the causal link between economic growth and the quality of the environment (coondoo & dinda, 2002). therefore, dinda (2004) puts a relevant question here: can economic growth be part of the solution and not the cause of environmental problems? this was the basic motivation for empirical studies in the search for proofs of interdependence between income growth and environmental degradation. petar mitić, milena kresoja, jelena minović 113 factors affecting the inversed‐u shape of the environmental kuznets curve factors that influence the inverted‐u shape between environmental degradation and income levels are (asumadu‐sarkodie and strezov, 2019a): • income elasticity of environmental quality • scale, composition and technique effect • international trade “income elasticity of environmental quality demand is the proportional change in environmental quality demand per the proportional change in income level.” (asumadu‐ sarkodie & strezov, 2019a). they further state that demand for quantity instead of quality means an increase in exploitation of natural resources and manipulation of environmental regulations and industry standards to attract polluting industries from developed countries. only when the level of income and the living standard increase, people are ready to pay for a better environment. in other words, the most common explanation for the ekc form is the idea that people attach greater value to ecological aspects only when the country achieves a sufficiently high standard of living (edenhofer et al., 2011, girod et al., 2014). the interdependence between environmental degradation and economic development takes place through three effects: the effects of scale, composition and technique (grossman & krueger, 1991). these effects are presented in figure 1. economic development has a negative impact on the environment, while the scale effect is in place. higher production volumes require greater exploitation of natural resources, thus increasing environmental degradation. furthermore, economic development implies a high consumption of non‐renewable energy sources that is cheaper than renewable energy (asumadu‐sarkodie & strezov, 2019a). the use of non‐renewable energy for industrial processes can reduce production costs and provide a greater volume of manufactured goods and services, but it nevertheless encourages the increase of harmful emissions, primarily from industrial processes (owusu & asumadu, 2016). furthermore, the composition effect implies that economic development has a negative or positive impact on the environment, depending on structural changes in the economy (asumadu‐sarkodie & strezov, 2019b). as the level of income grows, the structure of the economy is changing and economic activities that produce less pollution gradually increase. environmental degradation is increasing as the structure of the economy is directed from agricultural to industrial activities, but also with a structural change from the energy‐intensive industry to services and knowledge‐based innovations and technologies. the technique effect implies that economic development has a positive impact on the environment. as countries with higher levels of income invest more in research and development (komen et al., 1997), this allows the replacement of old technologies that emit large quantities of pollution with new, cleaner and more sophisticated technologies. this combined with strict environmental regulations and industry standards, leads to an improvement in the quality of the environment. taking all three effects into account, ekc suggests that the negative impact of the scale effect on the environment tends to govern at the initial stages of growth. it will ultimately be overcome by the positive impact of the composition and technique effect that tends to reduce the level of harmful emissions (dinda, 2004; asumadu‐ sarkodie & strezov, 2018). certain economists, such as lee & roland‐holst (1997) and jones & manuelli (1995) argue that trade is not the main cause of environmental degradation. however, free trade has diversified and contradictory effects on the quality of the environment, as it also increases pollution and motivates their reduction (dinda, 2004). through the scale effect, the quality of the environment decreases because increasing the volume of trade, and above all exports, increases the size of economic activities, which increases pollution. on the other hand, trade improves the environment through composition and technique effects. openness and trade 114 economic analysis (2019, vol. 52, no. 1, 109‐127) liberalisation leads to the specialisation of countries in those sectors where they have a competitive advantage. however, if a competitive advantage arises from liberal environmental regulations, then trade openness will degrade the environment. trade liberalisation, through the composition effect, is also called the pollution haven hypothesis. if the environmental protection regulations are weak, they attract energy‐intensive industries that emit large quantities of pollution. it is most often the case that developed countries transfer their industrial capacities to developing countries with poor environmental legislation. poor environmental policies and regulations in developing countries are becoming a source of comparative advantage, and therefore, changes in the trade structure promote environmental degradation in these countries (sun, zhang & xu, 2017). in the same way, if innovation, research and development, as well as clean and modern technologies are transmitted through foreign direct investments from developed countries to developing countries, this can reduce the level of pollution. an econometric framework of the environmental kuznets curve the studies that investigated the ekc hypothesis have common characteristics of the used data and methodologies. in other words, regardless of the different methods and techniques used in the analysis of the ekc, almost all follow a similar model specification. most of the data used in this type of research are panel data. therefore, the basic specification of the ekc model is as follows: , , , , , , , , where y represents environmental indicators,  is the constant, x, x2 and x3 represent the income level, the squared income level and the cubical income level, k are the coefficients estimates of the regression, z represents other indicators of interest for the model, i is a spatial index (country), t is the time index (year), and  is white noise. based on the econometric specification of the model, the testing of the relationship between environmental pollution and income levels can provide several interpretations (asumadu‐ sarkodie & strezov, 2019a; dinda, 2004). we have divided these interpretations into three groups. the first group displays linear relationships, which are presented in figure 2. figure 2. a linear relationship between environmental pollution and income source: authors petar mitić, milena kresoja, jelena minović 115 the left‐hand plot of the figure 2 represents a case where a monotonically decreasing relationship between environmental degradation and income exists (1 < 0 and 2 = 3 = 0). middle plot of the figure 2 represents a situation where no relationship between environmental degradation and income is detected (1 = 2 = 3 = 0), while the right‐hand plot of the figure 2 illustrates a case where a monotonically increasing relationship between environmental degradation and income is present (1 > 0 and 2 = 3 = 0). the second group represents the u shaped relationships between environmental degradation and income levels. these relationships are graphically presented in figure 3. figure 3. inverted‐u and u shaped relationship between environmental pollution and income source: authors left‐hand side of the figure 3 shows a situation where an inverted‐u shaped relationship exists, i.e. which supports the ekc hypothesis (1 > 0, 2 < 0 and 3 = 0). on the other hand, right‐ hand side of figure 3 represents a situation where the relationship has the shape of u shaped curve (1 < 0, 2 > 0 and 3 = 0). third and final group represents the n shaped relationships between environmental degradation and income levels, which relationships are graphically shown in figure 4. figure 4. inverted‐n and n shaped relationship between environmental pollution and income source: authors 116 economic analysis (2019, vol. 52, no. 1, 109‐127) left‐hand side of the figure 4 visualises an inverted‐n shaped relationship (1 < 0, 2 > 0 and 3 < 0). right‐hand side of the figure 4 represents a situation where there is a n shaped curve (1 > 0, 2 < 0 и 3 > 0). based on all the above mentioned, the ekc hypothesis is valid only in the case when 1 > 0, 2 < 0 и 3 = 0, i.e. left‐hand side of the figure 3. the turning point of the curve is then obtained as a maximum of the quadratic function: ∗ 2 . a vast number of econometric studies have used the previous model to test the existence of an ekc for a wide range of environmental indicators. it is necessary to point out that the values of the indicators in this type of research are often used in their logarithmic form. selected literature review for single countries as mentioned above, there is an extensive number of studies which tested the environmental kuznets curve hypothesis for individual countries. some countries, such as china, turkey, malaysia and pakistan, etc. have been of great interest in the context of testing ekc hypothesis, but there is a certain number of countries that have not yet been examined in this context. for example, ahmad et al. (2017) examined the validity of ekc in croatia using autoregressive distributed lag (ardl) model and vector error correction model (vecm) on quarterly data for the period 1992q1‐2011q1. their results confirmed the validity of the ekc, i.e. there is an inverted u‐shape relation between co2 emissions and economic growth in the long run. similarly, kang et al. (2016), lacheheb et al. (2015), and saboori et al. (2012) tested the relationship between economic growth and co2 emissions in china (1997–2012), algeria (1971‐ 2009), and malaysia (1980‐2009), respectively. using a spatial panel data model, kang et al. (2016) showed the existence of inverted‐n ekc in china. oppositely, lacheheb et al. (2015) used ardl co‐integration framework and showed that ekc hypothesis does not exist in algeria, while results from saboori et al. (2012) indicated that there is support for the ekc hypothesis in malaysia, again using ardl methodology. another study that examined the validity of ekc hypothesis for the period 1960‐2007 in china was conducted by šimurina & dobrović (2011). the authors used regression analysis and the following variables: economic growth (per capita gdp) and carbon dioxide (co2) emissions per capita. results presented by kang et al. (2016), indicate that the ekc hypothesis is rejected for china, but here a linear relationship fits the data more properly. another study that does not support the ekc hypothesis was conducted by al‐ mulali et al. (2015). they were examining vietnam for the period 1981‐2011 and showed that the relationship between gdp and pollution is positive in both the short and long run, follow an inverted‐u shape. to the contrary, li et al. (2016) found that ekc hypothesis is supported in china. the selected methodology was a dynamic panel model with generalized method of moments (gmm) estimator and ardl model with alternative panel estimator, to test ekc hypothesis in the period 1996‐2012. on the other hand, in the case of spain, esteve & tamarit (2012) examine the long‐run relationship between per capita carbon dioxide and per capita income over the period 1857– 2007. they utilised threshold cointegration techniques, and their results suggest the existence of an inverted‐u shape between two selected variables, supporting ekc hypothesis. saboori & sulaiman (2013) employed ardl methodology, johansen–juselius maximum likelihood approach, and vecm to test the relationship between economic growth, carbon petar mitić, milena kresoja, jelena minović 117 dioxide emissions and energy consumptions. these authors test the ekc hypothesis in malaysia for the period 1980‐2009, by employing both the aggregated and disaggregated energy consumption data. their results did not support the ekc hypothesis when aggregated energy consumption data was used. however, when data were disaggregated based on different energy sources, their study does show evidence of the ekc hypothesis. for romania, shahbaz et al. (2013) used ardl cointegration tests to analyse the dynamic relationship between economic growth, energy consumption and carbon dioxide emissions for the period 1980‐2010. their empirical results suggest that the ekc is found both in long‐and‐ short runs. same results were obtained in the case of pakistan for the period 1971‐2008. here ahmed & long (2012) tested the existence of ekc using data for carbon dioxide emissions, economic growth, energy consumption, trade liberalisation and population density. these authors utilised the cointegration analysis using the ardl bounds testing the approach on yearly data. the same methodology – ardl has been used by al‐mulali et al. (2015) for vietnam, bölük & mert (2015) for turkey, jalil (2012) for china, and mrabet & alsamara (2017) for qatar. bölük & mert (2015) test the validity of the ekc hypothesis during 1961‐2010. their results show the existence of a u‐shaped relationship between per capita greenhouse gas emissions and income in turkey. jalil (2012) test the long‐run relationship between openness and income inequality in the period 1952‐2009. it was found that income inequality rises with the increase of openness and then starts to fall after a critical point, which is in line with the ekc hypothesis. mrabet & alsamara (2017) tested the ekc hypothesis using two different environment indicators: the carbon dioxide emissions and the ecological footprint in the period 1980–2011. the variables used in this study are the real gross domestic product, energy use, financial development, trade openness, carbon dioxide emissions and the ecological footprint. their results suggest that the ekc hypothesis is not valid in qatar when they use carbon dioxide emissions, whereas the ekc hypothesis is valid when using the ecological footprint. furthermore, al‐mulali et al. (2016) investigated the ekc hypothesis for kenya from 1980 to 2012 using the ardl approach again. their results showed that fossil fuel energy consumption, gdp, urbanisation, and trade openness increased air pollution mutually in the long run and short run. al‐mulali et al. (2016) showed that the ekc hypothesis does exist in kenya. zambrano‐ monserrate et al. (2018) and tiwari et al. (2013) used ardl and vecm methodology to test the ekc hypothesis for peru (1980‐2011) and india (1966‐2011), respectively. zambrano‐ monserrate et al. (2018) showed that ekc hypothesis does not exist in peru, while tiwari et al. (2013) results suggested the presence of ekc in the long run as well as in short run in india. for malaysia, ali et al. (2017) investigated ekc using the following variables: the impact of real gdp per capita, financial development, trade openness, foreign direct investments, and energy consumption on co2 emissions throughout 1971‐2012. the authors employed ardl bound test and the granger causality test to investigate the long‐run relationship between the selected variables. their results suggest that the ekc hypothesis exists in malaysia. using the same methodology, jalil & mahmud (2009) tested the ekc relationship between carbon dioxide emissions and per capita real gdp in the period 1975‐2005 in the case of china. these authors used the following variables: carbon emissions, energy consumption, income, and foreign trade. jalil & mahmud (2009) found a quadratic relationship between income and carbon dioxide emissions, supporting the ekc relationship. fodha & zaghdoud (2010) used cointegration analysis to show that the ekc hypothesis was valid in tunisia for the period 1961‐2004. similarly, lau et al. (2014) employing the bounds testing approach and granger causality methodology and got results that the ekc hypothesis does exist for malaysia in the period 1970‐2008. for saudi arabia, mahmood & alkhateeb (2017) employed ardl cointegration tests in order to test the impacts of trade and income level on carbon dioxide emissions in the period 1970‐2016. the authors’ results showed inveterate the ekc hypothesis. for cambodia, ozturk & al‐mulali (2015) used the generalized method of moments and the two‐stage least squares to investigate whether better governess and 118 economic analysis (2019, vol. 52, no. 1, 109‐127) corruption control help to form the inverted u‐shaped relationship between income and pollution for the period of 1996–2012. their results suggest that the ekc hypothesis was not confirmed in cambodia. nasir & rehman (2011) and shahbaz et al. (2012) investigated the ekc hypothesis in case of pakistan for the period 1972–2008, and 1971–2009, respectively. both nasir & rehman (2011) and shahbaz et al. (2012) confirmed the existence of the ekc for pakistan. table 1. summary of studies on individual countries author period country methodology variables ekc ahmad et al. (2017) 1992q1‐ 2011q1 croatia ardl & vecm granger causality co2, gdp yes ahmed & long (2012) 1971‐ 2008 pakistan ardl co2, gdp ec, to, pd yes ali et al. (2017) 1971‐ 2012 malaysia ardl & vecm granger causality co2, gdppc, fd, to, fdi, ec yes al‐mulali, saboori & ozturk (2015) 1981‐ 2011 vietnam ardl co2, gdppc, el (fossil fuels) el (renewables), ca, lf, ex, im no al‐mulali, solarin, & ozturk (2016) 1980‐ 2012 kenya ardl & vecm granger causality co2, gdppc, el (fossil fuels) el (renewables), fd, to, ur yes bölük & mert (2015) 1961‐ 2010 turkey ardl co2, gdppc, el (renewables) yes esteve & tamarit (2012) 1857‐ 2007 spain threshold cointegration techniques co2, gdppc yes fodha & zaghdoud (2010) 1961‐ 2004 tunisia panel cointegration and vecm granger causality co2, gdppc, so2 yes jalil & mahmud (2009) 1975‐ 2005 china ardl co2, gdppc, ec, to yes jalil (2012) 1952‐ 2009 china ardl open, gini, fd, inf, yes kang, zhao & yang (2016) 1997‐ 2012 china the spatial panel data model co2, gdppc, to, cc, ur, pd yes lacheheb rahim & sirag (2015) 1971‐ 2009 algeria ardl co2, gdppc, cf, to no lau, choong & eng (2014) 1970‐ 2008 malaysia bounds testing & vecm granger causality co2, gdppc, fdi, to yes li et al. (2016) 1996‐ 2012 china dynamic panel model, gmm, ardl co2, iww, iws, gdppc, ec, to, ur yes mahmood & alkhateeb (2017) 1970‐ 2016 saudi arabia ardl co2, gdp, tr yes mrabet & alsamara (2017) 1980‐ 2011 qatar ardl co2, ef, gdppc, ec, fd, to no (for co2) yes (for ef) nasir & rehman (2011) 1972‐ 2008 pakistan panel cointegration and vecm granger causality co2, gdppc, ec, to yes ozturk & al‐ mulali (2015) 1996‐ 2012 cambodia gmm & tsls co2, gdp, el, to, cor, gov no petar mitić, milena kresoja, jelena minović 119 author period country methodology variables ekc saboori & sulaiman (2013) 1980‐ 2009 malaysia ardl, johansen–juselius maximum likelihood approach, vecm granger causality co2, gdppc, ec no (when aggregated ec) yes (when disaggregated ec) saboori, sulaiman & mohd (2012) 1980‐ 2009 malaysia ardl & vecm granger causality co2, gdppc yes shahbaz et al. (2012) 1971‐ 2009 pakistan ardl & vecm granger causality co2, gdppc, ec, to yes shahbaz et al. (2013) 1980‐ 2010 romania ardl co2, gdppc, ec yes šimurina & dobrović (2011) 1960‐ 2007 china regression analysis co2, gdppc no tiwari, shahbaz & hye (2013) 1966‐ 2011 india ardl & vecm granger causality co2, cc, gdppc, to yes zambrano‐ monserrate et al. (2018) 1980‐ 2011 peru ardl & vecm granger causality co2, gdppc, el, dng, pc no source: authors note: variables: co2 – carbon dioxide emissions, gdp – gross domestic product, gdppc ‐ gross domestic product per capita, to – trade openness, cc – coal consumption, ur – urbanisation, pd – population density, cf – gross fixed capital formation, ec – energy consumption, el – electricity consumption, ca – capital, lf – labour force, ex – exports, im – imports, open ‐ openness (further divided in trade ratio, average tariff rates, effective tariff rates, economic globalization and overall globalization), fd – financial development, inf – inflation, ef ‐ ecological footprint, fdi – foreign direct investments, dng – dry natural gas, pc – petroleum consumption, so2 – sulfur dioxide emissions, tr – total trade, cor – corruption index, gov – government effectiveness index, iww – industrial waste water, iws – industrial waste solid emissions, methodology: gmm – generalized method of moments, tsls – two‐stage least squares, ardl – autoregressive distributed‐lagged model, vecm – vector error correction model. selected literature review for groups of countries the ekc analysis can be performed and extended by considering a region or a group of countries instead of a single country. there are many available studies exploring relationships described above within various regions and groups of countries. mena countries are particularly interesting for researchers. according to the analysis performed on single mena counties, the results are very heterogeneous. arouri et. al (2012) investigated the nature of the causality relationship between carbon dioxide emissions, energy consumption, and real gdp for 12 mena countries (algeria, bahrain, egypt, jordan, kuwait, lebanon, morocco, oman, qatar, saudi arabia, tunisia, and uae) covering the time period 1981‐ 2005. the authors utilised bootstrap panel unit root tests and cointegration techniques and estimated panel error correction models (ecm) to examine the interactions between short‐ and long‐run dynamics of environmental variables. ekc hypothesis is tested for the mena region for co2 and each country separately. at the region level findings support an inverted u‐shape pattern associated with the ekc hypothesis for the mena region. on the other hand, at the country‐level, there is poor evidence in support of the ekc hypothesis for the studied countries except for jordan. this result is confirmed by farhani et al. (2018). the authors analysed the following 10 mena countries over the period 1990–2010: algeria, bahrain, egypt, iran, jordan, morocco, oman, saudi arabia, syria, and tunisia. the authors tested the ekc hypothesis but also considered modified ekc to explore the relationship between sustainability and human development. in addition to the variables chosen by arouri et 120 economic analysis (2019, vol. 52, no. 1, 109‐127) al. (2012), these authors added trade openness, manufacture value‐added and modified hdi in the list of independent variables. data were analysed using panel data methods: panel long‐run estimates (fmols and dols) and panel vecm. panel data results offer support in favour of the ekc hypothesis, i.e., there is an inverted u‐shape relationship between environmental degradation and income. unlike two studies which applied parametric approaches on the panel of data sets from the mena region and whose findings supported the ekc hypothesis, research by fakih and marrouch (2019) led to opposite findings. these authors examined the ekc hypothesis for the selected ten countries in the mena region and covered the period from 1980 to 2010. the analytical framework included only two variables: carbon dioxide emissions and real gdp. the approach applied in this study was a non‐parametric regression model and technique in estimating the functional form of the curve is the deviance difference test. findings revealed that the ekc hypothesis is rejected, i.e., provide evidence against the postulated inverted‐u shaped relationship between pollution and the level of economic development. another interesting group of countries is the organisation for economic co‐operation and development (oecd). churchill et al. (2018) examined the ekc hypothesis for 20 oecd countries for the period between 1870 and 2014. in order to achieve this goal, the authors investigated cross‐sectional correlations. the specification of the model was the following. the dependent variable was carbon dioxide emissions, while the set of independent variables consisted of gdp, the square of gdp, the ratio of trade population, population, financial development. utilising recently developed panel data estimators that account for cross‐sectional dependence and parameter heterogeneity, the ekc hypothesis is verified for the panel with three of the four estimators (mg, amg, and pmg). the similar results were obtained by lau et al. (2018) who studied the ekc hypothesis in 18 oecd countries for the period 1995‐2015. however, the main aim of the study was to investigate the effects of electricity production from a nuclear source, electricity production from non‐renewables and trade openness on co2 emissions. these authors employed technique generalized methods of moments (gmm) and panel fully modified ordinary least squares (fmols). the results support the ekc hypothesis in oecd countries where nuclear energy plays a pivotal role in protecting the environment. another group of countries has been very popular among researcher, and that is the association of southeast asian nations (asean). budhi utomo & widodo (2019) tested the ekc hypothesis in 9 asean countries within the period from 2007 to 2014. utilising advanced econometric technique generalized methods of moments (gmm) estimator they determined how economic growth and energy use influence co2 emissions. one of the significant findings is that ekc is based on economic growth for asean countries, but that energy use has a positive and not significant effect. heidari et al. (2015) performed ekc analysis for 5 asean countries in the period from 1980 to 2008 using the panel smooth transition regression model. this flexible model has two regimes: levels of gdp per capita below 4686 usd (1st regime) and gdp per capita above 4686 usd (2nd regime). in the 1st regime, there is an increase in environmental degradation with economic growth while the 2nd regime showed a reversed trend. the authors have derived results which support the validity of the ekc hypothesis in these asean countries. however, zhu et al. (2016) state that there is only poor evidence for supporting the ekc hypothesis. these authors used panel quantile regression model to investigate the influence of foreign direct investment, economic growth and energy consumption on carbon emissions in five asean countries. the chosen period is from 1981 to 2011. ekc hypothesis was also tested in bric countries. pao & tsai (2010) investigated the impact of economic growth and energy consumption on in bric countries from 1971 to 2005. the methodology included panel cointegration techniques and granger causality. the overall results support the ekc hypothesis. lau at al. (2018) continued examining the ekc phenomenon. they focused on 100 developed and developing nations by considering the role of institutional quality. the countries were classified into three groups: low income (13 countries), lower‐middle income (28 countries), petar mitić, milena kresoja, jelena minović 121 upper‐middle income (25 countries) and high income (34 countries) and the analysis was conducted for each group as well as for all countries together. the selected period was from 2002 to 2014. independent variable was co2 emissions, while gdp, the square of gdp, ratio of trade population, institutional quality, fdi, trade openness ratio were chosen as independent variables. the methodological framework included the generalised method of moments estimators. independent variable was co2 emissions, while gdp, the square of gdp, ratio of trade population, institutional quality, fdi, trade openness ratio were chosen as independent variables. the results provide evidence in support of the ekc hypothesis and an inverted u‐ shaped relationship between economic growth and co2 emissions for the whole group of 100 countries. on the other hand, the analysis conducted on the income‐based groups shows a strong influence of economic development stage on the existence of inverted u‐shaped ekc. it is shown that the ekc hypothesis is verified only developed, i.e., in high‐income countries, but not in developing nations. testing the ekc hypothesis in countries classified by income was also performed by shahbaz et al. (2019). they tested the ekc hypothesis for 86 high‐income, middle‐ income, and low‐income countries over the period 1970–2015. for this goal, the cross‐ correlation was applied to understand the relationship between globalisation and energy consumption in terms of time lags and leads. their findings revealed that there is clear evidence in support of the ekc hypothesis in 64 out of the 86 countries. zhang & meng (2019) investigated the ekc hypothesis using data from 1996 to 2014 on co2 emissions from 115 countries with multiple levels of per capita gdp and internet penetration. the chosen countries were grouped by income into low‐income, lower‐middle income, upper‐middle‐income and high‐income countries. they estimated functional forms with quadratic transformations of regressors. empirical results verify the existence of the ekc and reveal that internet penetration does generally reduce the actual income level beyond which pollution begins to decrease. developed countries were in the focus of beşe & kalayci (2019). they tested the ekc hypothesis for denmark, the united kingdom, and spain for the period 1870‐2014. the authors have examined long‐term relationships between gdp, co2, energy consumption, and the square of gdp using johansen cointegration test. according to the results, the ekc hypothesis is rejected. usa countries were analysed by işık et al. (2019). the authors tested the ekc hypothesis for ten selected usa states in the period from 1980 to 2015. these chosen states have the highest levels of carbon dioxide emissions in the usa. the influence of the following independent variables on the co2 emissions was estimated: real gdp, population, renewable and fossil energy consumptions. the panel estimation method was applied with cross‐sectional dependence. the empirical results verify the ekc hypothesis and indicate inverted u‐shaped for only five out of ten states. table 2. summary of studies on groups of countries author period country methodology variables ekc arouri et al. (2012) 1981‐ 2005 12 mena countries bootstrap panel cointegration techniques, and ecm co2, ec, gdppc yes beşe & kalayci (2019) 1960‐ 2014 denmark, united kingdom, & spain ardl, toda and yamamoto granger non‐causality test, var granger causality co2, ec, gdppc no budhi utomo & widodo (2019) 2007‐ 2014 9 asean countries gmm co2, ec, gdppc yes churchill et al. (2018) 1870‐ 2014 20 oecd nations cross‐sectional dependence, panel cointegration, mg, amg, co2, gdppc, tr, pop, fd yes (3 of 4 estimators) 122 economic analysis (2019, vol. 52, no. 1, 109‐127) pmg, ccemg estimators fakih & marrouch (2019) 1980‐ 2010 10 mena countries non‐parametric regression co2, gdppc no farhani et al. (2018) 2002‐ 2014 10 mena countries dols, fmols & vecm granger causality co2, gdppc, to, mav, hd, rl yes heidari et al. (2015) 1980‐ 2008 5 asean countries panel smooth transition regression model co2, ec, gdppc yes işık et al. (2019) 1980‐ 2015 ten states in usa panel estimation method with cross‐sectional dependence co2, gdp, gdppc, ec (fossil fuels), ec (renewables), pop yes for five states lau et al. (2018) 1870‐ 2014 100 developed and developing nations gmm co2, gdppc, to, inq, fdi yes lau et al. (2018) 1995‐ 2015 18 oecd countries gmm & fmols co2, gdppc, to, el (nuclear), el (non‐ renewable) yes pao & tsai (2010) 1971‐ 2005 bric panel cointegration, vecm granger causality co2, ec, gdppc yes shahbaz et al. (2019) 1970‐ 2015 86 countries cross‐correlation glo, ec yes for 64 countries zhang & meng (2019) 1996– 2014 115 countries functional forms with quadratic transformations of regressors co2, gdppc, ini, int, el, tr, fdi, inf, urb, ind, ar, pd, popgr, prw, dem yes zhu et al. (2016) 1981‐ 2011 5 asean countries panel quantile regression model co2, ec, gdppc, pop, fdi, to, inds, fd no source: authors note: variables: co2 – carbon dioxide emissions, gdp – gross domestic product, gdppc ‐ gross domestic product per capita, to – trade openness, ec – energy consumption, glo – globalization, ini – investment intensity, int – internet, fdi – foreign direct investments, tr – total trade, inf – inflation, urb – urbanization, el – electricity consumption, ind – industrialization, ar – aging rate, pd – population density, popgr – population growth, prw – proportion of women in total labour force, dem – democracy, fd – financial development, inds – industrial structure, inq – institutional quality, pop – population, hd – human development, mav – manufacture value‐added, rl – rule of law. methodology: ecm – error correction model, ardl – autoregressive distributed‐lagged model, vecm – vector error correction model, var – vector autoregression, gmm – generalized method of moments, mg – mean group estimator, amg – augmented mean group estimator, pmg – pooled mean group estimator, ccemg – common correlated effects mean group estimator, dols – dynamic ordinary least squares, fmols – fully modified ordinary least squares. countries: mena – the middle east and north africa region, asean – association of southeast asian nations, oecd – the organisation for economic co‐operation and development, bric – brazil, russia, india and china. concluding remarks for a summary of the ekc research conducted for single countries, it can be concluded that studies have been carried out over different periods depending on available datasets. the majority of analyzed studies have used carbon dioxide (co2) or sulfur dioxide (so2) as a depended variable, while energy consumption, gdp, and square value of gdp were used as explanatory variables. some authors used the set of explanatory variables as follows: trade liberalization, population density, financial development, trade openness, foreign direct investments, labour force, export, import, urbanization, foreign trade, environmental productivity, energy use, ecological footprint, coal consumption, control of corruption and governess, etc. in most of the studies dealing with ekc for single countries, the ardl petar mitić, milena kresoja, jelena minović 123 methodology is used. additionally, in these studies, other panel techniques were utilized, such as granger causality approach, vecm method, and cointegration approach. similarly, as in the single country case, studies conducted for a group of countries have been carried out over different periods, with a different set of input variables and various methodology frameworks. almost all studies have used co2 emissions as the depended variable, while energy consumption, gdp and square value of gdp were used as explanatory variables in nearly all of the studies. throughout time, the set of explanatory variables has been expanded towards considering trade openness, globalization, investment intensity, internet, foreign direct investments, total trade, inflation, etc. if countries are considered and analyzed as a group, then researches applied a wide range of methodologies and advanced econometric models appropriate to considered panel dataset. in most cases, standard tests such as panel unit root tests, cointegration techniques and granger causality were utilized. given that variables are cointegrated, different estimators were used to estimating the relationship between variables. due to the panel type of data, researchers tried to address the slope heterogeneity and cross‐ section dependence by considering panel data estimators such as amg and ccemg, that have shown advantages over mg. the other group of researchers used parametric dols and non‐ parametric fmols estimator to deal with bias by taking the leads and lags of the first‐ differenced independent variables. in addition to these estimators, researches also used a more advanced panel dynamic gmm to address autocorrelation and country‐specific effects. an innovative approach in testing ekc includes panel smooth transition regression model as well as panel quantile regression model. according to asumadu‐sarkodie & strezov (2019a), lind & mehlum (2010) claim that “the criteria are weak when “the true relationship is convex but monotone over relevant data values”, as such, the quadratic specification produces erroneous turning point and u‐shaped relationship.” they further claim that to properly test the existence of a u‐shape, “there is a need to test the decreasing relationship at low values within the interval values and the increasing relationship at high values within the same interval. thus, when the relationship increases at the left‐hand side of the interval and decreases at the right‐hand side, the traditional method of u‐ shape estimation is not suitable.” (lind & mehlum, 2010). they created an algorithm used to test the presence of the u‐shaped, 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(2016). “the effects of fdi, economic growth and energy consumption on carbon emissions in asean‐5: evidence from panel quantile regression.” economic modelling, 58: 237‐248. article history: received: may 5, 2019 accepted: june 7, 2019 doi: 10.28934/ea.23.56.1.pp32-42 first online: april 10, 2023 preliminary report corporate news disclosure and competitive advantage: what factors influence s&p 500 companies’ competitive advantage during 2022 economic crisis? miloš petković12f* 1 singidunum university, faculty of business, belgrade, serbia abstract this paper aims to explore corporate news related to the topic of the competitive advantage of s&p 500 companies in the period of the economic crisis in 2022. the observed companies are the biggest us companies listed on the new york stock exchange (nyse). the computerized qualitative analyses were done on 200 corporate news from january 2022 until november 2022, with 13,361 pages and 5,294,836 words. the research results prove that the us biggest companies disclosure intensively in public about their competitive advantage with 90.29% including text samples from initial corpus text. the companies disclosure about 4 main topics (factors) during this year’s crisis: (1) profitability; (2) financial market performance; (3) products and services; (4) top management leadership. the research article contributes to the current literature on competitive advantage narratives, how the biggest companies tend to achieve competitive advantage during the economic crisis and address messages to their stakeholders. these messages could be of the highest importance mostly because of existing uncertainties and high levels of risks. keywords: corporate news disclosure, competitive advantage, s&p 500 companies, economic crisis jel classification: m14, l25, h12 introduction the main company’s goal is to gain a long-term competitive advantage. in such a dynamic, global, and competitive market as it is at the moment, gaining a competitive advantage is not an easy task. in the last three decades, the market has changed dramatically. to better adapt to the continuously evolving global market, companies used their flexibility and efficiency in combination with advanced technology. this includes all different types of the latest technology that will result in better performance (li et al., 2020), and further sustainable competitive advantage (sakas et al., 2014). the focus completely changed, from supply-based, where the focus was on producers, to demand-based and complete concentration on customers. even though we are witnessing radical changes, quantitative and financial factors of success remained the same (petković et al., 2020). because of that, companies are looking for more advanced tools that will not only focus on financial factors, but on non-financial perspectives as well (jackson et al., 2020; tsai et al., 2016). * e-mail: mpetkovic@singidunum.ac.rs miloš petković 33 the studies published by bodnaruk et al. (2015) and campbell et al. (2014) proved the influence of qualitative data in the full-text corporate fillings (10-k form) and corporate news on companies’ final performance. the authors talked about the usefulness of such qualitative data in reducing risks coming from the external environment. public news disclosure influence significantly on investors’ attention and perception. unlike newspaper media, corporate news is written by the company’s management to communicate the company’s performance as well as potential plans. odders-white & ready (2008) talked about the influence of qualitative information on a company’s performance, precisely on asset value and stock prices. such corporate news and information can improve an existing company’s performance, lead to competitive advantage and reduce risk, especially in crisis moments. the main research objective is to explore corporate news disclosure in the s&p 500 biggest companies related to the topic of competitive advantage. corporate news disclosure will lead us to the main factors (independent variables) that influence competitive advantage during the 2022 economic crisis. international monetary fund (2022), in its latest annual report, talks about rising economic risks coming from the previous pandemic crisis, current economic challenges and high levels of uncertainties linked with higher inflation and interest rates, a drop in employment and investments, and higher levels of risk across different industries. the research results can, even more, motivate top managers and decision-makers to focus on the selected factors and to invest in them, which will result in constant and long-term competitive advantage. until now, the main focus was on immediate and short-term results such as profits, sales, and share prices, and not so much on long-term constant and stable economic benefits. the study is focused on s&p 500 companies listed on new york stock exchange (nyse) because it is a sample of the most profitable companies (uygur, 2019), but also the most successful (wang et al., 2022) in the world. the research has three main contributions to the literature. first, we contribute to the literature by proposing the factors that impact on company’s competitive advantage. the research paper results proved to us that four main factors create a company’s competitive advantage in crisis moments. second, we document that factors related to competitive advantage are very intensive and cover almost all corporate communication. without high frequency, it is difficult to expect the impact of the selected four factors on final performance. finally, we highlight indicators and precise narratives of each factor, which is explained in cluster text formations. it is of the highest importance to take into consideration precise indicators of each factor in order to gain long-term competitive advantage. companies’ decision-makers should focus on these indicators, invest and monitor their performance over time. the research paper is composed of five main sections. section 2 presents the literature review. section 3 works on the research methodology, whereas section 4 explains the final results. finally, section 5 concludes the paper. literature review corporate news communication and disclosure corporate communication is seen as a powerful tool in investment decision as they provide information about a firm’s plans, strategies, business models and further development. very often, corporate and qualitative news is followed by quantitative information presented in the company’s accounts (albertini et al., 2021). corporate communication is especially important in improving and growing a company’s reputation, brand and corporate image. it can be seen as a tool for market expansion only if a company shares positive and mixed information (heinberg et al., 2018). public communication is very important because it injects the necessary information into the market and facilitates the investors’ decision maker processes. it can also significantly influence the predictability of certain financial performances (ozik & sadka, 2013). campbell et al. (2014) highlighted the benefits of the possibility for companies to publish and disclose the information freely provided by top management. the free-text risk factor significantly reduces 34 economic analysis (2023, vol. 56, no. 1, 32-42) potential risks for all current and future investors. kravet & muslu (2013) confirmed the previous statement and expanded with the justification that changings in companies’ text disclosure influence future investments in that company. attention paid to the 10-k fillings has to be the highest because it shapes the company’s future growth. news in corporate publications is a very important tool for communication with its key stakeholders. this corporate communication can clarify different confusion in the market, reduce risk, limit uncertainty for the market participants, and improve performance. companies communicate variables that they want to improve (aman & moriyasu, 2022). one of the most important stakeholders of every organization is the customer. transparency of corporate disclosure sends an important signal to customers (higgins et al., 2020). it also brings the sincerity of a company’s motives. it is very important what the factors present in their corporate disclosure are (liu et al., 2022; peschel & aschemann-witzel, 2020). the link between corporate disclosure and competitive advantage authors kim et al. (2022) worked on the relationship between corporate managerial disclosure and investors’ attention on twitter. 715 unique companies with 86,891 tweets were included in the study. the findings showed that companies with highly positive earnings use this platform to publish even more posts related to earnings information, which resulted in even higher earnings improvement. on the other side, companies with bad earnings publish posts mostly related to non-earnings-related information on twitter. it is also very important that companies strategically decide the format of tweets (whether qualitative or quantitative information) and the tone of earnings tweets (whether positive or negative). continuous and sustainable strategic publications led these companies to long-term advantages compared to their competition. authors aman & moriyasu (2022) proved that corporate news communication impact significantly company’s competitive advantage. moreover, a company’s returns and liquidity increase more when news is disseminated by corporate disclosure rather than mass media. a study published by liu et al. (2022) proved that transparent corporate disclosure brings higher customer confidence and improves competitive advantage. studies published by bodnaruk et al. (2015), campbell et al. (2014), loughran & mcdonald (2011), tetlock (2007), and tetlock et al. (2008) justified the relationship between the value and impact of qualitative information on stock market performance. studies proved that full-text corporate filings shed light on the usefulness of this information. kravet & muslu (2013) confirmed that changings in corporate news disclosure influence stock market prices, trading volume, and stock return volatility. corporate news disclosure increases or decreases risks that are further associated with financial market performance and, finally, with the company’s competitive advantage. einwiller & carroll (2020) confirmed that negative corporate communication significantly influences final success. being competitive in crisis moments authors petković et al. (2020) discussed the importance of gaining a company’s competitive advantage. gaining a competitive advantage is not an easy, short-term task. it comes from a longterm period of investments, both financial and non-financial. each company is part of a vast global market. unfortunately, companies’ performance and competitive advantage do not depend on themselves only. companies’ performance and competitive advantage depend on major industry, macro and global events (baker et al., 2020). the recent crisis showed us that each company has to adapt to new circumstances in order to stay competitive in the market. these new crisis circumstances brought a high level of risk and uncertainties, oscillations of values in resources, higher interest rates, and inflations (ding et al., 2021). burdekin & tao (2021) stated that crisis moments caused significant fluctuations in global markets, starting with energy, cryptocurrencies, and capital resources. miloš petković 35 according to uddin et al. (2022) company’s competitive advantage allows corporate resilience and the possibility to better and faster overcome difficulties during crisis moments. this position is possible to achieve only with managerial abilities, investor sentiment, and customer loyalty. customer loyalty creates additional value and provides a sustainable competitive advantage as well as financial benefits during crisis moments. customer loyalty reduces systematic corporate risk (dou et al., 2021). in his study, petković (2022) focused on public disclosure of the biggest us banks during the period of crisis. it was qualitatively proven that financial institutions disclose intensive topics that they want to improve, such as profitability, economic growth, utilization of resources, and environmental activities. literature suggests that companies have to focus on organizational systems, processes, management practices, leadership styles, and corporate communication to provide sustainable, productive, and effective results (hasan & cheung, 2018). given that those segments give results, their role, even more, becomes important during shocks, crises, or restructurations (boubaker et al.,2022; nemlioglu & mallick, 2020). data and methodology data sample explanation the research paper focuses on corporate news related to corporate performance in the period of the economic crisis in 2022. the period of observation was from the 1st of january 2022 until the 22nd of november 2022 (when data was exported). corporate news is publicly available news. the sample includes the 500 biggest us companies that belong to the s&p 500 indexed companies. the companies are listed on the new york stock exchange (nyse). qualitative analysis by statistical software to proceed with lexical qualitative analysis of the selected sample of corporate news, using ‘bibliometrix package’ from the r software made it possible to characterize the sample. for the study, a protocol for performing textual analysis was created by iramuteq software developed on python language (interface de r pour les analyses multidimensionnelles et de questionnaires) (ratinaud, p., 2014). the software gives a rigorous textual data analysis in the field of management sciences (goulart et al., 2020). this method is used to link the word to its natural context because meaning depends on the position of the word in some semantic space. two rules have to be considered: first, words are considered important according to their frequency in the corpus text; second, words are linked to the lemma they belong. both singular and plural words belong to the same lemma (albertini et al., 2021). within the corpus text, each article is known as the initial context unit (icu). each text segment that forms each class is defined as elementary context unit (ecu). qualitative data analysis allows us to identify the association between text segments and their retrieval (souza et al., 2018). for the purpose of our study, reinert’s method and word cloud analyses were used for clustering and analyzing the corpus text. reinert’s method reveals the main topics of companies’ disclosure (aversa et al., 2022). the word cloud analysis identifies the lexicographical formations of words with the highest representativeness within the corpus text (lee, 2020). the research study sample was composed of 200 articles of full text, 5,294,836 words, and 26,373 forms. a computerized lexical content analysis method allowed us to identify the strategic intentions of the topic expressed in the companies’ official corporate news. preparing the text corpus the research paper corpus text was composed of 200 articles in 2022. the corporate news was obtained from the clarivate database proquest. the corpus text was created by copying the body of the text of each article into a text document. the corpus text was composed of 13,361 pages of 36 economic analysis (2023, vol. 56, no. 1, 32-42) pure text. after the whole text was copied into the text document, it was applied to the iramuteq software. the iramuteq software possesses the english dictionary related to managerial topics. the software’s dictionary will allow the whole corpus text to lemmatize into different categories or clusters. lemmatization of texts conserves singular forms of nouns and infinitive forms of verbs in order to be grouped into semantic categories or clusters. results and discussion reinert’s method results this first level of the analysis showed us that the corpus was made of 5,294,836 words, with 26,373 different forms. this phase covered 90.29% words of the whole starting corpus text, 151,074 text segments, 30,348 forms, 26,373 lemmas, 19,957 active forms, and 6,416 supplementary forms. such a high-level percentage means that the companies communicated about the same topics during the observed period. the elements previously presented are grouped into 4 main clusters or categories (figure 1). figure 1. a factorial representation of 4 semantic clouds source: author’s calculation miloš petković 37 figure 2. dendrogram of 4 main clusters of corpus text source: author’s calculation table 1. categories revealed in phase 1 category name % of forms analyzed category 1 profitability 34.79% category 2 market performance 34.70% category 3 products and services 19.16% category 4 leadership 11.35% source: author’s calculation figures 1 and 2 allowed us to understand more dynamically the most important relationships between the categories (variables) in a factor plan. to be considered in the clustering analysis, each word must be repeated a minimum of ten times in the corpus text. as we can see, all four categories are independent and homogeneous from each other, and we do not have overlapping. this means that the selected companies were communicating very precisely and very intensively about these four topics. category 1 consists of vocabulary related to profitability (cash, income, payment, revenue, net income, profit, finance, money, etc.). category 2 talks about the market performance of the company (share, price, market, eps, dividend, index, yield, stock, value, etc.). category 3 covers words related to the company’s products and services (product, service, goods, price, production, demand, supply, etc.). finally, category 4 communicates vocabulary related to top management and leadership (leader, president, management, director, executive, chairman, etc.). from the relationships between categories in figures 1 and 2, we can state that category 2 – market performance correlates towards category 4 – leadership, category 4 – leadership towards category 1 – profitability, and category 3 – products and services. we can conclude that performance in the financial market depends on the performance of the leader of the company, whereas the company’s top management performance depends on profitability and products and services. this level of analysis proved to us that categories 1 and 3 shared notions and appeared to be very close to each other on the figures. both categories were communicated dominantly with 34.79% and 34.70%, respectively, during the 2022 economic crisis. most companies' public disclosure is spent on communicating their profitability and product offerings. on the other side, category 4 and category 2 were separated. the percentage of communication in these categories was 19.16% and 11.35%. four main variables or categories are presented in the factor plan. the factorial analysis produces distances of words and proximity from the initial corpus text. this analysis includes the calculation of chi-square correlation values for each variable, frequencies, and contingency table 38 economic analysis (2023, vol. 56, no. 1, 32-42) that crosses the active forms and the variables. x-axis (or factor 1) refers to the distribution and distance from variables. y-axis (or factor 2) indicates a tangibility of the relationship between variables. the position of the variable is very important and shows us how these four variables are distributed. the factor plan has abscissa with the value of factor 1 (positive and negative abscissa) and ordinates with the value factor 2 (positive and negative ordinate). class 2 was found in an area of negative abscissa and ordinate. classes 3 and 4 were found in an area of positive abscissa and ordinate. class 1 was found in an area of positive abscissa and negative ordinate. from the above mentioned, we can conclude that classes 1 and 3 are close distance with a strong tangible relationship. similar research focused on the importance of voluntary disclosure in a company’s letters to shareholders on final performance. on a european sample of companies, albertini (2021) proved that lexical analysis of top management disclosures on continuous innovations, managerial competencies, and stakeholder values significantly improves competitive advantage. nevertheless, authors albuquerque et al. (2020), berman et al. (2019) and huang et al. (2021) expand and state that stakeholders’ loyalty reduces risks and keeps firms’ value stable during uncertain times. (petković, 2022) proved intensive corporate news disclosure on factors that positively influence the biggest us banks' performance. word cloud analysis results the word cloud analysis showed us the most frequent words related to the main 4 factors in the corpus text. in table 2 and figure 3 below, the results are presented: table 2. first 10 most frequent active forms form frequency pos year 30,894 nom share 27,033 nom net 23,500 nom million 22,400 nom company 20,648 nom price 20,040 verb asset 19,385 nom value 19,282 verb total 16,232 nom revenue 16,184 nom source: author’s calculation the word cloud analysis allowed us to visualize better the lexicography of the most representative and most frequent words investigated in the corpus text. given that the words year, share, net, million, company, price, asset, value, total, revenue, and others were investigated for the specific sample of companies, we found it relevant. the result shows us that the research sample is emblematic of the investigation of the corpus text. miloš petković 39 figure 3: word cloud analysis source: author’s calculation conclusion the research tends to contribute to the literature about the disclosure of competitive advantage in a company’s corporate news. the paper presents what the biggest us companies publish and how much attention they pay to factors influencing competitive advantage. companies are encouraged to share their strategic intentions in public disclosure with their stakeholders in order to reduce uncertainties. the research qualitatively explored corporate news disclosure on the topic of competitive advantage during the economic crisis. the research paper was focused on the 500 biggest us companies indexed on the s&p 500 list from january to november 2022. the corpus text included 200 different articles and 5,294,836 words on 13,361 pages. the research study covered 90.29% of the whole corpus text, which confirmed that produced clusters or factors represented most of the corporate communication. the study identified 4 main clusters related to profitability, market data, products and services, and leadership. from the 4 given factors, we can conclude that the achievement of competitive advantage of the biggest us companies depends on 3 internal factors: the company’s profitability, products and services, and top management leadership, and 1 external factor: financial market performance. the paper limitations come from the sample of only publicly listed companies that met our requirements. future research papers can also cover smaller and medium size companies in a separate sample. smaller and medium-sized companies have very limited or very specific corporate communication, which is completely different from large-size corporations’ communication. moreover, the research could be extended to working on listed companies from other countries. finally, future research can combine both quantitative and qualitative methods within the same studies. 40 economic analysis (2023, vol. 56, no. 1, 32-42) acknowledgement the research paper is supported by the research project (decision no. wgb-2/13/z/2020) by the wroclaw university of economics, wroclaw, poland. references albertini, e. 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(2022). a grey-based correlation with multi-scale analysis: s&p 500 vix and individual vixs of large us company stocks. finance research letters, 48, 102872. https://doi.org/10.1016/j.frl.2022.102872 article history: received: 29.11.2022. revised: 19.3.2023. accepted: 31.3.2023. microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp1-19 original scientific paper early‐life income shocks and old‐age cause‐specific mortality hamid noghanibehambari1* | farzaneh noghani2 | nahid tavassoli2 1 texas tech university, department of economics, lubbock, united states 2 texas tech university, rawls business school, department of management, lubbock, united states abstract this paper investigates the causal relationship between income shocks during the first years of life and adulthood mortality due to specific causes of death. using all death records in the united states during 1968-2004 for individuals who were born in the first half of the 20th century, we document a sizable and statistically significant association between income shocks early in life, proxied by gdp per capita fluctuations, and old age cause-specific mortality. conditional on individual characteristics and controlling for a broad array of current and early-life conditions, we find that a 1 percent decrease in the aggregate business cycle in the year of birth is associated with 2.2, 2.3, 3.1, 3.7, 0.9, and 2.1 percent increase in the likelihood of mortality in old ages due to malignant neoplasms, diabetes mellitus, cardiovascular diseases, influenza, chronic respiratory diseases, and all other diseases, respectively. key words: recession, public health, mortality jel classification: i18, i10, h51 introduction the disturbances in the accumulation of health endowments during the early-life period could alter the trajectory of individuals' outcomes later in life. several strands of empirical economic research have documented the mechanisms through which initial health endowments can explain, partly, the variations of short, medium, and long term individual outcomes including infant mortality, toddler mortality, cognitive development, test scores, completed education, employment, earnings, mortality rates during adulthood, and hazards of old-age cause-specific death (for a recent review, refer to costa (2015)). according to the fetal origin hypothesis, a nutritional shock during pregnancy can be compensated by an adjustment in vital organs and generally human system development with the main purpose of embryo's survival (barker, 1990). the lower quality of health endowment of the survived infants provides a channel to later-life outcomes. another possible explanation for this long-term link is that lower quality early-life conditions may posit individuals in inimical life trajectories (yeung et al., 2014). being born in a poor family might leave individuals with adverse health endowments but also could lead to lower education, lower likelihood of employment, and lower earnings. the lower earnings during adulthood could cause lower access to health care and so an increase in mortality. this effect reinforces the negative relationship between early-life conditions and adult * corresponding author, e-mail: hamid.noghanibehambari@ttu.edu 2 economic analysis (2020, vol. 53, no. 2, 1-19) mortality. another channel is families' selection for educational investment in their healthier/unhealthier children. as stated in costa (2015), since the marginal benefit of education rises at higher levels of schooling, householdds tend to sort their healthier children into high human capital development. therefore, healthier children benefit from higher educations and so higher earnings during adulthood. the higher earnings mean higher current nutrition and health-care access and so lower likelihood of mortality. exploring the long-term health effects of early-life conditions can have important policy implications. it could help policymakers identify the most vulnerable groups in the society, design more accurate healthcare policies to increase the health of the society, and decrease the mortality gap among different cohorts and gender-race groups. more importantly, health, as one of the fundamental components of human capital, has been shown to have sizable and statistically significant effects on aggregate output (bloom et al., 2004; fogel, 1994; grimm, 2011). therefore, a well-designed policy could not only lessen inequality but also contribute to long-term economic growth. this paper explores the effect of a negative income shock during the early-life period on old-age adult mortality due to specific causes of death. the main challenge to build a causal relationship is to find an exogenous shock that had an effect on families' income but is not correlated with their characteristics. moreover, such shocks should not directly affect individuals' outcomes later in life. a small branch of the literature uses booms and busts in aggregate output as the exogenous source (den berg et al., 2006, 2011; yeung et al., 2014). following this literature, we use business cycle fluctuations at the year of birth and first year of life as the source of shock to households' income. we use cause-specific mortality data, which covers all death records in the united states. for individuals born between 1910 till 1950, and who died between 1968-2004, we find a sizable, statistically, and economically significant effect of early-life fluctuations in real gross domestic product per capita on the risks of mortality due to different causes of death. a 1 percent reduction in gdp per capita at the year of birth is associated with an increase in the likelihood of death due to malignant neoplasms, diabetes mellitus, cardiovascular diseases, influenza, chronic respiratory diseases, and all other diseases by 2.2, 2.3, 3.1, 3.7, 0.9, and 2.1 percent, respectively. the marginal effects are still significant and in some cases larger using business fluctuations in the first year of childhood. in order to explore the potentially different effects of macroeconomic conditions across cohorts, we split the sample into four cohorts based on their year of birth. each subsample contains at least one severe recession. the negative effect of the recessions has mitigated over time and became even positive for cohorts born between the years 1943-1950. the main reason behind this sign reversion could be the large government anti-poverty policies such as the emergency relief act of 1933, aid to families with dependent children act of 1940, and social security act of 1935. note that this fact is consistent with the literature that mortality in wealthy countries like the us is procyclical (g. miller and urdinola, 2010; ruhm, 2000, 2015). however, these analyses work with datasets that cover the years after the start of these social programs. in the main results, we include dummies to capture the effect of these policies. the negative and statistically significant coefficients confirm the fact that this sign reversion for recent cohorts is, possibly, due to governmental policies to provide a minimum level of welfare (like nutritional sufficiency) for american families. although there is no established causal effect of government policies on later-life health outcomes, the cohort analysis points to a plausible avenue for future research. next, we stratify the sample based on race and gender. in all cases, the negative effects of recessions on cause-specific mortality are confirmed. the gender difference varies across models and depends on race and cause of death. however, comparing the marginal effects of whites and blacks, an income shock during childhood is more effective among whites. higher rates of infant mortality among blacks could partly explain this gap since they let fitter and healthier black individuals survive into adulthood, which shows lower cause-specific mortality later in life. even after controlling for education, occupation, and marital status, this gap prevails. however, all marginal effects are statistically significant at conventional levels. this paper makes a number of contributions to the current literature. first, while there is limited literature that explores the economic conditions early in hamid noghanibehambari, farzaneh noghani, nahid tavassoli 3 life and old-age mortality, no study has investigated this link for us data. more noticeably, no study has investigated early-life conditions and cause-specific death using us data. therefore, the main contribution of this paper to the literature is that it is the first study to fill this gap in the literature. second, it contributes to the literature that explores the latent outcomes of earlylife negative shocks by exploring the different causes of death among cohorts born in different economic circumstances. third, by presenting separate sets of marginal effects for different cohorts, this paper offers a plausible mechanism through which recessions started to be a healthy period in the us, which is the starting point of mass government aids and social security programs. third, using all death records in the us, which provides millions of observations, makes the results of this study more reliable compared to previous studies. the rest of the paper is organized as follows: in section 2, we provide a brief literature review. section 3 describes the core dataset, sample selection strategy, and gives a brief summary statistics of the final dataset. the identification strategy and main results are discussed in section 4. in section 5, we go over some robustness checks and show the heterogeneity of the coefficients in different sub-samples. possible issues and drawbacks of the analysis, some concluding remarks, and suggestions for future research are presented in section 6. a brief literature review recessions could affect the health endowment of individuals through different channels. as the main channel, it affects the wealth and earnings of households. lower earnings could be translated into lower nutritional access or health care affordability. this link between economic status early in life and short and long-term health outcomes is well established in the literature. ferrie and rolf (2011) use longitudinal data which covers the years 1895-2005 and show that us-born male who lived in a low socioeconomic household before age 5 are more likely to die younger, conditional on survivor until age 70, and more likely to die from heart diseases than those individuals who were in high-ses households before age 5. using panel study of income dynamics (psid), hoynes et al. (2016)investigate the long-run impacts of participation in the food stamp program. access to food stamps during early childhood is associated with lower odds of metabolic syndrome and raises the economic self-sufficiency of women in adulthood. the important implication of their paper is the causal effect of a direct policy-driven channel, namely nutrition, during childhood on health outcomes later in life. a small strand of literature uses fasting during the islamic holy month of ramadan as a plausibly exogenous nutritional shock in utero and investigates its impacts later in life. being exposed to ramadan during prenatal development is associated with lower birth weight, reduces the number of male births, increases the likelihood of disability during adulthood (almond and mazumder, 2011), lowers the test scores at age 7 (almond et al., 2014), intensifies the symptoms indicative of coronary heart problems and type 2 diabetes during old ages (van ewijk, 2011), diminishes cognitive and math test scores at school and decreases working hours during adulthood (majid, 2015). based on these studies, we expect that a negative income shock caused by a fall in gdp has adverse health effects on children in utero or in their early years of life by reducing nutritional stock available to households. another possible mechanism through which a recession could influence health outcomes is the reduction in pollution. recession comoves strongly with pollution and pollutant industries including the manufacturing sector (eaton et al., 2016; tavassoli et al., 2020). it is now well established that exposure to pollution during the antenatal development period has adverse health impacts for newborns. isen et al. (2017) use us administrative data to evaluate the long-term effects of the 1970 clean air amendment act. they exploit the variation of differential exposures of counties that were affected by the caaa and find that higher exposure in the year of birth is associated with lower earnings and labor force participation at the age of 30. chay and greenstone (2003) use variation in pollution exposure in us counties caused by 1981-1982 recession to estimate the effects of pollution on infant mortality rates and find that 1 percent reduction in total suspended particulates (tsp) will cause a 0.35 percent 4 economic analysis (2020, vol. 53, no. 2, 1-19) decline in infant mortality. through this channel, a positive relationship is expected between recession and health. following the influential paper of ruhm (2000), this theory was supported by empirical evidence of procyclical fluctuations in total mortality and several cause-specific death (coile et al., 2014; janet currie et al., 2015; mcinerney and mellor, 2012; d. l. miller et al., 2009; ruhm, 2015). in addition, an economic collapse during a severe recession could force mental pressure on pregnant mothers and cause more stressful pregnancies. this pathway, although not widely explored, has been shown to increase the probability of a low birth weight child and reduce the sex ratio (olafsson, 2016). the effect of these shocks could be deteriorated by parental overor under-investment in children. the parental investment could reduce the health endowment gap between their offspring or reinforce this gap if they decide to invest more in their healthier children (janet currie, 2011; frijters et al., 2010, 2013; yi et al., 2015). restrepo (2016) finds evidence that low educated parents allocate more resources to their offspring who had initially normal birth weight compared to their low birth weight children while high-educated mothers compensate this health gap among their children. mortality rates during adulthood and old-age could be partly explained by early-life nutritional and economic conditions. yeung et al. (2014) explore this path and find that an adverse income shock caused by a recession during pregnancy and the first year of life will increase the risks of old-age causespecific mortality. it increases the probability of death due to cancer among males and females by about 8 and 6 percent, respectively. in addition, it increases female mortality due to cardiovascular diseases by roughly 5 percent. den berg et al. (2006) use a longitudinal dataset covering the years 1812-2000 for individuals born in the period 1812-1912 in netherlands and document that household economic conditions early in life can explain adult mortality rates. they exploit booms and busts during childhood as an instrument for individual economic conditions. applying a hazard analysis, they find that being exposed to a boom early in life is associated with a 9 percent reduction in adult mortality rates. using the same instrument, van den berg et al. (2011) show that being born under a recession increases the probability of cardiovascular mortality later in life. den berg and gupta (2015) introduce a causal pathway for this effect. they show that marital status, as a determinant of adult mortality, is itself affected by economic conditions early in life. among women, longevity is reduced upon marriage in case they are born under adverse economic conditions. however, marriage has a protective effect for men. married men enjoy longevity and the marital status does not depend on economic conditions in early-life. on the other hand, male mortality rates comove, negatively, with business fluctuations in their early childhood. other relevant papers confirm the influence of economic conditions during early-life and later outcomes including health, mortality rates, and old-age cause-specific mortality rates (banerjee et al., 2010; case et al., 2005; d. m. cutler et al., 2007; flores and kalwij, 2014; frijters et al., 2010; myrskylä, 2010a, 2010b; myrskylä et al., 2013; noghanibehambari et al., 2020; rao, 2016; strand and kunst, 2006). data and sample selection strategy the main source of data is the multiple cause of death data files from us vital statistics. since there are multiple interactions between early-life circumstances and individuals' state of birth, we restrict the sample to the years 1979-2004, which contain the information on the state of birth. all individuals who were not born in the us excluding its territories are eliminated. the main filter for the final dataset is to choose a time-window for individuals' year of birth. going further back in time has the advantage of larger sample sizes and including more cohorts. the problem is the selection bias due to earlier mortality rates. for instance, cohorts born between 1900-1910 who died between the years 1979-2004 have a minimum and maximum age range of 69 and 104. old-age death due to different causes could have started earlier during their 50s or 60s. thus, the estimations will probably suffer from sample selection. to alleviate this problem, we let the maximum age at the beginning of the observation-window to be 69. this means that the year of birth is restricted to be above 1910. moreover, since the focus of this study is old-age hamid noghanibehambari, farzaneh noghani, nahid tavassoli 5 mortality, individuals below age 55 are excluded. therefore, all death records in the final dataset have occurred to persons who were born between 1910-1950, a period with several severe recessions and significant booms in the us economy. ultimately, in order to overcome the processing power limitation due to the large sample size, we use a 20 percent random sample withdrawn from the final dataset in all analyses. since the sample size still contains millions of observations, we expect to see similar results. indeed, when we use a 1 percent, 5 percent, and even 30 percent random sample, the marginal effects and their standard errors are quite similar to the current level of random sampling. we do not restrict this random sampling to be from a specific subpopulation or overor under-representing some subsamples. the random sample is drawn from the full sample. this random sampling has been done in the previous literature (j. currie and moretti, 2003). table 1 depicts a cross-tabulation of causes of death records by year of birth by gender. cardiovascular diseases are the main causes of death for both genders and malignant neoplasm diseases are the second. in most cells, male death rates are higher than that of females. historical estimates of us gdp per capita are extracted from jordà et al. (2017). the increasing trend in gdp per capita during 20th century comoves with other social and noneconomic outcomes like provision of public health, health care availability, progress in sewage systems, water cleaning, persistent increase in the number of schools and universities, and more noticeably improvements in governmental welfare policies. these secular trends make the use of gdp per capita as the instrument of economic conditions inappropriate. therefore, following yeung et al. (2014), we decompose the time series into a time trend and a cyclical component using the hodrick-prescott (hp) filter with a smoothing parameter of 200 (hodrick and prescott, 1997). figure 3 illustrates the trend and fluctuations for real gdp per capita between the years 1910-1950. starting around 1914, there are several recessions during this period (including the big recession) and several considerable boom periods (including world war ii years). note that a positive deviation from the trend refers to a boom in the economy and a downturn from the trend points to a recession. figure 4 shows a descriptive effect of being born during a recession (boom) on the average age of death from cardiovascular diseases. visually, except for individuals who died in their late 70s, being born during a recession increases the rates of death from cardiovascular diseases at each given age. one possible drawback in assessing the latent effects is the selection of most fit individuals to reach maturity. fetal deaths and infant mortality in periods of hardship can let stronger newborns survive. this fact causes the real effects of early-life conditions on adult outcomes to be underestimated. to alleviate this issue we use two other variables that can partly control for secular trends in the health of infants and other macro conditions. first, we use historical average grain prices interacted with state of birth. using historical meat prices reveals very similar estimates. this dataset is extracted from jacks (2013) which covers real prices (1900=100) of barley, corn, rice, rye, wheat, beef, hides, lamb, and pork among other commodities in the years 1850-2017. to proxy for the health environment during childhood, we use childhood mortality rates at the year of birth. the time series of childhood mortality rates for children 1-4 years old (interacted with state of birth in all specifications) are extracted from the national centre for health statistics. table 2 provides summary statistics of the final dataset. only over a few years, vital statistics asked about education and occupation. over the years 1989-1999, information on both variables is available. this table covers the selected years in order to provide information on education, too. for all causes of death, the median age at death is higher if individuals are born during a boom compared to those born during a bust. born during either a recession or a boom, females occupy a lower portion of each cause-specific death. as expected, log average grain prices are lower during busts and higher during booms. additional variables during this period, the main inflection point in american households' welfare, especially during recessions, was the start of a series of government social welfare programs. we define 6 economic analysis (2020, vol. 53, no. 2, 1-19) three indicators to account for the three most important of these acts: emergency relief act commencement (1933), aid to families with dependent children (afdc) that was enacted in 1940, and social security act (1935). moreover, we include in all formulations a dummy to control for the 1918 influenza pandemic which has been shown to have large health impacts among other outcomes during adulthood and old age (almond, 2006; almond and mazumder, 2005). dustbowl in the great plains during the 1930s was another possible channel to affect health since it damaged topsoils and agricultural products in certain ecological places. we include dummies to capture this phenomenon for states (states of birth) that were mostly affected: texas, new mexico, oklahoma, kansas, and colorado. in addition, we use 5-year dummies to account for all other secular trends in health improvements and other macro influences that changed over time but affected all individuals uniformly. methodology we take two approaches to reveal the causal relationship between early-life conditions and cause-specific mortality: nonparametric analysis in which we draw kaplan-meier survival curves to explore an illustrative relationship, and parametric analysis in which we apply extended cox model for hazard analysis. two periods in early-life are the main interest in this study: year of birth and first year of life. vital statistics does not ask about the month of birth. therefore, year of birth could attribute only to the period in utero or only the first year of life or both. this fact should be considered while interpreting the coefficients of the year of birth (yob) as the variable of interest. hence, (yob+1) refers to either the first or second year of life. however, we report all coefficients separately in all specifications. non‐parametric analysis figure 1 and figure 2 depict the kaplan-meier survival curves for different causes of death in different stages of life for cohorts born during an expansion versus cohorts born during a recession. the sample is stratified based on gender. it is well established that there is a gender difference in mortality and cause-specific mortality. figure 1 shows the survival curves of males and figure 2 depicts that of females. we selected two subsequent periods of expansion and recession during 1912-1913 (boom) and 1914-1915 (bust period) for three reasons. first, there are no government interventions during this period to deteriorate the income shock to households. second, neither the boom nor the bust is as severe as other recessions in the years 1910-1950. obtaining the latent effects of early-life conditions during a mild boom-bust period suggests similar results for more severe business fluctuations. third, public health improvements increased over time and so act at the benefit of later cohorts who were born during recessions. this will cause an underestimation of true effects if we compare two subsequent cohorts born during expansion-recession while leads to an overestimate if we compare cohorts born during succeeding recession-expansion periods. the latent effects of born in a recession are more informative at older ages. for any level of mortality rate, being born in an expansion is associated with higher age at death. cohorts who were born during a recession are more probable to die younger considering each cause of death. referring to the upper left panel of figure 1 and figure 2, the differential effect begins at age 70 for deaths due to malignant neoplasm diseases. there is no obvious difference between the start of this divergence among males and females. the middle left panel of both figures shows the survival curves for death due to cardiovascular diseases. the survival of both cohorts starts to diverge considerably around age 80, for both males and females. this fact reveals that, at least descriptively, the effects of adverse conditions in childhood can remain passive until much older ages. hamid noghanibehambari, farzaneh noghani, nahid tavassoli 7 parametric analysis following the literature (myrskylä et al., 2013; strand and kunst, 2006; yeung et al., 2014), we assume that conditional on individual characteristics the causes of death are independent from each other. we apply extended cox model which allows for time dependent variables (therneau and grambsch, 2013). a simple cox model can be written in the following form: h t, x t h0 t e ∑ (1) where t is the survival time, h is a hazard function, x represents covariates, and h_0 is the baseline hazard. the main results are presented in table 3. each column represents a separate regression. individual characteristics include age dummies, fixed effects for the current state of residence, gender, and race. however, the literature has documented a differential path for mortality among different races and genders. including a dummy for the race in these models will shift the survival trajectory vertically. however, stratifying the data will allow each stratum to form its own trajectory, which provides flexibility in survival paths and increases the precision of the estimates. therefore, instead of adding a set of dummies for the state of birth, state of death, race, and gender as control variables, we stratify the model by these variables. other control variables are explained in section 3.1. as shown in the first column of each panel in table 3, a 1 percent reduction in the cyclical component of gdp per capita during the year of birth is associated with 3.2, 2.8, 2.6, 1.9, and 3.7 percent increase in the likelihood of mortality due to malignant neoplasm diseases, diabetes mellitus, cardiovascular diseases, influenza and pneumonia diseases, and chronic respiratory diseases, respectively. the effects are larger for exposure to business fluctuation in the first year of life. next, to account for the secular increase in health conditions during childhood, we add an interaction of state of birth with rates of childhood mortality. to account for other macro conditions, we add the log of average grain prices interacted with the state of birth. the results are reported in table 4. the magnitude of the estimates falls but remains significant at 1 percent level. in the next stage, we add education, marital status, and a set of dummies for occupation. due to data limitations explained in section 3, the observations fall in the years 1989-1999 only. the results of full specification models for different causes of death are reported in table 5. a 1 percent decrease in the cyclical component of real gdp per capita during the year of birth is associated with 2.2, 2.3, 3.1, 3.7, and 0.9 percent rise in the probability of death due to malignant neoplasm diseases, diabetes mellitus, cardiovascular diseases, influenza and pneumonia diseases, and chronic respiratory diseases, respectively. the estimates are quite similar to the results of table 4 which implies that education and type of occupation do not mitigate the latent effects of adverse conditions in the early-life. the marginal effects of the first year in life are larger than coefficients of the year at birth for most causes of death in all three tables. among the causes that we explore here, cardiovascular diseases and chronic respiratory diseases are among the main mortality causes that are linked to adverse conditions during pregnancy and early years of life. for example, lawlor et al. (2006) investigate the socioeconomic conditions during childhood and causespecific death at older ages in sweden and find a positive association between economic conditions early in life and higher risks of death due to respiratory diseases. using data of the netherlands, yeung et al. (2014) find a positive association between economic conditions early in life and hazard of death due to respiratory and cardiovascular diseases. 8 economic analysis (2020, vol. 53, no. 2, 1-19) robustness checks race‐gender decomposition there is evidence on racial and gender gap in mortality (montez et al., 2011; satcher et al., 2005). if cause-specific mortality can be partly explained by childhood conditions then the racial and gender gap could provide different pathways from childhood condition into adult mortality and morbidity. to check for this differential effect, we split the sample into four groups: white males, white females, black males, and black females. the full specification models of the group decomposition are reported in table 6 through table 8 for different causes of death, separately. the gender difference depends on race and cause of death. childhood conditions are more effective on while males rather than white females for death due to malignant neoplasm diseases while for diabetes mellitus the impacts are more pronounced for females. black females are less affected by childhood conditions based on death due to chronic respiratory diseases compared to black males while in other causes of death their respective coefficients are larger. in general, cause-specific deaths in white people are more influenced by their childhood conditions compared to their black counterparts. the latter findings could be partly explained by higher fetal death and infant mortality among black people (elder et al., 2016). during hardships, infant mortality and fetal death increase among blacks more than whites. therefore, those black newborns who survive their infancy are the fittest and healthiest and have higher initial endowments. this higher level of initial health increases their life expectancy and reduces the mortality rates at older ages. thus, the lower coefficients are only a reflection of initial selection rather than the lower susceptibility of blacks to income shocks. cohort decomposition secular improvements in the health environment, changes in the provision of public health, the introduction of new vaccines, eradicating many formerly deadly diseases, and more noticeably the change in governmental policies to neutralize the adverse economic shocks lead to substantial variations in cohorts' health quality (costa, 2015; d. cutler and miller, 2005; noghanibehambari et al., 2020; noghanibehambari et al., 2020; noghanibehambari and salari, 2020). to account for this possible heterogeneity, we apply the baseline model separately for different cohorts. the results are depicted in table 9 through table 11 for six causes of death and four cohorts. two criteria are used to make cohort boundaries. first, a range should have at least one major recession and one major boom so that the model can compare different cohorts within our cohort-groups. second, it should reflect, partly, the medical time-line in the first half of 20th century. considering these facts, four cohorts based on year of birth are defined, as follows: 1910-1918, 1919-1928, 1929-1942, and 1943-1950. as shown in table 9, a 1 percent reduction in aggregate business fluctuation is associated with 1.5 and 0.8 percent increase in the likelihood of death due to malignant neoplasm and cardiovascular diseases for cohorts born between the years 1910-1918. surprisingly, the marginal effects increase to approximately 15 percent for cohorts born in 1919-1928. the signs reverse for cohorts born in the period 1943150 which implies that recessions are good for the health of newborns and reduces the probability of cause-specific mortality in old ages. this fact is confirmed for other causes of death shown in table 10 and table 11. for chronic respiratory diseases, the positive effect of recessions starts at the cohorts born in 1929-1942. this finding is consistent with the literature that recessions could improve the health of newborns (chay and greenstone, 2003; miller et al., 2009; page et al., 2017; tapia granados and ionides, 2017). however, these studies use the most recent data for the us and more specifically in the second half of the 20th century. in a similar analysis, cutler et al. (2007) use the dust bowl in great plains during the 1930s as the exogenous shock to income in utero and investigates its effects later in life. it finds no evidence on such effects on chronic diseases, disability, and infant mortality. one possible explanation for hamid noghanibehambari, farzaneh noghani, nahid tavassoli 9 these findings is the effectiveness of welfare programs. recall that a series of government policies started during the 1930s. these policies, like the social security act, could have provided pregnant mothers with sufficient nutrition. meanwhile, a recession could lower pollution and supply a cleaner environment. as suggested by ruhm (2000), recessions could lower obesity, increase physical activity, and decrease habits like smoking and drinking. therefore, an effective welfare program can offset the effect of recession by extending the access of households to nutritional resources that is the main channel through which adverse economic conditions can affect health. thus, the positive effects dominate the negative ones. discussion and conclusion the long term relationship between early-life economic conditions and old-age cause-specific mortality has been investigated in several studies using european data (bhalotra et al., 2017; den berg et al., 2006, 2011; yeung et al., 2014). virtually no study explored this topic using us data mostly due to lack of historical longitudinal data (costa, 2015; ferrie and rolf, 2011). this paper attempted to investigate this question using all death records in us vital statistics. it uses the fluctuations in the business cycle at birth as the instrument for economic conditions during infancy and finds that being born during a recession has a significant and substantive effect on the probability of cause-specific mortality. this negative relationship is stronger for older cohorts. in the nonparametric analysis, we showed that the effects on death due to cardiovascular diseases remain latent roughly until age 80. in a full specification of cox models, we find that 1 percent decrease in the cyclical component of gdp per capita is associated with 2.2, 2.3, 3.1, 3.7, 0.9, and 2.1 percent increase in the likelihood of mortality in old ages due to malignant neoplasms, diabetes mellitus, cardiovascular, influenza, chronic respiratory diseases, and all other diseases. cohorts born during a recession in earlier periods, e.g. 1910-1930, are more prone to be affected by the economic conditions early in life while the sign of the marginal effects reverses for recent cohorts, e.g. 1940-1950. this cohort analysis suggests that government welfare programs could neutralize the effect of income shock by granting american families a minimum level of nutritional requirements. this could let other positive effects of recessions to dominate the negative effect of an income shock (d. l. miller et al., 2009). this study has some drawbacks resolving which could point to future research avenues. first, the path from childhood economic conditions to old-age mortality passes through some mediatory channels. although we tried to proxy contemporaneous socioeconomic status by education, marital status, and occupation, no data is available to control for earnings, retirement age, years of labor force participation, wealth, insurance, and access to health care. all these variables can explain a significant portion of variation in mortality (gerdtham and johannesson, 2004). second, income shocks can adversely affect health during early-life in several ways including lack of sufficient nutrition, stressful pregnancies, lowering access to health care, and decreasing prenatal visits. disentangling the different mechanisms requires a different strategy. third, assuming that the main channel is nutritional deficiency, not all households are affected by a recession to the same extent. more educated mothers with higher socioeconomic status are less affected compared to families with lower socioeconomic status. this heterogeneity among individuals from different families is not captured in the current study. fourth, male embryos are more susceptible to external stressors and so during times of hardships sex ratio decreases. this will also lead to higher fetal death for males. thus, those male newborns that are born during harsh periods have been fitter, stronger, and healthier in the first place. hence, male cohorts born during a recession could be, on average, healthier than their female counterparts and possibly healthier than males born during a proceeding expansion. this fact will attenuate the estimation of the impact of childhood conditions on old-age cause-specific mortality 10 economic analysis (2020, vol. 53, no. 2, 1-19) references almond, d. 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(2015). early health shocks, intra-household resource allocation and child outcomes. the economic journal, 125(588), f347--f371. h am id n o gh an ib eh am b ar i, f ar za n eh n og h an i, n ah id t av as so li 1 3 t a b l e s t a b le 1 . t ab u la ti o n o f c au se s o f d ea th b y y ea r o f b ir th a n d g en d er y e a r o f b ir th : 1 9 1 0 ‐1 9 2 0 y e a r o f b ir th : 1 9 2 0 ‐1 9 3 0 y e a r o f b ir th : 1 9 3 0 ‐1 9 4 0 y e a r o f b ir th : 1 9 4 0 ‐1 9 5 0 m a le f e m a le t o ta l m a le f e m a le t o ta l m a le f e m a le t o ta l m a le f e m a le t o ta l m al ig n an t n eo p la sm 2 6 .2 2 4 .1 2 5 .2 3 1 .4 3 4 .5 3 2 .8 3 4 .1 4 2 .2 3 7 .5 3 0 .6 4 4 .7 3 6 .2 d ia b et es m el li tu s 2 .0 3 .0 2 .5 2 .5 3 .6 3 .0 2 .9 3 .9 3 .3 3 .3 3 .8 3 .5 c ar d io va sc u la r d is ea se 4 9 .5 4 8 .1 4 8 .8 4 4 .1 3 7 .4 4 1 .2 4 0 .5 2 9 .9 3 6 .1 3 6 .8 2 4 .9 3 2 .1 in fl u en za a n d p n eu m o n ia 2 .5 2 .2 2 .4 1 .6 1 .3 1 .5 1 .2 1 .1 1 .2 1 .3 1 .2 1 .3 c h ro n ic l o w er r es p ir at o ry 4 .4 3 .2 3 .8 3 .3 3 .3 3 .3 2 .0 2 .5 2 .2 0 .9 1 .4 1 .1 a ll o th er d is ea se s 1 5 .4 1 9 .3 1 7 .3 1 7 .1 1 9 .9 1 8 .3 1 9 .2 2 0 .3 1 9 .7 2 7 .1 2 3 .9 2 5 .9 t o ta l 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 (4 ,3 9 9 ,0 3 9 ) (4 ,0 7 8 ,2 4 1 ) (8 ,4 7 7 ,2 8 0 ) (3 ,4 7 4 ,8 1 0 ) (2 ,6 5 3 ,6 0 6 ) (6 ,1 2 8 ,4 1 6 ) (1 ,6 7 4 ,6 6 7 ) (1 ,1 6 5 ,3 8 4 ) (2 ,8 4 0 ,0 5 1 ) (9 0 4 ,7 0 4 ) (5 9 6 ,5 5 4 ) (1 ,5 0 1 ,2 5 8 ) n u m b er o f c as es 7 ,4 7 7 ,2 8 0 6 ,1 2 8 ,4 1 6 2 ,8 4 0 ,0 5 1 1 ,5 0 1 ,2 5 8 n ot es . d at a a re e xt ra ct ed fr om v it al s ta ti st ic s d at a fi le s. 5 0 % r an do m s am pl e is u se d. t a b le 2 . s am p le c h ar ac te ri st ic s b y c au se o f d ea th b y r ec es si o n i n d ic at o r at y ea r o f b ir th m a li gn a n t n e o p la sm d ia b e te s m e ll it u s c a rd io v a sc u la r in fl u e n za a n d p n e u m o n ia c h ro n ic r e sp ir a to ry a ll o th e r d is e a se s b o o m b u st b o o m b u st b o o m b u st b o o m b u st b o o m b u st b o o m b u st m ed ia n a ge a t d ea th 7 0 .3 7 6 7 .7 7 7 1 .6 5 6 9 .3 1 7 3 .3 3 7 1 .5 0 7 5 .6 0 7 4 .2 6 7 3 .3 3 7 2 .3 3 7 2 .6 0 6 9 .3 8 % (8 .8 7 9 ) (1 0 .6 2 ) (8 .8 7 7 ) (1 0 .6 7 ) (8 .8 5 1 ) (1 0 .6 2 ) (8 .3 7 7 ) (1 0 .1 9 ) (7 .5 9 9 ) (9 .1 4 1 ) (1 0 .2 5 ) (1 2 .5 4 ) e d u : h ig h s ch o o l 4 9 .4 1 4 9 .5 7 4 8 .5 6 4 9 .2 8 4 7 .9 0 4 8 .0 9 4 6 .1 6 4 6 .3 7 5 0 .5 4 5 0 .8 6 4 7 .6 5 4 7 .5 5 % (5 0 .0 0 ) (5 0 .0 0 ) (4 9 .9 8 ) (5 0 .0 0 ) (4 9 .9 6 ) (4 9 .9 6 ) (4 9 .8 5 ) (4 9 .8 7 ) (5 0 .0 0 ) (4 9 .9 9 ) (4 9 .9 4 ) (4 9 .9 4 ) e d u : < h ig h s ch o o l 1 6 .4 8 1 5 .3 6 2 3 .1 8 2 1 .8 0 2 0 .4 9 1 9 .5 7 2 2 .1 9 2 1 .7 1 2 0 .5 2 2 0 .1 1 1 9 .1 1 1 7 .7 3 % (3 7 .1 0 ) (3 6 .0 6 ) (4 2 .2 0 ) (4 1 .2 9 ) (4 0 .3 6 ) (3 9 .6 7 ) (4 1 .5 5 ) (4 1 .2 3 ) (4 0 .3 8 ) (4 0 .0 8 ) (3 9 .3 2 ) (3 8 .2 0 ) m ar ri ed 5 7 .5 4 5 8 .5 7 4 7 .8 3 4 9 .0 0 4 9 .1 9 4 9 .9 2 4 2 .0 6 4 1 .6 4 4 6 .3 3 4 6 .0 2 4 5 .3 0 4 4 .5 6 % (4 9 .4 3 ) (4 9 .2 6 ) (4 9 .9 5 ) (4 9 .9 9 ) (4 9 .9 9 ) (5 0 .0 0 ) (4 9 .3 7 ) (4 9 .3 0 ) (4 9 .8 7 ) (4 9 .8 4 ) (4 9 .8 7 ) (4 9 .7 0 ) w h it e 8 7 .6 8 8 7 .5 2 8 0 .0 0 7 9 .0 0 8 6 .8 3 8 5 .7 9 8 7 .6 8 8 6 .6 2 9 2 .9 3 9 2 .2 4 8 6 .7 0 8 4 .6 5 % (3 2 .8 7 ) (3 4 .1 5 ) (4 0 .0 0 ) (4 0 .7 3 ) (3 3 .8 2 ) (3 4 .9 1 ) (3 2 .8 6 ) (3 4 .0 5 ) (2 5 .6 4 ) (2 6 .7 5 ) (3 3 .9 6 ) (3 6 .0 5 ) f em al e 4 5 .8 1 4 6 .3 1 5 4 .3 2 5 2 .8 8 4 5 .5 0 4 4 .2 5 4 6 .8 1 4 6 .5 1 4 5 .8 3 4 6 .4 9 4 8 .6 7 4 6 .3 2 % (4 9 .8 2 ) (4 9 .8 6 ) (4 9 .8 1 ) (4 9 .9 2 ) (4 9 .8 0 ) (4 9 .6 7 ) (4 9 .9 0 ) (4 9 .8 8 ) (4 9 .8 3 ) (4 9 .8 8 ) (4 9 .9 8 ) (4 9 .8 6 ) c h il d m o rt al it y 8 1 .7 1 7 0 .1 6 8 4 .8 5 7 3 .7 7 9 1 .3 0 8 1 .6 4 9 8 .1 1 8 9 .9 9 9 0 .6 8 8 2 .5 6 8 6 .7 5 7 3 .9 8 (3 4 .0 5 ) (3 2 .3 7 ) (3 4 .1 1 ) (3 2 .9 4 ) (3 3 .4 4 ) (3 3 .5 7 ) (3 1 .4 5 ) (3 2 .8 8 ) (3 2 .0 8 ) (2 9 .9 2 ) (3 5 .8 4 ) (3 6 .4 3 ) l o g( a vg g ra in p ri ce ) 0 .0 5 6 7 -0 .0 5 0 6 0 .0 5 7 5 -0 .0 4 3 9 0 .0 5 9 1 -0 .0 2 6 7 0 .0 6 0 2 -0 .0 0 6 2 5 0 .0 6 2 9 -0 .0 4 0 9 0 .0 5 8 5 -0 .0 1 6 3 (0 .1 2 9 ) (0 .2 7 4 ) (0 .1 3 0 ) (0 .2 6 9 ) (0 .1 2 9 ) (0 .2 5 9 ) (0 .1 2 9 ) (0 .2 4 4 ) (0 .1 3 2 ) (0 .2 6 7 ) (0 .1 2 8 ) (0 .2 6 3 ) c as es 1 ,2 8 5 ,1 7 5 1 ,1 4 3 ,7 1 0 1 2 9 ,0 5 0 1 1 3 ,7 7 1 1 ,8 0 8 ,7 9 2 1 ,5 5 1 ,9 7 4 1 2 3 ,8 4 8 1 0 4 ,3 5 6 2 4 7 ,9 4 7 2 0 0 ,4 4 9 5 9 3 ,0 1 6 5 4 5 ,4 4 2 1 4 e co n o m ic a n al ys is ( 2 0 2 0 , v o l. 5 3 , n o . 2 , 1 -1 9 ) t a b le 3 . r eg re ss io n a n al ys is fo r th e e ff ec ts o f e ar ly -l if e r ec es si o n o n a d u lt s’ c au se -s p ec if ic m o rt al it y w it h o u t in d iv id u al c o n tr o ls a n d in te ra ct io n s m a li gn a n t n e o p la sm d ia b e te s m el li tu s c a rd io v a sc u la r in fl u e n za a n d p n eu m o n ia c h ro n ic r es p ir a to ry a ll o th er d is e as es h az ar d : (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , -3 .1 5 8 ** * -2 .8 3 5 ** * -2 .5 8 6 ** * -1 .9 4 1 ** * -3 .7 2 2 ** * -2 .4 6 5 ** * y ea r of b ir th (0 .0 1 3 ) (0 .0 4 2 ) (0 .0 0 9 ) (0 .0 4 0 ) (0 .0 3 3 ) (0 .0 1 5 ) b u si n es s c yc le , -3 .4 9 3 ** * -3 .2 5 8 ** * -2 .6 0 7 ** * -1 .9 1 0 ** * -3 .7 2 6 ** * -3 .1 0 1 ** * y ea r of b ir th + 1 (0 .0 1 6 ) (0 .0 5 3 ) (0 .0 1 1 ) (0 .0 5 0 ) (0 .0 3 9 ) (0 .0 1 9 ) a ge d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es d ec ad e d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es d u st b o w l p er io d ( t x , n m , o k , k s, c o ) y es y es y es y es y es y es y es y es y es y es y es y es 1 9 1 8 s p an is h f lu y es y es y es y es y es y es y es y es y es y es y es y es so ci al s ec u ri ty a ct s ta rt s y es y es y es y es y es y es y es y es y es y es y es y es e m er ge n cy r el ie f a ct s ta rt s y es y es y es y es y es y es y es y es y es y es y es y es a f d c a ct s ta rt s y es y es y es y es y es y es y es y es y es y es y es y es w o rl d w ar i i p er io d y es y es y es y es y es y es y es y es y es y es y es y es c as es 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 n ot es . s tr a ti fi ed b y se x, s ta te o f de a th , a n d ra ce . s ta n da rd e rr or s ar e cl u st er ed a t st at e of b ir th . d at a sp an s th e ye ar s 1 96 8 ‐2 00 4. 2 0 p er ce n t ra n d om s am p le i s u se d . ( * p< 0. 1 , * * p< 0 .0 5 , * ** p < 0. 01 ) t a b le 4 . r eg re ss io n a n al ys is fo r th e e ff ec ts o f e ar ly -l if e r ec es si o n o n a d u lt s’ c au se -s p ec if ic m o rt al it y w it h o u t in d iv id u al c o n tr o ls m a li gn a n t n e o p la sm d ia b e te s m e ll it u s c a rd io v a sc u la r in fl u e n za a n d p n e u m o n ia c h ro n ic r e sp ir a to ry a ll o th e r d is e a se s h az ar d : (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -2 .4 5 1 ** * (0 .0 5 4 ) -2 .5 6 8 ** * (0 .1 0 3 ) -3 .5 5 3 ** * (0 .0 6 9 ) -4 .0 9 6 ** * (0 .1 0 7 ) -0 .5 4 1 ** * (0 .0 4 4 ) -2 .3 5 4 ** * (0 .0 7 7 ) b u si n es s c yc le , y ea r o f b ir th + 1 -4 .3 3 9 ** * (0 .0 5 5 ) -4 .3 0 9 ** * (0 .0 9 3 ) -4 .5 3 1 ** * (0 .0 8 1 ) -4 .2 1 2 ** * (0 .1 0 5 ) -4 .5 6 2 ** * (0 .0 5 9 ) -4 .0 7 9 ** * (0 .0 6 4 ) in d iv id u al a ge a n d m ar it al s ta tu s d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es p o li cy , i n ci d en t, a n d d ec ad e d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es g ra in p ri ce s b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c h il d m o rt al it y b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c as es 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 n ot es . s tr a ti fi ed b y se x, s ta te o f de a th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st at e of b ir th . p ol ic y va ri ab le s in cl u d e: e m er ge n cy r el ie f a ct o f 19 33 , a fd c a ct o f 19 4 0, s oc ia l se cu ri ty a ct o f 19 35 i n ci de n t d u m m ie s in cl u d e: w or ld w ar i i p er io d , 1 91 8 sp an is h f lu , a n d d u st b ow l p er io d fo r st a te s t x , n m , o k , k s, c o d at a s p an s th e ye a rs 1 97 9 ‐ 20 0 4. 2 0 pe rc en t ra n do m s a m pl e is u se d. ( * p <0 .1 , * * p< 0 .0 5 , * ** p <0 .0 1 ) h am id n o gh an ib eh am b ar i, f ar za n eh n og h an i, n ah id t av as so li 1 5 t a b le 5 . r eg re ss io n a n al ys is fo r th e e ff ec ts o f e ar ly -l if e r ec es si o n o n a d u lt s’ c au se -s p ec if ic m o rt al it y, f u ll s p ec if ic at io n m a li gn a n t n e o p la sm d ia b e te s m e ll it u s c a rd io v a sc u la r in fl u e n za a n d p n e u m o n ia c h ro n ic r e sp ir a to ry a ll o th e r d is e a se s h az ar d : (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -2 .1 6 5 ** * (0 .0 4 6 ) -2 .3 4 6 ** * (0 .0 8 6 ) -3 .0 8 6 ** * (0 .0 5 9 ) -3 .7 0 1 ** * (0 .0 8 9 ) -0 .9 1 2 ** * (0 .0 6 8 ) -2 .0 8 2 ** * (0 .0 7 7 ) b u si n es s c yc le , y ea r o f b ir th + 1 -2 .8 3 4 ** * (0 .0 5 6 ) -2 .8 0 8 ** * (0 .1 2 4 ) -2 .4 9 6 ** * (0 .0 4 2 ) -2 .2 5 9 ** * (0 .0 9 1 ) -3 .3 0 8 ** * (0 .0 8 1 ) -2 .3 3 8 ** * (0 .0 5 9 ) in d iv id u al d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es p o li cy , i n ci d en t, a n d d ec ad e d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es g ra in p ri ce s b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c h il d m o rt al it y b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c as es 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 9 18 s p an is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) t a b le 6 . h et er o ge n ei ty b y d if fe re n t g en d er -r ac e g ro u p s fo r m al ig n an t n eo p la sm s an d c ar d io va sc u la r d is ea se s m a li gn a n t n e o p la sm c a rd io v a sc u la r g ro u p s b as ed o n : w h it e m al e w h it e f em al e b la ck m al e b la ck f em al e w h it e m al e w h it e f em al e b la ck m al e b la ck f em al e g en d er -r ac e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , -2 .9 7 3 ** * -2 .6 7 8 ** * -2 .3 4 4 ** * -2 .0 1 0 ** * -3 .1 6 0 ** * -3 .1 0 9 ** * -2 .1 5 6 ** * -2 .6 5 9 ** * y ea r of b ir th (0 .0 6 4 ) (0 .0 7 3 ) (0 .1 0 9 ) (0 .1 4 9 ) (0 .0 6 5 ) (0 .0 6 8 ) (0 .1 0 2 ) (0 .1 2 6 ) c as es 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 9 18 s p an is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) 1 6 e co n o m ic a n al ys is ( 2 0 2 0 , v o l. 5 3 , n o . 2 , 1 -1 9 ) t a b le 7 . h et er o ge n ei ty b y d if fe re n t g en d er -r ac e g ro u p s fo r d ia b et es m el li tu s an d i n fl u en za p n eu m o n ia d ia b e te s m e ll it u s in fl u e n za p n e u m o n ia g ro u p s b as ed o n w h it e m a le w h it e f e m a le b la ck m a le b la ck f e m a le w h it e m a le w h it e f e m a le b la ck m a le b la ck f e m a le g en d er -r ac e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -2 .7 7 2 ** * (0 .1 5 8 ) -3 .2 1 5 ** * (0 .1 4 7 ) -1 .7 4 1 ** * (0 .2 6 0 ) -2 .2 1 4 ** * (0 .2 4 4 ) -3 .2 9 7 ** * (0 .1 4 8 ) -2 .7 2 6 ** * (0 .1 2 5 ) -1 .9 9 7 ** * (0 .3 3 2 ) -2 .3 8 0 ** * (0 .2 4 8 ) c as es 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 91 8 s pa n is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) t a b le 8 . h et er o ge n ei ty b y d if fe re n t g en d er -r ac e g ro u p s fo r c h ro n ic r es p ir at o ry a n d a ll o th er d is ea se s c h ro n ic r e sp ir a to ry d is e a se s a ll o th e r d is e a se s g ro u p s b as ed o n : w h it e m a le w h it e f e m a le b la ck m a le b la ck f e m a le w h it e m a le w h it e f e m a le b la ck m a le b la ck f em a le g en d er -r ac e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -3 .9 9 9 ** * (0 .0 7 6 ) -3 .7 3 2 ** * (0 .0 9 2 ) -3 .2 0 6 ** * (0 .3 0 2 ) -1 .9 1 2 ** * (0 .3 1 2 ) -1 .9 0 8 ** * (0 .1 1 3 ) -2 .3 3 6 ** * (0 .0 8 2 ) -0 .7 2 6 ** * (0 .1 8 4 ) -1 .3 3 6 ** * (0 .1 3 5 ) c as es 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 9 18 s p an is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) t a b le 9 . h et er o ge n ei ty b y c o h o rt s fo r m al ig n an t n eo p la sm s an d c ar d io va sc u la r d is ea se s m a li gn a n t n e o p la sm c a rd io v a sc u la r h az ar d : 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , -1 .5 5 3 ** * -1 5 .1 3 6 ** * -1 .5 3 0 ** * 5 .3 0 2 ** * -0 .8 4 1 ** * -1 5 .3 2 2 ** * -1 .3 6 3 ** * 5 .4 4 5 ** * y ea r of b ir th (0 .0 9 3 ) (0 .0 3 8 ) (0 .0 4 0 ) (0 .0 2 6 ) (0 .0 9 2 ) (0 .0 3 7 ) (0 .0 4 4 ) (0 .0 2 7 ) c as es 2 ,6 6 7 ,6 0 0 2 ,3 8 0 ,6 7 6 1 ,5 0 9 ,6 1 3 4 3 7 ,4 6 2 2 ,6 6 7 ,6 0 0 2 ,3 8 0 ,6 7 6 1 ,5 0 9 ,6 1 3 4 3 7 ,4 6 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st a te o f bi rt h . i nd iv id u a l c h ar ac te ri st ic s ar e re st ri ct ed t o ag e an d m a ri ta l s ta tu s du m m ie s. d a ta s pa n s th e ye a rs 1 9 79 ‐2 0 04 . 2 0 p er ce n t ra n do m s am pl e is u se d . ( * p< 0 .1 , * * p< 0. 05 , * ** p < 0. 0 1 ) h am id n o gh an ib eh am b ar i, f ar za n eh n og h an i, n ah id t av as so li 1 7 t a b le 1 0 . h et er o ge n ei ty b y c o h o rt s fo r d ia b et es m el li tu s an d i n fl u en za p n eu m o n ia d ia b e te s m a ll it u s in fl u e n za p n e u m o n ia h az ar d : 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -0 .7 3 0 ** * (0 .1 2 5 ) -1 2 .6 3 2 ** * (0 .1 2 9 ) -0 .6 5 8 ** * (0 .0 7 0 ) 4 .7 0 1 ** * (0 .1 0 8 ) 0 .2 8 9 ** * (0 .1 0 4 ) -1 3 .9 9 0 ** * (0 .1 0 2 ) -0 .6 4 8 ** * (0 .0 9 0 ) 5 .1 8 8 ** * (0 .1 6 2 ) c as es 1 ,5 6 0 ,6 6 7 1 ,3 3 8 ,8 3 1 8 2 8 ,3 5 3 2 3 3 ,1 8 7 1 ,5 6 0 ,6 6 7 1 ,3 3 8 ,8 3 1 8 2 8 ,3 5 3 2 3 3 ,1 8 7 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st a te o f bi rt h . i nd iv id u a l c h ar ac te ri st ic s ar e re st ri ct ed t o ag e an d m a ri ta l s ta tu s du m m ie s. d a ta s pa n s th e ye a rs 1 9 79 ‐2 0 04 . 2 0 p er ce n t ra n do m s am pl e is u se d . ( * p< 0 .1 , * * p< 0. 05 , * ** p < 0. 0 1 ) t a b le 1 1 . h et er o ge n ei ty b y c o h o rt s fo r c h ro n ic r es p ir at o ry a n d a ll o th er d is ea se s c h ro n ic r e sp ir a to ry d is e as e s a ll o th e r d is e a se s h az ar d : 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -0 .7 7 0 ** * (0 .1 2 0 ) -1 2 .3 8 8 ** * (0 .0 7 8 ) 0 .4 3 3 ** * (0 .0 7 7 ) 5 .0 5 3 ** * (0 .1 3 8 ) -0 .2 4 1 ** * (0 .0 8 4 ) -1 1 .3 2 2 ** * (0 .0 4 7 ) -1 .0 5 1 ** * (0 .0 6 1 ) 4 .3 4 6 ** * (0 .0 3 9 ) c as es 1 ,2 6 4 ,9 2 7 1 ,1 1 8 ,6 5 7 7 0 9 ,2 7 8 2 0 1 ,0 4 7 1 ,2 6 4 ,9 2 7 1 ,1 1 8 ,6 5 7 7 0 9 ,2 7 8 2 0 1 ,0 4 7 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st a te o f bi rt h . i nd iv id u a l c h ar ac te ri st ic s ar e re st ri ct ed t o ag e an d m a ri ta l s ta tu s du m m ie s. d a ta s pa n s th e ye a rs 1 9 79 ‐2 0 04 . 2 0 p er ce n t ra n do m s am pl e is u se d . ( * p< 0 .1 , * * p< 0. 05 , * ** p < 0. 0 1 ) 18 economic analysis (2020, vol. 53, no. 2, 1-19) figures figure 1. mortality risks are constrained to males who died in period 1968-2004 and was born in the years 1912-13 (expansion) or 1914-15 (recession). figure 2. mortality risks are constrained to females who died in period 1968-2004 and was born in the years 1912-13 (expansion) or 1914-15 (recession). 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 malignant neoplasm 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 diabetes mellituse 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 cardoivascular disease 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 influenza and pneumonia 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 chronic lower respiratory 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 other diseases kaplan-meier survival curves 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 malignant neoplasm 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 diabetes mellituse 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 cardoivascular disease 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 influenza and pneumonia 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 chronic lower respiratory 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 other diseases kaplan-meier survival curves hamid noghanibehambari, farzaneh noghani, nahid tavassoli 19 figure 3. log of gdp per capita (ppp) in united states during 1910-1950. the trend extracted using a hodrick-prescott filter with smoothing factor of 200. figure 4. likelihood of death from cvd for cohorts born during recession and expansions in different stages of life. article history: received: july 3, 2020 accepted: december 8, 2020 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp59-71 original scientific paper estimation of price elasticity of demand for cigarettes in bosnia and herzegovina – macro data analysis dragan gligorić1* | saša petković1 | anđela pepić2 | jovo ateljević1 | borislav vukojević3 1 university of banja luka, faculty of economics 2 university of banja luka, entrepreneurship and technology transfer centre 3 university of banja luka, faculty of political science abstract tobacco consumption continues to be behavior engaged in by a large percentage of bosnia & herzegovina (bih) citizens. according to the official statistics, nearly half of the state’s adults, that is about 1,200,600 people, consume tobacco products on a daily bases. the state excise policy is one of the main available tools for reducing smoking prevalence because cigarette prices are under the direct impact of this policy. after its introduction in the second half of 2009, the specific excise tax on cigarettes has increased every year and was the main driver of cigarette price increase. in order to provide research-based evidence for more effective tobacco taxation policies in bih, in this paper we estimate the price elasticity of demand for cigarettes using the macro-level data for the period 2008 to 2017, on a semi-annual basis. the results have shown that the increase in prices of cigarettes has a statistically significant impact on cigarette consumption, at a level of 1%. the estimated price elasticity coefficient is in the range from -0.71 to -0.83, depends on the selected control variables used in the model. it means that the increase in real cigarette prices for 10% led to a decrease in cigarette consumption in the range from 7.1% to 8.3%. key words: demand, cigarettes, prices, elasticity, income, excise jel classification: e20, h20, c13 introduction smoking is an endemic problem in bosnia and herzegovina (bih). in 2016, the smoking prevalence in bih was close to 40% with a significant difference between men (46.9%) and women (28.5%), yet, the gender gap has been diminished over time, as the smoking prevalence is increasing among women (world bank, 2018). among youth, tobacco use prevalence among girls (9.7%) is significantly lower than among boys (15.5%). bih is among the top 10 countries in the world for cigarettes consumption (world atlas, 2018). level of tolerance towards smoking in bih, like in the neighboring countries, is relatively high yet with a tendency to decline. research evidence shows that smoking is among the leading preventable cause of death worldwide. bosnia and herzegovina is not an exception. based on the current percentage of people smoking in bih, premature deaths attributable to smoking are projected to be as high as 600,000 in the next 40 years (world health organization, 2016). * corresponding author, e-mail: dragan.gligoric@ef.unibl.org 60 economic analysis (2020, vol. 53, no. 1, 59-71) the state excise policy is one of the main available tool for reducing smoking prevalence (by reducing smoking initiation and increasing smoking cessation) and smoking intensity because the cigarette prices are under direct impact of this policy. the effects of tobacco taxation on smoking prevalence and smoking intensity depend on the price elasticity of demand for cigarettes. the first attempt to empirically estimate impact of tobacco taxes on the demand for of tobacco product in developing country was made by chapman and richardson (1990). using annual data for the period 1973-1983 they estimated excise tax elasticities of –0.71 for cigarettes and –0.50 for other tobacco products. previous research indicates that the price elasticity of demand for tobacco products in high-income countries is in the range from – 0.25 to – 0.50, with many clustering around – 0.40. a modest number of research conducted in low and middle-income countries (such as bih) have shown that demand for tobacco product is more responsive to changes in prices, estimated price elasticity has fallen mostly in the range between 0,5 and -1 (chaloupka et al., 2000; selvaraj et al., 2015). recent research conducted in the republic of serbia, based on aggregate level data for period 2002-2016, showed that price elasticity ranged between -0.76 and -0.62 (jovanovic, o. et al., 2018). so the larger effect of price increase on demand for tobacco can be expected among countries with lower levels of income, but also among socio-economic groups with lower levels of income, and among youth (al-sadat, n., 2005). this implies that state excise policy in these countries can be effective in reducing tobacco consumption. nevertheless, only a few low and middle-income countries have calculated their country-specific estimates of the price responsiveness of the cigarette market. lack of data or research capacity is often the reason why this information is not available (ross and al-sadat, 2007). the specific excise on cigarettes introduced in bih in 2009 and has increased every year. ad valorem excise, calculated on the retail price of cigarettes, stayed at the same level of 42% retail price. specific excise increased, from an initial level of 3.83 eur per 1000 cigarettes stick in the 2009 to 34.5 eur per 1000 cigarettes stick in 2017. this is the main reason for the increase in the cigarettes prices for about 175%, in the period 2008-2017. however, given the low industry price, retail cigarette prices in bih are among the lowest in europe. at the same time, budget revenues from specific and ad valorem excise were constantly increasing, despite a significant drop in consumption of cigarettes. regardless of observed the positive trends in cigarettes consumption and budget revenues, policy makers are often in a dilemma whether or not to continue with the trend of increasing specific excise tax. in order to provide research-based evidence for more effective tobacco taxation policies in bih, it is necessary to estimate prices’ elasticity. in this study, we developed the econometrics model of cigarettes demand based on the macro level data. to our best knowledge, this is the first estimate of the price elasticity of cigarettes demand for bih. following this introduction, the second section presents the data related to cigarettes consumption in bih, the short descriptive analysis and methodology. the third section presents and discusses the results of the regression analysis, while the fifth section concludes the paper. data and method to estimate the impact of an increase in the price of cigarettes on cigarette consumption, we use data for consumption and price of cigarettes. consumption of cigarettes accounts for over 97% of total tobacco products in bih in 2017 (indirect taxation authority of bih, 2018)1 and conclusions based on the analysis of consumption of cigarettes are valid and representative. data related to cigarette consumption and prices in bih are available for the very short period (2008-2017). we have collected data for the last ten years on the semi-annual level, to have 1 this estimate is based on only reported consumption. all informal sales, such as of cut tobacco on the street or in the farmers market, is not part of this estimation due to the lack of a reliable and unique assessment of the illicit market. dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 61 sufficient data for implementing time-series analysis. this period of analysis is relevant for bih, taking into account that specific excise on cigarettes was introduced in 2009. the time-series data for the period 2008-2017 are summarized in table 1. the per-capita consumption of domestic and imported cigarettes is calculated based on the semi-annually data of the number of issued excise stamps on tobacco and cigarettes sticks, provided by indirect tax authority of bih and the size of the adult population (aged 15 years or older). the excise stamp is issued for each cigarettes pack, and therefore, the number of issued excise stamps is equal to the number of cigarettes pack. consumption of cigarettes in the sticks is derived from the number of cigarettes per pack which mainly contain 20 sticks, but there exist packs with 18 and 24 sticks as well2. the indirect tax authority of bih provided us with detail semi-annual data, so we were able to calculate the exact number of cigarette sticks sold. the real tobacco consumer price index (cpi) we calculated using the average price of cigarettes and general cpi in bih. calculation of average price of cigarettes is based on the total value of issued excise stamps for domestic and imported cigarettes and the number of cigarettes (value/quantity), on the semi-annually basis, declared for sale in bih3. hence, we used official data, provided by indirect taxation authority, on the number of cigarettes and the total value of cigarettes to calculate average prices of cigarettes. then, based on the average prices of cigarettes, we created nominal tobacco price index. the average price of cigarettes pack in the first period (2008p1) is used as a base value and tobacco cpi index (2008p1=100) for the first period got value 100. for each next period, we calculated index as the ratio between the average price per pack for that period and the average price per pack in the base period, multiplied by 100. to obtain real tobacco cpi, we deflated it using general cpi in bih4. the purchasing power is one of the main determinants of aggregate demand and demand for a particular product. the most often used measure for purchasing power in the country is real income measured by real gross domestic product (gdp) per capita. we have also used real gni per capita as a proxy for real income. bih has the significant amount of unilateral transfers from abroad, and it means that gni per capita (gdppc + unilateral transfers pc) could be a better approximation of income for the estimation demand for cigarettes. the data on real income is available in the online publication of the agency of statistics of bih on a quarterly basis and we recalculate it on semi-annual basis. data on unilateral transfer is available in the balance of payments statistic in central bank of bih database also on quarterly basis and we recalculate it on semi-annual basis. also, as a proxy for purchasing power, we used real net average wages, provided by the national statistics agency. tobacco control policies other than cigarette taxes can also be an important determinant of demand for cigarettes (ross and al-sadat, 2007). we created two variables related to tobacco control environment in bih between 2008-2017. first tobacco control variable is “tlaw”, which is related to the introduction of law on tobacco of bosnia and herzegovina in 2010. law on tobacco has introduced stricter conditions in the field of tobacco production and trade. variable tlaw takes the value of 0 for the period 2008p1 – 2010p1 and value of 1 for the period 2010p22017p2, because it came into the force in may 2010 5. second tobacco control variable is “aban”, 2 until second half of 2014, every cigarette pack contained 20 cigarettes stick. since then, cigarette packs with either 18 or 24 cigarette sticks accounted on average only 0.66% of all sold cigarettes. therefore, the difference in number of cigarettes stick in cigarettes pack (two below and four above) has not statistically significant influence on tobacco cpi, during the calculation average price of cigarettes pack. 3 indirect taxation authority provided us with detailed data of the value and the number of issued excise stamps, number of cigarettes sticks (corresponding to the particular excise stamps) on semi-annual basis. 4 we calculated semi-annual general cpi (2008p2=100) using monthly inflation rates which are available on http://www.bhas.ba. 5 law on tobacco adopted in parliament bih in mid-april 2010, came into the force in may 2010, therefore its possible effect on cigarettes consumption could be expected in second half of 2010. 62 economic analysis (2020, vol. 53, no. 1, 59-71) and it reflect the adoption of code on commercial communications in december 2015 6. this code prohibited all forms of commercial communications related to cigarettes and other tobacco products, guns, firearms and pyrotechnical means, as well as opium drugs. variable aban takes value of 0 for the period 2008p1 – 2015p1 and value of 1 for the period 2015p2-2017p2. this two variables, “tlaw” and “aban” are summarized in tobacco control index “tcindex”. therefore, “tcindex” is the sum of two dichotomus indicators “tlaw” and “aban” (ross & al-sadat, 2007). therefore, variable tcindex takes value 0, for the period 2008p1-2010p1, value 0 for the period 2010p1-2015p1 and value 2 for the period 2015p2-2017p2. table 1. cigarette consumption, cigarettes prices and real income in bih, 2008p1 – 2017p2 period consumption of cigarettes (in eur) number of issued excise stamps (number of cigarettes pack) average prices of cigarettes (per pack) real tobacco cpi consumption (cigarettes per adult) real income (gdp pc) in eur real disposable income (gdp pc) in eur real net average wages (in eur) 2008 p1 212,670,325 261,540,001 0.81 100.00 1663 1789.1 2111.2 2229.0 2008 p2 240,964,705 299,359,999 0.80 99.33 1904 1884.2 2231.6 2378.4 2009 p1 229,652,884 282,960,000 0.81 101.73 1801 1765.0 2057.5 2468.4 2009 p2 244,288,614 251,930,000 0.97 119.66 1604 1792.8 2090.0 2433.6 2010 p1 263,831,212 239,180,000 1.10 134.96 1525 1776.7 2031.2 2421.6 2010 p2 218,533,349 215,344,360 1.01 121.46 1373 1794.2 2081.4 2395.2 2011 p1 294,236,356 232,391,160 1.27 149.20 1493 1827.2 2073.5 2388.6 2011 p2 305,416,626 241,090,000 1.27 147.70 1549 1839.2 2105.9 2382.0 2012 p1 282,548,074 195,360,000 1.45 167.19 1265 1861.6 2099.3 2377.8 2012 p2 317,968,842 218,854,500 1.45 166.37 1417 1848.1 2133.8 2362.2 2013 p1 293,572,563 180,221,775 1.63 186.88 1175 1878.8 2114.2 2358.0 2013 p2 245,014,137 148,870,000 1.65 191.16 971 1974.4 2289.2 2407.8 2014 p1 251,223,010 142,299,500 1.77 205.45 935 1925.4 2175.6 2406.6 2014 p2 290,028,786 159,298,000 1.82 212.48 1047 1979.7 2305.5 2419.2 2015 p1 290,416,345 147,811,500 1.96 229.96 978 2019.3 2267.3 2423.4 2015 p2 301,082,405 151,360,000 1.99 235.08 1000 2070.3 2339.5 2449.8 2016 p1 271,521,809 127,055,000 2.14 254.04 841 2024.3 2251.9 2473.2 2016 p2 294,837,486 137,330,000 2.15 254.46 909 2224.0 2482.4 2489.4 2017 p1 272,084,486 118,815,000 2.29 269.58 788 2052.8 2299.7 2490.0 2017 p2 293,329,175 124,440,000 2.36 275.89 826 2349.1 2612.3 2493.6 source: world bank data, 2018; indirect taxation authority of bih, 2018 to generate “per person” measures we used a number of inhabitants from the world bank database, due the poor quality of population data from the national statistics agency. also, the lack of official population statistics in bih has prevented us from using other control variables (such as male to female ratio, education, etc.). average nominal price of cigarettes significantly increased in the last ten years (for about 175%). excise duties (ad valorem) represented 49% of the price (before vat) until the introduction of specific excise in second half of 2009. by introduction of specific excise, the base for ad valorem excise calculation is changed, from price before vat, to retail price with vat. as a consequence, the rate of ad valorem excise changed from 49 % of the price before vat to 42% of retail price (price with vat) to keep roughly the same ad valorem excise burden of the retail price. specific excise duties increased from an initial level of 3.83 eur per 1000 cigarettes stick 6 the code on commercial communication came into force in january 2016. dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 63 in the 2009 to 34.5 eur per 1000 cigarettes stick in 2017, which is the main reason for the increase in cigarettes prices. this trend is visible in graph 1. figure 1. average nominal prices of cigarettes (per pack) source: indirect taxation authority of bih, 2018 along with the rise in the price of cigarettes, caused by the increase in excise duties, consumptions of cigarettes per adult decreased rapidly. the trend is shown on graph 2. consumption of cigarettes in the half-year period decreased from the value of 1904 per adult in the second half of 2008 to 826 cigarettes per adult in second half of 2017. 1663 1904 1801 1604 1525 1373 1493 1549 1265 1417 1175 971 935 1047 978 1000 841 909 788 826 400 600 800 1000 1200 1400 1600 1800 2000 2008 p1 2008 p2 2009 p1 2009 p2 2010 p1 2010 p2 2011 p1 2011 p2 2012 p1 2012 p2 2013 p1 2013 p2 2014 p1 2014 p2 2015 p1 2015 p2 2016 p1 2016 p2 2017 p1 2017 p2 consumption of cigarettes per adult (in stics) figure 2. consumption of cigarettes per adult (in sticks) source: indirect taxation authority of bih, 2018 64 economic analysis (2020, vol. 53, no. 1, 59-71) to estimate the demand for cigarettes, we used the following conventional model in linear functional form: const = α + β0 rtcpit + β1 rincomt + β2 tcontrolt + εt where const is aggregate consumption of cigarettes per capita, rtcpit is real tobacco cpi, and rincomt is real gdp per capita (alternatively we used also gni per capita or real wages), tcontrol are tobacco control variables. we used all variables in logarithm (log-log model)7, except tobacco control variables. tobacco control variables are dummy variables (tlaw and aban) or the sum of dummy variables (tcindex) and we put them directly in the regression, without logging. before testing for unit roots, because we use semi-annually data, we have to test our variables for the seasonal components. semi-annually, quarterly and monthly data usually tends to have seasonal components in variations. the seasonality becomes an issue in analysis of time series stationarity, as typical unit root tests do not deal with possibility of seasonal integration. autocorrelation function is a useful tool for analysis of presence of seasonality in time series. high value of autocorrelation coefficient at season lag s indicates presence of additive seasonality, while high and slowly declining autocorrelation coefficients on seasonal lags s, 2s, 3s, etc. indicate multiplicative seasonality. in addition, very high (close to one) and slowly declining autocorrelation coefficients on seasonal lags s, 2s, 3s, etc. of the time series after removing trend component (i.e. using first difference) also indicate high probability of seasonal integration (mladenovic et all., 2005). in order to analyze presence of seasonality, we estimate autocorrelation of up to forth order of logged time series (recommended level is at least 2s lags), both for level and first difference as shown in the table below: table 2. autocorrelation coefficients variable level first difference ac(1) ac(2) ac(3) ac(4) ac(1) ac(2) ac(3) ac(4) lcons 0.832 0.659 0.515 0.376 -0.371 -0.003 -0.117 -0.057 lrtcpi 0.851 0.707 0.546 0.411 -0.617 0.235 -0.211 0.335 lrincome 0.598 0.688 0.43 0.37 -0.626 0.354 -0.124 0.066 lrdincom 0.466 0.682 0.313 0.39 -0.697 0.536 -0.378 0.324 lrwage 0.44 0.114 0.083 0.025 0.316 -0.144 -0.127 -0.119 the estimated values of the autocorrelation function for the first differences reveals that time series most likely are not seasonally integrated, but lrtcpi, lrincome and lrdincom likely have seasonal component. as type of seasonality is hard to identify solely on the basis of autocorrelation in case of semi-annual data, we run autoregressive regressions up to second order, including also seasonal dummy to identify presence of the additive seasonality and seasonal autoregressive component to identify presence of the multiplicative seasonal component. the results of estimation for seasonal dummy and seasonal autoregressive component (coefficients for constant, trend and common autoregressive components are 7 in many economic situations (particularly price-demand relationships), the marginal effect of one variable on the expected value of another is linear in terms of percentage changes rather than absolute changes. in such cases, applying a natural log to both dependent and independent variables may be appropriate. relationship where both y and x are log-transformed, are commonly referred to as elastic in econometrics, and the coefficient of log x is referred to as an elasticity also, we can directly (from log-log model) obtain standard errors of estimated coefficients without using bootstrap procedure (wilkins et all, ruso et all, 2008; mulugeta et all., 2013). dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 65 omitted) shows that logged price index has additive seasonality, while real income and real disposable income have multiplicative seasonality, as shown in the table below. table 3. seasonal dummy and seasonal autoregressive component original lcons lrtcpi lrtcpi_sa lrincome lrincome_sa lrdincom rdincom_sa lrwage s_2 0.0565 -0.0564** -0.001 0.0557 -0.000 0.0617 -0.000 0.0014 (0.0328) (0.0189) (0.0110) (0.0497) (0.0023) (0.0397) (0.0021) (0.0026) sar(2) -0.0541 -0.4518 -0.454 0.5969*** -0.520* 0.4050** -0.354 0.1944 (1.4259) (0.3080) (0.3023) (0.1565) (0.2786) (0.1720) (0.3140) (0.3318) we use tramo/seats statistical tool, being the only software solution that supports seasonal adjustment of the semi-annual time series, to eliminate seasonality from price index and income variables. then we rerun autoregressive regressions on the seasonally adjusted data for these three variables (in the table indicated with sa suffix). after adjusting, seasonal components have been removed from price index and real disposable income, while seasonality still remained in real income, but statistical significance declined. table 4. seasonally adjusted variables period/ variable 2008 p1 2008 p2 2009 p1 2009 p2 2010 p1 2010 p2 2011 p1 2011 p2 2012 p1 2012 p2 rincom 1842.61 1836.41 1800.14 1777.33 1784.55 1796.51 1824.70 1845.69 1855.49 1857.71 rdincom 2187.18 2163.17 2107.86 2060.66 2055.53 2066.30 2086.21 2097.52 2111.85 2114.26 rtcpi 96.43 103.20 98.12 124.33 130.00 126.35 143.96 152.97 162.17 171.39 period/ variable 2013 p1 2013 p2 2014 p1 2014 p2 2015 p1 2015 p2 2016 p1 2016 p2 2017 p1 2017 p2 rincom 1876.43 1975.24 1931.36 1976.55 2030.42 2043.45 2084.36 2134.18 2160.64 2230.49 rdincom 2160.37 2226.28 2235.58 2263.51 2303.41 2294.52 2327.28 2379.85 2416.93 2484.73 rtcpi 182.26 195.87 201.31 216.94 225.91 239.56 249.93 258.95 265.57 280.53 having two variables with no seasonal component and three variables with seasonal component, we proceed further analysis with seasonally adjusted data for price index, real and real disposable income to avoid effects of seasonality on results of regression. we applied the dickey-fuller test for unit root on a logarithmic data (ateriou and hall, 2016, p.361). table 5. unit root test variable dickey‐fuller test for levels test statistics results consumption (lcons) -4.224 integrated at zero order i (0) real tobacco cpi (lrtcpi), seasonally adjusted -3.170 integrated at zero order i (0) real gdp pc (lrincom), seasonally adjusted -2.282 integrated at first order i (1) real gni pc (lrdincom), seasonally adjusted -2.898 integrated at first order i (1) real wages (lrwage) -3.914 integrated at zero order i (0) dickey-fuller test indicates that real income and real disposable income have unit roots in levels, but not in the first differences, so we can conclude that these three time series are first order integrated. 66 economic analysis (2020, vol. 53, no. 1, 59-71) regarding to the results of unit root test, which indicate that our variable are integrated at zero order and first order, we can apply two econometrics model:  the ordinary last squares (ols) on time series data, when we use variables in levels if they are i(0) and variables in first difference if they are i(1). due to the fact that variables which are integrated i (1) are logged real gdp and logged real disposable income their first differences (dlrincom and dlrdincom) are real growth rates of gdp and real growth rates of disposable income. consequently, our differenced variables represent a significant economic variable and can be used in ols estimation.  the autoregressive distributed lag (ardl) model which is preferable when dealing with variables that are integrated of different order, i(0) and i(1). the reparameterized result gives the short-run dynamics and long run relationship of the considered variables. if we have very short time series, ols model, if it can be applied, give much more reliable results than ardl (giles, 2013). in this analysis, we use ordinary last squares (ols) on time series data, due to the very short time series (10 years and corresponding series of 20 semiannually data). results we estimated several versions of our model. as a proxy for real income, we use real gdp, but also real disposable income, due to the significant amount of inward unilateral transfers from abroad, which significantly affect purchasing power in bih. the results of unit root test suggest us to use income variables in their first difference, which are in the fact real growth rates. because of the unexpected insignificance of this two proxy for real income, we also used real net average wages to check our results. we started with only two independent variables, real tobacco cpi (seasonally adjusted) and real income growth rate (proxy by real gdp pc growth rate, seasonally adjusted) in order to estimate the elasticity of demand for cigarettes. then, we introduced tobacco control variable in the model, one by one. first, we introduced variable tlaw, and then aban. at the end, we estimated the model which is the summary for all tobacco control polices, “tcindex”. the results for different versions of our model are summarized in table 6. each of our models includes income and prices, but tobacco control policy variables have introduced in the model one by one. as we write above, we used all variables in logarithm except tobacco control variables. these results suggest that real prices of tobacco products have a negative and statistically significant impact on the consumption of cigarettes, at 1% level of significance. this result is in line with our expectation. the increase in cigarettes prices for 1% led to a decrease in cigarettes consumption by in the range of 0.78% to 0.84%. the regression coefficient of real income growth is positive, which is in line with our expectations, but this coefficient is not statistically significant. table 6. linear demand model for cigarettes – (real income growth is proxied by gdp pc growth rate) variables (1) (2) (3) (4) lcons lcons lcons lcons lrtcpi -0.827*** -0.778*** -0.839*** -0.790*** [0.077] [0.133] [0.101] [0.097] dlrincome 0.250 0.342 0.189 0.215 [1.404] [1.454] [1.479] [1.431] tcindex -0.029 [0.064] tlaw 0.015 dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 67 variables (1) (2) (3) (4) lcons lcons lcons lcons [0.076] aban -0.043 [0.066] constant 11.355*** 11.131*** 11.408*** 11.173*** [0.392] [0.635] [0.482] [0.487] observations 19 19 19 19 r-squared 0.913 0.914 0.913 0.916 f statistic (prob.) 0.000 0.000 0.000 0.000 d-w d-statistic 2.061 1.928 2.120 2.002 breusch-pagan / cook-weis. test for heter. (prob > chi2) 0.809 0.832 0.763 0.769 jb test (prob.) 0.890 0.921 0.876 0.916 ramsey reset test (prob.) 0.763 0.721 0.741 0.823 multicolinearity test (vif) 1.50 3.28 2.06 1.83 standard errors in brackets *** p<0.01, ** p<0.05, * p<0.1 our control variables, which represent implemented tobacco control policy in bih, are not significant. their introduction in the model did not improve the model, which is shown by adjusted r-square. including different control variables in our model did not lead to significant changing in the value of price elasticity coefficient and we can conclude that our estimated coefficient of elasticity is stable. the validity of the overall regression was confirmed by f statistics whose probability is 0.000, or less than 0.01, and at the level of 1% of significance, we can say that the estimated model is statistically significant. independent variables explain more than 91% variance in the dependent variable, which shows adjusted r-squared. a lot of bih residents are employed or were employed in western europe. as a result, unilateral transfers from abroad significantly contribute to the domestic purchasing power of bih household. in the last ten year, the share of unilateral transfers in real gdp is about 15%, which is visible from the table 1 if we compare gdp pc and gni pc. taking into account this fact, we suspected that the insignificance of real income growth rate measured by real gdp pc growth rate is the result of using the wrong variable for the measuring purchasing power. therefore, we dropped gdp per capita growth rate from the model (variable dlrincom) and introduced gni per capita growth rate in the model (first difference of logarithm of real disposable income dlrdincome), also seasionally adjusted. table 7. linear demand model for cigarettes – (real income growth rate is proxied by gni pc growth rate, i.e. real disposable income growth rate) variables (1) (2) (3) (4) lcons lcons lcons lcons lrtcpi -0.776*** -0.756*** -0.799*** -0.736*** [0.094] [0.133] [0.103] [0.112] dlrdincome -1.200 -1.010 -1.908 -1.279 [2.001] [2.223] [2.350] [2.037] tcindex -0.016 [0.068] tlaw 0.051 [0.083] aban -0.046 [0.065] constant 11.106*** 11.012*** 11.189*** 10.905*** [0.478] [0.641] [0.506] [0.564] 68 economic analysis (2020, vol. 53, no. 1, 59-71) variables (1) (2) (3) (4) lcons lcons lcons lcons observations 19 19 19 19 r-squared 0.915 0.915 0.917 0.918 f statistic (prob.) 0.000 0.000 0.000 0.000 d-w d-statistic 2.039 1.970 2.244 1.993 breusch-pagan / cook-weis. test for heter. (prob > chi2) 0.745 0.767 0.615 0.757 jb test (prob.) 0.868 0.888 0.761 0.934 ramsey reset test (prob.) 0.458 0.477 0.528 0.571 multicolinearity test (vif) 2.27 3.86 2.82 2.37 standard errors in brackets; *** p<0.01, ** p<0.05, * p<0.1 introducing the new variable as a proxy for purchasing power did not result in the significance of these variables in the model. variables “dlrdincome” is not statistically significant. the regression coefficient of real disposable income is negative, which is not in line with our exaptation, but this coefficient is not statistically significant. increasing in cigarettes prices for 1% led to a decrease in cigarettes consumption by in the range of 0.74% to 0.80%. the variables, which represent tobacco control policies are not statistically significant. to check the impact of purchasing power on demand for cigarettes again, we created the model with a new variable which is often used in the literature as a proxy for the purchasing power – real average wages, obtained from national statistics agency. the results of the different version of models are presented in table 8. table 8. linear demand model for cigarettes – (real income is proxied by real wages) variables (1) (2) (3) (4) lcons lcons lcons lcons lrtcpi -0.786*** -0.730*** -0.846*** -0.747*** [0.076] [0.138] [0.127] [0.083] lrwage 0.194 0.207 0.450 0.637 [1.012] [1.036] [1.121] [1.086] tcindex -0.032 [0.066] tlaw 0.048 [0.082] aban -0.077 [0.071] constant 9.980 9.642 8.714 7.137 [5.849] [6.024] [6.344] [6.376] observations 20 20 20 20 r-squared 0.906 0.907 0.908 0.912 f statistic (prob.) 0.000 0.000 0.000 0.000 d-w d-statistic 1.985 1.858 2.171 1.947 breusch-pagan / cook-weis. test for heter. (prob > chi2 0.675 0.694 0.619 0.746 jb test (prob.) 0.786 0.826 0.7692 0.939 ramsey reset test (prob.) 0.455 0.444 0.486 0.644 multicolinearity test (vif) 1.54 3.66 2.98 1.88 standard errors in brackets *** p<0.01, ** p<0.05, * p<0.1 dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 69 once again, variables which represent purchasing power was not statistically significant. the coefficients of the tobacco control variables were again not statistically significant. impact of real tobacco prices is statistically significant, and estimated coefficients of price elasticity have a wider range of value. increase in cigarettes prices for 1% led to a decrease in cigarettes consumption in the range of 0.73% to 0.85%. the reason for the non-significance of real income growth, real disposable income growth and real wages on consumption of cigarettes in our models can be in the fact that bih has experienced a significant increase in this variable in the observed period. it is possible, that higher income allowed smokers to consume higher-priced brands, without increasing in quantity of consumption (john, 2008). adjusted r square in all models is slightly above 90%. we applied the ramsey regression specification error test for all models. those tests indicated that we did not exclude any important variables from our model. such exclusion would result in biased estimates. the durbin–watson test assessed the autocorrelation of ols model residuals. if residuals are correlated, ols estimates are unbiased. we found the values of the reported d statistic to be closer to the value two which implies that the residuals from linear regression are uncorrelated in all estimated models. the breusch–pagan/cook–weisberg test showed that residuals of the ols model have constant variance. therefore, no heteroscedasticity exists that would reduce the reliability of our hypothesis testing and cause ols estimators to be inefficient. the assumption about the normality of the residual in our models is satisfied, which has been verified using jarque – bera normality test. value of variance inflation factor suggests that out models don’t suffer from the multicollinearity problem. conclusion the specific excise on cigarettes introduced in bih in 2009 and has increased every year, from an initial level of 3.83 eur per 1000 cigarettes stick in the 2009 to 34.5 eur per 1000 cigarettes stick in 2017. ad valorem excise, calculated on the retail price of cigarettes, stayed at the same level of 42% retail price. the analysis for the period 2008p1-2017p2 shows that average prices of cigarettes increased by about 175%, while consumption of cigarettes decreased for more than 50%. the main reason for an increase in prices of cigarettes was continuous increasing of specific excise. in order to estimate the impact of increase in cigarette prices on the demand for cigarettes in bih, we developed three models, with three different measures of income. the only variable, which has significant impact on demand for cigarettes, was logarithm of real cigarette cpi. value of estimated coefficients was in the range of -0.73 to -0.85, and the estimated coefficient was stable across different models and different versions of a particular model. this implies that an increase in prices of cigarettes for 1% led to a decrease in the consumption of cigarettes in the range of 0.73% to 0.85%. this results are in line with previous research, conducted in low and middle-income countries (such as bih), which found that price elasticity of demand for cigarettes is in the range between -0.5 and -1 (selvaraj et al., 2015, jovanovic et al., 2018). results of our analysis suggest that the state excise policy is an effective tool for reducing cigarette consumptions in bih. if policy-makers in bih continue with the policy of increasing excise taxes, the consumption of cigarettes will decrease. acknowledgements this paper is a result of international research project "accelerating progress in taxation of tobacco and tobacco products in lowand middle-income countries". this research is funded by 70 economic analysis (2020, vol. 53, no. 1, 59-71) the university of illinois at chicago’s institute for health research and policy through its partnership with the bloomberg philanthropies. references agency for statistics of bih. 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(2007). analysis of tobacco demand, world bank, economics of tobacco toolkit. http://siteresources.worldbank.org/intph/resources/3demand.pdf article history: received: november 28, 2019 accepted: february 21, 2020 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp121-132 original scientific paper the role of balanced scorecard models in the assessment of board of directors performance jelena peković1* | stefan zdravković1 | goran pavlović1 1 university of kragujevac, faculty of economics, department for business management, kragujevac, serbia abstract there are a number of performance management systems that are used as mechanisms to control corporate operations, and one of the well-known is the balanced scorecard. business control is a fundamental issue, and the board of directors is an important internal control mechanism for improving the performance and competitiveness of corporations. the board of directors represents the link between the owner and the manager and his task is to constantly monitor the manager and to make sure that they carry out their activities in a way that will maximize profits for the owners of the capital. for the board to perform its role, its members need to have the appropriate competencies. the specific knowledge, skills, abilities and experiences of board members represent human capital. the subject of the research is to examine the possibility of applying the balanced scorecard model in the performance evaluation of the members of the board of directors and to examine the impact of the compensations of the board members, which are viewed as a factor of motivation and investment in human capital (hce), on the financial performance of the company, namely the rate of return on the total invested capital and the total invested assets (roe and roa). the results of the research showed that the balanced scorecard is an applicable model for evaluating the performance of the members of the board of directors, and that the level of compensation of the board members is positively correlated with the financial performance of the company. key words: balanced scorecard, board of directors, human capital, compensation of board members, financial performance jel classification: o21, m41, e24 introduction modern business conditions are characterized by a turbulent business environment, increasing pressure from competition, a high degree of risk and uncertainty, and incomplete awareness of economic actors. an effective corporate governance system is essential for companies to achieve good business performance. it is necessary for certain control mechanisms to determine whether managers carry out their business activities in order to maximize profits for owners of capital. board members represent an important internal control mechanism. kaplan & norton (1992) have designed one of the most famous performance management systems, the balanced scorecard (bsc). the model includes financial and non-financial benchmarks. the bsc model starts from a defined mission, vision, goals and strategy of the company and defines specific goals, tasks, benchmarks and initiatives from four basic causal * corresponding author, e-mail: jelenapekipekovic@gmail.com 122 economic analysis (2020, vol. 53, no. 2, 121-132) relationships: financial perspective, customer perspective, internal business process perspective and learning and growth perspective. the paper particularly emphasizes the application of the bsc model in the performance evaluation of board members, with particular reference to the learning and growth perspective, which encompasses the knowledge, competencies, abilities and compensations of board members, which can also be seen as human capital of the company (hce), and to the financial perspective, where the most significant financial criteria are the return on invested capital (roe) and the return on total invested assets (roa). previous research has used a qualitative approach when examining the impact of board members' compensation on a company's financial performance (higgs, 2003; edlin, 2005; parker, 2007). the contribution of this research is reflected in the implementation of the quantitative approach, where the compensation of board members is viewed as an element of the human capital of the enterprise and their impact on financial performance is examined. this determines whether board members have a significant impact on business results, or whether companies should allocate significant cash to board members. human capital can be defined as a set of knowledge, skills, experiences, attitudes, dedication, innovation and competence of employees (wang, wang, & liang, 2014). the main carriers of the so-called human capital is the members of the board of directors and other employees, who, by implementing specific competencies, enable them to create value for the company and achieve sustainable competitive advantage (ghorbanhosseini, 2013). by building unique human capital, companies enhance their business performance (alnacher & alhajjar, 2017). the financial perspective encompasses a variety of benchmarks, the most significant of which are roa and roe, which simultaneously measure asset efficiency and the earning capacity of an enterprise. the subject of the research is to examine the possibility of applying the balanced scorecard model in the performance evaluation of the members of the board of directors and to examine the impact of compensation of the board members, considered as an element of human capital (hce), on the financial performance of the company, namely the rate of return on invested capital (roe) and total invested assets (roa). the aim of the study is to determine the validity of the balanced scorecard model for evaluating the performance of board members, and to determine whether board members' compensation, as an element of human capital (hce), has a positive or negative impact on a company's financial performance (roe and roa). based on the review of works in the existing literature, the qualitative methodology will determine whether the balanced scorecard model is applicable for evaluating the performance of the members of the board of directors, while the quantitative methodology will determine whether the human capital of the members of the board of directors has a positive impact on the financial performance of the company. the empirical survey includes a sample of 35 companies that, according to the agency for business registers, earns high net profit during 2017. in these companies significant funds are earmarked for the remuneration of the members of the board of directors, which makes them suitable for analyzing the impact of the board members' compensation on the financial performance of the company. literature review balanced scorecard as a performance management model kaplan & norton (1996) developed the balanced scorecard concept and suggested that the vision and strategy of a company be more specifically defined from four basic, interconnected perspectives: 1. financial perspective – how to see shareholders, the primary goal is to implement a strategy that will maximize profits for equity owners; jelena peković, stefan zdravković, goran pavlović 123 2. customer perspective how customers see us, the primary goal is to achieve some degree of customer satisfaction and loyalty, thus ensuring the company has a long-term profitable business; 3. perspective on internal business processes what processes help us to achieve a sustainable competitive advantage, how effective they are; 4. learning and growth perspective what kind of human capital we need to gain competitive advantage. kaplan & nagel (2004) propose a three-part bsc program that includes: 1. enterprise scorecard harmonized list of results at company level; 2. board scorecard harmonized list of board results; 3. executive scorecards harmonized list of executors' scores. harmonized list at the company level implies that top managers, starting from a defined company strategy, develop goals, tasks, benchmarks and initiatives through the four outlined perspectives. this ensures that the strategy is translated into operational terms. figure 1 shows the balanced scorecard model. figure 1. conceptual framework for balanced scorecard source: kaplan, r.s., and norton, d.p. 1992. “the balanced scorecard measures that drive performance“. harvard business review, 70(1): 71‐79 after building the harmonized list at the company level, it is necessary to build the harmonized list at the board level. that is, the board of directors should evaluate and approve the corporate strategy map and the corporate level harmonized list. a harmonized list at this level also contains four perspectives: (kaplan & nagel, 2004) 1. financial perspective identical to that in the harmonized list of results at the enterprise level, the goal is to maximize value for equity owners; 2. stakeholder perspective this is a broader perspective than at the company level, because it is now important to respect the interests of all stakeholders; 3. perspective on internal business processes explains how the board contributes to the achievement of shareholder goals and relates to performance monitoring, reward systems etc.; 4. learning and growth perspective captures human capital as a source of competitive advantage, related to the specific skills, knowledge and capabilities of board members. financial perspective customer perspective internal business process perspective vision and strategy learning and growth perspective 124 economic analysis (2020, vol. 53, no. 2, 121-132) this research examines whether the balanced scorecard model is applicable to assessing the performance of board members, with particular reference to linking the learning and growth perspective with the financial perspective. that is, it examines how board members with their competencies, knowledge and skills, generally viewed as human capital (hce), affect the financial performance of a company (roa and roe). epstein & roy (2004) propose that the harmonized list be used to evaluate the performance of board members. the model is presented in table 1. table 1. balanced scorecard model at the board level perspective goals measures financial perspective long-term and short-term earnings roa,roe, eva, share price interest group (stakeholders) perspective ethical behavior and respecting the law, high level of corporate management and responsibility, identifying interest group needs employee satisfaction. customer satisfaction, number of meetings with stakeholders intern business process perspective efficient crisis management, company plans evaluation, compensation systems business performance during crisis, clear goals for board members, number of hours spent in defining corporate strategy learning and growth perspective improving board of directors structure, skills and knowledge of board members vaic, hce, training for board members source: epstein, m. j. and roy, m. j. 2004. “how does your board rate”. strategic finance, 28‐29. finally, a harmonized list of results also needs to be built at the executive level. the ceo builts harmonized list to ensure that the executive team performs activities and tasks in accordance with a strategy approved by the board. application of balanced scorecard model at board level there are numerous studies in the literature, which have examined whether the balanced scorecard model is applicable to the performance evaluation of board members. northcott & smith (2011) conducted a survey in new zealand with a view to reviewing the experiences of board members in applying the balanced scorecard model. large companies were selected for the sample to ensure that the effectiveness of the board of directors of some of the most influential companies in the country was examined. through a semi-structured interview, 35 board members expressed their views and experiences on the balanced scorecard approach. in addition to experience in applying the balanced scorecard model, additional criteria for selecting board members participating in the survey were that respondents were board members of at least two companies and spent at least three years in that position. in this way, it is ensured that the respondents can draw on the experiences of different companies as well as having spent sufficient time in the company. the contribution of the paper is reflected in the fact that their perceptions of the balanced scorecard model were expressed by the members of the board, who had experience in the practical application of the model. based on the processed interview results, the study concluded that the balanced scorecard is applicable at the board level and is a useful tool for evaluating the performance of board members. members of the board of directors indicated through interviews that the balanced scorecard model can be a very effective performance management system, and that by combining different goals and benchmarks from four basic perspectives, the performance of board members can be evaluated. jelena peković, stefan zdravković, goran pavlović 125 the study conducted in the territory of egypt (hussein & mansour, 2017), aimed to identify opportunities for the implementation of the balanced scorecard model in evaluating the performance of board members in the case of production companies. data were collected through questionnaires and in-person interviews, from three different samples: board members, manufacturing company managers, and financial analysts at brokerage firms. the results of statistical analyzes have shown that the balanced scorecard is an effective tool for evaluating the work of board members. the balanced scorecard model provides a comprehensive analysis and evaluation of the work of board members. based on the four model perspectives, it is possible to examine by appropriate benchmarks how members of the board of directors influence shareholder value creation, profit maximization, interest group satisfaction, internal business process efficiency, etc. the contribution of the paper is to provide empirical evidence on the feasibility of applying the balanced scorecard model, where by combining different indicators from four basic perspectives the performance of the board members can be evaluated. hoque (2014) provides an account of research on the balanced scorecard model as a mechanism for evaluating the performance of board members over the past 20 years. the research includes an overview of 114 papers published in accounting journals and 67 papers in management area. among other things, in the aforementioned papers, members of the board of directors spoke about their experiences in applying the balanced scorecard model in interviews, and there is empirical evidence that the model can be used to look at the impact of board members on shareholder returns, profit maximization, stakeholder satisfaction and more. based on the above, it can be concluded that the balanced scorecard model is applicable for performance evaluation of the members of the board of directors. however, the author suggests that it may be desirable that there be studies in the literature that will address the difficulties as well as potential failures in the implementation of the balanced scorecard model. such examples would be of benefit to companies planning to introduce a balanced scorecard model in their operations. chavan (2009) looks at the implementation of the balanced scorecard model in australian corporations. the growing importance of the model is discussed and the problems that companies face during implementation are explored. the case study method has been applied, the balanced scorecard model is being considered in two multinational corporations in australia. the first company did not achieve an appropriate level of profit, so it introduced a balanced scorecard model in its operations to analyze the impact of employees, including board members, on the profits made. the other company had extremely high operating costs, so with the introduction of the balanced scorecard model it improved the cost analysis and control. the results showed that it is possible to implement the model, but the limitation states that the outcomes may differ for smes. domanović (2017) points out that in the republic of serbia consistent application of the balanced scorecard model is achieved by those companies which are under the influence of foreign capital and are compelled to submit to the foreign owners business reports in accordance with the latest trends in measuring and managing the efficiency of companies. managers who have implemented the balanced scorecard are generally satisfied with the effects of applying the model on company performance. the best-rated performance is that the model provides a better understanding of stakeholders, clarifies and ensures that employees have a better understanding of the company strategy, increases owner satisfaction and provides an expanded customer base. also, the model is suitable for evaluating the performance of board members and considering their impact on the financial performance of the company. based on the above papers, which examined the possibility of applying the balanced scorecard model in the performance evaluation of the members of the board of directors, and in accordance with the subject and objectives of this research, the following research hypothesis can be formulated: h1: the balanced scorecard model can be used to evaluate the performance of board members. 126 economic analysis (2020, vol. 53, no. 2, 121-132) this research links the learning and growth perspective with the financial perspective from the balanced scorecard model. the objective is to determine how board members, through their compensation, viewed as human capital (hce), affect the financial performance of the company (roa and roe). if the members of the board of directors have an influence on the business results of the company, then it is justified to allocate significant funds to the board members. human capital and financial performance intellectual capital is defined as a kind of combination of intangible resources, which enables one company to survive in the market. one of the most well-known classifications implies that the components of intellectual capital are human, structural, and relational capital (meritum, 2002). human capital can be defined as a set of knowledge, skills, experience, attitudes, commitment, innovation and competence of employees (wang, wang & liang, 2014). human capital is considered to have four components (fitz-enz, 2000): elements that each employee brings to the work process (intelligence, energy, enthusiasm, experience, skills, emotional intelligence, and the like), ability to learn (promotion, imagination and creativity), ability to act (conversion of data into information for action) and motivation (information and knowledge sharing, development of team spirit and goal orientation, compensation of board members and other employees). modern business conditions require the construction of unique human capital, and it’s important to know that there is a difference between general and specific human capital. general human capital is acquired through education and may in some ways be accessible to all, but it will not lead to sustainable competitive advantage as it can be easily copied. that is why it is crucial to build specific human capital, which is unique to a given company and its employees. building specific human capital can be achieved by providing training, fostering creativity and innovation, respecting employees' ideas, involving employees in the decision-making process (luthans & youssef, 2004). the resource-based approach assumes that resources are a source of sustainable competitive advantage if they are rare, valuable, difficult to imitate, and unsuitable for substitution (barney, 1991). human capital is a critical resource for differentiating financial performance between different businesses and also a key source of competitive advantage for businesses. intangible resources enable the company to achieve sustainable competitive advantage and significantly affect its financial performance. the members of the board of directors can significantly contribute to the achievement of positive financial performance with their competencies, which are considered as human capital of the company. there are numerous studies in the literature on how board members, with their knowledge, skills, competences, which can generally be seen as human capital, affect a company's financial performance. previous research (babić & slavković, 2016) examines how board members influence organizational innovation with their competencies and dynamic capabilities. the paper applies a qualitative methodology based on the description, comparison and interpretation of scientific results in a defined problem area. an integrative model of interdependence of the board of directors and top management structure in the development of organizational innovation is defined. the study points out that the intellectual capital (human, structural, social and cultural capital) of boards of directors is the basis of the transformation processes through which the board of directors adds value to the organization. yadav & chakraborty (2017) examined how board members, with their competencies, skills and abilities, which are viewed as human capital (hce), influence the rate of return on total invested assets (roa). the sample contains 74 companies from different industries. the independent variable human capital is part of intellectual capital, so the methodology of vaic (value added intellectual coefficient), developed by professor ante pulic, was used to measure its impact. vaic represents the added value of intellectual capital, which is calculated when total costs are deducted from total revenues (excluding compensation for board members who are jelena peković, stefan zdravković, goran pavlović 127 viewed as an investment in human capital). subsequently, human capital (hce) is calculated when the previously determined vaic value is divided by the total earnings paid to board members in one year (hc). a financial indicator of roa is obtained when the net profit after tax is divided by the total invested assets or assets of the company. the results of correlation analysis (pearson coefficient) and regression analysis (β coefficient) show that human capital has a positive statistically significant influence on the financial performance of the company. in other words, members of the board of directors influence their asset efficiency (roa) through their competencies, which are viewed as human capital (hce). nguyen, nguyen, locke & reddy (2017) examined the impact of human capital on the financial performance of listed companies in vietnam. the research starts from a resource-based approach, according to which intangible resources are a key source of competitive advantage for companies. the research methodology includes a panel analysis of 315 companies, the results of which are observed over a four-year period. the results showed that human capital has a positive impact on the rate of return on total invested capital (roe) and the rate of return on total invested assets (roa). the study's recommendation is that companies in vietnam should invest cash in improving the competencies of board members because they have a significant impact on the financial performance of the company. a previous study (berezinets, garanina & ilina, 2016) points out that human capital is a set of knowledge, experience and skills of board members. the research was conducted to explain the relationship between human capital and financial performance of a company. the research applied qualitative methodology, that is, by reviewing already existing papers in the literature, it was found that the members of the board of directors influence their financial performance on the companies. the authors suggest that companies should pay great attention to the selection of candidates to be appointed to the board of directors, as they can significantly contribute to the achievement of positive financial performance. saravanan & mayur (2017) examined how human capital and board composition (external and internal members) affect the financial performance of banks. the methodology of the survey included a panel analysis for a period of five years within which the operations of 40 banks in india were analyzed. the results of the study showed that the board members competence influence the rate of return on invested assets (roa). also, the study's recommendation is that the board of directors is dominated by externally elected members to ensure independence from managers. the results show that banks dominated by external board members have improved financial performance. makkonen, wiliams & habersetzer (2018) examined how national diversity and personal innovation of board members affect a company's financial performance. the sample included a large number of firms within the european union, and the data collected related to the number of patents, research projects, innovation of companies, as well as the national diversity of board members. the practical implications of the study show that greater national diversity can increase innovation, and ultimately that board members improve their efficiency and effectiveness of internal company processes with their innovation, creative suggestions, and ideas, and thus contribute to better financial performance. the paper analyzes how members of the board of directors, through their compensations, which are a factor of motivation and investment in human capital, affect the financial performance of the company. the balanced scorecard approach is applied and emphasis is placed on linking the learning and growth perspective with the financial perspective. that is, board members' compensation is viewed as human capital (hce), and the impact on the return on invested capital (roe) and the return on invested property (roa) is examined. based on the aforementioned papers, which examined among other things how members of the board of directors through their competences, knowledge, skills, abilities, which can generally be viewed as human capital, influence the financial performance of the company, and in accordance with 128 economic analysis (2020, vol. 53, no. 2, 121-132) the subject and objectives of this research, formulate research hypotheses and present a conceptual model: h2a: board members with their compensations, which are viewed as an investment in human capital (hce), have a positive statistically significant impact on the rate of return on total invested capital of the company (roe). h2b: board members with their compensations, which are viewed as an investment in human capital (hce), have a positive statistically significant impact on the rate of return on total invested assets of the company (roa). figure 1. research model source: authors research methodology based on the review of works in the existing literature, the qualitative methodology will determine whether the balanced scorecard model is applicable to the performance evaluation of the members of the board of directors, while the quantitative methodology will determine whether human capital has a positive impact on the financial performance of the company. the empirical research includes a sample of 35 companies that operate in the republic of serbia and which, according to the data of the agency for business registers, stand out in 2017 according to the realized net profit. when to comes to the criterion of enterprise size, the sample contains 32 large, 2 small and 1 medium enterprises. the structure of the sample from the aspect of the enterprise sector criteria is as follows: manufacturing industry 14, mining 2, electricity supply 5, information and communication 4, wholesale and retail 4, professional, scientific and innovation activities 1, traffic and storage 3, arts, entertainment and recreation 1, administrative and support service activities 1. data on total assets and capital are taken from the balance sheets of companies, while data on operating income, total costs and net profit are taken from the income statement of companies. information on the costs of remuneration to the members of the management and supervisory boards is available in the audit report with the financial report that is the subject of the audit. all the above reports for the selected 35 companies are available on the website of the agency for business registers. in these companies significant funds are allocated for the remuneration of the members of the board of directors, and therefore such companies are suitable for analyzing the impact of the compensations of the board members, seen as an investment in human capital (hce), on the financial performance of the company (roe and roa). a particularly useful measure of intellectual capital is the so-called vaic model (value added intellectual coefficient). according to the above model, value added (va) is obtained when from the total revenue (tr) is deducted from the total cost (tc), except for those costs related to the remuneration of the members of the board of directors, which are not treated as a cost, but as an investment in human capital. the model can be expressed quantitatively as follows (pulic, 2000): va=tr‐tc (1) hce roe roa jelena peković, stefan zdravković, goran pavlović 129 in order to determine how value is realized, all components of intellectual capital (human, structural and relational) must be considered. however, given the scope of this paper, only human capital (hce), which can be quantified when the previously determined value added (va) is divided by the total remuneration paid to board members in one year (hc), will be considered further, which can be quantitatively represented as: hce=va/hc (2) financial indicators (roa and roe) are obtained when the total profit after tax is divided by the total invested assets, that is, the assets of the company (roa) and when the net profit after tax is divided by the total invested capital (roe) (janošević & dženopoljac, 2015) descriptive statistical analysis will be applied in the work to determine the mean values, average deviation, maximum and minimum of the achieved financial performance. also, the paper applies a simple linear regression analysis to determine whether board members, through their compensation, which are viewed as investment in human capital (hce), affect the rate of return on total invested capital (roe) and the rate of return on total assets invested (roa). based on the results of the regression analysis, a decision will be made to confirm or reject the research hypotheses. data processing will be done through the statistical software "spss v.20". results of the research the study used descriptive statistical analysis to determine the mean values, average deviation, maximum and minimum of financial performance achieved. the results obtained are shown in table 2. table 2. results of descriptive statistical analysis (note: data are expressed in thousands of dinars) net earning revenue total costs board members compensations total assets capital am 5934446,2 43959398 36174268 8,150,85 85667263,77 51477942 sd 7971056,9 55239310,2 43382573,4 4,389,42 178506147 12457724 max 40455606 252112496 166423480 19,544,00 986972352 68451877 min 1880549 100 327607 1,234,00 482830 194062 source: agency for business registers, the data calculation was performed by the authors note: am‐arithmetic mean; sd‐standard deviation based on the results, it can be concluded that the companies in the sample earn on average 5.9 billion dinars of net profit, 43.9 billion dinars of business income, while the total costs are on average 36.1 billion dinars. the average allocation of funds for the remuneration of the members of the management and supervisory boards is rsd 8.1 million, the average value of assets is rsd 85.6 billion and the share capital is rsd 51.4 billion. the largest discrepancy between the observed enterprises occurs in terms of asset value, where the standard deviation value is highest. the highest net profit in the sample was rsd 40.4 billion and the lowest was rsd 1.8 billion. the largest amount of funds for the remuneration of the members of the management and supervisory board was allocated by the company, which allocates rsd 19.5 million for this purpose, and at least rsd 1.2 million. simple regression analysis is used to examine the impact of board members and their compensation, knowledge, skills and abilities, generally viewed as investment in human capital (hce), on return on invested capital (roe) and return on invested assets (roa). the results obtained through the statistical software "spss v.20" are shown in table 3 and table 4. 130 economic analysis (2020, vol. 53, no. 2, 121-132) table 3. results of simple regression analysis (dependent variable: roe) independent variable β t sig. hce 0.286* 1.712 0.096 source: authors note: * ‐ coefficients are significant at level 0,1 table 4. results of simple regression analysis (dependent variable: roa) independent variable β t sig. hce 0.307* 1.852 0.073 source: authors note: * ‐ coefficients are significant at level 0,1 as both sig. values are less than 0.1 (0.096; 0.073), it can be concluded with 90% probability that members of the board of directors, through their compensations, which are viewed as investment in human capital (hce), affect the rate of return on invested capital (roe) and the rate of return on invested assets (roa). the values of the β coefficient (0.286 and 0.307) show that the members of the board of directors, with their compensations, which are considered as an investment in human capital, significantly influence the earning capacity of the company and the efficiency of the use of assets. however, the dependent variables in the research model (roe and roa) are influenced by many factors other than human capital. discussion the board of directors represents an important internal control mechanism, as it oversees the work of managers and protects the interests of the owners of the capital by advocating for a strategy that will maximize profits. the paper analyzes the balanced scorecard model as a mechanism for evaluating the performance of board members. based on a review of existing literature and analysis of papers examining the possibility of applying the balanced scorecard model in the performance evaluation of board members (northcott & smith, 2011; hussein & mansour, 2017; hoque, 2014; chavan, 2009; domanović, 2017), as and based on the suggestion of the author epstein & roy (2004) to use the balanced scorecard model to evaluate the performance of the board members, it can be concluded that the model is applicable for evaluating the performance of the board members, so hypothesis h1 is confirmed. the empirical research involved linking the learning and growth perspective with the financial perspective from the balanced scorecard model. that is, it was investigated how the members of the board of directors influence their financial performance with their compensations, knowledge, abilities, competencies, which are generally viewed as an investment in the human capital of the company, where the most important criteria were the rate of return on invested capital and the rate of return on invested assets. the results of the regression analysis showed that human capital (hce) has a positive impact on the rate of return on total invested capital (roe) and the rate of return on total invested property (roa), so h2a and h2b are confirmed. conclusion numerous previous studies have analyzed the balanced scorecard as a model for evaluating the performance of board members. the research was predominantly of a qualitative nature. the contribution and originality of the work is reflected in the fact that the balanced scorecard model has been analyzed with the aim of linking learning and growth perspectives and financial jelena peković, stefan zdravković, goran pavlović 131 perspectives, to examine in the empirical research how members of management approve their compensation, which is viewed as an investment in human capital (hce), affect the financial performance of the company (roe and roa). also, the paper emphasizes the importance of intellectual capital as a very important resource for achieving competitive advantage. few intellectual capital surveys have been conducted on the territory of the republic of serbia, so this fact gives more weight to the research, as it indicates that the owners of serbian companies should invest significant resources in intangible resources, and that great care should be taken in choosing candidates who will be appointed to the board of directors because they, with their competencies, can have a significant impact on the financial performance of the company. theoretical implications are reflected in the extension of scientific knowledge of the balanced scorecard model, as well as the impact of human capital on financial performance. the importance of the work is reflected in the fact that it was realized at the moment when the republic of serbia is in the process of transition, which creates the basis for research in similar economies, as well as the possibility of comparing the obtained results with the results of the conducted research after the transition process of the serbian economy is completed. managerial implications are reflected in the presentation of the results obtained to businessmen and experts, who, by building a unique human capital in the company, can achieve high financial performance. owners need to recognize the importance of intangible resources and invest more substantial funds in building a unique human capital. it is well known that an economy cannot be competitive unless its businesses are competitive. it is necessary to link the microeconomic and macroeconomic aspects, and the results of the research indicate that human capital has an effect on increasing the competitiveness of companies, and on the basis of this, the competitiveness of the serbian economy is increasing. there were some limitations to the research. first of all, the survey included 35 companies operating on the territory of the republic of serbia and this sample could be larger. also, the vaic method, as a measure of the added value of intellectual capital, has some limitations (andriessen, 2011; starovic & marr, 2002). future research should increase the sample and examine the impact of human capital on other financial performance. certainly, there is still plenty of room for research in the field of intellectual capital. it is 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10.28934/ea.19.52.2.pp28-42 original scientific paper post-merger performance in financial service industry: a case of the republic of serbia dejan erić1* | ivan stošić2 | vuk dapčević3 1 belgrade banking academy, faculty of banking, insurance and finance, belgrade, serbia 2 institute of economic sciences, belgrade, serbia 3 eurobank, belgrade, serbia abstract understanding consumers’ needs implies creating an adequate offering, which leads to good and institutions after mergers and acquisitions (m&a) with foreign organisations in the republic of serbia. the main actors in these m&a activities were banks. our research and analysis cover the period from 2002 when m&a processes were intensified by the end of 2017. the results obtained indicate that the arrival of foreign banks led to the consolidation of the serbian financial services market. numerous strategic advantages have been achieved, and a lot of weaknesses from the past have been eliminated. however, when analysing the most important profitability ratios (roa, roe, nim), a slightly different picture is obtained. compared with the banks that came through greenfield investments and a group of domestic banks, this group of banks made slightly lower performances. key words: mergers and acquisitions, post-merger performance, financial service industry, banks, serbia jel classification: g21, g23, g34 introduction the arrival of foreign banks on some national financial market is a form of cross-border mergers. over the past thirty years, the permanent growth of cross-border m&a has been noticed, especially in the banking sector, which can be seen from the data presented in graph 1. a more visible rise in the volume of m&a in the european banking sector began in the 1990s. especially in the period after 1999, with certain oscillations (primarily in the period between 2001-2004 and during the global financial crisis), there is a rapid growth of m&a banks when, european megabanks such as bnp paribas, bbva, intesa bci, unicredit… emerge as megamergers. at the same time, the m&a cross-border orientation are gaining momentum. namely, when banks were left without major development opportunities on the national level, they turned to cross-border m&a. within that, the eu banks have directed a significant part of their activities to the markets of central and eastern europe countries in transition. this trend, although with a certain delay comparing to other transition countries, did not overleap serbia in which many foreign banks became present precisely through various forms of m&a’s. * corresponding author, e-mail: dejan.eric@bba.edu.rs dejan erić, ivan stošić, vuk dapčević 29 graph 1. overview of m&a in the banking sector in the period 1986-2016 source: imaa, institute for merchants, acquisitions and alliances, www.imaa-institute.org in the beginning, we need to give a few introductory remarks on the changes that have taken place in the banking system of the republic of serbia in the last twenty years. in the period after 2000, the banking sector of serbia has undergone a series of fundamental changes, of which the most significant is related to major changes in the banking ownership structure. at one point, more than 100 banks operated at the banking market in serbia, and at the beginning of 2000, 84 banks had permission to operate. almost 90% of this number were banks with predominantly state-owned capital. only a few years later, after major transitional changes, the total number of banks almost halved. the banks with a majority share of foreign capital appeared, and the share of banks with state capital was dropping drastically. the mentioned major changes in the serbian banking structure were the result of two processes that took place in parallel. on the one hand, work permits were issued to interested foreign banks, and on the other hand, privatisation of existing state-owned banks was carried out (erić, stošić & dapčević, 2018). along with an increase in the number of m&a transactions and their total value, the scientific interest of a large number of researchers willing to devote themselves to research in this field has grown. namely, a number of open questions, regarding the motives and ways of foreign banks entering into the serbian market, the benefits they bring for clients, as well as the analysis of their business success degree, were raised before them. the motivation for this research was found in the fact that so far there are not too many researches that dealt with comparative analysis of the performance of certain categories of banks within the financial system of the republic of serbia. the key issues that we have tried to answer in this paper are the following: whether, and how successful they operated after being taken over by foreign banks? whether and to what extent did the method of entering reflect on the results of their operations in the later period? what are the comparative results of the operations of individual banking sectors (domestic db, "entered" into the banking sector through greenfield investments gb and those that came through the m&a process m&a)? ultimately, but not least, the post-merger performance of banks in the serbian financial market? the text is organized in several parts. in the first part, we presented a review of foreign and domestic literature in the field of m&a performance studies. the second part presents an overview of the research methodology and the sample used for analysis. the third part of the paper is devoted to a comparative statistical analysis of the basic business performance of 0 20 40 60 80 100 120 0 100 200 300 400 500 600 700 800 900 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 t ra n sa c ti o n s v a lu e (b n e u r ) n u m b e r o f tr a n sa c ti o n s global mergers and acquisitions in the banking sector 30 economic analysis (2019, vol. 52, no. 2, 28-42) certain segments of the banking sector in serbia. finally, in the fourth part of the paper, within the conclusions, the assessment of the performance of certain segments of the banking sector of serbia was presented, with a special emphasis on the analysis of the operations of banks created through the m&a process. literature review mergers and acquisitions (m&a) analysis in the financial sector attracts the attention of a large number of researchers. over the past twenty years, a significant number of researches were focused on the issue of these activities in the banking sector of transition countries. namely, during the period of intensification of the process of globalisation, especially from 1995-2006, about one-third of m&a’s of western european banks pertained to their transactions in european countries in transition (report on financial structures, 2016). this has led to an intensification of research into the motives, goals, and success of these m&a’s. on the banking market of the countries in transition, including the countries of south-eastern europe, reforms that were reflected in the privatisation of state banks and the opening of the domestic financial sector to foreign investors were implemented. consequently, in a relatively short period, foreign-owned banks became dominant in practically all central and southeast european countries. this trend has been present since the middle of the last decade of the last century to the present day, which can be seen in the following table: table 1. the trend of foreign banks ownership shares growth central europe southeast europe period/ rate % 1995 2000 2005 2010 period/ rate % 1995 2000 2005 2010 czech republic 15.5 65.4 84.4 84.8 bulgaria <1 75.3 74.5 84.0 hungary 36.8 67.4 82.6 81.3 croatia <1 84.1 91.3 91.0 poland 4.4 72.6 74.3 72.3 romania <1 46.7 59.2 84.3 slovakia 32.7 42.7 97.3 91.6 serbia <1 <1 66.0 72.5 slovenia 4.8 15.3 22.6 29.5 source: bonin et al. (2014) two basic groups of factors decisively influenced these two tendencies. on the one hand, it is a matter of extensive transitional changes in the poorly developed banking markets of the central and eastern europe countries, characterized by intense privatization and restructuring processes (bonin et al., 2005, estrin et al., 2009) and the ability of foreign "players" to enter these markets. on the other hand, there are "internal" factors that have determined the operation of banks in national markets. this was primarily related to the limited possibilities of achieving higher profits, the growth and expansion prospects through the conquest of new markets and the rapid increase in the placement of services, the implementation of economies of scale, risk diversification, customer tracking, etc. in addition to researching the motives and goals for m&a implementation, another attractive area for researchers was to analyse the effects of m&a transactions undertaken, and the assessment of their performance. namely, a large number of banking m&a in the developed countries has not yielded the expected results. the 2003 merrill lynch and the 2001 capgemini studies have shown that from 1990-2000, large bank deals have performed worse than smaller ones and that 50 per cent of financial services mergers eroded shareholder returns (moyer, 2009). dejan erić, ivan stošić, vuk dapčević 31 there are different ways to measure the performance of post-merger integration activity in the banking industry. very often, this is done by comparing the banks business performance before and after m&a. surprisingly, most studies that compared performance before and after the merger process did not reveal improved performance. in the study (ferrier et al., 2013), over two thousand m&a in the us were analyzed between 1988 and 2009, and it was empirically determined that the performance of banks after a status change, in many cases did not improve, but on the contrary deteriorated. other surveys (kama, 2007) pointed to opposite results in banks' business after m&a. two papers that proved that banks with majority foreign capital operated more effectively than domestic competitors are the best evidence that there are very contradictory opinions on the post-merger profitability of banks. thus, bonin et al. (2004) in their work on the sample of 67 banks in the economies of the six transition countries (bulgaria, czech republic, hungary, croatia, poland and romania) in the period from 1994 to 2002 show that foreign-owned banks are cost-efficient and provide a higher level of service than domestic banks. kraft et al. (2006) confirmed this thesis, indicating higher efficiency of banks in majority foreign ownership in croatia in relation to domestic banks. the analysis covers the period from 1994 to 2000 on the market where 43 banks operated. the mentioned authors conclude that the findings from work certainly support the justification of the process of selling state-owned banks to foreign strategic investors or the opening of the local market for the entry of foreign banks. fixer & zieschang (1993) stated that there are “three measurement methodologies on bank efficiency: the econometric frontier approach, the data envelopment approach and the thick frontier approach” (fixer & zieschang, 1993, p. 438). through these three approaches, the evaluation of the technical and allocative efficiency of banks is carried out. in order to improve and operationalise, they went a step ahead and developed the “index number approach” that takes into account all three approaches. unfortunately, this index is inapplicable in our conditions. the main reason lies in the lack of adequate data, especially ones from the financial market, which is still “shallow” and “narrow”. hence, the focus of the research in this paper is somewhat narrower than the area of application of the mentioned approach. according to altunbas & ibáñez (2004), the analysis of the post-merger performance of banks practices two types of empirical methods. the first relates to an analysis of the performance of newly created institutions by comparing the movement of their most important financial indicators in the financial statements. the second refers to the analysis of changes in the value of certain parameters in the financial markets. generally speaking, all m&a effects studies involve two sets of methodological approaches: event studies and comparisons of pre-merger and post-merger performance (erić, stošić & dapčević, 2018). event studies predominantly focus on the impact that the m&a announcement has on stock price movements. based on a sample of 1,320 european m&a conducted between 2003 and 2012, alsharairi et al. (2012) studied the different post-merger performance and process implementation effects. one of the newer papers in this group is the research by kyriazopoulos, drymbetas (2015), which includes a sample survey of 118 m&a transactions conducted in europe between 1996 and 2010. they compared the stock price movements on the day of the transaction announcement and after a certain period (3 and 10 days after the event). it was shown that the prices of the shares of the banks that were the target of the takeover had positive returns above the average, while the shares of the banks that initiated the m&a processes did not significantly respond. for the application of this methodology, a necessary precondition is an efficient capital market and a large number of publicly available information. this group of methods is hardly applicable in the domestic financial system, where the capital market is still in its initial phase of development, with low transparency and low liquidity. 32 economic analysis (2019, vol. 52, no. 2, 28-42) the second group of methods is related to the analysis of the financial performance of the combined banks before and after the realised transaction. hagendorff et al. (2008) in their study suggest that shareholders of the bank that undertakes acquisitions (or mergers), expect to be rewarded for taking the risk of entering into these operations, especially if these operations take place outside their home countries. huizinga, nilissen & vander (2001), on a sample of 52 horizontal european banking mergers, showed that these activities led to an increase in cost efficiency, but not a significant increase in profitability. the period in which m&a activities were analyzed was from 1994-1998. the results showed that the effects of economies of scale were achieved, which affected the reduction of total costs and increased operational efficiency. however, the vast majority did not lead to a significant improvement in financial performance, above all, profitability. most authors who were researching post-merger performance observed them based on profitability comparison a couple of years after the transaction was completed. according to vennet (1996), “the traditional measures of profitability are return on equity (roe) and return on assets (roa)”. according to this author, in the analysis of banking performances roe requires a special review, bearing in mind that “bank capital funds are subject to capital adequacy standards” (vennet, p. 1537). he points out that the level of costs and revenues strongly influence the profitability of banks. in his analysis, which covers the sample of 492 acquisitions realised in the last decade of the 20th century (of which 70 were cross-border), he uses certain ratio related to their movement (labour cost ratio and operating expense ratio). his analysis showed that in the short run, cross-border m&a does not bring a significant increase in profitability. this is explained by the need for larger investments, more aggressive appearance in new markets, which has implications on the level of interest rates, i.e. revenues and expenditures. kemal (2011) has a similar approach to measuring post-merger profitability. he uses public data from the financial statements by calculating the appropriate ratio on the royal bank of scotland case, following the takeover of a local bank in pakistan. this author compares a group of profitability ratios a few years before the m&a transaction and a few years after takes the following ratios roa, roe, gross profit margin, net profit margin, pre-tax profit margin and operating profit margin. the study covered only one bank, and the results unambiguously showed that the mentioned m&a did not lead to increased profitability. the process of mergers and acquisitions in the banking sector of serbia was the subject of research by a number of domestic authors (dinkić & jelašić 2001; kontić & kontić, 2009; janjić & lukić, 2009, marinković & ljumović, 2011; barjaktarević & paunović 2012; erić & đukić 2012, savović 2016, dimić & barjaktarević 2017, erić, stošić & dapčević 2018, etc.). a large number of these papers dealt with the mergers and acquisitions within the banking sector of serbia in the light of transition and privatisation, and they mainly point to numerous changes (and benefits) brought by the entry of foreign banks (e.g. eric & stošić, 2012; stošić & domazet 2014). a part of the papers focused on the analysis of the motive for the foreign bank's acquisitions on the local market. according to the research (marinković et al., 2011, pp. 527-528) the most important motives at the time of deciding on the entry of foreign banks into the serbian market, derived from the theory of profit growth and the use of market opportunities. that is a search for new clients, high competition on the market of the country of the capital origin, high-interest margin, as well as the unused borrowing potential of enterprises and the population on the capital market. the rank of the motive changed after entering the market, and at the time when the survey was carried out. as the most important individual factors, risk diversification, highinterest margin, unused borrowing potential of companies and population in the capital market, as well as the search for new clients, have arisen (domazet & stošić 2013). according to the authors' findings, the problems of comparative analysis of bank performance, depending on the model and origin of ownership, were not subject to studies that are more dejan erić, ivan stošić, vuk dapčević 33 detailed. this is precisely the focus of this paper, above all, with the aim of identifying the degree of success of the post-merger performance of the banking sector of serbia. methodology of research and sample for this work, the official balance sheet data of banks that operated in the banking sector of serbia in 2004 were used. the sectoral averages, according to the indicators, were calculated based on aggregate balance data published on the national bank of serbia (nbs) website. the survey sample represents 18 major banks, with an individual market share of more than 1% of the balance sheet assets of the banking sector at the end of the observed period. the sample excluded banks with negligible market share (less than 1% of the balance sheet assets of the banking sector), that is, banks that withdrew from the market or were shut down during the observed period. at the end of the observed period, 18 banks from the sample accounted for 95% of the total balance sheet assets of the serbian banking sector. for comparison, in 2012, they participated with 91%, in total assets; 2008 89%, 2005 80%, and in 2004 they accounted for 74% of the total balance sheet assets of the banking sector. by pointing to this data, we want to underline the fact that this is a representative sample. on the other hand, a tendency of concentration within the banking structure of serbia can be perceived at the very beginning. banks are divided into three groups based on the ownership structure and the way of creation. in particular, we took care to identify the group of banks that had significant m&a activities in the mentioned period. therefore, the subject of research in this paper consists of three groups of banks: • i group foreign banks that entered the serbian banking market through a greenfield or the purchase of an existing domestic small bank, which practically represents greenfield investment (gf). • ii group foreign banks that have entered the market by purchasing or merging with existing private or state banks, or essentially through the real mergers and acquisition (m&a), and • iii group domestic banks in state and private ownership (db). the first group includes all foreign banks that entered the serbian market through the gf or the purchase of an existing small bank to obtain a license for doing business and afterwards did not participate in significant m&a. this group consists of1: société générale bank (gf / 1977 – representative office/ 1991 corporate/ 2001 retail), raiffeisen bank (2001 gf), procredit bank (2001 gf), hvb/unicredit bank (2001 gf/ 2005 eksim bank), hypo /addiko bank (2002 deposit bank), volks/sber bank (2003 trust bank). the second group includes foreign banks that have entered the market by purchasing existing private or state-owned banks with a significant market share, or through massive privatisation of state-owned banks. this group includes2: banca intesa (2005 delta bank, 2007 panonska bank), eurobank (2003 post bank, 2006 national savings bank), alpha bank (2005 jubanka), vojvođanska bank (2006 nbg bank, 2017 otp bank), otp (2006 niška, zepter, kulska bank), 1 note: in 2001, two more gf licenses were issued to greek banks, namely alpha and nbg. these banks subsequently participated in large privatizations of state banks, and were in another group of foreign banks. 2 due to the fact that there is a limited availability of the available balance sheet data for the banks that merged, for the period before the m&a, the following available balance sheet data were used during the analysis: national savings bank for eurobank before 2006, kulska banka for otp before 2006, vojvođanska bank for nbg -vojvođanska before 2006, jubanka for alpha bank before 2005, continental bank for nlb bank before 2006. 34 economic analysis (2019, vol. 52, no. 2, 28-42) erste bank (2005 novosadska bank), credit agricole bank (2005 meridian bank), piraeus bank (2005 atlas), nlb/lhb bank (2003 lhb bank, 2006 continental bank). the third group includes domestic banks in state and private ownership (db). this group consists of only three domestic banks in the sample: 1. komercijalna bank, 2. aik bank and 3. poštanska štedionica bank. at the end of the observed period, they stand for a representative sample with over 95% of the assets of domestic banks, while the remaining domestic banks are not statistically significant (jubmes, mts bank, srpska banka, as well as direktna bank, which becomes significant only after the observed period and the takeover of piraeus bank). performance of the banking sector of serbia in the period 2004-2017 profitability indicators in the general assessment of profitability trends measured through asset yield (roa), there is high volatility during the analysed period. perhaps surprisingly, it is noticeable that at the very beginning of the observed period, domestic banks achieved high profitability rates, while both categories of foreign banks were below the average. the reason for lower profitability indicators for a group i gf banks is, among other things, the sharp rise in assets, while in the other group of banks m&a is characterised by high reserves and high operating costs, which also diverts the sector average into a negative zone. nevertheless, it should be noticed that the reason for a slightly higher profitability indicator with domestic banks lies partly in the fact that the sample of domestic banks was "purged" of bad banks that went into bankrupt during the period. graph 2. comparative overview of profitability indicators – return on assets (roa) in the period 2004-2017 note: roa return on assets=pbt*/avg. assets *pbt available instead net profit; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.html however, since 2006, gf banks have begun to achieve top-up profitability. in contrast, the m&a group of foreign banks had a profitability level that was below the market average throughout the analysed period. particularly unfavourable results of m&a groups of foreign banks were recorded in 2013, when the overall average of the entire banking sector was negative, due to the loss of m&a banks (primarily due to high reserves and operating costs). since the relationship between capital and assets for all banks is fairly stable and moving in the same ratio, the other important parameter of measuring the profitability of banks return on equity (roe) has moved in approximately the same range. namely, as well as the previously analysed profitability indicator roa, return on equity (roe) also shows volatility in the -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 roa banking sector domestic greenfield&licence m&a dejan erić, ivan stošić, vuk dapčević 35 observed period. the average of the sector at the beginning of the period is in the negative zone on account of the loss of the m&a group of banks due to the high provisioning and operating costs, which was repeated in 2013. when it comes to returning on equity (roe) of the m&a group of banks, it is below the average of the total banking sector of serbia in the observed period. even when this group operated in a positive zone, there was a constant presence of high reservations and operating costs, which reduced profit. the presence of high reservations and operating costs, in particular, state-owned domestic bank, dropped the average of this category during 2006 and 2007 into a negative zone, which was repeated at the end of the observed period. during the period, foreign gf banks mainly showed higher profitability (except for 2005 due to high operating costs) because they were not burdened with high reserves and costs associated with m&a activities. in achieving this result, they were not hindered by the constant significant increase in capital compared to the other two groups, which was especially expressed in the first half of the observed period. graph 3. comparative overview of profitability indicators return on equity (roe) in the period 2004-2017 note: roe return on equity=pbt*/avg. equity *pbt available instead net profit; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.html www.nbs.rs similar to the previous two ratios, the third key profit indicator net interest margin (nim) has diverse values over the period observed. what is generally observable is that highly capitalised banks, as well as banks oriented to retail and entrepreneurial jobs, achieve better value for this indicator. the reason is that capital does not generate interest expense, and the retail sector on average has a higher interest income. the nim analysis for three groups of banks points to very different values. domestic banks, as already established on the market, with a large client base in the retail sector, earn high net interest income (except for 2007, when the lower net interest income of top performers in this segment pushes the indicator down to the average). on the other hand, the sharp rise in foreign banks' assets affects below the average results of gf and m&a banks in the period after the takeover of local banks. the reverse effect for these two groups of foreign banks has aforementioned the deleveraging process that took place in 2013. -40,0% -30,0% -20,0% -10,0% 0,0% 10,0% 20,0% 30,0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 roe banking sector domestic greenfield&licence m&a 36 economic analysis (2019, vol. 52, no. 2, 28-42) in the last third of the observed period, increased competition on the market, as well as historically low-interest rates, pushed this indicator downwards and make all three categories of banks correlate with the average. conducted analysis of key profitability ratios of the banking sector indicates the high profitability of the domestic banking sector until the outbreak of the global financial crisis. after that, there is a sharp decline in profitability for all three groups of banks observed. the profitability of banks after the crisis was not at a satisfactory level. this was also contributed by the high share of "bad" loans (npl in certain years ranged to more than 20%). as a rule, such placements demanded far larger reserves (provisions), which immediately affected the decline in profit (net income), which further affected the decline in return on assets. at the same time, interest income decreased, which unfavourably affected the overall profitability of the banking sector. graph 4. comparative overview of profitability indicators – net interest margin (nim) in the period 2004-2017 note: nim = net interest income/ avg. interest bearing assets; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs a comparative analysis of the performance of certain groups of banks points to different results in different periods. however, it can be noted that in the initial period, 2004-2007, domestic banks were the most successful, and this primacy was later taken over by the group of gf banks. a particularly surprising finding of our analysis is that the banks that have occurred through m&a activity, with a few exceptions in certain years, were generally the least profitable. in particular, we emphasise that in some years, their unfavourable results led to negative trends in profitability for the entire banking sector of serbia. performance indicators to analyse the efficiency, as illustrative, we have investigated the cost/income ratio for all three groups of banks. the second group of banks that participated in m&a activities had a higher cost/income (c/i) indicator over the entire observed period, which indicates lower efficiency. this finding corresponds fully with the previous one. namely, lower efficiency consequently leads to lower profitability. the reason for this is the fact that m&a activities generate significant operational costs during the m&a itself, but also in the post-merger period. these costs relate to consulting costs, information systems integration, a surplus of employees, re-branding, marketing costs, etc. 0,0% 2,0% 4,0% 6,0% 8,0% 10,0% 12,0% 14,0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 nim banking sector domestic greenfield&licence m&a dejan erić, ivan stošić, vuk dapčević 37 in contrast, domestic and gf banks showed better efficiency for most of the observed period. graph 5. comparative overview of efficiency indicators in the period 2004-2017 note: cost/income= operating expenses/ operating income; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs indebtedness/solvency indicators at the beginning of the observed period, one of the most important indicators of indebtedness d/e (debt to equity) is higher than the average for the gf group of banks. the main reason for this lies in the fact that these banks financed the rapid growth of the loan portfolio from borrowed funds while retaining the existing amount of capital, unlike m&a banks, which, due to acquisitions, reached high levels of capital. the prudential regulation of the central bank and the measures from 2007, which conditioned further credit expansion by the amount of mandatory capital, lead to the equalisation of this indicator for all three categories over the observed period. graph 6. comparative overview of indebtedness indicators (debt/equity) in the period 2004-2017 note: total debt to equity = debt/equity; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs 0% 20% 40% 60% 80% 100% 120% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 cost/income banking sector domestic greenfield&licence m&a 0,00 2,00 4,00 6,00 8,00 10,00 12,00 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 debt/equity banking sector domestic greenfield&licence m&a 38 economic analysis (2019, vol. 52, no. 2, 28-42) the solvency of banks is best reflected through the amount of the reserves for non-performing receivables. at the beginning of the observed period, domestic banks have the above-average cost of reservations, due to the burden of poor placements from previous years. the second category, m&a banks, due to the takeover of banks with a certain level of bad placements, had a higher indicator than the average, but due to more stringent credit policies and faster growth of assets relative to domestic banks, it quickly returned to the sector average. during 2013, the m&a group of banks saw remarkable changes in the balance sheet and growth in provisions for bad placements, and a similar rise in reserves is occurring in 2016 with domestic banks, especially those in state ownership. gf banks record the lowest indicator during the observed period, since they entered the market without varying load, or with "clean" balances. subsequently, more stringent credit policies and strong portfolio growth contributed to keeping this solvency indicator below the sector average. graph 7. comparative overview of solvency indicators (provisions/expenses) in the period 2004-2017 note: provisions expense=provisions/avg. loans; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs capital adequacy indicators the banking sector of serbia is well capitalised, first of all, keeping in mind the prudential requirements of the regulator. in almost the entire period of analysis, the prescribed minimum for the capital adequacy ratio, according to the provisions of the national bank of serbia was 12%, which was above the average comparing to the countries of the european union. the reform of the entire banking sector at the beginning of 2000 aimed at creating a stable financial sector, which over the period under review managed to resist external shocks caused at first the by the global economic crisis, 2008-2009, and subsequently by the greek external debt crisis since mid-2010. during the entire observed period, the capital adequacy indicator is significantly above the prescribed minimum, with the performance of domestic banks additionally above the average. as noted, a sample of domestic banks was purged of problematic and bad banks that went bankrupt during the period, which, if included in the sample, would correct the indicator downwards. in particular, we emphasise that too high capital adequacy has its implications in terms of profitability, which has already been elaborated before. 0,00% 5,00% 10,00% 15,00% 20,00% 25,00% 30,00% 35,00% 40,00% 45,00% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 provisions expenses ratio banking sector domestic greenfield&licence m&a dejan erić, ivan stošić, vuk dapčević 39 graph 8. comparative overview of capital adequacy indicators in the period 2004-2017 note: *data published by banks individually / prior to 2006, there was generally the practice to descriptively indicate in the bank's annual reports, that this ratio is above the prescribed rate of 12% without quotation ratio; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs finally, we will note that liquidity indicators are not counted, as there is no uniformity in the expression of the most important liquidity ratio. the second reason lies in the fact that this indicator is not available for the whole period since the nbs started publishing it only since 2008. conclusions one of the key areas of transit processes in almost every country on the path to establishing market economy mechanisms is related to reforms in the field of the financial services industry. in this respect, a particularly important area refers to structural changes in the banking system. almost all countries in central and eastern europe have undergone these processes. as a consequence, we had changes in the banking structure in which some domestic, especially inefficient and bad banks disappeared. on the other hand, the market share of the foreign banks, which have proven to be more efficient, more flexible as the bearers of technological development and other innovations, has increased. the banking sector of the republic of serbia experienced major changes after 2000. the total number of banks has diminished; some of the formerly large and well-known banks have been liquidated, foreign banks have emerged. the processes of foreign banks' entry took place in one of two ways through greenfield investments (gf) and buying, taking over, merging with domestic banks (m&a). the focus of our research in this paper is aimed precisely on the analysis of the post-merger performance of this segment of banks. entry through m&a activities allows foreign banks some advantages in local markets. they are primarily related to the collection of new deposits, the expansion of the client base and the built-in organisational network, which can enable them to grow rapidly (ljumović et al., 2015). the conducted research and analyses in this paper generally point to the fact that the operations of m&a banks were successful. this is the result of the effects that have been achieved on the scale, scope, rationalisation of organizational and transaction costs, and the efficiency of management and organization. however, on the other hand, when the profitability of this group 0 5 10 15 20 25 30 35 40 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 capital adequacy banking sector domestic greenfield&licence m&a 40 economic analysis (2019, vol. 52, no. 2, 28-42) of banks is compared with the other two categories of banks (gf and db), it is evident that m&a banks were slightly lower in performance. this is primarily reflected in a regular review of roe and roa ratio movement that is lower with the m&a group of banks. the reason lies in the fact that m&a activities generated more operational costs, as well as the takeovers of domestic banks with npl legacy, which consecutively increased the provisioning cost and influenced lower profitability. with the nim indicator, this difference is not so obvious, primarily because strong competition on the market has balanced the interest income of market participants, with partial rebounding of domestic banks. the reason for this is that domestic banks increased their interest-bearing assets at a much slower pace in relation to foreign banks, as well as previously stated that the sample of domestic banks was "purged" of bad banks that went bankrupt during the period. analysing the individual segments of efficiency, we noticed that banks that conquered the domestic market through m&a had poorer performance compared to the other two categories. namely, m&a banks had a higher c/i indicator over the entire observed period, because m&a activities generate significant operating costs both during the m&a process and in the postmerger period. only the process of integrating information systems can last for years, and by the way, generate quite high costs. in contrast to m&a banks, domestic and gf banks showed better efficiency because they were exempt from these costs. m&a banks lagged behind gf banks in the solvency segment, as with the domestic banks acquired, the burden of legacy npl from previous years also came along. in this segment, m&a banks were not the worst, since more flexible domestic banks credit policy, impacted their highest index of reservation costs in the observed period. due to the prudential requirements of the regulator, all categories of banks were well capitalised and displayed capital adequacy that is significantly above the prescribed minimum. to better understand the results of the analysis, it is important to take into account the particularities of the serbian market from the perspective of customer loyalty to banks. namely, due to developments in the sector during the 1990s, when the client's confidence in the banking sector in serbia was quite ruined, a lower level of customer loyalty to banks was noticed. this is reflected in the fact that foreign banks from the gf category were able to relatively quickly increase their clientele and placements without having to participate in expensive acquisitions, which directly affected their profitability. finally, it should not be forgotten that in the middle of the observed period, the global economic crisis, which spilt rapidly on the domestic economy, also suddenly stopped the credit expansion, reducing revenues and increasing the number of npls. here lies another reason for the poor performance of m&a banks, since in the post-merger period, m&a banks should, among other things, bring profit growth, their flight stopped because credit activity was almost frozen, and on the other hand, all operating costs related to the m&a transaction remained, now combined with the effect of increasing the provision for non-performing loans. with this kind of ballast, m&a banks were hardly able to do better. acknowledgements this paper is a part of research project no. 179015 (challenges and prospects of structural changes in serbia: 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(1996). the efect of mergers and acquisition on efficiencz and profitability of ec credit institutions, journal of banking and finance, 20, pp. 1531-1558 article history: received: april 22, 2019 accepted: november 25, 2019 microsoft word 2011_1-2 original scientific paper    peer‐to‐peer networks and complementary goods:   the impact of openness and innovation on profitable piracy   le texier thomas *, université de rennes 1, france   gordah maher, université de nice – sophia antipolis, france   udc: 339.188.4    jel: f1        abstract – file‐sharing  is often depicted as detrimental to traditional commercial activities  and tends to dissuade official digital goods’ producers from innovating. meanwhile, evidence shows  that producers are likely to provide complementary hardware goods that are compatible with digital  goods available both offline and online. this article  investigates to what extent the  introduction of  peer‐to‐peer networks has a positive impact on the level of profits reached by producers.   our model shows that the file‐sharing activity does not crowd the official digital goods producers  and hardware goods producers out of the market. moreover, we find that there exists suitable quality‐ based strategies so that both types of producers benefit from the file‐sharing activity. the utility that  peer‐to‐peer networks provide to file‐sharers has to be considered cautiously for commercial firms to  gain positive outcomes from the file‐sharing activity.    key words: peer‐to‐peer networks, piracy, complementary goods, communities  introduction  the emergence of the internet as a new transactional space has deeply changed the way  consumers, producers and distributors  interact and has  therefore  led  to several economic  research tracks over the last decade. the development of new compression standards marks  a  significant  step  in  the  development  of  economic  analyses  related  to  the  internet,  thus  highlighting the transition to the ‘dematerialization era’ which leads to the widespreading of  digital files online and to new technological adoption issues (shapiro and varian, 1999; peitz  and  waelbroeck,  2006a).  the  consumption  of  such  digital  goods  is  more  particularly  facilitated by the emergence of new electronic platforms relying on specific organizational  models,  namely  peer‐to‐peer  networks  (krishnan  et  al.,  2003,  2004,  2007),  as  well  as  the  increasing abilities of users to participate in productive activities (toffler, 1980; von hippel,  1988;  von  hippel,  2005;  flowers,  2008).  the  increasing  use  of  computers  and  the  democratization of high‐speed broadband help internet users to get access to digital files,  thus  contributing  to  the  increasing  popularity  of  such  file‐sharing  networks.  as  an  illustration, the peer‐to‐peer activity nowadays represents 37% of the internet global traffic,  and  gradually  leads  to  the  emergence  of  new  networks,  like  fasttrack,  edonkey2k  or  bittorrent which have superseded the late napster.                                                         * université de rennes 1, crem – umr 6211 cnrs, 7, place hoche, 35065 rennes cedex, france, e-mail: thomas.letexier@univ-rennes1.fr      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   16 the popularity of the file‐sharing activity, as far as it is widely adopted online, is in many  cases perceived by commercial entities – producers and vendors – as a direct threat for their  own activities  which  would affect  their  perenniality on  markets  they historically used  to  control  (bourreau  and  labarthe‐piol,  2004).  as  such,  the  introduction  of  peer‐to‐peer  networks would represent a convenient way for users to get access to and acquire digital  goods without having to pay pecuniar fees. these considerations tend to define peer‐to‐peer  networks as intermediaries improving the consumption of digital goods by enhancing piracy  online and by altering the level of profits reached by commercial digital goods’ stakeholders.  in other terms, such arguments tend to state that the activity of commercial‐based networks  and peer‐to‐peer networks are substituable and that there does not exist any complementary  relationship beneficial that is for both of them. as a consequence, facing the popularity of the  file‐sharing activity, the technological  innovation efforts made by digital goods producers  would appear to be vain and costly.   yet, this point of view may have to be qualified, since recent research topics dealing with  internet activities have on the contrary revealed positive external effects between traditional  and  new  consumption  models  and  have  proved  that  the  emergence  of  new  distribution  channels may improve their profitability. for instance, evidence and economic analyses have  shown  that  offline  and  online  commercial  activities  are  likely  to  be  both  preserved  and  valuated  through  the  setting  up  of  specific  strategies  for  each  of  them  (brynjolfsson  and  smith, 2000; bakos, 2001; curien and moreau, 2004). economic studies dealing with open  source  software  research  tracks  have  also  underlined  the  existence  of  such  beneficial  relationships.  whereas  open  source  software  projects  were  previously  considered  as  competitors by software firms, the evidence of recent hybrid software development models  today exhibits new potential benefits  in a  framework  in which open source software and  commercial actors cooperate (dahlander and magnusson, 2005; bonaccorsi et al., 2006; shah,  2006).  the impact of piracy on the valuation of the traditional commercial‐based activities the  file‐sharing activity naturally  implies has yielded several major contributions, underlining  the importance of network effects in the outcome of producers (liebowitz, 1985; besen and  kirby, 1989; conner and rumelt, 1991; takeyama, 1994; king and lampe, 2003). focusing on  digital  goods  (peitz  and  waelbroeck,  2005;  liebowitz,  2006),  empirical  studies  reveal  contrasted results, as some scholars exhibit a detrimental effect on commercial actors’ profits  (peitz and waelbroeck, 2004; liebowitz, 2005; zentner, 2006) while others on the contrary  underline  a  beneficial  one  (oberholzer  and  strumpf,  2004).  the  piracy‐related  literature  usually  links  piracy  to  the  widespread  online  diffusion  of  digital  files,  thus  presenting  “sampling” as a way of enhancing the popularity of commercial digital goods (bounie et al.,  2005; peitz and waelbroeck, 2006b) as well as that of the artists concerned (gayer and shy,  2006; gopal et al., 2006). finally, some authors show that enhancing piracy and digital goods’  diffusion online have to be considered with the ensuing externalities resulting from the sales  of  complementary  goods.  more  particularly,  even  though  piracy  may  be  detrimental  for  digital goods’ producers, the diffusion and the unauthorized consumption of digital files are  likely  to  increase  the  level  of  profit  of  the  producers  providing  the  hardware  products  needed to use any digital goods (i.e., original or pirate ones) (gayer and shy, 2006). as such,  piracy‐related  studies  highlight  that  piracy  does  not  necessarily  represent  a  source  of       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     17 disutility but can also be used as a strategic tool for producers to increase their surplus (shy  and thisse, 1999; poddar, 2005). we actually do find evidence of such complementary goods  strategies through the actual provision of physical hardware terminals aiming at exploiting  both original and pirate digital goods. several well‐known companies (e.g., sony, philips or  pioneer) offer hardware products compatible with both official and ‘less official’ standards,  thus potentially casting on piracy to sell complementary and impossible‐to‐reproduce goods.  one may hence think, notably on account of the current popularity of apple and its ipod  players’ offer,  that using piracy  to enhance complementary sales  is a pertinent  industrial  strategy.     although  the  literature associating general  information economics  topics  (e.g., dealing  with network effects) with piracy ones has already led to a large number of contributions,  few  studies  have  dealt  with  the  impact  of  peer‐to‐peer  networks  on  the  diffusion  of  unauthorized digital goods and its market‐based consequences on traditional producers. it is  generally shown that the activity of peer‐to‐peer networks can improve the level of sales of  the products generally sold in stores under specific conditions (gayer and shy, 2003a; gopal  et al., 2004, rochelandet and le guel, 2005). the popularity of such file‐sharing networks  and the increasing interest these are currently arousing nevertheless require further analyses  to be carried out. studies related to the activity of peer‐to‐peer networks  in a managerial  framework notably stress that file‐sharing networks differ in their degree of openness, that is  the community‐based – non‐financial – benefits users derive from the file‐sharing activity.  the acquisition of unauthorized digital goods is therefore not as easy as it is often described,  since  access  and  participation  appear  to  be  regulated  by  somewhat  internal  policies  (asvanund et al., 2001; cunningham et al., 2004), thus impacting on the level of the goods  distributed online (domon and yamazaki, 2004). one key issue would therefore be to take  into account the organizational specificities on which file‐sharing networks are based so as to  see to what extent their activity may be profitable for producers.    we identify to what extent the level of openness of peer‐to‐peer networks may have a  positive impact on the level of profits reached by traditional producers. we notably develop  a  model  in  which  we  consider  two  types  of  producers,  each  evolving  in  a  monopoly  framework: digital goods producers and hardware producers. digital goods are available for  consumption in official or pirate form. such two types of digital goods differ in their quality,  as  pirate  digital  goods  are  likely  to  be  less  qualitative  than  official  ones  usually  are.  customers differ in their levels of preference for quality and have three adoption strategies:  official digital goods’ adoption and complementary hardware purchase, pirate digital goods’  adoption and complementary hardware purchase, or non‐adoption.  our  results  stenghten  the  ‘beneficial  complementary‐based  activity’  hypothesis  previously  highlighted  in  the  literature.  in  a  context  in  which  the  file‐sharing  activity  is  introduced,  we  point  out  that  the  official  digital  goods  firm  is  always  able  to  sell  their  products, and that the hardware goods firm  is not motivated to crowd the official digital  goods producer out of the market. moreover, the hardware goods producer intends to deter  non‐adoption  patterns  while  the  digital  goods  producer  –  fully  or  partially  –  serves  the  market. as such,  the existence of  peer‐to‐peer networks  is not  likely  to evict commercial  players from the market. moreover, our qualitative analysis aiming at measuring the impact  of the file‐sharing activity on both types of commercial activities reveals positive effects. as     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   18 such, we suggest  that  the  losses perceived by  the official digital goods  firm are  likely  to  result from the setting up of inappropriate quality‐based strategies according to the degree of  openness that file‐sharing networks may deliver. we thus underline that commercial‐driven  innovative efforts should cautiously be considered, according to the degree of openness file‐ sharing  communities  exhibit.  our  model  therefore  shows  that  the  diffusion  of  non‐ authorized digital goods may be enhance the outcomes of commercial producers, provided  that firms set up appropriate strategies to gain from a so‐called ‘outlaw’ activity (flowers,  2008). our findings tend to qualify the relevancy of the recent local policies that have been  initiated  by  the  recording  industry  association  of  america  targeting  the  file‐sharing  networks whose degree of openness is too high.  the  organization  of  this  paper  is  as  follows.  we  first  present  the  model.  second,  we  analyze the levels of price, quantity and profit that are obtained by the two producers when  the  file‐sharing activity does not apply. third, we analyze  the market structures  that are  likely to emerge when the file‐sharing activity is introduced, as well as the levels of profit  that  commercial  players  obtain  from  it.  fourth,  we  study  the  impact  of  the  file‐sharing  activity  on  commercial  ones  and  identify  potential  commercial  opportunities.  fifth,  we  conclude and provide directions for further research.  the model  we first present the properties of the market we consider, as well as the nature of the  goods  (i.e.,  digital  goods  and  hardware  goods)  on  which  we  focus.  we  then  present  the  demand side and the supply side that we take into account in the model.  digital goods, hardware goods and the market  we present a market in which technological users may adopt a digital good available in  two versions: official digital goods and pirate digital goods. users have to pay a fee ( 0 0p > )  if they adopt official digital goods while they do not have to incur any pecuniar cost if they  adopt pirate digital ones. in addition, technological adopters need to purchase a hardware  good so as to use the digital goods previously acquired. as such, digital goods and hardware  goods appear as complementary goods. moreover, as opposed to digital goods, which have  immaterial properties  that  facilitate piracy and unauthorized distribution on  the  internet,  hardware goods provide material characteristics that disable any copying schemes.  as opposed to some studies (e.g., gayer and shy, 2003b), we do not restrict our analysis  to the case of software and do not consider software‐related compatibility network effects.  we consider digital goods  in the forms these are usually  likely to appear on peer‐to‐peer  networks  online,  such  as  music  files,  video  files,  text  files,  etc.  our  model  applies  in  an  extreme  framework  in which peer‐to‐peer networks only provide  pirate digital goods,  in  respect with the argumentation of the majors who consider that digital goods available on  file‐sharing networks are unauthorized ones.       technological adopters  we set the size of the population of potential adopters as equal to n . we describe the  choices made by potential technological adopters by defining three utility functions. due to       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     19 the heterogeneity of  the users’ preference, adopters differ  in  their  intrinsic willingness  to  adopt or not adopt digital goods, depicted by [ ]0;1x ∈ . users with a high valuation for digital  goods exhibit a low value for  x , while users with a low valuation for digital goods present a  high value for x . potential adopters for whom  x  is close to 0 acquire official digital goods  and those for whom  x  tends to 1 do not adopt digital goods. users for whom the value of  x   is  intermediate  adopt  pirate  digital  goods  in.  adoption  choices  are  set  by  the  quality  provided by digital goods. in addition, we suppose that each potential user presents a level  of utility which is uniformly distributed, that yields to  i in xδ=  for adopter i .   as generally assumed (takeyama, 1994; shy, 1996; shy, 2001), we state that official and  pirate digital goods are vertically differentiated, i.e.,  0α β> > , where α  (resp. β ) represents  the  quality  of  the official  (resp.  pirate)  digital  goods  considered.  our  model  applies  in  a  framework in which the use of digital goods (whether official or pirate ones) requires the  purchase of a complementary hardware good. the cost of such a hardware good is  0hp >   and applies to each digital goods adopter.  we thus define three utility functions corresponding with the three adoption strategies  users are given: (i) official digital goods’ adoption and complementary hardware purchase,  (ii)  pirate  digital  goods’  adoption  and  complementary  hardware  purchase,  or  (iii)  non‐ adoption.   the utility of each adopter, according to her level of preference for digital goods, is given  by:   (1 ) (1 ) ( ) 0 ho h o hp h l u x p p u x p c u α β γ ∅ = − − − = − − − − = ⎧ ⎪ ⎨ ⎪ ⎩            ,  [ ]0;1x ∈                                                            (1)   the  use  of  peer‐to‐peer  networks  to  reach  pirate  digital  files  requires  learning  costs  ( 0lc > ). for  instance,  learning costs refer to the time needed for an adopter to be able to  efficiently use file‐sharing access software or to distinguish relevant digital files from those  that are not. such learning costs are likely to be lowered by the thematic orientations and the  scope  of  the  monitoring  policies  of  the  file‐sharing  networks’  moderators,  aiming  at  regulating  participation  within  peer‐to‐peer  networks.  as  a  consequence,  peer‐to‐peer  networks differ in their level of community‐based dynamics, openness thus relying on the  nature of the moderating policies applied within such networks. we therefore define  0γ >   as the degree of openness of the peer‐to‐peer network considered in our model. here, the  openness of peer‐to‐peer networks  is  likely  to generate a  twin‐effect on  the users of  file‐ sharing  networks.  firstly,  it  enables  file‐sharers  to  easily  get  access  to  suitable  files  and  overcome  their  learning  constraints  related  to  the  use  of  peer‐to‐peer  networks.  we  particularly state that openness is likely to outweigh the learning costs required to access and  efficiently use peer‐to‐peer networks providing pirate digital goods. secondly, the openness  of  peer‐to‐peer  networks  generates  both  social  and  economic  benefits  from  community‐ based interaction. as such, file‐sharers may derive positive outcomes from belonging to a  community whose scope is compatible with their own interests and expectations.       economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   20 producers  we consider two producers in the model. the digital goods producer provides official  digital goods to potential customers and the hardware goods’ producer provides physical  terminals aiming at using both official and pirate digital goods. as such, hardware producers  are  likely  to  benefit  from  piracy  and  the  ensuing  diffusion  of  pirate  digital  goods,  since  complementary hardware terminals tend to be needed for digital goods’ exploitation while  not being duplicable at no cost. these considerations highlight a potential conflict of interest  between the two types of producers that our model is aiming at estimating.  we  assume  that  official  digital  goods  are  sold  by  a  monopoly  firm.  the  firm  sets  a  price *op  that maximizes its profit defined by:  ( )o o o on p kπ = −                                   ( )2   0on >  represents the number of individuals adopting official digital goods and 0ok >  the  amount  invested  by  the  firm  to  produce  official  digital  goods.  due  to  the  informational  nature of digital goods and their reproduction facilities, we assume that production costs do  not depend on the level of production.   we also assume that hardware goods are sold by a monopoly firm. such an assumption  holds in a realistic framework in which the price convergence of complementary hardware  goods is observed. this representative firm sets a price *hp  which maximizes its profit defined  by:  ( ) ( )h h h h hn p k anπ = − +                                            ( )3   0hn >  represents the number of individuals purchasing hardware goods and 0hk >  the  amount invested by the firm to produce hardware goods. besides, as hardware production  relies  on  material  production  and  assembling,  0a >   represents  the  cost  needed  by  the  hardware firm to produce a single quantity of hardware goods.  the next section analyzes the levels of price, quantity and profit that are obtained by both  digital  goods  and  hardware  goods  producers  in  a  framework  in  which  the  file‐sharing  activity does not exist.  adoption and optimal strategies when file‐sharing does not apply  in a framework in which access to peer‐to‐peer networks is not possible, there are two  categories of users: individuals that purchase both official digital and complementary goods,  and individuals that do not.    figure 1. adoption patterns when file‐sharing does not apply           le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     21 the utility of each adopter in this case is given by:  (1 ) 0 ho h ou x p p u α ∅ = − − − = ⎧ ⎨ ⎩            ,  [ ]0;1x ∈                                                               ( )1'   1x   defines  the  level  of  intrinsic  preference  for  digital  goods  for  which  adopters  indifferently  choose  between  technological  adoption  ( ' 'o h+ )  or  non‐adoption  (∅ );  individuals exhibiting a level of  x  under  1x  thus adopt both the official digital good and the  complementary hardware one, while others do not adopt both of them. we find that:  ( )1 h ox p pα α= − −                                 ( )4   the official digital goods producer sets op  which solves  ( )max ( ) o o o o o o o p h on p k p kp pπ δ α α= − = −− −⎡ ⎤⎣ ⎦                                    ( )5   from( )5 , we find that the price of the hardware goods’ producer which maximizes her  profit is given by:  ( ) 2o hp pα= −                                   ( )6   the hardware goods producer sets hp that solves  ( ) ( )max ( ) ( ) h h h h h h h h p h on p k an p a kp pπ δ α α= − + = − −− −⎡ ⎤⎣ ⎦                                            (7)   from( )7 , we find that the price of the hardware goods’ producer which maximizes her  profit is given by:  ( ) 2h op a pα= + −                                                       ( )8   from( )6 and( )8 ,  we  find  values  for  price  equilibria  in  a  framework  in  which  both  producers maximize their profits when the file‐sharing activity does not prevail.  ( ) ( ) * * 3 2 3 o h p a p a α α = − = + ⎧⎪ ⎨ ⎪⎩                                    ( )9   assumption 1. when the  file‐sharing activity does not prevail, both producers provide prices  with positive levels, implying that:  aα >                                   ( )a1   this assumption stresses that digital goods producers have to provide a level of quality  high enough for digital goods to be adopted. assumption 1 implies that the price of official  digital  goods  is  always  higher  than  the  price  of  hardware  goods  when  the  file‐sharing  activity does not apply.  from( )4 and( )9 , we find the optimal quantity of both digital goods and hardware goods  sold by the two firms:  ( ) ( )*1 3 0x aα α= − >                                          ( )10      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   22 ( )10 shows that there is always a proportion of users that adopt both goods when peer‐ to‐peer networks do not exist. besides, as  ( ) ( )3 1 0 2a aα α α− ≤ ⇔ − ≤ ≤ , we find that there  is always a part of non‐adopters (i.e., both hardware and digital goods non‐adopters) on the  market.  from( )2 ,( )9 and( )10 , and from( )3 ,( )9 and( )10 , we find the optimal  levels of profits  that are reached by each firm at equilibrium:  ( ) ( )( ) ( ) ( )( ) 2* 2* 9 9 o o h h a k a k π δ α α π δ α α = − − = − − ⎧ ⎪ ⎨ ⎪⎩                             ( )11   proposition 1. both digital goods and hardware goods are produced if and only if a high enough  level of digital goods quality is provided by digital goods producers, i.e.,   ( ) ( ) ( ) ( ){ }2 2max 2 9 36 81 2 ; 2 9 36 81 2 ;h h h h o oa k a k k a k a k kα δ δ δ δ δ δ∈ + + + + + + +∞⎡ ⎡⎢ ⎢⎣ ⎣   proof of proposition 1. see appendix  proposition 1 suggests that the activity of hardware goods producers are linked to that of  digital goods producers.  i) there exists a  level of digital goods quality that provides a positive profit for both  hardware and digital goods producers;  ii) when  h ok k> , there exists a level of digital goods quality that may be detrimental to  the profitability of hardware producers;  iii) there exists a level of quality below which the profits of both producers are negative;  such a level has to be avoided by the digital goods producer.   proposition 1 evidences complementarities – or at least dependencies – between the activity  of hardware goods producers and that of digital goods producers. we find that the level of  quality  chosen  by  the  digital  goods  producer  may,  in  some  cases,  incitate  the  hardware  producer not to produce.  adoption and optimal strategies when file‐sharing applies  in a framework in which peer‐to‐peer networks are introduced, we stress the existence of  several scenarii  in  technological adoption schemes, depending on  the set of values of  the  parameters of  the model. we  first present  the general case and we  then analyze  the  five  scenarii that are likely to prevail when the file‐sharing activity is introduced. primary results  are eventually summarized.  assumption 2. when the file‐sharing activity applies, the level of satisfaction reached by users  whose valuation for pirate digital goods is high exceeds the cost required by the hardware producer to  produce one unit of hardware good.  aβ >                                            ( )a2   assumption 2 implies that adopters presenting a high level of valuation for pirate digital  goods are likely to adopt complementary hardware digital goods to use such digital goods in  a convenient and enjoyable way.       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     23 general case  when peer‐to‐peer networks are introduced and enhance the diffusion of unauthorized  digital  goods,  there  are  three  categories  of  users:  individuals  that  purchase  both  official  digital  goods  and  complementary  hardware  goods,  individuals  that  adopt  pirate  digital  goods and purchase hardware goods, and individuals that do not adopt either digital goods  or hardware goods.    figure 2. adoption patterns when file‐sharing applies: general case        the utility of each adopter in the general case is given by:  (1 ) (1 ) ( ) 0 ho h o hp h l u x p p u x p c u α β γ ∅ = − − − = − − − − = ⎧ ⎪ ⎨ ⎪ ⎩        ,  [ ]0;1x ∈                                       ( )1   2x   defines  the  level  of  intrinsic  preference  for  digital  goods  for  which  adopters  indifferently choose between official technological adoption ( ' 'o h+ ) or pirate technological  adoption ( '' p h+ ).  3x  defines the  level of  intrinsic preference for digital goods for which  adopters  indifferently  choose  between  pirate  technological  adoption  ( '' p h+ )  or  non‐ adoption (∅ ). thus, users do not purchase complementary hardware goods if their level of  intrinsic preference for digital goods is above 3x . in addition, users whose level of intrinsic  preference for digital goods is above 2x do not purchase official digital goods. we find that:  [ ] ( ) [ ] 2 3 ( ) ( ) ( ) ( ) l o h l x c p x p c α β γ α β β γ β = − + − − − = − − − ⎧ ⎨ ⎩                                      ( )12   the official digital goods producer sets *op  which solves  ( ) ( )[ ], 2max ( ) ( ) o o p p l o o o p c p p kπ δ α β γ α β= − + − − − −                                                         ( )13   from( )13 , we find that the price of the official digital goods’ producer which maximizes  her profit is given by:  [ ]* ( ) ( ) 2o lp cα β γ= − + −                                                     ( )14   the hardware goods producer sets *hp  which solves  ( )( )( ), 2max ( ) ( ) h h p p h l h h p p c p a kπ δ β β γ= − − − − −                                                        ( )15      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   24 from( )15 we find that the price of the hardware goods producer which maximizes her  profit is given by:  [ ]* ( ) ( ) 2h lp a cβ γ= + − −                                                     ( )16   from( )12 ,( )14 and( )16  we find the  level of  intrinsic preference for digital goods. we  easily deduce the ensuing optimal value of the quantity of both digital goods and hardware  goods sold by the two firms:  [ ] [ ] ( ) ( )[ ] ( ) * * * 2 2 * * * 3 3 ( ) ( ) 2( ) ; 2 ; l o l h x c n x x a c n x α β γ α β δ β γ β δ = − + − − = = − − − = ⎧⎪ ⎨ ⎪⎩              ( )17   assumption 3. we assume that preferences for digital goods are transitive according to the type  of adopters, i.e.,  * *3 2x x> , implying that:  ( ) [ ]( )lc aγ α β α− − > −                                         ( )a3   proposition 2. pirate digital goods’ adoption requires learning costs ( lc ) to be outweighted by  the level of openness of the peer‐to‐peer networks (γ ) to prevail.  proof of proposition 2. from ( )a3  and as ( )( ) 0a α α β− ≥ ,  ( ) 0l lc cγ γ− − ≥ ⇔ ≥ .    evidence  highlights  the  realistic  nature  of  proposition  2,  as  peer‐to‐peer  networks  provide to their users with numerous services and tools aimed at stimulating interaction and  mutual help, for example through the setting up of message boards, chatrooms or faqs. the  degree  of  openness  selected  by  the  moderators  of  file‐sharing  networks  and  its  ensuing  positive external effect all the more rapidly offsets the learning costs required by users to  access relevant pirate digital goods available online.  file‐sharing and technological adoption: case 1  case 1 refers to a situation in which the adoption of official digital goods is maintained  and in which potential adopters may either adopt or not adopt digital goods, whether they  are official or pirate ones.    figure 3. adoption patterns when file‐sharing applies: case 1        such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                                         ( )c1    ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                                   ( )c2        le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     25 ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                                                            ( )c3   ( )*2 0 lx cα β γ> ⇔ − > − −                                        ( )c4   ( )*3 0 lx c aγ β> ⇔ − − > −                                         ( )c5   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                        ( )c6   ( )*3 1 lx c aγ β< ⇔ − − < +                                         ( )c7   from( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c4 ,( )c5 ,( )c6 and( )c7 ,  we  find  that  case  1  applies when :  ( ) ( )( )[ ] ( ) ( )( )[ ] ; if 2 ; if 2 l l c a a a c a a γ α α β β α β γ α α β α β α β − − ∈ − + − > − − ∈ − − − < ⎧⎪ ⎨ ⎪⎩                                                                   ( )18   from( )13 ,( )14 ,( )15 ,( )16 and( )17 ,  in  a  context  in  which  case  1  applies,  the  profits  obtained by both firms are:  ( )[ ] ( )[ ]( ) ( )[ ] ( )( ) 2* , 2 2* , 2 ( ) 4 ( ) 4 o p p l o h p p l h c k a c k π δ α β γ α β π δ β γ β = − + − − − = − − − − ⎧ ⎪ ⎨ ⎪⎩                                                                   ( )19   file‐sharing and technological adoption: case 2  case 2 refers  to a situation  in which  the  firm which produces official digital goods  is  crowded out. in this context, official digital goods are not purchased and users adopt or do  not adopt pirate digital goods.    figure 4. adoption patterns when file‐sharing applies: case 2      such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                              ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                                                 ( )c3   ( )*2 0 lx cα β γ< ⇔ − < − −                                        ( )c8   ( )*3 0 lx c aγ β> ⇔ − − > −                                                               ( )c5   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                                   ( )c6   ( )*3 1 lx c aγ β< ⇔ − − < +                                                                         ( )c7      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   26 proposition 3. the firm which produces digital goods is never evicted from the market.   proof of proposition 3. ( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c5 ,( )c6 ,( )c7 and( )c8  can not  be simultaneously satisfied.    here, proposition 3 stresses that the file‐sharing activity cannot been depicted as the key  factor to explain why digital goods producers may be crowded out of the market.   file‐sharing and technological adoption: case 3  case 3 refers to a situation in which both firms (i.e., official digital goods and hardware  producers)  are  evicted.  in  this  context,  non‐adoption  patterns  prevail  and  threaten  the  perenniality of the cultural goods market.    figure 5. adoption patterns when file‐sharing applies: case 3      such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                                         ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                                                            ( )c3   ( )*2 0 lx cα β γ< ⇔ − < − −                             ( )c8   ( )*3 0 lx c aγ β< ⇔ − − < −                                         ( )c9   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                                   ( )c6   ( )*3 1 lx c aγ β< ⇔ − − < +                                         ( )c7     proposition 4. non‐adoption patterns do not prevail on the cultural goods market. when file‐ sharing applies, there does not exist settings in which digital goods (whether they be official or pirate)  are not purchased/adopted.  proof of proposition 4.  ( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c6 ,( )c7 ,( )c8 and( )c9  cannot  be simultaneously satisfied (e.g., ( )a2 and( )c9 are not compatible).    here,  proposition  4  reveals  that  the  file‐sharing  activity  is  not  likely  to  threaten  the  perenniality  of  the  cultural  goods  market.  at  least,  it  suggests  that  there  exist  other  key  reasons  to  explain  why  the  cultural  goods  market  may  vanish.  proposition  4  partially  explains the actual popularity of piracy and peer‐to‐peer networks. such a result also points  out that productive efforts made to enhance the quality of official digital goods enable the  hardware goods producer to maintain her activity. consequently, the official digital goods       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     27 producer  is not  incited to evict the hardware goods producer, since such an eviction also  naturally implies that of the official digital goods producer.  file‐sharing and technological adoption: case 4  case  4  refers  to  a  situation  in  which  the  hardware  goods  producer  fully  serves  the  market, while the digital goods producer is not evicted. in this case, non‐adoption patterns  do not apply.    figure 6. adoption patterns when file‐sharing applies: case 4        such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                              ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                           ( )c3   ( )*2 0 lx cα β γ> ⇔ − > − −                             ( )c4   ( )*3 0 lx c aγ β> ⇔ − − > −                                         ( )c5   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                        ( )c6   ( )*3 1 lx c aγ β> ⇔ − − < +                                       ( )c10   from( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c4 ,( )c5 ,( )c6 and( )c10 ,  we  find  that  case  4  applies when :  ( ) [ ]; if 2lc a aγ β α β α β− − ∈ + − − >                                     ( )20   from( )13 ,( )14 ,( )15 ,( )16 and( )17 ,  in  a  context  in  which  case  4  applies,  the  profits  obtained by both firms are:  ( )[ ] ( )[ ]( ) ( ) ( )[ ] ( )( ) 2* , 2 2* , 2 ( ) 4 4 o p p l o h p p l h c k a c k π δ α β γ α β π δ β γ β = − + − − − = − − − − ⎧ ⎪ ⎨ ⎪⎩                        ( )19   file‐sharing and technological adoption: case 5  case 5 refers to a situation in which the market is fully served by both hardware goods  and digital goods firms. this case reflects a situation in which the file‐sharing activity has not  a detrimental effect on the sales of both digital goods and hardware goods.     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   28 figure 7. adoption patterns when file‐sharing applies: case 5        such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                              ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )* *3 2 lx x c aγ α β α> ⇔ − − > −⎡ ⎤⎣ ⎦                                      ( )c3   ( )*2 0 lx cα β γ> ⇔ − > − −                             ( )c4   ( )*3 0 lx c aγ β> ⇔ − − > −                             ( )c5   ( ) ( )*2 1 lx cα β γ> ⇔ − − < − −                                      ( )c11   ( )*3 1 lx c aγ β> ⇔ − − < +                           ( )c10   proposition 5. the  cultural  goods market  cannot be  fully  served by both  digital  goods  and  hardware goods producers.  proof of proposition 5.  ( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c4 ,( )c5 ,( )c10 and( )c11  can  not be simultaneously satisfied.    as we have found in the case in which peer‐to‐peer networks are not introduced, we find  that digital goods producers do not fully serve the market. however, proposition 5 suggests  that non‐adoption patterns are downplayed by patterns of pirate digital goods adoption.  market structures    the  following  table  (table  1)  summarizes  the  main  results  we  have  previously  found  when the file‐sharing activity is introduced. moreover, we underline that two cases are likely  to appear in such a framework.    table 1. market structures when file‐sharing is introduced    case  details  results  case  1  the market is partially served by both producers  no‐adoption patterns partially apply  applies when  ( ) ( ) ( ) ( ) ; if 2 ; if 2 l l a c a a a c a γ α β β α β α γ α β α β α β α − − ∈ − + − > − − ∈ − − − < ⎧ ⎡ ⎤ ⎪ ⎢ ⎥⎪ ⎣ ⎦ ⎨ ⎡ ⎤⎪ ⎢ ⎥⎪⎩ ⎣ ⎦        le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     29 case  2  the digital goods producer is crowded out  the market is partially served by the hardware  firm  no‐adoption patterns partially applies  does not apply  case  3  both producers are crowded out  no‐adoption patterns prevail  does not apply  case  4  the market is fully served by the hardware firm  the market is partially served by the digital firm  no‐adoption patterns do not apply  applies when  ( ) [ ]; if 2 l c a aγ β α β α β− − ∈ + − − >   case  5  the market is fully served by both producers  no‐adoption patterns do not apply  does not apply    as cases 2, 3 and 5 do not apply, our primary results stress that digital goods producers  are always likely to sell their products. such results reveal that the perenniality of the digital  goods  producer  on  the  market  can  be  guaranteed.  the  hardware  goods  producer  is  not  motivated to crowd the digital goods producer out of the market so as to fully serve the  market. in other words, one of the main goal of the hardware goods producer is to deter non‐ adoption patterns, while the digital goods producer – partially or fully – serves the market.  all  the ensuing adoption  issues of course depend of  the  level of quality of digital goods  provided by the digital goods firm.   such settings reveal strong dependencies of hardware producers on digital goods’ that  are all the higher‐leveled as most pirate digital goods are generally issued from official ones  (e.g., through media copying, media ripping or miscellaneous files conversions).  our primary results are compatible with both short  term and  long  term perspectives,  since  the  crowding  out  of  official  digital  goods’  suppliers  would  in  the  long  term  permanently lead to the disappearance or the strong contraction of the pirate digital goods’  offer. as such, our findings primilarly suggest that the eviction of the official digital goods  supplier  should  not  to  be  targeted  by  the  hardware  goods’  firm  if  it  is  to  maintain  profitability in the long run.   for cases 1 and 4, the profits of both producers are as follows:  ( )[ ] ( )[ ]( ) ( ) ( )[ ] ( )( ) 2* , 2 2* , 2 ( ) 4 4 o p p l o h p p l h c k a c k π δ α β γ α β π δ β γ β = − + − − − = − − − − ⎧ ⎪ ⎨ ⎪⎩                        ( )19   lemma 1. the profit reached by the official digital goods producer depends on both the quality  gap (i.e., α β− ) and the degree of openness of the peer‐to‐peer community (i.e.,  ( )lc γ− − ).  more precisely, we find that the official digital goods producer reaches a positive profit in  two different frameworks:  • when  the  degree  of  openness  of  the  peer‐to‐peer  community  is  high  (i.e.,  ( ) ( ) ( )( ) ( )2 16 2 ;l oc kγ δ α β δ α β δ− − ∈ − + − +∞⎡ ⎡⎣ ⎣ ),  whatever  the  quality  gap  is;     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   30 • both when the quality gap is high (i.e.,  ( )4 okα β δ− > ) and when the degree of  openness  of  the  peer‐to‐peer  community  is  low  (i.e.,  ( ) ( ) ( )( ) ( )0; 2 16 2l oc kγ δ α β δ α β δ− − ∈ − − −⎡ ⎡⎣ ⎣ ).  lemma 1 suggests that the degree of openness is critical for the digital goods’ producer to  get  a  positive  profit.  in  a  specific  case,  a  lower  degree  of  openness  of  the  peer‐to‐peer  community can generate a positive profit when the quality gap is high. this result stresses  that qualitative efforts are likely to generate positive profits for the digital goods firm, by  taking into account the level of its fixed costs (i.e.,  ok ).  lemma 2. the profit reached by the hardware goods producer depends on both the quality of the  pirate digital goods available on file‐sharing platforms (i.e.,  β ) and the degree of openness of the peer‐ to‐peer community (i.e.,  ( )lc γ− − ).  similarly  to  the case of  the digital goods producer, we  find  that  the hardware goods’  producer obtains a positive profit in two different frameworks:  • when  the  quality  of  the  pirate  digital  goods  is  very  low  or  very  high  (i.e.,  ( ) ( ) ( ) ( )2 20; 2 4 4 2 2 4 4 2 ;h h h h h ha k ak k a k ak kβ δ δ δ δ δ δ∈ + − + + + + +∞⎡ ⎡ ⎤ ⎡⎣ ⎣ ⎦ ⎣u ), whatever the degree of openness of the peer‐to‐peer community is;  • when  the  quality  of  the  pirate  digital  goods  is  intermediary‐leveled  (i.e.,  ( ) ( ) ( ) ( )2 22 4 4 2 ; 2 4 4 2h h h h h ha k ak k a k ak kβ δ δ δ δ δ δ∈ + − + + + +⎤ ⎡⎦ ⎣ ),  and  when  the  degree  of  openness  of  the  peer‐to‐peer  community  is  high  (i.e.,  ( ) ( )( ) ( )2 4 2 ;l hc a kγ δ β δβ δ− − ∈ − − + +∞⎡ ⎡⎣ ⎣ ).   lemma  2  suggests  the  hardware  goods  producer  has  to  consider  both  the  quality  of  pirate  digital  goods  and  the  degree  of  openness  of  the  peer‐to‐peer  community  to  get  a  positive profit. moreover,  the hardware goods’ producer has  to set  its both costs  (i.e.,  a   and hk ) to reach such a valuable issue.   in this section, we have pointed out that, contrary to the conventional wisdom, the file‐ sharing  activity  does  not  evict  the  official  digital  goods  producer  and/or  the  hardware  producer from the market. following such a result, one key research question would be to  measure the nature of the impact (i.e., positive or negative) that the introduction of peer‐to‐ peer networks has on commercial activities (i.e., digital goods firm and hardware terminals  firm). the next section is devoted to this study.   comparative statics  in a framework in which digital goods were previously available in their official form, the  file‐sharing  activity  is  likely  to  have  an  impact  on  the  level  of  profits  reached  by  the  producers of official digital goods and hardware goods.  this section aims at seeing  if the  introduction of peer‐to‐peer networks  in the cultural  goods industrial landscape may deliver beneficial outcomes for both producers. to do so,  our approach is merely qualitative, inasmuch as we identify to what extent the file‐sharing  activity generates gains for the firm providing official digital goods and the firm providing       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     31 hardware  terminals.  qualitative  results  are  summarized  and  coordination  strategies  are  discussed.  the impact of file‐sharing on the profitability of official digital goods  producers  from  ( )11 and( )19 , we  find  that  the effect on  the  file‐sharing activity on  the  level of  profit of the producer of official digital goods is as follows:  ( ) ( ) ( )[ ] ( )( )2 2* 9 4 36o l c a δ π α α β γ α β α α α β δ = − + − − − − − ⎡ ⎤ ⎣ ⎦                                           ( )21   from( )21 , our mathematical analysis aiming at identifying the – positive or negative –  nature of the expression of  *oπδ provides the following results.     lemma 3. the file‐sharing activity may positively or negatively influences the profitability of the  official digital goods firm. the nature of such an influence depends on the qualitative effort (i.e.,α )  that is provided by the official digital goods firm – facing the production of pirate digital goods (i.e.,  β ) – as well as the degree of openness of the peer‐to‐peer community (i.e.,  ( )lc γ− − ).    more precisely, we find that the introduction of peer‐to‐peer networks enhances the level  of profit of the producer of official digital goods:  • when the digital goods firm sets a low level of quality for its official digital good  (i.e.,  ( )( )2 20; 324 288 186624 186624 104976 373248a a aα β β β∈ − + − +⎤ ⎡⎦ ⎣),  whatever the degree of openness of the peer‐to‐peer community is;  • when the digital goods firm sets a high level of quality for its official digital good  (i.e.,  ( )( )2 2 373248 ;324 288 186624 186624 104976a a aα β β β∈ +∞⎤ ⎡− + − +⎥ ⎢⎦ ⎣ ),  and  when  the  degree  of  openness  of  the  peer‐to‐peer  community  is  high  (i.e.,  ( ) ( ) ( )( )( ) ( )218 144 18 ;lc aγ α α β α α β α α− − ∈ − − + − − +∞⎤ ⎡⎥ ⎢⎦ ⎣ ).  however, we find that there exist settings in which the file‐sharing activity is detrimental  to that of the digital goods firm. indeed, negative externalities are likely to appear both when  the digital goods firm sets a high level of quality (i.e., α ) for its product and when the degree  of  openness  of  the  peer‐to‐peer  community  is  low  (i.e.,  ( ) ( ) ( )( )( ) ( )20; 18 144 18lc aγ α α β α α β α α− − ∈ − − + − −⎡ ⎡⎢ ⎢⎣ ⎣).  our  results  show  that  firms  producing  official  digital  goods  may  benefit  from  the  existence of peer‐to‐peer networks. moreover, suitable quality‐based strategies have to be set  up,  by  taking  into  account  the  degree  of  openness  that  peer‐to‐peer  communities  may  exhibit. in the case of the digital goods firm, the commercial losses the file‐sharing activity  may generate result from the setting up of quality‐based strategies that do not cope with the  level of community‐based utility that file‐sharers may get from peer‐to‐peer networks. thus,  we point out that commercial benefits may be generated from surrounded activities (e.g., the  file‐sharing activity) provided that appropriate strategies are delivered.       economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   32 the impact of file‐sharing on the profitability of hardware goods producers  from  ( )11  and  ( )19 , we find that the effect on the file‐sharing activity on the level of  profit of the producer of hardware goods is as follows:    ( )[ ] ( ) ( )[ ] ( )2 2* * *, 2 36 9 4h h p p h la c aπ π π δ αβ α β γ β αδ = − = − − − − −⎡ ⎤⎣ ⎦                   ( )22   from( )22 , our mathematical analysis aiming at identifying the – positive or negative –  nature of the expression of  *hπδ  provides the following results.    lemma 4. the file‐sharing activity may positively or negatively influences the profitability of the  hardware goods firm. the nature of such an influence depends on the quality of both official and pirate  digital goods (i.e., α  and β ), as well as the degree of openness of the peer‐to‐peer community.  more precisely, we find that the introduction of peer‐to‐peer networks enhances the level  of profit of the producer of hardware goods:  • both when  the quality provided by  the official digital goods producer  is high‐ leveled  compared  to  that  of  pirate  digital  goods  (i.e.,  ( ) ( )( )2 29 4a aα α β β− > − ) and when the degree of openness of the peer‐to‐ peer  community  is  high‐leveled  (i.e.,  ( ) ( ) ( )( ) ( )218 144 18 ;lc a aγ α β αβ α α− − ∈ − − + − +∞⎤ ⎡⎥ ⎢⎦ ⎣ );  • when the quality provided by the official digital goods producer is low‐leveled  compared  to  that  of  pirate  digital  goods  (i.e.,  ( ) ( )( )2 24 9a aβ β α α− > − ),   whatever the degree of openness of the peer‐to‐peer community is high‐leveled is.  nevertheless, we also find that there exist settings  in which the file‐sharing activity  is  detrimental to that of the hardware goods firm. indeed, negative externalities are likely to  appear both when the quality provided by the official digital goods producer is high‐leveled  compared to that of pirate digital goods (i.e.,  ( ) ( )( )2 29 4a aα α β β− > − ) and when the  degree  of  openness  of  the  peer‐to‐peer  community  is  low‐leveled  (i.e.,  ( ) ( ) ( )( ) ( )20; 18 144 18lc a aγ α β αβ α α− − ∈ − − + −⎡ ⎡⎢ ⎢⎣ ⎣).  similarly  to  the  case  of  the  official  digital  goods  firm,  our  results  show  that  firms  producing  hardware  goods  may  benefit  from  the  file‐sharing  activity.  we  find  that  such  beneficial outcomes depend on the levels of quality of both official and pirate digital goods,  as well as the community‐based benefits that peer‐to‐peer networks provide to their users.  qualitative results and coordination insights  the  following  table  (table  2)  summarizes  the  main  results  we  have  obtained  when  qualitatively  analyzing  the  impact  of  the  file‐sharing  activity  on  the  profitability  of  both  types of producers (i.e., official digital goods firm and hardware terminals firm).             le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     33 table 2. file‐sharing and commercial opportunities        ‘low’ degree of  openness  ‘high’ degree of  openness  ‘low’ official quality   (compared to pirate quality)  * 0oπδ >   * 0hπδ >   * 0oπδ >   * 0hπδ >   ‘high’ official quality   (compared to pirate quality)  * 0oπδ <   * 0hπδ <   * 0oπδ >   * 0hπδ >     from table 2, we find that the strategies led by the official digital goods firm for the file‐ sharing activity to be beneficial for its own activity are somewhat the same that are required  for the producers of hardware goods to  increase their profits. from a qualitative point of  view, we stress that conflicts of interest are not likely to prevail in this framework. moreover,  commercial players, whether they are digital goods producers or hardware goods producers,  have similar interests vis‐a‐vis the file‐sharing activity. indeed, we find that both producers  are likely to apprehend in the same way the ‘official quality’ (i.e., α ) variable and the ‘degree  of openness’ (i.e.,  ( )lc γ− − ) parameter.      discussion and further research  in this paper we have developed a model to analyze the impact of the introduction of  peer‐to‐peer  networks  on  commercial  activities,  by  distinguishing  official  digital  goods  producers  on  the  one  hand  and  hardware  goods  producers  on  the  other  hand.  in  this  framework, we have whether investigated if the diffusion of pirate digital goods is always  detrimental for both producers or if it might improve the level of profit of at least one of  them. when hardware goods are compatible with both official and pirate digital goods, we  have  shown  that  the  degree  of  openness  of  peer‐to‐peer  networks  (i.e.,  the  value  of  the  switching  costs  required  by  users  to  access  peer‐to‐peer  networks  and  use  pirate  digital  goods, as well as the benefits that file‐sharers may derive from community‐based interaction)  has a significant impact on the variation of the level of profits obtained by producers when  the file‐sharing activity is introduced.  starting from a framework in which peer‐to‐peer networks do not exist, we have firstly  stressed that the activity of hardware goods producers are linked to that of official digital  goods producers. moreover, we have pointed out that there exist complementarities – or at  least dependencies – between the activity of the hardware goods firm and the activity of the  official  digital  goods  firm.  in  some  cases,  the  level  of  quality  chosen  by  the  producer  of  official digital goods may incitate the hardware goods firm not to produce.  in a framework in which the file‐sharing activity exists, we have secondly stressed that  several  scenarii  depicting  technological  adoption  schemes  and  shaping  ensuing  market  structures are likely to prevail. yet, a deeper analysis has revealed that only two of these may  occur. in particular, we have pointed out that the official digital goods firm is always able to  sell their products, and that the hardware goods firm is not motivated to crowd the official  digital goods producer  out  of  the market.  in other words,  the hardware goods producer     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   34 intends to deter non‐adoption patterns while the digital goods producer – fully or partially –  serves the market. as such, contrary to somewhat common beliefs, the file‐sharing activity  does not appear to evict the official digital goods firm and/or the hardware goods firm from  the market.  we have thirdly intended to qualitatively measure the impact of the file‐sharing activity  on  both  types  of  commercial  activities.  we  have  found  that  the  file‐sharing  activity  may  positively  influence the  level of profits of both official digital goods and hardware goods  producers. hence, we have suggested that the losses perceived by the official digital goods  firm  are  likely  to  result  from  the  setting  up  of  inappropriate  quality‐based  strategies  according to the degree of openness that file‐sharing networks may deliver. interestingly, we  have  underlined  that  conflicts  of  interest  between  official  digital  goods  producers  and  hardware terminals producers are not likely to prevail. this result all the more stresses that  the file‐sharing activity may be beneficial for commercial activities, provided that firms set  up suitable strategies to generate gains from such a so‐called ‘outlaw’ activity.  our  results  support  the  setting  up  of  commercial  strategies  that  are  similar  to  those  recently observed, since many producers who used to fight against piracy nowadays exploit  both official and ‘less official’ technological standards to sell complementary material goods.  as such, the diffusion of pirate digital goods has led to the setting up of new commercial  strategies in which piracy is likely to be tolerated as it may enhance complementary sales.  we  have  found  that  innovative  strategies  may  be  considered  by  official  digital  goods  producers  provided  that  file‐sharing  communities  are  likely  to  provide  a  high  level  of  community‐based  benefits  (i.e.,  what  we  have  called  degree  of  openness)  to  their  users.   innovative strategies may be then considered, since the improvement of the quality of official  digital  goods  over  pirate  ones  may  increase  the  level  of  profits  obtained  by  commercial  producers. although  it may seem a priori paradoxal, the file‐sharing activity appears as a  factor stimulating commercial efforts to innovate. in this context, we have pointed out that  the existence of peer‐to‐peer communities which exhibit  low degrees of openness may be  detrimental  to  the  activities  of  commercial  players.  as  a  consequence,  the  setting  up  of  policies  aiming  at  shutting  file‐sharing  platforms  down  should  be  cautiously  considered,  since inappropriate quality‐based strategies led by official digital goods firms may lead to  the decrease of both producers (i.e., official digital goods firm and hardware terminals firm).  peer‐to‐peer networks and commercial producers exhibit  transversal relationships  that  reveal  retroaction  and  interdependence  between  their  activities.  contemporary  business‐ models  should  thus  take  into  account  the  existence  of  the  wide  range  of  digital  goods  available  online  and  their  diffusion  through  both  commercial  and  non‐commercial  distribution channels, notably through peer‐to‐peer networks. the compatibility prevailing  in both official and pirate digital goods is particularly likely to enhance the profitability of  commercial producers in the media industry and to allow the setting up of new commercial  strategies based upon the complementarity existing between immaterial and material goods.  the model we have presented represents – to our knowledge – one of the first attempts to  understand  the  influence of  the peer‐to‐peer networks on commercial activities. we have  intended  to  consider  the  file‐sharing  networks  not  only  as  simple  parallel  distribution  channels, but also as communities whose users derive community‐based utilities from their       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     35 participation. we have taken into account these two features of the file‐sharing activity to  analyze technological (i.e., digital goods and hardware goods) adoption issues.   the study we have held in this part however presents three limitations that we will deal  with in further contributions. first of all, we have assumed in our model that the users who  adopt pirate digital goods through file‐sharing platforms have the same learning constraints.  one  could  wonder  what  would  happen  if  users  were  heterogeneous  in  their  learning  abilities. although our model provides results aiming at measuring the impact of the file‐ sharing  activity  on  commercial  ones,  our  findings  are  qualitative.  quantitative  analyses  would deliver stronger insights to identify the optimal strategies that official digital goods  firms may set up to increase their profits. such a quantitative approach may evidence the  potential conflicts of  interest between official digital goods  firms and hardware  terminals  firms  that  our  qualitative  results  are  not  able  to  reveal.  by  considering  an  oligopolistic  framework in which several official digital goods producers and hardware goods’ producers  would  evolve,  it  would  be  possible  to  firstly  more  precisely  study  the  role  of  the  compatibility  between  technological  standards  on  commercial  actors’  profitability  and  to  secondly  stress  the  nature  of  the  optimal  industrial  strategies  that  should  be  considered.  such results would enable us to estimate the relevancy of the new strategies that have been  recently implemented by digital goods’ producers, such as the setting up of commercial file‐ sharing  networks  whose  offers  are  limited  to  the  content  of  the  catalog  held  by  each  producer, or the several merging attempts nowadays commonly observed between various  digital goods producers.   we think that the file‐sharing activity and its ensuing industrial economics applications  open relevant  fields  for  future research. one might  investigate  into  these research  tracks,  while others – we hope – will be interested in pondering over this vast and fruitful topic.    appendix: proof of proposition 1  digital goods are produced if the profit of the digital goods producer is positive, that is to  say ( )[ ]( )2* 9 0o oa kπ δ α α= − − ≥ .   such a conditions holds when ( ) ( )22 9 36 81 2 ;o o oa k a k kα δ δ δ∈ + + + +∞⎡ ⎡⎣ ⎣ .     in  a  similar  fashion,  hardware  goods  are  produced  if  the  profit  of  the  hardware  goods  producer is positive, that is to say ( )[ ]( )2* 9 0h ha kπ δ α α= − − ≥   such a conditions holds when ( ) ( )22 9 36 81 2 ;h h ha k a k kα δ δ δ∈ + + + +∞⎡ ⎡⎣ ⎣ .  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zentner, a. (2006) “measuring the effect of music downloads on music purchases”, journal of law and  economics, 49(1): 63–90.        article history:  received:  17 february 2011 accepted:  17 march 2011          ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp79-91 scientific review solving the problems of rural development as environmentally desirable segment of sustainable development vladan joldžić1* | ana batrićević1 | vera stanković1 | nikola paunović1 1 institute of criminological and sociological research, belgrade, serbia abstract the paper highlights key problems of rural development in the context of economic and environmental crisis, with focus on rural areas in serbia. it emphasizes the link between sustainable rural development and environmental protection, particularly in the fields of organic agriculture, small organic farming and agro-eco tourism. it analyses legislative and strategic documents regulating this issue on universal, european and national level, making suggestions to improve their application. obstacles for sustainable rural development include: uncultivated agricultural lands, soil pollution, insufficient irrigation or draining, agricultural lands fragmentation, poor infrastructure, inadequate tax policy, uncompleted restitutions, long probate proceedings and financially uncertain position of land-owners. some of them have environmental impacts and can be resolved by suitable policy and legislation, strategic planning, environmental education and financial stimuli for green agriculture. the paper suggests legislators and policy makers in the areas of: sustainable development, taxes, agriculture, green economy and environment protection to analyse more profoundly key problems of rural development and their linkage to nature conservation. when it comes to practice, it suggests which legal documents should be applied in order to achieve successful, sustainable and environmentally acceptable development of rural areas. the paper contributes to a better understanding of the relationship between sustainable rural development and environment protection, emphasizing the possibility to preserve nature and increase incomes of rural communities through green agriculture, small farm production and eco-tourism. it also states that current legislative framework provides preconditions for resolving the issues that might appear within, suggesting key steps for its future implementation. key words: sustainable development, rural development, agriculture, eco-tourism, environment protection, ecology, green economy jel classification: q01, q57 introduction the most widely accepted definition of sustainable development is the one from the report of the world commission on environment and development: our common future, also known as the brundtland report. it describes sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs” (world commission on environment and development, 1987). national sustainable development strategy of the republic of serbia defines sustainable development as targetsoriented, long-term (continuous), comprehensive and synergetic process with impacts on all * e-mail: vladanj@eunet.rs 80 economic analysis (2019, vol. 51, no. 1-2, 79-91) aspects of life (economic, social, environmental and institutional) at all levels (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). in its paragraph 54, the united nations’ resolution “transforming our world: the 2030 agenda for sustainable development”, adopted in 2015, proclaims 17 “global goals” of sustainable development with 169 targets between them. they include the following: 1) end poverty in all its forms everywhere; 2) end hunger, achieve food security and improved nutrition and promote sustainable agriculture; 3) ensure healthy lives and promote well-being for all at all ages; 4) ensure inclusive and equitable quality education and promote lifelong learning opportunities for all; 5) achieve gender equality and empower all women and girls; 6) ensure availability and sustainable management of water and sanitation for all; 7) ensure access to affordable, reliable, sustainable and modern energy for all; 8) promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all; 9) build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation; 10) reduce inequality within and among countries; 11) make cities and human settlements inclusive, safe, resilient and sustainable; 12) ensure sustainable consumption and production patterns; 13) take urgent action to combat climate change and its impacts; 14) conserve and sustainably use the oceans, seas and marine resources for sustainable development; 15) protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and halt biodiversity loss; 16) promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels and 17) strengthen the means of implementation and revitalize the global partnership for sustainable development. as stated in paragraph 55 of the agenda, “the sustainable development goals and targets are integrated and indivisible, global in nature and universally applicable, taking into account different national realities, capacities and levels of development and respecting national policies and priorities”. however, each state is free to decide how the global targets should be implemented into their national planning processes, policies and strategies. it is also emphasized that the link between sustainable development and other relevant ongoing processes in the economic, social and environmental areas should be recognised. by insisting on the correlation between economic, social and environmental fields in the process of sustainable development, paragraph 55 of the agenda implies that sustainable development comprises three interrelated components or aspects that should not be perceived as independent one from another. national sustainable development strategy of the republic of serbia highlights that sustainable development involves the need to harmonize the different aspects of development and the contradictory ideas included in each individual sectoral program. accordingly, the strategy’s key objective is to establish a balance between the three key factors, or three pillars, of sustainable development: 1) sustainable economic growth, economic and technological progress, 2) sustainable social development, based on social balance, and 3) environmental protection accompanied by reasonable use of natural resources. the strategy attempts to join these three pillars within an adequate institutional framework. sustainable rural development the term “rural” appears to be rather vague. although there is no exact definition of that term, rural areas can be clearly recognised. they form the space where human settlements and infrastructure occupy only small parts of landscape, whereas fields, pastures, woods, forests, waters, mountains and deserts tend to be predominant. in rural areas, people usually live in farmsteads or settlements of not more than 10.000 persons. however, the differences between urban and rural settlements vary from one country to another (ashley & maxwell, 2001). vladan joldžić, ana batrićević, vera stanković, nikola paunović 81 rural development represents "a multi-level process rooted in historical traditions" (van der ploeg et al., 2000: 391-392). today, it is related to a general restructuring of the economy at the global level and can be in part perceived as a response of the farm enterprises to new, more flexible trends in firms’ organisation. furthermore, modern rural development implies a new developmental model for the agricultural sector and a cohesion at farm level but also between different farms or farms and other rural activities as well as between local and regional ecosystems, specific farm-styles, goods, services etc. (van der ploeg et al., 2000). rural development can be observed either as a development policy managed by the state or as a broader concept of rural society change with or without state interventions. this implies that rural development refers to interventions of much more extensive character than agricultural development as well as to the process of rural society change that is not always directly influenced by the state (bogdanov, 2007). rural development should be perceived as a multi-actor process, involving a complex institutional setting. it is also multi-faceted process since it comprises a wide range of different practices, some of which are interconnected. these practices include: landscape management, natural values conservation, agro-tourism, organic farming and the production of high-quality and region-specific products (van der ploeg et al., 2000: 394). rural development also comprises nature conservation and landscape management and the development of short supply chains. all these activities are rather new and their number and variety actually seems to be much larger (knickel & renting, 2000). environmental sustainability is considered an important component of rural development is also given a significant amount of attention, especially in the european union. (ristić, 2013). the link between rural development and environmental protection was recognised for the first time in the 1980s, when agro-ecology emerged as an attempt to establish a scientific basis for alternatives to industrialized agriculture. the agro-ecological framework is based upon different intellectual traditions and disciplines, such as: peasant studies, ecology and environmentalism and development theory. it implies an alternative definition of sustainability from which an ecologically oriented discourse is shaped. its central concept is co-evolution of society and natural factors, i.e. humans and nature. (marsden et al, 2001). there are many aspects of rural development that are related to environmental protection: rural or agro tourism, agriculture and organic farming and food production are some of the most important ones. in accordance with the modern concept of rural development, agriculture is supposed to be multifunctional, which means that it includes some other activities that are not directed only towards the increase of production but comprise other benefits of rural environment. multifunctional agriculture has several aspects and one of them is environmental protection, i.e. conservation of biodiversity, preservation of natural landscapes and protection from floods, and erosion. namely, it has been converted from agriculture of production to agriculture of protection (pejanović & vujović, 2008). being socially, economically and ecologically acceptable, organic agriculture can significantly contribute to sustainable development of rural areas (ristić, 2013). due to declining economic activity, agricultural reforms, restructuring of the agricultural sector, deteriorating rural industrialisation and out-migration of educated young people from rural to urban areas, many rural communities have adopted tourism as an alternative development strategy. rural tourism is seen as a means for the economic and social regeneration of rural areas, particularly in eastern europe, and less developed countries of subsaharan africa, affected by rural poverty (briedenhann & wickens, 2004). rural, as a specific type of eco-tourism is already developing in some parts of serbia and should be strongly supported, in particular as a means to promote and enhance the conservation of environment. eco-tourism is considered environmentally responsible, it includes a low visitor 82 economic analysis (2019, vol. 51, no. 1-2, 79-91) impact, and contributes to socioeconomic participation of local populations (scheyvens, 1999). this type of tourism is also addressed to as agro-tourism and is also important for rural development. it is a type of tourism focused on healthy nutrition of tourists and spending time in healthy environment that is accomplished through the development of agriculture with respect to different aspects of sustainability (pejanović & vujović, 2008). tourism development has the potential to generate new jobs, improve community infrastructure and assist in revitalising the weakening economies of rural areas. that is the reason why governments often tend to see it as a solution to the problems of rural areas. but, it has to be developed wisely in order to avoid lack of incomes, the unfairness of profit distribution and the social costs to resident communities (briedenhann & wickens, 2004). therefore, it is important that local communities have some control over it and share the benefits it provides, which can only be provided if conservation and development at the local level are promoted (scheyvens, 1999). problems affecting rural areas in the past couple of decades, the state of rural development has been rather troubled, primarily due to rural poverty, decline in funding to the agricultural sector and inappropriate policy created by international funding agencies and developing country governments (ashley & maxwell, 2001). in spite of the fact that the importance of agriculture varies significantly from one european country to another, its general significance seemed to be decreasing in the past decade (van der ploeg et al., 2000). in the eyes of public and policy-makers, the agricultural sector has been considered detached, over-subsidized and unattractive because of crisis in food production, growing health risks, environmental loss, overproduction of low-quality products and the decline in number of producers and farm workers (marsden et al, 2001). poverty, marginalization, depopulation and low quality of life in rural areas causing village decay are now identified as a global problem (vasilevska, 2010). in developed countries, rural poverty is observed in the context of lower incomes per capita in rural areas in comparison to average national incomes and incomes in urban areas. poverty of some rural areas leads to their social exclusion, causes lower education and diminishes their developmental possibilities, similar to ghettos in urban areas. poverty in both rural as well as urban areas also results in the degradation of natural environment and has negative implications in social and economic sphere (bogdanov, 2007). the link between poverty and environment is often mentioned in the context of sustainable development. this refers to rural poverty as well, since rural development is particularly dependent on natural resources. researches show that high level of rural poverty and unemployment is most commonly closely related to the fact that rural areas predominantly depend on agriculture. the experiences of developed countries in resolving the problems of economic and demographic devastation of rural areas have confirmed that the policy of sustainable rural development should not support only agriculture but non-agricultural economic activities (ristić, 2013). the aforementioned is particularly important for environmentally fragile and poor rural areas, where incomes from agriculture are faced with the high risk and should be replaced with non-agricultural activities such as gathering (local flora and fauna, farming and livestock husbandry (reardon & vosti, 1995). problems of rural development in serbia rural areas comprise around 85% of serbia’s territory and are the home of one half of its population. there are altogether 5.965 rural settlements in serbia, whereas 6.158 are considered urban. demographic trends in rural areas are increasingly negative, primarily due to migration and negative birth rate. due to that, rural population comprises 40.6% of serbia’s vladan joldžić, ana batrićević, vera stanković, nikola paunović 83 population (strategy of agriculture and rural development of the republic of serbia for the period between 2014 and 2024, official gazette of the republic of serbia, no. 85/2014). natural resources (including agricultural lands, forests, waters, flora, fauna and cultural heritage) represent important components of rural areas in serbia. despite their natural potentials, rural areas in serbia are facing an array of persistent problems such as: negative demographic trends, undeveloped infrastructure, fragmented agricultural households that are not market-oriented, inadequate structure of production, low productivity rate, minimal household incomes, large share of agriculture in rural economy, low rate of diversification of rural economy, high unemployment rate, insufficient trading capacities, poor organisation, inability to compete with foreign producers, lack of state support etc. (pejanović, 2009; ristić, 2013). the crisis of serbian agriculture has been lasting for a long time and long-term problems that emerged as the consequences of lack of systematic and continuous economic policy measures caused a permanently inconvenient situation in agriculture (pejanović, 2009). as stated in national sustainable development strategy, intensive urbanization and industrialization in serbia have caused intensive migrations from rural to urban areas, massive loss of large fertile agricultural lands and decelerated socio-economic and cultural development of rural areas. the lack of systematic state support to integral rural development also contributed to the neglect and abandonment of households, agricultural lands and other natural resources in rural areas. nowadays, natural, infrastructural and other conditions relevant to agricultural production differ from one rural area to another. these differences affect social development, demographic characteristics, cultural features, attitudes towards tradition, views on modernization and environmental awareness of individual rural areas (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). numerous problems related to rural development also affect components of the environment such as: soil, water and forests. the main threats for soil quality include: soil acidification, minimisation of organic particles’ level in the soil, soil pollution and erosion. for example, more than one quarter of agricultural lands in serbia are acidified, as the result of uncontrolled use of chemical substances and some areas in the province of vojvodina (around 14%) are salted. irrigation of soil is also not conducted in an appropriate manner. a small share of agricultural land is irrigated legally, some are irrigated only partially and the number of parcels irrigated without necessary permission is much larger. one of the most delicate issues regarding future development of agricultural sector in serbia is a very inconvenient age and educational structure of population involved with this type of production. this problem might affect social structure of rural areas as well as the capacities of human resources to adopt and implement new technologies, changes in production structure etc. (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). rural households are not equipped with modern technologies, their production is not enough specialised and the motivation of employees is not very high due to low incomes (pejanović, 2009). in spite of efforts of relevant institutions directed towards the conservation of biodiversity including the ratification of international treaties, adoption of national legislative framework and establishing of numerous protected areas, serbia is still facing obstacles when it comes to the implementation of policies and strategies in this field. insufficient financial resources, missing of appropriate institutional framework, lack of monitoring and information systems are some of the reasons causing such situation. closely related to the issues regarding biodiversity are the problems in the area of forestry. around 29% of forests are devastated, natural forests are rather old and their natural renewing is missing, some of the forests are dry and there are not enough forest roads. all these problems lead to insufficient use of forests’ potentials. serbia has made significant improvements when it comes to legislative framework dedicated to animal welfare. however, the condition in this field, especially when farm animals and animals in traffic are concerned, is still not in accordance with international standards. this affects livestock 84 economic analysis (2019, vol. 51, no. 1-2, 79-91) production and has a negative impact on the trust of foreign consumers (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). legislative and strategic measures for resolving the problems of rural development united nations the un sustainable development agenda incorporates rural development in the goals of sustainable development, with special focus on developing and least developed countries. according to its paragraph 24, the states have made commitment to devote their resources to developing rural areas and sustainable agriculture and fisheries, supporting smallholder farmers, especially women farmers, herders and fishers in developing and least developed countries. in its second goal (end hunger, achieve food security and improved nutrition and promote sustainable agriculture), the agenda mentions rural development in the context of investment in rural infrastructure, agricultural research and extension services, technology development and plant and livestock gene banks in order to enhance agricultural productive capacity in developing countries, in particular least developed countries. within its eleventh goal, dedicated to making human settlements inclusive, safe, resilient and sustainable, the agenda promotes supporting of positive economic, social and environmental links between urban, peri-urban and rural areas by strengthening national and regional development planning. the economic and social council of the united nations plays an important role in the promotion of sustainable rural development on a global level. for example, ministerial declaration on promoting an integrated approach to rural development in developing countries for poverty eradication and sustainable development(http://www.un.org/esa/coordination/alliance/documents/website/ministerial% 20declaration.pdf) adopted in 2003 among other issues, states that the eradication of rural poverty and hunger is critical to the achievement of the internationally agreed development goals, including the millennium development goals. it suggests that rural development should be an integral part of national and international development policies, including bilateral donor response strategies and the activities and programmes of the united nations system. the declaration emphasizes that rural development should be pursued through an integrated approach, encompassing the economic, social and environmental dimensions. it should also take into account the gender perspective and consisting of mutually reinforcing policies and plans. such approach to rural development is supposed to be balanced, targeted, situation specific and locally owned. it must include local synergies and initiatives and be responsive to the needs of rural populations. although the declaration considers rural development the responsibility of each country it claims that enabling international economic environment is significant to support effective national development efforts, including rural development efforts. empowerment of population living in poor rural areas is strongly supported by the declaration. it is particularly pointed out that poor people living in rural areas should play a full and effective role in their development by participating in the decision-making processes, relevant to: resource allocation; promoting mechanisms. they are encouraged to influence the market and public policies as well as to participate fully in the design, development and implementation of rural development strategies and programmes. environmental protection is also mentioned in the declaration. the declaration reaffirms that sustainable agriculture and rural development are vital to the implementation of an integrated approach to food security and safety in an environmentally sustainable way. it states that rural populations play an important role in sustainably managing natural resources, including biodiversity and in combating desertification and land degradation. accordingly, the declaration supports the promotion of environmentally sound and sustainable natural resources vladan joldžić, ana batrićević, vera stanković, nikola paunović 85 management, including the implementation of integrated land management, sustainable forest management programmes and water-use plans. the declaration invites states and international organisations to target rural areas and households more systematically in their poverty reduction policies by integrating poverty eradication and food security as well as environmental objectives more firmly in poverty reduction strategies. european union third the european union has been insisting on coordination between agriculture, rural economy and sustainable rural development for decades and has adopted several documents regulating these issues and setting basic principles of their future development and management. rural development is a part of common agricultural policy and is included in the targets set by europe 2020: a strategy for smart, sustainable and inclusive growth. the so-called “neo-ruralism” emerged in the european union during the 1960s as a reaction to inconvenient position of agriculture and rural regions in industrially developed countries. it is based on the multifunctional concept of agriculture and presumption that agriculture is not the only activity rural areas can benefit from, but that it should also comprise: environment and natural landscapes conservation, food supply safety, increase of employment in rural areas, social and economic benefits, preservation of tradition and cultural heritage of rural areas etc. (pejanović & vujović, 2008). common agricultural policy (cap) of the european union represents a legal framework for agricultural and rural development of its member states (veselinović, 2009). it contains several documents pertinent to the issue of sustainable rural development and its environmental aspect. it was created in 1962, and reformed in 1992, 2003 and 2013, adapting the policy to a changing world. moreover, the commission's agenda 2000, adopted in 1999, established economic, social, and environmental goals within the objectives of the cap. today, four main regulations govern the common agricultural policy (https://ec.europa.eu/agriculture/cap-overview_en). they were introduced by a reform in 2013 to simplify legislation and have been applied since 2014. cap has always been taking into consideration the improvement of the environment and landscapes, and this issue represents an important strategic goal that member states are supposed to implement in their national strategies of rural development (veselinović, 2009: 61). when it comes to sustainable rural development and its environmental aspect, the most important of them is regulation (eu) no 1305/2013 of the european parliament and of the council of 17 december 2013 on support for rural development by the european agricultural fund for rural development (eafrd) and repealing council regulation (ec) no 1698/2005 (http://data.europa.eu/eli/reg/2013/1305/oj). the regulation invites eu member states to focus on priorities such as: knowledge transfer and innovation in agriculture, forestry and rural areas, farm viability, the competitiveness of all types of agriculture in all regions, promoting innovative farm technologies, sustainable management of forests, the organisation of the food chain, animal welfare, risk management in agriculture etc. it also asks them to focus on: restoring, preserving and enhancing ecosystems that are related to agriculture and forestry, the promotion of resource efficiency and the shift towards a low carbon economy in the agricultural, food and forestry sectors, and to promoting social inclusion, poverty reduction in and the economic development of rural areas (article 4). the regulation’s objectives also include environmental protection and climate change mitigation and adaptation. it invites member states to limit emissions in agriculture and forestry from key activities such as livestock production, fertilizer use and to preserve carbon sinks and enhance carbon sequestration with regard to land use, land use change and the forestry sector (article 4). furthermore, the regulation emphasizes that priorities for rural development in the eu should be pursued within the framework of sustainable development and environmental protection. it is also very explicit about the application of the polluter pays principle. among 86 economic analysis (2019, vol. 51, no. 1-2, 79-91) other goals of knowledge and information sharing between farmers, rural small or medium enterprises and forest holders, is the enhancement of their abilities to increase resource efficiency and improve their environmental performance while contributing to the sustainability of the rural economy (article 12). when improvement of rural areas’ development is concerned, the regulation suggests the following approaches: the creation and development of new economic activity in the form of new farms, the diversification into non-agricultural activities including the provision of services to agriculture and forestry, activities related to health care, social integration and tourist activities (article 17). the regulation points out forestry as a particularly important part of rural development, claiming that support for sustainable and climate friendly land use should include forest area development and sustainable management of forests (article 20). in that context, the regulation insists on granting payments to forest holders who provide environment-friendly or climate-friendly forest conservation services by enhancing biodiversity, preserving high-value forest ecosystems, improving their climate change mitigation and adaptation potential. the measures of particular importance include the reinforcement of the protective value of forests when it comes to soil erosion, maintenance of water resources and natural hazards (article 28). the targets set by europe 2020: a strategy for smart, sustainable and inclusive growth (european commission, 2010) represent an overall assessment of where the eu should be on key parameters by 2020. they are interrelated, mutually reinforcing and include: employment, research and development, climate change and energy, education and poverty and social exclusion. europe 2020 highlights three priorities: 1) smart growth: developing an economy based on knowledge and innovation, 2) sustainable growth: promoting a more resource efficient, greener and more competitive economy and 3) inclusive growth: fostering a highemployment economy delivering social and territorial cohesion. sustainable growth includes, among other, building a resource efficient, sustainable and competitive economy, developing new processes and technologies, including green technologies. the aim of this approach is to help the eu to prosper in a low-carbon, resource constrained world as well as to prevent environmental degradation, biodiversity loss and unsustainable use of resources. according to europe 2020, the european commission is therefore expected to establish a vision of structural and technological changes required to move to a low carbon, resource efficient and climate resilient economy by 2050. one of the measures to achieve this goal includes the changes of agricultural, rural development, and maritime policies so that they address climate change. the adaptation measures these policies are supposed to introduce are based on more efficient use of resources, which would also contribute to improving global food security. the european commission is obliged to mobilise eu financial instruments including rural development funds, as part of a consistent funding strategy that pulls together eu and national public and private funding. all these goals and guidelines confirm that there is a close and complex relationship between sustainable rural development and environmental protection, which should be taken into consideration when creating national policies and legislation. it is also worth mentioning that the european union has been supporting rural development in other states that are not its members for decades. since 2007, candidate countries and potential candidates are receiving eu funding and support through the instrument for preaccession assistance, or ipa. this mechanism provides help for other countries, depending on their needs and status in the process of european integrations (janković, 2009). ipa has replaced the former pre-accession assistance instruments, i.e. the phare, ispa and sapard programmes, the specific pre-accession instrument for turkey and the cards programme. one of ipa’s components refers to agriculture and rural development. current beneficiaries are: albania, bosnia and herzegovina, the former yugoslav republic of macedonia, kosovo, montenegro, serbia, and turkey (https://ec.europa.eu/neighbourhoodenlargement/instruments/overview_en). vladan joldžić, ana batrićević, vera stanković, nikola paunović 87 legal framework relevant to rural development in serbia legislative framework and strategic documents regulating the area of agriculture and rural development were not fully developed in serbia, which caused the lack of clearly defined agricultural policy and a set of long-term enhancement measures (veselinović, 2009). on the other side, the countries that have a developed policy of regional and rural development, rural development is considered a development priority and occurs in almost all national and regional development programs (vasilevska, 2010). in the past couple of years, the republic of serbia has adopted a large number of laws, strategies and other documents that regulate key issues related to agriculture and rural areas, including the following: 1) law on agriculture and rural development (official gazette of the republic of serbia, no. 41/2009, 10/2013 and 101/2016), 2) law on incentives for agriculture production and rural development (official gazette of the republic of serbia, no. 10/2013, 142/2014, 103/2015 and 101/2016), 3) law on agricultural land (official gazette of the republic of serbia, no. 62/2006, 65/2008, 41/2009 and 112/2015), 4) animal husbandry law (official gazette of the republic of serbia, no. 41/2009, 93/2012 and 14/2016), 5) strategy of agriculture and rural development of the republic of serbia for the period between 2014 and 2024 (official gazette of the republic of serbia, no. 85/2014), 6) national program for agriculture and rural development (ministry of agriculture and environmental protection of the republic of serbia, 2014: 167), 7) forestry development strategy of the republic of serbia (official gazette of the republic of serbia, no. 59/2006), 8) biodiversity strategy of the republic of serbia (official gazette of the republic of serbia, no. 13/2011) and 9) national strategy for sustainable use of natural resources and goods (official gazette of the republic of serbia, no. 33/2012). the adoption of legal documents regulating agriculture and rural development was one of the obligations serbia had to fulfil on its road towards the european integrations in order to harmonize its legislation with the standards of the european union. also, the world trade organisation requires its members to harmonise their legislative measures in the area of agriculture and their agricultural policies (veselinović, 2009). having in mind the fact that rural development cannot be observed separated from environmental protection and sustainable use of natural resources, the following legislative and strategic documents should also be taken into consideration: 1) law on nature protection (official gazette of the republic of serbia, no. 36/2009, 88/2010, 91/2010 and 14/2016), 2) law on environmental protection (official gazette of the republic of serbia, no. 135/2004, 36/2009, 36/2009, 72/2009, 43/2011 and 14/2016), 3) law on strategic estimation of environmental impact (law on strategic estimation of environmental impact, official gazette of the republic of serbia, no. 135/2004 and 88/2010), 4) law on estimation of environmental impact (official gazette of the republic of serbia, no. 135/2004 and 36/2009), 5) law on integrated prevention and control of environment pollution (official gazette of the republic of serbia, no. 135/2004 and 25/2015), 6) law on air protection (official gazette of the republic of serbia, no. 36/2009 and 10/2013), 7) law on waters (official gazette of the republic of serbia, no. 30/2010, 93/2012 and 101/2016), 8) law on forests (official gazette of the republic of serbia, no. 30/2010, 93/2012 and 89/2015), 9) law on spatial plan of the republic of serbia between 2010 and 2020 (official gazette of the republic of serbia, no. 88/2010) and 10) law on planning and construction (official gazette of the republic of serbia, no. 72/2009, 81/2009, 64/2010, 24/2011, 121/2012, 42/2013, 50/2013, 98/2013, 132/2014 and 145/2014). finally, the fact that rural development in accordance with the principles of environmental protection has the potential to be improved via popularisation and promotion of eco-tourism, the provisions of law on tourism (official gazette of the republic of serbia, no. 36/2009, 88/2010, 99/2011, 93/2012 and 84/2015) should also be concerned in that context. 88 economic analysis (2019, vol. 51, no. 1-2, 79-91) conclusion it is assumed that the problems of rural development can be adequately treated within the regional development framework. this is supposed to be done through an integrated planning approach in accordance with sustainable development paradigm. such political willingness is based on the harmonization of two traditional approaches: regional or physical planning and environmental protection. problems of rural development require an integral approach depending on the characteristics of each individual rural area, local developmental potentials and socio-economic background. integral approach to sustainable rural development is focused on the population, economy, environment and institutions. rural development has to take into consideration various components such as: economic, ecological, social, energetic, cultural, religious, infrastructural and. new forms of farm-based rural development activities are emerging and different participants compete for opportunities and resources in rural areas. for example, the interests of farmers and owners of agricultural lands might sometimes be in conflict with the interests of wildlife conservationists, eco-tourists, hobby-farmers or high quality food producers. namely, enhancing the natural resource base could contribute to the reduction of rural poverty in cases where soil degradation is reducing yields on the farms of the poor. on the other hand, conserving natural resources might increase poverty. this refers to cases where poor rural households earn their incomes from activities such as gathering of wild flora and fauna or even depend on these as their key survival strategy. therefore, it is essential to recognise the interests that these subjects share and try to incorporate them into national rural development policies. multifaceted nature of rural development requires the synergy between different fields of activity and between different levels and actors. synergy may occur between local and regional eco-systems, specific farm styles, specific goods and services, localized food chains and specific social carriers and movements, but it also refers to the correlation between ecology and economy. this means that modern concepts of sustainable rural development demand the change of traditional organisation and management structures and relationships and the division of responsibilities, tasks, activities and funds between the state and the private sector as its important partner and their joint efforts aimed to improve local development. in this, “new paradigm of rural development”, agriculture cannot be viewed as the only solution to rural poverty. on the contrary, it should be developed along with other actual and potential rural activities that are suitable to enhance the capacities of rural households and increase their incomes. just like other developing countries, serbia is also facing numerous problems in the area of rural development. some of them are present in other countries as well, whereas others represent the results of specific historical, political, economic, social and cultural circumstances. rural areas in serbia still seem to have certain resources for successful implementation of sustainable development concept. nowadays, especially in the times of economic crises, agriculture, agro-industry and the potentials of rural areas play a significant role in the overall economic development of our country. however, the presence of several limiting development factors require profound structural changes and significant investment in this field. sustainable development of agriculture should be recognised as one of priorities of overall economic development. such approach is in accordance with european standards, includes a multi-functional agriculture and high-quality food production as key argument for competency. for example, organic agriculture has been spreading in serbia since 1990, but the number of agricultural lands for this type of production has been increasing in the past couple of years, thanks to support of several state and civil organisations. another environmentally desirable potential of rural areas lays in their renewable sources of energy that can be used for the production of biomass and biodiesel. this refers to various organic materials that appear as the vladan joldžić, ana batrićević, vera stanković, nikola paunović 89 results of agricultural production. unfortunately, it appears that this potential has not yet been fully used in serbia and it deserves a much stronger financial and educational state support. education of rural population in the fields of environmental protection and sustainable use of natural resources, as well as about the application of modern technologies and approaches is also very important. however, local peasant or indigenous knowledge also has to be recognised as significantly different from standard scientific knowledge, embedded in local ecology and encoded in culture rather than theory. it is relies on the interdependent accumulation of local, natural and social resources, practices and knowledge. they are not only important for maintaining “old cultures”, but also contribute to a constant renewal of knowledge systems. finally, normative regulation of rural development and other issues related to it is one of key preconditions for a more active role of the state in this area. it could be said that lack of adequate legislative framework contributed to the inconvenient position of rural areas in serbia. therefore, the adoption of allows and strategic documents harmonised with european standards represents a positive step. however, the laws and strategic documents must be implemented properly, with a more intensive monitoring, larger long-term investments in the rural areas, and multi-sectoral support. this is not possible without financial support from the budget, foreign investments and appropriate use of ipa funds. acknowledgements this paper is a result of research project under the code 47011 (crime in serbia: phenomenology, risks and possibilities of social intervention) of the institute of criminological and sociological research, financed by the ministry of education, science and technological development of the republic of serbia. references animal husbandry law. official gazette of the republic of serbia, no. 41/2009, 93/2012 and 14/2016. ashley, caroline, simon maxwell. 2001. 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"report: our common future." http://www.un-documents.net/our-common-future.pdf article history: received: january 13, 2018 accepted: june 7, 2018 doi: 10.28934/ea.18.51.12.pp92-102 scientific review social responsibility of banks in the function of comparative advantage on the market milica raičević1* | dijana medenica mitrović 2 1 faculty of business studies “montenegro business school”, mediterranean university, podgorica, montenegro 2 faculty for business management bar, bar, montenegro abstract the business operation of companies is not neutral and is not perceived any more in terms of profitable operations, but also in terms of whether it is beneficial for the society. social responsibility contributes to improving relationships with key stakeholders, thus contributing to the long-term sustainability of the company. the paper points out to the positive link between corporate social responsibility (csr) and the reputation of the bank. without csr, neither the improvement nor the expansion of banking operations is possible. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a strong comparative advantage on the market. the paper gives a theoretical and practical overview of the concept of corporate social responsibility (csr), with a focus on the banking sector. in the theoretical part, the term csr is defined, as well as its significance and special features regarding the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its characteristics in terms of csr. the empirical part includes the qualitative analysis, based on the data available on the official sites of banks operating in montenegro. based on the collected internet data, an analysis of the factual situation was carried out, conclusions were given and recommendations have been made for the implementation of the csr concept with a view of improving the competitive position of banks on the market. through qualitative analysis of the available data, the advantages and disadvantages of corporate social responsibility of banks in montenegro were considered, as well as which csr activities are most represented and which still have the capacity to be improved and involved in the marketing strategies of the banks in montenegro. key words: social corporate responsibility, banks, reputation, marketing jel classification: n20, g20 introduction the turbulence of the environment, market changes that represent the process today, not just the business event as they once did, have led to the need for companies to re-examine themselves and to supplement their business strategy in order to gain competitive advantage in the market. in order to gain a competitive advantage they should focus on the people, that is, the need to increase the number of people who use their products and services or more simply believe in them. in order to be successful in a dynamic services market companies must delivered superior value to target customers who become more demanding, and choose products/services rationally, analysing relation between price and quality. the competitiveness of companies in the financial sector is largely based on fostering customer loyalty, integrating * e-mail: milica.raicevic@unimediteran.net milica raičević, dijana medenica mitrović 93 various communication channels, reducing operating costs and good risk management (domazet, stošić and hanić, 2016). in the last ten years, in the literature, as well as in the practice, the concept of social responsibility has started to develop, which focuses on the support to the community in which the business operations are carried out, and in return, these companies are recognized by the community as the companies which should be trusted, which is one of the ways in which the companies can contribute to their growth and their competitive advantage. banks, as a specific phenomenon by itself which has a specific way of generating profit, have realized that they have to incorporate the concept of social responsibility into their business strategy, in order to differentiate and gain a competitive advantage in the banking sector, which is characterized by an increasing number of banks and tougher competition in the financial market. the paper views the concept of social responsibility, the banks in montenegro, as well as the implementation or introduction of this concept in their operations. moreover, a positive correlation between corporate social responsibility (csr) reputation of the bank has been pointed out. the without the social responsibility of banks, it is not possible to improve or extend the banking operations. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a serious comparative advantage on the market. the initial hypothesis: the application of the concept of social responsibility is an important factor for achieving competitive advantage and strengthening the position of banks in the financial market, all through the creation of services that will improve and expand banking activities, to create satisfied consumers who are loyal. auxiliary hypotheses are: 1. the willingness of banks to invest in csr activities will increase the confidence in banks by customers and the community 2. developing awareness of the importance of csr for company business and training and inclusion of employees in csr activities provides for a higher level of business and better reputation 3. socially responsible activities address the problem for which the state does not have sufficient financial resources, which also affects the strengthening of the reputation of the bank 4. improving the business environment creates the conditions for developing the competitiveness of banks and strengthening their position in the financial market, and therefore profit. the paper gives a theoretical and practical overview of the concept of csr and its application in the banking sector. in the theoretical part, the term csr is defined, its significance and specific qualities related to the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its features in terms of csr. the empirical part covers qualitative analysis, on the basis of the data available from the official websites of the banks operating in montenegro. on the basis of the data collected from the internet, an analysis of the factual situation has been conducted, conclusions have been drawn and recommendations have been made for the application of the csr concept in order to improve the competitive position of banks on the market. through the qualitative analysis of the available data, the advantages and disadvantages of social responsibility of banks in montenegro have been studied. it has been analysed which csr activities are the most prominent, and for which there is still the space to be improved and involved in the marketing strategies of banks operating in this area. in the end, it has been pointed out that the awareness of the benefits the csr brings to the company has not still been developed in montenegro. the socially responsible practice is often perceived as an unprofitable and impractical activity. in recent years, in the banking sector, socially responsible activities are growing in importance and have a tendency towards growth. 94 economic analysis (2018, vol. 51, no. 1-2, 92-102) the social responsibility of banks is significant for the montenegrin economy and society, because socially responsible banking activities contribute to the improvement and advancement of the existing situation in certain segments which the country has insufficient resources to support. banks carry out their socially responsible activities through activities in the fields of education, health care, culture, sports, environment protection, and work with people with disabilities. in conclusion, the banks have a dual role, they are both promoters of socially responsible behaviour and institutions investing in those areas of vital importance, for which the state does not have enough resources. the csr of banks represents a serious comparative advantage in the market, because the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro and actively engage in solving problems at both the local and the national level. theoretical aspects of social responsibility of banks in montenegro defining the concept of corporate social responsibility social responsibility is now perceived as an inevitable part of the company's operations and one of the market differentiation options. in this context, social responsibility or corporate social responsibility (according to the world business council for sustainable development) can be seen as "the commitment of business units to contribute to sustainable economic development, cooperation with employees, their families, the local community and society as a whole aimed at improvement of the quality of their lives”(saraiva and serrasqueiro, 2007). this would mean that the concept of social responsibility does not perceive as the opposing sides, on the one hand, the people, the community and the environment, and on the other hand, the economic goals of the company. the concept of social responsibility would mean that the company assumes responsibility for the impact of its own activities on all the stakeholders of the company, as well as on the environment (zelenović, 2015). moreover, it should be emphasized that csr is not the same for every company, but that the business operations according to this principle depends on the size of the company, the economic region, the market and the actual operations of the company. as noted, the operations based on the corporate social responsibility principle connect and enhance the relationships between the company, stakeholders and the environment, and combines them into a single whole that generates benefits both for the company itself and for the meeting of the current needs of future generations. so the most famous model regarding the csr is the model of the pyramid presented by caroll (1996), according to which if the company is to be socially responsible, then it needs to be financially stable (to be profitable), then legally responsible (to respect the laws of the state and markets), then ethically responsible (to operate in accordance with the moral and ethical norms of the society, community and the market) and ultimately to have a philanthropic responsibility (to be a good citizen). when we talk about when the concept of social responsibility dates back, we could say that, from a historical point of view, it dates back to the thirties of the last century, and as the subject of research of experts and interested individuals, somewhat later, sometime to the nineties, when companies accept the contemporary concept of social responsibility and implement it into their business strategy so that the activities they carry out create value for the company's owners, on the one hand, and for a wider community, on the other. significance and characteristics of corporate social responsibility numerous questions are raised regarding the concept and implementation of corporate social responsibility. some of them are related to the actual implementation of this concept in the company's operations and they relate to whether social responsibility is cost-effective or not and whether it should be considered as a cost or as an investment (stojanovi-aleksić and allies milica raičević, dijana medenica mitrović 95 2016). the given questions cannot be answered either with yes or no, but the answers require perceiving the things from different angles. the concept of social responsibility can be viewed from the aspect of the impact that the company operating in accordance with the given concept has on the enterprise and the society. this would mean that the responsible behaviour earns praise, that is, produces positive effects with the public which can be seen in the long run and can create a positive image or improve the existing one. thus, the sense of security and confidence is created among the interested individuals and groups, which creates a positive effect on the actual operations of the company. this means that the concept of social responsibility creates a positive effect on the company through the activities that contribute to the positive image, and the image creates confidence among the stakeholders, which contributes to the increase of the value of company’s shares, greater market share, competitive advantage etc. the study carried out in the usa has shown that the factors related to the social responsibility have almost the same effect on the company's reputation as some traditional factors such as quality, price, usage etc. (stojanovi-aleksić and allies 2016) it should also be taken into account that there is another aspect that reflects the importance of social responsibility, and that is the reporting on corporate social responsibility which should be included in the results and reporting on the company's overall business operations. when we talk about the activities, that is, the areas that the concept of social responsibility entails, we would say that it is the promotion of social goals (humanitarian work), the interconnection between marketing activities and social goals (part of the revenue is allocated for solving the problems of vulnerable groups), volunteer work (voluntary work aimed at supporting and actively participating in a community-run activity) and corporate philanthropy (the company's contribution through humanitarian activities) (stojanovi-aleksić and allies 2016). specific phenomenon of social responsibility in the banking sector the above mentioned prompted us, when talking about social responsibility, to think first about the relationship between csr and profit-making companies, which perceive this concept as a way of contributing to the community, on the one hand, and of gaining greater competitive advantage, on the other hand. the banks generally did not have a need for such a concept. this is due to the fact that they are independent financial institutions that take care of their finances independently, as well as the fact that they are intermediaries in the economy and have no need to care about the profit. however, due to the development of the market, increase in the number of participants in the banking market and increase and creation of new banking services, banks had to find a way to improve their reputation, develop trust among customers, restore the trust through various activities that would be receptive to people's eyes and ears. the assets of the company are not worth without customers, the task of managing services marketing is not only to attract new, but also to retain existing customers. new customers can be attracted only by delivering superior service, the role of marketing is to create a superior offer and ensure customer satisfaction, but also to anticipate the future needs of its clients, only satisfied customers can be loyal to a given organisation (hanic, domazet, 2012).thus the banks have realized that the concept of social responsibility provides an opportunity for expansion and improvement of their business operations. they can incorporate this concept into their defined strategy and thus, through the csr activities, gain competitive advantage in the banking market. by implementing socially responsible activities, the banks become an active part of the community in which they operate (zelenović, 2015) through the following: • promotion of social goals through a financial contribution or other types of contribution to develop or solve a particular social goal, • general well-being marketing when a certain amount of revenue is allocated for the achievement of a social goal 96 economic analysis (2018, vol. 51, no. 1-2, 92-102) • corporate social marketing assistance in development, implementation of campaigns which contribute to raising the awareness of the health, the sick, environmental protection ..., • corporate philanthropy – making direct contributions to a charitable or social activity, • community volunteer work voluntary work of employees and partners, • socially responsible business practice adopting and implementing the business practice that supports a social goal which should improve the life of the community (both the people and the environment) (kotler, li, 2009). based on the above, market changes and behaviour in the banking sector have led to the situation where the banks behave in the following way (vunjak, kovačević, 2006): • customer orientation because he/she is the most important person • the client is the purpose of the banking business • respecting the wishes and demands of the clients • a higher marketing concept • customer service quality. the motive for introducing the concept of social responsibility appears at different levels (zelenović, 2015): • internal ethics processes in banks and • external ethics consequences of banking actions. practice of social responsibility of the banks in montenegro the empirical framework of social responsibility of the banks in montenegro banks, as independent financial institutions, have focused on the care about their finances until recently. the bank is perceived solely as a recipient and provider of banking services, whose employees dominate the clients, without the adequate system of rewards and without paying a particular attention to the competition and customer requirements. the turbulent environment, the saturation of consumers by marketing advertising of various forms, has imposed the need for incorporating the socially responsible operations in the strategies of banks, as the necessary prerequisite for acquiring and maintaining the competitive advantage. they must not be focused solely on profit, but must be socially responsible, and take care of the environment. this raises the question of whether company can be both environmentally and socially responsible and profitable at the same time (domazet, kovačević, 2018). the whole community benefits through the activities of corporate social responsibility and the clients are becoming aware of this. by associating their products and services with the solving of a particular social problem, the banks do their promotion and encourage customers to buy their products or services. banks can demonstrate corporate social responsibility by providing the financial resources for raising awareness of a social problem, encouraging campaigns for behavioural change, engaging in local initiatives, humanitarian actions, financing and implementing the business practice for environmental protection or improvement of community life. all of these activities can be carried out by the bank itself and in cooperation with public sector partners, profit and non-profit organizations. moreover, the bank encourages and supports both its employees and partners to help local organizations and actions through voluntary work. implementation of csr activities is increasingly under pressure, both internal and external, to apply a strategic approach. the bank needs to choose what it will focus on and how to link its philanthropic and other initiatives to its business goals and tasks. the goal of milica raičević, dijana medenica mitrović 97 investing in various forms of socially responsible strategies is the strengthening of the bank’s reputation. through its reputation, the bank creates barriers to its competitors, sends a message that its services are of high quality, improves its market position, which contributes to profit increase. at the level of the economy, such operations encourage increased competitiveness and transparency in business, encourages trust and partnerships with the target public. the goal of reputation is not that a bank is liked but to create its value through business success and the solving of community problem which the state cannot solve alone. changes in the way of thinking and behaviour have led to more customer-orientated banks today, respect for customers' wishes and demands, introduction of a higher marketing concept and an increase in service quality. today, even conventional banks are participating in the actions that are of general welfare to the community. some of these activities are as follows: local scholarships and sponsorships, financing in the field of sports, health care, culture, more affordable housing loans, financing of some traditional events in the community, etc. although the positive effect of applying the csr concept in the banking operations has already been recognized, this concept is still inadequately implemented in a wider scope in montenegro, although the trend towards the growth of csr activities has been present in recent years. the reason for this can be found in the still underdeveloped awareness of the benefits of socially responsible practice, since such practice is often perceived as unprofitable and impractical experience. the common approach to corporate social responsibility is usually limited, defensive and unrelated to the actual strategy of the bank. the csr activities should be aimed at enhancing the relationship between employees and customers (as key stakeholders) so that they do not abandon the bank. according to the official data of the central bank of montenegro, 15 licensed banks operate in montenegro. the data on corporate social responsibility of banks is available on the official websites of seven montenegrin banks, which suggest that a little less than half of the banks have recognized the importance of informing the stakeholders of this aspect of bank operations. the csr data is available for the following banks: 1. societe generale bank montenegro ad 2. prva banka crne gore ad podgorica 3. nlb banka ad podgorica 4. addiko bank ad podgorica 5. erste bank ad podgorica 6. crnogorska komercijalna banka ad podgorica member of otp group 7. hipotekarna banka ad podgorica on the basis of available data on the official websites of montenegrin banks, it can be concluded that socially responsible activities are mainly focused on the fields of health care, education, sports, culture and the promotion of environmental protection. analysis of the state of corporate social responsibility of the banks in montenegro analysis of the state of corporate social responsibility of the banks in montenegro was made on the basis of secondary data, available on the official websites of the banks operating in our territory. below is an overview of the key objectives and activities of the seven banks, which publish the information on their csr activities on their websites. societe generale montenegro bank indicates, as the objective of its csr activities, the support for projects in the field of health care, education and culture which are useful for citizens and society over a longer period of time. the social community has acknowledged the efforts of this bank and in 2011, 2012 and 2015 societe generale montenegro, as a socially 98 economic analysis (2018, vol. 51, no. 1-2, 92-102) responsible company, was given the iskra award for philanthropy for the overall contribution of the bank to the montenegrin society and for its contribution to inclusive education. the bank is also the winner of the naturally equal award received for the best practice in achieving gender equality in montenegro (http://www.societegenerale.me/mne/o-nama/o-societegenerale-banci-montenegro, accessed on 17.03.2018.). the activities of the bank focused on healthcare activities included cash donations for the purchase of necessary resources for the montenegro clinical centre and the institute for children's diseases, as well as for procurement of medical and sanitary equipment for healthcare institutions, primarily for health care centres and general hospitals in the territory of montenegro. in this way, the bank contributes to the creation of better conditions for the strengthening of health care and the care about the public health. the bank is also active when it comes to monetary donations and cooperation with nongovernmental organizations dealing with the problems of children with developmental disturbances, people with disabilities, children suffering from cancer, as well as women victims of violence and juvenile mothers. with these donations, the bank draws attention to this group of women and children and actively participates in an effort to improve the position of women and children in the montenegrin society. societe generale bank also directs its socially responsible activities towards the support for inclusive education (donations to the stimulation room in elementary schools, financing instruction manuals for improvement of the teaching process within the inclusive education). through donations for educational tools in kindergartens, the construction of children's playgrounds, presents for pupils who walk to school from rural areas, the concern is shown for young people and improvement of conditions in educational institutions. the bank also organized a student competition on the topic of corporate social responsibility, which contributes to the development of awareness of the importance of corporate social responsibility among this target group. within the activities aimed at environmental protection, the bank supported the activities of greening of certain parts of the capital. another action with the same goal was the purchase of electric bicycles for employees and clients. numerous activities include humanitarian aid for the most deprived families, donations for the library of the blind, as well as numerous sponsorships for art exhibitions of montenegrin artists. prva banka crne gore has actively participated in the realization of socially beneficial projects since the very beginning of its existence. it is recognized by its support for projects of national significance in the field of health care, culture, sports, as well as support for humanitarian and other projects that have an impact on raising the quality of life of the citizens in montenegro (http://www.prvabankacg.com/o-nama/drustvena-odgovornost/, accessed on 17.03.2018.). some of these projects by which prva banka crne gore confirms its strategic commitment to corporate social responsibility include: the ulcinj's greening project, sponsorship of the women's handball team of montenegro at the world championship in denmark, a donation for the internal ward of the bar hospital. nlb montenegro bank promotes its socially responsible operations through sponsorships or donations to cultural, sports and entertainment events as well as environmental protection projects. the largest and most significant sponsorship projects of nlb banka are: sponsorship of the budućnost basketball club, the as tennis club, the main sponsor of the national parks of montenegro, which has been its partner since november 2010 within the project 'obradujmo prirodu' (make the nature happy), which contributes to raising awareness of the importance of environmental protection and conservation of protected natural areas for future generations (https://www.nlb.me/me/nlb-banka/opste/sponzorstva-i-donacije, accessed on 17.03.2018.). milica raičević, dijana medenica mitrović 99 for several years, addiko bank ad podgorica has been allocating funds in a planned manner, within its budget, to support the local community, where it carries out its activities, through the support for the work of educational and healthcare institutions, and events aimed at promoting and preserving social values through the fields of culture, arts, non-commercial sports activities (https://www.addiko.me/o-nama/drustvena-odgovornost/sponzorstva-idonacije/, accessed on 17.03.2018.). the most significant activities include: donations to children and adolescents with developmental disturbances; cooperation with non-governmental organizations and primary schools to support children with autism spectrum disorders; donations to children suffering from cancer; donation to the institute for children's diseases for the supply of equipment for the orl ward. in cooperation with the red cross, it participates in humanitarian actions for socially vulnerable citizens and in voluntary blood donation activities. among numerous activities the following are also worth mentioning: donations to the fire department in tivat; assistance for the purchase of equipment for the national team of the special olympic games of montenegro; baskets for the school gym in žabljak; equipment for primary and secondary schools in kotor and tivat; procurement of exercise equipment in the gym of the junior team of the "jadran" water polo club; a donation aimed at improving the social inclusion of children and youth with developmental disturbances and people with disabilities; donations of children's books to libraries in podgorica and kindergartens in kotor and tivat; sponsorship of the sea dance festival. as a modern and practical bank focused on customers and their needs, addiko has also provided the festival's visitors with various opportunities to make simple financial transactions on-site. the sea dance festival payment card and the addico bank card was the official payment instrument at the sea dance festival, and addiko bank has also provided an atm for cash withdrawals for all visitors (https://www.addiko.me/onama/drustvena-odgovornost/sponzorstva-i-donacije/, accessed on 17.03.2018.). what seems interesting is the fact that all the activities listed on the website of addiko bank were conducted in the period from november 2016 to december 2017. erste banka actively and consistently contributes to the re-building of the value system, the development of society and culture in the country by initiating, acknowledging and providing organizational and financial support to the activities, projects, organizations and institutions acting in the same direction. erste banka gives its contribution to: the culture and arts, education, sports, social inclusion and environmental protection (https://www.erstebank.me/sr_me/footer-stanovnistvo/o-banci/sponzorstva-i-donacije accessed on 17.03.2018.). one of the ongoing programmes listed on the website refers to the best of south east programme: study in graz –development and further education programme, as well as international work experience for talented and dedicated graduates and students from montenegro, bosnia and herzegovina, croatia , macedonia, slovenia and serbia. crnogorska komercijalna banka bases its corporate social responsibility on supporting independently or as a partner the realization of projects in the field of culture, arts, science and sports. aware of the importance of entrepreneurial initiative in culture, ckb has supported the representative editions of the cid publishing house (economic, literary, legal, anthropological, historical) which has published important studies from the history, culture, nature of montenegro, as well as numerous capital translations (http://www.ckb.me/marketing-ipr/marketing-i-pr.69.html accessed on 17.03.2018.). ckb sponsors or participates in the organization of various events (concerts, mimosa festival, world savings day), gives donations in the field of health care, education and science, paying special attention to children and young people, through the scholarships to the best, but also through the ckb donations to the unicef projects. the support for sports clubs in football, basketball, handball, karate, and cooperation with the montenegrin water-polo national team are some of the csr activities of crnogorska komercijalna banka. ckb has recognized the importance of financing in the field of cinematography (film festival hercegfest) and arts. 100 economic analysis (2018, vol. 51, no. 1-2, 92-102) moreover, for the first time in montenegro ckb ensures the financing of renewable energy sources aimed at continuous improvement of efficient and sustainable economic, social and ecological environment (http://www.ckb.me/marketing-i-pr/marketing-i-pr.69.html accessed on 17.03.2018.). hipotekarna banka ad podgorica is the winner of the special award "iskra" for corporate philanthropy in 2016. the award has recognized the contribution and importance of corporate social responsibility of hipotekarna banka ad podgorica, which has several directions: investment in health care improvement, investment in culture, care for the elderly, investment in youth education and general contribution to the community. some of the csr activities of hipotekarna banka are: donations of books to educational institutions in montenegro; scholarships and the provision of international practice to the best students; procurement of reanimation vehicle for the needs of the institute for emergency medical assistance; together with the partners, the donations of vehicles for the transportation of patients on dialysis of the montenegrin clinical centre; participation in the donation to the clinic for gynecology and obstetrics; in cooperation with the non-governmental sector, the donations to the nursery home in bijelo polje; the general sponsorship of the montenegrin national theatre; donations of funds for the construction of a swimming pool in nikšić; sponsorship of the made in ny jazz festival; organization of panel discussions "live globally, work locally”(http://hipotekarnabanka.com/o-banci/vijesti accessed on 17.03.2018.). results of empirical research the overall goal of sustainable development is the long-term sustainability of economy and the environment, which will be achived by integrating economic, environmental and social aspects of the decision-making process (domazet, kovačević, 2018). adequate socially responsible activity of banks contributes significantly to the improvement and advancement of the existing situation in those segments of society and the local community which the state has either insufficient interest or resources to support. from the previous analysis of the state of corporate social responsibility of banks in montenegro, it can be seen that some banks are aware of their social responsibility, which is demonstrated through financial investments in certain activities. some of the most prominent activities include: inclusive education, work with people with disabilities, health care, education, sports, culture, environmental protection, work with the youngest, which are all segments of our society, for which insufficient funds are allocated from the state budget. table 1. csr activities of the banks in montenegro bank csr activity societe generale banka mne prva banka crne gore nlb bank mne addiko bank erste bank crnogorska komercijalna banka hipotekarna banka health care x x x x education and science x x x x x inclusive education x x social inclusion x x x x culture x x x x x x x sports x x x x x x arts x x x x environmental protection x x x x source: authors' analysis 18.03.2018. milica raičević, dijana medenica mitrović 101 banks have a dual role: the role of promoters of socially responsible behaviour and institutions investing in those areas of vital importance for community development, for which the state does not have enough resources. in this way, the banks are directly involved and become a partner to the country in solving strategic social issues, both at the local and the national level. banks also have some benefits from csr initiatives, namely: building a strong corporate reputation, contributing to overall business goals, attracting and retaining motivated workforce, supporting marketing goals, establishing strong relationships in the community, etc., which contributes to the comparative advantage of certain banks in the market. given that these activities are just some of those available to the banks in the area of corporate social responsibility, we hope that corporate social responsibility will develop in montenegro in the forthcoming period, and that the banks will also be in a position, through the appropriate selective credit and interest rate policy, as well as the establishment of special funds, to have a direct impact on the companies to behave in a more responsible manner. given that montenegrin banks are predominantly in foreign ownership and that the csr represents a serious comparative advantage on the market, the foreign banks which implement the csr send their customers a clear message that they are ready to stay in montenegro and actively engage in solving problems both at the local and the national level. conclusion as the conclusion of the paper and the conducted research, it is suggested that the concept of social responsibility and supplementing the bank's business strategy with it, can have multiple benefits for the bank itself, i.e. its competitive advantage in the banking sector, as well as for the improvement of the community and hence greater customer satisfaction. by introducing this concept, a positive image is built in the market, and thus a greater degree of trust is created in the operations of the bank by all interested individuals and groups. the paper analyses the concept of corporate social responsibility, its positive effect on the above-mentioned entities, the introduction of this concept into the strategy and business policy, the specific phenomenon of the bank and its operations, and the contributions that the introduction of this concept makes both for the bank and for all stakeholders of the bank. the results obtained by empirical research in montenegro indicate that banks carry out their socially responsible activities through the activities in the fields of education, healthcare, culture, sports, environmental protection, and work with people with disabilities. the conclusion is that banks have a dual role, they are both promoters of socially responsible behaviour and institutions that invest in those areas of vital importance, for which the state does not have enough resources. it was then concluded that the csr of banks constitutes a serious comparative advantage in the market, since the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro, and actively engage in solving problems both at the local and the national level. the contribution of this paper is reflected in the fact that through a qualitative analysis a breakdown has been given of the activities and areas in which the csr of banks in montenegro is present. an analysis of csr activities can be helpful to decision-makers in the marketing sector of banks in deciding how to use csr as one of the leverages 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first online: march 29, 2023 original scientific paper corruption as an obstacle to pandemic response: a covid-19 case study bruno škrinjarić10 f* | jelena budak1 | allison carragher2 1 institute of economics, zagreb, croatia 2 carnegie europe, brussels; institute of economics, zagreb, croatia abstract this research explores the relationship between corruption and pandemic outcomes by investigating whether european countries with higher levels of corruption were less successful in fighting covid19. data were analyzed using exploratory factor analysis and structural equation modeling techniques. results indicate that corruption prevalence and poor bureaucratic quality both decrease trust in government, and this effect is persistent notwithstanding the socioeconomic conditions or geographic attributes of a country. trust in government, coupled with stringency measures, is positively associated with the number of new people vaccinated and, thus, fewer covid-19-related deaths. furthermore, corruption undermines trust in the government and its institutions and, through this mechanism, prevents the suppression of the pandemic. unlike other scarce studies that looked at the direct link between corruption and vaccination only, we also investigated the impact of corruption on the outcomes of government pandemic restriction measures and added several contextual variables into the model. we found that corruption poses a significant obstacle to the pandemic response. our findings suggest to policymakers that their best weapon against covid-19 is vaccination and that renewed efforts to eradicate corruption and establish trust between governments and citizens can positively impact vaccination rates and limit the most devastating effects of the pandemic. keywords: corruption, trust in government, vaccination, covid-19, population health, europe jel classification: d73, i18 introduction corruption and its causes and consequences have been assessed from many different points of view. however, the understanding of corruption in circumstances of global disasters, such as the situation caused by the covid-19 pandemic, is rather limited (collins et al., 2020; greer et al., 2020). the pandemic generated social, economic, and governance crises (oecd, 2020) that opened opportunities for corruption (rose-ackerman, 2021), where the latter remains largely unexplored. the goal of this research is to investigate the relationship between levels of corruption and disastrous consequences of the covid-19 pandemic on the european continent by seeking to determine if countries where corruption is more dominant were less effective in combating the covid-19 pandemic and examining which factors explain the variations. our intuition is that societies where there is more corruption, poor bureaucracy, and poor socio-economic conditions * corresponding author, e-mail: bskrinjaric@eizg.hr 2 economic analysis (2023, vol. 56, no. 1, 1-19) do not trust the government and thus faced more institutional impediments to effectively coping with the pandemic and witnessed worse outcomes. concerns that corruption and low levels of trust in government could further distort efforts to fight the pandemic were raised in the early days of the outbreak before a vaccine was available. however, there has been little scientific study on whether corruption stands as an impediment to efficiently fighting covid-19 and, if so, whether the situation changed when vaccination became largely available. beyond corruption, could related determinants such as institutional quality and a government’s capacity to conduct sound policy measures mitigate the expected negative effects of the covid-19 pandemic? does the country’s health infrastructure play a key role in affecting the new cases of infection and covid-19-related deaths? considering these contextual factors and the overall socioeconomic conditions of a country, this research sheds new light on neglected aspects of fighting the covid19 pandemic in europe. our contribution to the literature is that, unlike other scarce studies that looked at the direct link between corruption and vaccination only, we looked at the impact of corruption on the outcomes of government pandemic restriction measures. secondly, we use a large sample of european countries. this gives us the right amount of heterogeneity between countries to explore relationships between different variables but also enough homogeneity in terms of geographical effects, season effects, and the general level of development. considering the contextual variables in a structural equation modeling (sem) model, the findings allow us to derive data-driven policy implications/recommendations. thirdly, we use detailed monthly data on the level of corruption, bureaucracy quality, and socioeconomic conditions for the observed countries in order to analyze changes in the relationships among variables throughout the waves of the pandemic and the introduction of vaccines. this paper is structured as follows: following the introduction, the literature review is provided in section 2. the research methodology and data sources are presented in section 3. in section 4, the empirical results of descriptive statistics, exploratory factor analysis, and a structural equation model are provided. finally, the conclusions, including suggestions for further research, are presented in the final section. literature review the abundant literature on determinants of corruption (treisman, 2000; elbahnasawy and revier, 2012) finds that low democratic standards (kolstad and wiig, 2016) and political risks and instability (serra, 2006) are positively associated with corruption, while the quality of political institutions is negatively associated with corruption (lederman et al., 2005). furthermore, there is ample empirical evidence that corruption impedes growth and is associated with lower levels of economic development (d’agostino et al., 2016). the relationship between the prevalence of corruption and the covid-19 pandemic has two components. firstly, corrupt rent-seeking might increase in times of crisis (such as wars, natural disasters, or a pandemic) due to market distortions mirrored in shortages that lead to price increases, illegal trade, and profiteering. a global ‘corruption wave’ during the covid-19 pandemic was observed in europe, with cases of misuse of public procurement and purchasing equipment on the grey market (steingrüber et al., 2020). the (initially limited) availability of vaccines further created opportunities for rent-seeking behavior and corruption (goel and nelson, 2021; undoc, 2020) throughout the vaccine value chain (transparency international, 2021). this corruption contributes to supply chain issues, thus depriving citizens of their ability to access medical supplies and receive quality health care (teremetskyi et al., 2020). in times of pandemics, the implementation of anti-corruption policies is endangered (amundsen, 2020; estrada, 2020), resulting in more corrupt societies becoming even more vulnerable to crises (yamen, 2021). bruno škrinjarić, jelena budak, allison carragher 3 on the other hand, the covid-19 pandemic has also given governments a chance to gain more legitimacy, enhance governance, and increase the level of trust in public institutions. messner (2020) explored institutional and cultural factors that influenced the covid-19 outbreak and found that a strong institutional context, including low corruption and high political participation, is negatively associated with the outbreak. ezeibe et al. (2020) concentrated on nigeria and explored the effect of political distrust on covid-19 spread. they concluded that boosting public sector accountability helps stem the spread of covid-19 by motivating citizens to obey safety measures. relevant research also indicates a strong negative relationship between corruption and effective government (mohamadi et al., 2017; schwab and sala-i-martín, 2015). it is reasonable to assume that in corruption-free environments, governments and societies can respond to pandemic challenges promptly, and in a well-organized and responsible manner. transparency, public trust, and government accountability are all seen as crucial to the effective and rapid response to a pandemic (rose-ackerman, 2021). in the initial covid-19 outbreak stages, most governments imposed non-pharmaceutical intervention measures such as lockdowns, travel bans, movement restrictions, and social distancing (megna, 2021), as well as public health and economic measures (chilton et al., 2020). some countries, such as switzerland and nordic countries, invoked new or amended laws on epidemics to allow for the implementation of stricter measures (francetic, 2021). the urgency of the crisis called for immediate policy responses. the late introduction of social distancing and lockdown measures seems to worsen the effects of the first wave (as arnold et al. (2022) showed for england). success in implementing these non-pharmaceutical interventions is dependent on trust, good communication (balog-way and mccomas, 2020; cairney and wellstead, 2021), public perceptions of risk, and behavioral responses to personal protection (dryhurst et al., 2020; mamen et al., 2021). nevertheless, further studies show that the success of the severe measures imposed during the first wave of the pandemic had a contrary effect in the later stages, primarily due to a reduction in public trust in actions undertaken by the government (sagan et al., 2022), with the level of trust varying significantly among countries (sabat, 2020). since the outbreak of the pandemic, several studies have contributed to the assessment of public policies to control the incidence of covid-19 (haug et al., 2020; saez et al., 2020). national responses across the globe have been shaped by two sets of factors: i) the capacity of the healthcare system and health infrastructure readiness, and ii) the governance quality from an organizational perspective, the administrative ability to operationalize actions, and political leadership (capano et al., 2020). literature on healthcare systems and policy responses to covid19 pointed out heterogeneity in regulations and operationalization of measures among countries (berger et al., 2021), concluding there are no one-size-fits–all policy recommendations. the capacity, organization, management, and other characteristics of health infrastructure garnered attention as the costs of covid-19 were expected to be higher in countries with less developed health systems and higher population densities (mckibbin and fernando, 2020). as covid-19 imposed an extra burden on health systems and hospitals (winkelmann et al., 2021), the combination of rather limited supply and increased demand for health services, and the lack of strict clinical acuity-based criteria for the allocation of health and medical resources, might lead to more corruption, especially in public procurement in the health sector (teremetskyi et al., 2020). nations with lower corruption prevalence have evidenced slower pandemic growth (attila, 2020; farzanegan, 2021), which suggests corruption stands as an obstacle to the efficient and effective fight against covid-19. finally, wealthier economies providing better socioeconomic and health conditions to citizens should be better equipped to handle the negative effects of the pandemic (bokhari et al., 2007), despite the negative economic consequences of covid-19 (see e.g. bodroža & lazić (2021) for western balkans). however, inversely, developed countries also tend to have older populations, which contributed to higher death rates due to covid-19. 4 economic analysis (2023, vol. 56, no. 1, 1-19) there is less research linking vaccination, corruption, and government efficiency, and the existing research has yielded contradictory results. vaccination is regarded as a powerful tool in the fight against pandemics, both to alleviate the burden on hospitals and health workers and to reduce fatalities. however, the public reactions to covid-19 vaccines have varied from strong demand to ‘anti-vax’ behaviors (benoit and mauldin, 2021), with different responses reflecting differing levels of trust in governments and science at both the individual and societal levels (debus and tosun, 2021; grawitch and lavigne, 2021). jelnov and jelnov (2022) showed that government accountability contributes to the success of vaccination campaigns, with higher vaccination rates observed in more liberal and less corrupt countries. farzanegan and hoffmann (2021) found a negative relationship between countries’ corruption prevalence and vaccination rates. on the other hand, this relationship was found to be positive in a comparative study of the 50 us states, indicating that corruption might also work as a ‘greasing mechanism’ in vaccine delivery and priority access (goel and nelson, 2021). data and methodology data sources this research is based on three data sources: (1) summarized data on the covid-19 pandemic (hereinafter: covid dataset) by ritchie et al. (2020); (2) data on economic, financial, and political risk ratings for 140 countries (hereinafter: prs dataset), obtained from the prs group (prs group, 2021); and (3) data on health system infrastructure (hereinafter: who dataset), taken from the world health organization (who, 2021). the covid dataset includes data directly related to covid-19, including new confirmed cases and deaths, total confirmed cases and deaths, data on hospitalized patients, and data on covid-19 tests and vaccinations, as well as healthrelated data. the prs dataset contains political, social, and economic data for various countries around the world. among others, it includes estimates on a country’s corruption level, bureaucracy quality, democratic accountability, government stability, and socioeconomic conditions. finally, the who dataset includes data on hospital capacity and health infrastructure. the covid dataset is reported on a daily basis, the prs dataset on a monthly basis, and the who dataset on a yearly basis; upon merging these three datasets, they were all transformed to a daily basis covering the period from february 1st, 2020, to december 31st, 2021. our analysis focuses on a set of 34 european countries (table 2 in appendix), as this gives us the right amount of heterogeneity among countries to explore relationships between different variables, but also enough homogeneity in terms of geographical effects, seasonal effects, and the general level of development. empirical methodology and variables our empirical model to be tested is presented in figure 1. vaccination rate is a mediation variable between latent construct trust in government (govttrust) and two outcome variables: (1) new cases of covid-19 (new cases); and (2) new deaths connected to covid-19 (new deaths). govttrust represents the government’s capacity to carry out sound policies and citizen readiness to follow government recommendations. it is estimated from a set of manifest variables (items): (1) corruption index, (2) bureaucracy quality index, and (3) socioeconomic index. these manifest variables are highly constant over time (figure 5 in the appendix), suggesting that pre-pandemic levels are very similar to those in the analyzed time frame. trust in government is hypothesized to affect the vaccination rate, which in turn affects new cases and new deaths attributed to covid19. bruno škrinjarić, jelena budak, allison carragher 5 figure 1. empirical model source: authors’ own work. note: “demographic” and “health” are in bold as these represent matrices of variables. additional variables which are hypothesized to affect the vaccination rate and two dependent variables are the stringency index and specific country group effects. the stringency index enters the model as a 7-day moving average, as it takes some time for stringency measures to affect both vaccination rates and new cases/deaths. country group effects enter the model as a set of dummy variables. demographic is a matrix of variables capturing a country’s demographics: namely, median age and population density. health is a matrix of variables capturing a country’s health infrastructure: specifically, the number of hospital beds and the universal health care (uhc) service coverage index. we also add gdp per capita (ppp) to account for the general wealth of an economy. a more detailed description of all variables used in this research is presented in table 3 in the appendix. there are two stages to our empirical methodology. firstly, we test the latent construct govttrust for dimensionality, consistency, and reliability. cronbach’s alpha (ca) coefficient, alphaif-deleted indicator, and different correlations were used to analyze the reliability of measurement scales. exploratory factor analysis (efa) was used to examine the dimensionality of the measurement scale, whereby the measurement models specified that each manifest variable (scale items) was loaded by only one latent construct (factor), and the independence of measurement errors was assumed (kline, 2015). secondly, after testing and estimating the latent construct (variable) govttrust, structural equation modeling (sem) was used to estimate the empirical model. results descriptive statistics figure 2 presents a distribution of corruption, bureaucracy quality, socioeconomic conditions (measures available on a monthly basis), and estimated trust in government in selected european countries as averages during the 2020–2021 period. corruption is lowest in nordic countries (denmark, finland, norway, and sweden), closely followed by austria, germany, iceland, ireland, netherlands, switzerland, and the uk. conversely, the highest corruption rates are recorded in non-eu eastern european countries like russia, belarus, serbia, moldova, albania, and ukraine. govttrust corruptionε 1 bureaucracy qualityε 2 socioeconomicε 3 gdp per capita vaccination rate ε 4 stringency index new deaths ε 5 country group new cases ε 6 demographic health 6 economic analysis (2023, vol. 56, no. 1, 1-19) the relationship between corruption and bureaucracy quality essentially divides european countries into two groups: those in which corruption is higher than bureaucracy quality and vice versa. socioeconomic conditions have been traditionally the most favorable in northern european countries like denmark, finland, and sweden; and in western european countries like belgium, germany, netherlands, and switzerland. countries with low corruption and high socioeconomic conditions have higher trust in government and vice versa. figure 5 in the appendix shows that these trends are rather stable over time. figure 2. corruption, bureaucracy quality, socioeconomic conditions, and estimated trust in government in selected european countries (average 2020–2021) source: authors’ own work. figure 3 displays the distribution of people vaccinated with one dose at least (per hundred) and estimated government trust in selected european countries from the beginning of 2021 onwards when the vaccine was made available to the public. the solid black line represents a linear trend between these two variables, illustrating that trust in government is positively correlated with vaccination rate. bruno škrinjarić, jelena budak, allison carragher 7 figure 3. vaccination rates and estimated trust in government in selected european countries source: authors’ own work. figure 4 presents a scatter diagram for the analyzed european countries showing four dimensions: (1) population vaccination rate (people vaccinated with one dose at least per hundred inhabitants); (2) total covid-19 deaths per million inhabitants; (3) average level of trust in government during the period 2020-2021 (those with a score below the median are designated as low-government-trust countries, and those above the median high-government-trust countries); (4) time horizon throughout 2021 with balances at the end of each month. trust in government is highest in denmark, finland, norway, and sweden (nordic countries), followed by austria, germany, iceland, ireland, the netherlands, switzerland, and the uk (marked in black). on the other hand, the lowest rates of government trust were recorded in eastern european countries that are not members of the eu, such as russia, belarus, moldova, serbia, and ukraine (marked in light gray). considering the time horizon, the vaccination rate progression is clearly visible. it is very low in the first quarter of 2021 in all countries, regardless of the level of government trust (given that the vaccine became available only at the beginning of 2021), and rising in the second and the third quarters of 2021, most significantly in countries with a higher government trust rate (which reached vaccination rates of over 70 percent). finally, looking at the correlation between vaccination rate and covid-19 deaths, it is evident that this association is stronger (in the sense of a higher absolute value of the correlation coefficient) in countries with a higher government trust rate. in other words, the increase in the population vaccinated in highgovernment-trust countries is correlated with fewer deaths from covid-19. 8 economic analysis (2023, vol. 56, no. 1, 1-19) figure 4. vaccination rate and total covid-19 deaths in selected european countries source: authors’ own work. the presented situation regarding the spread of the virus and associated deaths, vaccine dynamics, and non-pharmaceutical measures applied vary across european countries. this indicates some trends and relationships worthy of an in-depth investigation, where institutional factors of public trust in government should be considered. estimation of latent constructs list and descriptive statistics of manifest variables (items) used to estimate the latent “trust in government” variable are presented in table 4 in the appendix. ca coefficients and item correlations are shown in table 5 in the appendix. a ca coefficient value of 0.9225, coupled with measurement scale reliability analysis results, indicate that the measurement scale used to construct the govttrust variable possesses a satisfactory level of reliability. measurement scales’ convergent validity and dimensionality were analyzed by efa (table 6 in the appendix) and results show that these scales possess convergent validity and are one-dimensional. hence, the group of items can be considered a unique measurement scale that measures the perception of latent structures. model estimation latent construct govttrust estimated in the previous subsection, together with other variables, were then entered into the sem framework. results of this model are shown in table 1, which is presented in three panels – panel a shows the results of measurement equations (equations used to estimate latent construct); panel b details the results of structural equations (main equations bruno škrinjarić, jelena budak, allison carragher 9 in our model); and panel c enumerates goodness of fit indicators for the overall model. regarding the measurement equations (table 1, panel a), both an increase in socioeconomic conditions and bureaucracy quality are positively related to government trust, while a corruption increase is inversely associated with government trust. structural equation results (table 1, panel b) are divided into three parts: first, we examine the connection of various variables with the number of new people vaccinated; second, we consider covariates of new covid-19 cases; and third, we investigate covariates of new deaths attributable to covid-19. during the interpretation of these results, the reader should keep in mind that all dependent variables are in “per million of the population” units to account for different population sizes. table 1. estimated sem results panel a: measurement equations non-standardized standardized trust in government bureaucracy 1.000 (-) 0.875*** (0.006) corruption -1.342*** (0.011) -0.911*** (0.006) socioeconomic 1.506*** (0.012) 0.822*** (0.006) panel b: structural equations non-standardized standardized new people vaccinated stringency index 0.002*** (0.000) 0.203*** (0.010) country group (benchmark: central and eastern europe) western europe -0.015** (0.006) -0.039 (0.016) southern europe 0.048*** (0.004) 0.106*** (0.010) northern europe 0.034*** (0.005) 0.082*** (0.012) trust in government 0.044*** (0.003) 0.195*** (0.014) new cases new people vaccinated -1.278*** (0.035) -0.750*** (0.018) stringency index 0.006*** (0.000) 0.334*** (0.016) country group (benchmark: central and eastern europe) western europe -0.042*** (0.012) -0.063** (0.019) southern europe -0.137*** (0.014) -0.179*** (0.019) northern europe 0.019* (0.011) 0.027 (0.015) total people vaccinated 0.002*** (0.000) 0.214 (0.014) median age 0.007*** (0.001) 0.056 (0.011) population density 0.042*** (0.012) 0.037*** (0.011) gdp per capita -0.001 (0.000) -0.024 (0.017) hospital beds -0.226*** (0.021) -0.142*** (0.013) uhc -0.001 (0.001) -0.020 (0.015) new deaths new people vaccinated -12.940*** (0.417) -0.523*** (0.015) stringency index -0.139*** (0.003) -0.528*** (0.012) country group (benchmark: central and eastern europe) western europe -2.835*** (0.149) -0.298*** (0.015) southern europe -3.025*** (0.177) -0.272*** (0.016) northern europe -0.322** (0.131) -0.031*** (0.013) total people vaccinated -0.010*** (0.002) -0.066 (0.012) median age 0.185*** (0.017) 0.107*** (0.010) population density 0.283* (0.150) 0.017*** (0.009) gdp per capita -0.017*** (0.005) -0.057 (0.015) 10 economic analysis (2023, vol. 56, no. 1, 1-19) non-standardized standardized hospital beds -0.838*** (0.262) -0.036*** (0.011) uhc -0.016* (0.009) -0.022 (0.013) panel c: goodness of fit indicators n 9,925 chi-squared statistic 8,238.81*** rmsea 0.044 cfi 0.927 tli 0.917 gfi 0.920 notes: *** p<0.01, ** p<0.05, * p<0.10. standard errors are in parentheses. cfi comparative fit index, gfi goodness of fit index, rmsea root mean square error of approximation, tli tucker-lewis index. since this model is estimated once covid-19 vaccines were readily available, the number of observations (9,925) is different from that reported in table a1 in the appendix. source: authors’ own work. the first part of our model, which examined the effects of different variables on vaccination rates, reveals that trust in the government is positively and significantly related to new people being vaccinated. on average, a one index point increase in trust in government (all other things held constant) will increase the number of new vaccinations by 0.044 per million citizens (a similar interpretation is for the standardized estimated coefficient as well). the stringency index is also positively and significantly related to the level of trust in the government, where a unit increase in this index, ceteris paribus, will increase the number of newly vaccinated by 0.002 per million citizens, on average. this suggests that citizens who trust their government and its pandemic response efforts are more likely to get vaccinated and that trust in government is a stronger incentive for vaccination than strict government policies. the second part of our model, in which we considered new cases of covid-19 (per million), shows that a unit increase in new people vaccinated, all other things held constant, will lead to a decrease in new cases by 1.278 cases per million citizens. somewhat surprisingly, there is a positive association between the stringency index and the number of new cases, although the magnitude of this effect is very small. this can partly be explained by a certain lag between the introduction of stricter measures and the time taken for them to reduce new cases. median age and population density are both positively associated with new covid-19 cases, given that covid19 has been disproportionately lethal among older populations and higher population density facilities transmission of the virus (mckibbin and fernando, 2020). the third part of our model, focusing on factors connected to new deaths attributable to covid19, indicates that the number of new people vaccinated is also again negatively correlated with new deaths, with this magnitude being far greater than the one on new cases. this is in line with communications regarding the covid-19 vaccine that the primary goals of vaccination are to reduce fatalities and to alleviate the symptoms of the virus, while it does not eliminate the possibility of transmission. this relationship would be expected to be different for pandemics in which a virus was completely prevented by a vaccine. the stringency index in this case is also negatively associated with the number of new deaths, albeit to a much smaller magnitude. this result is also in line with the trend presented in figure 4, where most countries began reducing restrictive measures once the vaccine became readily available. as with the number of new cases, median age and population density are also positively associated with new deaths, and these effects are of a higher magnitude. in terms of healthcare infrastructure, both the count of available hospital beds and accessibility of healthcare (universal healthcare index) are, as expected, negatively associated with the number of new deaths. bruno škrinjarić, jelena budak, allison carragher 11 discussion and conclusion corruption, including the quality of bureaucracy and socioeconomic conditions, is significantly associated with a loss of confidence in the government. this trust in government, in combination with covid-19 government response strategies administrated and other effects stemming from specific country groups has been associated with an increase in people vaccinated, which in turn had been shown to reduce new covid-19 cases and new covid-19 deaths. this means that corruption seriously erodes trust in government, and this mechanism weakens the pandemic response. unlike other scarce studies that looked only at the direct link between corruption and vaccination, we also considered non-pharmaceutical interventions and the impact of corruption on pandemic outcomes, with several contextual variables included in the sem model. this broader analysis shows the negative effects of corruption on efficiently fighting covid-19 through both government policies and vaccination campaigns. the results of this paper are in line with previous research. our findings are similar to those of jelnov and jelnov (2022), who also find higher vaccination rates in countries that are perceived as less corrupt. their data show that a unit increase in corruption perception index (index scaled 0 to 10) is related to a 1 percentage point decrease in vaccination rate. farzanegan and hofmann (2021) analyze the association between public corruption and covid-19 vaccination rates in more than 90 countries worldwide and find that corruption in 2020 can explain about 50% of vaccination progress by mid-2021. these findings also hold practical relevance for policymakers. obtained results demonstrate that non-pharmaceutical interventions and vaccination are effective tools to reduce the spread of covid-19 and to minimize its fatality, although vaccination should be the primary target. this is despite claims to the contrary by anti-vax and anti-restriction communities. the model also indicates that government trust is a key component of an effective vaccination campaign and an effective response to covid-19. this leads us to believe that more needs to be done to eradicate corruption and build trust between citizens and governments. anti-corruption programming and efforts to increase public trust should be included in global health policy. current covid-19 challenges should not reduce funding or focus on such efforts, as corruption is severely undermining pandemic relief measures. lastly, this study is not without limitations and open questions for future research. first, a standard challenge in any latent variable estimation stems from the possibility of omitting an important item which is connected to the latent construct being measured. instead of relying on nationwide questionnaires on trust in government, which is prone to self-evaluation bias, we utilize the prs dataset with measures of various economic and financial risks for each country. however, future research is encouraged to use additional variables to approximate trust in government, such as government stability or democratic accountability. second, in spite of the limited data available, this research takes into account country-level sociodemographic attributes such as median age and population density; and for country-level healthcare, infrastructure is approximated by the number of hospital beds. these data were amended with country-level indicators on various key daily indicators related to the pandemic. future research is suggested to add demographic, social, and economic data on those who were affected and/or died from covid-19 to the model and estimate it on an individual level, (some initial attempts were already made by rieger and wang (2021)), and to expand the geographic scope of the research beyond the european continent to see if our findings remain consistent. thirdly, this research focused exclusively on the covid-19 pandemic, but future research is encouraged to determine whether these findings hold true for other past pandemics. fourth, there may also be an issue with the direction of causality, i.e., it is also possible that increased levels of covid-19 cases and deaths negatively impact government trust. lastly, instead of performing a general equilibrium analysis, this research performs an average analysis for given countries. during a pandemic, there are likely 12 economic analysis (2023, vol. 56, no. 1, 1-19) to be other spillovers and externalities, such as decreased mental health, increased levels of anxiety, disruptions of global value chains, etc., which we do not estimate. acknowledgments this research has been fully supported by the institute of economics, zagreb under the grant “tvoj grant@eiz” (project no. 3220). references amundsen, i. 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(2021). tax evasion, corruption and covid-19 health risk exposure: across country analysis. journal of financial crime, 28(4), 995-1007. doi: https://doi.org/10.1108/jfc-102020-0220 16 economic analysis (2023, vol. 56, no. 1, 1-19) appendix table 2. list of countries that entered analysis country frequency a percent cumulative albania 602 2.86 2.86 austria 615 2.93 5.79 belarus 612 2.91 8.7 belgium 636 3.03 11.73 bulgaria 603 2.87 14.6 croatia 615 2.93 17.53 czech republic 610 2.90 20.43 denmark 613 2.92 23.35 estonia 613 2.92 26.26 finland 642 3.06 29.32 france 647 3.08 32.4 germany 644 3.06 35.46 greece 614 2.92 38.39 hungary 607 2.89 41.27 iceland 612 2.91 44.19 ireland 611 2.91 47.09 italy 640 3.05 50.14 latvia 609 2.90 53.04 lithuania 611 2.91 55.95 moldova 603 2.87 58.82 netherlands 613 2.92 61.73 norway 614 2.92 64.66 poland 607 2.89 67.54 portugal 609 2.9 70.44 romania 614 2.92 73.36 russia 640 3.05 76.41 serbia 605 2.88 79.29 slovakia 605 2.88 82.17 slovenia 606 2.88 85.05 spain 639 3.04 88.09 sweden 639 3.04 91.13 switzerland 615 2.93 94.06 ukraine 608 2.89 96.95 united kingdom 640 3.05 100.00 total 21,013 100.00 note: a frequency in this table refers to days observed in each country. bruno škrinjarić, jelena budak, allison carragher 17 table 3. description of variables used in analysis variable description values source: covid dataset a new cases new confirmed cases of covid-19 (7-day smoothed) per million people in the total population. new deaths new deaths attributed to covid-19 (7-day smoothed) per million people in the total population. new vaccinations daily number of people receiving their first vaccine dose (7-day smoothed) per hundred people in the total population. stringency index government response stringency index: composite measure based on 9 response indicators including school closures, workplace closures, and travel bans. (oxford covid-19 government response tracker, blavatnik school of government) 0 – 100, 100 = strictest response gdp per capita gross domestic product at purchasing power parity (constant 2011 international dollars). median age median age of the population, un projection for 2020. population density number of people divided by land area, measured in square kilometers. source: prs dataset b corruption corruption index: a measure of corruption within the political system concerned with actual or potential corruption in the form of excessive patronage, nepotism, job reservations, ‘favor-for-favors’, secret party funding, and suspiciously close ties between politics and business. 0 – 6, higher values indicate higher corruption bureaucratic quality bureaucratic quality index: a measure of the strength and expertise to govern without drastic changes in policy (autonomous from political pressure) or interruptions in government services (established mechanism for recruitment and training). 0 – 4, higher values indicate higher quality socioeconomic conditions socioeconomic conditions index: a measure of the socioeconomic pressures at work in a society that could constrain government action or fuel social dissatisfaction. this index consists of unemployment, consumer confidence, and poverty. 0 – 12, higher values indicate better conditions source: who dataset hospital beds hospital beds per thousand people, which include inpatient beds available in public, private, general, and specialized hospitals and rehabilitation centers. in most cases, beds for both acute and chronic care are included. uhc index coverage index for essential health services (based on tracer interventions that include reproductive, maternal, newborn and child health, infectious diseases, noncommunicable diseases, and service capacity and access). 0 – 100, higher values indicate better services other variables country group 1 – central and eastern europe, 2 – western europe, 3 – southern europe, 4 – northern europe notes: a definition, methodology and sources behind all variables from covid dataset are available here https://github.com/owid/covid-19-data/tree/master/public/data. b definition, methodology and sources behind all indices from prs dataset are available here https://www.prsgroup.com/wpcontent/uploads/2018/01/icrgmethodology.pdf. definition, methodology and sources behind all indices from who dataset are available here https://covid19.who.int/data. 18 economic analysis (2023, vol. 56, no. 1, 1-19) table 4. descriptive statistics of latent constructs’ items latent construct item mean standard deviation minimum maximum govttrust corruption 2.42 1.18 0 4.5 bureaucracy 3.03 0.95 1 4 socioeconomic 7.70 1.39 4.5 11 note: “st. dev.” denotes standard deviation. table 5. item correlations and cronbach alphas latent construct item inter-item correlation item-rest correlation cronbach alpha alpha-ifdeleted govttrust corruption 0.8084 0.8340 0.9225 0.8940 bureaucracy 0.7681 0.8648 0.8689 socioeconomic 0.8179 0.8268 0.8998 table 6. exploratory factor analysis results panel a: eigen values factor eigen values percentage of explained variance cumulative percentage of explained variance 1 2.30986 1.0804 1.0804 2 -0.0731 -0.0342 1.0462 3 -0.0987 -0.0462 1.0000 panel b: eigen vector latent construct item f1 govttrust corruption -0.8697 bureaucracy 0.9011 socioeconomic 0.8610 bruno škrinjarić, jelena budak, allison carragher 19 figure 5. long-run trends (1985-2021) of corruption, bureaucracy quality, and socioeconomic conditions in selected european countries source: authors’ own work. article history: received: 16.1.2023. revised: 20.3.2013. accepted: 27.3.2023 ea_2019_2 doi: 10.28934/ea.19.52.2.pp71-92 original scientific paper ageing and productivity: an exploratory analysis of the portuguese case mariana monteiro1* | marta simões2 1 faculty of economics, university of coimbra, coimbra, portugal 2 ceber and faculty of economics, university of coimbra, coimbra, portugal abstract the portuguese labour force is ageing rapidly, corresponding to an increase in the share of older cohorts in the workforce, and there are no prospects that this situation will slow down. this study carries out an empirical analysis of the impact of workforce ageing on labour productivity in the portuguese economy considering data for the period 1971-2017. we investigate the main channels through which these demographic changes affect labour productivity, the accumulation of factors of production, physical or human capital, and total factor productivity (tfp), based on a cobb-douglas production function. the results from the estimation of our var model defined according to the aggregate production function that includes the capital-output ratio, educational attainment, tfp and an indicator of workforce ageing, and the corresponding impulse-response functions analysis do not allow us to identify any impact of the growth rate in the proportion of older workers on the growth rate of labour productivity. for the time being it thus seems that workforce ageing has not posed a serious threat to the portuguese economy, but this situation could rapidly change in the near future given the dismal demographic forecasts that project that the portuguese population will decrease from 10.5 millions of people in 2012 to 8.6 millions in 2060 (ine 2014). key words: labour productivity, workforce ageing, transmission mechanisms, portugal, var jel classification: e23, j11, o30, o47 introduction the portuguese economy almost stagnated during the 21st century and income levels are diverging from the average income per capita levels of the 28 european union member states (eu28). between 1996-2000 portuguese real gdp grew at an annual average rate of 4.08%, higher than the eu28, 2.92%; however, in the period 2001-2017, which encompasses the 200708 economic crisis, the sovereign debt crisis and the subsequent period of economic and financial assistance by the ecb, the european commission and the imf (2011-14), this rate decreased to 0.45% against 1.42% for the eu28 (pordata). this trend has been mainly explained by decreasing contributions from productivity (alves, 2017; national productivity board, 2019). portugal’s hourly productivity levels are indeed well below those of the eu28 (68%; 2000-2017). simultaneously, demographic ageing proceeds at a fast pace. between 1997 and 2017 portugal recorded the fourth largest increase of the old age dependency ratio (oadr) that stood at 32.5% in 2017 (eu28 29.9%), eurostat (2018). the portuguese population is getting older and the workforce is no exception. the proportion of the younger age groups of the * corresponding author, e-mail: mariana.monteiro14@outlook.com 72 economic analysis (2019, vol. 52, no. 2, 71-92) workforce, 15-24 and 25-34 years old, has decreased: in 2000 they represented 27.9% and 29% of the workforce, respectively; while in 2017 they represented 20.5% and 21.6%. on the other hand, the older age groups, 45-54 and 55-64 years old, which in 2000 represented 24.5% and 20.8% of the workforce, respectively, in 2017 increased their participation in the workforce to 28.4% and 25.7% (pordata). as portugal is getting older, is this ageing population bad for productivity and thus growth? this is the research question posed by the present study. previous studies have highlighted the economic importance of population ageing, including its impact on economic growth through productivity (nagarajan, teixeira & silva (2016); feyrer (2007; 2008); aiyar, ebeke & shao (2016); acemoglu and restrepo (2017; 2018)). an older workforce presents higher levels of experience and more firm/task/occupation-specific knowledge, which in turn has a positive impact on productivity resulting in faster output growth. also, as argued by galenson, (2019) the nature of creativity differs over the lifetime of individuals resulting in different types of innovations and thus productivity improvements but do not disappear in older individuals and can even increase with age. however, productivity may change over the life cycle because physical and cognitive abilities change with age. over the life cycle and as they get older, workers may suffer a depreciation of their knowledge and lose cognitive and physical abilities and it could also be the case that older workers are less inclined to take risks like becoming entrepreneurs or moving to a different career where they could be more productive; in addition, the difficulties of adapting to new technologies might also increase, reducing their productivity and thus output growth. however, acemoglu and restrepo (2017; 2018) pose that as the workforce ages firms are more likely to adopt technology that improves productivity such as robots. the relationship between age and productivity is thus not easy to establish, as evidenced in micro-level studies such as van ours & stoeldraijer (2011) and more generally in who (2015). we investigate workforce ageing contribution for productivity dynamics in portugal over the period 1971-2017. the empirical approach makes use of a var model inspired by the cobbdouglas aggregate production function to distinguish between the effects of workforce ageing (the proportion of the labour force aged 55-64 years) through factor accumulation, physical and human capital, and total factor productivity. to determine these impacts, we use impulseresponse functions (irfs) analysis and employ the standard cholesky decomposition. next we determine the cumulative impacts of workforce ageing on output per worker growth. the data used was retrieved from the portuguese national statistics agency (ine), pordata, the pwt and ameco databases. the paper proceeds as follows: after the introduction, the second section contains a brief review of the relevant literature. the next section describes the empirical strategy and the data used. the fourth section presents and discusses the main results and the final section gives some concluding remarks. literature overview according to ine, in 2017 portugal recorded a fertility rate of 1.37 children per woman, well below the replacement rate (2.1 children per woman). at the same time, the old age dependency ratio stands at 32.5 persons aged 65 and over (age when they are generally economically inactive) per 100 persons aged between 15 and 64 (persons of working age). as a result, the portuguese population is rapidly ageing, a source of concern at the political level and for society as a whole. in this context, understanding the economic mechanisms through which an ageing population affects a country's long run macroeconomic performance becomes a priority in order to design and implement the most effective and timely policies to prevent its potential economic costs. previous empirical studies on the topic also provide important background for a better understanding of the portuguese context. mariana monteiro, marta simões 73 population ageing slows growth in several ways, the most obvious of which is the fact that there will be less workers and, ceteris paribus, workforce shrinking due to demographic change will result in less aggregate output. nagarajan, teixeira & silva (2016) carry out an extensive review of the theoretical literature on population ageing and economic growth, highlighting different mechanisms of transmission, most of which result in slower economic growth. as the population gets older, we observe changes in consumption and savings patterns that can have detrimental effects on growth. on the hand, older people tend to consume more health related services and other goods related to old age, which can result in a higher relative weight of these sectors within the economy. if these are sectors with low potential for productivity improvements, aggregate productivity will slow down and so will national output growth. on the other hand, according to standard life-cycle consumption theory savings decreases in old age, leading to less capital accumulation and thus stifling growth. another mechanism of transmission is related to government interventions. population aging affects both public revenues and expenditures. on the one hand, tax revenues decrease as retired workers pay less income taxes; on the other hand, as the number of retired workers increases and the average life expectancy becomes higher, there will be a greater allocation of government resources to spend with the elderly (pensions, health, etc.), which in other demographic contexts could be directed to other purposes, such as public investment, and in this way promote growth. in addition, retired workers have higher educational attainment levels and, therefore, earn higher pensions. the increased spending on the elderly associated with lower tax revenues could result in an increase in the public deficit, leading to higher interest rates, less investment and growth. also, if those that are still working and firms have to pay higher taxes, this could act as a disincentive to work and as a disincentive for firms to invest. as a result, there could be a fall in productivity and output growth. finally, the influence of population ageing on growth might happen through productivity, which according to the authors is the mechanism of transmission with the most discrepant arguments and evidence. some authors argue that workers of different ages are not perfect substitutes and so different signs can emerge in term of the relationship between an ageing workforce and productivity. on the one hand, older workers have higher levels of experience and firm/task/occupation specific knowledge with associated higher levels of productivity. additionally, in modern knowledge based economies, creativity is an important driver of innovation and in this way productivity. according to galenson (2019), p.3 “creativity is not the prerogative of the young, but can occur at any stage in the life cycle. (...) the bold leaps of fearless and iconoclastic young conceptual innovators are one important form of creativity. (...) but there is another, very different type of creativity, in which important new discoveries emerge gradually and incrementally from the extended explorations of older experimental innovators.” on the other hand, over the life cycle workers become less productive because of weakened cognitive and physical abilities. it could also be the case that older workers are often less inclined to take risks like becoming entrepreneurs or moving to a different career where they could be more productive. if the latter effects are stronger than the former, population ageing, if it translates into an increase in the proportion of older workers, will be detrimental to growth, through a reduction in aggregate productivity. however, other authors argue that with modern economies increasingly mechanized/automated, the loss of physical and cognitive abilities by older people will not be relevant for aggregate productivity if firms become more likely to adopt technology that increases productivity, such as an increase in the use of robots in production and automation of tasks, as population gets older (acemoglu and restrepo 2017;2018). according to acemoglu and restrepo (2017; 2018), there will be an endogenous response of the economy to an ageing workforce. if, as population ages, the supply of workers declines relative to demand, wages will increase. faced with higher wages firms will have an incentive to invest in technologies that make labour more productive and this in turn promotes growth. the former discussion seems to imply that the issue is essentially empirical. a few recent studies make an attempt to assess the impact of population/workforce ageing on economic 74 economic analysis (2019, vol. 52, no. 2, 71-92) growth, highlighting in most cases the productivity channel. werding (2008) and feyrer (2007;2008) have explored the idea that workers from different age groups have different levels of productivity. to identify the impact that the age composition of the workforce may have on output growth per worker and on the growth rate of tfp, werding (2008) uses data for 106 countries, including 27 oecd economies, from 1960 to 2000, and estimates a model where the dependent variable is the growth of tfp and the main explanatory variables the different age groups. the results suggest the existence of an inverted u relationship between the proportion of workers belonging to different age groups and productivity. thus, up to the 40-49 years old group productivity is increasing; but from the age of 50 workers' contributions to productivity become less and less important. feyrer (2007; 2008) also concluded that demographic changes in the workforce have a significant correlation with labour productivity and output growth rates. thus, differences in the age structure of countries explain their differences in productivity. the same inverted u relationship was found between the proportion of workers belonging to different age groups and their productivity. the econometric models considered as dependent variables either the growth rate of output per worker or the growth rate of tfp. the sample covered 87 countries, also focusing on oecd countries alone (19 oecd countries in feyrer (2007) and 21 in feyrer (2008)) with data ranging from 1960 to 1990. the findings for both samples were consistent in showing that a very young or very old age structure is detrimental to the growth rate of output per worker. in both cases the regressions are derived from a cobbdouglas production function with physical and human capital in order to identify the most relevant mechanisms of transmission from ageing to growth, input accumulation or productivity. the authors find that the latter is the most important one. based on the same empirical approach, aiyar, ebeke & shao (2016) focus on the eu member states for the period 1950-2014, confirming also that workforce ageing leads to slower labour productivity growth. they also identified as the main underlying transmission mechanism tfp growth. the authors additionally estimated models to identify policy measures that can alleviate the negative effects of demographic change, concluding that the most important ones are better health conditions, innovation, human capital accumulation, labour market flexibility and a lower tax burden. in an even more recent study, poplawski-ribeiro (2019) uses the same methodology to reassess the empirical relationship between workforce ageing and tfp growth focusing on a panel data set composed of at least 32 and at most 73 advanced economies (aes) and emerging market economies (emes) over the period 1985–2014. one of the main contributions of poplawskiribeiro (2019) is the consideration of the age structure of employed workers and not the labour force, measured as the ratio of older employed workers (ages 55–64) to the total number of employed workers. the results show that ageing slowdowns tfp growth particularly in aes, but also in emes. maestas, mullen & powell (2016), liu & westelius (2017) and daniele, honiden &. lembcke (2019) tackle the issue from the perspective of us states, japanese prefectures and oecd regions, respectively. maestas, mullen & powell (2016) use data on the variation in the rate of population aging across u.s. states over the period 1980-2010 to estimate the economic impact of ageing on state output per capita. the results suggest moderate reductions in economic growth associated with population aging at the state-level, with about 2/3 of the total effect of population aging on the growth of gdp per capita arising from slower productivity growth. liu & westelius (2017) use data for 47 japanese prefectures over the period 1990-2007 to estimate the impact of the shares of 10-year age groups of the working age population (ages 20 to 69) on productivity. the results show that the age distribution of the working age population had a significant impact on total factor productivity, corresponding to a clear inverted u productivity pattern amongst age groups, with the excluded age group 40–49 being the most productive. the evidence found by daniele, honiden & lembcke (2019) for 1802 tl3 regions in 19 oecd countries over the 2006-14 period through the estimation of an empirical model where labour productivity is regressed on the ratio of old (aged 50 or more) to young workers (aged between 20 and 49) points also to a negative relationship, stronger in predominantly urban and mariana monteiro, marta simões 75 intermediate regions. this difference, according to the authors, could be due to the heterogeneous impact of ageing on productivity growth across sectors: tradable services are the sectors in which ageing has the most negative impact on productivity growth and these tend to concentrate in cities. different from the previous studies, acemoglu and restrepo (2017; 2018) provide evidence that ageing can meaningfully accelerate growth. data for 49 countries between the early 1990s and 2015 and for the us states reveal a strong positive correlation between the change in the ratio of the population above 50 to those between 20 and 49 and the change in the number of robots (per million of labour hours). estimates of the impact of ageing on gdp per capita from 1965 to 1990 and 1990 to 2015 reveal a positive association leading the authors to conclude that countries undergoing more rapid population ageing adopted more robots, which resulted in faster productivity and output growth. for the portuguese case, according to albuquerque (2015), the reduction of the working age population relative to the total population has already had an impact on the dynamics of output per worker. the authors observe the period 1999-2014 and perform a decomposition exercise disaggregating the portuguese real gdp per capita growth rate into four components: demographic, which consists of the working age population relative to total population; employment, which relates the number of workers to the total working age population; working hours, which is the ratio between the number of hours worked and the total number of workers; and productivity per hour, measured as gdp per hour worked. the first component, the demographic one, presented small but steady negative contributions, amounting to around 0.194% on average. most of the reviewed studies find a negative association between the age structure of the population/workforce and aggregate productivity but controversies remain, making it important to conduct an empirical study directed only at portugal to gain a better understanding of the effects of population ageing on productivity in this specific case. as van ours & stoeldraijer (2011) and more generally who (2015) point out, based on individual data workers’ productivity does not seem to fall with age because, for instance, even if there are negative impacts resulting from weakened physical and cognitive abilities these can be compensated for by the life and work experiences of older workers. other offsetting effects include the type of occupation, the type of tasks involved in the workers’ job and the age diversity of working teams. empirical strategy and data to investigate the impact of workforce ageing on productivity we estimate a var model defined according to a standard cobb-douglas aggregate production function, with human capital, as in hall & jones (1999), feyrer (2007; 2008) and aiyar, ebeke & shao (2016), highlighting potential differentiated effects of workforce ageing. the approach adopted by feyrer (2007; 2008) and aiyar, ebeke & shao (2016) is adapted to country specific analysis in the context of a var model as suggested by bação, gaspar and simões (2019). hall & jones (1999) assume that output, y, is produced according to the following production function: yt=ktα(atht)1-α (1) where k is the stock of physical capital, h is the amount of human capital-augmented labour used in production, a is total factor productivity and α is the capital share. output per worker, y, can thus be written as: yt=ktα(atht)1-α (2) 76 economic analysis (2019, vol. 52, no. 2, 71-92) where k represents the stock of real capital per worker, h is human capital per worker, a is total factor productivity (tfp) and α is the share of capital in output, assuming values between 0 and 1 and usually set at 1/3. the production function described in (2) can be also rewritten as: yt=(k/y)tα/(1-α)atht (3) where k/y is the capital output ratio. applying logarithms and first differences to both sides of equation (3) allows us to arrive at equation (4), where the δlog’s are the log-growth rates of the variables: δlogyt=[ α/(1-α)]δlog(k/y)tδlogat+δloght (4) this decomposition makes it possible to estimate the impact of workforce ageing on real output per worker considering its influence through the growth rate of the capital-output ratio, the growth rate of human capital per worker and the growth rate of tfp. thus, it is possible to analyse separately two effects, the effect via factor accumulation (physical and human capital) and the effect via tfp. for this purpose, a var (autoregressive vector) model is estimated (based on bação, gaspar & simões 2019) consisting of four endogenous variables ordered1 as follows: the growth rate of the proportion of older workers; the growth rate of human capital per worker; the growth rate of tfp and the growth rate of the capital-output ratio. the general var model of order p is given by equation (5), where x represents the column vector including the four variables described before. xt=α+β1xt-1+ β2xt-2+…+ βpxt-p+εt (5) the var approach is appropriate since it allows to treat all variables as endogenous. in addition, it allows us to obtain the reaction from each variable to a shock in one of the other variables, in particular we want to analyse how each component of the cobb-douglas production function reacts to a shock in the growth rate of the proportion of older workers and, based on these results, we determine the cumulative impact on the growth rate of output per worker. output per worker y is measured as the ratio between gdp at constant 2010 prices and the number of workers (or hours worked), both retrieved from ameco. workforce ageing is measured as the proportion of workers aged 55-64 in the labour force and was obtained from pordata. the capital stock data at constant 2010 prices is also from ameco. human capital per worker data was retrieved from the penn world table 9.1 and corresponds to a human capital index based on average years of schooling and an assumed rate of return to education, available from 1971 to 2014. to obtain the remaining 3 missing observations, the average growth rate of the former 10 years was calculated and used to obtain the values for the years 2015, 2016 and 2017. tfp was computed according to equation (2), using the time series mentioned above: from ameco we used the number of employees, real gdp at constant 2010 prices and the capital stock at constant 2010 prices; and from the pwt we used human capital per worker. the growth rate of total factor productivity had thus to be estimated; we did so based on the aggregate production function (equation 2) and setting α, the capital share, to one third, as is customary. figure 1 contains data on output per worker and workforce ageing for portugal and the eu28 over the period 1971-2017. from the inspection of figure 1, part (i), it is possible to see that portuguese output per worker is well below that of the eu28 average. in 1995 output per worker in portugal amounted to €30221.73 while the average eu28 worker produced € 47430.20. in 2017, these values were respectively € 37567.84 and € 60216.24, corresponding to 1 see the explanation for the ordering adopted in the next section. mariana monteiro, marta simões 77 an annual growth rate of 1% for portugal and 1.1% for the eu28. from graph (ii), figure 1, we can see that the proportion of workers aged 55-64 in the labour force both in portugal and the eu 28 shows a strong positive trend. in 2001 the figures were quite close, around 16%; in 2017, the values were, respectively, 20.6% and 20.1%. (i) outuput per worker (ii) workers aged 55-64 (proportion of the labour force) figure 1. output per worker and workers aged 55-64 as a proportion of the labour force, portugal and the eu28, 1971-2017 source: ameco, ine, pordata. figure 2 presents the annual growth rate of the proportion of older workers in portugal from 1971 until 2017 where it is possible to observe a steady increase since the mid-90s that however seems to be decelerating since more or less the year 2010. figure 2. workers aged 55-64 as a proportion of the labour force, annual growth rate, portugal, 1971-2017 source: pordata and authors’ computations. in figure 3 it is possible to observe the behaviour over time of the human capital index for portugal over the period 1970-2017, both in levels and growth rates. the level of human capital shows a strong positive trend, going from 1.4 in 1971 to 2.5 in 2017. as for its growth rate, it has remained positive for almost the entire period under analysis, however between 2000 and 2005 it recorded negative values, although very close to zero. 78 economic analysis (2019, vol. 52, no. 2, 71-92) (i) levels (ii) annual growth rate figure 3. human capital per worker, in levels and growth rates, portugal, 1971-2017 source: pwt 9.1 and authors’ computations. in figure 4 (i) it is possible to observe tfp in levels (2010=100) and growth rates. from 1971 to around 1990, the increase was considerable, from a value of 71 to a little over 100 but from then onwards tfp stagnated and shows a tendency to decrease during most of the 21st century. the respective growth rate thus shows a quite irregular behaviour but towards lower values at end of the period. (i) levels (ii) annual growth rate figure 4. total factor productivity, in levels and growth rate, portugal, 1971-2017 source: authors’ computations. finally, figure 5 presents the capital-output ratio series, in levels and growth rates. this variable, as can be seen from figure 5 (i) shows a positive trend over the period under analysis that came to a halt in 2012, decreasing ever since. regarding the growth rate of this variable, it is possible to observe alternating periods of positive and negative growth over the years. in more recent years, in particular since 2013, it recorded negative values in every year. mariana monteiro, marta simões 79 (i) levels (ii) annual growth rate figure 5. capital-output ratio, in levels and growth rate, in portugal, 1971-2017 source: authors’ computations. results before estimating the var model described in the previous section it is necessary to test for the stationarity of the variables included in order to avoid the spurious regressions problem. table 1 contains the results of four different unit root and stationarity tests (kpss and adf, with and without trend). the values in bold indicate stationarity and, as can be observed, the growth rates of output per worker and the growth rate of the proportion of older workers are stationary. human capital per worker, tfp and the capital-output ratio are also stationary in first differences. lastly, the log growth rates of output per hour worked (yh) and ptf per hour worked (ah) are also stationary according to the four tests. given these results we will use the variables in first differences in our var model to avoid spurious regressions. also, since according to the results in table 1 the variables ∆logy and ∆logw55 are only stationary with a trend, we also include a trend when estimating the var model. table 1. unit root and stationarity tests results (p-values) kpss trend adf trend kpss adf y < .01 0.998 < .01 0.099 ∆log y > .10 2.1e-5 < .01 0.97 w55 0.01 1 < .01 1 ∆log w55 0.097 0.049 0.042 0.111 h < .01 0.901 < .01 0.256 ∆log h > .10 0.395 < .01 0.726 a < .01 0.71 < .01 0.14 ∆log a > .10 0.1023 > .10 1.04e-05 ky > .10 0.056 < .01 0.232 ∆log ky > .10 0.011 > .10 0.0016 yh 0.028 0.339 < .01 0.858 ∆log yh > .10 0.004 > .10 0.0005 ah > .10 0.145 > .10 0.064 ∆log ah > .10 0.0009 > .10 0.0001 source: authors. the order of the var model was selected by setting a maximum order of two; this choice comes from dividing the result of the formula suggested by schwert (1989) for univariate ar models by the number of variables included in our model (four). the formula is thus: 80 economic analysis (2019, vol. 52, no. 2, 71-92) lmax = int([12(t/100)0.25]/4) (6) where int(.) is the integer part of the argument and t is the number of observations. the rationale for adjusting schwert’s formula in this way is that the same number of lags of each variable will be present in each equation of the var model; therefore, the four variables will be consuming degrees of freedom in every equation of the var model – the division by four takes this into account (see bação, gaspar & simões 2019). for both versions of the var model the information criteria and the likelihood ratio test points to one lag see table 2. table 2. number of lags to include in the var model source: authors. table 3 presents the estimated coefficients for the lagged growth rate of the proportion of older workers (∆log w55) in the equations for the other variables in the var model. in model 1, tfp was computed taking into account the number of workers (a). in model 2, tfp was computed taking into account hours worked (ah). most of the estimates are not statistically significant. the exceptions are the coefficients in the equation of tfp adjusted for hours worked and the equation of the capital-output ratio (model 2). in the first case, the sign is positive indicating that faster growth of the older workers group benefits economic growth via tfp. contrarily, the impact on the growth rate of the capital-output ratio is negative. the same signs apply in model 1, although the coefficients are not statistically significant. in any case, the magnitude of the estimated coefficients is large and could assign to growth rate of the proportion of older workers an important role in the evolution of productivity and the capitaloutput ratio. for the growth rate of human capital per worker, the influence is positive in both models, although never statistically significant. table 3. coefficients of the lagged growth rate of the proportion of older workers (∆log w55) in the other equations of the var (t = 45) coefficient std. error t-ratio p-value model 1 ∆log h 0.0678 0.0549 1.236 0.2240 ∆log a 0.4907 0.4567 1.075 0.2892 ∆log ky −0.5556 0.3463 −1.604 0.1167 model 2 ∆log h 0.0758 0.0542 1.399 0.1698 ∆log ah 1.385** 0.5291 2.617 0.0126 ∆log ky −0.6766* 0.3551 −1.905 0.0641 note: ***; **; * indicate statistical significance at the level of 1, 5 and 10%, respectively. source: authors’ computations. in a var model the correct way to assess the importance of ageing is by analysing the impulse-response functions. the difficulty is that this requires an assumption about the structure of the relationship between the variables in the model. here we employ the standard cholesky decomposition, which imposes a recursive structure on the shocks that change the variables so that the first variable in the var model reacts contemporaneously only to a shock to itself; the second variable reacts contemporaneously to a shock in itself and in the previous variable; the third reacts contemporaneously to a shock to itself and to the previous two lags loglik aic bic hqc 1 608.167 -26.553* -25.580* -26.192* 2 622.507 -26.478 -24.856 -25.876 mariana monteiro, marta simões 81 variables and, finally, the last variable in the model reacts contemporaneously to shocks to all the four variables in the var model. the growth rate of the proportion of workers aged 55-64 will be the first variable that appears in the var model since we believe that this is the variable that takes more time to adjust to shocks due to the fact that it is related to individual decisions made at least 15 years before on whether or not to have children. in this way we do not expect it to be influenced by shocks to the other variables, i.e. it is the most rigid variable. the growth rate of human capital per worker is also related with individual decisions regarding education, work experience, training opportunities provided in the workplace, public spending on education, etc. so it makes sense to be one of the model’s variables that takes more time to adjust and thus we place it in the second place in terms of the ordering of the variables in the var model. productivity might depend to a great extent on age and knowledge (education, work experience, etc.), thus the growth rate of tfp will be the third variable to be included in the model so that it may react contemporaneously to its own shocks and to shocks to the proportion of older workers and to human capital. finally, the growth rate of the capital-output ratio is the last variable to appear in the var model as this is the least rigid and thus adjusts most rapidly. this variable corresponds to the amount of physical capital available per unit of output, so if overall productivity changes, which depends on age and human capital, the amount of capital needed to produce each one unit of output also changes. also, since we consider the capital-output ratio and, according to the production function, output depends on the other variables included in the var, we expect it to adjust more rapidly. therefore, we will assume that the capital-output ratio will react contemporaneously to all the structural shocks in the other variables of the model. the estimated impulse-response functions and the 90% confidence intervals (grey lines) are shown in figure 6 based on the results from table 3 for var model 1, i.e. without adjusting for hours worked. given the irfs and the responses of the variables δlogh, δloga and δlog(k/y), it is possible to determine the impact of a shock to δlogw55 on the growth rate of output per worker using equation (4). (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure 6. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 1 from table 3 source: authors. 82 economic analysis (2019, vol. 52, no. 2, 71-92) the impulse-response functions are also not significantly different from zero (the confidence interval never excludes zero). nevertheless, the prevailing effect is negative: an increase in the proportion of older workers would appear to decrease tfp in a more intense way than the contemporaneous positive effect it has on human capital per worker and the capital-output ratio. consequently, the estimated impact of a temporary increase in the proportion of older workers would immediately shift down the growth rate of output per worker, as shown in figure 6, part (iv). the shift corresponding to a one-standard-deviation temporary shock in the δlogw55 would amount to about -0.0078 percentage points of the gdp per worker growth rate. however, in the following years the variable records positive values, reaching its maximum value after four years with the value of 0.0018, as expected, since the var model is stationary and so the long-term effect tends to zero. we also carried out the impulse response analysis considering output and tfp adjusted for hours worked using the results for var model 2 presented in table 3. the estimated impulseresponse functions and the 90% confidence intervals (grey lines) are shown in figure 7. the behaviour of the irfs of the different variables is similar to that of the previous model and again the results are not significantly different from zero (the confidence interval never excludes zero). a temporary shock of a standard deviation to ∆logw55 as a negative immediate impact on ∆logyh. in the following years the variable records positive values, reaching its maximum after three years (0.006) and approaching zero from then onwards as expected in a stationary var model. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure 7. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 2 from table 3 source: authors. overall, the results from the previous irfs analyses do not confirm the fears that the ageing of the portuguese workforce has resulted in substantial losses in terms of output growth at the national level. in fact, the results do not endorse any impact. from the reviewed arguments put foreword to explain a potential relationship between population ageing and economic growth, it seems that for the portuguese economy, so far, the productivity decline associated with weakened basic capacities (physical and cognitive) to do things as workers get older and the fact that they become less willing to take risks such as moving to a new job or start a new business is mariana monteiro, marta simões 83 being compensated by the positive productivity impact of their higher levels of experience, more firm/occupation/task-specific knowledge and higher creativity or by the fact that portuguese firms are reacting to labour shortages by introducing new technologies that increase labour productivity, as defended by acemoglu and restrepo (2017; 2018). finally, in order to get a broader view of the impact of demographics on productivity we extended the baseline var model to include other demographic variables corresponding to the different groups representing the age structure of the labour force (w45 proportion of workers between 45 and 54 years old; w35 proportion of workers between 35 and 44 years old; w25 proportion of workers between 25 and 34 years old). we leave out the proportion of younger workers, i.e. the 15-24 age group (w15), since the sum of the different age structure variables corresponds to 100% of the labour force. additionally, we include the total dependency ratio (id), i.e. the ratio between the number of people between 0 and 14 years old and the number of people aged 65 and over relative to the working age population (15-64 years old). table 4. coefficients of the lagged growth rate of the proportion of different age groups (∆logw55; ∆logw45; ∆logw35; ∆logw25) and of the dependency ratio (∆logid) in the other equations of the var model 1 ∆logw55 ∆logw45 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh 0.093 0.0617 1.510 0.1400 0.099 0.080 1.236 0.2246 ∆loga 0.085 0.4815 0.1765 0.8609 −1.269** 0.6243 −2.032 0.0498 ∆logky −0.349 0.3688 −0.9472 0.3501 0.677 0.4782 1.415 0.1659 ∆logw35 ∆logw25 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh −0.018 0.0636 −0.2796 0.7814 −0.032 0.0564 −0.5651 0.5756 ∆loga 0.851* 0.4966 1.714 0.0953 0.186 0.4399 0.4239 0.6742 ∆logky −0.583 0.3804 −1.532 0.1346 −0.295 0.337 −0.8750 0.3875 ∆log id coef. std. error t-ratio pvalue ∆logh -0.081 0.1149 −0.7088 0.4831 ∆loga 2** 0.8971 2.229 0.0323 ∆logky -1.41** 0.687089 −2.045 0.0484 model 2 ∆logw55 ∆logw45 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh 0.101 0.0614 1.648 0.1084 0.101 0.0861 1.171 0.2495 ∆logah 1.187 ** 0.5701 2.082 0.0447 −0.231 0.7996 −0.2889 0.7743 ∆logky −0.477 0.3742 −1.274 0.2110 0.549 0.5249 1.047 0.3024 ∆logw35 ∆logw25 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh −0.016 0.0640 −0.2431 0.8094 −0.027 0.0605 −0.4424 0.6609 ∆logah 1.181 * 0.5940 1.988 0.0546 0.184 0.5621 0.3272 0.7454 ∆logky −0.613 0.390 −1.572 0.1251 −0.435 0.3690 −1.179 0.2462 84 economic analysis (2019, vol. 52, no. 2, 71-92) ∆log id coef. std. error t-ratio pvalue ∆logh -0.072 0.1161 −0.6211 0.5385 ∆logah 1.511 1.0782 1.402 0.1698 ∆logky -1.47** 0.7078 −2.079 0.0451 note: ***; **; * indicate statistical significance at the level of 1, 5 and 10%, respectively. source: authors. from the inspection of the results in table 4 it is possible to see that, in what concerns the proportion of older workers, they remain basically unchanged. the lagged growth rate of the proportion of workers aged 55-64 is only statistically significant in the equation of the growth rate of tfp per hour worked, again with a positive sign. as for the other age groups, the vast majority of the estimated coefficients are not statistically significant. exceptions include: the proportion of workers aged 45-54 that show a negative impact on tfp (model 1) and the proportion of workers aged 35-44 that reveal a positive and statistically significant coefficient in the equations of both tfp and tfp per hour worked. the remaining statistically significant coefficients refer to the dependency ratio, which shows a positive impact on the equation of the growth rate of tfp (model 1) and a negative impact on the equation of the growth rate of the capital-output ratio. the estimated impulse-response functions and the 90% confidence intervals (grey lines) based on the results from table 4 for var models 1 and 2 are shown in figures 8 and 9, respectively. the behaviour of the irfs of the different variables is similar to that of the previous model and again the results are also not significantly different from zero (the confidence intervals never exclude zero). the results from these irfs also do not confirm the fears that the ageing of the portuguese workforce has resulted in substantial losses in terms of output per worker growth at the national level. the irfs for the remaining age groups and the dependency ration can be found in the appendix, figures a.1 to a.8. again the results are also not significantly different from zero (the confidence interval never excludes zero) rendering the age structure of the workforce and the overall population no role in the explanation of the dynamics of labour productivity in the portuguese economy. (i) human capital (ii) tfp mariana monteiro, marta simões 85 (iii) capital-output ratio (iv) output per worker figure 8. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 1 from table 4 source: authors. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure 9.impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 2 from table 4 source: authors. conclusion population ageing, in particular of the workforce, is an issue that europe, and especially portugal, have to face in a serious manner if they want to implement timely policies that can help avoid its potential economic costs. with ever-lower fertility rates and an ever-increasing average life expectancy, the old age dependency ratio and the proportion of older workers (aged 55-64) are increasing steadily, with potential important economic implications in the short and the long run. we investigated the contribution of workforce ageing for productivity dynamics in portugal over the period 1971-2017. the empirical approach makes use of a var model inspired by the cobb-douglas aggregate production function to distinguish between the effects of workforce ageing (the proportion of the labour force aged 55-64 years) through factor accumulation, 86 economic analysis (2019, vol. 52, no. 2, 71-92) physical and human capital, and total factor productivity. to determine these impacts, we used impulse-response functions (irf) and employ the standard cholesky decomposition. next we determined the cumulative impact of workforce ageing on output per worker. the results indicate that using workforce ageing in first differences (not levels) fits the data better, so ageing affects the level of output per worker (temporary growth effect). yet, workforce ageing is generally not statistically significant in the equations of the other variables in the var model. the irfs are also not significantly different from zero, but the performance of our var model may be affected by some series behaviour (e.g. the capital stock decline in recent years), requiring more investigation in the future. the fact that no significant impact on productivity was found might be an indication that older workers’ negative productivity impact due to the depreciation of knowledge and physical/cognitive capabilities is being exactly offset by the positive impact from their higher levels of experience, more firm/task/occupation-specific knowledge and higher creativity. policies such as broadening access to better health services, workforce training and lifelong learning can reduce the adverse impact so that it does not surpass the positive effect. yet, the rapid pace of technological development can make experience less relevant and a negative impact can emerge in the data. however, as argued by acemoglu and restrepo (2017) as the workforce ages firms are more likely to adopt technology that improves productivity such as robots and a positive impact on tfp could emerge. for the time being it thus seems that workforce ageing has not posed a serious threat to the portuguese economy, but this situation could rapidly change in the near future given the dismal demographic forecasts that project that the portuguese population will decrease from 10.5 millions of people in 2012, to 8.6 millions in 2060 (ine 2014). this paper suggested a methodology (based on bação et al. 2019; hall & jones, 1999; feyrer 2007, 2008; aiyar et al. 2016) to quantify and identify the mechanisms of transmission from population ageing to macroeconomic performance in country-specific situations. this is important for a more effective policy design that helps fight potential negative economic performance impacts of ageing. it is important to emphasize that each country is unique in terms of its characteristics and both the effects and the type of measures may differ from country to country. in any case, future comparative analyses with other ‘younger’ countries in a panel data context could help identifying productivity gains from slowing population ageing. from a macroeconomic performance perspective our findings thus do not confirm the pessimistic predictions concerning the negative impact of ageing on productivity and long run macroeconomic performance. our analysis, however, does not provide a definite answer to workforce ageing impacts on productivity growth in portugal. we used a var model defined according to a cobb-douglas production function to identify the impact of ageing on output per worker through factor accumulation and productivity. alternative approaches include considering different types of production functions and/or alternative modelling approaches such as an ardl model with output per worker growth as the dependent variable and additional explanatory variables. our aim was to implement the most robust analysis of the research question posed in this study, “is workforce ageing a threat to productivity and in this way economic growth?” but there are issues intrinsic to the data that may constitute important limitations. first, carrying out time series econometric analysis with a short data coverage might hamper the robustness of the results. second, the specific behaviour of some of the series used in the analysis, such as the physical or human capital series, may have a detrimental impact on the performance of our simple var model. acknowledgements we would like to thank pedro bação for his helpful comments and suggestions. the usual disclaimer applies. mariana monteiro, marta simões 87 references acemoglu, d. & restrepo, p. (2017). secular stagnation? the effect of aging on economic growth in the age of automation. american economic review, 107 (5): 174-79. acemoglu, d. & restrepo, p. (2018). demographics and automation. nber working papers no 24421. aiyar, s., & dalgaard, c-j. l. (2009). accounting for productivity: is it ok to assume that the world is cobb-douglas? journal of macroeconomics, 31(2), 290-303. aiyar, s., ebeke,c. & shao, x. (2016). the impact of workforce aging on european productivity. imf working papers 16/238, international monetary fund. albuquerque, p. (2015). demographics and the portuguese economic growth. iseg wp no. w17/2015/de/socius/csg. alves, r. p. (2017). portugal: a paradox in productivity. gee papers no. 0070. bação, p., gaspar, i. & simões, m. (2019). corruption and economic growth: the case of portugal. notas económicas, 49 (december), forthcoming. daniele, f.; honiden, t. & lembcke, a. (2019). ageing and productivity growth in oecd regions: combatting the economic impact of ageing through productivity growth? oecd regional development working papers no 2019/08. eurostat (2018). record high old-age dependency ratio in the eu. from https://ec.europa.eu/eurostat/web/products-eurostat-news/-/ddn-201805081?inheritredirect=true feyrer, j. (2007). demographics and productivity. the review of economics and statistics, 89(1), 100-109. feyrer, j. (2008). aggregate evidence on the link between age structure and productivity. population and development review, 34, 78-99. galenson, david w. (2019). the nature of creativity in old age. university of chicago, becker friedman institute for economics working paper no. 2019-67. hall, r. e., & jones, c. i. (1999). why do some countries produce so much more output per worker than others? the quarterly journal of economics, 114(1), 83-116. ine (2014). resident population projections 2012-2060. lisbon: ine. liu, y. & westelius, n. 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(1989). tests for unit roots: a monte carlo investigation. journal of business and economic statistics, 7(2), 147-160. van ours, j.c. & stoeldraijer, l. de economist (2011). age, wage and productivity in dutch manufacturing. de economist 159(2), 113–137. werding, m. (2008). ageing and productivity growth: are there macro-level cohort effects of human capital? cesifo working paper no. w2207. who (2015). world report on ageing and health. geneva: world health organisation. 88 economic analysis (2019, vol. 52, no. 2, 71-92) appendix (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.1. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 45-54 (∆logw45) based on var model 1 from table 4 source: authors. (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.2. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 35-44 (∆logw35) based on var model 1 from table 4 source: authors. mariana monteiro, marta simões 89 (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.3. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 25-34 (∆logw25) based on var model 1 from table 4 source: authors. (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.4. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the dependency ratio (∆logid) based on var model 1 from table 4 source: authors. 90 economic analysis (2019, vol. 52, no. 2, 71-92) (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.5. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 45-54 (∆logw45) based on var model 2 from table 4 source: authors. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.6. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 35-44 (∆logw35) based on var model 2 from table 4 source: authors. mariana monteiro, marta simões 91 (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.7. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 25-34 (∆logw25) based on var model 2 from table 4 source: authors. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.8. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the dependency ratio (∆logid) based on var model 2 from table 4 source: authors. 92 economic analysis (2019, vol. 52, no. 2, 71-92) article history: received: november 5, 2019 accepted: november 25, 2019 doi: 10.28934/ea.23.56.1.pp43-56 first online: may 12, 2023 original scientific paper exploring the economy – environment interactions in the western balkans: a panel data analysis petar mitić13f* | aleksandra fedajev2 | milena kojić1 1 institute of economic sciences, department for environmental economics, belgrade, serbia 2 the university of belgrade, technical faculty in bor, bor, serbia abstract in order to balance economic growth with environmental preservation, the implementation of sustainable policies is necessary. as such, it is imperative to have a comprehensive understanding of the intricate relationship between the economy and the environment. this study examines the relationship between co2 emissions and gdp per capita in five wb countries during 1960-2018, using a methodological framework that includes panel unit root testing, cointegration testing, and a vector error correction model. the study provides robust evidence of a long-term cointegration between co2 emissions and gdp per capita. furthermore, the study also reveals a short-run bidirectional causal relationship between co2 emissions and gdp per capita. in the long run, no statistically significant causality exists from gdp per capita to co2 emissions, but it is statistically significant from co2 emissions to gdp per capita. these findings offer valuable insights for policymakers to develop comprehensive policies that promote economic growth and environmental sustainability, such as investing in clean energy, implementing stronger environmental regulations, and encouraging environmentally sound management practices. keywords: economic growth, co2 emissions, wbs, panel causality, sustainability jel classification: c33, o13, q56 introduction threats of global warming have steadily grown in recent years. the european union (eu) has emphasized the need for climate change mitigation measures and has set ambitious targets for reducing greenhouse gas (ghg) emissions (skjærseth, 2021; dolge & blumberga, 2021). including the western balkan (wb) countries in the european green deal strategy and guiding the area toward 2030 and 2050 climate neutrality goals with eu money and support could expedite the region’s transformation. as a strategy that the eu and the wb will jointly implement, the green agenda can increase chances for successfully implementing climate-neutral policies and create more economically feasible scenarios for fast reductions in ghg emissions only in the short term. for long-term success, it is critical that neighboring countries also take significant environmental action. only in this way will the green deal agenda be entirely successful (ćetković et al., 2021). as “going green” becomes inevitable for both individuals and organizations (tongsoongnern & lee, 2022), transitioning to a “green” growth path remains challenging, particularly in the short * corresponding author, e-mail: petar.mitic@ien.bg.ac.rs 44 economic analysis (2023, vol. 56, no. 1, 43-56) term, due to the reluctance of wbs to abandon traditional “brown” sectors, skills, employment, market infrastructure, and established value chains. accelerated structural reforms must be carried out alongside a rational economic policy to attain sustainable economic growth (marjanović et al., 2021). although the carbon intensity of economic growth has decreased in recent years, it is still many times higher than in the eu (world bank, 2022). in 2018, the wb produced about 100 mt of co2 emissions from combustion and fossil fuel operations, accounting for nearly 3% of eu co2 emissions that year. although there were many changes during those years, and energy consumption altered due to political changes in the wb nations, this value is similar to 1990. co2 emissions in the region were 8.7% lower in 2018 than in 1990 (banja et al., 2020). however, the actions aimed at reducing pollution affect economic growth rates, which are already very low or even negative during the past few years (matić et al., 2022). after a severe economic downturn caused by the covid-19 pandemic (kisin et al., 2021), the wb countries are reconsidering their long-term growth and development strategies. they are at the crossroads of their future development path where they should decide if their development should be based on a “brown” recovery (which means employing existing manufacturing methods and benefiting from low costs of coal and labor and foreign direct investments inflow) or fundamentally change their economy to a “green” growth model. although the traditional “brown” industries require minor adjustments to crisis conditions, they are accompanied by high economic and environmental costs. on the other hand, “green” growth is not easy to achieve, and its benefits are not so apparent in the short term, especially as fiscal space has narrowed and the higher debt burden imposed by the crisis has limited the actions and funds available to governments when it comes to significant investments. nevertheless, continuing with the traditional “brown” growth will make long-term economic growth and development unsustainable (world bank, 2021). given the doubts about future development strategies, there is significant relevance to researching the interdependencies between environmental degradation and economic growth for the wb countries. such research can assist the wbs in achieving long-term economic recovery while also satisfying environmental goals, thereby promoting economic growth and development. in particular, investigating these interdependencies in the wb region is significant as it has not been extensively studied in previous research. as these goals are typically viewed as opposing in wb countries, understanding the link between them may also have relevance for the eu when these countries join the union. the research examines how co2 emissions and gdp per capita are related in five countries of the world bank. the study uses panel data analysis, which involves conducting tests for crosssectional dependence, unit root, cointegration, and granger causality and constructing a vector error correction model. this approach allows for investigating the link between economic growth and environmental degradation. the paper is organized as follows. section 2 presents a literature review of the relationships between economic and environmental indicators and their implications for developing countries, including the critical economic and environmental prerequisites for the balanced growth of wbs. section 3 describes the methodology for analyzing the relationship between economic growth and environmental degradation using panel data. section 4 presents the main research results. section 5 discusses obtained results in the wbs, including policy implications of derived findings. finally, section 6 concludes the paper while contributing to the ongoing debate about the relationship between economic growth and environmental quality in the wb region. literature review it is crucial to understand the relationship between economic growth and environmental deterioration to ensure the long-term sustainability of economic development. although economic growth can improve living standards and expand access to resources, it frequently petar mitić, aleksandra fedajev, milena kojić 45 harms the environment, leading to deforestation, air and water pollution, and climate change. researchers from many fields, including economics, environmental science, and ecology, have thoroughly examined this relationship using statistical analyses, case studies, and modeling approaches. their findings have highlighted the complexity of this relationship and helped shape policies and strategies for fostering sustainable economic growth and reducing environmental damage. this literature review section provides a brief overview of the extensive scientific research on this topic and the insights gained from it. the environmental kuznets curve (ekc) is possibly the most prominent theory when analyzing economic growth and environmental degradation at country, regional, and group of countries levels. ekc theory suggests that environmental degradation initially increases as a country experiences economic growth and industrialization but eventually declines once a certain level of economic development is reached. this theory assumes that as a country gains additional wealth, it has the resources to invest in environmental protection measures and shift towards cleaner technologies. the validity of the ekc hypothesis has been extensively examined in various studies using panel data and time series methods. panel data studies conducted by apergis & ozturk (2015), ummalla & goyari (2020), and pata et al. (2022) support the presence of the ekc, while time series studies for individual countries by sarkodie & ozturk (2020), suki et al. (2020), jiang et al. (2021), jahanger et al. (2022), and voumik et al. (2022) also confirm its existence. however, some research suggests that environmental degradation continues to persist even at higher levels of economic growth, as shown in panel studies by özokcu & özdemir (2017) and hussain & dogan (2021) and individual countries studies by ozturk & acaravci (2010), yilanci & pata (2020), and villanthenkodath et al. (2021). additionally, some studies provide conflicting evidence depending on the variable selection, such as those conducted by aung et al. (2017), mrabet & alsamara (2017), and ansari (2022). overall, the ekc remains contested, and further research is valuable to clarify its existence and validity. achieving both goals – increasing economic growth and pollution mitigation is especially challenging for developing and transition countries like wbs. adedoyin et al. (2020) analyzed the relationship between energy production and co2 emissions in three groups of countries from 1992 to 2014: central and eastern europe (cee), the commonwealth of independent states (cis), and new member states (nms). according to the empirical findings, a 1% increase in renewable energy production causes co2 emissions to rise by 0.04% and 0.02% in cis and cee countries but fall by 0.02% in nms countries. mitić et al. (2023) researched the situation in eight south-eastern european countries and found a short-run bidirectional causality between co2 emissions and employment and between available energy and employment. the long-run causal relationship results suggest that co2 emissions, gdp, and employment could significantly affect the system’s adjustment process as it departs from long-run equilibrium. mitić et al. (2017) used cointegration analysis to investigate a link between gdp and co2 emissions in transition economies. according to the recommendations given in this study, transition economies should follow global initiatives and adopt new processes and tools to control and restrict co2 emissions if they want to minimize co2 emissions while maintaining sufficient gdp growth. furthermore, arndt et al. (2017) emphasized that including developing countries in any successful global mitigation program is justified, given the level of existing emissions from developing countries and their high growth rates. the wb countries are still establishing and enhancing the appropriate legislative framework and strategies for climate change mitigation. furthermore, the implementation of these frameworks and strategies is still insufficient. the adoption strategy must involve transitioning to power plants using cleaner energy sources and identifying concrete economic policy goals and government support measures (knez et al., 2022). it should be noted that the application of the eu acquis on environment and climate in wb countries varies. it ranges from the basic stages of implementation to more advanced ones (banja et al., 2020). 46 economic analysis (2023, vol. 56, no. 1, 43-56) considering the significant challenges to long-term development prospects, it will be necessary for wb economies to undertake fundamental reforms and boost economic transformation. the financial sector can help to ease this transformation. unfortunately, green finance has fallen short of the needed size and scope internationally and notably in the wbs (world bank, 2022). besides financial sector weaknesses, the institutional environment is still not sufficiently developed to enable a smooth transition to green growth. the wbs have been through a difficult economic and political upheaval during the previous 30 years. following the chaotic and conflict-ridden 1990s, which had many adverse political and economic effects, the wbs region had an economic recovery at the beginning of the new century. economic growth trends and transition processes in economies of this region have resulted in a need for additional energy, requiring upgrades to the entire energy supply system. one of the fundamental characteristics of all the countries in the region is their reliance on solid fossil fuels, primarily coal, as an energy source while simultaneously being heavily reliant on oil, coal, and natural gas imports (dunjic et al., 2016). the energy sector, particularly coal, produces the most pollution. on the other side, there is a scarcity of mechanisms for monitoring, reporting, and verifying greenhouse gas emissions (berishaj, 2021). recent decades’ political and economic changes significantly impacted the energy supply of individual wb countries. except for albania, all countries were part of a single energy system before gaining independence. most wb countries inherited their energy infrastructure (for example, for oil, gas, and electricity) from the socialist federal republic of yugoslavia (sfry), where most of the production units were outdated, requiring rebuilding and efficiency improvements (lalic, 2011). consequently, one of the key characteristics of the wbs’ energy systems is their low energy efficiency, primarily reflected in power distribution energy losses (sanfey et al., 2016). the inadequately maintained and outdated energy infrastructure resulted in significantly greater energy intensity than the eu average. the primary underlying reasons for excessive air pollution in the region are capacity limits and governance challenges in implementing comprehensive, cross-sectoral air quality control initiatives. common issues include unsuitable regulations, insufficient enforcement of laws, and technological capacity shortages, such as incomplete emissions inventories and a lack of adequate air quality monitoring. furthermore, a country’s low institutional capability, mainly vertical and horizontal institutional coordination, poses a challenge to responding adequately when air pollution affects many sectors (kikoni & schiffbauer, 2020). typically, air pollutants generated mainly through human activities such as industry (including energy production), domestic heating, and transportation exceed the country’s standards. meanwhile, the wb countries’ primary sources of ghg are energy and transportation (banja et al., 2020). the mitigation of air pollution resulting from increased economic growth, especially industrial activities, will not be possible without switching to renewable energy sources (res) in producing energy. countries in the wbs have considerable renewable energy potential. in their long-term policies, many of them have set ambitious sectorial res targets. nevertheless, there is a huge disparity between these goals and the actual outcomes. although renewables provide numerous benefits acknowledged globally, the penetration of res into global and local energy markets remains limited (đurašković et al., 2021). due to numerous economic, environmental, political, and institutional challenges faced by wbs, it is necessary to intensify research in this area. it is crucial to consider the similarities of wbs but also the specificities of each country within the region to respond adequately to inherited problems and prospects. in this regard, this research is one of the necessary steps in this direction and should motivate more authors to focus their research on this region. petar mitić, aleksandra fedajev, milena kojić 47 data and methodology the study uses gdp and co2 emissions data for five wb countries: albania, bosnia and herzegovina, montenegro, north macedonia, and serbia. the data span a period from 1960 to 2018. the real gdp per capita data was obtained from the maddison project database 2020 and used as a measure of economic growth (jutta & van zanden, 2020). the data for co2 emissions per capita were obtained from the global carbon atlas, a widely recognized source for co2 emissions data (global carbon atlas, 2022; friedlingstein et al., 2022; andrew & peters, 2021; un, 2019). it is important to note that the data for the time frame between 1960 and 1995 are approximations for all countries except albania. this is because, during this period, all countries except albania were a part of the socialist federative republic of yugoslavia (sfry), and reliable data for each country is unavailable. therefore, the data estimates were done ex-post using available information. both data sets were collected for the same countries and periods, allowing for an analysis of the relationship between economic growth and environmental quality in the wbs. the econometric analysis in this research is based on the methodology framework presented in figure 1. figure 1. methodology framework source: authors. the first methodology framework step is to conduct cross-sectional dependence tests. these tests are vital diagnostics before estimating any panel data models. the presence or lack of crosssectional dependency dictates the next methodological step. if cross-sectional dependence is detected in the data, additional analysis processes must be conducted to account for it. only a few cross-sectional reliance tests are available to identify the cross-sectional dependency issue (see table 1 for a summary). 48 economic analysis (2023, vol. 56, no. 1, 43-56) table 1. residual cross-section dependence test test test application breusch and pagan (1980) lm test panels with a small number of cross-section units. pesaran (2004) scaled lm panels with a large number of cross-sectional units and large time dimensions. pesaran (2004) cd test panels with a small number of cross-sectional units and small-time dimensions. baltagi et al. (2012) bias-corrected scaled lm test panels with a large number of cross-sections and small-time dimensions. source: authors. if the panel dataset consists of a small number of cross-section units, then the breusch and pagan (1980) lm test is the most reliable choice. if the panel dataset consists of many crosssection units, then the better choice is the pesaran (2004) scaled lm test, a standardized version of the lm test. pesaran’s (2004) cd test is the most appropriate if the panel dataset consists of small cross-sections and time dimensions. finally, for panel datasets with panels with large crosssections and small-time dimensions, the best choice is bias correction for the scaled lm test proposed by baltagi et al. (2012). the null hypothesis in these tests is “there is no cross-sectional dependence in the data.” we used all four tests to look for any cross-sectional dependence between the time series in the research to confirm the accuracy of the findings. since the results demonstrated the absence of cross-sectional dependence (see results section), panel unit root tests of the first generation have been applied. the order of cointegration is determined through five-panel unit root tests: levin, lin & chu (levin et al., 2002), breitung (breitung, 2001), im, pesaran, and shin (im et al., 2003), fisher-adf (maddala & wu, 1999) and fisher-pp (choi, 2001) tests. the existence of a unit root is the null hypothesis for each of the five tests, as opposed to the alternative hypothesis that there is not one. each test is applied to logarithm transformations of the time series at the level and then at first difference. once the panel unit root tests have been applied, the next methodological step is to apply the johansen-fisher panel cointegration maximum likelihood-based test (johansen, 1988; johansen, 1995). the proof that the time series are all not stationary at level is sufficient for examining the cointegration and the long-run relationship between the variables. the johansen-fisher panel cointegration test is based on johansen’s methodology and maximum eigenvalue. the initial point is a vector autoregression (var) of the order of 𝑝𝑝 𝑦𝑦𝑡𝑡 = 𝜇𝜇 + �𝐴𝐴𝑖𝑖𝑦𝑦𝑖𝑖−1 + 𝜖𝜖𝑡𝑡, 𝑝𝑝 𝑖𝑖=1 (1) where 𝑦𝑦𝑡𝑡 is an 𝑛𝑛 × 1 vector of variables integrated of order one 𝐼𝐼(1) variables, 𝐴𝐴 is an autoregressive matrix, 𝜇𝜇 is intercept and 𝜖𝜖𝑡𝑡 is an 𝑛𝑛 × 1 vector of innovations. the model can be rewritten as δ𝑦𝑦𝑡𝑡 = 𝜇𝜇 + πyt−1 + �γ𝑖𝑖δ𝑦𝑦𝑖𝑖−1 + 𝜖𝜖𝑡𝑡 , 𝑝𝑝−1 𝑖𝑖=1 (2) where π = ∑ 𝐴𝐴𝑖𝑖 − i 𝑝𝑝 𝑖𝑖=1 and γ𝑖𝑖 = −∑ 𝐴𝐴𝑗𝑗 𝑝𝑝 𝑗𝑗=𝑖𝑖+1 for 𝑖𝑖 = 1, … , 𝑝𝑝. if the matrix π does not have full rank but rather reduced 𝑟𝑟 < 𝑛𝑛, then there exist two 𝑛𝑛 × 𝑟𝑟 matrices 𝛼𝛼 and 𝛽𝛽 with rank 𝑟𝑟 such that π = 𝛼𝛼𝛽𝛽′, where the elements of 𝛼𝛼 are the analogous adjustment of coefficient in the vecm and 𝛽𝛽 is the matrix of parameters of the cointegrating vector. we apply the maximum eigenvalue test, which can be expressed as petar mitić, aleksandra fedajev, milena kojić 49 𝜆𝜆𝑚𝑚𝑚𝑚𝑚𝑚 = 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁(1 − 𝜆𝜆𝑟𝑟+1) (3) where 𝑁𝑁 is the length of the time series and 𝜆𝜆 denotes characteristic roots obtained from the projected matrix. the null hypothesis is that there are 𝑟𝑟 cointegration (𝑟𝑟 = 0) vectors, and the alternative hypothesis is that there are 𝑟𝑟 + 1 cointegration vectors. that is null hypothesis is that there is no cointegration among variables. the above test statistic does not follow the chi-square distribution and is based on pure unit-root assumption. if there is cointegration among variables, it means a long-run interrelationship exists among them. the following methodology step evaluates the short-run relationship of cointegrated series by estimating vector error correction model (vecm). the existence of cointegration suggests a causality relation among variables, at least in one direction. we estimate the vecm and use granger causality. dynamic panel causality test established on vecm is developed in the equations δ𝐶𝐶𝑂𝑂2,𝑡𝑡 = 𝛼𝛼𝑐𝑐 + �𝛾𝛾𝑖𝑖 𝑐𝑐 𝑚𝑚 𝑖𝑖=1 δ𝐶𝐶𝑂𝑂2,𝑡𝑡−1 + �𝛿𝛿𝑠𝑠𝑐𝑐 𝑞𝑞 𝑠𝑠=1 δ𝐺𝐺𝐺𝐺𝑃𝑃𝑖𝑖,𝑡𝑡−𝑠𝑠 + 𝜆𝜆 𝑐𝑐𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑐𝑐 + 𝑢𝑢𝑖𝑖 (4) δ𝐺𝐺𝐺𝐺𝑃𝑃𝑡𝑡 = 𝛼𝛼𝑔𝑔 + �𝛾𝛾𝑖𝑖 𝑔𝑔 𝑚𝑚 𝑖𝑖=1 δ𝐺𝐺𝐺𝐺𝑃𝑃2,𝑡𝑡−𝑖𝑖 + �𝛿𝛿𝑠𝑠 𝑔𝑔 𝑞𝑞 𝑠𝑠=1 δ𝐶𝐶𝑂𝑂2,𝑡𝑡−𝑠𝑠 + 𝜆𝜆 𝑔𝑔𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑔𝑔 + 𝑣𝑣𝑖𝑖, (5) where 𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑐𝑐,𝑔𝑔 denotes lagged residuals estimated from the long-run cointegration, 𝛾𝛾𝑖𝑖 𝑐𝑐 and 𝛿𝛿𝑠𝑠 𝑔𝑔 denote short-run adjustment coefficients, and 𝑢𝑢𝑖𝑖 and 𝑣𝑣𝑖𝑖 denote uncorrelated zero mean disturbance terms. the akaike or the schwarz information determines the optimal lag lengths 𝑚𝑚 and 𝑞𝑞. firstly, the existence of long-run causality can be reviewed by checking the significance of the speed of adjustment of the coefficients of 𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑐𝑐,𝑔𝑔 that is 𝜆𝜆 𝑐𝑐,𝑔𝑔. the coefficients indicate the speed at which adjustments to deviations from the long-term equilibrium occur in response to alterations in individual variables. the statistical significance of coefficients 𝜆𝜆 𝑐𝑐,𝑔𝑔, determines the long-run relationship in the cointegrating process, and movements along this path can be deemed permanent. secondly, the statistical significance of the coefficients 𝛾𝛾𝑖𝑖 𝑐𝑐 and 𝛿𝛿𝑠𝑠 𝑔𝑔 can be interpreted as a short-run causality because the dependent variable responds only to short-term shocks to the stochastic environment. results and discussion results the breusch-pagan lm, pesaran scaled lm, bias-corrected scaled lm, and pesaran cd tests are principally conducted to detect any cross-sectional dependence among the time series. based on the results presented in table 2, the null hypothesis of no cross-sectional dependence (correlation) in weighted residuals is accepted, suggesting an absence of correlation or crosssectional dependency among the time series. 50 economic analysis (2023, vol. 56, no. 1, 43-56) table 2. residual cross-section dependence test test statistics breusch-pagan lm 2.013904 pesaran scaled lm -1.785745 bias-corrected scaled lm -1.828849 pesaran cd -0.395904 source: authors’ calculation. note: statistical significance levels are indicated as follows: *** represents significance at p < 0.001; ** represents significance between p = 0.001 and p = 0.01; * represents significance between p = 0.01 and p = 0.05. cross-section effects were removed during computation. the first generation of tests assumes that cross-sectional units are independent of each other, while the second generation tests relaxes this assumption and permits cross-sectional dependence. before conducting cointegration testing, it is crucial to establish the order of cointegration using five panel unit root tests: levin, lin & chu, breitung, im, pesaran, and shin, as well as adf-fisher and pp-fisher tests. in all five tests, the null hypothesis is that a unit root exists, with the alternative hypothesis being the absence of a unit root. the outcomes of these tests are presented in table 3. table 3. panel unit root test results variable levin, lin & chu t* level first difference co2 -0.67385 -21.8346*** gdp -0.25069 -6.65684*** breitung t-stat level first difference co2 1.05322 -15.7657*** gdp -1.48945 -8.51767*** im, pesaran and shin w-stat level first difference co2 0.47319 -18.9006*** gdp 0.23179 -7.11565*** adf fisher chi-square level first difference co2 6.19320 187.563*** gdp 8.76358 63.2753*** pp fisher chi-square level first difference co2 7.16849 189.432*** gdp 4.52145 71.9744*** source: author’s calculation. note: statistical significance levels are indicated using the following notation: *** denotes significance at p < 0.001, ** denotes significance between p = 0.001 and p = 0.01, and * denotes significance between p = 0.01 and p = 0.05. the unit root tests employed schwarz automatic selection to determine the lag length. fisher tests used an asymptotic chi-square distribution for computing probabilities, while all other tests assume asymptotic normality. the results from the five tests demonstrate that all variables are non-stationary at level but stationary when converted to first differences. at the 0.01 significance level, we fail to reject the null hypothesis of a unit root at level, but we can reject the null hypothesis of a unit root for the first difference. as such, the variables are integrated of order 1 – i(1). all tests indicate nonstationarity at level and stationarity at the first difference, prompting us to proceed with cointegration testing. petar mitić, aleksandra fedajev, milena kojić 51 therefore, table 4 displays the outcomes of the johansen fisher panel cointegration test, which reveals that there is at least one cointegrated equation, signifying that the variables are cointegrated in the long-run. according to pao & tsai (2011), confirming cointegration eliminates the possibility of spurious relationships. these results suggest that there is granger causality, at least in one direction. table 4. johansen fisher panel cointegration test results null hypothesis: variables are not cointegrated hypothesized no. of ce(s) trace maximum eigenvalue r = 0 22.02* 20.03* r ≤ 1 14.05 14.05 source: author’s calculation. note: statistical significance levels are indicated using the following notation: *** denotes significance at p < 0.001, ** denotes significance between p = 0.001 and p = 0.01, and * denotes significance between p = 0.01 and p = 0.05. the symbol r represents the number of cointegrating equations. the interval for lags is set to 1 1 (in first differences). the probabilities are computed using an asymptotic chi-square distribution. given that the johansen fisher cointegration tests confirm the existence of a long-run relationship between the variables in our model, the vector error correction approach is a viable method for estimating the cointegrating coefficients. table 5. panel causality analysis results short-run granger causality error correction δco2 δgdp ect (-1) coeff. δco2 54.25702*** -1.250434 -0.013515 δgdp 61.16536*** -3.051348** -0.016419 source: authors’ calculation. note: statistical significance levels are indicated using the following notation: *** denotes significance at p < 0.001, ** denotes significance between p = 0.001 and p = 0.01, and * denotes significance between p = 0.01 and p = 0.05. δ denotes the first difference operator, while ect (-1) represents the error correction term lagged one year. the results of a granger causality test and a vecm for the relationship between co2 emissions (δco2) and gdp per capita (δgdp) are presented in table 5. the variables are expressed as first differences (δ), implying that the analysis is performed on the changes in the variables over time. the results of the short-run granger causality test reveal a short-run causal relationship between the changes in co2 emissions and gdp per capita, as the significance level of the test (p < 0.001) indicates statistical significance. this implies that over the short run, changes in co2 emissions significantly impact changes in gdp per capita and vice versa, establishing a short-run bidirectional panel causality between co2 emissions and gdp per capita. the findings, however, imply no statistically significant long-term causality from gdp per capita to co2 emissions. the lack of a long-term causality from gdp to co2 implies there is a lack of evidence that aberrations from this relationship are corrected over time, as the error correction term (ect) for δco2 (-1.250434) is statistically non-significant. nevertheless, the non-significant ect for δco2 emissions does not necessarily suggest no long-run relationship between the two variables; therefore, this conclusion should be cautiously approached. other factors, such as the sample size, the presence of omitted variables, or measurement error, could also affect the significance of the ect. this claim is further supported by the fact that, as mentioned above, the results of the short-run granger causality test still suggest a causal relationship between δco2 and δgdp over the short run. 52 economic analysis (2023, vol. 56, no. 1, 43-56) this assertion is further strengthened by the statistically significant ect(-1) for δgdp, which points to a long-term causality from co2 emissions to gdp per capita. a decrease in co2 emissions is associated with a rise in gdp. the long-run equilibrium between the two variables is represented by the ect (-3.051348**), with the negative and statistically significant ect showing a negative adjustment mechanism to correct deviations from the long-run relationship. therefore, it might be concluded that the findings imply a long-term relationship between co2 emissions and gdp with a negative adjustment mechanism to remedy aberrations from this relationship. the scale of the ect can be used to estimate the speed of adjustment. discussion and policy implications long-term economic disruption may result from the detrimental effects of co2 emissions on the environment (such as climate change and air pollution). for instance, extreme weather events, like hurricanes, floods, and droughts, brought on by climate change can harm infrastructure, sabotage supply chains, and lower agricultural productivity. air pollution can also have health impacts on individuals, leading to more considerable healthcare costs and diminished workforce productivity. the findings of this paper have significant policy ramifications for the wb countries. initially, the cointegration results show that co2 emissions and gdp per capita have a long-term relationship, suggesting that a long-run relationship exists between the variables. this finding is significant because it emphasizes the link between environmental sustainability and economic growth in the wbs. furthermore, the granger causality test results and the vecm suggest a shortrun bidirectional causality between co2 emissions and gdp per capita. the importance of simultaneously addressing economic growth and environmental sustainability in wb countries’ policies and plans is highlighted by this finding. furthermore, the statistically significant error correction term for δgdp suggests that a longterm causal relationship exists and runs from co2 emissions gdp per capita, with a negative adjustment mechanism to correct deviations from the long-run relationship. this suggests that a decline in co2 emissions results in a rise in gdp per capita, underscoring that policies and actions to cut co2 emissions, such as improving energy efficiency, encouraging the use of green energy sources, and implementing carbon taxes, can have positive spillover effects on the economy. as shown in a recent study (đurašković et al., 2021), investing in renewable energy can have positive impacts on both employment and innovation. furthermore, improving energy efficiency can decrease production costs and increase competitiveness. these benefits can be achieved by developing and implementing energy-efficient technologies, such as smart grids and energyefficient buildings, as well as using renewable energy sources like solar and wind power. by adopting such measures, economies in the wb region can reduce their dependence on fossil fuels and mitigate the potential impact of global energy market fluctuations. in order to encourage businesses to cut their co2 emissions and embrace environmentally friendly practices, policymakers in the wbs ought to consider the complex interplay between economic growth and environmental sustainability to formulate policies that balance both objectives. investing in clean energy and green technologies through green finance (world bank, 2022), enacting stronger environmental regulations and taxes, following global initiatives in this area (mitić et al., 2017; arndt et al., 2017), and encouraging environmentally sound management techniques can help reduce pollution and protect natural resources while stimulating economic growth. by adopting a comprehensive approach to policy-making, wb countries can achieve sustainable development and contribute to a greener future for the region and beyond. conclusion the wbs have undergone significant economic and political transitions in recent decades, resulting in increased industrialization and urbanization with significant environmental impacts, petar mitić, aleksandra fedajev, milena kojić 53 leading to growing concerns about the region’s environmental sustainability and its potential effects on economic growth. the sofia declaration on the green agenda for the wbs and other international policies have highlighted the importance of balancing economic and environmental sustainability in the region. this paper’s findings add to the research on the intricate link between economic growth and the environment in the wbs. the cointegration results suggest a long-term relationship between co2 emissions and gdp per capita, emphasizing the need to address economic growth and environmental sustainability in policies and plans. furthermore, the vecm has identified a negative adjustment mechanism suggesting a rise in co2 emissions will cause a decline in gdp per capita, highlighting the need for sustainable economic growth to lower co2 emissions and protect the environment. the short-term bidirectional causality between co2 emissions and gdp per capita further underscores the need for policymakers to adopt a comprehensive approach to policy-making. investing in clean energy and green technologies, enacting stronger environmental regulations and taxes, and encouraging environmentally sound management techniques can help reduce pollution and protect natural resources while stimulating economic growth. policymakers can use these findings to formulate policies that balance economic growth and environmental sustainability. however, more research is needed to fully understand the complex relationship between economic growth and the environment in the wbs. future studies can build on these findings to further inform policies and plans that promote sustainable development in the region. additionally, it is important to consider other environmental, social, and economic variables, such as population growth, income inequality, and access to education and healthcare, to develop a comprehensive understanding of the challenges and opportunities for sustainable development in the region. acknowledgments this research has been financed by the ministry of science, technological development and innovations of the republic of serbia. references adedoyin, f., abubakar, i., bekun, f. v., & sarkodie, s. a. 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(2020). investigating the ekc hypothesis for china: the role of economic complexity on ecological footprint. environmental science and pollution research, 27(26), 32683–32694. https://doi.org/10.1007/s11356-020-09434-4 article history: received: 16.3.2023 revised: 4.5.2023 accepted: 8.5.2023 https://doi.org/10.1016/j.rser.2019.109481 https://doi.org/10.1007/s10784-021-09529-4 https://doi.org/10.1016/j.jclepro.2020.121669 https://doi.org/10.28934/ea.22.55.2.pp91-106 https://doi.org/10.1002/pa.2126 https://esa.un.org/unpd/wpp/ https://doi.org/10.1186/s40008-021-00259-z https://doi.org/10.1016/j.heliyon.2022.e10357 https://elibrary.worldbank.org/doi/epdf/10.1596/36402 https://openknowledge.worldbank.org/handle/10986/38189 https://doi.org/10.1007/s11356-020-09434-4 ea_2013_3-4 finalna ver scientific review reforms of the imf in the context of the global financial crisis1 plchová božena, university of economics, prague, czech republic baranenko elena2, institute of economic sciences, belgrade, serbia udc: 339.732.4 ; 338.124.2(100) jel: f33; g01 id: 203722764 abstract – the imf during its existence has undergone numerous changes. from the institution established for international monetary cooperation and oversight over fixed exchange rate regimes, the imf has turned into an institution whose main goal is the maintenance of the global economic and financial stability. in order to achieve this goal, the imf in the modern era focuses its activities primarily on the prevention of emergence of economic crisis and minimising of their negative effects. however, at the end of the xx and the beginning of the xxi century, due to inefficient activities and poor results, especially when it comes to solving the crisis in south east asia and argentina, the fund began to lose its credibility and found itself in a deep crisis. the imf has tried to take steps that would lead to the improvement of the situation, but it did not manage to achieve tangible progress. the global economic crisis has further highlighted the existing drawbacks and omissions, which the fund has been faced with. however, the growing demand for financial support from member states, as well as the need for the organization that would succeed in preventing the emerging of crisis and facilitate the fight with its consequences, were providing serious support to the fund. the imf's new effort has been focused on reforming its structure and the way of functioning. this paper analyzes the progress achieved by the imf in the implementation of reforms related to resolving the difficulties caused by the crisis and discusses possible directions for future activities of the fund including an overview of vulnerabilities and the possibility of their elimination. key words: imf, reforms, financial crisis introduction over the last few years we have been witnesses of one of the biggest financial crisis, which significantly influenced the development of the global economy and placed it into a recession. the global character of the crisis, the severity of the impact and the number of 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. 2 elena baranenko, ma, research associate, institute of economic sciences, belgrade, phd student at the faculty of international relations, department international trade, the university of economics in prague, e-mail: elena.baranenko@ien.bg.ac.rs economic analysis (2013, vol. 46, no. 3-4, 1-13) 2 affected countries, industries, companies and people indicated that it was necessary at the international level to conduct qualitative research of this phenomenon and deepen cooperation in order to avoid or prevent the proliferation of new financial crises of similar range and consequences. in this context, international financial organizations could actually play a significant role. one of the most important players in the international financial arena, whose main objective is to support financial stability, is the international monetary fund. for many years, the imf among other things has been trying by its activities to prevent the emergence and spreading of financial crisis, but despite all efforts it did not manage to achieve significant results in this area. lack of effective action, numerous internal problems as well as failures in solving the economic crises that erupted in the last two decades of the last century have influenced the imf to become a frequent target of criticism from the governments of various countries, large financial companies and professional public and in that way eventually began to speculate about the justification of the existence of this international economic organization. „in the last 60 years, the imf has promoted economic stability and socio-economic development. this organization, despite specific expectations, however, it did not achieve so much, so some observers consider that, in general, is not qualified to deal with the needs of countries that have certain problems. although it has the organizational capacity, the imf as well as other international financial / economic organizations must play a more coherent and effective role in the world. in the past, however its role was quite inefficient and discouraging“(paunovic, 2011, p.108). criticism is greatly tightened after the occurrence of the global financial crisis in 2007, when we could again notice that there are serious shortcomings when it comes to efficiency of the prediction and prevention of the emergence of crises, as well as the impact of the imf on the reduction of its consequences. also, the existing problems and weaknesses in the functioning of the fund have come to the fore. all this emphasized the necessity of reforming the imf as soon as possible and adaptation of its activities to modern turbulent period. the current financial crisis and imf activities in the framework of dealing with the crisis, the fund during the last 5 years has intensified activities in many areas and carried out a series of reformist steps in order to meet the needs of member countries and also contribute to the stabilization of the world economy. basic steps could be summarized in three points: perfecting the loan process and increasing permanent financial resources of the imf; improving projections and evaluations in order to strengthen the regulation of the world economy; regulation of international private capital flows. 1. perfecting the loan process and increasing permanent financial resources of the imf • process of lending one of the main goals in the first point was the formulation of such conditions for getting the loan, which would „enable the fund to respond with more flexibility to the diverse pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 3 liquidity needs of members with sound policies and fundamentals“(imf, 2012). necessity of the improvement of financing mechanism stemmed primarily from the fact that since the beginning of the crisis the demand for loans by the member countries has increased dramatically. for example, in the pre crisis period in 2007, the fund has lent approximately sdr 10 billion, while in may 2013 this amount increased significantly and accounted for more than sdr 93 billion (see the figure 1.). figure 1. imf credit outstanding for all members from 2003-2013 (in billion sdrs) source: imf it is interesting to mention that prior to the crisis, there were a lot of speculations that the fund most of its activities in the framework of financing had focused exclusively on developing countries (mostly low-income countries), while on the other side industrialized countries had begun to lose interest in the offer coming from the imf. this has contributed to the deepening of the crisis the fund has been facing with over several years, because it was unclear what exactly is the purpose of this organization and what type of work it is actually doing. however, after the emergence of the global economic crisis, the situation has significantly changed. in fact, by the end of 2008, the amount of borrowed funds in developed countries is almost equal to the amount of funds allocated to developing countries, and since 2009, the share of developed countries compared to developing countries has become considerably larger. it can be said that the global economic crisis „saved“ imf or, in other words, it gave him a second chance to achieve its basic goals and ultimately contribute to the stabilization of finance and economy in the world. • new lending instruments by implementing its intentions for improving credit processes in the framework of reforms, as a response to the challenges of the crisis, the imf starting from 2009, created several new instruments, which will be analyzed in the next section of the publication. economic analysis (2013, vol. 46, no. 3-4, 1-13) 4 the first two instruments, flexible credit line (fcl) and precautionary and liquidity line (pll), are intended for countries with a strong economy, and for countries having a healthy macroeconomic environment, strong institutional framework and follows the recommendations of the imf. the essence of fcl is about providing member countries with opportunities to apply for a loan before plunging into a serious crisis. countries can apply for a loan if they meet the qualifying criteria, or have a sound macroeconomic environment, strong institutional framework and follow the recommendations of the imf. for these countries then there is no conditionality or additional conditions nor limited access to financial resources. in addition, countries can withdraw the loan at any time. financial resources are available during 6 to 12 months with a maturity of 3.25 to 5 years. until now, fcl has been approved for poland, mexico and colombia. in 2010, the imf expanded its offer by introducing precautionary and liquidity line (pll). pll also applies to countries with a strong economy, which for some reason (usually due to certain weaknesses or moderate vulnerabilities that negatively affect the ability to meet the qualification criteria of fcl) are unable to use flexible credit line. pll allows the applicant to withdraw financial resources up to 1000% of quota in period from 12 to 24 months. table 1. some of the imf lending arrangements (in thousands of sdrs) member date of arrangement total amount agreed undrawn balance imf credit outstanding under gra stand-by arrangement (sba) antigua and barbuda june 07, 2010 67,5 16,875 50,625 bosnia and herzegovina september 26, 2012 338,2 202,92 404,994 georgia april 11, 2012 125 125 363,163 jordan august 03, 2012 1,364,000 852,5 511,5 kosovo april 27, 2012 90,968 12,752 96,976 romania march 31, 2011 3,090,600 3,090,600 7,682,625 st. kitts and nevis july 27, 2011 52,51 9,407 44,216 total 5,128,778 4,310,054 9,154,098 flexible credit line (fcl) mexico november 30, 2012 47,292,000 47,292,000 0 poland, republic of january 18, 2013 22,000,000 22,000,000 0 total 69,292,000 69,292,000 0 precautionary and liquidity line (pll) 1/ morocco august 03, 2012 4,117,400 4,117,400 0 total 4,117,400 4,117,400 0 source: imf pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 5 it should be mentioned that there was also a change, when it comes to the stand-by arrangement. in fact, since 2009 the sba is more flexible, and the conditions of its approving are significantly easier. among other things, within the sba there has been an increase in the supply of funds as well as borrowing limits.3 the next group of instruments is related to low-income countries. namely, within the „helping the world’s poorest“ imf offers more flexible programs and higher volume of loans (financial resources allocated for the period 2009-2014, whose mission is to reduce poverty and promote economic growth reached 17 mld.usd). aiming to provide a coordinated funding of low-income countries, the imf in 2010 formed a fund to promote economic growth and poverty reduction (prgt) and defined three lending instruments, which in april 2013 were advanced again in order to improve flexibility of the financial support. lending instruments or windows are the following: the extended credit facility (ecf), the standby credit facility (scf) and the rapid credit facility (rcf). ecf (succeeds the poverty reduction and growth facility) is the basic tool for providing medium-term financial support for low-income countries facing the balance of payments problems. the arrangement is intended for 3 to 5 years and gives the possibility to withdraw funds in the amount of up to 100% of its quota per year or 300% of its quota in total. in order to be able to obtain assistance, a country must provide a letter of intent which should contain the planned measures and policy actions to improve macroeconomic stability and a country's poverty reduction. the scf (replaced the high-access component of the exogenous shocks facility (esf)) is intended for low-income countries that have a strong and sustainable macroeconomic position, but faced with short-term balance of payments problems caused by political shocks or omissions. the period of the arrangement is 1 2 years, while the level of funding can be 100% of quota per year or 300% of quota in total. funding under the scf carries an interest rate of 0.25%, so that by the end of 2014 is acquitted of all interest. the rcf (streamlines the imf’s emergency assistance for low-income countries) provides rapid financial assistance to low-income countries facing an urgent balance of payments need and also in a wide variety of circumstances, including internal and external shocks, natural disasters, and other fragile situations. fund support under the rcf is provided without conditionality or reviews, in the form of direct payments, whereby access to financial resources is limited to 25% per annum or 75% cumulatively. financing under the rcf currently carries a zero interest rate, has a grace period of 5½ years, and a final maturity of 10 years. 3 http://www.imf.org/external/about/lending.htm economic analysis (2013, vol. 46, no. 3-4, 1-13) 6 table 2. some of the imf lending arrangements (in thousands of sdrs) poverty reduction and growth trust (prgt) extended credit facility (ecf) 2/ afghanistan, islamic republic of november 14, 2011 85 61 93,32 armenia, republic of june 28, 2010 133,4 26,6 132,478 bangladesh april 11, 2012 639,96 457,114 310,123 benin june 14, 2010 74,28 21,22 77,126 burkina faso june 14, 2010 82,274 6,45 136,038 burundi january 27, 2012 30 20 90,096 central african republic june 25, 2012 41,775 34,812 65,331 comoros september 21, 2009 13,573 3,115 9,715 cote d'ivoire november 04, 2011 390,24 178,86 512,277 gambia, the may 25, 2012 18,66 7,775 32,833 guinea february 24, 2012 128,52 73,44 55,585 haiti july 21, 2010 40,95 4,914 36,036 kenya january 31, 2011 488,52 71,921 641,049 kyrgyz republic june 20, 2011 66,6 28,544 118,215 lesotho june 02, 2010 50,605 5,68 47,025 liberia november 19, 2012 51,68 44,298 49,52 malawi july 23, 2012 104,1 65,05 128,717 mauritania march 15, 2010 77,28 11,04 75,067 niger march 16, 2012 78,96 56,4 52,946 sao tome & principe july 20, 2012 2,59 2,22 3,436 sierra leone july 01, 2010 31,11 8,91 78,318 solomon islands december 07, 2012 1,04 891 12,629 total 2,631,117 1,190,254 2,757,877 source: imf • financial recourses in order to provide a sufficient level of funding primarily to support the development in developing countries and emerging countries affected by the crisis, the imf has focussed on increasing the lending capacity. in april 2009, at the summit of the g-20, in the framework of the so-called „creating crisis firewall“ process, the increased lending capacity was approved by imf and amounted up to usd 500 billion in the size of the nab, while in 2010, the board of governors of imf approved an unprecedented doubling of quotas to approximately usd 733,9 billion (sdr 476,8 billion) (imf, 2013). according to (weiss a. martin, 2013), increase of financial resources through the nab instead an increase in quotas, was long-standing frustration among emerging market economies that, after years of sustained economic growth, their representation at the imf did not reflect their current economic position in the world economy. in april 2010, the volume of funds under the new arrangements to borrow (nab) was extended to nearly 560 billions usd (sdr 367.5 billion) and further 13 countries and several new institutions entered into the mechanism. in december 2011, the euro area pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 7 countries were committed to providing additional funding for the imf worth around 200 billion usd. 2. improving projections and evaluations in order to strengthen the regulation of the world economy • financial surveillance the second point, which imf defines as sharpening imf analysis and policy advice, is related primarily to prevent a new outbreak of the financial crisis. the global financial crisis revealed that there were serious failures when it comes to the fund's surveillance system that did not adequately react to the basic signs of the arrival of the crisis, primarily in build up of systemic risk (xafa, 2010). in an attempt to eliminate the major drawbacks and to strengthen financial surveillance, the imf has conducted a series of activities in the past three years. one of the first steps was directed to improving risk analysis and also the analysis of the linkages between the real economy, the financial sector and external stability, namely integration the analysis of financial stability with the macroeconomic analysis of the member countries4 (wickmanparak, 2012, p.3). the next important step is related to the financial sector assessment programmes (fsaps). in september 2010, the imf’s executive board decided to make fsap mandatory for 25 „systemically important“ member countries in this group had entered 15 of the g20 countries and the majority of members of the financial stability board (smyslov, 2012). in order to achieve improvement of quality assessment considerable attention has been devoted to improving the methodology and the fund's „stress testing tools“, as well as other factors like crisis management frameworks, institutional cooperation etc. (imf, 2013). among other things, there was an increase in flexibility, improved integration fsaps with the imf survelliance framework, as well as „clearer delineation of institutional responsibilities for stability and development, with greater institutional accountability.“ (imf, 2013) aiming to improve the practice of surveillance, particularly in relation to deepen the analysis of economic, financial and fiscal risks, as well as cross-sector and cross-border spillovers, the imf in cooperation with the financial stability board (fsb) on the proposal of the g20 in 2008 also focused on refining the effectiveness of the early warning exercise (ewe). despite the fact that the ewe is not intended to forecast crises, its „analytical techniques, practical experience, seasoned judgment and unique databases“ could significantly contribute to the prevention of crises or mitigation of potential consequences caused by crisis (lipsky, j, 2010). the imf will focus its activities on the major weak points of the ewe, which are primarily considered as unclearly defined goals, limited coordination and insufficient organizational capacity (brooks, s. et.al, 2013). the collaboration of the fund and the fsb is of fundamental importance towards removing obstacles, namely the 4 according to the latest of triennial surveillance reviews from 2011 compared to previous tsr from 2008, there was an improvement of the surveillance system. as an example of successful implementation of the goals, the executive board stated that there was a useful contribution between fund surveillance and analysis of external spillovers, which was conducted for five biggest systemic economics. economic analysis (2013, vol. 46, no. 3-4, 1-13) 8 integration of fund's macro-analysis financial with perspectives of fsb on regulatory and supervisory system. efficient communication is also very important, which means that all the results and recommendations of the ewe will be adopted by policymakers of the member states, while, on the other hand, the imf will be able to provide precise warnings and consistent policy advices. in july 2012, in response to the all above mentioned factors necessary for the improvement of surveillance framework, the executive board approved integrated surveillance decision and introduced new pilot external sector support. integrated surveillance decision imf is focused on enhancing of legal framework. in line with establishment of strengthened legal framework it was defined that the new framework would be based on the following postulates: • concentrating on the key issues of global economic and financial stability within multilateral surveillance • deepening of integration between bilateral and multilateral surveillance • providing sufficient coverage for a member country’s exchange rate as well as domestic economic and financial policies • providing effective coverage of significant spillovers from member countries’ policies onto global financial stability. when it comes to the pilot external sector report, its main purpose is fostering the assessment of external imbalances effectiveness. combining bilateral and multilateral perspectives in a single report, the pilot report provides a systematical analysis of financial indicators (exchange rates, current accounts, capital flows, reserves adequacy), which determines the external position of the largest economies.5 the report assesses, among other things, the potential policy responses. in order to assess external imbalances the new external balance assessment approach is being used. that approach allows identifying impact of a range of structural factors, respectively policy distortions in fiscal policy, capital controls etc. on a country’s current account. the approach also focuses on identifying weaknesses in the country’s policies and assessments whether the some changes in that context should be realized or measures should be taken. to further strengthen surveillance, the executive board recently developed a new financial surveillance strategy presenting major priorities and concrete steps of conducting surveillance in the coming years. „the aims of the strategy are for the imf to improve its understanding of macro-financial relations, to become better at identifying contagion risks across national borders and to increase its cooperation with other organisations. this is no easy task and the work involved is far from complete. this is something that the imf will need to develop on an ongoing basis” (wickman-parak, 2012). • governance reform although not directly related to the global economic crisis, reform of the management structure is essential for the future admirable position of the imf in the global financial system, so anyway we should analyze what significant changes have occurred in the past few years. 5 for now the analysis covers 28 of the largest economies plus the euro area pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 9 management reforms are primarily a consequence of the growing importance of developing countries and new emerging markets. the variable position of many countries from the above groups directly influenced the need to adapt management structures of the imf to new rules in order to ensure equal treatment for all member states. the first step on the road to reform was the adoption of the package of measures in the 2008, that should strengthen the position and at the same time increase the impact of dynamic economies through quota increases for 54 member countries and through increasing voting power of low-income countries by almost tripling their basic votes. in 2010, the executive board approved another reform packages focused primarily on a doubling of imf quotas that would lead to a shift of 6 percent of quota shares6 to the developing countries and dynamic emerging economies. that rebalancing of quotas, for example, opened the door in top 10 shareholders of the fund for two new member countries, india and brazil (imf, 2011). in order to improve position of the dynamic emerging economies and developing countries in a decision making process, the further reform steps refer to a restructuring of the executive board’s composition. as a result, board members from advanced european economies will be decreased by two members; and all executive directors will no longer be appointed, but elected. in addition, it was also agreed that the size of the board will remain the same (24 members) and will be reviewed every eight years. figure 2. progress with the acceptance of the board reform amendment source: imf 6 the quota shift was enabled thanks to reducing of shares of some developed countries economic analysis (2013, vol. 46, no. 3-4, 1-13) 10 the proposed quota increases, as well as an amendment to the imf’s articles of agreement initially, should be accepted by the membership in late 2012. however, the process of adoption of new measures has not been completed yet. according to the executive board’s last revision of progress toward implementation of the reform package, „as of april 10, 2013, 148 members having 77.4 percent of fund quotas had consented to their proposed quota increases under the 14th general review of quotas. as of the same date, 136 members having 71.3 percent of the total voting power had accepted the proposed amendment to reform the fund’s executive board” (imf, 2013, p1.). the main reason why the process of reforming the imf governance structure had not been completed yet, was the primarily position of the usa and the fact that the us congress refused to approve reallocation of $65 billion of the us loan to the imf into a permanent increase in shareholding. although we hope that participants of the g20 summit can find acceptable solution, which will be held in september in st. petersburg, russia, according to opinion of many analysts, it is unlikely that the reform will be implemented by the end of the year. concluding remarks despite justified criticism which the imf has been facing with over the last few decades, it is obvious that this organization has a huge impact and plays an important role in the global financial system. imf potentials are enormous, however, because of numerous problems and disagreements, their effective implementation could be hardly reached. the imf has already tried to make some steps that could eliminate drawbacks and change his reputation of inefficient organization. but the most important reforms were defined only after the outbreak of the global economic crisis, when all the weaknesses and failures came to the fore and it was necessary to take precautions in order to strengthen the legitimacy of the imf and the restoration of confidence in the fund as an organization that promotes global economic and financial stability. these reforms have to some extent contributed to the improvement of the situation. however, there are still a lot of unresolved problems and weaknesses where the imf should focus its activities in order to eliminate them. first of all, it is necessary to put more effort in reforming the governance structure and quotas. despite the fact that there has been a shift in the redistribution of votes among the member states, this change is not yet sufficient to be able to reflect the real position of countries in the world economy. the imf has already been criticized because it lacks legitimacy and that represents the interests of developed countries at the expense of developing countries. disposal of ratification of major measures defined by reform will have a negative impact on the reputation of the fund. among other things, imf should strengthen its role in preventing the emergence of crises. so far, the fund did not manage to successfully perform this role because its analysis is very dependent on the economic data that come from different countries, which very often affect the competency and objectivity of the results of the analysis in the sense that they do not reflect the real economic situation. to be able to perform better forecasts, the imf should focus on gathering more precise information and providing more comprehensive estimates and analysis. pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 11 the next step that would lead to more efficient coordination of the fund activities in the framework of providing global economic and financial stability should refer to further strengthen of surveillance over the economic and financial policies of member countries (truman, 2010). in this regard, truman proposed revision and reconstruction of the obligations of imf membership based on amendments to the imf articles of agreement and governance changes. reconstruction of the obligations should be maintained in order to achieve directing of financial and economic policies of the member states towards establishing price stability (internal stability), eliminating manipulation of exchange rates and stimulating economic growth. therefore, in order to improve monitoring over the fulfilment of obligations, it would be necessary to elaborate „norms for members’ policies and performance” (truman, 2010). these norms are supposed to represent the steps and procedures that member states had to implement in order to meet its own obligations. also, truman suggests creating a special independent committee-international monetary and financial committee-composed of independent experts from different countries. committee in the framework of bilateral surveillance would consult the member states concerning economic policy and performance. in addition, monitored country should explain shortfalls (deviations) in fulfilling standards. committee should be discussing all the details with employees of the fund and only after that it would hand a report to the executive commission. the next step should be related to the strengthening of the role of the fund in the macroeconomic adjustment and stabilization of the international monetary system, because the imf is often criticized for lack of paying attention to this very serious problem. in 2011, the executive board of the imf held a meeting where it was analysed the progress made in recent years in the context of strengthening the international monetary system. also, the main directions of future activities have been defined. although the imf made an important step forward, in the opinion of many experts, there are numerous shortcomings of the imf new „institutional view”. as the main weak points primarily considered are the possibility of implementing the institutional view ((truman , e, 2013; galagher, k and ocampo, a., 2013), as well as absence of a robust framework for analysing „the influence of policies and conditions in recipient and source countries on capital flows”. this was an overview of some of the most fundamental problems that must be solved. as can be seen, in the coming period the imf will be faced with a very hard and serious work. depending on the efficiency and speed of implementation of reform steps and measures will be clear whether the fund will finally become stable and effective institution capable of contributing to the financial stability and prosperity in the world. references brooks, s., et. al. 2013. „coordination critical to ensuring the early warning exercise is effective”, policy brief. no.4, http://www.balsillieschool.ca/sites/default/files/no4_1.pdf. gallagher, k., and ocampo, j.a. 2013. imf’s new view on capital controls, http://www.ase.tufts.edu/gdae/pubs/rp/gallagher_epw_capital_controls_2013.pdf. international monetary fund. 2011. important milestone reached to reinforce imf legitimacy, http://www.imf.org/external/pubs/ft/survey/so/2011/new030411a.htm. economic analysis (2013, vol. 46, no. 3-4, 1-13) 12 international monetary fund. 2012. annual report 2012: working together to support global recovery, http://www.imf.org/external/pubs/ft/ar/2012/eng/pdf/ar12_eng.pdf. international monetary fund. 2012. imf reboots framework for economic monitoring, http://www.imf.org/external/pubs/ft/survey/so/2012/pol071912a.htm. international monetary fund. 2013. financial sector assessment program: frequently asked questions, http://www.imf.org/external/np/fsap/faq/#q2. international monetary fund. 2013. imf’s response to the global economic crisis, http://www.imf.org/external/np/exr/facts/changing.htm. international monetary fund. 2013. proposed amendment on the reform of the imf executive board and fourteenth general review of quotas status of acceptances and consents. finance, legal, and secretary’s departments, http://www.imf.org/external/np/pp/eng/2013/041013.pdf. lipsky, jh. 2010. forewarned is forearmed: how the early warning exercise expands the imf’s surveillance toolkit, http://blog-imfdirect.imf.org/2010/09/23/forewarned-is-forearmedhow-the-early-warning-exercise-expands-the-imf%e2%80%99s-surveillance-toolkit/ paunović, s. 2011. uloga međunarodnog monetarnog fonda u savremenoj ekonomskoj krizi. beograd: savez samostalnih sindikata srbije. smyslov, d. 2012. „реформирование международного валютного фонда: проблемы и решения. регулятивные аспекты”. деньги и кредит, no. 1. http://www.cbr.ru/publ/moneyandcredit/smyslov_01_12.pdf. truman, e. 2010. „strengthening imf surveillance: a comprehensive proposal”, policy brief, 10-29, http://www.iie.com/publications/pb/pb10-29.pdf. truman, e. 2013. „managing international capital flows: the imf’s „institutional view” falls short”, realtime economic issues watch, http://www.piie.com/blogs/realtime/?p=3595 weiss, m. 2013. international monetary fund: background and issues for congress, http://www.fas.org/sgp/crs/misc/r42019.pdf. wickman-parak, b. 2012. the imf’s role-new thinking in the wake of the financial crisis, http://www.bis.org/review/r121009i.pdf. xafa, m. 2010. „role of the imf in the global financial crisis.” cato journal, 30(3), http://www.cato.org/sites/cato.org/files/serials/files/cato-journal/2010/11/cj30n3-5.pdf. reforme mmf-a u kontekstu globalne finansijske krize rezime –.međunarodni monetarni fond je tokom godina svog postojanja pretrpeo brojne promene. iz institucije osnovane u svrhu promovisanja međunarodne monetarne saradnje i nadzora nad fiksnim režimima deviznog kursa, pretvorio se u instituciju čiji je glavni cilj održavanje globalne ekonomske i finansijske stabilnosti. da bi se ovaj cilj postigao mmf u modernom dobu svoje aktivnosti fokusira prevashodno na prevenciju ekonomskih kriza, kao i na minimiziranje njihovih negativnih efekata. krajem xx i početkom xxi veka, zbog neefikasnog delovanja i slabih rezultata, posebno kada je reč o rešavanju krize u jugoistočnoj aziji i argentini, fond je počeo da gubi kredibilitet i na kraju se sam našao u dubokoj krizi. mmf je pokušao da preduzme određene korake koji bi vodili poboljšanju situacije, ali nije uspeo da ostvari značajniji napredak. globalna ekonomsko kriza pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 13 je dodatno naglasila postojeće nedostatke i propuste sa kojima se fond suočavao. međutim, rastuća potražnja država članica za finansijskim sredstvima, kao i potreba za jakom organizacijom koja bi mogla uspeti da spreči širenje krize i olakša borbu sa njenim posledicama, su pružili snažnu podršku fondu. stoga je novi napor mmfusmeren prvenstveno na reformu sopstvene strukture i načina funkcionisanja. u radu se analizira napredak postignut od strane mmf u sprovođenju reformi vezanih za rešavanje poteškoća izazvanih krizom i razmatraju se mogući pravci budućih aktivnosti fonda, uključujući pregled ključnih nedostataka i mogućnosti njihovog eliminisanja. ključne reči:. međunarodni monetarni fond, reforme, finansijska kriza article history: received: 9 september 2013 accepted: 9 december 2013 ea_2015_1-2 udc: 339.137.2 303.446:339.564(497) jel: f10, f14 cobiss.sr-id: 216169228 preliminary reports the comparative analysis of export competitiveness of ex-yu countries halilbašić muamer1, brkić snježana, university of sarajevo, school of economics and business, sarajevo, bosnia and herzegovina bosić vedrana, sarajevo, bosnia and herzegovina abstract – the paper deals with the analysis of ex-yugoslav countries' export performance (bosnia and herzegovina, croatia, macedonia, montenegro, serbia and slovenia) over the period 2006-2013. the paper is aimed at assessing these countries’ export competitiveness and determining its dynamics in trade with the world. the analysis included the research into and comparison of export characteristics – the volume and dynamics of export flows, geographic and product export structure and concentration, technological export sophistication, export specialization expressed through revealed comparative advantage, intensity and direction of change in export structure. in order to gain a comprehensive insight into export competitiveness, a few indicators were used: balassa rca index, michaely index, herfindahl-hirschman concentration indices, etc. the indices were calculated based on the information from relevant databases of the world bank and international trade centre, aggregated at the second and sixth hs2002 level, for the eight-year period and/or for the first and the last year. the research revealed that ex-yu countries’ export performance is generally unsatisfactory, despite the progress that individual countries registered in the observed period. most countries have comparative advantage in the products of traditional, declining industries, a high share of semiproducts and primary products, and a negligible share of high-technology products in their export portfolio, a stagnating export structure, and a low degree of geographic and product export diversification. mutual comparisons showed that the group is not homogenous and that, besides the described common characteristics, there are significant differences within the group in certain aspects of export competitiveness. the eu member–states, croatia and particularly slovenia, have a series of advantages compared to countries that are candidates and potential candidate. the greatest progress toward the improved export competitiveness was achieved by serbia, while montenegro got the poorest rating for export competitiveness key words: ex-yu countries, export competitiveness, export structure, revealed comparative advantages (rca), export diversification, export concentration 1 school of economics and business university of sarajevo; e-mail: muamer.halilbasic@efsa.unsa.ba halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 109 introduction the significance of exports as a given economy's growth factor depends on their volume, structure and trend, which is related to the issue of studying a country's export performance and competitiveness. export competitiveness is primarily understood as a country’s ability to sell commodities in foreign markets at the price and quality that can be compared to competition, while achieving the foreign-trade balance. export competitiveness comprises different aspects of export performances including trend, structure, diversification and quality of exports. the paper is aimed at assessing export competitiveness of the countries of former yugoslavia (ex-yu countries) and determining its dynamics in the trade with the world. the research focuses on export characteristics of six ex-yu countries – bosnia and herzegovina (bih), montenegro, croatia, macedonia, serbia and slovenia in the period 2006-2013. the research included a comparative analysis of export dynamics and structure (production, geographic and technological one), of changes in export portfolio, geographic and product export concentration and revealed comparative advantage of the observed countries. the research results should provide for the identification of advantages and shortages of analyzed countries regarding export competitiveness that would serve as a basis for definition of appropriate recommendations aimed at improving their export positions. in order to obtain a comprehensive insight into export competitiveness, a few different indicators were used: indicators of export composition and revealed comparative advantage (balassa rca index, michaely index), indicators of export diversification (share of top five export products and top five export markets, the number of export products, herfindahlhirschman indices of geographic and sectoral export concentration), and export quality indicators (export product classification by technology content). the data gathered from relevant databases of the world bank2 and international trade centre3 were analyzed at the second level of harmonized commodity description and coding system classification(hs 2002). the indicators were calculated, compared and interpreted at the annual export level for the period 2006-2013, and/or the first and last year of the period (2006 and 2013 respectively). theoretical background the concept of competitiveness is extremely broad and comprehends a few different aspects. what everybody agrees about is the complexity of concept and of its theoretical basis. in the same time, there is no consensus about the definition of competitiveness, regardless of the fact that the issue has been the topic of a number of theoretical and empirical studies for years. this leaves space for different definitions, which define this term at the macro, mezzo or micro level, while some try to integrate all the three levels. mlađen kovačević (2002) believes that all the described dimensions of competitiveness are essentially mutually conditioned. janno reiljan and dorel tamm (s.a.) also consider competitiveness 2world bank.world integrated trade solutions (wits).database. (available at: http://wits.worldbank.org/wits/) 3international trade centar (itc).trade map. (available at: http://www.trademap.org/index.aspx) 110 economic analysis (2015, vol. 48, no. 1-2, 108-129) multidimensional concept (i.e. four-dimensional concept); they created a scheme including as follows: extent of competitiveness (broader and narrower concept), area of competitiveness (economic, political, social etc. concept of competitiveness), “location” of competitiveness (concepts of internal, regional or international, i.e. global competitiveness), and management of competitiveness (international agreements, government policies, company strategies, etc.). in the context of this scheme our paper focuses on the international economic competitiveness at the macro level. the most significant contribution to the development of the broader concept of international competitiveness was provided by michael porter (1991). before the emergence of porter’s concept, which was a distinctive revolution in the theory of international trade and was therefore labeled as a “new paradigm”, the development of thought on international trade and, tentatively, on international competitiveness, was long dominated by the concept of comparative advantages founded on david ricardo’s theory of the 19th century. based on the premises of perfect competition, free trade, constant costs, immobility of production factors and the “world” without technological and other changes, the concept offered an incomplete and static explanation of reasons for international trade and the structure of the trade, which was adopted by neo-classic theories that followed, the most notable one being the hekscher-ohlin’s theory. as opposed to the concept of comparative advantages elaborated in the traditional theories of international trade, and partly in individual more recent theories, the concept of competitive advantages developed by porter is not limited to countries with the favorable factor endowments (natural resources, population), nor is static – a country can create the new so-called reinforcement factors, and the focus of explaining the international trade shifts from a country to an industry or product. porter’s understanding of international competitiveness is related to the development of competitiveness first in the national market. in order to answer the question as to why some countries are more successful in certain industries compared to some others, porter develops his famous “diamond” as a system with four basic determinants of competitive advantages, with strong interaction: production factor conditions, demand conditions, related and supporting industries, firm strategy, structure and rivalry. porter added two new factors, government policy and chance, which support the described system. (michael porter, 1991). one of the definitions that attracted some attention at a time and that highlights the macro-dimension of international competitiveness in a narrower sense is the definition by bruce r. scotta and george c. lodgea (1985) who understand a country’s competitiveness as its ability to most rationally employ the national resources in accordance with international specialization and trade, so that this ultimately leads to the growth of real income and the standard of living. scott (1985) also defines the international macro-competitiveness as a country’s ability to produce, distribute and service products in international framework in the competition with goods and services from other countries, though in a way that secures the increase in the standard of living. jan fagerberg (1988) believes that “international competitiveness of a country’s economy is its ability to realize central economic policy goals, especially growth in income and employment, without running into balance of payment difficulties”. a number of authors also relate the concept of international competitiveness to the national economy’s ability to ensure economic growth without trade imbalance, i.e. to halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 111 produce goods and services which will ensure the growing real income both in the domestic and in the international market. (lorena škuflić, 1999). according to some narrower definitions, international competitiveness is completely equaled to a country’s exporting ability. experts of the united nations’ conference on trade and development claim that a country’s global ability to export reflects the successfulness of state enterprises and their competing ability, which in turn depends on factors from their business environment (unctad, 1987). this leads us to the narrower understanding of international competitiveness, which boils down to the export competitiveness. export competitiveness is defined as a country’s ability to sell commodities in foreign markets, at the price and quality that can be compared to competitors (us international trade commission, 2010). christian h.m. ketels (2010) defines export competitiveness as “… an increase in ability to sell domestic goods and services in the world market.” applied methodology same as there is no consensus about the definition of international competitiveness, there is no universally accepted way of its empirical measurement. international competitiveness can be analyzed using a number of quantitative and/or qualitative indicators, most of which are related to the conditions and trends in the foreign trade sector (lorena škuflić, 1999), primarily to export characteristics and dynamics. the volume, structure and dynamics of exports, as well as the attitude toward imports affect its significance for economic growth and development. there are a few dozens of different export competitiveness indicators, which can be classified according to different criteria. according to the world bank’s classification (world bank, 2011), from the viewpoint of their purpose, i.e. the export characteristic that should be “measured”, one can distinguish three groups of export competitiveness indicators: a) indicators of export composition and revealed comparative advantages; b) export diversification indicators, and c) export quality indicators. indicators of export composition and revealed comparative advantages are balassa revealed comparative advantages index (balassa rca), michaely index (mi), trade performance index (tpi). use of these indicators is primarily aimed at establishing sectoral specialization. export diversification indicators, which mostly indicate the degree of production or geographical concentration, consist of herfindahl-hirschman index (hhi), total entropy index (tpei) and index of export market penetration (iemp). export quality indicators include export technology content and sophistication, which in turn indicate the technological structure. there are a few classifications of export technology content, the four most significant ones being: the classification proposed by the organization for economic cooperation and development (oecd, 2002), classification proposed by joe tidd and john bessant (2009), classification by the international trade department of the world bank (2011), and classification of the international trade centre (international trade centre, n.d.). in order to analyze export competitiveness as comprehensively as possible, and to get a full picture of export competitiveness, it is necessary to use a few indicators. for the actual research, a shortlist of indicators from the described classification was made, which includes those that were assessed as the most suitable from the aspect of their purpose and the 112 economic analysis (2015, vol. 48, no. 1-2, 108-129) availability of data for their calculation. the selected indicators include balassa index of revealed comparative advantage, michaely index in its modified expression, herfindahlhirschman index, itc classification of products by technology content etc. balassa rca index (bi) in his paper „trade liberalization and 'revealed' comparative advantage“ of 1965, bella balassa first used the index of 'revealed comparative advantage' which is based on exports as the only variable. since that time original balassa index has become the most frequently used index of revealed comparative advantage the index of revealed comparative advantage is a measure of a country’s relative advantage or disadvantage in a certain industry represented by trade flows (world integrated trade solutions, 2014). bi uses the trade pattern to identify the sectors in which an economy has a comparative advantage, by comparing the country of interests’ trade profile with the world average. (mia mikić and john gilbert, 2009). the original balassa rca index reflects the relative export structure, and is calculated as the ratio between a given product’s export share in the country’s overall exports and the share of the product’s global exports in the overall world’s export (balassa, 1989): (1) c –given country; w– all countries (world) or a group of countries; s – given sector; s – all the sectors included in the analysis; t – time period; bi reveals that a country has a comparative disadvantage in sector s, if 0 < bi < 1, while it has a relative advantage in sector s, if 1 < bi < . balassa index allows estimates of export capability of a country’s individual industries by ranking and comparing relative shares of different industries’ exports within the country (cross-sector comparison), by ranking and comparing relative shares of different countries’ exports at a sectoral level (cross-country comparison), and by revealing changes in the relative shares over time. (elias sanidas and yousun shin, 2010) michaely index (mi) michael michaely (1962, 1967) construed the so-called index of dissimilarity for a country, with the aim of measuring the total dissimilarity in the commodity composition of trade. the index value ranges within the 0-1 interval; the higher the index value, the less similar are commodity compositions of exports and imports of the observed country.4 4 mi reaches the maximum value in the case when there is total dissimilarity, which means that all products are only exported or only imported. the minimum index value (mi=0) occurs in the case of halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 113 michaely index (mi) has a broad range of applications. its use is recommended when measuring the degree of similarity between trade patterns. it is used for the comparison of trade patterns, e.g. the comparison of a country’s import and export patterns, export (import) patterns of two countries or a group of countries, etc. (pablo coto-millán, 2004). it is also used as a measure of international trade specialization at a sector level (keld laursen, 1998). mi is an excellent indicator of the dynamics of a country’s export structure, i.e. the dynamics of revealed comparative advantage. however, it indicates the intensity of change, rather than its direction (coto-millán, 2004; halilbašić, 2012). the formula for calculating the dynamics of a country’s export structure using mi, a synthetic indicator of dissimilarity, is given below: (2) t – years being compared; – exports of sector s of country c over time t=2; – total exports of country c over time t=2; mi advantage is the simplicity of result interpretation, since it takes value from 0 (perfect stability of specialization patterns) to 2 (absolute mobility of specialization patterns). herfindahl-hirschmanov index (hhi) although it was first used as a measure of asymmetry, in the 1940s, herfindahlhirschman index was related to the economic theory only in 1976 (keith cowling and michael waterson, 1976).5hhi can be used as a measure of the degree of a country’s export concentration, when it is calculated using the following formula (juan felipe mejía, 2011): = (3) value of exports of sector s of country c; – value of total exports of country c. the lower hhi value indicates the higher export (production) dispersion and a lower degree on export concentration and specialization. a lower value of hhi is also a sign of a higher degree of export diversification. we distinguish between hhi production concentrations, which measure export dispersion from the aspect of export products, and hhi geographical concentrations, which total, perfect similarity, when each product is both exported and imported, proportional to its share in total exports and imports. (snježana brkić, 2010) 5 since 1984, regulatory institutions in the usa started using hhi as a measure of concentration in judicature, banking, in the area of electric power and aviation (mark g. lijesen, 2004). 114 economic analysis (2015, vol. 48, no. 1-2, 108-129) measure the same but from the export partners’ aspect (world integrated trade solutions, 2013). technology content of exports the paper uses itc classification, which provides an insight into the percentage share of five types of products of different levels of processing in a country’s exports. these are: primary products, semi-finished products, capital equipment, consumer goods and hightechnology products (international trade centre, s.a.). research results exports dynamics and performances over the observed period (2006-2013), all former-yugoslav countries registered an increase in their trade. compared to the beginning of the period, almost all the countries registered an increase in exports (except for montenegro) and an increase in imports (except for croatia). in this respect, the highest value of commodity exports and imports was achieved by slovenia6, and the lowest by montenegro. bih ranked fourth by the amount of exports, and fifth by the amount of imports both in the beginning and at the end of the period7. eeach country of former yugoslavia imported more products than it exported over the observed period, which resulted in the continuous trade deficit. in 2013, the highest trade deficit in absolute terms was registered by croatia – 9.03 billion usd, although, when compared to 2006, the deficit actually decreased (from 11.13 billion usd). with the deficit of 4.60 billion usd in 2013, bih retained the fourth position. a decrease in the value of deficit in 2013 compared to 2006 was registered by slovenia8, serbia and croatia.9 trends in the observed countries’ exports significantly coincide. after growth in 2007 and 2008, commodity exports decreased in the year of economic and financial crisis (2009), while in the following four years (2010-2013) exports of all the observed countries continued to increase, though of different intensities. all ex-yu countries, except for montenegro, registered an increase of commodity exports in the observed period. serbia experienced the evident increase and doubled its exports compared to 2006. (figure 1) 6 with the recorded value of commodity exports of 28.73 billion usd and commodity imports of 29.38 billion usd in 2013, slovenia maintained the top position it had in 2006 as well. 7 the volume of bih trade for 2013 amounted to 15.98 billion usd, which is by 5 billion usd or 45.46% higher compared to its trade in 2006. in the period 2006-2013, the volume of bih trade was significantly determined by imports, which was twice as high as exports over the entire period (10.29 billion usd of imports versus 5.69 billion usd of exports in 2013). 8 from 2 billion usd in 2006 to 640 million usd deficit in 2013. 9 the table with all the data is available in the appendix to the paper. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 115 figure 1. exports dynamics of ex-yu countries, in 000 usd, 2006-2013 source: authors on the basis of data from itc, trade map and state statistical office of republic of macedonia export increase by a greater rate than imports also resulted in an increase of the degree in export-import coverage in all the countries in 2013 compared to 2006, except in montenegro, which registered a decrease. montenegro has the lowest level of export-import coverage in both observed years 30.22% in 2006 and 21.05% in 2013. the highest value of coverage was registered by slovenia 91.18 and 97.82% respectively. slovenia’s export revenues almost fully cover payments due to commodity imports. the greatest increase of export-import coverage, of over 20 percent, was registered by serbia (from 48.80 to 71.11%), which allowed it to move from the third to the second position, while bih, croatia and macedonia managed to raise the coverage by 9 to 10 percent and mostly maintained previous positions.10 exports structure over the observed period, exports of most ex-yu countries were dominated by manufactures of metal (particularly aluminum and products of aluminum, iron and steel), machinery manufactures (nuclear reactors, electrical machinery), manufactures of mineral fuel industry, and wood manufactures. (table 2) ex-yugoslav countries’ export portfolios are dominated by products characteristic of the world export markets that are growing below the average world rate of 10%, which coincides with the results obtained by lucia orszaghova et al. (2013) through the analysis of export portfolios of four ex-yugoslav countries11 for the period 1999-2010. bih and serbia export products which increased their respective shares in the world export markets, i.e. products that are included in the “winners in declining sectors”12. montenegro, croatia, macedonia 10 authors’ own calculation on the basis of data from itc, trade map and state statistical office of republic of macedonia. 11 the analyzed countries included: montenegro, croatia, macedonia and serbia. 12 in order to present a country's export performance compared to trends in world demand and estimate the potenttial of long-term export growth, itc uses the so-called „bubble“ graphs. the 116 economic analysis (2015, vol. 48, no. 1-2, 108-129) and slovenia export products which decreased their share in the world export markets that grow below the rate of 10%, and their export portfolios are thus dominated by “losers in declining sectors”. (itc, 2014) all the ex-yugoslav countries mostly focus their export on semi-products and least on the high-technology products. in their commodity export structure, the share of semi-products ranged from about 55-56% in the case of slovenia, croatia and macedonia to 61% in bosnia and serbia, while it was the highest in montenegro, where it amounted to 74% (in 2013). they are followed by consumer goods, with the market share that varied from 15 to 22% in all the countries except for montenegro (only 5.2%). share of primary products is significant in most countries as well except for slovenia (only 4.1%.) slovenia and croatia registered a higher share of capital equipment than of primary products. the lowest share of capital equipment was registered in montenegro and bih. no significant share of high-technology products was registered in the observed years. in 2013, high-technology products had a very low share in all the countries’ commodity exports. bih13 and montenegro registered the lowest shares of these products in commodity exports, and they are followed by macedonia and serbia. (table 1) table 1. technological export structure of ex-yu countries, 2013 products14 country bih montenegro croatia macedonia slovenia serbia primary products 10.6 16.3 10.1 13.6 4.1 12 semi-products 60.6 73.6 54.8 54.4 56.6 61.1 capital equipment 7.8 4.7 17.5 10.1 18.4 10.6 consumer goods 18,3 5.2 15.7 21.9 20.4 15.4 high-technology products 1.4 1.3 6.6 2.8 5.1 2.6 source: authors on the basis of data from itc, trade competitiveness map with respect to geographic orientation of ex-yu countries’ exports in the observed period, they registered the greatest share of their exports and imports with the european union as a whole. to illustrate this point, in 2013 almost all the countries, except for montenegro achieved an average of 60% of their exports in the eu27 market – montenegro 28.3%, bih 57.8%, serbia 58.1%, croatia 58.2%, macedonia 62.8%, and the highest share was achieved by slovenia – 68.5%. (wto, 2013) presented data lead to the conclusion on significantly high export dependence of these countries from the eu market. particular relations each of them with the eu in terms of their membership status or status in the process of association to the graphs provide information on the value of product exports and compare the annual growth of the country's share in world exports to the annual increase in world demand over a five-year period (international trade centre, 2014), and are divided into four segments, where products are classified as: winners in growing sectors (champions), losers in growing sectors, winners in declining sectors or losers in declining sectors. 13 these products' share in croatia's commodity exports was almost five times higher compared to the same products' share in bih commodity exports. 14note: there are share of 1-2% of unclassified products for every country. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 117 union15 create possibilities forfurther growth of export to the eu market and even higher export dependence in the next future. revealed comparative advantages ex-yu countries export specialization compared to the world was analyzed based on the revealed comparative advantages, founded on the calculation of balassa index. the highest values of bi index for bih both in the beginning and in the end of the period were measured in the production of wood and articles of wood, footwear, explosives, aluminum and articles thereof, furniture, raw hides and skins and leather, etc. six out of ten sectors with the highest bi’s registered an increase in specialization, while the others registered a decrease. in montenegro, the highest bi’s were identified in the production of aluminum and articles thereof, raw hides and skins and leather, beverages, explosives, wood and articles of wood, tobacco and manufactured tobacco substitutes, etc. most sectors registered an increase in specialization, some even twofold (raw hides and skins, vegetables); however, bi for aluminum production decreased twofold. the highest bi values for croatia were found in the production of arms and ammunition, wood and articles of wood, fertilizers, salt, sulphur, earths and stone, miscellaneous edible preparations, live animals, etc. an increase in specialization was registered by seven out of ten product groups, and was the greatest in the production of arms and ammunition (three times) and live animals (four times)16. macedonia registered the greatest comparative advantage in the production of tobacco and manufactured tobacco substitutes, miscellaneous chemical products, articles of apparel, iron and steel, vegetables, etc. specialization decreased in six out of ten products, but bi for chemical products increased almost seven times. with respect to serbia, comparative advantage was revealed in the production of arms and ammunition, fruits, products of the milling industry, cereals, sugars and sugar confectionery, etc. all the products registered a decrease in comparative advantage. slovenia revealed the greatest comparative advantage in the production of aluminum and articles thereof, wood and articles of wood, pharmaceutical products, tanning or dyeing extracts, man-made filaments etc. an increase in comparative advantage was observed in almost all top ten products, but values of bi’s of top 5 industries are much lower than for top 5 of other countries.17while top ten product groups where bih, montenegro and macedonia revealed comparative advantage had a significant total share in these countries’ exports (37%, 39% and 59% respectively), the total export share of serbian, croatian and slovenian product groups with the greatest comparative advantages was relatively low (19%, 20% and 26% respectively). however, the fact remains that the total export share of ten products with highest bi decreased in all the countries, most in montenegro (almost twofold). there are no major similarities in the comparative advantage patterns’ among the observed countries if analyses top 10 lists there are only three products that are the same on 15 slovenia (2004) and croatia (2013) are the eu member – states, macedonia (2005), montenegro (2010) and serbia have a status of candidate countries, and only bih has the status of a potential candidate (2008). 16 the greatest decrease of bi – more than four times – was registered in the production of ships, boats and floating structures. 17 the table with top ten industries by bi index for each country is provided in the appendix. 118 economic analysis (2015, vol. 48, no. 1-2, 108-129) the lists18). all the countries have comparative advantage in the production of aluminium and articles thereof, and four of them (except for macedonia and serbia) also in the production of wood and articles thereof. the intensity of change in export structure was measured using michaely index (mi). mi was used as an indicator of the dynamics of a country’s export structure, or the dynamics of revealed comparative advantage. according to mi, ex-yugoslav countries mostly experienced the perfect stability in the 2006-2013 period, and in some cases a very low intensity of change in their most significant industries’ exports. accordingly, mi reveals that ex-yugoslav countries are not export competitive in the world with their most significant industries’ products. table 2. top 5 export industries of ex-yu countries and michaely index, 2006-2013 bosnia and herzegovina croatia industry mi industry mi 27 mineral fuels, mineral oils etc. 0.02 27 – mineral fuels, mineral oils etc. 0.00 94 furniture 0.01 84 – nuclear reactors, boilers, 0.01 76 aluminium and articles thereof 0.02 85 – electrical machinery and 0.00 44 wood and articles of wood 0.01 44 – wood and articles of wood 0.01 84 – nuclear reactors, boilers, 0.02 30 – pharmaceutical products 0.01 macedonia montenegro industry mi industry mi 72 iron and steel 0.04 27 – mineral fuels, mineral oils etc. 0.14 38 miscellaneous chemical products 0.07 76 – aluminum and articles thereof 0.18 62 articles of apparel, not knitted 0.03 72 – iron and steel 0.03 84 – nuclear reactors, boilers, 0.03 22 – beverages, spirits and vinegar 0.00 85 – electrical machinery and 0.01 44 – wood and articles of wood 0.00 serbia slovenia industry mi industry mi 87 – vehicles other than railway or 0.07 85 – electrical machinery and 0.01 85 – electrical machinery and 0.03 87 – vehicles other than railway or 0.01 84 – nuclear reactors, boilers, 0.01 84 – nuclear reactors, boilers, 0.01 39 – plastics and articles thereof 0.00 30 – pharmaceutical products 0.02 27 – mineral fuels, mineral oils etc. 0.01 27 – mineral fuels, mineral oils etc. 0.02 source: authors on the basis of data from itc trade map mi value for bih shows that in the period 2006-2013 there was no change in the intensity of exports of mineral fuels, furniture, aluminium and manufactures thereof, wood manufactures and nuclear reactors. in the same period, croatia and slovenia registered the perfectly steady exports of their top five industries. montenegro registered a very low intensity of change in the exports of aluminum and manufactures thereof and mineral fuels. a low intensity of change was also registered by macedonia in the exports of various manufactures of chemical industry, and by serbia in the exports of vehicles. other 18 only on lists for top ten products with highest bi for serbia and montenegro four products are the same. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 119 montenegrin, macedonian and serbian industries registered the perfect stability of exports in the same period. (table 2) exports concentration by the number of ex-yu countries’ export markets whose individual values were higher than 100,000 usd in 2013, slovenia is ranked highest, with 96 larger export markets, and montenegro is ranked lowest, with 42 larger export markets. an increase in the number of export markets in the period 2006-2013 was registered by bih, montenegro and macedonia, while the number of export markets decreased for slovenia, croatia and serbia. regardless of the decrease in the number of export markets, these three countries maintained their top three rankings among ex-yu countries. bih is the only country that improved its ranking (from five to four), montenegro remained at the bottom (although the number of its export markets increased threefold), while macedonia moved from the fourth to the fifth position. (table 3) table 3.number of export markets of ex-yu countries, 2006 and 2013 country number of markets > 100.000 usd 2006 2013 growth/fall bosnia and herzegovina 61 76 ↑ croatia 95 82 ↓ macedonia 62 66 ↑ montenegro 16 42 ↑ slovenia 103 96 ↓ serbia 81 78 ↓ source: authors on the basis of data from wits, trade outcome indicators according to the values of herfindahl-hirschmann index of geographic export concentration (hhi) in 2013, serbia and croatia registered the highest, and macedonia and montenegro the lowest export dispersion of all ex-yu countries (hhi=0.06 versus hhi=0.1619) in the period 2006-2013, most countries, except for macedonia and serbia, increased the degree of their geographic export diversification. although the degree of its geographic concentration remained the same, serbia retained the first position with the most dispersed exports of all ex-yu countries, while croatia joined it at this position, and followed by slovenia. bih decreased the degree of export concentration (from 0.10 to 0.80), and thus moved from the fourth to the third position. macedonia is the only ex-yugoslav country which registered the increase in geographic exports concentration in the observed period.20 (table 4) 19 the lower value of hhi index is a sign of greater export dispersion – a higher degree of geographic diversification, i.e. a lower degree of export geographic concentration and specialization. 20 compared to the exports of fast-growing economies (bric countries), ex-yu countries’ exports were twice less geographically dispersed. (vedrana bosić, 2015.) 120 economic analysis (2015, vol. 48, no. 1-2, 108-129) compared to the exports of fast-growing economies (bric countries), ex-yu countries’ exports were twice less geographically dispersed. (vedrana bosić, 2015.) table 4. geographic export concentration of ex-yu and bric countries, 2006 and 2013 country hhi geographic exports concentration 2006 2013 change bosnia and herzegovina 0.10 0.08 ↑diversification croatia 0.09 0.06 ↑diversification macedonia 0.11 0.16 ↑concentration montenegro 0.24 0.16 ↑diversification slovenia 0.08 0.07 ↑diversification serbia 0.06 0.06 no change ex-yu average 0.11 0.10 ↑diversification brazil 0.05 0.06 ↑concentration china 0.08 0.07 ↑diversification india 0.05 0.04 ↑diversification russia 0.04 0.05 ↑concentration bric average 0.06 0.05 ↑diversification source: authors on the basis of data from wits, trade outcome indicators sectoral export concentration was analyzed by determining the number of exported products of the observed countries, and by calculating and comparing hhi of sectoral export concentration for 2006 and 2013. by the number of exported products with the export values higher than 100,000 usd, slovenia is ranked highest, with 2,417 products, while montenegro is ranked lowest among ex-yugoslav countries, with 198 products. in the 2006-2013 period, most ex-yu countries, except for montenegro and croatia, increased the number of their products of higher export value. the greatest increase (of some 300 new products) was registered by serbia, which thus improved its ranking from third to second. slovenia retained the first position. croatia moved from the second to the third position. (table 5) table 5. number of exports products of ex-yu countries, 2006 and 2013 country number of products > 100.000 usd 2006 2013 growth/fall bosnia and herzegovina 805 1,022 ↑ croatia 1,676 1,534 ↓ macedonia 607 668 ↑ montenegro 201 198 ↓ serbia 1,400 1,701 ↑ slovenia 2,161 2,417 ↑ source: authors on the basis of data from wits, trade outcome indicators halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 121 hhi of sectoral export concentration for 2006 and 2013 revealed a high degree of concentration for all the observed countries21, which indicates a low diversity in export supply. (table 6) table 6.sectoral export concentration of ex-yu countries, 2006 and 201322 country hhi of product concentration 2006 2013 change bosnia and herzegovina 0.02 0.01 ↑ diversification croatia 0.01 0.01 no change macedonia 0.02 0.04 ↑ concentration montenegro 0.34 0.12 ↑ diversification slovenia 0.01 0.01 no change serbia 0.01 0.01 no change average ex-yu countries 0.07 0.03 ↑ diversification brazil 0.01 0.03 ↑ concentration china 0.01 0.01 no change india 0.02 0.03 ↑ concentration russia 0.17 0.17 no change bric average 0.05 0.06 ↑ concentration source: authors on the basis of data from wits, trade outcome indicators most countries (four out of six in the observed sample) registered the same degree of export concentration in 2013. croatia, slovenia and serbia retained the same value of hhi of sectoral export concentration of 0.01 as in the beginning of the observed period and were, in 2013, joined by bih. compared to 2006, only bih and particularly montenegro registered an increase in export dispersion. montenegro decreased the degree of concentration almost three times (from hhi=0.34 to hhi=0.12), though it was not enough to push it from the last position by export dispersion compared to the other countries. only macedonia registered deterioration, in terms of an increase in the degree of export product concentration and specialization. over the observed period, ex-yu countries registered a decrease (from 0.07 to 0.03) while fast-growing countries experienced an increase (from 0.05 to 0.06) in the average value of hhi of product concentration, whereby china is the country with the highest export product diversification in the observed period. concluding remarks the analysis of ex-yu countries’ export competitiveness in the period 2006-2013 generally indicated their unsatisfactory export performance, despite the progress that some of them registered over the observed period. the weaknesses are primarily related to the product export structure, patterns of comparative advantages, export quality in terms of its 21 a lower value of hhi of export product concentration is a sign of greater export dispersion (sectoral diversification), i.e. a lower level of sectoral concentration and specialization, and vice versa. 22 data were analysed at 6th aggregation level of hs 2002 classification. 122 economic analysis (2015, vol. 48, no. 1-2, 108-129) technological sophistication, and the degree of geographic and product export diversification. all the discussed countries (except for montenegro) increased their exports over the observed period; however, their role in the world markets remained minor. although all the countries still reveal the trade deficit, they managed to achieve higher export-import coverage due to faster export growth. these countries’ exports are dominated by the products of traditional, declining industries, with an extremely high share of semi-products, primary products and consumer goods, while the share of high-technology products is negligible. such an inadequate export structure in terms of the level of processing and technology contents was retained throughout the observed period. despite a certain increase in export dispersion (in most countries except for macedonia and serbia), increase in the number of export products (except for montenegro and croatia), and a decreased share of main export industries, ex-yu countries’ exports still show a high level of geographic and product concentration, which means a great export dependence on a smaller number of markets and a smaller number of products. the highest revealed comparative advantage of these countries are mostly observed in the traditional sectors, such as production of metals and articles thereof, wood and articles thereof, apparel, etc. in this respect, the comparative advantage patterns reveal perfect stability in the observed period, almost without emergence of comparative advantages in new sectors. some changes in comparative advantages patterns only refer to an increase in the level of specialization in export sectors and decrease in total export share of product groups with most revealed comparative advantages. based on a few analyzed indicators, the best export performance was registered by ex-yu countries which are eu members – primarily slovenia and then croatia, compared to the countries that have the status of candidate or potential candidate. over the observed period, both countries registered an increase in exports, increase in export-import coverage and a decrease in trade deficit, with slovenia in the lead, since it almost achieved the foreign-trade balance. compared to the other countries in the sample, eu members increased the degree of specialization in the sectors with revealed comparative advantages, registered a higher level of export dispersion in terms of increasing the number of export products and the number of export markets, and of increasing the degree of product export diversification; in the same time they also register a more favorable technology export structure by the level of product processing. the greatest progress in the observed period was registered by serbia, with respect to various aspects of export competitiveness, except for the fact that the number of export markets and the degree of specialization in all the sectors with comparative advantages decreased. despite the progress in some segments, bih and macedonia’s export competitiveness can be assessed as relatively stagnant and less favorable compared to the three previously described countries. the poorest rating of export competitiveness was achieved by montenegro, due to deterioration in trends of a few indices. research results point to the need both for a further increase in exports and the improvement of its structure in terms of increasing the diversity of export supply and improving the technology content of export products, which in turn requires modernization of industries, as well as support by 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5,687,314 -4,131,474 -4,607,616 croatia 21,502,494 20,953,444 10,376,964 11,927,531 -11,125,530 -9,025,913 macedonia 3,762,715 6,599,824 2,041,265 4,266,855 -1,721,450 -2,332,969 montenegro 1,841,505 2,348,873 556,459 494,376 -1,285,046 -1,854,497 serbia 13,172,330 20,550,990 6,427,892 14,613,752 -6,744,438 -5,937,238 slovenia 23,013,428 29,375,441 20,982,713 28,734,599 -2,030,715 -640,842 source: authors on the basis of data from itc, trade map and state statistical office of republic of macedonia table 2. top 10 industries of ex-yu countries, by bi and export share, 2006 and 2013 bosnia and herzegovina 2006 2013 industry bi share bi share 44 wood and articles of wood 9.9 8.9 9.6 6.7 64 footwear 9.3 5.7 9.3 6.5 36 explosives 4.1 0.1 8.5 0.2 76 aluminum and articles thereof 9.9 11.4 8.4 7.1 94 furniture 6.5 7.6 8.2 10.3 41 raw hides and skins and leather 8.1 2.0 7.6 1.5 28 inorganic chemicals 7.4 5.0 6.6 4.0 66 umbrellas 1.8 0.0 5.0 0.1 46 manufactures of straw, of esparto 4.3 0.1 4.4 0.1 17 sugars and sugar confectionery 2.0 0.5 3.4 0.9 total share in exports of bih 41.3 37.4 montenegro 2006 2013 industry bi share bi share 76 aluminum and articles thereof 50.3 57.7 26.3 22.2 41 raw hides and skins and leather 3.5 0.9 8.6 1.7 22 beverages, spirits and vinegar 9.3 5.4 8.1 5.0 36 explosives 5.0 0.1 7.3 0.2 44 wood and articles of wood 5.0 4.5 7.1 4.9 24 tobacco and manufactured tobacco substitutes 0.5 0.1 6.7 1.5 11 products of the milling industry 0.2 0.0 5.1 0.5 68 articles of stone, plaster, cement 0.6 0.2 3.8 1.0 18 cocoa and cocoa preparations 0.2 0.0 3.7 0.9 7 edible vegetables, certain roots, tubers 1.7 0.6 3.7 1.3 total share in exports of montenegro 69.5 39.3 halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 127 croatia 2006 2013 industry bi share bi share 93 arms and ammunition 4.9 0.3 18.9 1.1 44 wood and articles of wood 4.5 4.0 8.0 5.6 31 fertilisers 6.6 1.6 7.1 2.4 25 salt, sulphur, earths and stone 7.8 1.9 7.0 1.7 21 miscellaneous edible preparations 5.2 1.5 4.5 1.5 1 live animals 0.4 0.0 4.1 0.5 89 ships, boats and floating structures 15.6 11.4 3.6 2.8 41 raw hides and skins and leather 3.8 0.9 3.5 0.7 68 articles of stone, plaster, cement 2.0 0.6 3.3 0.9 76 aluminum and articles thereof 2.5 2.8 3.2 2.7 total share in exports of croatia 25.1 19.9 macedonia 2006 2013 industry bi share bi share 24 tobacco and manufactured tobacco substitutes 20.7 4.7 18.7 4.3 38 miscellaneous chemical products 0.2 0.2 14.9 15.1 62 articles of apparel, not knitted 13.7 18.0 10.7 11.5 72 iron and steel 9.4 25.2 7.7 16.5 7 edible vegetables, certain roots, tubers 6.8 2.2 4.8 1.7 19 preparations of cereals, flour 2.8 0.8 4.0 1.4 25 salt, sulphur, earths and stone 7.9 1.9 3.9 0.9 20 preparations of vegetables, fruit, nuts 3.2 1.0 3.4 1.2 22 beverages, spirits and vinegar 5.9 3.4 3.4 2.1 26 ores, slag and ash 1.7 1.3 3.3 4.2 total share in exports of macedonia 58.6 58.9 serbia 2006 2013 industry bi share bi share 93 arms and ammunition 10.8 0.7 8.1 0.5 8 edible fruit and nuts 7.0 3.1 6.2 3.3 11 products of the milling industry 7.0 0.5 5.5 0.6 10 cereals 7.2 3.0 4.9 3.3 17 sugars and sugar confectionery 10.6 2.6 4.9 1.3 36 explosives 3.9 0.1 4.1 0.1 74 copper and articles thereof 6.0 6.7 3.6 3.1 76 aluminum and articles thereof 3.6 4.2 3.2 2.7 24 tobacco and manufactured tobacco substitutes 0.9 0.2 3.2 0.7 40 rubber and articles thereof 4.4 4.3 3.0 3.4 total share in exports of serbia 25.3 19.0 128 economic analysis (2015, vol. 48, no. 1-2, 108-129) slovenia 2006 2013 industry bi share bi share 76 aluminum and articles thereof 4.3 4.9 4.3 3.6 44 wood and articles of wood 2.6 2.4 4.1 2.9 30 pharmaceutical products 2.8 6.9 4.0 10.6 32 tanning or dyeing extracts 3.1 1.5 3.7 1.6 54 man-made filaments 2.7 0.9 3.6 0.9 68 articles of stone, plaster, cement 3.2 0.9 3.3 0.9 56 wadding, felt and nonwovens 3.0 0.4 3.2 0.4 82 tools, implements, cutlery,spoons 3.1 1.1 2.6 0.9 83 miscellaneous articles of base metal 2.6 1.0 2.6 0.9 94 furniture 5.2 6.0 2.6 3.2 total share in exports of slovenia 26.0 26.0 source: authors on the basis of data from wits, trade outcome indicators komparativna analiza konkurentnosti izvoza zemalja bivše jugoslavije rezime – rad se bavi analizom izvoznih performansi zemalja bivše jugoslavije (bosna i hercegovina, crna gora, hrvatska, makedonija, slovenija i srbija) u periodu 2006-2013. godine. cilj rada je ocjena izvozne konkurentnosti navedenih zemalja i utvrđivanje njene dinamike u robnoj razmjeni sa svijetom. analiza je obuhvatila istraživanje i upoređivanje karakteristika izvoza – obima i dinamike izvoznih tokova, geografske i proizvodne strukture i koncentracije izvoza, tehnološke sofisticiranosti izvoza, izvozne specijalizacije izražene otkrivenim komparativnim prednostima, intenziteta i smjera promjene u izvoznoj strukturi. u cilju potpunijeg sagledavanja izvozne konkurentnosti korišteno je više indikatora: balassin rca indeks, michaelyjev indeks, herfindahlhirschmanovi indeksi koncentracije i dr. indeksi su računati na podacima relevantnih baza svjetske banke i međunarodnog trgovinskog centra, agregiranim na drugoj i šestoj razini hs2002, za osmogodišnji period i/ili za prvu i posljednju godinu. istraživanje je pokazalo da su izvozne performanse ex-yu zemalja općenito nezadovoljavajuće, uprkos napretku koji su pojedine od njih ostvarile u posmatranom periodu. većina zemalja ima komparativne prednosti u proizvodima tradicionalnih, opadajućih industrija, visok udio poluproizvoda i primarnih proizvoda, a zanemariv udio visokotehnoloških proizvoda u svom izvoznom portfoliju, stagnantnu izvoznu strukturu, te nizak stepen geografske i proizvodne diverzifikacije izvoza.međusobno poređenje pokazalo je da grupa nije homogena, te da, pored navedenih zajedničkih karakteristika, unutar grupe postoje i značajne razlike u pojedinim aspektima izvozne konkurentnosti. članice eu – hrvatska i posebno slovenija imaju niz prednosti u odnosu na zemlje u statusu kandidata i potencijalnog kandidata. najveći napredak u pravcu poboljšanja izvozne konkurentnosti ostvarila je srbija, dok je ocjena izvozne konkurentnosti za crnu goru najnepovoljnija. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 129 ključne reči: zemlje bivše jugoslavije, izvozna konkurentnost, izvozna struktura, otkrivene komparativne prednosti (rca), izvozna diverzifikacija, izvozna koncentracija article history: received: 14 april, 2015 accepted: 19 april, 2015 doi: 10.28934/ea.21.54.2.pp68-81 original scientific paper customer experience and integrated marketing communication in the automotive lubricants market tatjana cvetkov-čikošev1 | ivana domazet20f* | valentina vukmirović2 1 nis ad, belgrade, serbia 2 institute of economic sciences, belgrade, serbia abstract with the advent of new digital communication channels, the use of media for marketing purposes is changing dynamically and fundamentally. also, the manners of using different media sources in order to obtain the requested information are diversified, which inevitably affects when, where and in what way potential customers choose certain brands. accordingly, the aim of this paper is to identify the way in which customer makes the decision to purchase and consume a particular brand. this implies analyzing the key points of contact between the brand and customers, which leads to the desired profitability of the behavior of targeted customers. this paper presents the results of a research conducted in 2018, within the relevant group of respondents, for the automotive lubricant industry and the observed brand nisotec. the obtained results indicated the complexity of the decision-making process of targeted customers, because they differ in the manner and degree of traditional and digital media use, customer behavior and attitude towards the industry and other interests, which conditions the brand response in terms of creating an optimal strategy of integrated marketing communications. key words: customer experience; customer journey; decision making; integrated marketing communication; digital communication channels; automotive lubricants market jel classification: m31, m21 introduction contemporary manners of doing business pose certain challenges to marketing practices, which is the result of a fact that customers, brands and media are fundamentally changing. technology, and especially the internet, is changing the way in which people communicate and establish interactions. with the frequent appearance of new media, customer habits are changing, as well as the manner in which they choose and use different media sources. consequently, this affects the time, place and way of selecting a brand. nowadays, customer attention is fragmented more than ever, and consuming several media sources at the same time means that customers are no longer passive, in the sense that they only receive information about brands through mass media such as print or tv, and remember or store them for later consideration. instead, customers are now active and seek information as needed through search engines, mobile devices, blogs and brand websites. new ways of communicating, however, allow for greater personalization of message content, time and location of message delivery, allowing businesses to use multiple types of media to achieve specific communication goals. * coressponding author, e-mail: ivana.domazet@ien.bg.ac.rs tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 69 besides communication, i.e., choosing what and how to communicate, and at which points of contact, the focus of businesses is on customer experience, because customers now communicate with businesses through multiple points of contact and multiple channels and media. this results in more complex customer paths, from expressing interest for a product to realizing purchase and providing recommendations for others. the aim of this paper is to identify customer trajectories, critical points of contact and adequate marketing communication as a response to this, which leads to profitable customer behavior. the focus of this paper is the empirical testing of various forms of marketing direct and indirect communication and measuring the effects of promotional activities on the sale of the nisotec brand of motor oil products in the automotive lubricants market, i.e., identifying which marketing communication strategies contributed to achieving the company's goals regarding the customer journey. from a broader perspective, this paper seeks to identify the way in which the customer makes the decision to buy and consume a particular brand, recognize critical points of contact, and identify responses in the form of adequate communication, which leads to the desired profitable behavior of targeted customers. in the focus of the analysis are the types and effects of motor oil brands marketing communication, customer confidence in the analyzed brand, as well as their visibility. in this regard, the subject of analysis in this paper is the concept of integrated marketing communications (imc). imc refers to the concept of marketing activities planning, based on the realization of added value through the integration and synergistic action of various strategic activities such as advertising (propaganda), direct marketing, sponsorship, pr, and digital communications. in addition to the application of the imc concept, which should serve as a basis, the emphasis within the modern communication strategy should be placed on digital communication. today, digital communication takes precedence over traditional marketing, in terms of the achieved effects but also participation in annual marketing budgets. literature review terms such as experience, experience management, customer/consumer experience, brand experience, customer experience management, as well as many similar derivative terms, which are basically synonymous, are gaining in importance in academic and professional literature (domazet, 2018; lemon & verhoef, 2016). although the term customer experience is used in the literature, numerous authors talk about the experience alternately connecting it with both customers and consumers (yakhlef, 2015). anyhow, when talking about the digital environment, there is a difference. online customer experience is an implementation of the concept of customer experience in the online environment (domazet, neogradi & simović, 2019). however, the term "user experience", which is widely used today, comes from the field of user interface design and refers to the aspect that is described as experience. the user experience is defined as “the overall interaction with the object as well as the thoughts, feelings, and perceptions that result from that interaction” (albert & tullis, 2013). however, in relation to the quality of service or loyalty, and even satisfaction, this topic is not thoroughly researched in scientific papers. also, this term is often associated with entertainment industry organizations, such as amusement parks. anyhow, where there are services, but also products, and customers, experiences will be whether they are good, bad, or neutral. every service comes with experience and all services or products, whatever they are, can engage customers emotionally (berry & carbone 2007). many people equate experience with amusement, being only one type of desirable reaction, besides gaining someone's attention. in addition to amusement, as a domain of experience, learning occurs when the customer actively participates in informing, concluding, acquiring new knowledge and skills, i.e. when the customer's intellect is actively involved (domazet, đokić & milovanov, 2018). 70 economic analysis (21, vol. 54, no. 2, 68-81) customer experience management strengthens companies to lead consumer/user knowledge to improvements that lead to financial gains, such as (havíř, 2017): • improving customer retention and loyalty • higher consumption of existing users • optimized process of acquiring new users • reduced customer service costs • increased brand awareness and its strength. managing user experience is more than a system of measuring and acting on the basis of user feedback. it is a discipline that begins with executive management and becomes a company culture. a commitment to customer research, employee involvement and continuous program innovation is needed. reducing and closing the gap between what the company offers and what the user experience really is, requires data on experiences, and systems that will use them appropriately (domazet, 2007). in general, there is a certain gap between the perception of companies and customers in relation to what is experienced (klaus & maklan, 2013). most companies, as many as 80 percent, describe the experience they deliver as superior, and only eight percent of customers describe the experience they receive in the same manner. differentiation based only on traditional elements is no longer sustainable and growing number of authors consider customer experience as a new element of differentiation. to establish long-term relationships with customers, the number of points of contact with customers is increasing. therefore, there is a need to manage what customers experience in each of the points of contact. companies are facing accelerated fragmentation of media and channels, and the management of this phenomenon, the so-called omni-channels, is the norm in today’s business. in addition, social networks lead to more complex relationships among users, which poses a new challenge for companies. companies have less and less control over the experience and the overall path of users, which creates new places to interact with the brand (hanić & domazet, 2011). both academia and practice agree that the overall user experience is a multidimensional construct that includes several components thinking, emotions, behavior, feelings, and the social component that are a response to what a company offers all the way to user decision making (schmitt 1999; verhoef et al., 2009). anyhow, experience alone can relate to specific aspects of the offering, such as brand or technology, and consists of individual company and customer contacts at contact points. also, experience is gained at each point of contact in multiple stages of a single user’s decision making (verhoef et al. 2009). researching the user experience is a very important challenge for researchers in the years ahead, due to the growing number and complexity of brand and customer contact points, and the belief that a strong, positive experience within the user path results in several levels positive word of mouth, loyalty growth and higher conversion rates of each point of contact with the brand (de bruyn & lilien, 2008). the user experience is a dynamic process, traveling with the company along the shopping cycle through different points of contact with the brand. the process consists of a pre-purchase phase, a purchase phase and a post-purchase phase. in each phase, experience is gained through points of contact, of which only a few are under the control of companies. the first phase includes all user interactions with the brand and its category, before the transaction or purchase. these behaviors include recognizing the need for specific product or service, searching for information, and considering product purchase. in the second phase, the purchase process itself is observed, including selection, ordering and payment. although this activity takes the least time to perform, so to speak it is a matter of seconds, the most attention in the marketing literature is paid to this very phase. many researchers deal with the influence of marketing activities on the purchase decision e.g., kotler and keller (2017), see marketing mix and its influence, and berry, carbone and hackel (2002) who argue on environment and atmosphere. tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 71 on the other hand, research findings on optimal product assortment conclude that, sometimes, too much information make customers stop searching for products as they are overwhelmed with options. therefore, this often results with customers giving up on their purchase intentions. similar conclusions are obtained when it comes to online behavior (mcgrath, 2010). the third phase consists of interactions with the brand after the purchase use or consumption, expressing interest in additional services and brand engagement. at this stage, the product or service is a critical point. accordingly, many researches deal with the experience of product consumption or use, the decision to return the product, buy it again, or tell someone, praise the product and retell their experience. in addition to these topics, loyalty is also mentioned as an important phase of customer-product interaction. in the post-purchase phase, customers may re-purchase the product or considerate other alternatives. in this paper, the customer journey path is discussed in the context of automotive lubricant industry. both customer and company aspect are observed. key points are identified, including those in which customers continue or interrupt their journey, with the aim of optimizing and improving the points that the company can manage. integrated marketing communication concept companies focus on the manners in which users interact with multiple points of contact. moreover, companies' focus is on observing how customers progress from consideration, search and purchase to use, repurchase and eventual dissemination of good impressions and experiences to others. analysis of customer journey path, i.e. user experience, is an important step in understanding it, in order to maximize the effects of marketing communications. the aim of the analysis is to describe that path and understand the options and choices in each of the phases. in the paper batra and keller (2016) two communication models are combined into one concept, including different media and their capabilities on the one hand and user decisionmaking paths and points of contact on the other, ensuring aim fulfillment, i.e. reaching desired outcome. this model answers questions about the effects of various types of communication and communication platforms which best encourage the achievement of communication goals in each of the phases of the customer path. moreover, the model provides an insight into the manner in which all of these options can be integrated to maximize the effects of business communications. according to the authors, a model which is clear, understandable and dynamic was needed by both managers and academia. therefore, the research conducted in this paper builds upon it, exploring the possibilities on the example of automotive lubricants market. in order to develop a well-integrated marketing communications program, it is of interest to first understand how communication fits into the customer decision-making path. the resources available to the customer, his or her mindset in receiving and processing different messages, as well as the outcomes of these messages are equally important (kerr, patti, 2015). it is important to recognize what knowledge, attitudes and tendencies towards certain actions each customer has, plus the level of customer interest in a certain message, product or service. the outcomes of communication are numerous, from familiarity, transmitting information or creating emotional connections and establishing trust, to taking action and recommending a brand (cvetkov-čikošev, 2019). which outcome will occur, and to what extent, depends on the effects of the interaction, customer characteristics, the content of the message and the context in which it is processed. 72 economic analysis (21, vol. 54, no. 2, 68-81) figure 1. the influence of different factors on communication source: batra & keller (2016) many studies indicate that customer characteristics, i.e. motivation, ability and opportunities to understand communication, affect the intensity and direction of that understanding, i.e. the outcomes of communication. if there is no motivation, ability and opportunity, the communication itself can result with no outcome or lead to an unwanted outcome (misunderstandings, inadequate actions, etc.). motivation and abilities are clear characteristics of potential customer. the possibility of processing communication in general is determined by the way in which that communication takes place, which channel of communication is used, as well as the context in which the message is received. the motivation or desire to comprehend an information varies in relation to whether and how customer perceives the brand as helpful in performing a certain task. the complexity of this process is increased by the level of risk and the level of importance of the category itself the geolocation of the user for receiving and interpreting the message on a mobile device or the level of search, e.g. retargeting in online advertising. situational factors also affect the aspect of the emotional state of the user and the willingness and desire to obtain information. in addition, the manner in which customer processes information depends on previous knowledge and knowledge of the brand and category. at the beginning of the search for the category, potential users will probably not be able to understand in detail the comparison of different attributes. anyhow, they should still understand which brands are more or less relevant and which will enter the selection and be elected at the moment of making a purchase decision. interactions between motivation, ability, and situational factors have a significant impact on communication planning (pickton & broderick, 2004). for example, sms messages about a brand can be received in a moment of high motivation, but the situation might not be suitable for adequate processing of the message. messages received through social networks, from verified sources and friends, have high credibility, but it can happen that these friends cannot provide the level of detail that is needed to make a purchase decision. tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 73 the aims of communication can be: • creating familiarity and recognition the foundation of any brand or marketing activity is creating awareness and ensuring that the brand takes up enough space in memory, and that it is thought of in the right way, in the right place and at the right time. according to keller (2009), a good place of a brand in memory is achieved when the brand is associated with different clues category, situations or needs. in some cases, for example with new products, it is necessary to be aware of the unmet needs and the brand that addresses that need. • transmitting detailed information after creating awareness, it is necessary to convince customers of product or service benefits. convincing customers of brand performance is based on the importance of the benefits that the brand or service has for consumers, and the understanding that the brand is able to meet those benefits more appropriately. in today's world, where there is too much information and little attention, it is a great challenge to efficiently deliver detailed information about a particular product or service. • creating brand image and personality the most successful brands offer two types of benefits for customers, both tangible and intangible ones. brand stories can be told through different types of people and situations in which they use the brand and thus paint the image that is built around the brand. the brand personality is in fact compiled of all human qualities that customers assign to the brand honesty, competency, amusement, which influences customer self-perception and customer-brand relationship. • building trust even in a situation where customers receive and process information, it is possible that they will not use it to make a judgment and decision if they do not consider it credible and trustworthy. literature indicates that one often encounters the "source effect", which speaks of the important role that the source has, i.e. credibility, expertise, likeability, etc. in order to process a particular message. customers are increasingly skeptical and knowledgeable, and there is a great need for authentic messages and products. social networks and communication on these channels with friends and acquaintances indicate the great importance of messages that originate from wellknown, trusted sources, in relation to distant sources clearly motivated to sell the product. • provoking emotions the importance of emotional, social and symbolic influence on the motivation to buy a product has been well-known both in theory and practice. brands can increase their overall perceived value by adding emotional or social benefits in addition to functional ones. the messages that brands send can influence this perceived added value, through, for example, the mechanism of cultural significance. a wide range of benefits helps to evoke emotions that influence consumer decision making. • inspiring action received, processed and accepted message may influence preferences and choices, but not necessarily lead to action and desired behavior. the causes can be various, but the essence is the lack of appropriate connection between understanding, influence and behavior (lazarevićmoravčević, 2019). therefore, it is often necessary to send special messages that aim at a certain action, i.e. the behavior of customers who are already positively oriented towards the brand. • building loyalty after the interaction with the product or brand, customers evaluate the level of their satisfaction, how much their expectations are in line with product experience, which is usually the result of marketing activities, i.e. communications. satisfaction management is an essential part of a broader goal strengthening loyalty and avoiding customer churn. 74 economic analysis (21, vol. 54, no. 2, 68-81) • connecting people customer satisfaction should lead to repurchase and loyalty, but not necessarily to brand recommendation. the recommendation and wom are extremely important in the service sector, without which potential users cannot obtain tangible and credible evidence of quality and trust. in order for a recommendation to be made, customers should be in frequent contact with the brand and the brand should influence the development of brand love. one of the ways that brand love can be developed is by taking into consideration the role that the brand has for the customer. the brand can become symbolically and emotionally important, not just functionally. moreover, the messages that the brand sends to current customers should be motivating in the sense that they want to convey them to their friends and acquaintances. methodology and results for the purposes of a research conducted in this paper, a survey questionnaire was developed. it included questions related to visits and purchases at gas stations, as the sale of nisotec oils and lubricants is mostly realized at gas stations due to its greatest availability in this sales channel. moreover, questions related to brand and automotive lubricants market knowledge, as well as the use of different sources of information on these products were included. the research was conducted at the novi sad fair in may 2018, on a sample of 800 respondents who visited the fair event. the questionnaire, as a research instrument, focused on the analysis of the effects of the type and manner of communication of motor oil brands, consumer confidence in the analyzed brands, as well as their visibility. the structure of the respondents was conditioned by the fact that they were visitors of the fair, thus forming an unrepresentative sample (table 1). the largest number of respondents were visitors from vojvodina and belgrade, compared to the shares of these regions in the nationally representative sample. also, the structure differs by age and gender in relation to the structure of the sample for the brand tracking studio the visitors of the novi sad fair were mostly men and older drivers in relation to the representative sample. table 1. sample structure gender in % male 77% female 23% total 100% age (years) in % 18-30 11% 31-50 42% more than 50 47% total 100% driver in % yes 82% no 18% total 100% source: authors' research tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 75 the questionnaire consisted of the demographic set of questions, including age, gender, car ownership and driving status. the following segments of the research were: knowledge and use of motor oil brands, and the influence of communication on decision making, as well as the application of different types of communication of the nisotec brand. the empirical research resulted in primary data that represented a valuable and compatible analytical segment with secondary data from the research study (brand tracking), which has been conducted by nis for several years. results the analysis of responses of different age groups was mostly conditioned by differences in attitudes towards technology, and the use of different types of media. changes in media use, especially by younger generations of customers, have caused advertisers to rely less on traditional media and more on other types of direct marketing, such as internet advertising, direct advertising, consumer-generated advertising, and buzz marketing. as a result of social networks emergence and their rapidly growing popularity, companies are realizing the need to be present in digital media and are beginning to develop marketing plans for digital communications. generation y members, the so-called millennials, represent an important market segment for which digital marketing content is created. the upbringing of this generation was accompanied by the development of digital technologies, which influenced the way they think, approach information and process them (vukmirović, kostić-stanković & domazet, 2020). undoubtedly, the effects of digital marketing communication on this market segment will be even more evident when correlated with realized sales results. in this regard, it is believed that the internet and social networks, as well as new technologies, have empowered generation y to actively participate not only in collecting information about products and brands, but also in the process of their creation and improvement (domazet, lazić & simović 2014). as a consequence, the role of the customer during the value creation process changed. they are no longer a passive factor to which the value created by companies is simply delivered. customer has become an active factor that has a significant role in the value creation process, i.e, co-creator of value. the results of a research conducted in this study indicated that the highest influence on decision making has the recommendation of mechanics (chart 1). as many as 80% of survey participant said that this manner of communication has a high or highest influence on their decision-making (grades 4 and 5, on a scale of 1-5). the second most trusted source are family members and friends, or their recommendations, which were especially emphasized by female participants, who seem to be much less cognitively involved in the choice of motor oils. also, they are much more susceptible to the adoption of information from sellers at gas stations, and react to actions and promotions. 76 economic analysis (21, vol. 54, no. 2, 68-81) figure 2. distribution of answers on the most trusted sources of information when deciding on motor oil brand purchase source: authors' research observing the communication of the nisotec brand, graph 2 indicates that the majority of survey participants has noticed marketing communication initiatives at gas stations, followed by sales promotions. the fact is that that many automotive lubricants customers visit nis petrol gas stations, and the employees at the gas stations perform their task conscientiously and recommend nisotec to customers. on the other hand, it is even more important that customers who shop at nis gas stations are aware of company's communication initiatives. similarly, customers are highly aware of sales promotion initiatives. in the case of gas stations as communication channels, the aim to introduce fuel customers with an additional range, more precisely the nisotec range, has been met. interestingly, although survey participants were fair events visitors, only 40% of respondents confirmed that they noticed promotion initiatives during fair events, probably thinking of another fair they visited or not considering fair events as a type of communication. there is a difference between subgroups on this issue. namely, men noticed race and driver sponsorships significantly more than women, while women more often notice friends' recommendations and advertisements in newspapers and magazines. the respondents from the group of older than 50 years stated that they had noticed any communication from nisotec to a lesser extent when compared to the younger respondents. respondents between 30 and 50 years of age are more likely to say that they have noticed advertising in newspapers and magazines and on the radio, as they use those media to collect information more often than respondents from other age groups. 79,9 38,1 22,8 16,9 11,1 9,0 6,9 6,9 6,3 6,3 6,3 5,8 5,3 mechanics' recommendation friends' recommendation actions and promotion recommendation at ps web page presence at fairs tv advertisement fb page radio fb ads newspapers and magazines sposorship of races and drivers banners top 2 boxes tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 77 figure 3. distribution of answers on the channel through which nisotec brand advertising was noticed source: authors' research observing the attitudes of different groups of respondents, the most important aspect of communication is its impact on purchase intention. namely, certain types of communication are easier to remember, remain in memory longer and generally have a greater or lesser reach. in general, it is clear that advertising at gas stations will be the most frequently mentioned type of communication as visitors to the fair and nis stand are more likely to be the visitors of gas stations. also, visits to gas stations are a relatively frequent activity. understandably, when making a contact with employees it is somewhat inevitable to obtain information about a particular sales promotion initiative, including nisotec brand. on the other hand, research results imply that there are differences between those who are aware of the brand and those who purchase it, in relation to the type of communication they prefer. namely, respondents who do not purchase the brand, but are aware of it, notice radio advertisements and sponsorship collaborations with professional drivers more often. in that sense, it can be said that these two channels of communication affect the brand's popularity and attractiveness. anyhow, as these respondents do not purchase the brand, the awareness itself is not an important motivator which will lead to a purchase decision. nisotec customers respond favourably to advertising on digital channels, especially on the official website, as well as social media networks. even though the popularity of these media within survey sample was not high, it still indicates that there are those who can remember the advertisements distributed through these channels. it should be borne in mind that the respondents were not shown nisotec advertising visual solutions, which would lead to higher scores in memory. also, the role of digital channels seems to be twofold as they allow for the distribution of detailed information on the quality of lubricants, product tests performed and other information that give credibility to this brand. 58,7 43,9 39,2 13,2 11,1 11,1 10,6 8,5 7,4 5,8 4,8 0,5 0,5 7,9 recommendation at ps actions and promotion presence at fairs friends' recommendation newspapers and magazines sposorship of races and drivers tv advertisement radio mechanics' recommendation banners web page fb ads bilboards none 78 economic analysis (21, vol. 54, no. 2, 68-81) table 2. most trusted sources on motor oil information which sources of information do you trust the most when choosing motor oil brand? nisotec customers other customers motor oil quality 67.1% 50.9% mechanic/auto repair shop recommendation 39.7% 50.7% price 39.6% 27.4% friends' reccommendation 21.3% 16.9% location of motor oil vendor 27.9% 12.8% motor oil brand 18.4% 11.6% recommendation from gas station employees 15.7% 4.3% advertisements 1.4% 1.1% other 0.0% 1.1% source: brand tracking study 2018, authors' interpretation on the other hand, the very fact that brand official website site exists and is regularly updated, indicates that the brand cares about its customers and builds trust and confidence. when it comes to advertising on social networks, younger respondents generate more favourable reactions. apart from service information, to some extent there is an expectation of rewards for loyalty, be it a discount or promotional material. the activations on social networks which are rewarded, result with increased visits and higher number of engagements. taking into consideration the results of the brand tracking study, which aims to monitor specific indicators such as knowledge, use, trust, recommendation and loyalty, which are observed as a measure of communication success, it can be concluded that marketing activities were successfully implemented. it has already been shown that certain types of communication have different characteristics and potentials, and that certain channels have different audiences, which generally and differently consume different content distributed through these media channels. table 3. familiarity of automotive lubricant brands which brands of automotive lubricants from the list do you know? 18 – 24 yr. 25 – 34 yr. 35 – 44 yr. 45 – 54 yr. 55 – 64 yr. castrol 71.7% 80.8% 84.5% 82.5% 80.8% shell 57.5% 66.9% 68.7% 68.4% 65.2% optima-modriča 53.7% 57.4% 68.5% 71.2% 73.9% mobil 56.4% 66.7% 64.9% 62.2% 61.8% galax 44.3% 52.2% 58.3% 60.3% 63.3% nisotec 55.6% 55.0% 58.9% 56.0% 45.5% total 49.0% 52.2% 53.1% 49.9% 48.3% luk oil 39.7% 40.5% 41.0% 38.9% 39.6% mol 24.9% 29.5% 31.5% 30.1% 30.3% texaco 16.7% 25.6% 28.4% 29.9% 31.3% fenix-fam kruševac 16.9% 21.8% 29.3% 28.3% 30.4% prista oil 8.4% 9.3% 11.1% 8.7% 10.7% none 3.6% 0.9% 0.7% 1.2% 1.0% source: brand tracking study 2018, authors' interpretation tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 79 when it comes to brand awareness, the results do not differ statistically among different age groups. this leads to the conclusion that marketing communication initiatives were appropriately created in order to be processed by all categories in an adequate way to make an impact. in addition, many correlations were tested, where for the purposes of this paper one proven correlation was presented. the results presented in table 4 indicate that there is a relationship between brand use and brand satisfaction. these results are an important predictor of future behaviour, as satisfied customers are more likely to repurchase a product they are satisfied with. table 4. correlation of nisotec brand use and brand satisfaction mlpi_1 nisotec mlcss_1 nisotec mlpi_1 nisotec pearson correlation 1 .247* sig. (2-tailed) .034 n 334 74 mlcss_1 nisotec pearson correlation .247* 1 sig. (2-tailed) .034 n 74 75 *. correlation is significant at the 0.05 level (2-tailed).1f1 source: authors' research this research does not explore in detail the decision-making path, i.e. it does not consider the very beginning of customer journey in which customers a brand research is conducted. in addition to all the above mentioned, we can conclude that satisfied customers are promoters of the brand, which provide recommendations to their friends and acquaintances. besides gas stations, sales promotions, and fair promotions, friends' recommendations are remembered by every third respondent. arguably, this percentage could be even higher, considering the possibility that respondents might have had difficulties recalling advertising initiatives at the moment of answering a questionnaire. the idea of integrating marketing communication for nisotec brand has always been present. anyhow, the main step has been made by considering the customer journey concept and introducing this way of thinking. this includes reflecting on which stage is the customer when the company wants to propose the move to the next purchase phase and what activities should be undertaken to achieve the desired outcome. this implies that the company should know what information, in which manner and through which media should be delivered to the customer in order to provoke desired behaviour. when each type of customer passes through this cognitive filter, the company can comprehend which activities overlap, which are important for everyone and which are necessary to carry out. although this process is demanding, especially in the beginning of its implementation, and that nis company is still in initial phase in terms of changing the established ways of thinking, it is very effective, and the assumption is that effects are yet to be seen. 1 in the legend of the table, next to the correlation coefficient, one or two stars are added. one star indicates that the correlation is statistically significant, with a margin of error of 0.05, and two indicates that the correlation is statistically significant with a margin of error of 0.01. in this case, there is a possibility of an error of 0.05. * 80 economic analysis (21, vol. 54, no. 2, 68-81) conclusion research results presented in this paper have a twofold significance. on one hand, they contribute to the development of the field of user experience through application in practice. on the other hand, they encourage marketing practitioners to further research the application of this concept in other industries. in the case of the nisotec brand, the leading brand of motor oil in the automotive lubricants market, integrated marketing communications have a positive effect, while individual communication channels have different effects on different types and customer segments, which is the expected result according to basic product characteristics. digital channels such as forums, websites and social networks mostly influence the segment of younger customers who use these channels more intensively. this leads to the conclusion that for younger generations, those who are not familiar with life without the internet and mobile phones, digital communication channels are very important. therefore, brands must adapt their appearance and the content of messages they distribute via digital communication channels. therein lies the biggest challenge, how to captivate their attention, activate and engage them and turn them into loyal customers and brand ambassadors. however, additional research is needed in terms of younger generation's attitudes, as they are the active participants in creating marketing communication. this research found that the younger generations consume and create content differently, but it is necessary to learn more about their attitudes, in order to create an adequate mix of digital marketing communications. in the ideal scenario, with new knowledge, young people would be engaged in communication activities and satisfied with the interaction with companies. accordingly, improved results would be achieved and the newly created, mostly digital communication. the same could be applied to other target groups, i.e. those that are not yet the independent drivers. essentially, they have the greatest market potential for the company, because of the fact that they are entering the world of drivers and car use, and the question is how familiar are they with the concept of motor oil, the manners and reasons for its usage as well as the available brands of this product in the market. references albert, w., and tullis, t. 2013. measuring the user experience: collecting, analyzing, and presenting usability metrics. newnes. usa. batra r., and keller k.l. 2016. 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"digital transformation of business portfolio through dcrm". in: digital transformation: new challenges and business opportunities. silver and smith publishers, london, pp. 214-235 domazet, i. s., đokić, i., and milovanov, o. 2018. "the influence of advertising media on brand awareness". management: journal of sustainable business and management solutions in emerging economies, 23(1):13-22. domazet, i., lazić, m., and simović, v. 2014. "mogućnosti i pretpostavke za razvoj ikt industrije u srbiji". in: b. drašković [ed.] deindustrijalizacija u srbiji: mogućnost revitalizacije industrijskog sektora, beograd: institut ekonomskih nauka, pp. 619-637 tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 81 domazet, i., neogradi, s., and simović, v. 2019. "značaj društvenih mreža kao digitalnih kanala komunikacije u srpskim bankama". marketing, 50(4):289-297. domazet, i. (2007). "unapređenje konkurentnosti preduzeća primenom crm strategijskog koncepta". in rakita b, et al. ed. management and marketing under globalization, faculty of economics, belgrade. hanić, h. and domazet, i. 2011. „managing customer relationship within financial organisations”. polish journal of management studies, 4(1):151-166. havíř, d. 2017. "a comparison of the approaches to customer experience analysis". economics and business, 31(1): 82-93 keller k. l. 2009. "building strong brands in a modern marketing communications environment. journal of marketing communications, 15 (2): 139–155 kerr, g, and patti, c. 2015. "strategic imc: from abstract concept to marketing management tool". journal of marketing communications, 21(5):317–339. klaus p, and maklan s. 2013. "towards a better measure of customer experience". international journal of market research, 55(2):227–246. kotler f., and keller k. 2017. marketing management. pearson prentice hall, new jersey. lazarević-moravčević m. 2019. "characteristics of marketing communication strategy of a small enterprise", economic analysis: applied research in emerging markets, 52(2):104-112. lemon k., and verhoef p. 2016. "understanding customer experience throughout the customer journey". journal of marketing, 80(6):69-79. mcgrath, j. m. 2010. "using means-end analysis to test integrated marketing communications effects". journal of promotion management, 16(4):361–387. pickton d., and broderick a. (2004). integrated marketing communications. pearson educations ltd, london. schmitt, b. 1999. experiential marketing. new york, the free press verhoef, p. c. (2003). "understanding the effect of customer relationship management efforts on customer retention and customer share development". journal of marketing, 67(4):30-45. verhoef, p. c., lemon, k. n., parasuraman, a., roggeveen, a., tsiros, m., & schlesinger, l. a. 2009. "customer experience creation: determinants, dynamics and management strategies". journal of retailing, 85(1), 31–41. vukmirović, v., kostić-stanković, m. and domazet. i. 2020. "influencers as a segment of digital marketing communication – generation y attitudes". quarterly marketing journal marketing, 51(2): 98-107. yakhlef, a. (2015). "customer experience within retail environments". marketing theory, 15(4):545-564. article history: received: july 28, 2021 accepted: august 19, 2021 http://ebooks.ien.bg.ac.rs/1451/ http://ebooks.ien.bg.ac.rs/1451/ customer experience and integrated marketing communication in the automotive lubricants market tatjana cvetkov-čikošev1 | ivana domazet20f* | valentina vukmirović2 introduction literature review integrated marketing communication concept methodology and results results conclusion references ea_2016_3-4 udc: 005.311.121:005.591.6 005.521:334.7(497.11) jel: o33, m1 cobiss.sr-id: 228332812 preliminary report statistical monitoring of innovation capacities of the serbian firms as decisionmaking tool mosurović ružičić marija1, kutlača đuro, belgrade university, institute “mihajlo pupin”, belgrade, serbia abstract – the subject of this paper is to underline the importance of using data obtained via the official statistical reports that is based on oslo manual methodology manual (community innovation survey) for strategic decision making both at the national level as well as at the level of the company. these data enable monitoring and evaluating the innovation capacity of the firms with the aim of improving it. the paper, also, points out the importance of the firm's innovation capacity assessment as an impeller of economic development based on knowledge. by the data obtained by presented methodology, national decision makers can clearly comprehend and improve the direction of innovation policy and its integration into the wider policy framework that encourage economic development based on innovation. at the firm level, the use of data implies development of professional management of the innovative firm that will be able to respond to problem situations of the modern economy through the formulation of appropriate strategies. the paper analyzed data from three statistical periods during which the oslo manual methodology had been applied in serbia. analysis has shown that the data obtained in this way are not sufficiently used by decision-makers an occasion rating innovation capacity of enterprises. key words: innovation capacity of the firms, innovation activities, oslo manual, community innovation survey, strategic decision. introduction the importance of innovation is not possible to ignore. they are incorporated into everyday life. innovation could not be seen only in a narrow sense as a driver for increasing the wealth of the nation and prosperity, but also in a more fundamental senseas a tool that enables individuals to do things that they had never done. innovation is not only significant in terms of sustainable economic growth, but also in terms of changes of direction of economic progress and ultimately increases the quality of life (freeman, 1988). 1 marija.mosurovic@pupin.rs 70 economic analysis (2016, vol. 49, no. 3-4, 69-80) observation of the firms innovation capacity in a certain period may provide insight into the dynamics of the inventiveness of a certain economic activity which provides a space for comparing the development of certain sectors and determine the technological leader (suarezvilla , 1990). some of them are based on developed practices of cooperation between the various innovation stakeholders, knowledge capital development, and some are related to organization design and human resources management. in accordance with that, various databases can represent a source of information which can be used for determining the innovation capacity of the firms. this work particularly emphasized the importance of the data obtained using the methodology oslo manual, which represents the methodological framework for the creation of community innovation survey (cis) a questionnaire that investigates innovation activities within the firms. this methodology provides a better understanding of the innovative behavior of firms through the definition of indicators of firms’ innovation capacity. in that way, the influence of innovation on employment, competitiveness, economic growth, trade, etc ., could be determined. also, the obtained data can be used, by applying appropriate statistical programs and techniques, for constructing different models for further investigating of specified dimensions of firms’ innovation capacity. analysis and assessment of the impact of the firms’ innovation capacity on the firms’ competitiveness are equally important for the macro and the micro level of decision making. at the macro level, a competitive advantage based on the technology development has been influenced by the development of system variables of the national economy, i.e. the elements of the national innovation system. the level of development of infrastructure, political and other institution which determine the function of creation of transfer technology and diffusion indicate the development of national innovation system (author). at the company level, the importance of technology is analyzed functionally: exploring how technology can influence the business activities that lead to increasing market share of the company, both on domestic and foreign markets. besides, the company can gain a competitive advantage in innovation, through efficient use of technology developed within the company or the market (aralica & račić, 2007). understanding of the firm’s innovation capacity at the national level can provide insights into how the innovation of the nation has been changed over the time, besides that, the relationship between national innovation stakeholders can be monitored. firm’s innovation capacity the importance of innovation for improving the functioning of national economies has been recognized in the literature. many authors believe that the innovation capacity could be seen as the driving force for economic growth and development and competitive advantage. in the literature, there is a consensus that innovation has significant implications on the performance of national economies, the region and beyond (arrow, 1962; freeman, 1988; romer, 1990, van tunzelmann, 1995; mervar, 1999; radošević, 2004; oecd, 2005; knell, 2006; lentz&mortensen, 2006; courvisans & mackenzie, 2014; melinkas, 2014;), etc. mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 71 national innovation capacity in the narrowest sense is the "country's ability to produce, commercialize and enable the smooth flow of innovation over a longer period of time" (furman et al., 2002). the success of innovative companies can be measured not only through the consideration of innovation and/or the economic performance of the firms but also includes activities which are related to the performance evaluation during the implementation of the innovation process. these activities, beside evaluation of a technological aspect of innovation, include the evaluation of non-technological dimension of the innovation process such as the mechanisms for diffusion and transfer of technology, the strength of interaction between all national innovation stakeholders as well as organizational design components. through measuring of innovation capacity of the firms over some period, it is possible to gain insight not only of the economic activity of the firms, but also in the economic activity of the nation, and even the region. the decline in innovation capacity in some sectors certainly can identify the future problems and can be used as an indicator for taking corrective actions (lukjanska, 2014). the firm’s innovation capacity assessment reinforces and improves the competence of all relevant individuals and institutions, including the complete system environment. at the national level through the improvement of the innovation capacities, the competitiveness of the firms, specific industries, as well as the national economy at the whole, can be enhanced. thus increased competitiveness is based on better utilization of knowledge. at the regional level, increasing innovation capacity improves the potential for innovative cooperation, clustering, and regional development. at the firm level, assessment of innovation capacity is important for the management of the firms and includes the identification of the current situation, through the assessment of innovation performance, and to the anticipation of the desired state. through defining action plans with the aim to overcome the identified variations, the strategic management at the firm level can be improved. innovation management at national level is a complicated and complex process that includes mechanisms for the establishment of the effective fitting of innovation capacity with needs of the economy. successful innovators can be determined by their capacity for fitting research and development with knowledge of market demands (freeman, 1982). peter drucker (2003) believes that the success of innovation is in close connection with the specific systematic approach in analyzing all sources of innovation. he also underlined that for successful innovation, it is necessary that there is a recognized need for it. its findings also indicate that innovation is not linked only to companies with high technology, but also for the companies with lower technological level. for a successful understanding of the firm’s innovation capacity, the indicators of innovation input and innovation output should be explored which is possible by using various databases. statistical sources for innovation capacity indicators for investigating of innovation activities of the firms with the intention of assessing their innovation capacity, there is no precisely defined set of indicators. the number and type of indicators varies according to the objectives and tasks of the analysis. basic statistical sources 72 economic analysis (2016, vol. 49, no. 3-4, 69-80) for indicators of innovation capacity of firms can be different databases (maroulis & tsipouro, 2011): • eurostat provides data for all european union member states, as well as certain which are not yet. using this database comparison between the countries and region make easier. • oecd provides data for quality analysis and between countries that are not members of the european union. • national statistical offices provide statistical data at national level. data obtained from these sources can be internationally comparable if the common methodology is used. these institutions provide data to the international statistical organizations. • innovation union scoreboard provides data that enable assessment of innovation performance of european union member states and beyond to identify the strengths and weaknesses of their systems of research, development and innovation. • different specialized databases of patent activities (european patent officeepo; world intellectual property organizationwipo, etc.); bibliometric data (web of science, scopus, kobson), etc. • periodic and/or one-time researchcollection and processing of qualitative and quantitative data. in recent years, the great efforts have been made to develop indicators for monitoring the performance of innovative firms. there are various initiatives related to the development of innovation indicators that originated from different areas: education, based on developed practices of cooperation between the various innovation stakeholders of data relating to the organization and management of human resources. however, the most prominent source of information for measuring innovation performance of enterprises is the community innovation survey. information about research and development costs, patents and bibliometric data can be obtained from periodic reports relating to the research and development of citation indexes and other sources. but, the information obtained in this manner, observe only certain aspects of the innovation capacity of the firms. this paper points out the importance of using data gathered using the oslo manual methodology for decision makers. firms continually develop their products and processes and establish new knowledge. it can be seen as a dynamic process rather than static. only adequate use of knowledge could improve competitiveness at the firm level. oslo manual is a comprehensive guide for collection, processing and analysis of data that can describe the innovation process (eg. innovation activities, expenditures for the performance of innovation activity, as well as the connection of the company with other actors of the national innovation system), the implementation of significant improvements in products and processes in the company (different types of innovation), and to obtain information about the factors that affect the performance of innovation activities and their effects. all this information is very important for researching firm’s innovation capacity. the distinguishing of four types of innovation: innovation of products/services, innovation mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 73 process, innovation in organization and innovation in marketing makes this approach useful for the understanding of innovation from various aspects. data, which are obtained from community innovation survey, are used for the creation of indicators that describe firm's innovation capacity. the specific indicator may refer to only one question from the questionnaire, although often it is an analytical framework for few questions (oecd, 2005). based on the study of indicators it is possible to make a different kind of comparison regarding innovation performance of the firms in other to assess and follow the dynamics of changing their innovation capacity at all levels of observation. data obtained by using this methodological framework can be used further for creating the different analytical models depending on the aim and users of the analysis. the oslo manuel methodology has evolved over time so its development could be followed through several periods (oecd, 2005): • the first stage covers the period of the eighties and nineties of the last century when different models for monitoring innovation activities in the firms have been developed; • at the beginning of the nineties, exactly in 1992, when the first edition of oslo manual was published, stared the new stage of methodology development for firm’s innovation capacity assessment. by this manual, it is enabled tracking of innovation activities in the manufacturing sector with the main focus on technological innovation; • disadvantages of the first edition of the oslo manual were overcome with the second edition, which was published in 1997. this edition was included some methodological improvements. the service sector was also covered; • the last, the third edition of the oslo manual is improved in accordance with the recommendations of users and represents a major step forward compared with previous editions. improvements can be seen primarily through the complex approach of monitoring firms innovation capacity, which includes beside technological dimensions , the non-technological dimension of the innovative behavior of firms. the main advantage of this edition is the comprehensive methodological framework of analysis. statistical monitoring of innovation activities of the firms were conducted in serbia during the four three-year cycle using oslo manuel methodology. this paper presents a comparative analysis of some indicators of innovation capacity of serbian firms in the last three cycles. information obtained by using this methodology which is applied through community innovation survey are input for a design of a framework for analyzing the innovation capacity of enterprises that were investigated. this information enables the creation of a large number of indicators that make up the national innovation capacity internationally comparable. indicators of innovation capacity in the serbian firms assessment of the innovation capacity of the serbian firms in a narrow sense means the mechanism for an understanding of creating and development of product innovation, process innovation, innovation in marketing and organizational innovations. this 74 economic analysis (2016, vol. 49, no. 3-4, 69-80) information is available on the basis of the community innovation survey, by which is possible to collect a lot of different information for creating a large number of indicators that could describe innovation inputs and innovation outputs (mohnen et al., 2006; knell, 2006; aralica et. al., 2008). in this part of the paper indicators that could describe some dimension of the innovation capacity of the serbian firms will be presented: investment in innovation activities, sources of financing innovation activities, the share of revenues from the implementation of innovation activities in the total income of the company. for the analysis, official statistical data of the statistical office of the republic of serbia will be used. the data are collected by applying the methodological tool of oslo manual. in this way, it will be possible to follow the dynamics of individual indicators of innovation capacity of firms in serbia during three three-year periods during which the official community innovation survey was conducted in serbia. investing in innovation activities is one of the most important indicators of innovation capacity of the firms. as soon as the company realizes the importance of these kinds of expenses, its chances for success are greater. figure 1 shows the dynamics of expenditure on innovation activities during the observed periods. figure 1. expenditure for innovation activities in serbian firms (%) during the periods 2008-2010, 2010-2012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. during the observed three-year statistical period, the companies in serbia invested in their own research capacity the most, through the provision of necessary equipment and the implementation of internal research and development activities without any significant variations during the period that was considered. beside the mentioned types of innovation activities, the firms may implement and other types such as preparation of feasibility studies, testing, routine software development and industrial engineering. innovation activities cannot be observed separated because conducting the one doesn't exclude the others. they are almost always carried out 13.6 5.2 75.1 6.1 0 7 2.3 80.3 7.1 3.3 12.3 2.6 64.3 9.5 11.3 in-house r&d purchase of external r&d acquisition of machinery, equipment, and software acquisition of external knowledge other 2012-2014 2010-2012 2008-2010 mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 75 simultaneously. for example, internal research and development activities often involve the purchase of new machinery and equipment and/or purchase of certain forms of intellectual property rights as well as providing education and acquiring new knowledge and skills. companies recognize the need to undertake research and development activities in order to survive in business. most of the companies, especially in less developed economies play a less risky role of imitators (contrary to technology leaders) or technology followers. this means that most innovation expenditures will be connected with purchasing equipment, software and rights to use someone else's intellectual property rights (patents and nonpatented inventions, licenses, trademarks). there is increasing tendency in these expenditures in serbia within observed periods: (9.5%) in the period 2012-2014 compared to the previous periods observed (figure 1. 7.1% and 6.1%). external financial support for conducting innovation activities is mainly provided from government funds in serbia, but there is decreasing tendency in funding from this kind of sources in the last reporting period (63.2%) compared to the previous two periods (70.8% and 63.2%). it is encouraging that the importance of investment in innovation activities is recognized at the local level. however, in order to establish a functional link between results of innovation activities and the economy needs, firms should turn out to market in order to find additional financial sources. figure 2 shows that the firms in serbia identified the importance of applying for the framework programs (fp) of the european union. these programs are with the aim to establish the better efficiency of research and development in order to improve the economy of the european union as the most dynamic, competitive global economy based on knowledge. figure 2. the structure of public financial support for innovation activities in serbian firms (%) during the periods 2008-2010, 2010-2012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. technological innovation can occur through the introduction of new products and processes (radical innovation), which substantially change the dynamics of the sector, or as a 28.6 82.3 10.5 1.9 29.2 70.8 13.1 2.4 36.8 63.2 11.4 2.8 local or regional authorities central government the european union (eu) fp7 2012-2014 20102012 2008-2010. 76 economic analysis (2016, vol. 49, no. 3-4, 69-80) small improvement in existing products and processes (incremental innovation). in the public, the term innovation is mainly related to radical innovation, but, one should have in mind that the higher profits could be achieved through conducting less risky, incremental innovation. it is especially important for countries that do not have the large financial capacity. according to schumpeter, "radical" innovations shaping the great economic changes, while incremental enable this process to take place continuously. the structure of the percentage of firm’s total turnover over observed periods is shown in figure 3. innovative enterprises in serbia mostly obtain the income from products that have undergone minor changes or were only new for the company (oecd, 2005). figure 3. the structure of total turnover of innovative activity in serbian firms (%) during the periods 2008-2010, 2010-2012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. the results of performing innovation activities usually can be seen as a number of generated innovation. the firm could also be considered as innovative if during underperforming period conduct innovation activities regardless of whether scientific results achieved during the period or not. inclusion and abandoned and innovation in progress are covered by definition (oecd, 2005). on the basis of the oslo manual methodologies results of performing innovation activities can be expressed as the product/ service innovation, innovation in organization and marketing innovation (figure 4). 4.4 3.8 3 7.3 9.1 5 35.2 37 35 53.1 50.1 57 20082010 2010-2012 2012-2014 products new to market products new to firm changed or only marginally modified product non innovators mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 77 figure 4. innovation activities by type in serbian firms (%) during the periods 2008-2010, 20102012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. the data presented in table 4. shows that the highest number of innovative firms were identified within the period 20082010. a slight decreasing tendency in the number of innovative firms in serbia is also presented especially in the last period of observation. this fact influences the results of innovation activities. perhaps the topics of some research in the future should be an investigation of the causes that led to a decline in the number of companies that have performed innovation activities in the last three-year period under review. conclusion firms’ innovation capacity assessment is very important for making strategic decisions at the firm’s level, but also in decision-making at the national level through the creation of different policies. there is the unquestionable role of assessment of the innovation capacity of firms for their management. strengthening the innovation capacity of enterprises leads to improving the competence of all relevant individuals and institutions, including the complete system environment. innovation management and building innovation capacity implies a strong and complex interaction between the national research base, decisionmakers in this field. developing capacities, skills, and innovation management skills, as well as the creation of a friendly environment for innovation, are the key things that could be advised to decision makers at all levels for improving the innovation capacity of firms in serbia. changes in technology and market requirements, "force" the innovative firms in their effort in the implementation of different strategies, depending on available resources, the general attitude of management and ultimately "lucky" circumstances (freeman, 1982). 27.4 28.2 32.5 29.3 15.5 52.1 21 19.1 31.4 29.7 7.9 55.4 20.4 20.2 24.9 23.8 10.9 59.5 0 20 40 60 80 product innovations process innovation organisational innovation marketing innovation ongoing or abandoned innovation non-innovators 2012-2014 2010-2012 2008-2010 78 economic analysis (2016, vol. 49, no. 3-4, 69-80) innovation strategy of the firm should be an integral part of the general strategy of every company that conducts research and development activities. strategic management of the company should continuously monitor and investigate the relationship of innovation input and innovation output of firms in contexts of overall firm s performance. there is the need for the existence of highly skilled management of innovative firms that can respond to problem situations of the modern economy through the formulation of appropriate business strategies. the role of government in fostering innovation of enterprises is seen through the creation and implementation of a set of interrelated measures and incentive mechanisms, which include the provision of a large amount of financial resources (from the budget and allocations within the framework of encouraging the business sector), as well as the creation of an adequate economic environment for efficient function of national innovation system. in order to ensure efficiency funding, there is a need for focusing research and development efforts on a certain set of priority areas. determining the strategic priorities should be a systematic by applying bottom-up rather than top-down approach (smart specialization, foresight, etc.). innovation policy should be addressed towards the problems of practitioners and synchronize the activities of all actors of the national innovation system. this can be achieved in best way through a horizontal approach to the innovation policy that overcome the scope of work of one ministrycoordination of innovation policy with the policy of economic development. only in that way, it will be possible to develop a model of economic growth that will lay on the effective use of innovation as well as the transfer of innovation in the economy. the main characteristics of the model should be (fabris, 2014): increase in export demand, import substitution, more emphasis on the manufacturing sector as a generator of economic growth, competitiveness based onknowledge-transfer technology. the work presented here points out the importance of innovation capacity of firms assessment by using the methodological framework developed by the oecd, oslo manual, which is widely recognized as the strategic decision-making tool in developed countries. data obtained through community innovation survey are very descriptive for analysis, monitoring assessment of innovation capacity of firms, in spite of the survey limits, which are listed below: (oecd, 2005; knell& nas & 2006): • detailed analysis of the innovation capacity of firms in some cases requires data that that are not covered by community innovation survey; • it is very hard to understand innovation expenditures from the classical financial report. in order to interpret these data in the proper way, it is necessary to analyze the data from other various business-related reports, particularly financial; • it is difficult to determine the timeframe of the analysis. period covered by the questionnaire refers to three years, but the results of innovation activities are often known only in a future period; • do not provide enough information about the general institutional environment, such as the education system, labor market, and financial system. this paper presents that the assessment of the innovation capacities of companies providing quality information to improve the innovative performance in the future, both at mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 79 the level of individual companies, and the level of national economies. analysis of certain indicators of innovation capacity in serbia during the three three-year periods has shown that their value has not changed significantly over time. a slight decline in the values of certain indicators is even noticed in the last reporting period. this information suggests that decision-makers at all levels of decision-making do not use enough information provided by community innovation survey. it should be considered as a potential area for investigation in the future. acknowledgment: the paper is a part of the research done within the projects iii47005 and tr36025, funded by ministry of education, science and technology development for the period 20112016. references aralica, z., & račić, d. 2007. „može li transfer tehnologije objasniti stvaranje izvozne konkurentnosti u hrvatskoj.“ tematski zbornik radova xiv naučnog skupa: tehnologija, kultura i razvoj, održanog 27-30.08.2007. godine u tivtu. 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radošević, s. 2004. „a twotier or multi-tier europe assessing the innovation capacities of central and east european countries in the enlarged eu.“ jcms, 42 (3): 641-666. renate, l. 2014. “regional innovation policy and systemcase of latvia.“ the annals of the university of oradea. romer, m.p. 1990. „endogenous technological change.“ journal of political economy, 98 (5): 71-102. suarez-villa, l. 1990. „invention, innovative learning, and innovative capacity.“ behavioral science, volume 35 (4): 290-310.s von tunzelmann, n.g. 1995. technology and industrial progress. edward elgar publishing limited, england. article history: received: 10 november, 2016 accepted: 25 november, 2016 microsoft word 2011_3_4_finalna ver.doc original scientific paper    bridging the learning gap in the market for higher education:   e‐learning and public subsidies  ben youssef adel*, letexier thomas, ragni ludovic,   university of nice sophiaantipolis, france   udc: 37.014  jel:i20; i28; l13; l35     premošćavanje jaza učenja na tržištu visokog obrazovanja:   e‐learning i državna subvencija      abstract – this article aims at analyzing the adoption patterns which apply on the market for  higher  education when  two  types of  learning organizations – namely,  traditional  learning and  e‐ learning organizations – provide educational programs. we focus on the impact of public subsidies to  e‐learning providers in order to evaluate the conditions under which the learning gap is bridged. a  welfare analysis is introduced to estimate the relevance of such ‘pro e‐learning’ public policies. our  first results show that public subsidies enable the e‐learning organization to provide quality‐based and  pricing strategies that tend to be similar to those of the brick’n mortar organization. besides, we find  that such short‐term policies positively impact on the global level of quality which is provided by both  providers. nevertheless, our welfare analysis underlines contrasted results about the relevance of such  short‐term public policies.    key words: adoption patterns, costs, e‐learning, public subsidies, quality, welfare  introduction  information and communication  technologies have deeply changed  the scope and  the  nature of  the market  for  higher  education  (bates, 2005).  indeed, virtual campuses and e‐ learning  programs  have  emerged  as  relevant  alternatives  to  traditional  ‘brick’n  mortar’  learning  organizations,  thus  providing  somehow  distant  learning  features.  following  the  developing of such new types of learning providers, it has been suggested that it is possible  to consider a market for higher education learning services in which academic institutions  and  virtual  campuses  are  key  actors  (allen  and  shen,  1999;  belfield  and  levin,  2002;  brasington, 2003; sosin et al., 2004). the advent of virtual campuses and e‐learning programs  leads to two major changes  in the market for higher education. a first significant change  affects the scope, the boundaries and the nature of competition in such a market. a second  major change is related to the provision of quality for programs in this market inasmuch as  e‐learning programs tend to stimulate the developing of new – ict‐related – uses.   the quality of the learning services each channel is likely to provide represents one key  issue  following  the  appearing  of  new  competition  dynamics  on  the  market  for  higher                                                         * université de nice sophia‐antipolis gredeg umr 6226 crns     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   2 education.  icts  have  been  shown  to  enable  teachers  and  learning  staff  to  develop  pedagogical innovations (becker and watts, 2001; rivkin et al., 2005; cukusic et al., 2010).  friedman  (1962),  hoxby  (1994;  2000),  west  (1997),  dee  (1998)  and  jaag  (2006)  find  that  educational mobility leads learning organizations to provide higher‐leveled quality for their  programs whereas lesser optimistic results are obtained by epple and romano (1998), hoyt  and lee (1998), jepsen (2002) and mcmillan (2004). although the impact of the competition  effect on learning quality remains unclear, such contributions have opened alternative paths  to  study  the  delivering  of  educational  services.  the  european  union  has  taken  various  initiatives  so  as  to  promote  e‐learning  programs  and  to  overcome  the  so‐called  ‘learning  gaps’. some countries of its members states (i.e., france and spain) have hugely subsidized  these  programs.  although  the  impact  of  government  subsidy  on  performance  and  social  outcomes  in  the  traditional  market  for  higher  education  has  largely  been  explored  by  scholars  (schneider,  2010;  yamauchi,  2011),  the  whole  impact  of  such  policies  remains  unclear in the case of e‐learning and deeper analyses have to be carried out.  the aim of this article is to analyze the impact of public subsidies to e‐learning providers  in  order  to  evaluate  the  conditions  under  which  the  learning  gap  is  bridged.  a  welfare  analysis is introduced to estimate the relevance of such ‘pro e‐learning’ public policies in a  framework in which traditional learning and e‐learning organizations compete by providing  educational  programs.  our  first  results  show  that  public  subsidies  enable  the  e‐learning  organization to provide quality‐based and pricing strategies that tend to be similar to those  of the brick’n mortar organization. besides, we find that such short‐term policies positively  impact on the global level of quality which is provided by both providers. nevertheless, our  welfare analysis underlines contrasted results about the relevance of such short‐term public  policies.  the paper  is organized as  follows. section  two presents  the settings of  the model  (2).  section  three  identifies  optimal  quality‐based  and  pricing  strategies  when  the  market  for  higher  education  partially  and  shared  (3).  section  four  analyzes  the  impact  of  public  subsidies on both competition outcomes and welfare (4). section five concludes (5).  the model  we  present  a  market  in  which  two  commercial  organizations  act  as  duopolists  when  providing learning services. we introduce two types of learning providers, namely brick’n  mortar campuses and virtual campuses. these traditional organizations are more likely to  provide mass‐oriented services whereas virtual ones rather provide customized services to  better  match  the  needs  of  the  students.  they  also  differ  in  the  nature  of  the  constraints  students have to face when adopting one of the two services. we develop a model in a ‘à la’  hotelling framework in which providers sell differentiated services, the traditional campus  (resp. the virtual campus) being located at 0 (resp. 1). adopters are uniformly distributed on  the hotelling  line and their total mass  n   is equal to 1. they adopt at most one  learning  service that  is provided by either the traditional campus or the virtual campus. be  x  the  location of each product on the line ( [ ]0;1x ∈ ). utility functions are defined as follows:       ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   3 ( ) 1 1 2 2 if adopts from the traditional campus 1 if adopts from the virtual campus 0 if does not adopt x r q tx p u r q t x p + − −⎧ ⎪ = + − − −⎨ ⎪ ⎩       ( )1   r  ( 0r > ) is the gross utility adopters derive from learning services.  tx  (resp.  ( )1t x− ) is  the transportation disutility adopters get from adopting the learning program provided by  the traditional campus (resp. the virtual campus). transportation cost  t  captures the nature  of the constraints which lead students to adopt at most one of the two educational services.  such constraints are related to both technical features (e.g., equipments) and abilities (e.g.,  competences) to use one of the two types of service.  x  (resp.  ( )1 x− ) represents the distance  between any adopter’s ideal product and that provided by the traditional campus (resp. the  virtual  campus).  1p ( 1 0p > )  is  the  price  the  brick’n  mortar  provider  charges  to  students  when adopting learning programs and  2p ( 2 0p > ) represents the price students have to pay  to adopt e‐learning programs.  1q   ( 1 0q > )  (resp.  2q ,  2 0q > )  is  the  level of quality  that  is  provided by the traditional provider (resp. the virtual provider). we here interpret learning  qualities as the efforts carried out by the organizations to hire high‐leveled learning staff and  to  contribute  to  the  provision  of  high‐leveled  diploma.  we  suppose  that  the  content  of  learning programs provided by the two types of learning organizations is the same. product  differentiation can only be measured by the way educational services are released.   both  learning  providers  are  driven  by  pure  for‐profit  motives  to  develop  learning  programs. we define their objective functions as follows:  ( ) ( ) 2 1 1 1 1 1 2 2 2 2 2 2 2 2 2 n p f q n p n f q π π ⎧ = − −⎪ ⎨ = − −⎪⎩                      ( )2   1π  (resp.  2π ) is the profit function of the traditional learning provider (resp. the virtual  learning provider) when supplying her programs. we define  1n  ( ] [1 0;1n ∈ ) as the mass of  the students who adopt the programs provided by the brick’n mortar campus whereas  2n   ( ] [2 0;1n ∈ )  represents  the  mass  of  the  students  who  adopt  e‐learning  services.  both  organizations  face  costs  whose  cost  structures  are  not  the  same.  the  traditional  learning  provider  has  to  support  fixed  costs  f1  to  carry  out  the  provision  of  learning  services  inasmuch as the setting out of brick’n mortar activities requires buildings to be allocated and  both teaching and administrative staffs to be paid. nevertheless, the mass of the students  who adopt traditional learning services is not likely to strongly affect the levels of costs of the  learning  supplier  since  her  activity  is  based  on  a  mass‐consumption  scheme.  for  simplification purposes, we set the level of marginal costs to zero. the provider of e‐learning  programs has to face marginal costs when carrying out her activity inasmuch as it is based  on a customization‐based approach. indeed, since each student is likely to be individually  provided  a  specific  learning  program  and  teachers  are  likely  to  be  more  involved  in  participating to personal trainings, marginal costs  2f  have to be taking into account when  providing learning services. we however suggest that fixed costs are much lower‐leveled in  the case of commercial e‐learning activities. again, for simplification purposes, we set the     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   4 level  of  fixed  costs  to  zero.  as  generally  assumed,  we  eventually  suppose  that  both  producers face innovation production costs whose shapes are quadratic. such costs lead both  learning providers to design suitable pricing and quality strategies to maximize their profits.  we define the adoption decision process as a four‐step game:  • at  step  0t = ,  both  the  traditional  organization  and  the  virtual  organization   decide whether to provide or not to provide learning programs;  • at step  1t = , both organizations simultaneously set qualities  1q  and  2q ;   • at step  2t = , both organizations set prices  1p  and  2p ;  • at step  3t = , students decide to adopt or not to adopt the product released by  either the brick’n mortar organization or the virtual campus.  providers and potential adopters have full and common knowledge of the production  outcomes, whether  they concern  prices and qualities. we suppose  that  their expectations  about the way prices and qualities are defined do apply.  we consider the specific case in which the market is partially served and shared. indeed,  the gross utility adopters derive from getting access to learning services (i.e.,  r ) is low so  that access to learning services is limited. therefore, we here focus on the case in which both  the cultural and political landscapes of the countries are likely to generate learning gaps.  optimal strategies and competition outcomes  potential adopters have a low intrinsic valuation for learning services and/or constraints  to access educational services that are high so that no‐adoption patterns are introduced. the  two learning providers consequently act as ‘local’ monopolists.     figure 1. adoption patterns when the market is partially served        our analysis holds for specific values for t  and  2f .   assumption 1a. transportation costs t  are large so that  1t > .   mobility is limited so that there exist adoption constraints which do not allow potential  adopters to easily switch from one learning provider to the other one.  assumption 1b. marginal costs  2f  are lower‐bounded so that 2f t< .   assumption 1b is introduced to restrict our analysis to a framework in which marginal  costs are low‐leveled enough so that the e‐learning provider may generate a positive profit  from her commercial activity.        ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   5 in addition, we restrict our analysis to ‘reasonable’ values of  r , namely  r .1  assumption 2. the intrinsic valuation for learning services  r  is defined so that  ( )2 20 2 1 2f r t f< < < − + .  assumption 2 presents the conditions for values of  r  we have to consider for the market  for higher education to be partially‐served. let us stress that assumption 2 can be extended  and expressed so that  ( )2 2 20 2 1 2 2 1 2 1f r t f t t f< < < − + < − < − + .  solving backward, we identify optimal levels for quality, prices and adoption patterns:  * 1 * 2 2 2 1 2 1 r q t r f q t ⎧ =⎪⎪ − ⎨ −⎪ = ⎪ −⎩ * 1 * 2 2 2 1 ( 1) 2 1 tr p t tr f t p t ⎧ =⎪⎪ − ⎨ + −⎪ = ⎪ −⎩ * 1 * 2 2 2 1 2 1 r n t r f n t ⎧ =⎪⎪ − ⎨ −⎪ = ⎪ −⎩        ( )3a , ( )3b  and ( )3c   marginal costs  2f  only affect the optimal level for quality, price and adoption of the e‐ learning provider. this results from the partially‐served nature of the market. one can easily  see from assumptions 1a, 1b and 2 that levels for  *1p ,  * 2p ,  * 1q ,  * 2q ,  * 1n  and  * 2n  are all positive.    proposition 1. both learning providers reach out positive profits and partially serve the market  when potential adopters have a ‘low’ intrinsic valuation for learning services.  proof of proposition 1. one can easily observe from assumption 1a that the traditional  learning provider generates a positive profit from her activity provided that fixed costs  1f   are sufficiently small. it is straightforward to show that the profit of the e‐learning provider  is positive at the optimal state for any value of  2f  ( 20 f t< < ).   traditional  learning  and  e‐learning  activities  are  thus  both  found  to  be  sustainable  inasmuch as their respective optimal levels of profit are always shown to be positive.  proposition 2. when the market for higher education is partially served, the traditional learning  organization sets out higher (resp. lower) quality (resp. price) levels for their learning programs than  the ones which are provided by the e‐learning organization.  proof of proposition 2. from assumptions 1a and 1b, one can easily find that   ( ) ( )* *1 2 2 1 2 2 0p p f t t− = − − <⎡ ⎤⎣ ⎦  and  ( ) * * 1 2 2 2 1 0q q f t− = − > .  the  traditional  learning  provider  appears  more  likely  to  attract  a  higher  scope  of  potential adopters. nevertheless, let us remind that no‐adoption patterns apply due to the  structure of the market for higher education.  learning divides’ and public policies  no‐adoption patterns are represented by the optimal mass of non‐adopters, which is    [ ] ( )* * *1 2 21 ( ) 2( ) 1 2 1n n n t r f t∅ = − + = − + − −           ( )4                                                          1 if  r   is shown  to be  ‘too’  low, global no‐adoption patterns are  likely  to apply on  the market  for  education. we do not analyze such a case in this article.      economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   6 we obviously find that  *n∅  is positive for any value of t ,  2f  and  r  under assumptions 1a,  1b and 2. moreover,  ( )* * 2 ,n n f r∅ ∅=  is unsurprisingly found to be an increasing function for  2f  and a decreasing function for  r . consequently, one may see appropriate to set up public  policies which tend to make levels for marginal costs  2f  lower and levels for valuation for  educational programs  r  higher. although such policies are both shown to reduce the gap for  learning access, they differ in the amount of time which is needed for positive outcomes to be  reached out. the setting up of information campaigns which are led to develop the intrinsic  valuation for educational programs are somehow likely to be efficient in the long run. we  therefore restrict  our public analysis  to  the  example of  public subsidies  to  the  e‐learning  provider  (e.g.,  public  support  to  purchase  it  terminals  or  computers).  the  total  amount  allocated by the public authorities thus depends on the number of adopters of e‐learning  services. marginal public subsidy is noted  s  ( 0s > ) and is defined so that  ( )2 0f s s∂ − ∂ <                     ( )5   s  refers to the amount which is allocated by public players to the virtual campus to enhance  the  providing  of  e‐learning  programs  and  to  reduce  the  so‐called  ‘learning  divides’.  the  impact  of  such  a  type  of  public  policies  can  be  measured  by  analyzing  the  effect  that  marginal costs  2f  have on optimal price and quality levels, as well as on profits. the level of  marginal subsidy  s  is of course assumed to be lower to that of marginal cost  2f  (i.e.,  2s f≤ ).    we first analyze the effect of public subsidies on the optimal levels we previously pointed  out (4.1.). a welfare study is then carried out to see to what extent public subsidies may be  socially‐improving (4.2).   public subsidies and competition outcomes  we define  * * *1 2q q q= +  as the quality effort which is jointly provided by the two learning  organizations. as we have supposed that educational programs are homogeneous products,  one can interpret  *q  as a – yet preliminary – measure of social outcome. we show that  ( ) ( )* 22 2 1q r f t= − −                   ( )6   the  effect  of  public  subsidies  on  the  optimal  quality  and  pricing  strategies  of  both  learning providers, as well as that on their profits, are expressed as follows:  * 1 2 * 2 2 0 1 0 2 1 q f q f t ⎧∂ =⎪ ∂⎪ ⎨ ∂⎪ = − < ⎪ ∂ −⎩ * 1 2 * 2 2 0 1 0 2 1 p f p t f t ⎧∂ =⎪ ∂⎪ ⎨ ∂ −⎪ = > ⎪ ∂ −⎩ * 1 2 * 2 2 2 0 0 2 1 f r f f t π π ⎧∂ =⎪ ∂⎪ ⎨ ∂ −⎪ = − < ⎪ ∂ −⎩            ( )7a , ( )7b  and ( )7c   lemma 1. when potential adopters have a low intrinsic valuation for learning services, public  subsidies have a positive  (resp. negative)  impact on  the quality  (resp. pricing)  strategy of  the  e‐ learning provider whereas they have no effect on that of the brick’n mortar learning provider. public  subsidies enable the e‐learning provider to increase her profits whereas such subsidies do not affect  that of the traditional organization.        ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   7 the effect of public subsidies on the global quality effort is given by  * 2 1 0 2 1 q f t ∂ = − < ∂ −                    ( )8   lemma 2. public subsidies improve the level of global quality effort.  lemma  2  provides  first  social  insights  about  the  providing  of  public  subsidies.  it  somehow stresses that the providing of marginal subsidies does negatively  impact on the  joint level of quality delivered by both types of learning organizations. as such, exclusive  public support  to  the e‐learning provider  is  likely  to  lead both providers  to offer higher‐ leveled services.   public subsidies and welfare  we  discuss  welfare  outcomes  to  identify  the  impact  of  public  subsidies  on  welfare.  aggregate  adopters  surplus  is  equal  to  * * *1 2as as as= + .  the  surpluses  of  both  learning  organizations are equal to the sum of the profit of the brick’n mortar provider  *1π  and that of  the e‐learning provider  *2π . welfare is defined by the sum of both adopters and providers’  surpluses, as well as of the level of total public subsidy (i.e., public deficit)  ( )* *2 2s s n s n= = × .  indeed,  we  here  consider  that  public  authorities  take  rational  decisions  when  designing  public policies  inasmuch as subsidies are allocated  if and only  if two conditions are met.  these conditions state  that  (i)  the  impact of public subsidies on both  the producers’ and  consumers’ surpluses is shown to be positive, and (ii) public deficit  s  is overcome by the  increase of the level of total surplus which results from the setting up of such a public policy.   when  public  subsidies  are  provided  to  the  e‐learning  organization,  its  marginal  cost  decreases to a level that is equal to  2f s− . we define the optimal level of welfare  *w  as   ( ) ( )( ) ( ) * 1 * 2 1 ** * * * * * * 1 1 2 2 1 2 2 0 d 1 d 1 x x x x w r q tx p x r q t x p x s xπ π = = = + − − + + − − − + + − −∫ ∫   we find that   ( ) ( )( ) ( ) ( ) 2 22 2* 1 2 1 1 3 1 2 2 1 2 1 r f s w f t r r f s s t t − −⎡ ⎤⎛ ⎞ ⎡ ⎤= − + − + − − − ⎢ ⎥⎜ ⎟ ⎣ ⎦− −⎝ ⎠ ⎣ ⎦      ( )9   one  can  find  that  levels  for  welfare  are  positive,  provided  that  fixed  costs  1f   are  sufficiently small (see proof  in appendix a). the  impact of public subsidies on welfare  is  expressed as follows:  ( )( ) ( )( ) 2* 2 1 1 2 1 w r f t s t s t ∂ ⎛ ⎞ = − + −⎡ ⎤⎜ ⎟ ⎣ ⎦∂ −⎝ ⎠                    ( )10   proposition 3. when the market is partially‐served, public subsidies are beneficial to welfare for  ‘low’ values for marginal public subsidy  s , and detrimental otherwise.     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   8 proof of proposition 3. we  find  that  * 0w s∂ ∂ > for values  for  s   that are set out by  public authorities so that  ( )( )21s t t r f< − −  and that  * 0w s∂ ∂ <  for values for  s  that are  defined so that  ( )( )21s t t r f> − − . �  we  find  that  public  subsidies  may  be  relevant  to  reach  out  welfare‐improving  states  provided  that  the  level  of  marginal  subsidy  does  not  exceed  a  maximal  value.  upper‐ bounded  public  support  is  likely  to  be  welfare‐improving  for  areas  in  which  access  to  learning programs is limited.    the optimal decision‐making of public authorities can be seen as the result of a welfare‐ maximizing program of which  ( )( )* 21s t t r f= − −  is the result.2 let us note that such an  optimal  level for  s   is higher (resp.  lower) than marginal cost  2f   if  ( )2 2 1f t t r> −  (resp.  ( )2 2 1f t t r< − ). when public authorities define levels for public subsidies so that  20 s f≤ ≤ ,  *s  is set out at a level which is equal to  ( )( )21t t r f− −  if values for  2f  and  r  are so that  ( )( )2 2 1f t t r≥ − , and  * 2s f=  if values for  2f  and  r  are so that  ( )( )2 2 1f t t r≤ − .  it  is  needed  to  see  if  the  setting  out  of  public  subsidies  whose  marginal  amount  is  ( )( )* 21s t t r f= − −  or  * 2s f=  eventually leads to the disappearing of ‘learning divides’ or if  they only attenuate them.  proposition 4. although public subsidies eventually foster the adoption of educational services,  they may not lead to the disappearing of the ‘learning gap’.  proof of proposition 4. see appendix b.   proposition 4 suggests that short‐term oriented public policies may not be sufficient for  ‘learning divides’ to disappear. indeed, one can see that a – yet narrower – ‘learning gap’  may apply, depending on the values of both  r  and 2f . short‐termed public support to e‐ learning organizations cannot thus be seen as a great  ‘equalizer’ which would lead to the  developing of universal access to educational services.   conclusion  the  aim  of  this  article  has  been  to  analyze  to  what  extent  the  setting  out  of  public  subsiding may affect the bridging of ‘learning divides’ while stimulating the providing of  high  levels of quality for educational programs. following the  increasing popularity of e‐ learning  services,  we  have  built  a  model  in  which  a  traditional  learning  organization  competes  with  a  virtual  one  while  having  to  deal  with  differing  cost  structures  so  as  to  measure the relevancy of ‘pro’ e‐learning support policies from a social point of view. one of  our major research directions has been to identify how public policies should be designed to  eventually  facilitating  access  to  learning  services  while  not  levelling  down  overall  educational quality.                                                         2 as  ( ) ( )22 * 2 1 2 1 1 0w s t t∂ ∂ = − − < , the value  *s  for  s  which is defined so that  * 0w s∂ ∂ =  depicts a  maximum state.        ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   9 the impact of public subsidies has been analyzed, notably to measure to what extent they  are  likely  to  reduce  the  ‘learning  divides’  one  may  observe  in  areas  in  which  intrinsic  valuation  for  educational  services  is  low.  our  welfare  analysis  has  evidenced  that  the  providing of public subsidies that level is too high is detrimental from a social viewpoint. it  has also revealed that – under some specific circumstances – public subsidies may not be  efficient  enough  to  fully‐cover  the  ‘learning  gap’.  this  last  result  can  lead  to  several  interpretations.  a  somehow  pessimistic  interpretation  is  that  it  may  not  be  possible  to  provide  universal  access  to  educational  services  through  the  designing  of  short‐termed  public  policies.  although  the  setting  out  of  public  policies  is  found  to  ‘equalize’  the  competitive game between the two types of learning organizations from both a pricing and  quality‐based point of view, detrimental effects to welfare levels may appear. we suggest  that  the  mixing  of  short‐term  (e.g.,  public  subsidies)  and  long‐term  (e.g.,  educational  campaigns)  public  policies  may  be  appropriate  to  lead  to  the  disappearing  of  ‘learning  divides’. yet, such a practice is likely to generate coordination failures and seems to provide  efficient results only when political contexts are found to be stable. nevertheless, we would  like to address another – rather optimistic – interpretation. indeed, our findings pinpoint that  it  may  be  possible  for  public  authorities  to  widen  access  to  educational  services  while  preserving  their  ‘cultural’  learning‐provision  model.  put  it  differently,  they  may  allow  a  larger scope of people to get access to educational services while avoiding the emerging of a  mass‐consumption model for such higher services.  the analysis of  adoption  patterns  for  educational  services raises major concerns  from  both  market‐based  and  public  viewpoints.  we  strongly  believe  that  both  empirical  and  model‐based  further  contributions  will  lead  to  the  better  understanding  of  adoption  dynamics  within  the  market  for  higher  education  and  to  the  shaping  of  suitable  public  policies.     appendixes  appendix a. positive welfare levels   the level of welfare that applies when the market for higher education is partially served  is given by  ( ) ( ) 2 2* 2 1 2 2 2 2 1 1 2 1 2 ( )( ) ( ( ) ) 2 2 1 w f t r r f f s f s t r r f s t ⎡ ⎤ ⎡ ⎤⎡ ⎤= − + − − + − + + + − +⎡ ⎤⎣ ⎦⎢ ⎥ ⎣ ⎦⎣ ⎦−⎣ ⎦   from assumptions 1a and 2, it is straightforward to find that  * 0w >  for sufficiently small  values of  1f . �  appendix b. proof of proposition 2   as we previously pointed out, two cases have to be taken into account: (i)   ( )( )* 2 2; 2 1s f f t r t= ≤ −  and (ii)  ( )( ) ( )( )* 2 21 ; 2 1s t t r f f t r t= − − ≥ − .  let  us  first  focus  on  the  ( )( )* 2 2; 2 1s f f t r t= ≤ −   case.  we  show  that  ** 0n∅ >   if  the  following conditions are simultaneously met:     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   10 ( )( ) ( ) ( ) 2 2 2 2 1 2 2 1 2 1 0 1 2 (2 1 ) 2 1 2 1 r t f t r t f r t f t t f < −⎧ ⎪ ≤ −⎨ ⎪ < < < − + < − < − +⎩   such conditions can be summarized as follows:  ( )( ) ( )( ) ( )2 2 2 20 2 1 1 2 2 1 1 2 (2 1 ) 2 1 2 1f t f t r t t f t t f< < − < < − < − + < − < − +   in a similar fashion, we show that  ** 0n∅ <  if the following conditions are simultaneously  met:  ( )( ) ( ) ( ) 2 2 2 2 1 2 2 1 2 1 0 1 2 (2 1 ) 2 1 2 1 r t f t r t f r t f t t f > −⎧ ⎪ ≤ −⎨ ⎪ < < < − + < − < − +⎩   such conditions can be summarized as follows:  ( )( ){ } ( )2 2 20 max 1 2 2 1 ; 1 2 (2 1 ) 2 1 2 1t f r t f t t f< − < < − + < − < − +   we  thus  identify possible conditions under  which public subsidies are  found  to  fully  bridge the ‘learning gap’ and other conditions under which such policies are not found to be  efficient enough to fully cover this gap.   similar results are found when the  ( )( ) ( )( )* 2 21 ; 2 1s t t r f f t r t= − − 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yamauchi,  f.  (2011).  school  quality,  clustering  and  government  subsidy  in  post‐apartheid  south  africa. economics of education review, 30 (1), 146‐156.         apstrakt – ovaj članak ima za cilj da analizira usvajanje modela koji se primenjuju na tržištu  visokog  obrazovanja  posmatrajući  dva  tipa  edukativnih  organizacija  ‐  one  koje  pružaju  klasične  edukativne programe i one koji pružaju e‐learning obrazovne programe. posebno je posmatran uticaj  državnih  subvencija na  e‐learning organizacije u  cilju procene uslova pod kojima premošćuje  jaz  učenja. predstavljena  je analiza blagostanja u cilju procene relevantnosti ovakvih državnih politika  koje  favorizuju  e‐learning.  naši  prvi  rezultati  pokazuju  da  državne  subvencije  omogućavaju  e‐ learning organizacijama da primenjuju cenovne, i strategije bazirane na kvalitetu koje teže da budu  slične  onima  kod  brick’n  mortar  organizacija.  pored  toga,  utvrdili  smo  da  kratkoročne  politike  pozitivno utiču na nivo ukupnog  kvaliteta  koji pružaju  oba  tipa  organizacija.  ipak, naša  analiza  blagostanja ističe različitost rezultata u vezi sa relevantnošću ovakvih kratkoročnih državnih politika.        article history:  received:  5 november 2011  accepted:  14 december 2011          economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   68 apstrakt  ‐  u  centru  pažnje  plana  oporavka  eu  za  period  2010.‐2014.  su,  takozvane,  ʺpametne  investicijeʺ,  koje  treba  dugoročno  da  obezbede  veći  rast  i  održivi  razvoj.  ʺpametna  investicijaʺ znači ulaganja u istraživanje i razvoj (r&d), kao i ulaganja u obrazovanje iz javnih i  privatnih  izvora  finansiranja. u cilju podsticanja  investicija u aktivnosti  istraživanja  i razvoja od  strane  privatnog  sektora,  preporučuje  se  korišćenje  javno‐privatnog  inovativnog  partnerstva   (direktan način), kao  i šire upotrebe poreskih podsticaja za  istraživanje  i razvoj (indirektan način).  kako poreski pristup istraživanju i razvoju ima jak uticaj na donošenje odluka, ovaj rad će se baviti  različitim  r&d  poreskim  (računovodstvenim)  modelima  i  njihovom  uticaju  na  finansijske  performanse preduzeća.  kako  je  bosna  i  hercegovina  prihvatila  međunarodne  računovodstvene  standarde  (mrs)  i  međunarodne standarde finansijskog izveštavanja (msfi) kao svoj računovodstveni okvir, ovaj rad  će ispitati adekvatne mrs i msfi u cilju identifikovanja ʺpozitivnihʺ ili ʺnegativnihʺ efekata svakog  r&d poreskog modela, radi pravilnog finansijskog tretmana ovih aktivnosti u preduzećima.  opšti cilj ovog rada  je da odgovori na pitanje: koja model poreskih subvencija za  istraživanje  i  razvoju bi bio najprikladniji za bih, poštujući sadašnji pravni i računovodstveni okvir, kao i troškove i  koristi svakog preporučenog modela?    ključne reči – računovodstveni tretman aktivnosti r&d, računovodstvena analiza, r&d  poresko planiranje i stimulansi, obim i porast r&d baziran na subvencijama, korporacijski porez kao  stimulans r&d aktivnosti.        article history:  received:  15 july 2011 accepted:  21 september 2011          professional paper    general characteristics, role and importance of international  marketing information system  stanetić vedran*, institute of economics ad banja luka  bosnia and herzegovina   udc:  339.138   jel: m31; l22; f23  osnovne karakteristike, uloga i značaj međunarodnog  marketinga informacionih sistema abstract –  information  flow  from  the company  to  the market, and contrary also, enables  effective communication of the subject with the environment. formalizing and directing that kind of  flows emanates information systems. the task of such systems is constantly refreshing the content of  the information flow. this ensures that company`s decisions, which would be undertaken, are adequate  and in the right time. information systems find their application in almost all areas of business. maybe  the most  interesting of them are marketing  information systems. however, such systems are often  considered a substitute for marketing (market) research, or if there are undertook marketing (market)  research,  then  there  is no need  for marketing  information  system. this  paper  seeks  to prove  the  opposite, that these two concepts are not identical, and therefore not mutually exclusive but rather  complementary and compatible. since the operations of business entities are  increasingly becoming  regional  or  global,  that  makes  sense  to  talk  primarily  about  international  marketing  information  systems. local business levels should be regarded only as a fragment of the total portfolio of markets.  the  last statement  is valid especially  if  the domicile market  is not sufficiently  large  for profitable  production or if it is under‐developed    key  words:  information  systems,  market,  marketing,  information,  marketing  research,  international environment  characteristics of international marketing information system  definition of international marketing information system  it is not an easy task to give a comprehensive and complete definition of international  marketing information system (imis), which would be easily understood at the same time.  defining difficulties arise  from  the complexity of  the aforementioned system,  interwoven  elements  that  make  up  the  imis,  their  entanglement  and  complementarity  with  other  activities in the enterprise, as well as understanding the role and importance of the imis. in  order to understand properly the meaning of the imis it is recommended to start with the  etymological  analysis  of  the  imis  concept.  the  compound  ʺinternational  marketing  information  systemʺ  will  be  briefly  analyzed  word  by  word  ʺsystemʺ,  ʺinformational,ʺ                                                         * address: krfska 94, 78000 banja luka, republika srpska, bih; e‐mail: vedranstanetic@ekinst.org,  staneticv@yahoo.com     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   70 ʺmarketing,ʺ  while  the  adjective  ʺinternationalʺ  is  in  brief  content  analyzed  through  the  entire text.   it is important to understand correctly the meaning of the word ʺsystemʺ because it is the  basis  for  not  only  a  imis,  but  also  any  other  form  of  organization.  according  to  efraim  turban, ephraim mclean, and james wetherbe (1999, pg. 40, 41) a system is a collection of  elements,  such  as:  people,  resources,  concepts  and  procedures,  intended  to  perform  an  identifiable  function  or  serve  a  goal.  a  system  is  separate  from  its  environment  by  a  boundary.  the  system  is  inside  the  boundary,  whereas  the  environment  lies  outside.  in  short, the system is determined by elements, its tasks and purpose, as well as the limits that  can be very abstract. especially interesting are the systems that collect and process various  kind of information. information system (is) of enterprise is defined as a set of human and  technical means that, with a certain organization and methodology, perform the collection,  storage, processing and disseminating to the use of data and information (lazo roljić, 1997,  pg. 23). is can be represented graphically by the diagram as follows:    figure 1. schematic view of the information system    inputs    processing outputs  business  problems:  data  information  instructions  opportunities  programs  people  equipment  storage    solutions:  reports  graphics  calculations  voices  tactics                control     feedback decision makers  auto‐control                     source: turban, mclean, and wetherbe (1999, pg. 18)  in  the  previous  figure  is  shown  that  the  tasks  of  the  is  are  to  collect  and  process  information,  which  goal  is  to  create  information  reports  for  different  purposes.  the  information system is a system that is oriented to decision making information.  classification of is in companies can be done in various ways. is can be classified taking  into account four main aspects: the organizational level, functional area, provided support,  system architecture, etc. however, regardless of classification, the structure of is is the same  and  consists  of  the  previously  mentioned  elements.  for  this  paper,  the  most  interesting  classification of is is based on the division of functional areas in the companies. besides to  marketing is, there are also: accounting is, financial is, manufacturing is, human recourses  is and the like. also, for purpose of this paper it is important only formal is, as opposed to  informal whose study is more in the field of operating management, or sociology.  in order to understand properly the marketing information system, it is needed to start  with  the  concept  of  the  marketing  system.  the  essence  of  the  marketing  system  is  the     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   71 information flow between producers and consumers. the flow of these data is twofold. data  from consumers go  to  the manufacturer. the content of  this data  include: needs, desires,  preferences and problems, and it is defined as the purchasing power demand. on the other  hand, information circulate from the manufacturer to the consumers and the content of this  data is about its mission, goals and tasks, in other words information about marketing plan  and program  ‐ defined as an offer. the process of communication between company and  customers  is  needed  to  ensure  that  market  exchange  would  be  performed  without  complications and to mutual satisfaction. this means that the consumers will satisfy their  needs, meet  their desires, solve  their problems and remove  the  tension; and, at  the same  time, the company will make a profit with lasting affection by consumers. as could be seen,  the marketing system is very complex, and when it is added to the information system leads  to more complex systems.  to generate a continuous flow of appropriate information is an essential task of imis. the  environment of the company is subject of constant change. these changes are particularly  evident  in  the  international environment. imis goal  is  to create an optimal database as a  basis for effective marketing management. there are two basic tips to keep in mind when  observing the imis that are continuous flow of data collection and international environment  as inevitable element in a globalized business world.   the  main  task  of  imis  is  an  ”intelligenceʺ.  intelligence  refers  to  the  gathering  of  information from decision‐making system`s environment and exploring that information in  an  effort  to  recognize  the  existence  of  problems  (gilbert  a.  churchill,  1991,  pg.  28).  therefore, the tasks of the imis are to continually survey the widest surrounding, to collect  general data that is even few suspected that might be of importance for the system, further  processing of these data, then thoroughly explore, and try to determine whether these data  represent or suggest changes in the environment that could be a threat or an opportunity for  the reference system. when it is concluded on the basis of such ʺgeneral informationʺ and  using ʺinsightʺ that there are threats or chances in environment, such information is further  transferred to a higher level of decision making.   when it comes to comparison between marketing information system (mis ‐ referring to  the information system oriented toward the domestic market only) and imis, the conclusion  is  the  same  as  the  comparison  between  domestic  and  international  marketing  research.  looking evolution through time first have came mis. however, the issue of performance is  not a matter of chronology rather than rationality. the broad framework of observation, or  more  statistical  populations,  theoretically  creates  a  greater  chance  of  optimal  choice.  the  practical significance of imis, in a liberalized and the changing business world, is increasing.  the need for a systematic approach to information collection and dissemination in the field  of  international  marketing  is  conditioned  by  the  weaknesses  that  are  typical  for  most  companies. according to boris tihi (2003, pg. 320) those weaknesses can be summarized as  follows:  • there are many information, concerning various aspects of market problems, but  the lack of a system that would select and direct that information force decision‐ makers  to  take  unsystematic  “information  hunt”  in  making  any  specific  marketing decisions;     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   72 • above mentioned “hunting” takes place in the business environment and within  an  entity,  and  a  result  of  unsystematic  work  is  the  fact  that  many  valuable  information are losing within the organizational structure of a subject;  • what  makes  situation  more  difficult  is  that  a  lot  of  information  are  often  not  formally recorded, information are kept in minds of individuals who sometimes  jealously keep information for themselves believing that it could ‘’increase their  authority’’ in some situations;  • late arrived information at the decision making place are practically worthless;  • due to unsystematic data collection and use of different sources of information, it  is difficult to assess the degree of reliability, which is an essential precondition for  the quality of decisions.  the only applicable way to solve the mentioned to solve the mentioned problems is a  systematic approach. one of the possible systematic approaches to the problem mentioned is  by  imis. the emphasis  in  these systems must be on determining  the precise  information  needs  of  each  marketing  decision  makers.  this  ensures  that  they  have  exactly  the  information they need, when they need them, to make the decisions that they have to. it is  not  easy,  but  it  is  possible  knowing  what  characterize  quality  and  developed  imis.  for  indicators of the quality and development of information activities miodrag jovićević (2001,  pg. 161) takes the following:  • the  time  between  the  moment  of  emerging  and  the  moment  of  noticing  a  problem;  • sources of data and information – to be known in advance and to provide data  and information of current, future and historical character;  • quality of data and information – reliability, accuracy and authenticity;  • procedures and programs of data and information processing – to be known and  provided  in  advance,  that  we  know  what  the  relationships  and  the  degree  of  abstraction of the past and the future projection;  • knowledge – a  fundamental prerequisite  for solving problems and conducting  informational activities.  content of an international marketing information system  within  a  imis  comes  to  generating  information  necessary  for  strategic  and  tactical  decision‐making in an international environment. for a better insight into complex structure,  and for the completeness and clarity, content of imis will be shown as a picture. this ensures  a complete overview of the elements and relationships between elements of a imis.  on  the  next  figure  is  shown  the  content  and  structure  of  elements,  and  a  connection  between  them  in  imis.  the  system  consists  of  three  essential  parts:  the  information  component,  processing  of  collected  data  and  the  application  of  the  imis.  information  components are included in the imis in the form of internal, external and other data. based  on the data collected, it is necessary to apply the methods of sorting, processing, analysis and  synthesis.  the  resulting  information  are  input  in  the  subsystemʹs  tasks  of  imis.  what  is  important to emphasize and what is not shown in the previous figure, is a feedback. data  and  information  regarding  the  purpose  and  quality  of  the  imis  application,  or  decisions     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   73 made  on  the  basis  of  information  obtained  through  imis,  have  to  become  one  of  the  components of information or re‐entry to miss.    figure 2. international marketing information system    information  components    issues in the data  aggregation process  applying the  international  information system    external data              macroenvironmental  information      data      scaning the global  environment                comparability        infrastructure  data               allocating resources                         synthesizing and      market size and  structure                            data input               interpreting data    monitoring company  performance    internal data        updating and  maintaining        company sales and  market performance    system      transfer of ideas and  experience           source: samule c. craig, and susan p. douglas (2005, pg.423)     the functioning of the international marketing information system  for successful operation of a imis is necessary to exist three sub‐systems shown in the  second  figure.  in  the  following  text  will  be  briefly  analyzed  each  of  the  subsystems  and  connections between them.  information components – source of the required data is the basis of the work of any of  information system. all data sources, from the point of origin can be divided into external,  internal and other sources.  external data are: macroeconomic indicators, data on infrastructure, as well as data on  market  size.  data  about  macro‐economic  situation  in  individual  countries,  regions  or  globally, could be only the secondary. the most complete such information can be found in  the database of: un, world bank, oecd economic indicators, eurostat and the like, as well  as  on  the  websites  of  other  institutions  that  monitor  such  indicators.  data  on  market  infrastructure  can  also  be  geographically  structured,  for  example:  globally,  regionally,  nationally, and locally in the cities, depending on which the target market is. these are data  about  the  media  infrastructure,  for  example:  electronic  media,  print  media,  outdoor  advertising  media  (billboards,  posters,  etc.),  and  retail  infrastructure,  e.g.:  type  of  organization and structure of retail organizations and wholesale  legislation,  the nature of  competition  and  the  like.  data  about  company`s  products,  about  market  size  and  it`s  structure, as well as alternative and complementary products can be found in databases. it is     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   74 important that the product`s market would not be too narrowly defined. therefore there is  the need to collect and analyze data on complementary and substitute products.  internal data are contained within the company itself. these data are relating to: financial  indicators (for example roa, roe, etc.); market indicators (for example market share, sales  costs,  increased  sales  by  individual  product  lines  and  the  like);  data  about  employees  (example fluctuations, the emergence of new professions of interest to the company, etc.);  data obtained through the marketing research studies (for example research centralized or  organized for particular target markets and the like).   other  data  sources  can  be  divided  into  two  groups:  people  as  a  source  of  data  and  observation  of  physical  stimuli  as  another  data  source.  people  could  create  and  transfer  ideas,  experiences  and  knowledge  within  the  organization,  or  between  world  or  region  markets. they create and transmit information to each other. such communication occurs in  the  oral  and  written  form,  staff  meetings,  teleconferencing  and  so  on.  also,  this  communication can be separated to the internal, within the same enterprise, and external,  communication  with  sales  representatives,  managers  from  other  countries,  promotion  agencies, distributors and so on. a complete picture about same market could be obtained  only by visiting that market, observing it and talking with customers and business partners,  looking  at  shopping  habits  and  the  type  of  retail  outlets,  monitoring  advertisements  on  electronic and print media,  looking at weather conditions, geographical terrain, quality of  transport infrastructure and the like.   issues in the data aggregation process – imis could not function  ideally  just on the  basis of data collected. there are also some technical problems, for example: quality of data  collected, data entry, constantly update the content of the data collected and the like. the  quality of data collected depends on the possibility to make comparisons with data collected  in other countries. this problem is usually related to the existence of different data collection  procedures, as well as different accounting practices between countries and regions of the  world.  data  are  presented  in  units  of  measure  that  can  be  quantitative,  qualitative  and  monetary  indicators  (e.g.  goodwill).  quantitative  measures  generally  are  not  a  problem.  however, monetary measures are subject to strong and rapid changes due to: changes  in  exchange  rates,  price  fluctuation  on  stock  exchanges  or  other  markets,  changes  in  fiscal  policy of the observed countries, or due to changes in the ways of their calculation. entering  data procedures define the degree of similarity and type of data to be collected to be useful  for  the  system.  there  have  to  be  defined  by  whom  and  how  to  enter  data  within  the  enterprise,  in  order  to  make  collection  procedures  more  successful.  also,  it  have  to  be  defined  how  to  change  data  presentation  to  make  them  comparable.  this  is  particularly  important  for data coming  from external sources. data  issued by  the un or world bank  generally  do  not  have  mentioned  problems  because  those  data  usually  cover  the  entire  world, and their parameters are either global or highly standardized for certain regions or  countries. the problem is with a regional or national data. these problems are reflected in  different ways of: collecting, sampling, systematization, generalization of data and the like,  to  the  language  of  presentation.  it  is  necessary  to  ensure  that  the  system  continuously  collects new data and to processes them. the processed data are synthesized, in other words  those  processed  data  are  the  basis  for  drawing  conclusions.  new  information  should  be     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   75 compared with previous ones and, in the case of difference, investigate the difference and  inform management. the system should be constantly maintained and serviced.  application (tasks) of imis – by roche (as cited in craig and douglas, 2005, pg. 434),  imis  is used  in performing  the  following  four  tasks: scanning  the global environment  to  monitor trends and pinpoint those with specific implications for the geographical areas and  product markets  in which the company  is  involved, assessing how to reallocate resources  and efforts across different countries, products markets and target segments so as to achieve  desired rates of growth and profitability, monitoring performance in different countries and  product markets through  the world, and transferring  ideas and experience from different  countries and areas of the world throughout the organization.  feedback – even  if  it  is not shown  in the previous figure, the  importance of feedback  should be particularly emphasized. through the previous analysis of imis it is mentioned  the  importance  of  re‐entry  of  data  into  the  system.  the  information  flow  in  imis  is  continuous. this is a fundamental feature of the marketing information system that ensures  the  quality  of  marketing  decisions  (momčilo  milisavljević,  1999,  pg.  62).  based  on  the  information collected and create through the imis, the company affects its environment. the  environment  reaction  creates  a  new  situation.  new  data  from  changed  environment  represents a new entrance into the system. in that way a company gets a feeling about the  success of implemented decisions, and the effectiveness of an imis, which in turn should be  constantly creating new, more favorable business conditions for the company.  the process of international marketing research in the absence of an international  marketing information system  the  relationship  between  international  marketing  research  and  imis  has  to  be  understood  as  a  relationship  of  complementarity  rather  than  equality  or  competition.  although  they have  the same goals and similar  tasks, ways of achieving  these goals and  tasks  are  based  on  different  grounds.  this  reflects  theirs  complementarity.  international  marketing  research  project  usually  occurs  when  a  company  finds  the  problem  that  often  needs to be urgently solved. that leads to an emphasis on data collection and analysis rather  than on the development of the formal and regular collection of information. therefore, the  main  difference  between  the  research  project  and  the  system  is  in  time  and  speed  of  execution. the research project appears in times of crisis, so from time to time and as rarely  as possible. on the other hand, the data collection process is ongoing, or the keyword in the  definition  of  marketing  information  system  is  ʺregularʺ,  since  the  emphasis  in  marketing  information system  is  the establishment of systems  that produces  information needed  for  decision making on a recurring basis (churchill, 1991, pg. 24). however, the project must be  completed as soon as possible due to the fact that the duration of the crisis only exacerbates  the situation of the entity which drives the research project. the system of data collection,  since it is a continuous process, has enough time to conduct quality research and make the  necessary analysis.  another important difference relates to the scope of research. considering that the study  (project) of research is conducted in a relatively short period of time, it is very often that so  called preliminary (investigative or orientation) research is neglected. according to the tihi     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   76 (2003,  pg.  83)  preliminary  research  is  a  way  to  get  an  information  that  is  not  strictly  formalized, as is the case with detailed research based on the plan drawn up in advance, and  therefore this type of study is called investigative. the ultimate goal of investigative research  is obtaining the necessary prior knowledge of the specific problem in a rational manner. it is  a  preceding  surveys  and  it  is  based  only  on  secondary  data.  in  preliminary  studies  are  commonly used four methods shown in the following figures:    figure 3. the four methods of preliminary research        research of existing literature            studies of previous experience  preliminary research          analysis of selected cases            pilot studies          sources: tihi (2003, pg. 84)    the figure shows a structured review of methods of preliminary research. the first and  basic  method  of  search  is  to  use  available  literature:  books,  magazines,  newspapers,  databases  accessible  through  the  internet,  libraries,  statistical  publications,  regular  information services for marketing research and the like. also, the use of othersʹ experiences  much  simplifies  and  cheapens  investigation.  therefore,  it  is  necessary  to  collect  other  experiences: field vendors, consultants, engineers and specialists, consumers and customers,  competitors and so on. the third method is based on learning through case studies. it is a  realistic analysis of some past or current problems and opportunities facing a company. the  last  method  of  preliminary  research  is  a  pilot  studies.  these  are  informal  methods  of  communication with customers through which could be know the motives and opinions of  consumers. preliminary research is especially important to a large international marketing  research projects. many of the facts, opinions and attitudes, which are already well known in  the domestic market, we have to find out when we come to another market. therefore, the  phase of preliminary research is almost obligatory in these cases and requires the collection  and analysis of numerous and diverse data (tihi, 2003, pg. 397).  the  third  difference  between  the  market  research  in  general,  and  therefore  the  international marketing research and imis is contained in the following assertion: the task of  marketing  research  is  to  provide  information,  while  the  marketing  information  system  focuses on the routing of information flow  in the direction to those who make marketing  decisions.  this  distinction  is  important  because  the  information  is  completely  worthless  unless  it  is  relevant  and  is  effectively  communicated  (geoff  lancaster  and  lester  massingham, 1997, pg. 333). previous  thesis  is based on  the kotler`s model of marketing  information  system,  where  marketing  research  is  treated  as  a  subsystem  of  marketing  information system (philip kotler, 1999). in this system, marketing research is conducted on  behalf  of  marketing  information  system.  all  obtained  information  are  analyzed  and  compared  with  information  gathered  from  internal  sources  of  the  company,  as  well  as     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   77 scanning the environment. thus the final information has high value and reliability because  it has been checked and confirmed many times. from the prior discussion could be seen how  the international marketing research methodology would be quite poor and the less reliable  if it is not combined with imis. their combination is a superior way of gathering reliable  information.  this  is  a  sure  path  to  successful  decision‐making  and  management  in  international marketing.  compatibility of international marketing information system with international  marketing research  compatibility analysis  according to jovićević (2001, pg. 129)29 compatibility could be determined as a situation  in which two or more objects (procedures, methods, goals, programs, ideas, etc.) can coexist  within one, as a part of the same system, so that the existence of one does not preclude the  other. some studies have shown that managers do not know what information to request for  researchers  and  analysts.  they  know  only  what  is  available.  experience  from  local  and  international business practice show that many companies do not have established market  research systems or the systems are reduced only to routine predictions based on empirical  cognitions or to analyzing of historical data (hasan hanić and čivić beriz, 2009, pg. 43). this  problem could be overcome by efficient functioning of imis. it provides, among other things,  the survey of the international environment and general information in form of intelligence.  on  the  basis  of  such  general  information,  managers  can  identify  important  threats  and  opportunities  in the environment, and how it fits  into the strategy and other plans of the  company. thus they are able to know exactly what information they need, and such, in this  case, detailed  information should be required of analysts and researchers of  international  marketing.  such  detailed  information  could  be  provided  by  comprehensive  international  marketing research. above mentioned is most easily represented graphically as follows:    figure 4. relationship between marketing research and marketing information system                                      sources: tull, hawkins, 1987, (as cited in tihi, 2003, pg. 325)                                                           29 similar milan vujaklija. (2002).; grupa autora, (1994, pg. 638)   environment    internal data  external data     marketing  research      decisions                       requests      information     instruction      marketing  managers    periodic information  monitoring  information  requested  information    mis        feedback         economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   78 figure 4 shows the relationship between marketing information system and marketing  research,  as  well  as  their  relationship  with  marketing  managers  and  the  environment.  previous  paragraph  depicted  an  explanation  of  such  relations  in  the  international  environment.  a slightly different relationship between marketing information system and marketing  research  is  shown  in  the  third  kotler`s  model  (philip  kotler,  1999).  in  that  model,  a  marketing research system, as a subsystem of marketing information system, is integrated  into the whole system together with the other three subsystems. according to the mentioned  model,  a  system  of  marketing  research,  in  union  with  the  system  of  internal  reports,  marketing information system and system‐analytical marketing, is working on collecting and  converting  data  from  the  internal  and  external  environment  into  information  useful  in  making decisions.  according  to  that model,  international marketing  research  is  part  of  a  larger system – marketing information system. this is clear evidence that those two systems  do not overlap. if it is provided that they are integrated into a higher system and the system  is properly organized, than there is no overlapping goals and responsibilities in their mutual  existence, as well as excessive spending organizational resources.  all of these on the relationship between imis and international marketing research could  be circled by the following heinzelbercker`s (1977) statement (as cited in hasan hanić, 2003,  pg.  599):  in  the  last  two  or  three  decades  market  research  is  developed  in  three  complementary  directions  which  represent  paths  from  traditional  marketing  research  till  marketing information system. they are characterized by:  • orientation to the method,  • orientation to the decision‐making,  • orientation to the system.  it  is  expected  that  the  integration  gap  between  marketing  research  and  marketing  management will soon be eliminated thanks to the system orientation of marketing research.  affirmation of systematic approach in marketing has led that a trends in marketing research,  method and decision making oriented, connect with each other, simultaneously providing  the missing link ‐ organization of the whole range of marketing information in relation to the  needs of marketing managers for information. this attitude becomes clear by following bellʹs  (as cited in hanić, 2003) stating: although the market research continually modernize and  make it more relevant for management problems solving, because of the narrowness of its  functions it is, unfortunately, inadequate to fully satisfy the information needs of marketing  staff. due to concerns about implementation of marketing research techniques, researchers  were unable to resolve a number of information problems in a company. as marketing has  become more complex, there was a need to expand its functions in order to provide greater  quantity and higher quality of information. application of marketing approach has led to the  development of marketing information systems. systematic orientation in marketing has led,  therefore,  to  the  knowledge  that  traditional  market  research  should  be  seen  as  part  of  a  larger marketing  information system. according  to hanić  (2003, pg. 602) development of  marketing research toward marketing information systems enabled:  • marketing  research  orientation  to  the  needs  for  information  of  marketing  management.     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   79 • continuously collecting of external information – marketing information system  contributes to the elimination of the situation in which are the most continuously  collected only internal information, while the collection of external information is  made by ad‐hoc marketing research with a defined beginning and end, concerning  a particular project. marketing managers need a marketing  intelligence system,  which would be ʺtailoredʺ to suit their needs.  • to organize total it activities in the marketing – marketing information system  should be structured so that decision‐making processes is supported by organized  flow of relevant information from sources that are in the company and outside it.  based on the presented analysis, it can be said that international marketing research and  imis  not  only  compatible  but  also  complementary,  i.e.  they  complement  each  other  to  achieve the common goals at a higher level.  identified savings due to the compatibility  from  the  analysis  above  it  is  clear  that  by  combining  and  complementing  imis  and  international marketing research are generating a new quality, which in itself contributes to  the  efficiency  and  savings  for  business  enterprises.  effective,  i.e.  well  structured  and  rationally organized international marketing information system, according to hanić (2003,  pg. 598), provides multiple benefits:  • provide more information in the time unit.  • allows to achieve the same  level of satisfaction for  information needs at  lower  cost.  • helps to large and decentralized companies to integrate information scattered in  smaller organizational units into a meaningful whole.  • provide a basis for effective application of the marketing concept – contributes to  enlargement of the overall marketing productivity of companies.  • enables faster identification of trends in the marketing environment.  • it enriches the analysis.  • provides  optimal  decision‐making  –  developed  and  cultivated  marketing  information system contains a bank of models which help marketing managers in  making optimal decisions.  • provides better control of marketing plans and actions implementation.  • provides data protection.  to the previous list it could be added the removal of redundancy as one more benefit.  avoid redundancy means saving time and unnecessary costs in obtaining information. in the  case of international marketing research, the imis should be considered a benefit gained by  its existence and costs arising from its organization and operation. although there are some  general  indication  about  usefulness  of  the  existence  and  functioning  of  the  imis  and  international  marketing  research,  in  each  case  it  should  be  re‐checked  their  opportunity.  only in a case of their synergetic effect their combination justifies their purpose. therefore,  to determine  the exact savings  in  the coexistence of  international marketing research and  imis depend upon the situation, or a planned project.     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   80 conclusion  international  marketing  information  system  is  a  complex  system,  within  the  organizational  structure,  focused  on  information  flow  from  a  company  towards  the  environment and vice versa. imis should integrate, lead and organize all communications  between company and the environment. this communication should not be limited to data  and information on supply of enterprise and demand from customers, but it should include  all  forms  of  information  that  could  be  used  in  company  decision  making,  and  better  informing  consumers  before  the  act  of  buying.  in  that  case,  the  company`s  environment  should  be  widely  seen,  that  takes  information  from  all  or  most  of  the  world  market  by  various market segments, other industries, various centers of decision‐making and the like.  collecting and processing data and information, and submission of processed information in  decision‐making must be timely. this provides rationality in business decisions making. the  tasks  of  the  imis,  in  addition  to  the  above,  are  monitoring  of  business  performance  of  organizational units of enterprises in various markets, as well as the transmission of ideas  and  experiences  from  other  countries  and  regions  of  the  world  to  the  organization.  relationship  between  marketing  research  and  imis  are  characterized  by  mutual  complementarity  and  compatibility.  their  complementarity  is  reflected  in  the  fact  that  marketing research is detailed and targeted at solving specific problems. unlike marketing  research, which takes place periodically and with limited duration, the information flow in  the imis is permanent and without a defined time period. from the mutual complementarity  and compatibility between imis and international marketing research, derives cost savings  for a company that strives to constantly observe its environment, thoroughly research and  identify  potential  problems,  timely  decisions  making  and  monitor  the  results  of  those  decisions. timely response to identified and explored, existing and potential problems, that  the company meets, creates a greater benefit than the cost of implementation and operation  of a imis. on the other hand, the elimination of consequences of bad or overdue decisions of  the  company,  in  terms  where  do  not  exist  a  imis,  creates  more  costs  than  the  costs  of  implementation and operation of a imis. because of all this it could be concluded that the  imis should take a more important position in the organizational structure of companies that  are proactive and market‐oriented.  references   cateora,  philip  r.,  and  graham,  john  l.  (2007).  international marketing.  13th  edition,  mcgraw‐hill  irwing, new york  churchill, gilbert a. (1991). marketing research – metodological foundations. fifth edition, the dryden  press  craig, samule c., and douglas, susan p. (2005). international marketing research. john wiley & sons  ltd. england  galogaža, milan. (1998). principi marketinga, knjiga prva i druga. copyright by milan galogaža, novi  sad  grupa autora. (1994). ekonomska i poslovna enciklopedija. savremena administracija, beograd  hanić,  hasan.  (2003).  istraživanje  tržišta  i  marketing  informacioni  sistem.  ekonomski  fakultet  beograd, beograd     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   81 hanić, hasan and beriz, čivić. (2009). “specificities of online concept in comparision with a classic  concept of marketing research.“ economic analysis, vol. 42, no. 2009/1‐2s: 43‐52.  harvard business review. (1991). “marketing research – the right way”, harvard business review  paperback no. 90061  jovićević miodrag. (2001). informacija i odlučivanje. univerzitet crne gore podgorica  kotler, philip. (1999). upravljenje marketingom, informator zagreb  kumar, v. (2000). international marketing research. prentice‐hall inc. new jersey  lancaster geoff i massingham lester. (1997). menadžment u marketingu. ps grmeč, beograd  macura, perica. (2000). sistem informacija promocije. glas srpski, banja luka  milisavljević, momčilo. (1999). marketing. univerzitet u beogradu, ekonomski fakultet  rakita, branko. (2003). međunarodni marketing. ekonomski fakultet beograd  roljić, lazo. (1997). osnove informatike. univerzitet u banjoj luci, poljoprivredni fakultet banja luka  tihi, boris. (2003). istraživanje marketinga – peto izmjenjeno i dopunjeno izdanje sarajevo. «dom štampe»  zenica  turban,  efraim,  mclean,  ephraim,  and  wetherbe,  james.  (1999).  information  technology  for  management. john wiley & sons inc.  vujaklija, milan. (2002). leksikon stranih reči i izraza. izdavačko preduzeće prosveta, beograd        apstrakt – protok informacija od kompanije prema tržištu, i obrnuto, omogućava efektivnu  komunikaciju  subjekata  sa  okuženjem.  formalizaciju  i  usmeravanje  informacija  omogućava  informacijoni  sistem. suština  funkionisanja  sistema  se odnosi na neprekidno osvežavanje  sadržaja  informacionog  toka,  što  pruža  mogućnost  preduzećima  za  pravovremeno  donošenje  odluka.  informacioni sistemi nalaze primenu u gotovo svim oblastima poslovanja. između ostalih,  jedan od  najinteresantnijih je marketinški informacioni sistem, koji se često smatra substitutom marketinškog  istraživanja (tržišta). njegova upotreba se često percipira nepotrebnom ukoliko se aktivno učestvuje u  istraživanju  tržišta.  cilj  rada  je  da  dokaže  suprotno,  tj.  da  ova  dva  koncepta  nisu  identična  i  međusobno  isključiva,  već  komplementarna  i  kompatibilna.  kako  poslovanje  sve  više  teži  regionalizaciji  i  globalizaciji,  aktuelnost  međunarodnih  informacionih  sistema  dobija  na  značaju.  poslovanje na lokalnom nivou treba posmatrati isključivo kao fragment ukupnog tržišnog portfolia,  naročito  ako  domaće  tržište  nema  potrebne  kapacitete  za  profitabilnu  proizvodnju  ili  ako  je  nerazvijeno.     ključne reči: informacioni sistemi, tržište, marketing, informacije, marketinško istraživanje,  međunarodno okruženje        article history:  received:  27 july 2011 accepted: 25 october 2011        review    book review  organizational behaviour and culture:   globalization and the changing environment  of organizations    edited by  professor mirjana radovic‐markovic      in  this  review  we  introduced  a  book  „organizational  behaviour  and  culture:  globalization  and  the  changing  environment  of  organizations“,  published  by  vdm  verlag  dr.  müller e.k ,germany, in july 2011.   the book represents a unique responses on a very actual and  generally  known  issues.  radovic‐markovic,  m.  in  forward  pointed out that this book focuses on a body of knowledge that  balances  and  requires  that  many  disciplines  should  be  brought  together  to  create  a  contemporary  approach  to  organization  behavior  and  transformation  (of  both  organization  and  the  individual) in a changeable business environment. her intention  as a book editor was  to explore the organization behavior, culture  and strategies relating to effective organizational and managerial performance.  at  the  micro  level,  it  covers  topics  such  as  organizational  behaviour,  organizational  changes  and  restructuring  of  entities.  on  the  other  hand,  the  book  deals  with  terms  of  organizational culture and behaviour examining their impact on economic development and  sustainable growth, when concerning macro level of investigation. these issues, due to the  financial crisis and rapid changes in global economic environment, became very important  for every economic entity.    the book consists of five parts. the first part, entitled globalization, organization behavior  and culture, deals with the issues of organizational behaviour, gender gaps and the influences  of  organizational  culture  on  enterprises  organizational  structure.  in  the  first  chapter,  organizational behaviour in a global context: gender issues, professor radovic‐markovic  stresses  two  most  important  issues  that  are  essential  for  all  modern  companies.  first  is  changes management, that requires from the company to frequently change its strategy and  structure in order to stay competitive in global economy. the second one, cultural diversity,  became  one  of  ordinary  problems  that  companies  in  transition  economies  face  in  recent  years. managing cultural diversity is one of the most important factors of competitiveness  nowadays. gender gap problems, radovic‐markovic addresses, still exist in modern times.  women in eu, earns on the average, 15% less than men (page 18). their participation in top     đukić, m., et al., book review, ea (2011, vol. 45, no. 3‐4, 82‐85)   83 management levels is also significantly lower. therefore, it is on economic policy creators to  find mechanisms for women equal access to economic and financial resources. as radovic‐ markovic  suggest,  female  entrepreneurship  is  one  of  the  major  factors  that  contribute  economic growth  in many developing countries. in the second chapter, ondrej jaško and  ana  jaško examined  the  influence of organizational culture on enterprises organizational  structure.  organizational  model  creation  is  highly  dependent  on  different  cultures  by  determining  business  strategy,  leadership  style,  motivation  etc.  when  evaluating  work  performances  it  is  necessary  to  consider  whether  corporate  culture  is  well  designed.  however, as the authors mentioned, this field is still not enough explored in modern papers  and there is lot of space for further investigations.   second  part  of  the  book  focuses  on  individual  organizational  aspects  such  as  communication  and  motivation  problems  in  modern  companies.  in  the  third  chapter,  managing  communication  in  changeable  business  environment,  authors  present  theoretical  approaches and importance of good communication for companies as well as for managers.  it is intuitive that good communication is vital part of every successful business. but, it is not  always easy to provide efficient communication to achieve coordination and integration of  organizational units on different levels. it is up to managers to provide good communication  using  proper  communication  techniques  of  oral,  or  nowadays  electronic  communication.  when considering environment, things become more complicated since we can do almost  nothing to control it. communication is very related to other management and organization  concepts.  chapter  four  observes  connection  between  communication  and  motivation.  professor  chambers  explores  how  communication  and  motivation  work  together  and  provides tactics as a some kind of guide for managers how to motivate their employees. she  suggests managers to be enthusiastic and friendly oriented toward their employees. people  included  in  projects  need  to  be  well  informed  about  project  progress  and  know  exactly  predicted  rewards  system.  creating  clear  short  term  and  long  term  goals  as  well  as  reasonable deadlines are also considered as tremendously important. considering all these  advices  good  communication  figures  as  a  key.  all  mentioned  concepts  are  developed  in  order to provide formula of business success. professor simandan developed theories that  explain success from completely different point of view. he investigated correlation between  geographical and  interindividual differences and outstanding entrepreneurial success. his  conclusion is that intelligence as well as place one grew up are from exceptional importance  for business success. however, he underlined, only by exploring one’s potentialities, one can  learn  the  things  one  is  good  at.  this  uncertainty  is  pure  wealth  for  him.  conclusions  obtained,  by  simandan,  should  be  motive  for  engaging  more  people  on  the  path  of  entrepreneurship.   in  the  third  part,  the  organizational  context,  readers  will  discover  a  lot  of  interesting  concepts and empirical findings that can be very helpful for understanding nature of modern  organizations.  cvijanovic  and  lazic  considered  importance  of  adequate  macro  organizational  restructuring.  once  created  organizational  entities  have  vertical  and  horizontal  connections.  linking,  dynamisation  and  coordination  within  macro  organizational entities represents a necessary macro organizational structure and it is often  called „harmonization“. the authors stress that modern company is doubtless in need for  performing periodical harmonization through soft structural modalities. as examples they     economic analysis (2011, vol. 45, no. 3‐4, 82‐85)   84 address  work  groups,  collegiate  boards,  commissions  etc.  this  means  need  for  behavior  harmonization too, both direct (through the chosen form), and indirect (through the chosen  model).  in  this  context,  stress  is  also  considered  as  one  of  the  objective  conditions  in  everyday business. in order to improve efficiency as much as it is possible, leaders sometime  increase stress level of their employees. respecting this issue, krumov, larsen and hristova  formulated several hypotheses to test impact of leadership styles on stress experienced by  employees. obtained results indicate the following:   • that demographic characteristics (gender, age, education, family status, number  of children in the family and total length of service in the organization) influences  strategies for coping with chronic stress.  • there are significant correlations between leadership style and perceived stress of  the employees in organizations.  • there are correlations between the leadership style and the strategies for coping  with the stress of the employees.  • the  respondents  perceived  stress  and  the  leadership  style  of  their  leaders  determine the desirable strategies for coping with professional stress.  authors summed up that, especially in time of crisis such as recent global financial crisis,  companies not led by ego‐based charismatic leaders do better than the average on the stock  market.  as  well  as  knowing  itself,  modern  and  competitive  company  need  to  be  future  oriented trying to predict future events and moves of their competitors. recognizing that  managers are often myopic concerning competitors and competitors moves are not always  rationally predictable, drossos and fouskas tried to develop conceptual model that will help  analyzing  competition  and  making  strategic  decisions.  by  their  findings,  successful  competition  analysis  should  include  w1  (sufficient  identification  of  competitors),  w2  (organizational  learning  from  competitor’s  strategies),  w3  (effective  prediction  of  competitor’s behavior) and w4 (successful implementation of competition analysis process  outcomes in firm’s competitive strategy formulation). sum of variables should be equal to 1.  model they developed can be very useful both for new and mature companies. economically  educated auditorium certainly recognize balance scorecard (bsc) concept as one of the well  known concept of strategic planning originated by robert kaplan. globa and gavurova in  chapter  9  examined  learning  and  growth  perspective  of  balanced  scorecard  system  and  focused  their  research  on  slovakia.  they  systematized,  examined  and  evaluated  chosen  attributes  of  the  bsc  system  within  the  process  of  its  implementation  in  the  slovak  organizations,  in  order  to  identify  potential  problems  and  to  propose  possible  solutions.  obtained results made them able to propose two implementation techniques of the morality  profile  into  the bsc strategy maps,  through  incorporation of ethics  into  the existing bsc  perspective or extension of the bsc system by the business ethics perspective. relationship  of  business  ethics  with  the  knowledge  management  is  underreported  in  the  relevant  literature.  however, sometimes management  that respect principles of good organization  restructuring, communication, motivation and proper leadership styles do not meet targets.  reasons for that could be various and sometimes not so evident. product design is one of the  factors that have to be taken into account. malikova performed an empirical investigation in  order to find out consumers criteria for buying products. research is focused on slovakian  and french market. her starting hypothesis was that consumer nationality determines the     đukić, m., et al., book review, ea (2011, vol. 45, no. 3‐4, 82‐85)   85 importance of the same packaging criteria. results she obtained approved that nationality  matters. consumer preferences in france, country with long experience strongly differ from  slovaks. implications of this finding are very useful. packaging designers should be aware  that  nationality  should  not  be  forgotten  when  targeting  foreign  markets,  creating  new  design, redesigning packaging etc.        the fourth part of the book is considering organizational culture and economic development,  and consists of two papers which observe organizational culture from aspects of economic  development and as competitive  advantage. lucian and silviu gave sum up  of  the  most  valuable  definitions  and  functions  of  organizational  culture  concept,  also  trade  off  in  orientation of organizational culture dimensions between various factors, as results towards  processes,  opened  towards  closed  system,  level  and  type  of  control  etc.  types  of  organizational cultures are important part of this paper because it includes classification of  organizational cultures and give analyses based on different features. they suppose that it is  nowadays absolutely necessary to understand functions of organizational culture in modern  enterprises, and to recognize factors that influence on it, both internal and external. the most  important are the national culture and the vision or mission of the organizationʹs founders.  the outline is concerning manifestation and types of organizational culture and it is a great  prelude for the next paper which is observing culture and cultural diversity from an aspect  of  competitive  advantage  for  economic  development.  after  the  cultural  development  process,  there  is  an  interesting  point  of  view,  presenting  culture  as  an  iceberg.  certain  elements of culture are visible to the bare eye and easily noticeable, while most of it is hidden  “under water” – deeply rooted in the value system of the organization.  redzepagic, eric and  stosic concluded that those organizations where there is harmony between the elements of  organizational  culture  and  the  formulation  of  a  strategy,  may  lead  to  better  business  performance, and may have a positive impact on the national economy as a whole.  the final part of this book is kind of mixture composed of three very important issues,  such as social psychology, entrepreneurship development and sustainable economic growth in eu. in  this chapter authors gave their opinion on a body of knowledge that balances and requires  that  many  disciplines  should  be  used  together  to  create  a  contemporary  approach  to  organizational  behavior  and  transformation  in  a  changeable  business  environment.  first  chapter recognizes problem of youth migration and distinctive reasons as economical and  psychological,  also  as  socio‐economic  inequalities  in  eu  countries.  last  paper  includes  information and analysis of support of woman entrepreneurship by european commission,  its aims and projects on promoting this issue.   after reading this book, we were delighted to share the impressions with the auditorium  and all interested readers from different economic areas as well as the authors whose field of  research cover psychology and sociology. due  to  its multidisciplinary approach  it can be  very useful  for  politicians,  engineers and all people  from practice  that run companies or  some company departments. we warmly recommend this book to students, researchers and  everyone interested in organizational behaviour, human resources and entrepreneurship.   mihajlo đukić, saša milivojević  institute of economic sciences    author guidelines    general outline  authors submitting to the economic analysis are requested to email full paper in english. pictures, if  imported, should be placed separately in the zip file in tiff, jpg, gif or cdr format in resolution of  300 dpi.  manuscripts are blind reviewed with the understanding that they are substantially new and have not  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manuscript. economic analysis use aea rules for references.  12. abstracts would be sent to editor‐in‐chief by email                                            cip ‐ каталогизација у публикацији  народна библиотека србије, београд    33        economic analysis / editor‐in‐chief  mirjana radović‐marković. ‐ vol. 42, no. 1  (2009)‐           . ‐ belgrade (zmaj jovina 12) :  institute of economic sciences, 2009‐ (novi  sad : sp print). ‐ 30 cm    polugodišnje. ‐ je nastavak: economic  analysis and workersʹ management = issn  0351‐286x  issn 1821‐2573 = economic analysis (belgrade)  cobiss.sr‐id 169576460        doi: 10.28934/ea.22.55.2.pp1-19 first online: october 21, 2022 original scientific paper repo rates as reference interest rates: testing the expectations hypothesis of the term structure of interest rates sanja nenadović10f* 1 phd candidate, university of belgrade, faculty of economics, department for statistics, belgrade, serbia abstract the subject of this paper is the consideration of the role of the repo market and the quality of repo rates in the formation of reference interest rates that would be used to assess the value of financial instruments and derivatives. unsecured money markets carry a certain level of risk; thus, the question arises whether the existing reference interest rates should be replaced by repo rates or other interest rates on secured loans. through operations on the short-term money market, central banks try to influence interest rates with long maturities. one of the most well-known theories that considers the question of the relationship between short-term and long-term interest rates is the expectations hypothesis. in this paper, the expectations hypothesis is tested on the example of daily data of overnight interest rates related to secured interbank loans. two samples were used, and term premiums were estimated for both short-term (up to one year using libor interest rates) and longterm maturities (from two to ten years using ice swap interest rates). the hypothesis is tested using two traditional econometric tests. the first test examines the relationship between the long-term change in the overnight rate on secured loans and term premiums for different maturities. the second test examines the relationship between the short-term change in long-term rates from the unsecured market and term premiums. by applying both tests together, it should be determined how well the overnight interest rates on secured interbank loans predict long-term interest rates on unsecured loans. the tests were also applied to the overnight interest rates of interbank loans that are not secured in order to get a better comparative picture. the results show that collateralized interest rates are good indicators of benchmark interest rates and, in some cases, even more accurate predictors of long-term interest rates keywords: reference interest rates, repo rates, expectations hypothesis, ibor transition, collateralization jel classification: g12, g17, g20 introduction repo markets provide financial institutions with the necessary cash, so they play an essential role in managing short-term cash fluctuations. in addition to the necessary cash, the repo markets provide access to securities, enabling the efficient functioning of secondary markets. the regulatory definition of high-quality liquid assets (hqla), as part of the liquidity coverage ratio (see basel committee on banking supervision, 2001), recognizes the importance of the * e-mail: sanja_bgd@yahoo.com sanja nenadović 9 repo market for the liquidity of the secondary securities market. defining high-quality liquid assets includes the existence of an active repo market. repo, which has hqla as collateral, serves to mitigate credit and liquidity risks, so interest rates on such loans are suitable for the role of reference rates. there are two main segments in the repo market, bilateral and tri-party repo. the bilateral repo market consists of investors and collateral owners who exchange money and securities directly without a clearing bank. bilateral repo transactions may allow general collateral or impose restrictions on eligible collateral (special repo transactions). in addition to investors and collateral owners, the tri-party repo market includes the participation of clearing banks that enable settlements. clearing banks act as intermediaries, administrative processing details between the two parties in a repo transaction. tri-party repo is used to finance general collateral (so-called general repo transactions), where investors accept any collateral in securities. here, the centralized settlement mechanism minimizes operational risk. the issue of benchmarking became more urgent after the british regulator announced that banks would no longer be required to implement libor after 2021. moreover, the monetary policy caused declining market liquidity has undermined previously reliable unsecured benchmarks, such as eonia, the overnight rate. consequently, reference interest rate administrators have been looking for virtually risk-free interest rates that would serve as a replacement for existing reference interest rates. the repo rates emerged as the first logical solution. as liquidity has migrated from unsecured money markets in recent decades, the question arises whether the investor should use repo rates instead of ibor reference rates. some markets have already done that. reference rate administrators have chosen the secured overnight financing rate (sofr) for the usd, swiss average overnight rate (saron) for the chf, the canadian overnight repo rate average (corra) for the cad, the overnight repurchase rate (thor) for thb, etc. however, one of the main disadvantages of repo rates is the significant variations in their amount depending on collateral quality. such variations suggest that market microstructure issues could have played a more significant role in explaining repo rate movements (hull and white, 2013). one attempt to circumvent these problems is the mts / nex markets family of repo rates (rfr), in which the statistical filter shortens the upper and lower quartiles of daily repo rates. 1f1 another objection to using repo rates in constructing yield curves is that there is no way to determine the complete maturity structure of repo contracts. there are not enough maturity repo transactions in all repo indices to extend the yield curve to more maturities. the reliance on market swaps could mitigate the unavailability of repo transactions in extrapolating time rates. consultations initiated by isda (see isda, 2020) related to the transition to rfr rates suggest continuous compounding of overnight rates throughout the observed period. still, repo market plays a critical role in the transmission of monetary policy and the overall functioning of the financial system. in the euro area, repo market is the largest segment of money market. the euro repo market has grown significantly in the last couple of decades. realized repo transactions in 5 most active countries of the euro area (uk, france, germany, italy and spain) reached 234.5 billion euros in 2018.2f2 in us, 2.5 trillion us dollars are financed using repos on average daily in 2021.3f3 large volumes on repo market have an impact on financial stability, and therefore this market should not be neglected when discussing the scope of money market interest rates that should be considered as reference interest rates. 1 source: https://www.icmagroup.org. 2 source: https://sdw.ecb.europa.eu. 3 source: https://www.sifma.org. 10 economic analysis (2022, vol. 55, no. 2, 1-19) the main research question of the paper addresses the suitability of collateralized interest rates as reference interest rates. in particular, it tests the eligibility of these rates with traditional tests of the expectations hypothesis, such as those proposed by campbell and shiller (1991). answering the aforementioned research question is important from the standpoint of asset pricing, since adequate reference rates, in addition to carrying minimal risk, should be solid predictors of future interest rates, both short-term and long-term. literature review numerous authors have dealt with the issue of repo rates and the role of the repo market. the earliest works relate to special repo rates and the effects of the special repo market. one of the best-known in this field is duffie (1996), which discusses the theoretical factors that lead to special repo rates lower than most interest rates on loans with similar maturities and risk profiles. jordan and jordan (1997) deal with a similar issue, empirically confirming the previous hypothesis. fisher (2002) explains the close relationship between the price premiums of securities and special repo rates on the same securities. buraschi and menini (2002) deal with the link between liquidity risk and repo rates. they quantify the amount of average liquidity premium contained in the difference between general and special repo rates, which they claim is variable over time. vayanos and weill (2008) show that liquidity and the fact that some of the securities are special are two components of the price premiums of securities and derive a theoretical model that includes the absence of arbitrage. recent works are more focused on the general repo market. bartolini, hilton, sundaresan, and tonetti (2011) discuss general repo markets and collateralization associated with these markets. gorton and metrick (2012) investigate the link between the 2007-2008 financial crisis and the repo market, showing that changes in the libor -ois spread highly correlate with repo rates. bottazzi, luque and páscoa (2012) examine how securities markets and repo markets coexist within the general economic equilibrium. huh and infante (2017) point to the importance of the role of repo transactions in brokerage in the securities market. the components of the difference between repo rates and rates on unsecured loans are empirically analyzed by nyborg and rösler (2019), using data on general repo rates on overnight transactions. there are some recent papers focused on the role of repo market in general economic environment and its behaviour during debt crisis. armenter and lester (2017) provide a model that includes key features of the federal funds market and instruments introduced by the federal reserve. they use this model to study the effects of overnight reverse repurchase agreements on federal funds rate and other factors in the economic environment. boissel, derrien, ors and thesmar (2017) analyze a segment of the repo market during the eurozone sovereign debt crisis. they show that during the crisis of 2011, repo rates strongly respond to movements in sovereign risk, in particular for giips countries, indicating significant ccp stress. d’amico, fan and kitsul (2018) quantify the scarcity value of treasury collateral. they estimate the impact of security-specific demand and supply factors on the repo rates of u.s. treasury securities and find an economically and statistically significant scarcity premium. arrata, nguyen, rahmouni-rousseau and vari (2020) test the interactions between the pspp and repo rates using empirical data. their results show a negative correlation between bond purchases and associated repo rates. however, repo markets and collateralization do not mean the total absence of credit risk. the parties in repo transactions may still fail to fulfill their obligations. the presence of credit risk leads to the need for careful selection of contractual parties to perform repo transactions as efficiently as possible. government bonds are the most commonly used collateral in the repo market. the risk with these bonds is minimal (especially credit risk) as governments meet their obligations. although there is no risk-free financial instrument, by minimizing the impact of the sanja nenadović 11 credit risk of counterparties, then adequate collateral management, and implementing operational efficiency, repo can significantly reduce credit and liquidity risk. in addition, most repo transactions are overnight. that is why it is less risky than interest rates on long-term loans. however, an overnight rate not secured by collateral, regardless of the rate in question, carries a risk precisely because of the non-coverage by collateral. some authors, such as longstaff (2000), argue that an overnight rate is a better indicator of a risk-free rate due to borrowing. he tests the validity of the expectations hypothesis on the example of short-term usd repo rates. corte, sarno, and thornton (2008) further expand the test, which they also apply to the example of short-term usd repo rates. however, these papers do not test how reasonable repo rates are in estimating the forward-term structure of interest rates from the unsecured market (for example, libor and swap markets), which would allow repo rates to play the role of reference interest rates. expectations hypothesis of the term structure of interest rates the expectation hypothesis assumes that the yield on a long-term bond is equal to the average expected yield on a short-term bond over the life of the long bond plus some constant risk premium. most tests examine the ability of implicit interest rates to predict future yields. test results generally indicate that forward yields are biased predictors of future interest rates (see fama, 1984; campbell and shiller, 1991; and bekaert, hodrick, and marshall, 1997). campbell and shiller (1991) proposed the most famous tests of the expectation hypothesis, also used in this paper. these tests focus on predicting the difference in yields between longterm and short-term bonds. according to the hypothesis, predicting this difference should reflect the weighted average change in yields on short-term bonds over the life of the long-term bond and changes in yields on long-term bonds over the life of the short-term bond. the equation represents the relationship between the long-term and the expected short-term rate �̅�𝑟𝑡𝑡 𝑛𝑛 = 1 𝑘𝑘 ∑ 𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 ) + 𝑐𝑐𝑛𝑛,𝑚𝑚 𝑘𝑘−1 𝑚𝑚=0 (1) in which 𝑛𝑛 = 𝑘𝑘𝑘𝑘 denotes the maturity of the long-term rate, which is equal to the product of the maturity of the short-term rate (𝑘𝑘) and its time-frequency (𝑘𝑘). assuming rational expectations, the expression also applies �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 = 𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 ) + 𝜐𝜐𝑡𝑡+𝑚𝑚𝑚𝑚 𝑖𝑖 = 0, … , 𝑘𝑘 − 1 (2) where the 𝜐𝜐𝑡𝑡+𝑚𝑚𝑚𝑚 process is a white noise process, i.e., an error term of the �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 . substitution ( 2 ) in ( 1 ) gives �̅�𝑟𝑡𝑡 𝑛𝑛 = 1 𝑘𝑘 ∑ �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚𝑘𝑘−1 𝑚𝑚=0 − 1 𝑘𝑘 ∑ 𝜐𝜐𝑡𝑡+𝑚𝑚𝑚𝑚 + 𝑐𝑐𝑛𝑛,𝑚𝑚. 𝑘𝑘−1 𝑚𝑚=0 (3) in order to ensure stationarity, a short-term rate is deducted from both sides, which gives 1 𝑘𝑘 ∑ �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 − �̅�𝑟𝑡𝑡 𝑚𝑚 = 𝛼𝛼1 + 𝛽𝛽1(�̅�𝑟𝑡𝑡 𝑛𝑛 − �̅�𝑟𝑡𝑡 𝑚𝑚)𝑘𝑘−1𝑚𝑚=0 + 𝜔𝜔(𝑡𝑡 + 𝑛𝑛 − 𝑘𝑘). (1) equation ( 4 ) represents the first test of the expectations hypothesis. the null hypothesis is that the slope coefficient 𝛽𝛽1 is equal to one. error 𝜔𝜔(𝑡𝑡 + 𝑛𝑛 − 𝑘𝑘) must be orthogonal to the constant and the difference between the long-term and short-term rate. the ordinary least squares method is suitable for estimating the unknown parameters. in contrast, the standard errors are calculated by the general method of moments due to hansen (1982), since overlapping observations cause serial correlation. 12 economic analysis (2022, vol. 55, no. 2, 1-19) the equation (1) is equivalent to (𝑛𝑛 − 𝑘𝑘)𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚 𝑛𝑛−𝑚𝑚) = 𝑛𝑛�̅�𝑟𝑡𝑡 𝑛𝑛 + 𝑘𝑘�̅�𝑟𝑡𝑡 𝑚𝑚 + 𝑛𝑛𝑐𝑐𝑛𝑛,𝑚𝑚. (5) by subtracting (n-m)�̅�𝑟𝑡𝑡𝑛𝑛 from both sides, it is clear that 𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚 𝑛𝑛−𝑚𝑚) − �̅�𝑟𝑡𝑡 𝑛𝑛 = 𝑚𝑚 𝑛𝑛−𝑚𝑚 (�̅�𝑟𝑡𝑡 𝑛𝑛 − �̅�𝑟𝑡𝑡 𝑚𝑚) + 𝑛𝑛 𝑛𝑛−𝑚𝑚 𝑐𝑐𝑛𝑛,𝑚𝑚. (6) it is obtained by applying relation ( 2 ) to equation (6) and introducing parameterization �̅�𝑟𝑡𝑡+𝑚𝑚 𝑛𝑛−𝑚𝑚 − �̅�𝑟𝑡𝑡 𝑛𝑛 = 𝛼𝛼2 + 𝛽𝛽2 𝑚𝑚 𝑛𝑛−𝑚𝑚 (�̅�𝑟𝑡𝑡 𝑛𝑛 − �̅�𝑟𝑡𝑡 𝑚𝑚) + 𝜗𝜗(𝑡𝑡 + 𝑘𝑘). (7) regression (7) represents the second test of the expectations hypothesis. the ols specification uses the orthogonality of the error 𝜗𝜗(𝑡𝑡 + 𝑘𝑘) according to the constant and the adjusted difference between the long-term and short-term rate at the moment 𝑡𝑡. the null hypothesis is that the slope coefficient is 𝛽𝛽2 equal to one. equations (4) and (7), viewed together, fully reflect the expectations hypothesis. equation (4) represents the relationship between term premiums and long-term changes in short-term interest rates. in contrast, equation (7) represents the relationship between term premiums and short-term changes in long-term interest rates. if one is valid for each 𝑛𝑛 and 𝑘𝑘, then the other is valid for each 𝑛𝑛 and 𝑘𝑘. however, for specific values 𝑛𝑛 and 𝑘𝑘, one may be valid, while the other may not necessarily be valid (see cambpell and shiller, 1991). empirical results this chapter will present the test results of the hypothesis given by equations (4) and (7). the idea is to test the extent to which overnight interest rates secured by collateral are good predictors of interest rates with longer maturities, which are collateral-free. two alternative samples are analyzed, a shorter one (the so-called subsample) covering the period from 3.4.2018 until 7.10.2021, and longer, which covers the period from 2.1.2001 until 7.10.2021. the emphasis is put on the shorter sample to compare better results between new interest rates published from 2018 (e.g. sofr) and those for which data historically reached far. at the same time, the period after 2018 eliminates the period of the financial crisis in 2008. on the other hand, the tests of the expectations hypothesis show bias in smaller samples (see bekaert, hodrick, and marshall, 2001), so a larger sample was analyzed to test the stability of estimates. table (1) provides an overview of summary indicators for both samples. table 1. descriptive statistics of daily interest rate series subsample whole sample interest rates subsample size mean sd min max sample size mean sd min max effr 1284 1.15 0.99 0.04 2.45 7584 1.44 1.64 0.04 6.67 sofr 1284 1.16 1.03 0.01 5.25 1284 1.16 1.03 0.01 5.25 libonusd 1281 1.15 0.99 0.05 2.40 7581 1.49 1.66 0.05 6.87 eonia 1284 -0.42 0.05 -0.50 -0.25 1375 -0.42 0.05 -0.50 -0.25 ester 738 -0.55 0.01 -0.58 -0.51 738 -0.55 0.01 -0.58 -0.51 liboneur 1281 -0.53 0.06 -0.60 -0.44 7581 1.15 1.69 -0.60 5.77 repoeur 1277 0.10 0.07 -0.03 0.38 1368 0.10 0.07 -0.03 0.38 sonia 1284 0.39 0.31 0.04 0.71 7584 2.02 2.08 0.04 6.93 libongbp 1284 0.38 0.30 0.03 0.70 7584 2.06 2.10 0.03 7.00 repogbp 88 0.48 0.01 0.45 0.49 6388 2.31 2.10 -0.25 6.74 saron 1284 -0.72 0.02 -0.79 -0.63 7583 0.23 1.01 -1.69 3.72 sanja nenadović 13 subsample whole sample interest rates subsample size mean sd min max sample size mean sd min max libonchf 1284 -0.79 0.01 -0.89 -0.75 7584 0.29 1.12 -1.16 4.58 tona 1284 -0.04 0.02 -0.08 -0.01 7582 0.07 0.15 -0.08 0.71 libonjpy 1284 -0.09 0.02 -0.21 -0.03 7584 0.09 0.19 -0.21 1.58 repojpy 1825 0.21 0.19 0.07 0.76 source: author’s calculations. no data for the jpy denominated repo rates due to data unavailability. data and calculation methodologies the libor and ice swap interest rates data come from the refinitive (thompson reuters). the data are publicly available for other series of interest rates used in the paper. interest rate data for five major global currencies are analyzed: the us dollar (usd), the euro (eur), the british pound (gbp), the swiss franc (chf) and the japanese yen (jpy). table 2 provides an overview of the interest rates used in this paper. the term premium is the difference between interest rates with a maturity of more than one day (libor and swap) and overnight interest rates, whether they relate to transactions covered or not covered by collateral. for each series of overnight interest rates, an analysis was performed on the same yield curves constructed from libor (for shorter maturities ) and swap (for longer maturities). sofr and saron represent secured interest rates for usd and chf. sofr, which the federal reserve bank of new york announced in april 2018 as an almost risk-free rate, is the average of transactions weighted for overnight repo rates on securities in the us repo market, and it replaces the libor dollar. saron is an overnight repo rate for the swiss franc, developed by the swiss national bank (snb) and the swiss stock exchange as a risk-free rate that changes the swiss franc libor. for the british pound, the euro and the japanese yen, repo rates are used as indicators of collateralized rates. these are overnight gilt repo rates with general collateral for gbp. the bank of england publicly reported these data until 2.6.2018. the observation period for gilt repo rates is 4.1.2000 to 29.6.2018. table 2. an overview of analyzed interest rates interest rate currency tenor (s) * collateral coverage effective federal funds rate (effr) usd on no secured overnight financing rate (sofr) usd on yes euro short-term rate (ester) eur on no european overnight index average (eonia ) eur on no overnight repo rate for eur eur on yes sterling overnight index average (sonia) gbp on no overnight repo rate for gbp gbp on yes swiss average overnight rate (saron) chf on yes tokyo overnight average rate (tona) jpy on no overnight repo rate for jpy jpy on yes london interbank offered rate (libor) all 5 currencies on, 1w, 1m, 2m, 3m, 6m, 12m no ice swap rate all 5 currencies 2y, 3y, 4y, 5y, 6y, 7y, 8y, 9y, 10y no source: author’s calculations. on – overnight; w – week; m – month; y – year. 14 economic analysis (2022, vol. 55, no. 2, 1-19) the tokyo repo rate / overnight transaction (% (t + 1)) is used for jpy. data are published by the bank of japan and are available for the period from 30.10.2007 to 26.10.2012. due to daily data unavailability, the euro data for repo rate are approximated. the data on the daily level of the eonia index are modified with the difference between the monthly data for the eonia index and monthly bank repo transaction rates for the euro area. data on banking rates are published by the european central bank and are publicly available. the observation period is 31.12.2018 to 4.1.2021. the data are observed at a daily frequency. all the rates are continuously compounded zerocoupon rates, calculated using the formula �̅�𝑟𝑡𝑡 𝑛𝑛 = 𝑙𝑙𝑛𝑛 � 1 1+𝑓𝑓 𝑟𝑟𝑡𝑡 𝑛𝑛� 1 𝑓𝑓 (8) where 𝑓𝑓 represents day count convention. the assumption is that every month has 30 days and the year 360. for the number of days shorter than 30, the exact number of days is used for the given period. interpolated values have replaced missing data (non-working days, for example). swap rates are also zero-coupon interest rates, calculated using the bootstrap method with a semi-annual frequency. hypothesis testing results tables 3 and 4 show the results of regression tests of equations (4) and (7) using the data described in the previous chapter. the tables show slope estimates and their standard errors that include newey-west corrections (newey and west, 1987). estimates show a slight increase in interest rates on us dollar-denominated loans in the subsample. the results for the remaining four currencies indicate the absence of a correlation between the level of estimates and the term structure of interest rates. a negative sign appears in the repo rate for the british pound and saron interest rates. at the significance level of 5%, the coefficients for interest rates sofr, effr, liboronusd, repo rate for eur, liboronchf, tona and liboronjpy deviate statistically significantly from zero. on the whole sample, the estimates differ from those on the subsample. similar to the results in the subsample, estimates of the slope of interest rates on us dollar-denominated loans grow up to 12 months. the estimates remain relatively unchanged for the remaining maturities, varying around one. a similar pattern is not observed for other currencies. the statistical significance of the coefficients changed at the interest rates for the japanese yen, whose coefficients are not significantly different from zero on the whole sample. most estimates are statistically significantly different from zero in the long-run part of the curve. in both observed samples, the collateralized rates sofr and repo eur have an advantage over non-collateralized rates. their estimates are relatively closer to unity and with a similar level of precision as estimates for non-collateralized interest rates. repo gbp has much less favourable results than sonia and libor on rates on the subsample. however, such results are prone to a small sample bias (for the gbp repo, only 88 observations were available). on the whole sample, the results for the gbp repo are more favourable and closer to the results of non-collateralized rates. this similarity of the results is especially noticeable in the short-term part of the curve. the results favour a collateralized rate for the japanese yen on the short-term part of the curve. in this part of the curve, repo slopes are closer to one than the slopes for tona and libor on rates. the only currency where the results speak in favour of the superiority of non-collateralized rates is the chf. the estimates for saron deviate far from the ratings for the libor on rate, which are closer to unity. similar conclusions are reached in analyzing the results for both observed samples. sanja nenadović 15 table 3. the results of equation (4) testing source: author’s calculations of ols estimates for slope coefficients (newey-west standard errors with n-m-1 lag in parentheses). * statistical significance at 5% the slope estimates for equation (7) in both samples are pessimistic in many cases, which are results similar to those published by campbell and shiller (1991). they show that estimates have a negative, therefore erroneous, sign for different subsamples that they analyze at different periods and sample sizes. the exceptions to this "rule" are the interest rates for usd and gbp for the shorter sample, where the ratings are positive. also, for a larger sample, the slopes of the long-run part of the curve have a positive sign, but they deviate from the unit. for most interest rates, as 𝑛𝑛 increases, the slope estimates with positive signs also increase, while for the negative ones, the estimates decrease as 𝑛𝑛 increases, all moving away from unity. slope estimates are wildly inaccurate in many cases, with reasonably high newey west standard errors. the statistical significance of the estimated slopes (at a significance level of 5%) on the shorter sample exists for the us dollar for maturities greater than 12 months, the repo rate denominated in the british pound for maturities over six years, and the tona interest rate for maturities up to 3 months. the situation is slightly better for all currencies except eur in the sample, especially for shorter maturities (up to 12 months), where many coefficients deviate statistically significantly from zero. when comparing results between collateralized and non-collateralized rates, there is no significant difference in the results. similar behaviour in terms of signs, the statistical significance of coefficients and deviations of estimates from the unit exist with collateralized interest rates. due to the unavailability of data for �̅�𝑟𝑡𝑡+𝑚𝑚𝑛𝑛−𝑚𝑚 which are non-observable data, the regression-based equation (7) is approximated by �̅�𝑟𝑡𝑡+𝑚𝑚𝑛𝑛 . bekaert, hodrick, and marshall (2001) note that this change in variables leads to an upward bias in predicting the slope coefficient. 16 economic analysis (2022, vol. 55, no. 2, 1-19) values greater than one are expected under the null hypothesis, even asymptotically. however, since the exact approximation is used for all series, they are all exposed to the same bias, so it is possible to compare their estimated values. table 4. the results of equation (7) testing source: author’s calculations of ols estimates for slope coefficients (newey-west standard errors with zero lags in parentheses). * statistical significance at 5% sanja nenadović 17 the regressions (4) and (7) indicate that the expectations hypothesis may be valid for the us dollar, where the hypothesis for sofr holds a higher probability relative to effr and libor on rates. table 5 gives the results of hypothesis testing 𝛽𝛽1 = 1 and 𝛽𝛽2 = 1. only the results for which the null hypothesis cannot be rejected at the significance level of 5% are presented. in the first test (𝛽𝛽1 = 1), the hypothesis cannot be rejected at relatively longer maturities for the usd interest rates (effr, sofr and libor on). estimates of coefficients for maturities of 12 months do not deviate significantly from the unit in both samples. on the whole sample, other maturities for which the coefficients do not deviate significantly from the unit are 2, 3 and 6 years. on the whole sample, the collateralized interest rate (sofr) recorded better results in higher p values than the non-collateralized interest rates (effr and libor on). as for the second hypothesis 𝛽𝛽2 = 1, it cannot be rejected for shorter maturities, namely usd 6m, gbp 1w and gbp 1m. the slope estimates of these pairs do not deviate significantly from the unit on the subsample. the exception is libor on for the one-week term premium, where the slope estimates do not deviate significantly from the unit on both observed samples. for the us dollar, the collateralized rate sofr has similar results as non-collateralized rates, while for the british pound, non-collateralized rates have better results at these maturities. table 5. slope constraint tests in equations (4) and (7) beta1=1 n f(1.n) p effr 12m 1279 0.00 0.95 effr 12m 7579 1.19 0.28 effr 2y 2620 2.40 0.12 effr 3y 2620 2.22 0.14 effr 6y 2620 1.84 0.18 sofr 12m 1279 0.35 0.56 sofr 2y 1279 0.01 0.92 sofr 3y 1279 1.00 0.32 libonusd 12m 1279 0.00 0.95 libonusd 12m 7579 0.74 0.39 libonusd 2y 2620 1.87 0.17 libonusd 3y 2620 1.73 0.19 libonusd 6y 2620 1.76 0.18 beta2=1 n f(1.n) p effr 6m 1278 0.16 0.69 sofr 6m 1278 0.30 0.59 libonusd 6m 1278 0.09 0.76 sonia 1w 1281 1.13 0.29 sonia 1m 1281 0.15 0.70 libongbp 1w 1281 0.16 0.69 libongbp 1w 7581 1.66 0.20 libongbp 1m 1281 0.11 0.74 source: author's calculations (only the results for which 𝐻𝐻0 is not rejected). conclusion this paper analyses the eligibility of repo rates in forming reference interest rates by checking the validity of the expectation hypothesis. reference interest rates should be indicators of riskfree interest rates, and the expectations hypothesis is one of the essential theories of the term structure of interest rate on risk-free loans. other contributions from the literature have not given the repo rates as risk-free rates much attention so far. the main reason is the presence of considerable variability in their amount, which is a consequence of different collateral quality structures. in addition, there is no way to determine the entire maturity of the structure of repurchase agreements, which constitutes a 18 economic analysis (2022, vol. 55, no. 2, 1-19) serious potential obstacle for future research. therefore, most authors use some of the interest rates on unsecured loans that do not face the above problems. the paper applies the traditional tests of the expectation hypothesis proposed by campbell and shiller (1991). the hypothesis on daily data for 15 overnight interest rates is tested, in which five of them are covered with the general collateral. five currencies were considered: usd, eur, gbp, chf and jpy. the term structure from libor and ice swap interest rates for all five currencies is constructed. the analysis was conducted on shorter and longer samples to compare different interest rates better. some of the overnight interest rates for which the hypothesis was tested are relatively new (e.g. sofr and ester), so there is limited data availability. based on the results of testing the expectations hypothesis, the conclusion is that overnight interest rates covered by collateral are equally good predictors of term premiums as their unsecured rivals. in some cases, they have proven to be even more precise indicators (for example, sofr regressed to the swap rate in equation (7)). when we add to that the fact that collateral contributes to lower credit risk, it can be concluded that there is no reason not to apply repo rates as an official benchmark for risk-free interest rates. relatively low credit risk is a significant advantage of repo rates worth considering and far outweighs the disadvantages of repo rates, which are mainly methodological. quantifying this advantage could be a topic for future research in the area of repo rates and collateralization. acknowledgements i wish to thank milos bozovic, branislav boricic, dejan soskic, irena jankovic and two referees for their comments on the previous version of this paper. literature isda. 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(2008). a search-based theory of the on-the-run phenomenon. the journal of finance, 63(3), 1361–1398. article history: received: july 4, 2022 revised: september 30, 2022 accepted: october 3, 2022 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp36-47 original scientific paper development and implementation of the integrated marketing communications concept tatjana cvetkov čikošev1* 1 nis a.d., belgrade, serbia abstract understanding consumers’ needs implies creating an adequate offering, which leads to good and sustainable relations over time. consumers, under the influence of (new) technologies, change their habits, attitudes and behaviour in the usage of certain product or service as well as the way they communicate. analysis of the effects of created communication on the brand through developing imc model is the main objective of this paper. considering consumers’ demographic structure, not only the points at their path to purchase, usage or recommendation, the effects among different groups will be analyzed. questions that are important for this paper are about awareness of brands in the category, noticeability of certain ways of communication, and the influence of that communication on behaviour is measured. the goal of every communication is sales and repeated sales, but in that process potential users should be introduced to brand, create a need and want to use that brands, to be satisfied, loyal and be its ambassadors. beside usage of the results of primary research, desk method of collecting and analysing is also used, in order to have detailed insight of certain aspects that are related to the objective of this paper. the results of conducted research indicate that the implementation of integrated marketing communications leads to additional sale and better brand positioning, as well as company positioning in the market. additionally, effective integrated communications positively influence brand positioning and consumers ‘satisfaction is in positive relation with the repeated purchase of the brand. key words: integrated marketing communications, brands, positioning, customer experience, consumer behaviour jel classification: m31 introduction in today’s world, consumers, brands, and the media are changing, fundamentally some would say. those changes put marketers in front of many challenges. how we interact and how we communicate is directly under the influence of the technology and the internet and its development. with “epidemic” of new media, consumers change, and how they use and utilise different media sources, which consequently have influence on brand choice timing, place and way of choosing. consumers attention is divided, as they willingly (or not) multitask. consumers are not passive receivers of brand information, through so‐called traditional media, print or tv, which accumulate in their memory for usage once they need that information, as it was supposed before. they are now active seekers of information when in need – using all available * e‐mail: tatjana.cvetkov@nis.eu tatjana cvetkov čikošev 37 means ‐ different search engines, (mobile) browsers, blogs, forums, brand websites (porcu, del barrio‐garcia, kitchen, 2017). marketers are now, under the influence of these new ways of communicating, creating personalised content of the message, personalise time and location of conveying this message, and utilising more (as much as it is needed) media to achieve set communication objectives. the other side is more complex customer journeys and the focus on customer experience (domazet, stošić, lazić, 2018). customers may now have interactions with firms through multiple channels and media, almost countless number of touch points. the objective of this paper is to identify customer journey, critical touch points and adequate communication as an answer to it, that leads to profitable customer behaviour. the model of integrated marketing communication that is used as a base for this paper is presented as a conceptual framework. therefore the idea is to empirically test it on one brand, and try to answer some of the questions emerged in the original work. one of the issues are the effects of the communication, which option(s) is the best fit for achieving set goals on the customer journey (domazet, đokić, milovanov, 2018). or, how all the communication options may be integrated to maximise the effects. authors of the conceptual framework, batra and keller (2016), propose, among others, checking the role of brand web page, positive and negative sides, and if it works in growing trust and emotions. beside this, the paper is analyzing consumer behavior on the lubricant market, as well as outcomes of created communication. integrated marketing communication communication marketing communications are the means by which firms attempt to inform, persuade and remind consumers – directly or indirectly – about the products and brands they sell (kotler & keller, 2009). as shown in table 1, eight major modes of communication make the marketing communications mix: the first half of the table, advertising, sales promotion, events and pr, are considered as more mass media types of communications. the other half, direct marketing, interactive marketing, wom and personal selling are 1 on 1, more personal modes of communication (keller 2009). marketing communications is the narrator of the brand story, it tells or shows consumers the story about the product – where, when, how and why is used, as well as who is using it, the typical user. also, it tells a story about the company and their values. using the tools of marketing communications companies make relations of their brands and places, events, other brands, other people. experiences are created, feelings are provoked, and all other things attributed to the brand, company, product or service (domazet, 2012). beside aforementioned, marketing communications can build communities, both online and off‐line (faškova & kretikova, 2015). table 1. major communication types (1) advertising –promotion of ideas, goods or services by an identified sponsor in any form that is paid and is not personal (2) sales promotion – the objective is to encourage trial or purchase of product, service, brand, supported by diverse incentives, for limited (short) time (3) events and experiences – in order to create interactions on daily basis or for special occasion firms design programs or sponsor different events (4) public relations and publicity – the main goal is to promote or protect a company’s image or its products. services, brands 38 economic analysis (2019, vol. 52, no. 1, 36‐47) (5) direct marketing – using different means of communication (mainly digital – e‐mail, and other electronic means of communication, but also mail, telephone) to speak directly with customers and prospects. (6) interactive marketing – different to direct marketing, as main goal is to engage customers to interact, and raise awareness, improve image or elicit sales of products and services. also, these activities and programs are online (7) word‐of‐mouth marketing – any recommendation, information about user (buyer) experience, mouth ‐to‐mouth (thus it may be written, electronic, or really verbal) communications (8) personal selling – face‐to‐face interaction – presentation of product/service/brand, q&a, ordering – with potential buyer source: kotler & keller (2009) the communication environment changed and it not easy at all for marketing communications (domazet & neogradi, 2018). the media environment has changed dramatically ‐ new media, technology driven, grow, while on the other side traditional advertising media such as tv, radio, magazines and newspapers are losing their position(s) (chang & thorson, 2004). everything is changed – the time, the place, and how consumers process communications, and even their choice is to process them at all. in this new media environment, the consumer is the one who has control. consumers not only have more choices of media to use, they also have a choice about whether and how they want to receive commercial content (domazet, stošić & hanić, 2016). the broadband internet connections, ad‐skipping digital video recorders, multi‐purpose (smart) mobile phones and portable music and video players and all other changes in consumers lives, enforce marketers to rethink many of their traditional practices almost daily (kaplan & koval, 2003; kiley, 2005). put in its simplest form, integrated marketing communications (imc) is the bringing together of all marketing communications activities working towards the same goal. integrated marketing communications are the coordinated, consistent means by which firms attempt to inform, incent, persuade, and remind consumers, directly or indirectly, about the products and brands. (pickton & broderick, 2004). integrated marketing communications is a process which involves the management and organization of all individuals and organizations involved in the marketing communications process within and external to the organization, in the analysis, planning, implementation and control of all marketing communications contacts, media, messages and promotional tools focused at selected target audiences in such a way as to derive the greatest enhancement and coherence of marketing communications effort in achieving predetermined product and corporate marketing communications objectives (pickton & broderick, 2004). integration of marketing communications should be or lead to synergy, which is described as the 2 + 2 = 5 phenomenon. in terms of marketing communications, that means that bringing together the various types and forms of marketing communications in a mutually supportive and enhancing way then the resulting ‘whole’ is more than the simple sum of its parts (hanić, domazet & simeunović, 2012). on the other side, lack of integration of marketing communications elements must be acknowledged ‐ not only that various promotional tools have to perform independently of the other elements but also that, collectively, the total effort can be counter‐productive (mcgrath, 2010). integration is not an easy process and cannot be effortlessly be achieved, but when it is reached, the 4es and 4cs of imc create the synergistic benefits of integration (pickton & broderick, 2004). imc should be enhancing (improve; intensify), economical (least cost in the use of financial and other resources), efficient (doing things right), effective (doing the right things). the 4cs of integrated marketing communications are coherence (logically connected), consistency (not self‐contradictory), continuity (connected and consistent over time), complementary communications (producing a balanced whole). integration is not easily achieved, and while the problems of integration are not impossible, they are significant for a variety of reasons. imc is discouraged by mindset of individuals tatjana cvetkov čikošev 39 involved (fear of change and loss of control) and their abilities (esp. managers), classifications and language, the structure of organizations, sense of superiority, the scale of the task, adequacy of budgets, and dimensions of integration. the imc conceptual framework the marketing communications environment is transformed by technological advances and other factors and becomes a new challenge and/or opportunity to the ones that practice it. for example, great versatility and precision of digital media is huge potential, but on the other side, they are challenging for integration (domazet & stošić, 2013). marketers need new tools and ways of thinking that can provide structure to an increasingly complex communications environment if they want to use these new media opportunities. to better understand how to develop and deliver fully integrated communication programs in today’s changing marketing world, batra and keller (2016) reviewed academic research and proposed conceptual framework. result of their academic research review is following five main themes: 1. decision journey nowadays significantly differs to the one it was in the past ‐ imc programs need to be more carefully designed and implemented to maximize results, esp. having in mind media and messages, that should be stage appropriate 2. every communication option has its own strengths and weaknesses and generates specific (different to other types) of effects on consumer knowledge and behaviour along consumers’ decision journeys. additionally, marketers’ ability to aim for the specific outcome with greater precision increases by new media options 3. there is a myriad of interaction and synergy across communications. different types of information, different communications and all their combination and sequence, create relations that lead to change consumer knowledge and behaviour in meaningful ways. 4. once they identify changes in knowledge and behaviour (direct or indirect) caused by different communications, marketers can choose those communication options that are most likely to collectively achieve brand objectives. 5. digital communication options, hardly present in the past, influence consumers directly as well as indirectly and the way they interact with many other digital or nondigital communication options. a conceptual framework is presented in figure 1. it shows the combination of two conceptual models in order to assist in the development and delivery of imc programs. on one side there is consumer and communication outcomes – the knowledge and understanding of the consumer, the context, and the content – everything that “colors” the (desired) outcome (kerr & patti, 2015). the communications matching model should commend the best‐aligned media and messaging options, by bearing in mind the specific objectives and desired outcomes at different stages of the consumer’s journey on one side and the different media features (batra & keller, 2016). the communication optimisation model is about effectiveness and efficiency ‐ all proposed communication options are evaluated to ensure that maximal collective effects result (batra & keller, 2016). by considering communication matching and integration in detail, the two communications models offer a comprehensive top‐to‐bottom view of marketing communications. the framework offered can help guide managerial thinking and academic research in several specific areas. for example, it may help understanding online versus offline communication, which media/messages are controlled by marketers versus the ones that consumers create and influence, digital versus nondigital differences, as it is broad and neutral regarding media. when thinking about communication optimization model it is important to consider coverage (reach of the desired effectiveness of different communication options), contribution (is it affecting consumer positively, influencing each stage along their journey), communality 40 economic analysis (2019, vol. 52, no. 1, 36‐47) (common associations across communication options?), cross‐effect, conformability (is this appropriate answer to different consumers, their different characteristics and communication needs). well‐designed imc program should perform well on these criteria. however, there are more opportunities to match communications to one another if more modalities are employed (audio, images, video…), to appeal to different audiences. (batra & keller, 2016). figure 1. imc conceptual framework source: batra & keller (2016) the communication matching model studies the needs/gaps in consumer knowledge and behaviours, compares the current position of different targeted consumer segments to where they need to be, relative to the brand’s needs. afterwards, suggests the most appropriate media combinations that should best meet these needs/gaps at each stage along the journey (batra & keller, 2016). the journey consist of 12 steps – from having a need at a category level, knowing about (can recall and recognize), over active consideration, search for more information and building brand knowledge, liking and having trust, willing to pay (more) for it, having (high) desire to act, and consuming/using, to satisfaction, both attitudinal and behavioral loyalty, engagement and interaction, and advocating for this particular brand. an emerging and increasingly recognized best practice in the area of brand and customer management is that experiences are emotional and emotions are multi‐dimensional. there are two dimensions of primary interest – valence (was the experience good or bad? answer shows what we often get right) and arousal (was the experience memorable or forgettable? answer leads to what we often overlook). the more memorable and vivid an experience is, the stronger the emotional imprint it creates ‐ and the higher that person's advocacy and resistance to switching to competitors (robins, 2015). identifying those aspects of the experience that leave an emotional imprint, leads to customer‐centric insights on which attributes to promote, to drive loyalty and enhance customer lifetime value. according to robins (2015), direct experiences create more positive and memorable experiences than indirect experiences. owned and earned experiences (usage, wom, in store, sponsoring, etc.) create more positive and memorable experiences than paid experiences. tatjana cvetkov čikošev 41 the effects of created communication the industry of lubricants lubricant can be defined as a substance that reduces friction, not limited to that function, but also completing certain strict, specific demands. for example, modern motor oil has to lubricate surfaces, but at the same time has to have the cooling ability, corrosion protection, sealing, cleaning engine elements and it has to be thermally and oxidatively stable. without those traits, it wouldn't be able to please the complex demands of the modern engine. durability and reliability of a machines operation and of various mechanisms is greatly conditioned by the right selection and application of lubricant. namely, poor lubricant selection or its wrong application are the cause of premature and rapid contact surface wear, permanent deformation and damage. lubricants are chosen specifically for different parts of a machine. so for example in motor vehicles, the engine is lubricated with motor oil, the transmission mechanism with transmission oil, certain bearings with lubricating grease and similar. the task of motor oil in an engine is to:  lubricate the engine, reduce friction and wear of metal surfaces and moving parts when in contact  clean the internal engine parts from carbon black particles  seal the engine (cylinder ‐ piston assembly), blocks the penetration of combustion glasses into the engine crankcase and it raises the engine compression  protect internal engine parts from corrosion  provide the correct engine operation in low as well as in high temperatures  secure added cooling demand for lubricants in the balkan region has stabilised from 2015. in the period 2008‐2013 was a drop and stagnation due to the economic situation. by the year 2025, a 10 percent growth in demand is expected (mandakovic & novina, 2015). a significant qualitative structure change and a growth in demand of top of the line quality lubricants is expected in the region due to very strict environmental legislation and change and renewing the automobile transportation fleet. new industry technological solutions will also play a part on the qualitative change of the structure of lubricants. there are a total of 80 brands of small manufacturers. by the year 2030, a 46 thousand tons growth is forecasted in the serbian market. main market development growth factors are – macroeconomics, environmental protection and sustainable development. nisotec brand was presented to the serbian market in 2008. as a result of novolin rebranding, produced in the nis oil refinery in novi sad. after the completion of a detailed market analysis of the serbian and regional markets in 2010, a new market oriented strategy was adopted, a complete redesign of the label's visual identity and an advertising campaign was done under the "simply better" slogan. the same year, nisotec brand became the general sponsor of dusan borkovic, who ended that season as the runner up of the european rally championship and in the general standings. there was a formation of the nisotec racing team. nisotec gets the leading position in the serbian market in 2012. that same year cooperation with dusan borkovic continues, which quickly lead to the realisation of both parties vision: nisotec as a champion of quality, confirmed by a quality and good design champion trophy, with plenty of gold medals at the novi sad agriculture fair, thus becoming a leader on the domestic market and nisotec racing team becoming a european champion. with the goal of following modern market tendencies, in 2013 there was a nisotec packaging rebranding done. quality levels were differentiated based on the color of the packaging and oil types based on the label colors. an asortiman of nisotec lubricating grease was introduced. the distribution network and new sales channels was expanded in 2014 which led to an increase in market share of nisotec in the lubricant market, thus confirming the leading position in serbia. new 42 economic analysis (2019, vol. 52, no. 1, 36‐47) confirmation was received from engine and equipment manufacturers as well as ohsas 18001:2007 quality certificate. today, in this oil brand asortiman there is over 200 products in over 500 different packages, and all of them cover over 20 different range of application. created communication marketing support is an important component in a brand life, and in the case of lubricants and serbian market, consist of several activities that lead to increase of brand awareness and loyalty, and ultimately, sales. generally speaking, all major communication types are used in order to reach set targets by the company. pr and publicity support every event and every sales promotion organized at nis petrol and gazpromneft petrol station as well as other sales outlets covered by distributors. among events, brand takes presence at fairs. presence in digital media is through website (with information about promotions, trends... ), as well as an online program that help consumer choose the lubricants that are best suited for their vehicles. also, advertising through google (google search and google display) are part of the communication set for the brand. having loyalty program “sa vama na putu” makes usage of direct marketing possible – informing customers via e‐mail, viber messaging or sms. specifically, this year communication plan of activities, towards customers, had one new product launching and one new product packaging introduction, price promotion activities, presence at agronomical fair in novi sad, as well as a campaign „moj auto voli nisotec“. all activities are noted in table 2, together with both communication optimization and matching models, i.e. platforms and outcomes. the idea of integration of marketing communication for this brand was always present, thus breakthrough is made by considering consumer journey of several personas. one type of users consider themselves as experts regarding their vehicle, and therefore the best lubricant. they read magazines and websites regarding this topic, they may be those who recommend others what to buy/use, but may not be loyal to brands, but to types of lubricants. they know when they need to change lubricants, and when in need, they search the net (and other offline sources, like auto magazines), visit some stores and always petrol station. they may be price sensitive, thus they like to consider themselves as smart shoppers. the main answer to their need is quality, not overpriced lubricant, nourishing their smart shopper image. the other type is opposite to them, those who have no knowledge and don’t need to know ‐ they rely on recommendation, mechanics and car service people mostly. for them, easy to find – easy to use is most important. they either have to be able to buy the lubricant at the car service or somewhere where they usually go (supermarket, ps where they usually go, auto shop near car service...). third group are those who constantly have to be assured that they are making the right decision, that the quality, price and other features are the right ones. for them, a good image and brand presence is very important. forth group are the ones with the habit, who once made a decision what to buy and continue to follow the route. in a situation in which they buy a new car, with different engine and needs, they may change their habit, otherwise they are not easy to be reassured. fortunately, they are behaving the same with the petrol station choice, so nisotec has the opportunity to remind them of its presence and assure them of its quality and price. tatjana cvetkov čikošev 43 table 2. imc implementation for nisotec activity top down (communication optimization model) bottom up (communication matching model) new product launch ‐ nisotec antiled feb 2018 web campaign promotion at ps promotions with sampling direct marketing – messages (sms, viber) pr remind of need for the category, learn, active consideration trial and work on trust improve awareness of this specific product, as well as total brand awareness price discount for snnp and agro card users march 2018 pos posters website pr consideration and buying awareness growth 85. international agricultural fair in novi sad may 2018 event presence media conference pr and publicity digital sms awareness knowledge of brand trust satisfaction new packaging of nisotec adblue june 2018 pr pos promotion web site awareness of the new possibility buying satisfaction moj auto voli nisotec july 2018 radio campaign web campaign promotion an ps pr awareness (remind) buying satisfaction 50% discount for the second pack of nisotec testerol september 2018 pos brand web page company fb and instagram pr consideration and buying awareness growth with evro diesel get nisotec diesel lub (nis agro card users) october 2018 pos on target petrol stations sms not loose gas oil users, but turn them to euro diesel trust awareness source: nisotec communication plan, 2018 the effects on brand five years ago, nis gpn started with the brand tracking study, in order to unify and continuously track market dynamics ‐ usage and attitudes of consumers regarding fuels, petrol stations and lubricants, as well as brands (awareness, usage, image, communication…). the insights obtained are used for decision making, strategic and marketing plans to keep and grow the current position. the sample consists of weekly drivers, 18‐64 years old, who use a car as a main way of transportation. one of the important questions is the place of purchase of lubricants, and it shows that habits are not easily changed – the share of stores that sell car parts is the same from wave to wave. comforting is the fact that nis petrol station succeed in keeping lubricants’ buyers, i.e. those who buy lubricants at petrol station. 44 economic analysis (2019, vol. 52, no. 1, 36‐47) figure 2. purchase place ‐ where do you usually buy lubricants? source: brand tracker survey, 2013‐2018, nis, serbia regarding the brand awareness, nisotec reports an increase. one‐half of drivers are aware of this brand, compared to 35% in the previous wave. the results of this year activities are to be measured by the end of this year. figure 3. total brand awareness ‐ which brands from the list do you know? source: brand tracker survey, 2013‐2018, nis, serbia this study also tracks the reasons which are important for decision making and shows growth of importance of price, quality and recommendations of mechanics. users need to be assured that their choices are the best fit for their car for the budget they have. figure 4. decision making ‐ which source of information do you trust the most? source: brand tracker survey, 2013‐2018, nis, serbia 0% 20% 40% 60% 80% 100% wave 1 wave 2 wave 3 petrol station car parts stores service supermarkets other 0% 20% 40% 60% 80% 100% wave 1 wave 2 wave 3 store location price quality brand friend's recommendation mechanics' recommendation tatjana cvetkov čikošev 45 another, performed among the visitors of novosadski sajam in may 2018, shows which media platform has an influence on consumers, which one they have noticed nisotec used, as well as the difference among users. figure 5. influence on decision making source: nis survey at novosadski sajam, may 2018, nis this study shows that the highest influence on decision making has mechanics’ recommendation; even 80% says this communication has a high or highest influence on their decision. another trustworthy sources are friends and family, especially mentioned by females, who are much less (mentally) involved in choosing lubricants. they are also more susceptible to information received from people at petrol stations, and also actions and promotions. figure 6. nisotec communication noticed source: nis survey at novosadski sajam, may 2018, nis mechanics' recommendation friends' recommendation actions and promotion recommendation at ps web page presence at fairs tv advertisement fb page radio fb ads newspapers and magazines sposorship of races and drivers banners top 2 boxes top box recommendation at ps actions and promotion presence at fairs friends' recommendation newspapers and magazines sposorship of races and drivers tv advertisement radio mechanics' recommendation banners web page fb ads bilboards none 46 economic analysis (2019, vol. 52, no. 1, 36‐47) figure 6 shows that the majority has noticed communication at ps, i.e. recommendations, followed by actions and promotions. interestingly, even being at fair, only 40% report noticing this kind of communication, most probably thinking of some other fair or not considering presence at fair as a communication. some differences among subgroups are also noticed regarding this question – males more than females have the notion of seeing sponsorship of races and drivers, while females mention friends recommendations and seeing ads in print. the oldest group of respondents (older than 50 years) are less often mentioning seeing certain nisotec communication, compared to younger users. those aged 30‐50 years more often mention noticing radio and print, as if they more often listen and read those media. the effects can (and will be) measured by units sold, profit and profitability, but the results are collected once a year. immediate actions, like price promotions, show results in an increase of sales during the action, but it’s also important to know the yearly results. year to date data show ambiguous information, and it’s hard to tell what the yearly result will be. conclusion the model of integrated marketing communication that is used as a base for this paper is applied, thus integration is not easily achieved. the effects of communication are measured and appreciated. the selection of which option(s) is the best fit for achieving set goals on the customer journey is not an easy process and is not fully conveyed ‐ the customer journey way of thinking is one barrier, the budget constraints together with options available and acceptable for the company are another set of barriers. still, even this level of integration of marketing communication leads to an additional sale and better positioning. seams that it’s not enough to integrate activities for one brand, as the brand is part of a bigger system, and certain activities are not owned by the brand. that is, the structure of organization and adequacy of budget are barriers that slow down the process of integration. the customer journey way of thinking is not fully accepted and implemented, it seems it takes more time, and more trials (and errors). on the positive side, some critical touch points are observed and communication as an answer to it, which leads to profitable customer behaviour, was applied. references batra, r., keller, k.l. 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(2015). “customer lifetime value & loyalty in the new consumer economy”, total customer experience philadelphia 2015 article history: received: november 13, 2018 accepted: may 29, 2019 doi: 10.28934/ea.19.52.12.pp48‐55 original scientific paper assessing organisational maturity in predictive analytics of telecommunications companies in the republic of macedonia kalina trenevska blagoeva1 | marina mijoska1* 1 ss.cyril and methodius university, faculty of economics ‐ skopje, department for e‐business, republic of macedonia abstract data analytics and predictive analytics are among major trends companies are facing worldwide. in a highly digitalised environment, it is not only to question the usage of data analytics but how analytically mature organisations are. the goal of this paper is to assess organisational maturity in predictive analytics of telecommunications companies in the country. in order to assess the level of organisational maturity in predictive analytics, we use predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competence, deployment and governance). for each dimension, four maturity levels are defined: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony (capgemini, 2012). survey results confirmed that analysed companies fully understand the benefits of predictive analytics as a valuable source of gaining competitive advantage from data. the overall level of predictive analytics maturity is set between levels 2 or 3 for almost all dimensions. this research is the first attempt to analyse organisational maturity in predictive analytics in the country. its originality derives from the specific characteristics and development of the telecommunications sector. this sector is one of the most advanced service sectors in the country and hence represents a benchmark concerning digital transformation. results of this survey provide useful information needed to design a roadmap for migrating towards higher maturity levels key words: organisational maturity, predictive analytics, predictive analytics maturity framework, telecommunications sector, republic of macedonia jel classification: m19, l96 introduction companies in all industries worldwide are using and benefiting from data analytics. data analytics, especially big data analytics, advanced analytics, and predictive analytics, are among the major trends for 2017 companies worldwide are facing (gartner, 2017). but, in spite of how powerful data analytics is, almost every organisation of every size is currently struggling with the challenges associated with building a proper analytics team and becoming a data‐driven * corresponding author, e‐mail: mijoskam@yahoo.com kalina trenevska blagoeva, marina mijoska 49 organisation. in the literature, there are a variety of explanations about what a data‐driven company is and how an organisation can become one. an organisation where every individual can use data to improve decision‐making and has ubiquitous access to the needed data can be considered as a data‐driven company. there is no doubt that more companies will attempt to drive value and revenue from their data (forester, 2017). “predictive analytics is a branch of the advanced analytics which is used to make predictions about unknown future events and uses many techniques from data mining, statistics, modelling, machine learning, and artificial intelligence to analyse current data to make predictions about future” (www.predictiveanalyticstoday.com). predictive analytics provide analysing large amounts of data with different variables; it includes clustering, decision trees, market basket analysis, regression modelling, neural nets, genetic algorithms, text mining, hypothesis testing, and decision analytics (mishra and silakari, 2012). the goal is to go beyond knowing what has happened to providing a best assessment of what will happen in the future (https://www.forbes.com). data and analytics are also changing the nature of industry competition. the most significant changes are reported in high tech, media and telecom, and consumer and retail (mckinsey, 2016). the ability to derive new insights from data using analytics techniques can enhance the decision‐making process in companies. in today’s analytics economy, in which data science is increasingly adopted by companies across all industries, it is not only to question the usage of data analytics but how analytically mature organisations are since the higher levels of analytical maturity provides better perspectives. in this sense, analytical maturity refers to organisations being able to get their business to its optimal potential by using predictive analytics. using the maturity model can provide an understanding of the current state and help management form a strategy of what level of capability is desired in order to support the achievement of organisations objectives. the telecommunications sector has seen momentous growth over the past decades and continues to be a critical force for growth, innovation, and disruption across multiple industries/countries. as a whole, the telecommunications industry generates upwards of 1 trillion euro in service revenues each year (https://www.statista.com/). the 54 telecommunications companies on the 2018 forbes global 2000 list claim more than $3.4 trillion in assets and totalled nearly $1.5 trillion in revenue last year (www.forbs.com). while in the past revenue was essentially sourced from a traditional landline and wireless services, today the range of products and services available in this industry is persistently increasing, offering further opportunities for revenue creation. the telecommunications industry is competing on analytics and embracing the new science of winning by investing in data science capabilities within the enterprise. these companies use predictive analytics for analytical customer relationship management (acrm), fraud reduction, bad debt reduction, price optimisation, call center optimization, etc. in the study published by ernst & young “global telecommunications study: navigating the road to 2020“, participants scored “improving big data and analytics capabilities” as very important in order to boost their organisational agility, with nearly 40% of respondents selecting it as a priority. consumer behavior has changed significantly in the last five years. consumers are shifting to applications like whatsapp, facebook messenger, snapchat, and instagram rather than calling and texting. according to stephan gatien, general manager of telecommunications business, sap, the core services of telcos – text, voice, and data – are actually evaporating and the revenue associated with these services is evaporating as well. the big challenge in this industry is to determine how to offset the degradation of this revenue coming from text, voice, and data to a certain extent, by buying new services that will be relevant to subscribers. in the article. “turning data into insights: how digitization creates new opportunities for the telecommunications industry, julie stoughton, the head of telecommunications marketing and communications at sap, stated that telecommunications 50 economic analysis (2019, vol. 52, no. 1, 48‐55) companies are trying to reinvent themselves and stay relevant in the digital era. this has led to two major trends. first, companies are focused inward on their customer experience. they need to retain their most valuable customers and secondly, telcos are looking outward. they’re considering how they can monetize the enormous volume of iot data currently in their possession. there is no doubt that data analytics is not going to be neglected as a valuable tool for achieving that reinvention, not only for telecommunications companies but other service companies as well (stoughton, 2018) the telecommunications industry is area specific industry regarding predictive analytics use. this counts for the telecommunications sector in the republic of macedonia as well. this sector is one of the most advanced service sectors in the country and hence represent a benchmark concerning digital transformation. in line with global trends, the telecommunications market in the country is developing rapidly, particularly in the mobile segment. telecommunications in the republic of macedonia include radio, television, fixed and mobile telephones, and the internet. according to the latest report of agency of electronic communications of the republic of macedonia ‐aec, the telecommunications market in the country is fully dominated by two companies (makedonski telekom and one. vip) in all segments of the market (mobile, internet, fixed lines). according to the data of the same report, in 2017, the mobile operators' share in the mobile telephony market per number of active subscribers shows that makedonski telekom’s share was 47.97%, while one. vip operator’s share was 49.57%. the market share of mobile operators in the republic of macedonia by revenue generated from the provision of mobile communication services on the retail market is as follows: makedonski telekom has the largest market share at 52.56%, while one. vip operator has a market share of 47.21%, with a third operator having an insignificant share of 0.23%. the market shares were calculated for the total revenue, which represents the sum of revenues arising from call initiation service, monthly subscription, data transfer, terminal equipment, sms, mms, roaming (traffic, sms and data), and other revenues. the operators’ share in the total number of active subscribers to broadband and narrowband internet access via mobile network (2g/3g/4g) states that one.vip operator has a market share of 52.18%, makedonski telekom has a market share of 46.51%, while the third operator has an insignificant market share of 1.31% (www.aek.mk). methodology and results according to the latest data and analytics global executive study and research report (2018) prepared by mit sloan management review, organisations can outperform by making use of data from multiple sources. these organisations are considered innovative and analytically mature. data analytics in companies matures differently with regards to different aspects/dimensions and different parts of an organisation (departments). in practice, the maturity path of an analytical organisation is not linear in all dimensions and departments. it has a more complex trajectory which is not synchronised nor by dimension or sector/department. according to lismont (2017) “it is not unfamiliar that analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy”. (lismont, 2017). but, what analytically mature organisation means and how one organisation can become innovative and analytically mature. different authors and consulting groups propose different analytics maturity models/frameworks in order to reach a predefined analytical maturity level. in the literature, one of the latest research representing a summary of the existing analytics maturity models is one of chen and nath (2018). according to their research, numerous maturity models have emerged recently, following the proliferation of the predictive analytics tools development. chen and nath (2018) suggest that business analytics maturity models can kalina trenevska blagoeva, marina mijoska 51 be categorized by the following determinants: technology, organization, capability, and impact ‐ focused. one of the latest is the analytic processes maturity model (apmm) for evaluating the analytic maturity of an organisation (grossman, 2018). the apmm identifies analytic‐related processes in six key process areas, defined as: 1) building analytic models; 2) deploying analytic models; 3) managing and operating analytic infrastructure; 4) protecting analytic assets through appropriate policies and procedures; 5) operating an analytic governance structure; and 6) identifying analytic opportunities, making decisions, and allocating resources based upon an analytic strategy. based upon the maturity of these processes, the apmm framework of grossman (2018), organizations can differ i.e. reach five maturity levels defined as: level 1 ‐ organizations that can build reports level 2 ‐organizations that can build and deploy models; level 3 ‐ organizations that have repeatable processes for building and deploying analytics; level 4 ‐organizations that have consistent enterprise‐wide processes for analytics; and level 5 ‐ enterprises whose analytics is strategy driven. this model is based upon the capability maturity model ‐ cmm that is the basis for measuring the maturity of processes for developing software created by software engineering institute, carnegie mellon university. another approach which provides estimation of analytics maturity i.e. analytical maturity levels differs organizations in three major categories based on their relative level of sophistication in adopting analytics i.e. 1) the analytically challenged organizations display limited analytical capabilities; 2) analytical practitioners largely use analytics to track and support performance indicators; and 3) analytical innovators incorporate analytics into virtually every aspect of their strategic decision‐making, including gleaning data from a variety of sources such as direct measurement and sensors, industry data, and third parties (ransbotham and kiron, 2018, p.7). according to the defined methodology, in order to determine the relative analytics proficiency of an organization, it is suggested to calculate the analytics core index, based on the organization’s core analytics capabilities in three major areas like: (1) ingesting data (capturing, aggregating, and integrating data); (2) analyzing data (descriptive analytics, predictive analytics, and prescriptive analytics); and (3) applying insights (disseminating data insights and incorporating insights into automated processes). in detail. the analytics core index is calculated by assessing how effectively the organisation performs these seven analytics‐related tasks and activities defined like 1. capturing data, 2. aggregating/integrating data, 3. using descriptive analytics, 4. using predictive analytics, 5. using prescriptive analytics, 6. disseminating data insights and 7. incorporating analytics insights into automated processes (ransbotham and kiron, 2018, p.9). the measurement process is based on a five‐point scale ranging from very ineffective to very effective. the analytics core index score represents the sum of the responses to the seven questions, scaled to a range from 0 to 100. higher levels of analytical maturity are associated with higher levels of customer engagement, which in turn is associated with higher scores on the analytics core index, which in turn is associated with greater use of diverse data sources. this means that organizations that make effective use of a wide range of data sources — from different types of technologies and different types of entities, such as customers, vendors, competitors, and publicly available sources — are more likely to use analytics to generate higher levels of customer engagement and gain a competitive advantage than organisations that use fewer sources of data. (ransbotham and kiron, 2018, p.9). according to lismont et al., (2016), the application of analytics in organisations generally differs with regards to five different aspects like: data, enterprise or organisation, leadership, targets or techniques and applications, and the analysts who apply the techniques themselves. in their research, they found that the analytics organisation in companies matures with regards to these aspects. moreover, analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy (lismont et al., 2016). 52 economic analysis (2019, vol. 52, no. 1, 48‐55) in our survey in order to assess the level of organisational maturity in predictive analytics, we use the predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. in different business units within the same organisation, there are different maturity levels. for that reason, managers from different organisational sectors were approached and interviewed. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competency, deployment and governance). for each dimension, managers were asked to choose the appropriate level of usage out of four available maturity levels: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony. this framework can serve as a roadmap for moving the organisation towards achieving its predictive analytics goals. the suggested framework which defines analytics adoption level of an organisation and its environment is illustrated in figure 1. figure 1. the pamfa – dimensions and maturity levels source: capgemini. 2012. “measuring organisational maturity in predictive analytics: the first step to enabling the vision”, p.8. according to the defined methodology, the five different aspects/dimensions of predictive analytics maturity are assessed. the first dimension is vision and strategy. it is rare today for an organisation to develop software and information systems, without striving to use the data in best way. in this sense, having an analytics vision and strategy is very important, as the long term decisions an organisation makes about how it uses its data is needed. by defining maturity level of this dimension, the companies can write a broad “analytical map” in which the current level of the organisation will be stated, accompanied with the vision of the future wanted level. the roadmap can help in harmonising predictive analytics incentives with the organisation’s high‐level strategic goals. it demonstrates where legitimisation, or execution of extra activities, is required. pamfa looks at the current predictive analytics strategy, distinguishing any gaps and key enablers required for execution. having a vigorous methodology set up makes it conceivable to prioritise analytics initiatives based on enterprise level business imperatives, not departmental ones. the second measurement is called – enablers, and it alludes to discovering how prepared the company’s environment is to adopt or pursue predictive analytics. pamfa examines the data condition, legacy solutions, analytics process, and technology and support arrangements. it likewise survey the association's comprehension of predictive analytics and its impression of the advantages. among the empowering enablers considered in the framework are an information framework that suits predictive analytics needs and a justified portfolio of applications. kalina trenevska blagoeva, marina mijoska 53 the third dimension is competence. this implies that organisations ought to have a full understanding of all current predictive analytics projects, and of parts where analytics could be used further on. next is deployment. this measurement estimates the organisations capacity to convey predictive analytics and coordinate it into business processes which is a basic part of predictive analytics maturity. the central matter predictive analytics is to power is the decision making capability of the organisation. the last, fifth dimension in the pamfa is governance. governance is a regularly disregarded yet fundamental part of predictive analytics. therefore, it is essential to look at the organisation’s modelling lifecycle management and its administration of model precision and pertinence. for every one of these measurements, four maturity levels are characterized. level 1 is called impromptu. at this level, sporadic and secluded analytic capability results from impromptu undertakings done by a solitary administrator or speciality unit. the second dimension is named solo. level 2 is separated into two sub‐levels: amateur solo, implying that predictive analytics abilities and procedures exist for the most part at an individual dimension, and are not natural to the organisation, and professional solo which is a brilliance inside a silo. predictive analytics processes, capacities and environment meet up to address business issues adequately, yet just for individual tasks. level 3 is named ensemble. on this level, one can perceive predictive analytics activities crosswise over business functionalities, with certain procedures being made together. the last, most developed level is symphony level, where well‐organised, company’s wide activities apply analytics for achieving business advantage. this framework can fill in as a guide for moving the organisation towards accomplishing its predictive analytics objectives. pamfa is structured not exclusively to distinguish the present dimension of predictive analytics development, yet additionally to find the company's ideal analytics maturity level (iaml). the iaml is the dimension that would empower the firm both to capitalise on existing assets and furthermore to put ideally in extra assets, so as to accomplish key objectives and infer greatest business benefits. the results of the survey confirm that analysed companies fall somewhere around level 2 or 3 for almost all dimensions. more precise, results for each dimension are shown in the table below. table 1: survey results vision and strategy enablers competency deployment governance a b a b a b a b a b level 1 impromptu level 2 solo * * * * * level 3 ensemble * * * * * level 4 symphony regarding the first dimension, vision and strategy, analysed companies are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not formulated enterprise vision and strategy for using predictive analytics as a valuable asset for the company as a whole. although some employees in separate departments have an analytics vision, yet there is no single formulated analytics strategy, even for that department. the achieved level is relatively high and can be a boost for achieving higher level on other dimensions. the maturity of the analysed companies for the second dimension – enablers is on level 2 (solo). this implies that separate business departments may work together with innovation or business intelligence units, yet there is almost no data exchange. while discussing this 54 economic analysis (2019, vol. 52, no. 1, 48‐55) dimension with the managers‐respondents, it was obvious that they are not satisfied with the alignment of the processes. the third dimension is called competency. analysed companies in our research are on level 2 of maturity. this implies that some business units, individual competency may exist, but it is not used widely on a regular basis. the reported level is in correlation with the reported level of the dimension enablers, and the silo thinking is still an obstacle in this companies for performing predictive analytics and monetizing its results. for the fourth dimension ‐ deployment, the answers from the interview are more dispersed. this means that company a is on the second level of maturity and company b on the third. level 2 (solo) means that in company a integration with the business information systems is manual. for company b which is on level 3 (ensemble), this score shows that the analytics is integrated with decision‐making systems. for both companies, the predictive analytics model output is not yet integrated with business intelligence systems, decision‐making systems and business information systems. the last dimension (governance) for both companies shows level 3 of maturity. this level, ensemble, means that business unit level governance in both companies exist but, there is still a limited enterprise‐level governance. according to the results, the overall level of predictive analytics maturity is set between levels 2 and 3 for analysed companies. although both companies are doing well on maturity journey, there is an evident difference in the maturity of the fourth dimension – deployment. the pamfa can serve as a plan for guiding the organisation to achieving its predictive analytics objectives. this framework is designed not only to identify the current level of analytical maturity but also to discover the organisation’s ideal analytics maturity level (iaml) (capgemini, 2012). the limitation of the research methodology is the subjectivity that is expected in assigning the levels by the managers‐respondents. overestimating the levels of maturity is possible. however, this bias is present in every methodology of this type. with respect to initially measurement, vision and methodology, broke down organizations are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not characterised and verbalised a venture vision and technique for utilizing it on a big business level. increasingly exact, an investigation people in some speciality units have an examination vision, yet there is no enunciated examination methodology, notwithstanding for a solitary speciality unit yet. vision is explained by individual speciality units, alongside the it, who need to help the vision. the accomplished dimension is moderately high and can be a lift for accomplishing a more elevated amount on different measurements. conclusion organisations nowadays are focused on predictive analytics as a valuable tool to use data for achieving competitive advantage. the telecommunications sector in the country is one of the most advanced service sectors and hence represent a benchmark concerning the digital transformation. the results of our survey confirmed that telecommunications companies in the country understand the benefits of predictive analytics as a valuable source to gain a competitive advantage from data. the interview results confirm that organisations fall somewhere around level 2 or 3 for almost all dimensions. this survey results provide useful information needed to design a plan for migrating towards the higher levels of maturity. the road to achieve higher levels across all dimensions is hard, and it will take full management commitment in order to maintain competitive. this research is the first attempt to analyse organisational maturity in using predictive analytics in the country. its originality derives from the specific characteristics and development of telecommunications sector in the country and its importance. knowing where an organization is on this journey will help managers/strategists to kalina trenevska blagoeva, marina mijoska 55 adopt ideal analytics maturity level, i.e. the highest level that would enable organisations to derive maximum business benefits and achieve its strategic objectives. further research can include companies from other industries in the country (finance, health) since the pamfa can be used to measure and describe their predictive analytics efforts. references agency for electronic communications of the republic of macedonia. 2018. “report on the development of the electronic communications market in the republic of macedonia for 2017.“ https://www.aek.mk capgemini. (2012). „measuring organizational maturity in predictive analytics: the first step to enabling the vision.“ https://www.capgemini.com ernst & young. (2015). “global telecommunications study: navigating the road to 2020.“ https://www.ey.com grossman, robert l. (2018). “a framework for evaluating the analytic maturity of an organization.“ international journal of information management, 38: 45–51 chen, l. & nath, r. (2018). "business analytics maturity of firms: an examination of the relationships between managerial perception of it, business analytics maturity and success", information systems management,. 35(1): 62–77 lismont, j., et al. (2017). “defining analytics maturity indicators: a survey approach.“ international journal of information management, 37 (3): 114‐124 mckinsey global institute. (2016). “the age of analytics: competing in a data‐driven world.“ https://www.mckinsey.com mishra, n. & silakari, s. (2012). “predictive analytics: a survey, trends, applications, opportunities & challenges.” international journal of computer science and information technologies, 3 (3): 4434‐ 4438 morabito, v. (2015). “big data and analytics: strategic and organizational impacts.“ springer ransbotham, s. & kiro, d. (2018). “using analytics to improve customer engagement, findings from the 2018 data & analytics global executive study and research report.” mit sloan management review, https://www.sloanrieview.mit.edu stoughton, j. (2018). “turning data into insights: how digitization creates new opportunities for the telecommunications industry.” https://www.digitalistmag.com trenevska blagoeva, k., josimovski, s., mijoska, m. & jovevski, d. (2018). “determinants of analytics usage to improve customer engagement in chosen macedonian companies.“ knowledge ‐ international journal, 22(1): 187‐192. valdez‐de‐leon, o. (2016). “a digital maturity model for telecommunications service providers“, technology innovation management review, 6 (8): 19‐32 https://www.digitalistmag.com. https://www.forbs.com https://www.gartner.com https://www.infoworld.com https://www.predictiveanalyticstoday.com https://www.statista.com article history: received: may 16, 2019 accepted: june 21, 2019 ea_2014_3-4 udc: 338:339.137.2(4-672eu) jel: o24, f10 cobiss.sr-id 211780364 original scientific paper competitiveness of the european union: pre-crisis trends and impact of the financial crisis makrevska disoska elena1, university ss. cyril and methodius in skopje, faculty of economics skopje, republic of macedonia nenovski tome, university american college skopje, republic of macedonia abstract – this paper has the aim to point out the risks of reducing the eu competitiveness by analyzing the indicators of price and cost competitiveness, as well as the structural and technological aspects of competitiveness. the influence of the world crisis on the competitiveness and export performances of the eu is in the focus in order to show at what extent the global downturn may have aggravated previously existing needs for readjustment of the functioning of the union. not only that the crisis showed that the problems in the union were not created recently, but also it demanded urgent needs of new improved policy in order to regain the competitiveness strength and performances. the reformulated strategy needs to be based on openness and innovation, with investment in research and development. long-term expectations are to be made comprehensive structural changes in order to overcome structural differences between individual member states and to increase the overall competitiveness. additionally, trade barriers are needed between individual member states to be removed and higher individual and aggregate rates of economic growth are to be achieved. it is clear that the effects of deep integration of the eu has not yet been achieved, and expected benefits may not be realized, if internal and external balance of the union is not maintained. key words: competitiveness, trade, exchange rate, technology, productivity introduction over the past two decades, european union (eu) managed to hold its position on the world market, competing with the usa and japan, and as well as with new rivals such as china and india. but even before the crisis, the productivity growth started slowing down and the eu faced with the serious challenges of losing world market positions due to the loss of competitiveness. under the term ’’competitiveness’’ in the literature can be found many different definitions. generally, an economy is competitive if it does things that are likely to encourage economic growth. the simple measure of economic growth is the value of the 1 postal adress: blvd. goce delchev, 9v, 1000 skopje, republic of macedonia, e-mail: elenam@eccf.ukim.edu.mk makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 21 gross domestic product (gdp). but, if a country is increasing its gdp that would not mean that the country’s competitiveness has improved. for instance, if the growth is based on natural resources and their favorable price developments, the gdp will grow (gdp= quantity multiplied by prices), but the economy will not have significant improvements in the competitiveness. in case, the reason for the dynamics and the quality of economic growth is determined from the level of labor productivity, then we can make difference. in the macro economy it is widely accepted that the difference in labor productivity is the reason for the great differences in the level of economic growth in the countries in the world economy (mankiw, 2010). krugman (1996) has also declared that the real essence of competitiveness is reflected in the productivity. still, many economists believe that not only the quantity of economic production is important, but also the quality of living of the people (aiginger, 2004). that would mean, greater opportunities for education, healthy life, rich cultural life etc. that can be measured by the second indicator of economic growth, gdp per capita. higher the gdp per capital means higher living standards of the population. still, gdp per capita does not take into account the country’s ability to distribute the gained wealth in a fair manner (it is calculated on average level). another weakness is that we can get wrong conclusion. for example if we have the same value of the gdp, but decreasing growth rates of population, we will get higher gdp per capita. some authors (haiman & altena, 2007) find the linkages between competitiveness and trade (traditional theories). popular discussion often views ‘competitiveness’ as a way to narrow the current account deficit of the balance of payments. that can be measured by the growth of the export of the market share (participation of the total value of the export in the total world export). the essence of this theory is compounded by openness to trade tending to be associated with openness to ideas. especially for small economies, openness to trade should boost economic growth by increasing domestic competitive pressures (from imports) and allowing domestic producers access to wider markets and so economies of scale (from exports). still these theories do not take into account the quality of the product or the service or the branding of the products. on long run, non pricing factors (structural and technological aspects) such as: research and development, regulatory regime and other have significant influence on the competitiveness of the products and of the economy. finally, if we summarized all the above mentioned views, the competitiveness of one country can be defined as ability of the country to compete on the world market, with final goal to increase the wealth of the country and the living standards (ottaviano at al., 2009). the definition according to the traditional theories will be applied in the context of the paper. in the first section, the trends in the world trade and eu trade are analyzed, from the creation of the european economic community to 2010. in the second section the discussions about the indicators of competitiveness will take place. the approach towards the eu competitiveness will be analyzed according to the traditional approaches that consider the successful export performance – either in terms of export growth or export market share and by the standard indicators of cost and price competitiveness. to determine the price competitiveness, the real effective exchange rate is used. cost competitiveness is analyses by the ulc (unit labor costs) in manufacturing sector and consumer price deflator in order to see the trend of the movement of the real effective exchange rate. also, additional data from economic analysis (2014, vol. 47, no. 3-4, 20-34) 22 the global competitiveness report (world economic forum, 2013) and of europe 2020 strategy will be integrated in the paper in order to give multi-dimensional concept of competitiveness. in order to overcome the flaws of the traditional theories in the third section, technological aspects and other aspects of the non-price competitiveness of the eu will be elaborated. this paper has the aim to point out the risks of lowering the eu competitiveness. the influence of the world crisis on the competitiveness and export performances of the eu is in the focus in order to show at what extent the global downturn may have aggravated previously existing needs for readjustment of the functioning of the union. not only that the crisis show that the problems in the eu were not created recently, but also ask for urgent need of new improved policy in order to regain the competitiveness strength and performances. the methodology of this research is based on quantitative analysis. it will be presented in a form of time series analysis for the case of eu, concerning the period 1958-2012, and for the indicators of competitiveness 2000-2012 in order to point out the dependence among observations at different points in time. core suppliers of the needed data will be the euro stat, international monetary fund and un comtrade databases. the expected outcome of the research is to summaries the main reasons that contribute to loss of the world trade positions of the eu which will lead to conclusions about the future prospects of the eu and need for high productive strategy. trends in the world trade and trade of the eu global external imbalances widened persistently over the last several years. international trade flows contracted sharply in the fourth quarter of 2008 and first quarter of 2009 mainly due to the decline in the economic activity and aggregate demand, which was result of the beginning of the world economic crisis, the percentage decline of the world trade in 2009 compared to 2008 was 22.73% (table 1). table 1. annual growing rates of the world trade by region and selected economies (%) 2006 2007 2008 2009 2010 2011 2012 world 15,38% 15,24% 15,45% -22,73% 21,79% 19,54% 0,30% north america 11,90% 7,97% 8,83% -23,56% 22,97% 15,62% 3,54% south and central america 21,07% 19,66% 24,51% -24,32% 27,84% 26,41% 0,61% europe 14,24% 16,58% 12,41% -23,60% 12,75% 17,63% -4,87% commonwealth of independent states 27,61% 26,10% 34,58% -35,28% 28,83% 32,69% 2,89% asia 16,27% 15,23% 16,87% -18,60% 31,42% 20,09% 3,31% others 21,15% 18,83% 31,00% -25,11% 24,16% 25,55% 4,80% european union (27) 14,07% 16,35% 11,88% -23,62% 12,50% 17,24% -5,23% intra-trade 13,84% 16,39% 9,88% -23,54% 9,88% 15,92% -6,93% extra-trade 14,54% 16,29% 15,83% -23,76% 17,45% 19,55% -2,34% source: eurostat, comext database; national statistics; global trade atlas; imf, international financial statistics. http://www.wto.org/english/res_e/statis_e/quarterly_world_exp_e.htm makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 23 regarding the regions, the exceptional decrease was noticed in the commonwealth of independent states (c.i.s) of 35.28% in 2009, while the region of asia has the lowest slowdown in the volume of trade of 18,6% on annual basic. still, the decline in the trade has high degree of synchronization across countries, as a result of the developed and closely connected financial market and transmission power of the informational technologies. the downfall of the total trade of eu was 23,62% in 2009 compared with 2008. the declining foreign demand in the wake of the 2008/09 global economic downturn hit the eu’ export sector particularly hard. this led to increasing concerns about the prospects for eu` exports and competitiveness, particularly at a time when exporters had already been struggling to adjust to the fiercer competition and other structural changes resulting from globalization. while partly reflecting the relatively high openness of the european economy, this has also prompted increasing concerns about the competitiveness of the union. trends in exports and imports may serve to calculate the value of the current account of the european union. trade balance of union in the reviewed period had a mainly negative value , i.e. value of imports is higher than the value of export and is worsening over the last decade. since 2002 the trade deficit is widening, and it reached the highest negative value in 2008 (525,1 billion euros). the recovery was in 2009, when the trade balance showed positive tendencies. according to the data from euro stat only in the period 1993-1998, the eu exerted a positive trade balance (figure 1). figure 1. trade balance of eu (billions euros/ecu) source: еurostat, (2011): external and intra-eu trade: a statistical yearbook, data 1958 – 2010, european commission, luxemburg, *the data cannot be consistent on the yearly intervals because of the lack of data so far, european policymakers seem to have watched the growing imbalances without much concern, in the hope that the eu will be largely unaffected (ahearne, jürgen, 2005). additionally, the trade account balance, as well as the current account balance has never constituted a condition for acceptance of a single currency. even in maastricht criteria for entry in the euro zone, there are no restrictions on trade or current account deficit. under article 143 of the treaty on the functioning of the european union, only countries countries that have not yet adopted the euro may receive financial assistance to deal with have problems in the balance of payments (treaty of the functioning of the european union). the reason why the eu does not allow for funding the deficit in the trade account is because it is considered that no economy cannot be exposed to speculative attacks of the common currency. therefore, deficits between countries that are already members of euro economic analysis (2014, vol. 47, no. 3-4, 20-34) 24 zone should be financed through short-term financial markets, without the need for intervention by the monetary authorities. the problem is systematic. the trade deficit of the eu is a result from the countries that traditionally achieve trade surplus (luxembourg, finland, the netherlands and germany) and countries with traditionally high deficits (greece, portugal and spain). however, the deficit in the trade account of greece, portugal and spain was balanced until the mid1990s. obviously, the process of convergence of these countries in the monetary union impacted negatively on the country, resulting in deepening deficit due process of adaptation to the eu. just for example, the spain balance of trade increased in 2006 approximately four times more compared in 1999 (trading economics database). interesting is that the crisis created cyclical movements in the trade balance of the eu countries. the countries that traditionally have trade surplus, experienced lowering of the trade balance, and vice versa for the countries with the trade deficit. by approaching price and cost competitiveness this research will try to give an answer to these problems. approaching price and cost competiveness of the eu competitiveness of the eu as a main global trade leader is achieved by the advantages of the existence of the common market. the eu is the world`s largest exporter with well positioning in the global value chain. still, the common market of the eu is fragmented by the domestic producers that do not use the advantages of the economies of scale as a result of not synchronized policies. with the beginning of the economic crisis, many of the structural weaknesses of the union were revealed. as the private demand remain resilient and the public expenditure increased the internal imbalance of the union. slugging international demand and poor economic outlook limited the potential for export. the trends of the export of the eu is moving almost in the same direction as the total trade of the eu. export growth reached its peak in 2007 with 17% annual growth, and experienced decline in 2009 of 23%, compared with 2008. after the short recovery the export showed 5% decrease in 2012 compared to the previous year. according to the share of the export of the eu in the world export, the relative indicator is slowing down (figure 2). with the exception of the period 1958-1960, the union had the highest share in the value of world exports in the whole observed period. in 1996, eu had a 20.8% market share of the world trade in goods (excluding intra-eu). this market share has been lowered by competitive pressures from emerging economies, falling to 16% in 2010. the second largest world exporter were usа, whose share has been declining gradually since 2000. the most remarkable development is that china as fastest growing economy from 2005 onwards become the third largest exporter in the world, followed by japan as the fourth largest world exporter. thus, if we make comparison, we can see that the rise in the export share of china for 10 p.p. from 1996 to 2010, has been fairly affected by the eu (fall of 4,8 p.p.), usa (4,6 p.p.) and japan (3,7 p.p.) over the same period. makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 25 figure 2. participation of the countries in the total world export of goods source: еurostat, (2011): external and intra-eu trade: a statistical yearbook, data 1958 – 2010, european commission, luxemburg, *the data cannot be consistent on the yearly intervals because of the lack of data the eu's export performance varies significantly between markets. the eu shows a decrease in market shares on some of the most dynamic importing markets during the last decade. the largest gain is in the usa market, where the eu accounted for over one fifth of the import market in 2007. this performance coincided with shrinking shares of japanese and to a lesser extent, of canadian and asean exports in the same market. conversely, the eu loses market shares on the brics markets. the small market share loss of eu products on the rapidly expanding chinese market could, however, have a large impact in the long run. this appears to be mainly associated with the unfavorable trends in price competitiveness of the eu. measured in terms of relative export prices, european central bank estimates that the euro area price competitiveness deteriorate by around 10% between 1999 and 2008 (ecb, 2010). the decrease in the price competitiveness is confirmed by the movements of the nominal effective exchange rate, given in figure 3. an increase of this indicator suggest an appreciation, which indicated lowering of the price competitiveness. the appreciation of the exchange rate was from 2002 to 2009, after it experienced depreciation until 2012. the figure show that the euro zone has lower price competitiveness compared with the eu as an economy of 27 member countries (not taking into consideration croatia, because of the lack of data). figure 3. nominal effective exchange rate (index 2005=100) source: european commission, http://ec.europa.eu/economy_finance/db_indicators/competitiveness/data_section_en.htm * ic 36 = group of 36 industrial countries y = -0.0011x + 0.2067 r² = 0.1906 eu usa china japan south korea ea17 vs eu27 ea17 vs ic36 eu27 vs ic36 economic analysis (2014, vol. 47, no. 3-4, 20-34) 26 still, the price competitiveness differs from country to country. high price competitiveness is achieved for germany, france, austria and finland. losses in price competitiveness is recorded in most of the countries were at the same time experienced decline in the export estonia. malta, cyprus, greece. the losses in market shares have coincided with a degradation of cost competitiveness, measured by the unit labor costs. the rise in the real effective exchange rate indicate lowering of the cost competitiveness. as a consequence of the strong growth of real wages since 2002 in most of the countries, ulc has increased both in the eu and euro area as a whole (figure 4). figure 4. real effective exchange rate (ulc) (index 2005=100) source: european commission, http://ec.europa.eu/economy_finance/db_indicators/competitiveness/data_section_en.htm despite the intensive wage growth which is a long term trend, during the whole period from 2002-2011, the peripheral member states register high unemployment rate, which indicates low wage sensitivity to the unemployment movements (figure 5). additionally the cyclical effect of the crisis caused losses in the labor productivity, meaning faster decline of output relative to employment during the slump. between the first quarters of 2008 and 2009, production decreased by 19% while hours worked fell by 8%. (european commission. 2013). figure 5. fluctuations in eu ulc are mainly caused by variations in labor productivity growth source: european commission, (2013): european competitiveness report 2013:toward knowledge driven reindustrialization, european commission, commission staff working document swd(2013)347 final, p.28 ea17 vs eu27 ea17 vs ic36 eu27 vs ic36 makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 27 therefore, as a result of the insufficient labor productivity achievements, despite the introduction of new technologies and good business practices, the economic growth in the union was slowing down. in other words eu is not an optimal currency area, except the lack of wage flexibility, the eu does not have convergence in the business cycles, has low mobility of labor force and capital. in this regard, it can be concluded that in the event of economic shock, when there is no flexible foreign exchange regime and autonomous monetary policy in the member states, the labor mobility or wage flexibility cannot recover the differences among the economies in the monetary union (trpeski, kondratenko, jankoski, 2013). therefore there is limited potential growth of national spillovers. this argument is supported by the regional competitiveness index (rci) calculated by the european commission, which measures the different dimensions of competitiveness at the regional level in eu countries. rci reveals substantial differences in competitiveness within some countries. in france, spain, the united kingdom, the slovak republic, romania, sweden and greece the level of variability across regions is particularly high. thus, large gap in regional competitiveness is harmful for national competitiveness and consequently for the union as a whole (the world economic forum, 2014). nonprice competitiveness while for most eu countries price competitiveness has been a critical factor in shaping relative export performance with respect to major direct competitors – most notably developed economies – other non price-related factors play a part. generally, non-price competitiveness comprises the structural and technological aspects of competitiveness. in this context, factors such as research and innovation, infrastructures, as well as the regulatory and tax framework of a country, are critical because they affect the prospects of achieving higher productivity growth and thus competitiveness in the medium and longer term (ecb, 2010). the european competitiveness report (2013) shows that the eu has comparative advantages in most manufacturing sectors (15 out of 23) accounting for about three quarters of eu manufacturing output. they include vital high-tech and medium-high-tech sectors such as pharmaceuticals, chemicals, vehicles, machinery, and other transport equipment (which includes aerospace). in the high tech sectors, the eu has comparative advantage in pharmaceuticals but lags behind in the rest of this broad category (computers, electronics, and optical equipment). even in the medium high-tech sectors, eu comparative advantage is lower than for the us and japan. more importantly, china and the other emerging industrial economies are quickly gaining ground in the knowledge intensive sectors and rather than merely assembling high-technology products they are now producing them. even though the data in table 2 confirm that the china is a leader in high tech industries, still this is not a reliable data. it is a result of the offshore activities of the usa and eu for a low cost production. economic analysis (2014, vol. 47, no. 3-4, 20-34) 28 table 2. comparative advantage by technology intensities in manufacturing, 2011 high tech medium high tech medium low tech low tech eu 0,85 1,14 0,89 1,01 japan 0,73 1,59 0,86 0,16 usa 0,88 1,22 0,96 0,68 brazil 0,32 0,76 0,87 2,5 china 1,56 0,72 0,85 1,29 india 0,4 0,49 1,93 1,33 russia 0,08 0,45 2,74 0,49 source: un comtrade the type of specialization of the countries can explain the cyclical movements in the trade balance. since, there is a difference between elasticity of different categories of goods and services, trade in services, except for transport, declined with less dynamics than trade in goods. in the trade in goods investment good register the greatest reduction. contrary to these trends, the trade of traditional “un cyclical” sectors, such as food, beverages and pharmaceutical products, was far more resilient. consequently, countries that entered the global economic crisis with large trade deficits had a significant improvement in the condition of the trade account during the 2008 2010. countries that had substantial trade surpluses had note lowering of the positive balance in the trade. this suggests that the decline in trade surplus of the countries that traditionally generate a positive trade balance (germany, france, austria, belgium and netherland) is due to the elasticity of world demand for capital intensive products and investment goods, in which these countries are highly specialized. conversely, countries with trade deficits (greece, spain, cyprus, slovenia and finland) that have high specialization in consumer goods, had slightly reduced exports due to the global “un elasticity” demand (mauro, foster, lima, 2010). these developments are cyclical, i.e. they are occurring due to the impact of the economic cycle in which the world economy is. thus, after the crisis, current trends in the trade balance will be present again. consequently, the existence of different economic structures of the countries is a systemic problem for the union . although it can be equated with the imbalance globally, there is a significant difference. globally, the adjustment are achieved through exchange rate movements, while within the monetary union (such as the eu) that must be achieved through fiscal adjustment and coordination of policies within the member countries (mrak, 2010). we believe that decreased labor productivity of the union is important and influence negatively not only for price, but also for non-price competitiveness. labor productivity, and especially multi-factor productivity, is often seen as indicator of technical progress. increased labour productivity means more output is produced with less labor, which can be due to technological or organizational improvements and other non-observable factors. makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 29 reasons behind loss of the eu competitiveness in order to explain why european growth came down from the extraordinary levels it reached during the golden age (1950-1973), and most importantly the technological lagging of eu behind usa we will compare the indicators of labor productivity and labor input between eu and usa. table 3. levels of eu-15 relative to the usa, in ppp, (usa=100) 1950 1973 1995 2004 gdp per capita 45,5 76,8 74,9 74,1 gdp per working hour (labor productivity) 39,5 75,4 98,3 90,3 working hours per head of population (labor input) 115,2 101,9 76,2 82,1 source: ark, van b., o’mahony, m., timmer, p. m., (2008) "the productivity gap between europe and the united states: trends and causes", journal of economic perspectives, volume 22, number 1, pages 25–44 according to the numbers in the table 3, the problem is ascribed entirely to a relative fall in labor input (from index of 115,2 in 1950 to 76,2 in 1995 and 82,2 in 2004 compared with the usa). the reason for this is: a) the ratio of population of employed to the population of working age is higher in usa 74% (oecd database) compared with eu of 68% (euro stat database) . the data shows that are that employment rate (age group 20-64) is still below the objectives set in "europe 2020" of 75% of the population. b) the structure of the working population has aged considerably in recent decades. between the 1960 and 2000 the average dependency ratio (defined as number of persons aged 60 or more years per 100 persons aged 15-59 years) for the eu-15 rose from 26 to 35. at the same time, the dependency ratio for the united states remained almost constant at around 25. during the period 1995-2015, the population above the standard retirement age, 65 years, will increase by 17 million (30%). within this group the very old, those over 80, will increase by 5.5 million or 39% (blanchard, 2004). c) fall of the utilization rate of labor in europe compared with usa which is a result of the sustainable preference for leisure due to the higher social protection of the workers and also by the labor rigidness of the european market. taking into consideration that the average hours worked are much shorter in eu and the employment rate is much lower compared with the usa, we can get artificially boosted indicator of the productivity. as the data show the productivity in eu did not decrease, just opposite the index gdp per working hour increase from 75,4 in 1975 to 98,3 in 1995. then decreased to 90,3 in 2004, but still remain below usa (index=100) (table 2). this indicator should be revised in order to compare the real productivity gap between eu and usa. according to cette (2004), the european productivity level should be revised downwards, which suggest that the productivity gap between eu and usa remain substantial. the main turning point for widening the productivity gap is considered to be since 1995. taking into account indicators of annual productivity growth, in the usa, average annual labor productivity growth accelerated from 1.2 percent during the period 1973–95 to 2.3 economic analysis (2014, vol. 47, no. 3-4, 20-34) 30 percent during 1995–2006. comparing the same two time periods, annual labor productivity growth in the european union declined from 2.4 to 1.5 percent (ark, o’mahony, timmer, 2008). in the mid-1990s, there was a burst of higher productivity in industries producing information and communications technology equipment (ict), and a capital-deepening effect from investing in information and communications technology assets across the economy. in turn, these changes were driven by the rapid pace of innovation in information and communications technologies, fuelled by the precipitous and continuing fall in semiconductor prices. europe has been lagging behind the usa not only in ict investment but also in total productivity growth in ict producing as well as ict using industries. practically, the period of the two oil shocks 1973-’74 and 1978-’79 marked the end of the fast growing industries like chemical and automotive industry, production of plastics and artificial fibers, which have been the main driving force of economic growth in the postwar period. for thirty years, between 1950 and 1973 europe enjoyed a “golden age” of growth, stability and social cohesion. all industries were replaced by new industrial sectors with high added value, such as electronics, chemicals and pharmaceuticals, computer technology and telecommunications. although newly industrialized economies-japan and "economies tigers" of southeast asia, at that time were trying to increase the competitiveness of these industries, especially electronic, still in the information technology products and bio pharmaceutical products usa, had a big competitive advantage (dyker, 1999). also, eu is lagging in the investment in research and development (r&d). according to the objectives set out by the european commission (2010a), "europe 2020", each eu should consider costs for r&d to be amounted 3 % of its national gdp (same as in the lisbon strategy). in the period 1995 2010, the cost of r&d calculated as a percentage of gdp in the eu and the euro area are relatively fixed, and moving with an average value of 1.8 % of gdp, which is below the set limit. eu and the euro area have only a higher spending rate on r&d than china. within the eu, only sweden and finland with 3.7 % exceeding the target. other countries that have a higher than average rate of union are: germany (2.69 %) and denmark (2.85 %). in 2008, japan had the highest percentage of allocation of 3.45 %, followed by south korea with 3.36 % and 2.76 % in the usa. south korea has significant rise in the cost during the reporting period. it seems that the lisbon strategy for making the eu the world’s most competitive economy is a failure. still, an extension of the failed approach is in the works. after lisbon strategy, the europe 2020 strategy has emerged with some principle tasks, but central ideas of the lisbon strategy have been kept. the lisbon answer has been the “open method of coordination. it was to aim at the middle ground, where key policy domains remain a national competence but are recognized as being of common interest. eu continue with the lisbon-type reforms and developed new instruments of economic governance, especially with the beginning of the economic crisis. some authors (wyplosz, 2010) state that lisbon strategy should die a peaceful death and that a brand new model is needed. we believe that the model is adequate, even though there is no explicit productivity growth target formulated in the europe 2020 strategy, but trends in labor productivity are monitored as one of its main indicators. the countries from eu makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 31 need to find their own ways of adjusting to the opportunities and dislocations of the new information and communications technologies. we believe that large extent of the reforms should remain under the member states` authority, which can bring higher incentive for its implementation, thus contributing to accomplish common interest. when one country becomes more productive, it benefits (through demand) the whole eu and raise the productivity of the rest of the countries. there also, need to be ensure greater labor mobility and flexibility of the common market, that can help the union to improve the competitiveness and also to be able to face adverse shocks in the future much easier. conclusion data for foreign trade of the eu show that the integration process and the introduction of the euro had contributed for the union to become the biggest "trade player " in the world. however, there has been a gradual of trading positions of the eu. that is not only a result of the economic crisis, but due to the major structural weaknesses (shortcomings) of the eu. in other words, the situation in the foreign account is created due to the gap in productivity, which led to a real depreciation of the exchange rate in favor of countries that have traditionally been exercising surplus. at the same time, most of the other member states of the eu realized permanent foreign trade deficit that, among other things, was a result of the large discrepancy between labor productivity and wages, whose ultimate effect was perceived in shrinking or stagnant rates of economic growth of these countries. it turned out that the economy of eu has a series of structural inconsistencies and numerous drawbacks in its economic system. the lack of compliance of the internal policies, was one of the most important reasons for the occurrence of asymmetric shocks in the union, reducing the competitiveness of the economy eu and strengthening the negative effects from the existing economic crisis. among the member states of the eu was created gap in prices for homogenous products. even thought, the purpose of the single market was to allow free movement of goods, service, capital and labor, the goal was not met due to different price levels. the difference in prices and production costs have caused a negative impact on trade flows in the union. eu shows a decrease in market shares on some of the most dynamic importing markets during the last decade, especially asean market. the orientation of the trade towards the emerging countries can be suggestion for the rest of the member states for faster out of the crisis and balanced trade account in the future. but on the other hand it is needed to boost the trade relations between eu countries in order to gain and improve the trade conditions in the common market. long-term expectations and needs for the common market is to make a comprehensive structural changes in order to overcome structural differences between individual member states to increase the overall competitiveness and individual, to remove trade barriers between individual member states and to achieve higher individual and aggregate rates of economic growth. it is clear that the effects of deep integration of the eu has not yet been achieved, and expected benefits may not be realized, if the internal and external balance of the union is not achieved. economic analysis (2014, vol. 47, no. 3-4, 20-34) 32 according to our opinion, the eu needs changes in the long term strategy which should be oriented towards targeting specific systematic problems of individual member states of eu. the reforms need to be make in order to enhance competitiveness, seen as a priority. when one country becomes more productive, it benefits (through demand) the whole eu and raise the productivity of the rest of the countries. even thought the relationship between labor productivity and market share gain is not straightforward, we tried to point out that decreased labor productivity growth in the case of eu influence on the declining share of the world market. firms and industries from eu are facing tough competition from low-cost producers (especially from the asian countries) and therefore they are forced to rationalized their production in order to survive. in that direction, the measures need to be oriented towards decrease in the employees` protection and higher initiative for regional and mobility of the labor force. additionally, if the competitiveness of the union is not improved, the balance in the trade account will be provided by increased unemployment, particularly in certain sectors which are 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"europe 2020 – a strategy for smart, sustainable and inclusive growth", commission staff working document, brussels, 3rd of march, ref: com(2010)2020 makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 33 european commission official web site, http://ec.europa.eu/economy_finance/db_indicators/competitiveness/data_section_en.htm (accessed march 25, 2014) haijman, w. and altena, p. 2007. in search of clusters. netherland: mansholt graduate school of social science. krugman, p. r. 1996. "making sense of the competitiveness debate: international competitiveness", oxford review of economic policy, 12 (3): 17-25 mankiew, gregory. 2010. macroeconomics. 7th edition. usa: worth publishers. mauro, f. , forster, k. and lima, a. (2010). the global downturn and its impact on euro area exports and competitiveness. frankfurt: european central bank. mrak, mojmir. 2010. “eurozone crisis: what went wrong and where do we stand now?”. working material. slovenia: university of ljubljana: 4-8 gianmarco i.p., ottaviano, taglioni, d. and di mauro, f. 2009. "the euro and the competitiveness of european firms". economic policy, 24 (57): 5-53. trading economics, http://www.tradingeconomics.com/spain/balance-of-trade (accessed april 2, 2014) treaty of the functioning of the european union, http://eurlex.europa.eu/lexuriserv/lexuriserv.do?uri=oj:c:2008:115:0047:0199:en:pdf (accessed march 14, 2014) un comtrade database, http://comtrade.un.org/ (accessed march 12, 2014) world economic forum. 2014. "the global competitiveness report 2013-2014", http://www3.weforum.org/docs/wef_globalcompetitivenessreport_2013-14.pdf (accessed april 20, 2014) wyplosz, charles. 2010. "the failure of the lisbon strategy", http://www.voxeu.org/index.php?q=node/4478 (accessed march 7, 2014) konkurentnost evropske unije: trendovi pre krize i uticaj finansijske krize rezime – cilj rada je da se ukaže na rizike od smanjenja konkurentnosti eu analizirajući pokazatelje cene koštanja i konkurentnosti, kao i strukturne i tehnološke aspekte konkurentnosti. uticaj svetske krize na konkurentnost i izvozne performanse eu je sve više u fokusu kako bi se ukazalo na to koliko globalna kriza može da oteža već postojeće potrebe za sanacijom funkcionisanja unije. ne samo da je kriza pokazala da problemi u uniji nisu nedavno nastali, već je nametnula hitne potrebe za poboljšanje nove politike kako bi povratila snagu konkurentnosti i performansi. preformulisana strategija treba da se zasniva na otvorenosti i inovacijama, uz ulaganja u istraživanje i razvoj. dugoročny očekivanja treba da budu sveobuhvatne strukturne promene u cilju prevazilaženja strukturnih razlika između pojedinih država članica i povećanje ukupne konkurentnosti. pored toga, neophodno je i da se uklone trgovinske barijere pojedinih država članica kao i da se postignu više pojedinačne i ukupne stope privrednog rasta. jasno je da još uvek nisu postignuti efekti duboke integracije u eu, a očekivane koristi ne mogu se realizovati ukoliko se interni i eksterni bilans unije ne održava. economic analysis (2014, vol. 47, no. 3-4, 20-34) 34 ključne reči: globalizacija, internacionalizacija, biznis, globalna tržišta, ekonomska integracija article history: received: 8 september 2014 accepted: 23 november 2014 microsoft word 2007_01_02.doc agri‐environmental policy in poland:   challenges and evaluation approaches  jadwiga ziolkowska, humboldt university of berlin  key words agri‐environmental policy, agri‐environmental measures, transformation  udc: 338.43.02:719.502.2         jel: q1, q5  original paper  abstract ‐ the main objective of the paper is to investigate challenges for the agri‐environmental  policy in poland and to detect methodical approaches which can be used for the evaluation and design of agri‐ environmental measures to make them more effective. analysing the development of the agri‐environmental  policy in the transformation process in poland, before and after the accession to the european union, we  state that several changes are necessary to  improve the efficiency and effectiveness of agri‐environmental  measures in poland. the acknowledged methodical approaches can be helpful to evaluate agri‐environmental  measures and to specify problems to be solved in the following years.  introduction  before the transformation process in poland, the necessity of environmental protection in ru‐ ral areas has not been promoted very widely. the reason was the belief that environmental pollu‐ tion was caused by the industry. in the following years of the transition process and before the  accession to the european union, several measures have been undertaken in order to improve the  environmental protection in agriculture. thus, in the course of the structural change in the polish  economy, also changes in the agricultural and environmental policy have appeared.   since the accession of poland to the european union (eu) in may 2004 agri‐environmental  policy is obligatory for the policy of rural areas according to the eu regulation 1257/99 on support  for rural development from the european agricultural guidance and guarantee fund (eaggf)  (europäische kommission, 1999b). also agri‐environmental measures are realised in poland as regu‐ lar political instruments. as the agri‐environmental policy is new in poland, no empirical evalua‐ tion has been undertaken until now. the only available descriptive evaluation delivered by the  ministry of agriculture and development of rural areas is based on statistical data regarding the  number  of  participating  farmers  and  the  budget  amount  spent  on  supporting  the  agri‐ environmental measures.   according  to  the  eu  regulation  farmers  realising  agri‐environmental  measures  are  sup‐ ported with compensation payments  for  their services  for  the environment. thereby,  following  objectives should be promoted with agri‐environmental measures:  o ways of using agricultural  land which are compatible with the protection and  im‐ provement of the environment, the landscape and its features,  o natural resources, the soil and genetic diversity,   o an environmentally‐favourable extensification of farming and management of low‐ intensity pasture systems,  o the conservation of high nature‐value farmed environments which are under threat,  o the upkeep of the landscape and historical features on agricultural land,  o the use of environmental planning in farming practice.  according to the european commission (n.d.), the agri‐environmental measures are direct  instruments to protect the environment in rural areas apart from the direct stimulation measures  e.g.  land  set‐aside  scheme  or  the  „cross‐compliance“  (obligatory  environmental  requirements  which have to be fulfilled to be eligible for direct payments from the first pillar of the common  2007 ‐ 6  •  economic analysis®  agricultural policy – cap). agri‐environmental measures are interpreted as the most important  instruments of environmental protection in rural areas in the national policy after the accession to  the european union. therefore, we focus our investigation and discussion on these measures and  do not address the other instruments.   in this paper we discuss the development of the agri‐environmental policy in the transition  process of the polish economy. additionally, we analyse changes occurred in the regulation of the  agri‐environmental policy before and after the accession of poland to the european union. against  this background we analyse challenges resulting for poland  in  the following years and discuss  methodical approaches which can be used for the evaluation and design of agri‐environmental  measures to make them more effective and objective‐oriented.   the  paper  is  structured  as  follows.  first  we  present  the  development  of  the  agri‐ environmental  policy  in  the  transformation  process  and  continue  the  discussion  for  the  pre‐ accession phase to the european union. next, we present the implementation rules and the realisa‐ tion of agri‐environmental measures after the accession to the european union. in the following  chapter we analyse challenges for the agri‐environmental policy in poland. next, we compile and  discuss possible methodological approaches which can be used in the evaluation and design of the  agri‐environmental policy. according to the experience with these methods in other countries of  the european union, we discuss advantages, potentials and difficulties connected with the imple‐ mentation of the respective approaches.   agri‐environmental policy in poland in the transformation process  since may 2004 poland is a new eu member state. with the accession to the european union  poland  adopted  the “acquis  communautaire”  and  thereby  agri‐environmental  programmes  were  acquired as obligatory measures for the policy of rural areas. agri‐environmental measures are  realised within the national agri‐environmental programme which is a new paradigm in poland.   the very first political discussions on the necessity of environmental protection in poland  were initiated in the 70‐th, when the environmental protection was defined as a new political pur‐ pose. in 1976 the environmental protection has been established in the polish constitution (welfens,  1993). in the centrally planned economy, the economic progress had a priority against the envi‐ ronmental protection in rural areas.   after the economic changes and the transition from the centrally planned economy to the  free market economy, a heterogeneous picture of environment was stated in poland. on the one  hand, immense environmental pollution caused by the industrial sector was found; on the other a  lot of protected areas and natural resources were maintained. this phenomenon is called „post‐ communist paradox” these days (sandberg, 1999, p. 48). additionally, the low importance of the  environmental protection in agriculture was determined by the fact that the factual measured pol‐ lution of the air, ground and water was ascribed to the industrial development. due to the great  importance of market‐oriented agricultural activities, environmental problems such as ground and  water pollution, accumulation of chemical pollutions, emissions of fertilisers were not discussed  by political stakeholders. moreover, economic and social problems in rural areas e.g. smallholder  farming and missing information about the necessity of the environmental protection in agricul‐ ture or else missing political instruments were the main problematic issues in the transition proc‐ ess which inhibited the development of agri‐environmental policy in poland (sapek, 1998, p. 78).  the first concrete environmental measures in agriculture were defined in 1990 with the „na‐ tional environmental policy” (ministry of environmental protection, natural resources and forestry,  1991). following, new environmental organisations were established, e.g. inspection for environ‐ volume 40 • spring 2007 • 7  mental protection, polish ecological club, national fund for environmental protection and water  policy. environmental measures were, however, mostly supported by  international and private  foundations. the political comment from 1991 “environmental protection policy of the country”  had the aim to diminish the agricultural pollution. in 1992 on behalf of the national fund for envi‐ ronmental protection and nutrition policy  the study “the pro‐ecological orientation of polish  agricultural policy at the end of the 20th century” was published, which promoted a coherent  agri‐environmental  policy  (oecd, 1999, p. 31).  in  1994,  the  document  “the  outlines  of  socio‐ economic policies for the polish countryside, agriculture and food processing industry until the  year 2000” was published by the polish ministry of agriculture and nutrition policy in which po‐ tential disadvantages of  the agricultural production  for  the environment were presented. since  then, the environmental protection policy in rural areas was characterised by two targets: firstly –  the necessity to remove environmental pollution caused by the industrial sector from the time of  the centrally planned economy (oecd, 1995), secondly – the wish to access the european union.  in 1997 sixteen working groups for different sections of the common agricultural policy were es‐ tablished in the polish ministry of agriculture and nutrition policy such as e.g. “structural funds  and rural development” or “agriculture and protection of agricultural environment” (ministry of  economy and food agriculture, 1998). hence, the terms “environmental protection in agriculture”  and following “agri‐environmental policy” have been adopted very quickly. in march 1997 the  project “green lungs of poland” was initiated in the east‐northern part of poland with the aim to  create a basis for the future agri‐environmental programmes according to the eu regulations (ted‐ erko, 2000). also other measures were planned and partially realised in preparation for the eu ac‐ cession.   agri‐environmental measures in poland before the eu accession  before the accession of poland to the european union, no political regulations promoting  environment‐friendly  measures  in  agriculture  existed.  the  national  budget  expenditures  were  planned to a low extent also for environmental tasks such as:  o preservation of domestic farm animal species,  o support for ecological farming,  o advisory  services  for  farmers  with  regard  to  fertilisation  and  usage  of  pesticides  (klisowska, 2001, p. 79).  the first successful agri‐environmental measures supported by the european union were re‐ alised in 2000 and 2001 within the eu project phare99 in two regions of poland: subcarpathia and  warmia‐masuria. the responsibility  for  the  implementation of  the measures was by  the polish  agency for management development, whereas the realisation was coordinated and controlled by  the ministry of agriculture and development of rural areas. within the project, 277 farms in the  voivodship subcarpathia (from the 386 applications) and 131 farms in warmia‐masuria (from 213  applications) were supported (umwp, 2003; faber and duer, 2001; domagalska, n.d.). in the follow‐ ing, additional agri‐environmental measures were planned within the program sapard (special  accession programme for agriculture and rural development) for the period 2000‐2006. with this  programme,  the  adaptation  of  the  polish  regulations  to  the  european  “acquis  communautaire”  should  have  been  prepared  and  concrete  realisation  patterns  for  agri‐environmental  measures  should have been delivered. the measures were planned as continuation of the phare99 and as  complementary instruments for the phare2000 as well as phare2001 which supported ecological  farming with 2,5 million € (mrirw, 2004b, p. b2). the measures were planned in chosen regions in  2007 ‐ 8  •  economic analysis®  poland with immense problems of natural protection or else in regions with valuable natural re‐ sources such as: o warmia‐masuria (13 500 ha) – high erosion problems,  o subcarpathia (4 000 ha) – problems with fallow land,  o valley of warta‐river (1 500 ha) – natural protection area for different bird species,  o valley of narew and biebrza rivers (11 000 ha) – the biggest peat and bog areas in  europe, biotopes for bird species of international importance.  ecological farming was approved to be realised in each region of the country. the assess‐ ment of the regions was conducted on behalf of experts representing following institutions: minis‐ try of agriculture and development of rural areas, ministry of environment, institute for melio‐ ration and greenland, institute for farming, fertilisation and soil sciences, institute for agricul‐ tural economics and nutrition policy, and the national advisory centre for development of the  agriculture and rural areas. in general, the area of 30 000 ha and 3 500 farmers should have been  engaged in the realisation of the agri‐environmental measures under sapard 2000‐2006 with the  budget of 2 % of the total sapard‐expenditures. the programme should have been co‐financed  by  75 %  from  the  eu  budget  (faber  and  duer,  2001,  p.  66).  for  the  time  period  2000‐2006,  22,3 million € were planned for agri‐environmental measures and the annual payment rate was set  to 120 €/ ha (mrirw, 2002). due to changes in political strategies and missing legal rules for the  appropriate implementation of the agri‐environmental measures, the planning and realisation of  agri‐environmental measures was abandoned under the sapard in order not to hinder other po‐ litical instruments of the sapard‐programme (mrirw, 2002, p. 117‐121). apart from dissatisfac‐ tion of farmers, the ministry of agriculture and development of rural areas advised to more pre‐ cisely prepare agri‐environmental measures. according to the statement of the ministry, in the face  of the awaiting accession to the european union, the priorities should be placed on the prepara‐ tion  of  agri‐environmental  measures  under  the  national  agri‐environmental  programme  2004‐ 2006 (zysk, 2002).   agri‐environmental measures in poland after the eu accession  after the accession of poland to the european union and the implementation of the “acquis  communautaire” agri‐environmental measures became obligatory for the policy of rural areas. in  the first membership period 2004‐2006 the agri‐environmental measures were co‐financed from the  european agricultural guidance and guarantee fund (eaggf) and from the polish state budget.   the support for agri‐environmental activities is granted to farmers who are owners or ten‐ ants of farm land of more than 1 ha and who oblige themselves to meet all agri‐environmental  commitments for at least five years. the agri‐environmental measures exceed the requirements of  the  “good  agricultural  practice”.  therefore,  additional  realisation  costs  resulting  for  farmers  should be reimbursed with public funds in form of compensation payments. the support should  be calculated by responsible national or regional administration offices on  the basis of:  income  losses, additional costs resulting from the commitment given, and the need to provide an incentive  (stimulation premium). the compensation rates for agri‐environmental measures can be enlarged  by 20 %, provided one measure is realised on the natura‐2000 protection areas or in the case  when in organic farming system, plant production is balanced with animal production.  in  the  negotiation  process  seven  agri‐environmental  measures  (‘sustainable  agriculture’,  ‘organic farming’, ‘extensive meadow farming’, ‘extensive pasture farming’, ‘ground and water  protection’, ‘buffer zones’, and ‘domestic farm animal species’) were proposed by the polish min‐ volume 40 • spring 2007 • 9  istry of agriculture and development of rural areas and approved afterwards by the european  commission.  due  to  a  differentiated  system  of  cost  calculation  for  the  respective  agri‐environmental  measures  and  due  to  different  instructions  for  the  monitoring  process,  the  agri‐environmental  measures were divided in 40 realisation options. additionally, agri‐environmental measures can  be realised horizontally (in all regions in poland) as well as regionally (in specific priority zones).  while the measures ‘organic farming’, ‘ground and water protection’, ‘buffer zones’, and ‘domes‐ tic farm animal species’ are realised in all regions of the country, the ‘sustainable agriculture’, ‘ex‐ tensive meadow farming’, and ‘extensive pasture farming’ can be realised only in the 69 priority  zones in poland.   the agri‐environmental measures are realised within the national agri‐environmental pro‐ gramme. the national agri‐environmental programme is an integral part of the plan for devel‐ opment of rural areas (prow). the available budget for agri‐environmental measures amounted  to 348,9 million € for the time period 2004‐2006 and was stepwise extended in the following years:  70,5 million € in 2004, 116,2 million € in 2005 and 157,7 million € in 2006 (mrirw, 2004a, p. 129).  the co-financing rate for agri-environmental measures amounts to 80 % from the eaggf which results from the fact that all regions in poland were ascribed as “objective-1-regions” [1] (european commission, 2003, p. 20). the other 20 % are financed from the polish state budget. the budget expenditures can be utilised according to the “n+2” rule during two following years after the finish date of the programme. after this time, the budget not used for the approved objectives has to be repaid to the european union (europäische kommission, 2004). thus, due to a  low  interest of farmers  in the agri‐environmental measures  in  poland in the first membership period 2004‐2006, the committee for monitoring of the plan for development of rural areas decided on the 23.11.2006 to shorten the budget for the national agri-environmental programme by 37 % down to 218,9 million € (mrirw, 2007).   the national agri‐environmental programme  is defined, planned and coordinated by the  polish ministry of agriculture and development of rural areas. the competences regarding the  preparation,  realisation  and  control  processes  rest  on  the  national  and  regional  offices  of  the  agency  for  restructuring and modernisation of agriculture. however, regional experts, stake‐ holders or farmers have no impact on political decision‐making processes in agri‐environmental  policy.  challenges for the agri‐environmental policy in poland  agri‐environmental measures are regular political instruments which create chances both for  farmers which directly benefit from financial support and for the society due to an improvement of  environmental quality. however, the agri‐environmental measures create also a great challenge as  the idea of environmental protection in agriculture realised in the form of regular political instru‐ ments is relatively new in poland. therefore, little experience is given in this term and no practical  implementation  patterns  are  known,  especially  by  political  decision‐making  committees.  thus,  decision‐making with regard to environmental objectives is not familiar to political stakeholders,  farmers, or the society.   the first challenge is the fact that financial support from the first pillar of the cap for mar‐ ket‐oriented farms is strictly dependent on the implementation of “cross compliance” – environ‐ mental rules which have to be fulfilled to be eligible for direct payments. challenging for farmers  is to implement new requirements and to adopt farming systems to new regulations. for political  stakeholders the challenge is given by the necessity to undertake appropriate measures to make  agri‐environmental policy more effective and to alleviate the further evaluation process.   2007 ‐ 10  •  economic analysis®  according to the experience with agri‐environmental policy in the eu‐15 as well as to a case  study conducted  in poland  (ziolkowska, 2007) challenging  is  to  influence  farmers perception of  agri‐environmental measures and to show ways to understand the measures as not only supported  activities but also as  instruments which can directly  improve  the environmental quality. thus,  challenging is to sensitise farmers for the problems of the natural protection and to teach them to  be not only producers but also ‘nature guards’, which undoubtedly would strengthen their social  role.  several analyses on agri‐environmental measures proved  that  the compensation payment  rates in poland are assessed as insufficient to reimburse all costs resulting for farmers from the  implementation of the measures. indeed, the compensation payment rates were calculated by the  ministry of agriculture and development of rural areas on the basis of income losses and other  costs estimated within an economic survey of farms in the three following years 1999, 2000, and  2001 (rada ministrów, 2004). however, the calculation does not contain any stimulation premium.  this fact can have contra‐productive effects for farmers in a long term perspective. thus, the com‐ pensation payment calculation covering all costs of implementing the agri‐environmental meas‐ ures is an important challenge for poland. alternatively, other approaches can be recommended  such as bidding payments successfully used in the us. according to this system farmers partici‐ pating in the conservation reserve programme offer their environmental services to the state (rei‐ chelderfer and boggess, 1988). thus, prices are estimated for the respective environmental services of  the applying farmers and only the offers are accepted which can be realised by the minimal costs  and which simultaneously promise the highest environmental benefits (s.a. latacz‐lohmann, 1993;  lehmann, 2005, p. 4‐6). although this system is very successful in the us, it has not found any wide  acceptance in the european union until now.   additionally, in the first membership period of poland in the european union the invest‐ ment costs for agri‐environmental measures had to be covered by farmers, which was a serious  financial challenge. the recent evaluation of the national agri‐environmental programme in po‐ land helped to improve the implementation regulations and established the investment costs as an  integral measure (“non‐productive investments”) in the national agri‐environmental programme  2007‐2013 (mrirw, 2006a,b).   also the evaluation of agri‐environmental measures is challenging also due to the fact that  the effects of agri‐environmental policies can be estimated in a long‐term perspective. moreover,  the environmental effects can be influenced by other external effects of economic activities in other  sectors and can be measured only by means of concrete indicators. linckh et al. (1996, p. 22) and  bussmann et al. (1997) proved that environmental elements such as water, ground, air, biodiver‐ sity, and landscape can be influenced by different external factors. therefore, the extent and the  effect quality of agri‐environmental measures can not be assessed in the short perspective, which is  the state in poland nowadays.   agriculture is said to “produce” both positive and negative external effects. as difficult ap‐ plies  to  completely  cover  all  external  effects  and  evaluate  them  with  economic  monetary  ap‐ proaches. potential indicators can be helpful, however, in many cases, they can not reflect all as‐ pects of the complex agri‐environment. thus, economic evaluation approaches are in several cases  inappropriate  to  characterise  intangible  (immeasurable)  characteristics  or  effects  of  agri‐ environmental programmes. the evaluation of agri‐environmental measures is of a particular im‐ portance as usage of natural resources has a great influence on the social welfare, apart from the  externalities  (positive externalities – external economies or negative externalities – external dis‐ economies).  according  to  the  recommendations  of  the  european  commission,  the  externalities  should be analysed possibly on the lowest administrative level in order to consider typical envi‐ ronmental, political, and institutional conditions/ contexts of the regions (europäische kommission,  volume 40 • spring 2007 • 11  2000, p. 15). thus, the challenge resulting for the evaluation and realisation of agri‐environmental  measures in poland is to design and implement the measures on the regional level (in voivodships  – regional administrative units) which is opposite to the current conception in poland to design the  agri‐environmental measures on the national level. the positive results of regional responsibilities  for agri‐environmental measures were proved by several studies. the german agricultural asso‐ ciation and world wide fund for nature (wwf) proposed recommendations for the future de‐ sign of agri‐environmental programmes in the european union. according to it, the adaptation of  agri‐environmental measures to specific regional conditions and priorities can help to more effec‐ tively design and finance the programmes (dlg, 2002).   other challenges for the polish agri‐environmental policy are related to the cooperation be‐ tween regional and national entities and stakeholders in terms of design and evaluation of the na‐ tional agri‐environmental programme. in poland, this cooperation is given between the ministry  of  agriculture  and  development  of  rural  areas  and  the  national  and  regional  offices  of  the  agency for restructuring and modernisation of agriculture. however, the plans to develop and  finance the national agri‐environmental programme are taken on the national level without any  participation of regional stakeholders or farmers. the practitioners are, however, the persons who  best know regional necessity and priorities with regard to environmental protection. in this term,  the integration and tighter cooperation between national and regional stakeholders and decision‐ makers would be beneficial both for farmers and the environment (dlg, 2002).   moreover, dlg recommends replacing the current activity‐oriented measures (payments for  the realisation of the measures) by the result‐oriented measures (compensation for the actual envi‐ ronmental outputs). thereby, higher efficiency can be achieved and potential negative external  effects (spillover effects or farmers’ income losses) can be minimised (latacz‐lohmann, 1995). from  the  other  point  of  view,  the  result‐oriented  realisation  pattern  of  agri‐environmental  measures  would discourage many farmers and bring the question if all investment costs met nowadays can  be reimbursed on the base of the achieved outputs in the future. the proposition of the dlg seems  to be effective and efficient to improve budgeting of the agri‐environmental policy. however, at  the current development stage of agri‐environmental measures  in poland  its adaptation would  result in a decreasing participation in the national agri‐environmental programme.   other difficulties and challenges for the evaluation of agri‐environmental programmes result  from different environmental conditions and different usage of natural resources in different re‐ gions in poland. the fragmented structure of the polish farms (the average farm size in poland  amounts to 8,6 ha (dmochowska, 2003)), the diversification of the agricultural production, simple  farming systems with a huge variety of biotopes are characteristics which require to define differ‐ ent objectives in each region. however, in each voivodship the same agri‐environmental measures  with the same objectives are realised. thus, a risk exists that the compensation payments for the  realisation of agri‐environmental measures will be used by farmers in region, in which no prob‐ lems  occur  or  else  the  problems  are  very  minor.  thereby,  aside‐effects  of  agri‐environmental  measures can be stated (spillover effects). in order to minimise such negative effects, regional con‐ ditions should be considered in political strategies.   other problems connected with  the evaluation processes are missing methodological and  conceptual evaluation tools. also missing reference data, limited data access or high evaluation  costs inhibit evaluation processes of the agri‐environmental policy. these problems can be already  stated in poland. due to the complex character of the programmes, the named difficulties can not  be abolished. they create, however, a challenge  to diminish negative or  limiting  factors  in  the  evaluation processes.   2007 ‐ 12  •  economic analysis®  the evaluation and design of the agri‐environmental policy with the aim to achieve possible  maximal environmental effects  is very complex. the discussion shows, however,  that  the envi‐ ronmental effects can be maximised while planning the agri‐environmental measures on regional  levels considering concrete environmental, economic and social conditions.  evaluation approaches for agri‐environmental policy in poland  due to a short experience with agri‐environmental policy in poland the methodical evalua‐ tion approaches have not been implemented to a wide extent until now and little experience  is  given in the evaluation and design of agri‐environmental measures. before the implementation of  the national agri‐environmental programme, an ex‐ante analysis was conducted by the ministry  of agriculture and development of rural areas (mrirw, 2004a) and output, effect, and result in‐ dicators were defined (mrirw, 2004b, p. p4‐p8). by means of these indicators solely qualitative  analysis can be done basing on statistical data regarding the number of participating farmers or the  support amount for the respective measures in the country or else in the voivodships. the evalua‐ tion of agri‐environmental measures is complex due to the fact that no market for environmental  goods exists and no marginal prices are set for the usage of natural resources. in this context a  question arises which evaluation methods are most appropriate to directly capture ecological ef‐ fects of agri‐environmental programmes? the evaluation theory of the agri‐environmental policy  delivers several approaches which were already proved in practice. as an example, by means of  the “willingness to pay” (in the case of positive external effects) or the “willingness to accept” (in  the case of negative external effects), ecological outcomes can be indirectly measured. the imple‐ mentation of a certain approach is, however, combined with several risks, especially with regard to  indirect assessments (bartmann and busch, 1998, p. 24).   other problems can be related to the incommensurability and the subjectivity of evaluation  approaches on regional and the eu‐level. thus, positive effects in terms of environmental objec‐ tives assessed in one eu member country by means of a certain evaluation approach and com‐ pared to the status‐quo of this country can differ from the effects in other countries after similarly  positive evaluation conducted by means of the same method (hilfenhaus, 1991). thus, using differ‐ ent approaches, more significant distortions should be taken into account.  according to the oecd (1994, p. 31‐33, 1997), environmental indicators could be used in po‐ land for the evaluation of agri‐environmental measures to estimate the influence of agriculture on  the environment. the indicators are related to the soil erosion, water quality, grade of the envi‐ ronmental  protection,  greenhouse  gases,  biodiversity,  habitats,  and  agricultural  landscape.  the  aim of these  indicators  is to reflect the current situation compared to a reference situation. the  oecd indicators as well as other indicators developed by the european commission (“indicators  for integration of environmental issues in the common agricultural policy” (keg, 1999, 2000) and  the european environment agency (eea, 1993, 2005) create an extension of the implemented out‐ put, effect, and result indicators in poland and could help to more effectively evaluate and design  the agri‐environmental policy in the long‐term perspective.  the evaluation methodology provides several direct and indirect approaches (primary and  secondary analysis) to state about the agri‐environmental programmes. the most used are multi‐ criteria‐decisionmaking‐method (mcdm) which can be used in political decision‐making proc‐ esses for design of the environmental policies. best known are cost‐benefit and cost‐effectiveness  analysis.   as new approaches count ‘agri‐environmental panels’ as a form of “round tables” and ‘me‐ diation practices’ which have the aim to get together political stakeholders and practitioners  in  volume 40 • spring 2007 • 13  order to find best possible solutions for agri‐environmental problems (wwf, 2001, p. 44‐50; endres,  et al, 1991, p. 94‐95). for a sectoral and regional analysis „regionalised agri‐ and environmental  information  system  for  germany“  (regionalisiertes  agrar‐  und  umweltinformationssystem  für  deutschland“ (raumis) has been approved (weingarten and schleef, 2000; gömann, et al, 2005).  according  to  pruckner  (2003)  for  the  evaluation  of  environmental  problems,  approaches  should be chosen which can help to better create political decision‐making processes. for practical  evaluation and policy design mathematically founded interactive decision‐support methods were  developed. kirschke and jechlitschka (2002) propose linear programming for evaluation and de‐ sign of agri‐environmental measures. a successful evaluation of the agri‐environmental policy in  an interactive process with political stakeholders is provided with a case study for saxony‐anhalt  in germany (kirschke, et al, 2004, 2007). the suitability of this method was also proved for evalua‐ tion and design of agri‐environmental measures in poland (ziolkowska, 2007). landscape model‐ ling, which also covers the field in agri‐environmental policy, is an innovative evaluation tool in  the last years (dabbert, et al, 1999).  due to the complexity of agri‐environmental aspects, no unique and homogenous methodol‐ ogy is given to be implemented for the evaluation of all environmental problems/ programmes.  the european commission has not accurately specified which approaches should be used for the  evaluation  of  agri‐environmental  measures  (europäischer  rechnungshof,  1998).  principally,  ap‐ proved methods should be used in the evaluation process (europäische kommission, 1999a, p. 21).   conclusions  with this study several challenges for the agri‐environmental policy in poland have been re‐ vealed. additionally, the importance of an extended evaluation of agri‐environmental measures  was  confirmed.  the  deliberation  presents  outlooks  for  the  future  development  of  the  agri‐ environmental policy, and especially the agri‐environmental measures to make them more effec‐ tive  and  efficient.  the  question  is  the  more  important  as  no  empirical  evaluation  of  agri‐ environmental measures in the first membership of poland in the european union has been con‐ ducted by the ministry of agriculture and development of rural areas in poland until now. in the  course of the transition process and before the accession of poland to the european union several  changes in terms of the environmental protection in rural areas have been undertaken. beginning  with pilot projects before the accession to the eu, agri‐environmental measures became regular  instruments of the environmental protection in agriculture (obligatory for the policy of rural ar‐ eas). with the implementation of the agri‐environmental measures new challenges revealed.   according  to  the  presented  discussion,  several  challenges  have  been  revealed  for  agri‐ environmental measures such as the necessity to sensitise farmers for the problems of the natural  protection,  the  necessity  of  a  more  precise  calculation  of  compensation  payments  for  agri‐ environmental measures, the necessity to improve financing of the agri‐environmental measures  and  to consider regional preferences  in  the decision‐making process,  the necessity  to minimise  negative aside‐effects of the agri‐environmental measures such as spillover effects or income losses  resulting for farmers, the necessity to extend evaluation of agri‐environmental measures, the ne‐ cessity to improve access to statistical data and diminish other disturbing evaluation factors, and  the choice of an appropriate evaluation method.   by means of qualitative and quantitative evaluation approaches, existing difficulties in the  realisation and financing the agri‐environmental measures can be found and solved. the most ap‐ proved  methods  are  cost‐benefit  and  cost‐effectiveness  analysis  as  well  as  multi‐criteria‐ decisionmaking‐methods. new methods such as  ‘agri‐environmental panels’ and mathematical  2007 ‐ 14  •  economic analysis®  approaches such as linear programming give a chance to evaluate and design agri‐environmental  measures interactively with political decision‐makers. these methods have been already success‐ fully proved in germany and poland. using these or other evaluation approaches, ways can be  found to more effectively design the agri‐environmental measures in the future.   [1] as „objective‐1‐regions“ are classified  those regions  in the european union which are  characterised by poor economic conditions. in order to improve the competitiveness of these re‐ gions, higher support rates from the european funds were adopted. according to the cap reform  on  the 26.  june 2003  in luxembourg,  the maximal eu co‐financing rate  for agri‐environmental  programmes was enlarged up to 85 % in objective‐1‐regions (from heretofore 75 %) and up to 60 %  (from heretofore 75 %) in the non‐objective‐1‐regions.  references  bartmann, h. and busch, a.a. (1998), ökonomische (monetäre) bewertung als basis für umweltpolitische maßnahmen.  beiträge zur forschung, mainz: johannes gutenberg‐universität mainz.  bussmann, w., klöti, u., and knoepfel p. (1997), einführung  in die politikevaluation, basel und frankfurt am main:  helbig & lichtenhahn.  dabbert,  s.,  herrmann,  s.,  kaule,  g.,  and  sommer  m.  (1999),  landschaftsmodellierung  für  die  umweltplanung.  methodik, anwendung und übertragbarkeit am beispiel von agrarlandschaften, berlin: springer.  dlg (deutsche landwirtschafts‐gesellschaft) (2002), the agri‐environmental programmes – approaches to their fur‐ ther development. // http://www.pg.fal.de/pdf/agrarumweltprogr_e.pdf (accessed: 04.11.2005).  dmochowska, h. (2003), portrety polskich regionów, warszawa: gus.  domagalska,  e.  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zysk, a. (2002), “co dalej z programami rolnośrodowiskowymi?”, środowisko, vol.17, no 233, pp. 7‐10.  microsoft word 2007 3 4.doc 2007 ‐ 28  •  economic analysis®    abstract: renewed confidence in the positive benefits of fdi to the economic development of the  host country has led many countries to be more open towards fdi since the beginning of 1990s.1 as a result  of increased liberalisation and technological advances, fdi flows rapidly increased during last few decades.  fdi increased as a ration of domestic investment and gdp in many countries (unctad, 2005). however,  while some countries attracted large fdi flows, others were less successful, even though they had liberalised  fdi regimes. a huge number of different studies on the impact of fdi on economic growth and productivity  of domestic economy have been published.2 a general conclusion of these studies is that the benefits of the  foreign companies in terms of economic development, even though they possesses a bundle of desirable assets  (including a long‐term external financing, new technology, skills, management practice and market access),  and in general they are more productive, pay higher wages and are more export intensive than local firms,  are by no means automatic. in addition, researches showed that fdi can also lead to some less desirable or  undesirable outcomes such as rising inequality between individuals or groups of individuals in the society  and between the regions, direct or indirect crowding‐out of local capabilities or an erosion of the tax base or  labour and environmental standards. development of the local absorptive capacity (skills, r&d, infrastruc‐ ture and etc.), is of the key importance in shaping the ultimate effect of fdi, suggesting an important role of  complementary policy. different programmes of encouraging linkages between tncs and local firms, pro‐ grammes supporting clusterisation and upgrading fdi are also approved as  important. in this paper we  analyze appropriate role of fdi policy in raising national competitiveness. the first section discusses the role  of fdi in technology transfer, learning and competitiveness. here we analyze benefits and costs of internal‐ ized technology transfer through fdi flows and in general, this type of technology transfer is very efficient  mean of  transferring a package of capital, skills,  information, networks, and brand names  to developing  countries. for many technologies, internalised transfers are the only possible mode of transfer. also, inter‐ nalization may be the most efficient way of transferring the tacit knowledge involved and in the case of rapid  technology changes. however, internalized technology transfer may also have some expenses. in general, the  more standardized and diffused the technology and the more capable the buyer, the more economical will  externalized modes be. a more subtle reason in favour of externalization concerns the existence of learning  benefits, deepening and externalities. costs of internalized technology transfer are especially expressed on the  top level of technological capabilities where local innovative efforts become viable. at this stage, there is a  case for restricting reliance of internalized forms to promote local r&d capabilities based on externalized  forms, or for intervening in the fdi process to induce mncs to transfer more advanced technological func‐ tions. we discuss the rationale for fdi policy and preset the experience of ireland and singapore since these  two  countries  have  been  highlighted  for  using  the  best‐practice  policies  toward  attracting  fdi.  using  benchmarking method we analyze fdi policy in bosnia and herzegovina.  1 it is important to mention that more open approach toward fdi is became necessity having in mind wto rules and  importance of technology transfer because they have maid almost impossible for developing countries to build up an  industrial capacity behind closed doors.  2 these studies are focusing on different level of analyses (country, sector or company) and they are different by the  number of countries included in the analyses. for detailed review of the results of these researches see te velde (2003).  foreign direct investment and  national competitiveness – financial aspects  adnan rovčanin, university of sarajevo key words : fdi policy, competitiveness, bosnia and hertzegovina  jel : e21, e22, f21  original paper  volume 40 • autumn 2007 • 29  introduction    renewed confidence in the positive benefits of fdi to the economic development of the host  country has led many countries to be more open towards fdi since the beginning of 1990s.3 as a  result of increased liberalisation and technological advances, fdi flows rapidly increased during  last few decades. fdi increased as a ration of domestic investment and gdp in many countries  (unctad, 2006a). however, while some countries attracted large fdi flows, others were less suc‐ cessful, even though they had liberalised fdi regimes.  a huge number of different studies on the impact of fdi on economic growth and productiv‐ ity of domestic economy have been published.4 a general conclusion of these studies is that the  benefits of the foreign companies in terms of economic development, even though they possesses a  bundle of desirable assets (including a long‐term external financing, new technology, skills, man‐ agement practice and market access), and in general they are more productive, pay higher wages  and are more export intensive than local firms, are by no means automatic. in addition, researches  showed that fdi can also lead to some less desirable or undesirable outcomes such as rising ine‐ quality between individuals or groups of individuals in the society and between the regions, direct  or indirect crowding‐out of local capabilities or an erosion of the tax base or labour and environ‐ mental standards. development of the local absorptive capacity (skills, r&d, infrastructure and  etc.), according to those analyses, has a key importance in shaping the ultimate effect of fdi, sug‐ gesting an important role of complementary policy. different programmes of encouraging linkages  between tncs and local firms, programmes supporting clusterisation and upgrading fdi are also  approved as important.  this paper is organised as follows. the first section discusses the role of fdi in technology  transfer, learning and competitiveness. here we analyze benefits and costs of technology transfer  through fdi flows and tnc subsidiary characteristics which enable them to contribute more to  the national competitiveness of its host country. in the second section, we discuss the rationale for  fdi policy and preset the experience of ireland and singapore since these two countries have been  highlighted for using the best‐practice policies toward attracting fdi. in the third section of the  paper, using benchmarking methodology, we analyze fdi policy in bosnia and herzegovina by  comparing it with the experiences in the two countries. finally, in the forth section we draw con‐ clusions and give some policy recommendations.  the role of fid in raising national competitiveness  global fdi flows are dominated by the multinational corporations (mncs). mncs are also  the main source of innovation and innovation is often the main competitive factor that allows them  to become and remain multinational  (unctad, 1999). as  the major  innovators, mnc are  the  main source of international technology transfer. their role is naturally higher in high‐technology  activities where production and export grow much faster than the total world production and ex‐ port (lall, 2003).   in general, technology flows between the mnc affiliates (hereinafter: internalized technol‐ ogy flows) are very efficient means of transferring a package of capital, skills, information, and  brand names to developing countries. for many technologies, internalised transfers are the only  3 it is important to mention that more open approach toward fdi is became necessity having in mind wto rules and  importance of technology transfer because they have maid almost impossible for developing countries to build up an  industrial capacity behind closed doors.  4 these studies are focusing on different level of analyses (country, sector or company) and they are different by the  number of countries included in the analyses. for detailed review of the results of these researches see te velde (2003).  2007 ‐ 30  •  economic analysis®  possible mode of transfer, since innovators are unwilling to part with them to unrelated parties.   even where technologies are available at arm’s length, internalization may be the most efficient  way of transferring the tacit knowledge involved because of the commitment of transferor and its  capability to support learning. if the technology is changing rapidly, internalization provides the  most direct access to improvements. if the activity is export oriented, internalized transfers offer  the additional advantages of international marketing skills and networks, established brand names  or, of increasing relevance, access to integrated production structures spanning several countries.   however, internalized technology transfer may also have some expenses. profits are realized  by the mnc on the package as a whole rather than  just the  innovation component. if the host  country already possesses other elements of the package, it is cheaper to buy the technology sepa‐ rately. in general, the more standardized and diffused the technology and the more capable the  buyer, the more economical will externalized modes be. however, there is a more subtle reason:  the existence of learning benefits, deepening and externalities may tilt the choice in favour of ex‐ ternalization even for relative complex and difficult  technologies. in such activities, reliance on  foreign  investment can shorten  the  learning period but reduce  the other benefits of  technology  transfer and capability building.   costs of internalized technology transfer are especially expressed on the top level of techno‐ logical capabilities where local innovative efforts become viable. on this level there can be a con‐ flict of interest between the host country and foreign investor. there are god reasons for interna‐ tional  investors  to keep  innovative work centralized at home or  in a  few developed countries;  these  include ease of coordination, skill availability, proximity  to main markets, and more ad‐ vanced science and technology infrastructures. at the same time, it is important for countries at a  certain stage of industrial development do deepen their capabilities and move into the innovation  led competitiveness phase, according to porter’s classifications.5 there  is clear scope for a clash  between the social interests of the host economy and the private interests of mncs. at this stage,  there is a case for restricting reliance of internalized forms to promote local r&d capabilities based  on externalized forms, or for intervening in the fdi process to induce mncs to transfer more ad‐ vanced technological functions.   the above discussion also  implies that tnk subsidiaries with a certain characteristics are  able  to contribute more  to raising and sustaining national competitiveness of  the host country.  o′donnell and blumentritt (1999) point out the following: (1) the level in which the subsidiary has  an active role in creating and  implementing corporative strategy and the level in which it is a crea‐ tor and user of the knowledge within company; (2) the type of industry, i.e. the level of technology  which the subsidiary is using in its business processes; (3) the volume of the formal and informal  training of the subsidiary’s employees; (4) the degree to which the activities and outcomes of the  foreign subsidiary affect or are affected by the activities of headquarters or other foreign subsidiar‐ ies. the subsidiary characteristics stressed here  involve a high degree of knowledge and skills  transfer from the parent company to its foreign location. in that way they impact innovative capa‐ bility of the host county and its competitiveness. they also may have synergetic effect. a subsidi‐ ary that is both, high‐tech or knowledge intensive as well as having a global mandate role will de‐ velop to an even greater extent the firm‐level resources that contribute to national competitiveness.  foreign direct investment policy  as it was already mentioned, fdi flows continuously grow as well as their ratio in the total  investments. however, while some countries managed to attract large fdi flows, others were less  5 for the detailed insight in the national competitiveness development phases see porter (1990).  volume 40 • autumn 2007 • 31  successful; even they had liberalized their fdi regimes. the objectives of fdi attraction differ by  country (e.g. access to modern technology, market access, economic growth and poverty allevia‐ tion). also, while some countries pay more attention to the quantity of flows, others change their  policy focusing more  to  the quality of fdi. the  term quality usually refers  to fdi with a high  value‐added fdi and/or to fdi with positive linkages and spill‐over effects for the domestic econ‐ omy. countries that have had successful development based on fdi continued with their activities  on further fdi upgrading by encouraging the existing mnc affiliates to develop into strategic in‐ dependents, or by targeting higher value‐added fdi.  the key question economic policy makers in one country should discuss is how fdi can be  incorporated in the country’s development strategy. since the implementation of fdi policies re‐ quire financial resources (through up‐front grants, promotion activities and institutional reform or  through tax concessions) they should decide, if a such an option exist at all, if using fdi is more  efficient and effective way of realising the objectives set in the development strategy. finally, how  much the country will relay on fdi in realising its objectives, and also which type of fdi is neces‐ sary with this respect.   with respect to fdi, the host country in general has to recognise and remove two specific  market failures. the first one refers to the problem of missing information foreign investors are  facing, and the other is the divergence in interest between mobile foreign investors and the host  economy. regarding the degree of the country  intervention on removing these market failures,  lall (1995) identified four different approaches: (1) passive open‐door policy with limited policy  interventions and no industrial policy, (2) open door policy with selected to improve supply con‐ ditions, (3) strategic targeting of fdi, and (4) restrictive fdi policy. while options (1) and (4) are  not  sufficient  to  exploit  opportunities  for  technological  learning,  the  optimum  for  many  low‐ income countries will be near the second approach and only if local capabilities develop a more  strategic and targeted approach may produce better results.   selection of the certain fdi policies should be followed by adequate  implementation. the  most successful are the countries that can follow fdi policies consistently and respond in a flexible  manner to demands by potential investors. as a good and appropriate implementation of this pol‐ icy can be mentioned economic development board – edb – singapore or ireland development  agency – ida.  finally, it is important to point out that some world trade organisation agreements, such as  agreement on conditions for foreign investments, which unable the member countries to use so  called trade‐related investment measures ‐ trim, agreement on trade‐related aspects of intel‐ lectual  property  rights  –  trips,  and  agreement  on  subsidies  and  countervailing  measures  –  scm, limit the options for the domestic fdi policy. however, the general assessment is that there  is still some scope for creating the corresponding fdi policies and for their incorporating in devel‐ opment strategy of the country. it is more a question of whether a country desires or is able to  conduct a proactive fdi policy.  fdi policy in ireland and singapore  in this part of the paper we present fdi experience of ireland and singapore. both countries  have been stressed for using best‐practice policies towards attracting fdi. we first briefly present  some data which highlight importance of fdi in these two economies, than we analyze the role  played by policy in attracting and upgrading fdi and enhancing linkages between tncs and local  firms.   2007 ‐ 32  •  economic analysis®  ireland  economic analysts agree that fdi has played an important role in transformation a largely  agricultural irish society into one of the fastest growing economies in europe with one of the high‐ est per capita gdp. fdi has created jobs in new sectors, raised investment and enhanced overall  and local productivity. in 1995, foreign affiliates in irish manufacturing accounted for 47.1 per cent  of the total number of employees, 76.9 per cent of value added, 52.6 per cent of wages and salaries,  68.0 percent of r&d expenditure (in 1993), 82.3 per cent of exports and 77.8 per cent of imports  (oecd, 1999). value added per employee in foreign‐owned firms was over 60 per cent higher than  in domestic firms. barrel and te velde (1999) estimate the impact of fdi on overall technical pro‐ gress and find it to be significant and positive.   visible influence of fdi on irish economy has resulted in huge number of papers that stress  importance of different factors in attracting fdi, starting from industrial (ruane and gorg, 1999)  and macroeconomic policy (fitz gerald, 2000), but also some other factors (ruane and gorg, 1999)  such as its location. some papers also put attention to policies for upgrading fdi and to make link‐ ages between tncs and local firms (o′malley, 1998).   industrial policy towards fdi has been implemented by ida. initially a part of the depart‐ ment of industry and commerce with powers to issue grants that covered the costs of land and  buildings, ida was established as a separate state agency in 1969 with the responsibility for na‐ tional industrial development. ida expanded quickly in terms of staff (230 initially) and location  of operation with ida staff operating worldwide. ida targeted aggressively and firm‐specifically  involving telephone calls, presentations, provision of research, visits and other meetings. the ida  identified electronics and pharmaceuticals companies from the us as offering the best opportuni‐ ties for fdi led industrialisation.6   the ida was also able to award grants to firms covering part of their initial capital expendi‐ ture and these were later coupled to employment generation.7 ida expenditure per job decreased  from over ir 35,000 in the period 1981‐1987 to ir 10,000 over 1993‐1999. total expenditure of ida  ireland in 1999 amounted to ir 160 million, with ir 129 million paid in grants and ir 21 million  paid  towards promotion and administration, of which ir 5 million  towards marketing, consul‐ tancy, promotion and advertising (ida, 2000).   fiscal  incentives  have  been  perhaps  more  important  in  attracting  fdi  (ruane  and  gorg,  1999). there was a  fifteen‐year  (zero)  tax holiday on profits  from new export profits  from  the  1950s, which changed into a 10 per cent corporate tax to all new firms (compared to around a stan‐ dard 50 per cent corporate tax rate by that time) from 1982 to be consistent with eu rules. under  futher international pressure ireland is now committed to a 12.5 per cent corporation income tax  for all firms from 2003, with some concessions until 2010. thanks to these fiscal incentives and spe‐ cific targeting, the ida was in the position to develop key export‐intensive sectors (electronics and  pharmaceuticals) leading to band‐wagon and agglomeration effects.   while specific industrial policies have been very important in attracting fdi, there are also  macroeconomic policies and other important factors without which it would have been difficult to  attract fdi. the government has consistently followed a policy of skill‐upgrading by providing  education (fitz gerald, 2000). the availability of skills further improved recently through net im‐ migration of irish and other nationals. while  the physical  infrastructure was  initially neglected  6 these sectors now form the basis of industrial clusters. in 1999, 15 per cent of employment in foreign companies (ida  supported) was in pharmaceuticals/healthcare and 49 percent in electronics/engineering.   7 nowadays, these grants must be consistent with eu rules on state aid which means that they are still allowed only in  low‐income regions.  volume 40 • autumn 2007 • 33  until the late 1980s, eu structural funds (6 per cent of gdp in early 1990s) have helped to develop  the infrastructure since then. ida ireland also develops land and industrial parks for foreign in‐ vestors.   other important factors have been strong historical ties with the us, which helped to attract  us investment, the use of the english as the official language and more recently the boom in the  us and electronics sector.  last but certainly not least, the opening‐up of the irish market, first with signing anglo‐irish  free trade agreement in 1965 and than eu membership in 1973, combined with proximity to the  huge eu market has been of crucial importance for the development of ireland as an export plat‐ form to the eu. however, we must notice that portugal and greece are also close to the eu, but  have been less successful in attracting fdi. economic (as opposed to geographical) distance be‐ comes more important as transportation costs fall and the ´weightless´ economy gains in impor‐ tance.  up to early 1990s, ireland focused more on attracting quality fdi rather than on upgrading  existing fdi. firms in high‐value added sectors were targeted (e.g. through higher grants) more  because  they  added  new,  high‐value  exports,  rather  than  because  they  could  link  in  with  (non)existing local manufacturing capabilities. from the early 1990s there was also concern about  developing affiliates (as ´strategic independents´), focusing on raising the level of r&d in foreign  and also domestic firms. while business r&d as a percentage of gdp has been rising from 0.7 in  1981 to 1.4 per cent in 1997, it is rather low according to the international standards (oecd, 1999).   while attracting export‐intensive tncs ensures fewer fears of crowding‐out of domestic op‐ erations,  there was considerable concern  that  the economic distance between  local and  foreign  firms was too great to lead to significant spillovers and linkages. as a reaction to this national  linkage a programme has been launched. the aim of this programme was to improve organisa‐ tional and marketing skills as well as quality and productivity of local firms to bring it up to the  standard required by tncs. tncs helped to upgrade local suppliers by providing technical know‐ how. partly as a result of the nlp, but also because tncs were present in the market for a longer  time, irish raw material purchases rose between 1988 and 1998, from 15.4 per cent to 21 per cent in  non‐food manufacturing and from 13.2 to 22.8 per cent in electronics (ruane and gorg, 1998). a  key  strategy  for  developing  local  capabilities  was  to  develop  sub‐supply  industries  along  the  value‐added chain, not only for supply of tncs in ireland but also to be able to compete interna‐ tionally, thereby also reducing the dependence on tncs.   singapore  there are many stories about singaporeʹs remarkable development path and the role that  fdi has played8 singapore developed from a struggling low‐income colony in 1960s to a modern  and developed high‐tech country. gdp growth rates have continued to be 10 per cent on average  over the past fourth decades. at the same time, the accumulated stock of fdi as a percentage of  gdp has risen from 5.3 per cent in 1965 to 98.4 per cent in 1998 (yeung, 2001). in 1997/1998, foreign  firms employed 50.5 per cent of workers in manufacturing, 29.1 per cent in trade and 25.7 per cent  in finance.   singapore became independent after two‐year stint with malaysia failed in 1965. singapore,  though traditionally an important trading port, was now isolated from its hinter‐land, as indonesia  refused to import goods and malaysia wanted to cut out the middle‐man singapore in its trading  activities. singapore also lacked natural resources and entrepreneurial business elite. further, there  8 for the detailed insight in the fdi policy in singapore see lall (2000).  2007 ‐ 34  •  economic analysis®  was the impending withdrawal of the british armed forces, which contributed an estimated 20 per  cent to the economy. all these made an import‐substitution strategy virtually impossible. singa‐ pore had no policy option but to industrialise relying on tncs bringing their expertise and tech‐ nologies.   singaporeʹs industrial strategy was partly based on a 1960 undp study on the future of sin‐ gapore. this study recommended the establishment of economic development board (edb) to be  responsible for industrialisation of singapore. the edb was founded in 1961 as one‐stop agency  with a budget of around us$ 25 million (over 4 per cent of gdp). in the beginning of its work edb  was  focusing on ship repair, metal engineering, chemicals and electrical equipment and appli‐ ances.  the edb has acted proactively (developing sites, seeking promotion) and responded to mar‐ ket forces ever since it began operations. the edbʹs aim was to promote industries (mainly foreign  after 1965) in singapore and begun to build up offices abroad. it had four divisions: investment  promotion, finance, projects and technical consultant service and industrial facilities. it was set up  as an autonomous government agency, which could set ist own wages, had a board comprising  business and other agencies, and had an  international advisory board comprising executives of  major foreign companies located in singapore. while in the initial stages the notion of a one‐stop  centre was helpful to attract fdi, the operations became more complex over time and resulted in  the specialisation towards fdi promotion while other activities were  left to other agencies. the  edb has maintained close links with those new agencies ever since and still acts as a one‐stop ser‐ vice.   the edb decided to spend a significant share of allocated funds on the development of the  jurong industrial estate. an uncultivated piece of land was quickly transformed into an industrial  estate with adequate infrastructure and factories and a new port was built. however, the estate  was unsuccessful in the early years and with only twelve pioneering firms in 1961, it had slow start  (activity remained sluggish until 1965). the edb had invested vast sums in joint ventures, some of  which had failed. nevertheless, there have never been real doubts about the fdi‐led industrialisa‐ tion opposite to other developing countriesʹ view that tncs only exploit developing countries.   the industrial strategy proved to be successful by the late 1960s and early 1970s and was  able to reduce unemployment rate fairly quickly. whilst employment generation was a major fo‐ cus of policy in the 1960s and early 1970s, this shifted to capital‐intensive projects in the 1980s, and  knowledge‐intensive sectors in the 1990s. the incentive structure is complex and has developed  over time. a significant  incentive was the pioneer industries ordinance of 1959, with firms ex‐ empted (or significantly reduced) from the 40 per cent corporate tax for a fixed period of time pro‐ vided  that firms developed new products. as  the result  the share of manufacturing output for  firms with pioneer status increased from 7% in 1961 to 51.1% in 1971 and 69% in 1996. another  important tax incentive was the reduction the corporation tax for capital‐intensive industries that  suppose to replace labour‐intensive industries.  over time wages rose, especially in the period 1985‐1986, when the county faced first post‐ war recession. it was obvious that singapore could only cope with rising wages in local firms de‐ veloped capabilities (technical and human resources) and  if tncs continued to upgrade (using  r&d  incentives,  incentives  to set‐up high skilled head quarters and encouraging  joint research  institutes  through government  funding). special programme has been  launched  in 1986, under  which tncs were encouraged to enter into long‐term supply contracts with local firms, leading to  upgrading. the edb began to target knowledge‐intensive industries that could pay higher wages.   as part of a number of relevant skill‐upgrading schemes (lall, 1996), the psb is responsible  for the skill development fund. set up in 1979, it imposed levy on the payroll on employers for  volume 40 • autumn 2007 • 35  every worker earning less than a pre‐determined amount. it is an efficient way to enhance within‐ firm skill upgrading of unskilled workers because firms themselves do not have sufficient incen‐ tives to do so.   more recently, the edb has followed a cluster approach, targeting firms around the electron‐ ics/semi‐conductor, petrochemicals and engineering industries.9 the cluster approach also leads to  enhanced linkages and spillovers to the local economy. government further enhances the value of  the cluster through investment in r&d centres.  while the above indicates a strong role for industrial policy, macroeconomic policies have  also played a role. infrastructure has been built with regard to the needs of tncs. trade policies  have always been very liberal with very low tariff and thanks to an increase in iso certificates also  low non‐tariff  trade barriers. besides  training, general education has also been  important  (lall,  1996).   however, there are also some external factors, which have shaped policies towards fdi or  have been important in attracting fdi, and which may take the case of singapore less general in its  application to other countries. singapore is a city‐state with a relatively authoritarian state that can  formulate policies without much resistance from either other levels of government, or from civil  society. further, singapore never runs government deficits, which  is helpful  to  find capital  for  (profitable)  investment (in part financed out of a high statutory pension  levy). perhaps another  factor for attracting fdi is that the working language is english. further, the location in the time  zone enabled financial services to fill the gap between the us and europe during the 24‐hour day.   bosnia and herzegovina  since the declaration of independence from the former yugoslavia in the beginning of 1992,  bosnia and herzegovina suffered from a conflict for more than three years. according to dayton  peace agreement, which is signed in 1995, bosnia and herzegovina was to remain a single state  comprising two constituent entities – the federation of bosnia and herzegovina, and the repub‐ lika srpska. in the post‐war period economic reconstruction was at the centre stage of activities  and transition to a market economy was to be enhanced.   table 1: b&h main economic indicators indicators  2003  2004  2005          nominal gdp (million eur)  6,812  7,495  8,052  gdp per capita (eur)  1,778  1,950  2,095  real gdp growth rate (%)  3.0  6.0  5.5  annual inflation rate (%)  0.6  0.4  3.7  annual unemployment rate (%)  42.0  43.2  31.1*  trade balance (million eur)  ‐3.035  ‐3.227  ‐3.781  inward fdi (million eur)  *  534  421  * revised estimates based upon the annual labour force survey carried out for the first time in april 2006  source: statistical agency of b&h; central bank of b&h bosnia and herzegovina has relatively stable macroeconomic climate, characterised by sus‐ tained economic growth, stable currency and low inflation (see table 1). in 2005, nominal gdp  reached 8.05 billion eur. real growth was 5.5 per cent, continuing the underlying trend of growth  of around 5.5 – 6 per cent. the central bank of bosnia and herzegovina (cbbh) that started its  9 the edb began an s$ 1 billion cluster development program in 1994, and has recently tripled in size.  2007 ‐ 36  •  economic analysis®  operations in august 1997, pegged its currency (the convertible marka) first against the german  mark and later the euro through the currency board system.10 average inflation rate is the lowest  in see region. b&h has a liberal trade regime with average tariff rate of 6 percent, the lowest in  see after croatia. bh has also signed free trade agreements with all see countries.  the other side of the economic situation in b&h is as follows. the real gdp in 2005 was only  63 percent relative to one from 1989, which is much lower comparing to transition countries aver‐ age (ebrd, 2005). unemployment rate is incredible high. a liberal trade policy compound with the  lack of international competitiveness resulted in huge trade deficit. export to import coverage has  been slightly growing in last few years but still is less than 40 per cent. current account deficit in  2004 was about 17 percent relative to gdp (world bank, p. 24). b&h’s revealed comparative ad‐ vantage in eu markets is concentrated in products with low level of processing. in addition, bh  exports  to  the  eu  are  heavily  concentrated  in  natural  resources‐based  and  unskilled  labour‐ intensive products. resources‐based products the dominant category, accounting for 45 percent of  eu‐bound exports in 2002, while the unskilled labour‐intensive products accounts for the 42 per‐ cent. unlike experiences in other ceecs, bh witnessed limited restructuring in factor intensities of  its  exports.  combined  share  of  skilled  labour‐intensive  and  capital‐intensive  products  in  eu‐ destined sales remained virtually unchanged at about 13 percent over 1997‐2003 period (world  bank, 2005, p. 36‐37).  the enterprise sector of b&h is poorly integrated into international production and distribu‐ tion networks. firms in b&h are primarily inward‐oriented. for example, over 63 percent of the  surveyed firms  in beeps2 relied on foreign sources for their supplies of material  input. at the  same time, export receipts were 10.6 percent of sales revenue in 2002, a number lower than the  see8 regional average of 12.5 percent. only surveyed firms in serbia and montenegro reported  weaker export intensity among the eight see countries. surveyed firms in b&h also fared worse  than the average see firm regarding their activities in new international markets. every fifth sur‐ veyed see firm exported to new markets between 1998 and 2002, while only 6.6 percent of the  surveyed firms in bh had reached new foreign customers during the same period. the reaching of  new markets by bh companies between 1998 and 2002 is similar to the international expansion of  firms in albania and sam, but considerably lower than that of firms from romania and bulgaria  (broadman et. al., 2004).    fdi policy in bosnia and herzegovina  after the 1992‐1995 war, foreign nationals are encouraged to  invest  in the country and to  take part in the privatization process. foreign ownership is generally unrestricted, except in a few  sectors where it is limited to 49 per cent of the legal capital. under the 1998 law on foreign direct  investment policy, foreign investors are given national treatment, and enjoy the same rights (in‐ cluding property rights) and obligations as local investors. they are free to transfer profits abroad  and to repatriate funds related to their investments. no performance requirements are imposed as  a condition for establishing an investment. protection against expropriation is available. guarantee is  given to investors, in the event of a change in legislation, to choose to be subject to the law that is  favourable to them. moreover, in the event of civil unrest arising from political disturbance, pro‐ tection against loss incurred by foreign investors is offered by the investment guarantee agency, a  state body, and backed by the ing bank of netherlands.   the foreign investment promotion agency (fipa), a state body established in july 1999 by the council of ministers, is responsible for promoting and attracting foreign investment. with links at  various levels of government and industry, it provides information on legislation and investment  10 convertible mark is pegged to the euro at a fixed exchange rate of km1 = euro 0.51129.  volume 40 • autumn 2007 • 37  opportunities to potential investors, and assists them to establish joint ventures or greenfield op‐ erations.  bosnia and herzegovina enhances its attraction for fdi in authorizing duty‐free imports of  capital goods that contribute to the capital base of a foreign‐invested enterprise. as the country’s  taxation rate is under the jurisdiction of each entity, investment incentives offered may vary be‐ tween the federation of bosnia and herzegovina, and the republika srpska. the rate of corporate  income tax is 30 per cent in the federation of bosnia. the federation law on corporate income tax  provides that the corporate income tax is reduced for a period of 5 years equal to the percentage of  foreign capital invested in the assets of the company, provided that the foreign capital is greater  than 20 per cent of total capital. this incentive includes companies with 100 per cent foreign capital  investment. the rate of corporate  income tax  is  invariably 10 per cent  in the republika srpska.  bosnia and herzegovina introduced vat on the 1st january 2006 at a flat rate of 17 per cent on all  goods and services and it is collected on the state level.  access to any of the nine free trade zones (ftzs) is possible to both local and foreign inves‐ tors, where most activities may be performed. additional benefits are granted to firms operating  within a ftz boundary. goods manufactured or transformed in the zone may also be sold in the  local market, after payment of duties and taxes on imported items. no taxes and contributions are  levied, except on salaries paid. transactions within an ftz may be expressed in any foreign cur‐ rency and investors are permitted to open foreign‐exchange accounts in authorized banks.    table 2: inward fdi in see region  in million of dollars as % of gross capital formation   fdi flows  1990‐2000  (average)  2003  2004  2005  1990‐2000 (average)  2003  2004  2005  albania  63  178  332  260  21.1  13.5  18.5  13.8  b&h  78  381  606  298  7.8  26.4  34.1  16.0  bulgaria  301  2,097  3,443  2,223  18.1  54.3  68.1  35.1  croatia  544  2,133  1,262  1,695  13.1  25.2  12.5  15.4  fyr, macedonia  59  95  157  100  9.7  12.2  15.9  9.7  romania  656  2,213  6,517  6,388  9.4  17.4  39.9  28.1  serbia and  mont.  165  1360  966  1481  13.4  44.9  24.4  35.8  slovenia  139  333  827  496  3.6  5.1  10.6  5.9    source: unctad (2006b)  despite all the above efforts fdi inflows in b&h are among the lowest in see region (see  table  2).  what  is  maybe  more  important,  according  to  the  world  economic  forum  estimates  (2006), fdi contribution  to b&h  technological upgrading, export and competitiveness  is rather  low.     comparison of b&h with ireland and singapore  here we will make some interesting comparisons between fdi policy in b&h experiences in  ireland and singapore.   o as we saw in the second section of the paper both countries, ireland and singapore,  had an aggressive one‐stop agency with ample political power to swing policies to‐ wards foreign investment. foreign investment promotion agency in b&h has no po‐ litical power. it has around twenty employees. because of relatively low salaries fipa  2007 ‐ 38  •  economic analysis®  is facing problem of frequent fluctuations of its stuff. in last few years its budget has  not been changing and it around 1,5 million of km.   o ireland and singapore followed a pro‐fdi policy consistently and had a strong proac‐ tive  industrial  policy  approach  (perhaps  not  always  explicit  in  policy  documents)  with fiscal incentives and grants. fipa dos not have the strategy of fdi promotion.  every foreign  investor  is treated equally. it dos not matter from which  industry  it  comes, what kind of technology it bring, or is it export oriented or not. b&h has ap‐ plied passive open‐door policy with  limited policy  interventions and no  industrial  policy, according to the lall (1995) classification.   o both countries realised that local capabilities did not develop sufficiently, and put in  place linkage programmes between tncs and local firms. fipa nor any other politi‐ cal entity in b&h do not even analyze the issue of potential gaps between tncs and  the local economy. it is left to the market forces.  o both countries launched programmes of upgrading established foreign investors to  solve the problem of rising factor prices. in b&h there is no political entity which is is  authorised for following activities or  launching programs directed  toward existing  foreign investors.   o what is maybe the most important is that in the case of both countries fdi policy was  clearly fitted in with their development strategies. in this way they were able to de‐ velop  integrated fdi policies. they have used both macroeconomic and  industrial  policies and they have used them to attract fdi, upgrade existing fdi and to enhance  linkages and spillovers to domestic firms.11    conclusions and policy recommendations  based upon renewed confidence the positive effects associated with fdi many developing  countries are  increasingly  looking  for best‐practice policies  towards fdi. whilst fdi can bring  positive effects (technology, finance, market access or brand names), it can also bring negative ef‐ fects. moreover,  the positive effects are not automatic  for host countries and depend on many  other policies and external factors.   importance of different policies depends on the specific country characteristics, the objective  of the country and the derived fdi strategy. however, we can identify some common elements. in  each country fdi policy should fit in with a countryʹs development strategy. also, fdi policy are  likely to be some combination of different policies. macroeconomic polices, as we saw in the case  of ireland and singapore, are often combined with specific industrial policies. both of them are  used for affecting the location decision of foreign investors, affecting upgrading established for‐ eign investors and affecting linkages and spillovers to domestic firms. realising that fdi policy  should comprise policies in each of these categories is a positive step towards enhancing the bene‐ fits of fdi.   analyzing fdi policy in bosnia and herzegovina and comparing it with the experience some  other successful countries we can point out some broad policy recommendations:  o first of all, b&h has to fit in its fdi policy with its development strategy;  o it has to work more on building  local capabilities (r&d, education etc.) and  infra‐ structure to establish economic fundamentals to attract fdi and benefit from fdi;  11 both of these countries had favorable external factors, but according to here reviewed studies they were not decisive in  attracting fdi.  volume 40 • autumn 2007 • 39  o it is needed to start target specific firms that fit into development strategy which can  be coordinated by a true one‐stop investment promotion agency, with more political  power and resources (human and financial);  o fipa or some other political entity has to put in place linkage programmes between  tncs and local firms and programmes of upgrading established foreign investors to  solve the problem of rising factor prices.  literature  1. barrell, r. and te velde, d.w. (1999): ʹlabour productivity and convergence within europe: east german &  irish experienceʹ, niesr discussion paper 157  2. 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theories salamzadeh aidin1, university of tehran, faculty of entrepreneurship, tehran, iran abstract – new venture creation is a hot topic and different scholars tried to shed light on this fascinating research subject. despite the vast body of existing literature, there is little consensus about which theoretical perspectives and theories are best suited for describing and explaining the phenomenon. one of the most controversial topics is that “whether this phenomenon could be considered as a process or not?” this paper presents the existing views and theories on new venture creation, and tries to answer the mentioned question. to do so, moroz and hindle’s (2012) distinguished views are used. finally, the paper concludes with some suggestions and remarks. the main contribution of this paper is to criticize the existing perspectives and theories, to categorize them, and to present a more comprehensible view of the phenomenon. key words: new venture creation, perspectives, theories, process introduction the history of new venture creation is as old as the history of organizations (salamzadeh, 2015). however, in the early stages of this domain, i.e. organization sciences, less emphasis were placed on the “new venture creation” phenomenon. as one could see, the earliest notions of new venture creation came from distinguished theories of schumpeter in 1912 and 1934 (schumpeter, 1912, 1934). schumpeter (1937), in “the theory of economic development”, considers new ventures as one of the factors affecting economic development. he sees new venture creation as dependent on entrepreneur’s opportunity recognition process, and leads to technological change. he believes that innovation and creative destruction are the most important elements of creating new ventures, and new venture creation could be the engine for economic development. later, in 1970s, hannan and freeman (1977), in their theory of population ecology, highlight the importance of external environment in determining the lifestyle of companies in the same industry. this theory provides insights into the birth of a new type of company in a typical industry. however, the insights are less prone to be used at the meso and micro levels. these works of followed by other authors for several years, until in 1984, van de ven et al (1984) draw the attention of researchers in this field to consider the phenomenon in different levels, i.e. individual, organizational, and ecological levels. however, it did not take 1 faculty of entrepreneurship, university of tehran, 16th street, north kargar avenue, tehran, 1439813141, iran, e-mail: salamzadeh@ut.ac.ir 102 economic analysis (2015, vol. 48, no. 3-4, 101-109) so long. just one year later, gartner (1985) proposed his challenging view, which dominated the literature, and focused on too narrow a range of determinants to explain new venture creation. these works are followed by others such as, katz and gartner (1988), vesper (1990), aldrich (1990), larson and starr (1993), bhaves (1994), carter et al. (1996), veciana (1988), aldrich, (2000), deakins and whittam (2000), sarasvathy (2001), delmar and shane (2004), grimaldi and grandi (2005), lichtenstein et al. (2006), serarols (2008), lim et al. (2008), samuelsson and davidsson (2009), campbell and de nardi(2009), dimov (2010), davidsson and gordon (2012), brush et al. (2014), and becker et al. (2015). yet, there is a lack of consensus on how to describe and explain this phenomenon. in this paper, the author tries to elaborate the axioms and presumptions used in the existing literature on new venture creation to elaborate what could be the best choice. thus, it answers to the question: “whether new venture creation could be considered as a process or not?” to do so, first the existing literature is briefly reviewed. then, the axioms and presumptions behind each study are discussed, and finally, the paper concludes with some remarks and suggestions for future directions. literature review: controversial perspectives and theories recently, kuratko et al. (2015) investigated the existing approaches, one of which was new venture creation view. they consider eight major themes which characterize recent research about entrepreneurs and new venture creation: (i) venture financing, (ii) corporate entrepreneurship, (iii) social entrepreneurship and sustainability, (iv) entrepreneurial cognition, (v) women and minority entrepreneurs, (vi) the global entrepreneurship movement, (vii) family business, and (viii) entrepreneurial education. on the other hand, proposing a “universal model” for “new venture creation” is not easy, and some scholars believe that it is not promising or reasonable. while some authors agree to the process view, some disagree. the rationale behind these arguments is the source of challenges in this domain. this dilemma, initiated by gartner (1985), is followed by others and no consensus is reached yet. some argue that this process is complex and varies among different entrepreneurs in different environments (haugh, 2007), and some argue that transition between stages is not done automatically (bhave, 1994). similar to gartner (1985), storey (1994) also criticizes the stage models. he personally adheres to this belief that understanding the factors which have influence on growth is important, compared to considering the stages. albeit this view is initiated by gartner (1985) and followed by many others, some process models show that considering a process model in which the environment and environmental factors are included could alleviate this dilemma. some studies on new venture creation approve this argument (e.g. see, parker, 2006). by the way, despite gartner’s (1985) critiques on process models, just one year after publishing his famous views, katz and gartner (1988) presented a model which implicitly follows a process view. they suggested four factors, i.e. intentionality, resources, boundaries, and exchange of resources in boundaries which show the creation of a typical new venture. these indicators convey a logical sequence behind the famous story of new venture creation. that means, once an intended entrepreneur starts its new venture creation activities, he or salauzadeh, a., new venture creation, ea (2015, vol. 48, no. 3-4, 101-109) 103 she searches for resources, shapes the boundaries, and exchanges his/her resources, and enters into a market. this view is similar to larson and starr’s (1993) conceptualization, which used network theories to explain new venture creation, and bhave’s (1994) view which considers the opportunity stage, the technology set-up, the organization-creation stage, and the exchange stage. however, larson and starr (1993) and bhave (1994) explicitly make arguments following process model views, some scholars like vesper (1990), lichtenstein et al. (2006), lim et al. (2008), campbell and de nardi (2009), dimov (2010), brush et al. (2014) try to be more conservative and not enter into this controversial debate. again, haugh (2007) points out that different management styles are considered contingent to each stage in new venture creation. although, this might be true, one could propose that high rates of failure might be a direct result of mismanagement of entrepreneurs/founders in different stages (cardon et al., 2011). for instance, charismatic leadership might be an integral part of managing a new venture in the very early stages, such as recruiting new experts, dealing with angel investors, etc., however, it might not be appropriate in the next stages, such as resource mobilization which requires a more pragmatic that charismatic management style. moreover, haugh (2007) argues that these stage models assume that movement between stages is triggered by a specific crisis. this is a challenging argument to make, which needs to be explored in another studies. remember the notion made by bhave (1994) which tells that there is a transition between stages, and compare it to the haugh’s (2007) argument. even if haugh (2007) disagrees with the process view, she accepts it implicitly. veciana (1988) follows a timeline view. in her view, there are several stages in a lifecycle of an organization, i.e. gestation, creation, launching, and consolidation. she tries to be more specific, and makes clear arguments. later, núñez (2007) elaborates this model in more details, and adds practical comments to this work. deakins and whittam (2000) also make a similar argument. despite the views that disagree with the process model, deakins and whittam (2000) consider formation of an idea, opportunity recognition, pre-start planning and preparation, entry into entrepreneurship launch, and post entry development, as the stages to new venture creation. serarols (2008) agrees with veciana (1988), núñez (2007), and deakins and whittam (2000). he explicitly breaks down the new venture creation process into some stages, i.e. concept (or gestation) stage, planning stage, and implementation stage. samuelsson and davidsson (2009) investigate the venture creation process, and mention that katz and gartner (1988) categorize gestation activities under three groups, i.e. legitimacy building activities, relationship building activities, and resource acquisition activities, which were considered by scholars such as delmar and shane (2004). recently, davidsson and gordon (2012) conducted a panel study of new venture creation, and considered three main areas, i.e. characteristics of nascent entrepreneurs (person), antecedents and characteristics of new venture creation (process), and explaining new venture creation process outcomes (outcomes). in this study, they highlighted the existing approaches on new venture creation, and mentioned that the process view is dominated in last five years. more recently, becker et al. (2015) presented a model, an integrative view of a dynamic multi-stage new venture emergence, that they considered it as a first step towards an integrative discussion of new venture emergence. they used entrepreneurship theories in the 104 economic analysis (2015, vol. 48, no. 3-4, 101-109) field of opportunity discovery and creation. also, they mentioned that there should be a new venture creation process. to elaborate their meaning, they used moroz and hindle’s (2012) distinguished work which considers entrepreneurship as a process. moroz and hindle (2012) differentiated between four types of entrepreneurial process models, which are: static frameworks, stage models, process dynamic models, and quantification sequence models. these theories and perspectives are among the most important new venture creation studies which have numerous proponents and opponents. cons and pros to these views challenged the ideas in their works, but as mentioned earlier there should be some starting points to reach consensus. in the next section we use moroz and hindle’s (2012) categorization of entrepreneurial process models to elaborate the status in this domain. discussion: new venture creation models on the one hand, it is axiomatic that new venture creation is an integral part of entrepreneurship (timmons and spinelli, 1994). in fact, entrepreneurship deals with new venture ideas or opportunities to be discovered, created, evaluated, and exploited in order to create value (shane and venkataraman, 2000). on the other hand, like any other being, organizations or ventures have their lifecycles (lester et al., 2003). they pass through a lifecycle: embryos, birth, growing, and death. as mentioned earlier, organization science, entrepreneurship, and some other fields have focused on different aspects of these entities. yet, the research on new venture creation is still young and in its embryonic stages. considering that new venture creation is a process, and using moroz and hindle’s (2012) distinguished views, the studies could be classified into the following categories: (i) static frameworks: these frameworks capture the overall process. these models divide into a priori stages major tasks or phases. one major weakness of these models is that “they tend to narrow the scope of investigation and that temporal orders of events do not fit the proposed stages and/or often overlap” (moroz and hindle, 2012) (type 1). for instance, see van de ven et al. (1984), gartner (1985), vesper (1990), lim et al. (2008), campbell and de nardi (2009), etc. (ii) stage models: these models add sequences to static frameworks and make sequential processes. these models “characterize the overall process of venture creation without examining the sequence of activities, consists of a limited set of variables connected by speculative causal links; process oriented but do not capture sequence of dynamics” (moroz and hindle, 2012) (type 2). for instance, see katz and gartner (1988), bhave (1994), etc. (iii) process dynamic models: these models show the influence of context and process variations on outcomes. these models “employ qualitative methods to examine how and why variations in context and process shape outcomes; often interpretive, temporal, and change oriented” (moroz and hindle, 2012) (type 3). for instance, see larson and starr (1993), lichtenstein et al. (2006), sarasvathy (2006), etc. (iv) quantification sequence models: these models explain new venture creation based on a historical sequence. these models are “historical sequence-based approaches of the new venture creation process; this approach does not allow salauzadeh, a., new venture creation, ea (2015, vol. 48, no. 3-4, 101-109) 105 researchers to understand the dynamics of how antecedent conditions shape the present and the emergent future within the process (moroz and hindle, 2012) (type 4). for instance, see veciana (1988), carter et al. (1996), deakins and whittam (2000), grimaldi and grandi (2005), serarols (2008), becker et al. (2015), salamzadeh and kawamorita (2016). (v) other models: any other model which do not fit the four mentioned models. for instance, see aldrich (1990, 2000), sarasvathy (2001), delmar and shane (2004), etc. table 1 presents an overview of extant models of new venture creation and their key components, events, stages, or domains. as it is shown in the table, the literature lacks coherence and a clear set of models, and it is too narrowly focused and limited in scope. table 1. an overview of extant models of new venture creation model class author(s) year key components/events/stages/domains static frameworks van de ven et al. 1984 individual, organizational, ecological gartner 1985 individual, organizational, environment, process vesper 1990 technical know-how, product or service idea, personal contacts, physical resources, customer orders lim et al. 2008 acquiring financial resources, developing products, developing a market and acquiring customers, acquiring human and production resources, delivering products, developing production systems, developing other systems campbell and de nardi 2009 “who are you?”, “what are you trying to accomplish?”, “what have you and others put into the business?”, “what have you accomplished?”, “what remains to be done?” stage models katz and gartner 1988 intentionality, resources, boundaries, exchange of resources in boundaries. bhave 1994 opportunity; technology set up/organizing; exchange stage; separate opportunity process: external and/or internal process dynamic models larson and starr 1993 focus on essential dyads, converting dyadic ties to socio-economic exchanges, layering the exchanges lichtenstein et al. 2006 measure the emergence in the dynamics of new venture creation sarasvathy 2006 inputs, effectual strategy, outputs quantification sequence models veciana 1988 gestation, creation, launching, consolidation carter et al. 1996 up and running, still trying; given up deakins and whittam 2000 formation of an idea, opportunity recognition, pre-start planning and preparation, entry into entrepreneurship launch, post entry development grimaldi and grandi 2005 the incubation models serarols 2008 concept (or gestation) stage, planning stage, implementation 106 economic analysis (2015, vol. 48, no. 3-4, 101-109) model class author(s) year key components/events/stages/domains becker et al. 2015 a dynamic multi-stage new venture emergence model salamzadeh and kawamorita 2016 formation stage, challenges, exit stage other aldrich 2000 opportunity identification based on expertise, prior experience, and education sarasvathy 2001 effectuation delmar and shane 2004 legitimacy building activities, relationship building activities, resource acquisition activities source: self-elaborated conclusion “organizational genesis does not mean virgin birth” (padgett and powell, 2012). it is “a journey from conception to birth” (evers, 2003). the process of new venture creation is a journey in which an entrepreneur or a group of entrepreneurs engage in entrepreneurial activities, to turn a new venture idea or an opportunity into value. to do so, like any other entrepreneurial activity, they should follow a process. although the literature on new venture creation lacks consensus about a universal model, this research showed that there should be a process view toward this phenomenon to increase the rate of success and to make a better understanding of it. to do so, the author reviewed the literature to find the nuances and differences in diverse views. next, the author used moroz and hindle’s (2012) outstanding view to categorize the main existing new venture creation models. but, the difference between this research and their approach is that the author considered all the relevant theories and frameworks, and not only the selected one. although one could easily marginalize the ideas in this domain as “merely” addressing entrepreneurship as a process, the range and perspicacity of topics examined demonstrated that new venture creation is a more focused area of research. future researchers might study the main axioms of studies in this domain, categorize them into homogenous groups, and make clearer axioms. also, still there are some dark points which need to shed light on, like investigating the levels of analyses, which is referred to in moroz and hindle (2012), to conduct panel studies like the one done by davidsson and gordon (2012) focusing on process views. using other theories might add fruitful insights to the existing literature as well, such as activities proposed by delmar and shane (2004), which could be integrated into a process view. however, there are some limitations such as considering the industry type, entrepreneurial styles, type of new venture ideas, and last but not least the context. references aldrich. howard e. 1990. “using an ecological perspective to study organizational founding rates.” entrepreneurship theory and practice, 14(3): 7-24. aldrich. howard e. 2000. organisations evolving. 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innovative and imitative new ventures.” small business economics, 33(2): 229-255. sarasvathy, saras. d. 2001. effectual reasoning in entrepreneurial decision making: existence and bounds. academy of management best papers proceedings 2001, ent: d1–d6. sarasvathy, saras. d. 2006. effectuation: elements of entrepreneurial expertise. cheltenham, u.k.: edward elgar. schumpeter, joseph. a. 1912. the theory of economic development. leipzig: duncker and humblot. schumpeter, joseph. a. 1934. the theory of economic development: an inquiry into profits, capital, credit, interest, and the business cycle (vol. 55). transaction publishers. serarols carlos. 2008. “the process of business start-ups in the internet: a multiple case study.” international journal of technology management, 43 (1-3): 142-159. shane, scott., and sankaran venkataraman. 2000. “the promise of entrepreneurship as a field of research.” academy of management review, 25(1): 217-226. storey, david. 1994. understanding the small business sector. london: routledge. timmons, jeffry a., and stephen spinelli. 1994. new venture creation: entrepreneurship for the 21st century (vol. 4). burr ridge, il: irwin. van de ven, andrew h., roger hudson, and dean m. schroeder. 1984. “designing new business startups: entrepreneurial, organisational and ecological considerations.” journal of management, 10: 87-107. veciana, josé maria. 1988. “empresari i process de creacio d’empreses.” revista economica de catalunya, num.8. may-august. vesper, karl. h. 1990. new venture strategies, 2nd ed. englewood cliffs, nj: prentice hall. salauzadeh, a., new venture creation, ea (2015, vol. 48, no. 3-4, 101-109) 109 kreiranje novih poslova: kontroverzne perspektive i teorije rezime – otvaranje novih poslova je vruća tema i stoga su različiti naučnici pokušali da je rasvetle u svojim istraživanjima . uprkos obimnoj postojećoj literaturi, gotovo da ne postoji konsenzus o tome koje perspektive i teorije su najprikladnije za opisivanje i objašnjavanje ovog fenomena. jedna od najkontroverznijih tema je "da li se ovaj fenomen može smatrati procesom ili ne?" ovaj rad prikazuje postojeće stavove i teorije o novom stvaranju firmi, i pokušava da odgovori na spomenuto pitanje. da bi to učinili, moroz i hindle (2012.) su pokušali da naprave razlike izmedju različitih stavova . konačno, u radu se daje zaključak sa nekim priedlozima i primedbama. glavni doprinos ovog rada je kritika postojećih teorija, kako bi se izvršila njihova sistematizacija i predstavio razumljiviji pogled na fenomen. ključne reči: razvoj novih poslova, perspektive, teorije, proces article history: received: 12 june, 2015 accepted: 5 december, 2015 doi: 10.28934/ea.21.54.2.pp1-19 original scientific paper beyond the returns the u.s. mutual funds value and growth style weighted sector portfolios investment performance attribution boris korenak10 f* | nikola stakić2 1 investometrix group, lakeshore m8v 1e7, toronto, on, canada 2 singidunum university, danijelova 32, belgrade, serbia abstract the aim of this study is to provide insight into the portfolios constructed out of sector mutual funds, based on value and growth investment styles. moreover, this study does not exclusively consider the returns, but it looks beyond them by incorporating the holdings data into portfolio performance attribution. we use two different sector mutual funds across the us sectors, over the observed decade. the findings show that smart money was not able to produce the value on the cumulative basis. we show that growth style was favourable over the observed decade. in addition, by implementing the growth style based on shiller price-to-earnings in the portfolio construction and assigning sector weights the tested portfolio offset partially and fully the negative effect by managers’ stock selection. overall, the holdings-based relative portfolios attribution in relation to appropriate benchmarks gave additional insight into dynamics of the alpha creation and the loss of alpha. brinson-fackler and brinson-hood-beebower attribution models are used including distinct model versions. in addition, the geometric attribution model is used to provide analytical consistency for multi-period attribution. key words: brinson models, geometric attribution, mutual funds’ performance, allocation effect, selection effect jel classification: g110 introduction in an effort to examine investment performance it is quite common to focus solely on the returns. based on the return track record different risk metrics can be calculated. they can be based solely on portfolio return (such as value-at-risk) or in relation to the benchmark (such as tracking error). together with the benchmark return data they are used to present risk-adjusted measures (such as information ratio). there are plenty of regression based multi-factor models that are used to examine investment performance of the institutional investors. usually used factors can be related to investment style, macroeconomic or microeconomic attributes. however, commonly overlooked data by researchers are holdings data, for both portfolio and benchmark. to get a deeper level of insight, it is necessary to understand the sources of the * corresponding author, e-mail: korenak.boris@investometrixgroup.com 2 economic analysis (2021, vol. 54, no. 2, 1-19) investment active performance, thus there is a necessity to look beyond the return-based approach and include holdings data into analysis. the aim of this study is to closely examine the investment performance of portfolios that are composed out of the us sector mutual funds in relation to the broad market index s&p500. weights for portfolios sectors exposure were assigned according to the investment style. furthermore, we broke down the sector allocation and security decisions across 11 sectors, for each of the 10 observed years, using two-set of returns and holdings data, for both value and growth style investment style, with the annual rebalancing frequency. also, the multi-period issue was addressed in the appropriate way and the cumulative results were presented. to achieve that we deployed asset-grouping attribution models. two different arithmetic attribution models were used including different model versions. in addition, geometric attribution model was used to provide analytical consistency for multi-period attribution. the assumptions are that an investor assigns the weights to sector in the us, based on shiller price-to-earnings ratio, and to achieve that exposure he/she uses sector mutual funds. this can be observed from the perspective of the fund-of-funds as well, that portfolio is composed out of mutual funds units. the rest of study provides theoretical background, data source, reasoning for the used methodology, as well as presented results and discussions, followed by conclusions. literature review various regression models have been used to explain the source of the return and risk. these models are known in investment performance attribution as factor-based models. one of the most prominent example of multi-factor model is fama and french (2015) five-factor model. the five-factor model extends the three-factor model by adding two factors: robust-minusweak profitability (rmw) and low-minus-high (conservative-minus-aggressive) investment (cma). previously commonly used fama and french (1993) three-factor model in academia for empirical research, uses the market beta, small minus big (smb), and high-minus-low book-tomarket ratio (hml). another extension to the model is carhart (1997) four-factor model, that uses momentum as additional factor. lastly, the most used model due to its simplicity is capital asset pricing model (capm), despite that it failed many empirical tests (eugene f. fama and kenneth r. french, 2004). there is also a special sub-group within factor models, that are non-linear models. traditional non-linear models are treynor-mazuy (1966) model and henriksson-merton (1981) model. abergel and thomas (2021) introduced a different approach to the performance analysis of multifactor investment strategies. characteristic of this methodology is a cross-sectional projection of asset returns onto the factors to form approximate portfolio returns. also, it shows nonlinear interaction terms between factors that produce the investment portfolio construction, as well as a natural and intuitive decomposition of the portfolio performance as the sum of factor contributions. lastly, this study offers practical applications to multi-factor equity strategies. as an alternative to return-based attribution, there is an asset-based approach. this approach requires, in addition to returns, beginning period holdings data for the portfolio and benchmark. this approach is not only return-based, like the factor-based approach. asset-based approach can be holdings-based (including different frequency of holdings data) and transaction-based. to avoid unexplained residuals, that are especially prominent in the portfolios that deploy strategies with high turnover and whose underlying exhibits high volatility, transaction-based approach is preferred over holdings-based approach (spaulding, 2018). spaulding (2018) performed empirical comparison between transaction and holdings-based attribution. former can be less precise especially if the lower frequency is used. also, if the turnover of the observed portfolio is high then it can lead to unexplained residual. in addition, the boris korenak, nikola stakić 3 author finds that the residuals caused by holdings-based analysis can be extensive and are not always necessarily correlated with turnover, as might be anticipated. within asset-based approach the most used models are brinson models, such as brinsonfackler (1985) and brinson-hood-beebower models (1986). however, since the introduction of these models both standard terminology and the interpretation have slightly changed. the terminology that is almost universally accepted now is asset (segment) allocation (term that was used by brinson and fachler was market selection), security selection and interaction effect (term that was used by brinson and fachler was cross-product). vashisht and gupta (2014) study underlines the concept of performance attribution, the methodology used by two of the most important performance attribution models namely brinsonhood-beebower model and brinson-fachler model. the study also discusses different approaches used for performance attribution, like arithmetic or geometric and the periodicity effects in carrying out attribution for multi-periods. peng (2020) used holding-based approach to analyze actively managed mutual funds in china. his research suggests that there is a positive correlation between holding-based model and regression model, fama-french three-factor model that he used for the comparison. during the observed period he found that most of the chinese mutual funds were able to deliver positive stock selection effect. however, most of the funds fail to deliver positive asset allocation effect due to inability to predict policy changes. interestingly when it comes to the interaction effect, contrary to the original authors that perceived interaction effect (cross-product) as residual value, spaulding (2003/2004), campisi (2004) and bacon (2008) perceive it as a direct result of the combined allocation and selection effects. latter two authors proposed that interaction effect should be included within selection effect, since it is not an inherent part of the investment decision process. arithmetic attribution has a disadvantage over geometric attribution when it comes to multiperiod attribution. arithmetic return for the multi-period fails to include the compound effect over time. to overcome this issue different algorithms have been used for smoothing and linking returns. initially, they were introduced by grap (1997) and carino (1999) and additional solutions have been offered by menchero (2000), frongello (2002) and bonafede and others (2002). reztsov (2011) offers detailed comparison between arithmetic and geometric approach. also, this study offers linking algorithm that is order independent. on another side, geometric excess return for the full observed period can be calculated from the compounded total allocation and selection effects, without residual. for multi-period attribution geometric approach is preferable (bacon, carl r., 2002). when it comes to investment style, pettengill et. al. (2014) performed mutual funds investment style performance analysis that included period of 1979 to 2012. their findings go in favor of value over growth mutual funds. they showed that value funds outperform growth funds especially in terms of lower realized risk and higher realized terminal wealth. when it comes to allocation, selection and interaction effect for the individual segments, their total geometric values for the whole period do not compound to the total excess return. this is the reason why weber and arno (2018) address them as semi-geometric models. also, menchero (2000/2001) presented a model that could be perceived as fully geometric, since individual allocation and selection effects compound through time. when it comes to multicurrency attribution, traditional brinson model was adjusted initially by ankrim and hensel (1992) followed by karonsky and singer (1994). 4 economic analysis (2021, vol. 54, no. 2, 1-19) data and methodology data data that were used for the calculations includes the following inputs portfolio sector weights (𝑤𝑤𝑖𝑖), portfolio sector returns (𝑅𝑅𝑖𝑖), benchmark sector weights (𝑊𝑊𝑖𝑖) and benchmark sector returns (𝐵𝐵𝑖𝑖), for the period 2011 to 2020. holdings-based approach with the annual frequency was deployed. portfolios sector weightings were based on value and growth investment styles. to distinguish between investment styles, we used historical sector price-to-earnings ratio adjusted according to professor shiller. that means that earnings were calculated as a 10-year average at any given point. data was obtained from s&p global, and fidelity and morning star mutual funds data bases. total sector returns were used. manager sector peers’ groups returns were used and obtained from the morning star mutual funds data base. they cover all 11 sectors that are classified by global industry classification standard (gics): information technology, health care, financials, consumer discretionary, communication services, industrials, consumer staples, energy, utilities, real estate, and materials. also as a represented group, mutual funds that were used to construct the fidelity portfolios are the following ones: fidelity select communication services portfolio (fbmpx), fidelity select consumer discretionary portfolio (fscpx), fidelity select consumer staples portfolio (fdfax), fidelity select energy portfolio (fsenx), fidelity select financial services portfolio (fidsx), fidelity select health care portfolio (fsphx), fidelity select industrials portfolio (fcyix), fidelity select technology portfolio (fsptx), fidelity select materials portfolio (fsdpx), fidelity real estate investment portfolio (fresx), and fidelity select utilities portfolio (fsutx). during the observed period s&p 500 index composite sectors have changed. real estate was spun off from the financial sector post september 16, 2016. due to that we decided to include allocation towards real estate sector post-2016, to make it more comparable to the s&p 500 benchmark. telecommunication services sector was renamed to communication services, with issues added from other sectors post september 20, 2018. we use the latter name throughout the whole observed period. methodology four different portfolios made up of the sector mutual funds were used. first portfolio is value weighted peers sector mutual funds portfolio. where, as the name suggests sector weights allocation was based towards sectors with the relatively low shiller price-to-earnings ratios. here we have used managers’ average returns for the given sectors from the whole database of morning star mutual funds. the same approach was used to construct the value weighted fidelity mutual funds portfolio, using only the returns for fidelity sector mutual funds. portfolio sector weights were assigned proportional to sectors with relatively higher shiller price-to-earnings ratio and was used to implement the growth strategy for two different series. thus, we constructed the following portfolios growth weighted morning star peers sector mutual funds portfolio and growth weighted fidelity sector portfolio. for performance attribution asset-grouping models used in research are two brinson models, as well as the geometric approach. brinson-hood-beebower model the first one is brinson-hood-beebower model, where total allocation effect is calculated in the following way. boris korenak, nikola stakić 5 benchmark return (b) is the weighted sum of the individual segment returns. b = ∑𝑊𝑊𝑖𝑖𝐵𝐵𝑖𝑖 (1) semi-benchmark return (bs) is a hybrid measure, that uses portfolio weights and benchmark segment returns. 𝐵𝐵𝑠𝑠 = ∑𝑤𝑤𝑖𝑖𝐵𝐵𝑖𝑖 (2) allocation effect for the individual segment (ai): 𝐴𝐴𝑖𝑖 = (𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖)𝐵𝐵𝑖𝑖 (3) total allocation effect can be expressed as: 𝐵𝐵𝑠𝑠 – b = ∑𝑤𝑤𝑖𝑖𝐵𝐵𝑖𝑖 − ∑𝑊𝑊𝑖𝑖𝐵𝐵𝑖𝑖 = ∑(𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖) 𝐵𝐵𝑖𝑖 = ∑𝐴𝐴𝑖𝑖 (4) it represents the value that is added/lost by having different segment weights in portfolio than the segment weights in the benchmark. as long the portfolio has overweighted the sector in which benchmark has delivered positive results the allocation effect will be positive. next, for securities selection within the sector we need to take in consideration the selection effect, that is calculated in the following way. in addition to previously used benchmark return (b), another hybrid metrics needs to be used, and that is semi-portfolio return (rs). it uses the benchmark sector weights and portfolio sector returns. 𝑅𝑅𝑠𝑠= ∑𝑊𝑊𝑖𝑖𝑅𝑅𝑖𝑖 (5) selection effect for the individual sector (si) 𝑆𝑆𝑖𝑖 =𝑊𝑊𝑖𝑖(𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) (6) when it comes to total selection effect, it is expressed as following: 𝑅𝑅𝑠𝑠 – b = ∑𝑊𝑊𝑖𝑖𝑅𝑅𝑖𝑖 − ∑𝑊𝑊𝑖𝑖 𝐵𝐵𝑖𝑖 = ∑𝑊𝑊𝑖𝑖(𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) = ∑𝑆𝑆𝑖𝑖 (7) it represents the value that is added/lost by having different securities weights in the portfolio segment than the securities weights in the benchmark segment. this version of the model has a residual, when compared to the total excess return. the residual can be explained by interaction effect, and when included it fully explains the excess return. the excess return can be obtained in the following way. 𝐵𝐵𝑠𝑠 − b + 𝑅𝑅𝑠𝑠 − b + r − 𝑅𝑅𝑠𝑠 − 𝐵𝐵𝑠𝑠 + b = r − b (8) brinson-fachler model where the agency supported the research, authors should have a funding acknowledgement in the form of a sentence as follows: we used two different versions of brinson-fachler model. 6 economic analysis (2021, vol. 54, no. 2, 1-19) allocation in both versions is the same. however, it is different than in brinson-hood-beebower model because it takes in account not only individual sector benchmark return but also total benchmark return. 𝐵𝐵𝑠𝑠 – b = ∑(𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖) (𝐵𝐵𝑖𝑖 − 𝐵𝐵) = ∑𝐴𝐴𝑖𝑖 (9) on another hand, selection effect can be shown in two different versions (with and without interaction effect). version with the self-standing interaction effect. pure selection is expressed as: 𝑅𝑅𝑠𝑠 – b = ∑𝑊𝑊𝑖𝑖 (𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) (10) interaction effect is the following: r – 𝑅𝑅𝑠𝑠 – 𝐵𝐵𝑠𝑠 + b = ∑(𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖) (𝑅𝑅𝑖𝑖 −𝐵𝐵𝑖𝑖) (11) version with the combined selection and interaction effects. in this version of the model, the selection is expressed as following: r – 𝐵𝐵𝑠𝑠= ∑𝑤𝑤𝑖𝑖(𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) = ∑𝑆𝑆𝑖𝑖 (12) to summarize, bhb and bf models’ attribution results difference is due to individual segment allocation effect. however, the total allocation effect results are the same. selection effect is the same based on these two models and is presented in that manner. geometric model in addition, we used geometric attribution approach, where: individual sector geometric allocation effect is the following: a𝑖𝑖 𝐺𝐺= (𝑤𝑤𝑖𝑖 – 𝑊𝑊𝑖𝑖) ( (1 + 𝐵𝐵𝑖𝑖) (1 + 𝐵𝐵) 1) (13) total geometric allocation effect is: 𝐴𝐴𝐺𝐺 = (1 + 𝐵𝐵𝑠𝑠) (1 + 𝐵𝐵) 1 = ∑ a𝑖𝑖 𝐺𝐺 (14) individual sector geometric selection effect is: s 𝑖𝑖 𝐺𝐺= 𝑤𝑤𝑖𝑖 ( (1 + 𝑅𝑅𝑖𝑖) (1 + 𝐵𝐵𝑖𝑖) 1) (1 + 𝐵𝐵𝑖𝑖) (1 + 𝐵𝐵𝑠𝑠) (15) total geometric selection effect is: 𝑆𝑆𝐺𝐺= (1 + 𝑅𝑅) (1 + 𝐵𝐵𝑠𝑠) 1 = ∑ s𝑖𝑖 𝐺𝐺 (16) boris korenak, nikola stakić 7 lastly, geometric excess return is expressed as: r𝑒𝑒𝑒𝑒𝑒𝑒𝐺𝐺 = (1 + 𝑅𝑅) (1 + 𝐵𝐵) 1 (17) important property, for the multi-period attribution of the geometric approach is the following: 𝑅𝑅𝑒𝑒𝑒𝑒𝑒𝑒𝐺𝐺 = ( 1 + 𝑆𝑆𝐺𝐺)(1 + 𝐴𝐴𝐺𝐺) − 1 = (1 + 𝑅𝑅) (1 + 𝐵𝐵) – 1 (18) results and discussion in this section we present our findings of performance attribution for the analyzed portfolios. first, we answered the question did the mutual fund investment managers add or lose value for investors by making security selection decisions in comparison to s&p500 sector returns. in other words, we discuss the stock selection effect within sectors, for both morning star mutual funds sector peers and fidelity mutual sector funds. actually, this gives us the answer to the question “how smart is the smart money” for the observed period. then we dive into each of the four portfolios and try to understand the source of alpha (or negative alpha). more precisely, portfolio performance attribution, is based on brinson-fachler and brinson-hood-beebower model, as well as the geometric model that addresses the multiperiod performance. how smart is the smart money? in order to get the insight into managers’ stock picking skills, it is necessary to consider the selection effect. we would like to point out that the selection effects are the same no matter which version of the brinson’s models we use for performance attribution. used version of the brinson model will play a role only later when we discuss the allocation effect, but for the stock selection it is irrelevant. this is the reason why we present selection effect only based on two different data series, and not at the portfolio level. when we analyze the morning star database sector mutual funds (figure 1) for most of the observed years majority of sector mutual funds have underperformed in relation to the average stock performance for the given sector. that shows that managers, on average, were not able to beat their appropriate sector benchmarks. cumulative combined selection effect for the whole 10-year period is negative and it was 18.22%. however, relative performance in relation to the sector benchmark is quite heterogenous across the sectors. results suggest that there is a certain level of consistency in alpha that managers were able to produce for the certain sectors. one of the rare examples of positive alpha consistency is health care sector. however, majority of the sector mutual funds from the morning star database exhibit negative alpha with a relative high level of consistency year-over-year. 8 economic analysis (2021, vol. 54, no. 2, 1-19) figure 1. morning star peers sector mutual funds portfolio combined selection effect source: authors when we analyze the stock selection effect of the fidelity sector mutual funds, our finding show that fidelity managers did overall better in relation to the morning star sector peers (figure 2). the majority of differences in returns in relation to morning star peers can be assigned to the period of 2014 until 2019. where, fidelity managers for certain sectors managed to add value to stock selection whereas their peers almost universally underperformed in relation to the benchmark for the mentioned period. also, our findings suggest that managers for the given funds were able to beat their peers on consistent base. this is especially prominent for information technology, communication services and health care. however overall, on cumulative bases total selection effect is still negative and it was -4.40%. however, what is common for both series is that the year 2020 is an outlier for both. that suggests that the managers’ stock selection decisions were superb in relation to s&p500 sector benchmarks almost for all sectors. this might suggest that there are certain biases in managers’ stock selection in general such as the company size or investment style that are widely spread throughout their investment philosophy and strategy. furthermore, this can be an explanation through the relative high level of correlation of stock selection effect between fidelity and morning star peers. -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00% 8,00% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 energy materials industrials consumer discretionary consumer staples health care financials* information technology communication services** utilities real estate* boris korenak, nikola stakić 9 figure 2. fidelity sector mutual funds portfolio combined selection effect source: authors value weighted morning star peers sector mutual funds portfolio it is important to stress out that when it comes to sector allocation effect brinson-fachler and brinson-hood-beebower models they produced the same total allocation effect for any given period, in our case a year. on another hand, allocation effect is differently allocated across the sectors. figure 3 is an example of comparison of allocation effect of brinson-fachler and brinsonhood-beebower models. for example, according to the brinson-fachler model the highest negative allocation effect for the year 2020 is the energy sector -1.79% and according to the brinson-hood-beebower model it is for the information technology sector -1.28%. however, total allocation effect for year 2020 is the same based on both brinson’s models and it is -3.33% -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00% 8,00% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 energy materials industrials consumer discretionary consumer staples health care financials* information technology communication services** utilities real estate* 10 economic analysis (2021, vol. 54, no. 2, 1-19) figure 3. value weighted morning star peers sector mutual funds portfolio – allocation effect bf vs. bhb model comparison source: authors figure 4 shows arithmetic attribution results for each of the analyzed years. it can be observed that value weighted morning star peers sector mutual funds underperformed in relation to the s&p500 sector benchmarks for eight of ten years that can be noticed based on excess return. moreover, sector allocation based on value investment style and higher assigned weights towards the sector with the lower price-to-averaged-earnings. sector allocation effect is positive for two periods and security selection effect is positive for only one period. clearly, value investment style was not in favour for the observed decade. moreover, negative alpha produced by sector mutual funds managers made even worse results. as a result, only two years of positive total excess return for value weighted morning star peers sector mutual funds portfolio. figure 4. value weighted ms peers sector mutual funds total portfolio allocation and selection annual effects – arithmetic approach source: authors -4,00% -3,50% -3,00% -2,50% -2,00% -1,50% -1,00% -0,50% 0,00% 0,50% allocation (bf) 2020y allocation (bhb) 2020y -6 ,2 8% -0 ,5 0% 1, 16 % -6 ,3 5% -2 ,8 1% -2 ,1 0% -1 ,5 8% -3 ,9 5% -4 ,3 0% 6, 20 % -0 ,3 3% -0 ,0 7% -0 ,2 6% -0 ,9 8% -2 ,0 1% 1, 95 % -1 ,1 2% -0 ,7 3% -0 ,9 7% -3 ,3 3% -6 ,6 1% -0 ,5 7% 0, 91 % -7 ,3 3% -4 ,8 2% -0 ,1 5% -2 ,7 0% -4 ,6 8% -5 ,2 7% 2, 87 % 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 11 multiperiod attribution and geometric approach for the cumulative 10-year period arithmetic attribution approach is not appropriate. it can be only used by implementing different types of algorithms. geometric approach does not leave residual, and it is not order dependent. therefore, it is a preferable approach. also, excess returns for single periods cannot be linked geometrically together to get the excess return for multiperiod. figure 5 shows annual geometric excess return. however, as stated linked annual geometric excess returns to get the geometric return for the 10-year period would be a mistake. table 1 summarizes the geometric attribution results for the 10-year period. geometrical excess return is negative, and it is -23.77%. it was obtained as geometrical excess return between portfolio geometrical multiperiod return and benchmark geometrical multiperiod return. another way how the excess geometric return for the multiperiod can be obtained is to calculate total multiperiod effect. because geometric attribution does not leave residual, they must be equal. sector allocation geometric effect for the 10-year period is negative, as a result of underweighting the sectors that had high shiller price-to-earning ratio and overweighting the ones that had lower than average s&p500 shiller price-to-earning ratio. stock selection for the value weighted morning star peers sector mutual funds portfolio is even more negative and the value for investors is lost for the observed period. allocation and selection effects are geometrically linked, and the result is in the line with the previously calculated 10-year excess return. figure 5. value weighted ms peers sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors 12 economic analysis (2021, vol. 54, no. 2, 1-19) table 1. value weighted ms peers sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 180.43% 267.89% -23.77% -6.79% -18.22% -23.77% source: authors value weighted fidelity sector mutual funds portfolio here we have another portfolio which was constructed based on value investment style. however, this time fidelity sector mutual funds were used to assign portfolio weights. stock selection effect was positive half of the observed time period. in all of the observed years when selection effect was positive it was significant enough to offset negative allocation effect and produce total positive excess return for the given year. such as in the 2020, 2019, 2017, 2013 and 2012 years (figure 6). on another side, unfavourable value investment style resulted in only one year of positive sector allocation effect out of the whole decade. it was the main factor why overall excess returns are negative and they only added to the negative stock selection effect. overall, negative excess returns are present in half of the observed years, and they were more significant than the positive ones. figure 6. value weighted fidelity sector mutual funds total portfolio allocation and selection annual effects – arithmetic approach source: authors -6 ,0 9% 2, 28 % 1, 98 % -3 ,1 3% -1 ,3 9% -2 ,3 3% 1, 94 % 0, 00 % 1, 38 % 7, 10 % -0 ,3 3% -0 ,0 7% -0 ,2 6% -0 ,9 8% -2 ,0 1% 1, 95 % -1 ,1 2% -0 ,7 3% -0 ,9 7% -3 ,3 3% -6 ,4 2% 2, 21 % 1, 72 % -4 ,1 1% -3 ,3 9% -0 ,3 8% 0, 82 % -0 ,7 3% 0, 41 % 3, 76 % 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 13 multiperiod attribution and geometric approach when we observe a decade as a whole, we use once again, the geometric approach. (figure 7). because of the previously explained known properties of the excess return for the multi period, negative total geometric sector allocation effect and negative combined geometric security selection effect were used to calculate the total effect for the whole period. total effect is also negative, as expected and it is -10.72% (table 2). these results are in line with the geometric difference between the value weighted fidelity sector mutual funds portfolio return and s&p500 benchmark return. for the observed decade, portfolio produced 228.46% and the benchmark produced 267.89% which resulted in excess return of -10.72% which is by definition the same as the total effect for the whole multiperiod. figure 7. value weighted fidelity sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors table 2. value weighted fidelity sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 228.46% 267.89% -10.72% -6.79% -4.22% -10.72% source: authors 14 economic analysis (2021, vol. 54, no. 2, 1-19) growth weighted morning star peers sector mutual funds portfolio moving to the growth style portfolios, we are starting with the portfolio that is constructed by sector peers. sector allocation effect, this time, is drastically different than the one that we obtained using the value style investment strategy. by assigning higher portfolio weights to the sectors with lower shiller price-to-earnings ratio we ended with the nine out ten years positive sector allocation effects. this as a result did not have a major impact on annual total excess returns that one might expect. this is because the stock selection effect for morning star peers is strong enough to offset the positive allocation effect as a result of the growth style. overall, only three out of ten observed years ended with the positive excess return (figure 8). figure 8. growth weighted ms peers sector mutual funds total portfolio allocation and selection annual effects – geometric approach source: authors multiperiod attribution and geometric approach by observing the whole decade for growth weighted morning star peers sector mutual funds portfolio, it can be seen that portfolio return of 218.89% was still below the benchmark return and it produced negative excess return of -13.32% (figure 9) (table 3). this is despite the positive sector allocation effect of 5.87% because managers from the morning star database made many suboptimal stock selection decisions in comparison to the benchmark and they fully offset all the positive effect of the growth investment style that was implemented in the portfolio construction. -6 ,6 2% -0 ,6 1% 1, 12 % -5 ,5 2% -2 ,4 3% -3 ,1 0% 1, 49 % -3 ,7 7% -4 ,3 8% 6, 34 % 0, 50 % 0, 69 % 0, 42 % 0, 53 % 1, 39 % -1 ,4 1% 0, 75 % 0, 63 % 0, 88 % 2, 14 % -6 ,1 2% 0, 07 % 1, 53 % -4 ,9 9% -1 ,0 4% -4 ,5 1% -0 ,7 4% -3 ,1 4% -3 ,4 9% 8, 49 %2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 15 figure 9. growth weighted ms peers sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors table 3. growth weighted ms peers sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 218.89% 267.89% -13.32% 5.87% -18.12% -13.32% source: authors growth weighted fidelity sector portfolio moving to the growth investment style portfolio that was constructed using only fidelity sector mutual funds our findings are very different than for the other portfolios. positive sector allocation effect for nine years this time together with the lower negative sector selection effect resulted in six out of ten periods of positive excess return (figure 9). for individual years positive allocation effect, in certain years it partially offset negative security selection effect and in other years they were working in synergy with one another. the most prominent example of synergy is the year 2020. 16 economic analysis (2021, vol. 54, no. 2, 1-19) figure 10. growth weighted fidelity sector mutual funds total portfolio allocation and selection annual effects – geometric approach source: authors multiperiod attribution and geometric approach as with other portfolios we performed multiperiod attribution. however, this time our results are different in a sense that total excess return was slightly positive. this means that portfolio outperformed the benchmark on the cumulative basis for the observed ten-year period. despite the negative selection effect as a result of fidelity managers’ suboptimal stock selection decisions on average growth weighted fidelity sector portfolio was able to beat the benchmark by implementing growth investment style (figure 11). moreover, for the whole period sector allocation effect was 5.87% and selection effect together with interaction effect negative -4.40%. that led to the slightly positive total effect of 1.21% which can be also obtained by portfolio compound return of 272.33% in relation to the benchmark (table 4). important note is that combined selection effect includes the interaction effect. that is the reason why the combined selection is not the same between value and growth portfolio using the same data series. -7 ,3 1% 2, 02 % 2, 70 % -2 ,5 0% -1 ,3 5% -3 ,6 8% 2, 61 % -3 ,9 0% 1, 56 % 8, 63 % 0, 50 % 0, 69 % 0, 42 % 0, 53 % 1, 39 % -1 ,4 1% 0, 75 % 0, 63 % 0, 88 % 2, 14 % -6 ,8 1% 2, 71 % 3, 11 % -1 ,9 6% 0, 04 % -5 ,0 9% 3, 36 % -3 ,2 7% 2, 44 % 10 ,7 8%2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 17 figure 11. growth weighted fidelity sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors table 4. growth weighted fidelity sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 272.33% 267.89% 1.21% 5.87% -4.40% 1.21% source: authors conclusion by incorporating holdings data into performance attribution, we were able to get a closer insight in the portfolios investment performance that are composed out of the us sector mutual funds in relation to the benchmarks. especially valuable was to analyze sector mutual funds performance using different models and approaches, as well as to construct investable portfolios and implement the performance attribution of the same ones. this gave us opportunity to draw certain conclusions. growth style overperformed value style based on the sector allocation effect. portfolio sector weighting was based on shiller price-to-earnings ratio. reason why growth style was favourable over value style is because sectors where investors were ready to pay the highest earning multiplier were the ones that had the highest price appreciation, over the observed decade. expectations for the high growth rate of earnings in the future created a price momentum. this is especially prominent in the information technology sector. smart money underperformed when it comes to stock selection within sector mutual funds. this was true for average sector mutual fund from the morgan star database, as well as selected fidelity sector funds. 18 economic analysis (2021, vol. 54, no. 2, 1-19) in addition, both sector selection and sector allocation effects are quite heterogenous across the sectors. that means that managers in different sectors were not equally successful to beat their appropriate benchmarks. there is a strong correlation of stock selection effect between morning star and fidelity sector mutual funds year-over-year. reason for this might be related to certain fundamental biases in investment philosophy and strategy of sector mutual funds managers. finally, total excess return for multiperiod was only slightly positive for one out of four analyzed portfolios. after finding out that the stock selection effect is negative, it was clear that the positive total excess return must be driven by significant enough sector selection effect that would be able to offset the average suboptimal stock selection decisions of managers. value style underperformed the benchmark so there was no chance for value portfolios to beat the benchmark. growth portfolios had the mixed success in regard to delivering alpha. growth weighted morning star peers sector mutual funds portfolio did not produce a positive alpha. even in relation to the value weighted fidelity sector mutual funds portfolio, it slightly underperformed. the reason for this is the difference in stock selection skills between average sector mutual funds manager and selected fidelity sector mutual funds managers. the growth weighted fidelity sector portfolio had small enough negative stock selection effect, that it was possible to be fully offset by value that was produced with the growth style sector weighting on annual basis. this study was limited on equity only sector mutual funds that had only exposure to domestic market. because the mutual funds have exposure to usd we did not have to incorporate the fx market attribution. also having mutual funds that are equity only made performance attribution comparable. in addition, the attribution for self-standing years is more intuitive for users using arithmetic models. however, when it comes to multiperiod, the whole ten-year period was more adequate to be analyzed by geometric attribution. hence, we presented the multi-period excess return in relation to total 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value weighted morning star peers sector mutual funds portfolio multiperiod attribution and geometric approach value weighted fidelity sector mutual funds portfolio multiperiod attribution and geometric approach growth weighted morning star peers sector mutual funds portfolio growth weighted fidelity sector portfolio multiperiod attribution and geometric approach references udc: 336.744/.746 336.76(497-15) cobiss.sr-id 252604940 scientific review assessing a currency substitution persistency in the western balkan region mehmed ganić1* | alina dizdarević1 | agim mamuti2 1 faculty of business administration, international university of sarajevo, bosnia and herzegovina 2 american university in the emirates (aue) dubai, united arab emirates abstract the study aims to examine the euroization phenomenon in seven western balkan countries (albania, bosnia and herzegovina, bulgaria, croatia, romania, serbia and macedonia) between 2000 and 2015 and a number of –specific challenges faced by the region. more precisely, the paper analyzes the impact of the latest global financial crisis on the extent of currency substitution persistency by exploring the trends before, in wake of the financial crisis, and after the financial crisis. the study employed several indicators as a proxy variable for measuring of the overall level of currency substitution or euroization and cross country analysis in selected countries (liability euroization, credit euroization and deposit euroization and asset substitutionoverall euroization index). finally, the study found that deposit euroisation, credit euroization, and liabilities euroization in seven western balkan countries is still high with relatively high degree of heterogeneity. in some countries of the western balkan region the process of euroisation was further intensified in spite of the consequences of the latest global financial crises, while in the other ones the crisis years were marked by the trend of de-euroisation. in overall, this study does not find any significant evidence on significantly increases or decreases in currency substitution at the region sub-samples. finally, student t-test results indicate that there is no significant difference in means of before, in wake and after the financial crises at level of western balkan region. key words: credit euroization, deposit euroization, liability euroization, western balkan region jel classification: f41, g01, e52 introduction the question of euroisation has been on the forefront of the economic debate. it is very natural that this debate intensifies and leads the economic analysis process during and after crisis. the western balkan economies are known as the highly euroised countries. it seems impracticable to report all available leadership definitions within the scope of this paper. due to this, it will be contented with definitions which are distinguishable and relevant to approach in question. the terms euroisation and dollarization are used interchangeably to describe a situation when residents of a country hold foreign currency and when the assets and liabilities, including bank loans, deposits, as well as non-banking assets are denominated in foreign currency (izeand levi yeyati, 2003). euroisation is especially a widespread phenomenon in transitioning economies which needs to be carefully considered and comprehended. among the transitioning economies the western * e-mail: mganic@ius.edu.ba 44 economic analysis (2017, vol. 50, no. 3-4, 43-54) balkans is one of the most euroised regions in europe characterized by a history of political uncertainty, macroeconomic instability, conflicts as well as by the hyperinflation (bechmannand scheiber, 2012). the study explores the dynamics of euroization as a widespread phenomenon in the western balkans, by focusing on seven countries in the region (albania, bosnia and herzegovina, bulgaria, croatia, macedonia, romania and serbia). post-socialist development characterized by disparities in levels of economic development across the region is the main reason for selecting the western balkan region for this research. in order to define variables needed to conduct the analysis, a detail research on previous writings on this topic has to be made. the findings of number studies are shown in literature review section. this paper first of all aims to discuss the concept of euroisation and make a twofold contribution to the current debate. firstly, is to examine the impact of latest global financial crises on the trends of euroisation of deposits, loans, and liabilities in selected countries. secondly, it evaluate if there is consistency in the impact of euroisation over the years across countries. in this study, the main research question is to investigate whether the latest financial crisis caused any changes in euroization level in the western balkan region? there are no many researches on analysis trend of euroisation in post crises period in western balkan region. main reason may be found in the lack of data especially in long term. most of the researches were conducted in pre crises period. consequently, the significance of this paper is to provide more information about trends of euroization in selected transition countries in post crises period. this paper consist of the following sections: the second section of this paper contains literature review, and followed by methodology. the fourth section contains cross-country analysis, and paper ends with conclusion and recommendations. literature review in the literature on monetary theory and system, there exist many works on dollarization/euroization and its advantages and weaknesses, but very limited number of academic work has been carried out about trend of euroization in crises and post crises period. the term euroisation is described by winkler, et al. (2004) as a term which refers to the situation when a country uses the currency of another country. the term is used interchangeably with the term dollarization. however, the term dollarization is used more frequently than the term euroisation, and suggests the replacement of the national currency in general. a large number of indicators of euroisation can be found in research literature. the choice of a concrete indicator to analyze the quantitative data depends on the characteristics of the economy and its purpose to be used. traditional approaches to the measurement of euroisation are mainly based on foreign currency deposits. reinhart, et al. (2003) describes the dollarized economy as one in which economic entities hold a part of a foreign currency portfolio, and / or the one in which the private and public sector borrow in foreign currency. thus, financial euroisation implies the euroisation of deposits and / or loans. on the side of banking assets, the level of euroization is most often measured by the ratio of fx loans or fx indexed loans to total loans. financial euroisation is actually asset and liability euroisation, while the term real euroisation is used for the situation when the foreign currency is set for the local prices and wages (winkler et al., 2004). fischer (1982) suggests that the country which adopts foreign currency benefits from the elimination of costs related to the exchange of domestic currency for the foreign one. moreover, mehmed ganić, alina dizdarević, agim mamuti 45 dollarization can lead to improvement in a country's economic integration with the economy whose currency is adopted (dallas and tavlas, 2001; frankel and rose, 1998). as a result of higher integration, the gdp levels and business cycles may converge with the issuing country (dallas and tavlas, 2001). also, shocks between euroized and the foreign country become more symmetrical, business cycles become more synchronized, and the integration further improves (winkler et al., 2004). barro and gordon (1983) argue that the financial euroisation can benefit the country since it is fostering macroeconomic stability by solving the problem with credibility that arises when a domestic central bank is not able to pre-commit itself to a low rate of inflation. by adopting the monetary policy of the foreign country with a high degree of credibility, the level of inflation and interest rates in the domestic economy is expected to converge to the level in the foreign country (winkler et al., 2004). if the convergence works, the output costs associated with disinflation in the low environment should be avoided (országhová, 2015). ize and levi yeyati (2003) describe financial euroisation as the situation when assets and liabilities are held in foreign currency; while calvo and veigh (1992) discuss that the process of euroization begins with substitution function of money as a store of value, which is the most vulnerable function in the periods of inflation. within the balance sheets of households, asset euroisation is referred as the situation when households hold deposits in foreign currency, whereas the liability euroisation represents their obtained loans in foreign currency (calvo and veigh, 1992). when it comes to the banks' balance sheets, the asset euroisation refers to the situation when banks are lending in foreign currency, while raising deposits in foreign currency refers to liability euroisation (calvo and veigh, 1992). ivanov, et al. (2011) defines the deposit euroisation as the tendency of households, enterprises, and even governments, to hold deposits in foreign currency. the western balkans region is an area characterized by a long history of political uncertainty, macroeconomic instability, and distrust in the quality of institutions (bechmann & scheiber, 2012). the region as whole has a long history of hyperinflation, which is one of the driving forces for euroisation (bechmann & scheiber, 2012). however, the countries of western balkanswere characterized by the abundant supply of foreign capital inflows, which made foreign currency lending easily accessible at low interest rates. the easy access to foreign currency lending caused the liability side of banks’ balance sheets to become heavily dominated in foreign currency (országhová, 2015). also, the countries’ economic and financial links with the countries in eurozone as well as the overall eu integration process intensified the process of euroisation (fabris et al., 2004). luci et al., (2006) investigated the level of euroisation in albania, by taking into account foreign deposits and foreign currency in circulation. they found very high level of euroisationin albania (45%). merollari and mosko (2015) investigated the level of euroisation in albania between 2007 and 2014 and suggested that the level of euroisation is relatively high, even though the official euroisation did not take place yet. the results of the study indicate that the ratio of the foreign currency deposits to the total is over 30% and therefore the tendency towards euroisation is high. as it is argued by galac (2012), euroisation in croatia is a consequence of a set of historical events in both economic and financial spheres. besides the events, it is influenced also by the monetary and prudential measures of the croatian national bank and by the attempts by banks to minimize their financing costs (galac, 2012). madzova et al. (2014) discuss that the process of intense euroisation in macedonia started in 2002 when the euro was adopted as the exchange rate anchor. however, they found the extensive use of euro in the banking system of macedonia was followed by the process of deeuroisation, which implies the decrease in the level of liquid assets, deposits, and loans in foreign currency. 46 economic analysis (2017, vol. 50, no. 3-4, 43-54) euroisation in serbia was investigated by chailloux et al. (2010) who claim that the phenomenon is rooted in a history of instability in macroeconomic terms. chailloux et al. (2010) also argue that after the process of intense euroisation, the process of de-euroisation has started, so that the borrowers have become more interested in the local currency borrowing. methodology the paper examines the trend of currency substitution persistency seen through the case of the selected western balkan countries. it analyzes qualitatively pre-determinants of the latest financial crisis and statistically describes selected countries’ indicators sourced from the world bank data, national central banks annual reports and imf database. the study has divided the years into three different sub periods: 2000-2007 (pre-recession period), 2008-2009 (recession period) and 2010-2015 (post-recession). data for all variables used in the study are sourced an annual basis. the rationale behind this division is to compare the countries’ trend of currency substitutions before, during and after the crisis and to explore whether the trend of currency substitution is influenced by the global financial crises. the analysis involved the manipulation of data with an aim of getting the results which would answer the research question. due to data consistency problems, a relatively short time series of annual data was employed in order to measure changes in the level of currency substitution. in much of the existing professional literature, we encounter various variables for measuring the degree of dollarization / euroization. in order to examine how the latest financial crisis influences on the changes in the degree of currency substitutions of the western balkan countries, a set of certain variables need to be determined and tested. by examining of previous researches on measuring euroisation it is possible to note that some authors employed a whole range of variables to measure the level of euroisation of a particular national economy (ize and levi yeyati, 2003; calvo and veigh, 1992; ivanov, et al. 2011). accordingly, some variables as deposits, loans and liabilities, between 2000 and 2015, are employed to estimate the extent of currency substitution in the selected transition countries hit by latest financial crises. credit euroization is measured as the ratio of foreign currency denominated loans to total loans; liability euroization is measured as the ratio of foreign currency denominated liabilities to total liabilities; and deposit euroization is measured as ratio of foreign currency denominated deposits to total deposits. furthermore, euroization index (roeinhart, et al., 2003 and imf) as the ratio of foreign currency bank deposits to m3 (broad money) is used to measure the level of asset substitution and represents proxy variable for euroization. for the sake of our analysis , the study employs a descriptive statistical analysis (mean) to assess certainty level of currency substitutions across the western balkan region while for the purposes of estimating the significance of the difference in means between numerical variables, a parameter t-test: two-sample with unequal variances is used. the first indicator used in many studies is deposit dollarization (ize and levy yeyati, 2003). another important point that we can speak about is liability euroization. also as a measure of euroisation is increasingly used by indicator of liability euroization(barajas and morales, 2003). this indicator is calculated as the ratio of foreign currency denominated liabilities as percentage of total liabilities. the inclusion of this indicator is based on recent experiences from the recent financial crisis as the private and public sector liabilities in developing countries were largely denominated in foreign currency. based on an overview of research problem, and the aims of the study, this paper set out the main hypotheses as follows. h1: there is no significant difference in means of before, in wake and after the financial crises for our variables mehmed ganić, alina dizdarević, agim mamuti 47 h0: there is significant difference in means of before, in wake and after the financial crises for our variables. cross-country comparison analysis financial sector development the degree of financial intermediation, as measured by the ratio of banking sector assets' to gdp, is one of the most representative indicators of the maturity of the banking sector. as shown in figure 1, the western balkan region is characterized by a relatively high degree of heterogeneity. between 2000 and 2015, the average percentage of bank assets to gdp ranges between 55.69% (romania) and 111.6% (croatia). with the exception of croatia (121.6% of gdp) and bulgaria (106.2% of gdp) where the size of the banking system in relation to gdp is predominantly above 100% of gdp, the level of financial intermediation in other western balkan countries is predominantly below 90%. if we neglect the banking sector of romania, in other analyzed eu member states (i.e. bulgaria, and croatia), the banking sector made the progress in its development showing greater saturation in comparison to the other countries in the region. analyzed as a percentage of gdp, it was found that croatia has the most developed banking sector (121.6% of gdp) measured by total assets of banks while the least development was observed in romania (75% of gdp). figure 1. total assets of banks as % of gdp (2000-2015) source: the authors’ elaborations on global financial development database (gfdd), national cbs furthermore, the ratio of private sector credit to gdp provided by the banking sector to measure of financial development reveal significant differences between the western balkan countries (figure 2). in our case it varies widely across the countries. in the three new eu member states the ratio has grown slowly in the range between 45.00% (romania), 73.25% (croatia) and 75.50% (bulgaria). bulgaria’s standard deviation is high showing us that the country has experienced significant fluctuations in evolution of its banking sector. 0.00 50.00 100.00 150.00 average stdeviation min max 48 economic analysis (2017, vol. 50, no. 3-4, 43-54) figure 2. bank private credit to gdp (%), 2000-2015 source: the authors’ elaborations on global financial development database (gfdd), national cbs among the other countries of the western balkan region out of eu the highest ratio was found in b&h (56.37%) and it doubled several times between 2000 and 2015. the highest value in relative terms for this ratio was found in bulgaria, (75.50%), while the lowest one was recorded in albania (38.26%) and romania (45%). moreover, the highest share of deposits in gdp (figure 3) was recorded in albania (71.7%) and slovenia (69%), with the lowest in romania (34.4%) and serbia (47.15 %). the reason for lower ratio in romania and serbia may be found in excessive of hyperinflation in the middle of 1990s. figure 3. bank deposits to gdp (%) for selected western balkan countries (2000-2015) source: the authors’ elaborations on global financial development database (gfdd), national cbs our cross-country comparisons of average total deposits to gdp ratio indicates that serbia (47.15%) and romania (34.4%) with their ratio are lagging significantly behind other analyzed countries. the demand for loans has been steadily increasing over the period 2000-2015. the positive trends in terms of economic growth, privatization revenues, as well as restored confidence in the banking system have created a basis for the creation of deposits potential. (de) euroization in western balkan countries during the period of transition only few western balkan countries established financial system similar to the ones in advanced transition countries. the level of euroization significant varies among countries in the region. cross-country comparisons of euroization deposits as measured by fx deposits to total deposits show some differences in terms of euroization 0.00 20.00 40.00 60.00 80.00 albania b&h croatia macedonia serbia romania bulgaria average stdeviation min max 0.00 20.00 40.00 60.00 80.00 average stdeviation min max mehmed ganić, alina dizdarević, agim mamuti 49 deposits across region in the years before the crisis, in the wake of crisis and after the crisis (figure 4). as it can be seen from figure 4, the growth of euroization deposits is generally found in albania and serbia as a notable exception. more specifically, in pre-crisis period, fx deposits amounted to the 63.21% of the total deposits, which increased to 72.25% in the wake of crisis, and 75% in post-crisis period. as presents, croatia is among the countries with the highest extent of euroization deposits. in the pre-crisis period the ratio amounted to 68.23%, while the period of de-euroisation was experienced during the crisis as result deposit withdrawals. after the crisis, however, there was high degree of euroisation deposits when compared to the one in the pre-crisis period. on the other side, macedonia recorded fall of the deposit euroisation and the ratio had declined significantly compared to pre crises period. in the meantime, when pre crisis and crisis periods are compared, it can be seen that there was a slight decline in deposit euroisation during the crisis. figure 4. deposit euroization, between 2000 and 2015 source: imf country reports, different issues after the crisis, a trend of further deposit euroisation was found in albania, croatia serbia and bosnia and herzegovina. the data for macedonia, romania and bulgaria shows the decline in deposit euroisation. in case of romania, the crisis period was marked by the 7.54% decline in deposit euroisation, while in the post-crisis period there was only 1.92% decline. in bulgaria, the data indicates that the trend in de-euroisation deposit before, during, and after the crisis was similar. however, in the case of bosnia and herzegovina, the crisis period was marked by deposit de-euroisation, while in the post crisis-period the ratio of foreign-currency denominated deposits in total deposits increased to 44.47%, which is lower than 46.65% as experienced in pre-crises period. when the comparison is made across countries, it can be said that the tendency towards holding euroization deposits in albania and serbia increased during the financial crisis while in the case of romania, bulgaria, serbia, croatia, bosnia and herzegovina, and macedonia recorded de-euroisation of deposits in the wake of crises. moreover, in the post-crisis period, the data on albania, croatia, and serbia shows the trend of growth euroisation deposit. however, the data on macedonia, romania, and bulgaria show that deposit de-euroisation occurred in the years following the financial crisis. further, considering western balkan countries the differences in the extent of credit euroization in serbia, albania, croatia, macedonia, romania, bulgaria, and bosnia and herzegovina, in pre-crisis, in the wake of crises, and post-crisis period are given in figure 5. as it 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00 albania croatia macedonia serbia romania bulgaria bosnia and herzegovina before in wake after 50 economic analysis (2017, vol. 50, no. 3-4, 43-54) can be seen from figure 5, the post-crisis period was affected by decline of credit euroization in albania and macedonia. on the other side, in the post-crisis period the credit euroisation has slightly risen in romania and bulgaria. however, croatia and bosnia and herzegovina experienced the opposite trends. additionally, in croatia the ratio decreased (68.85%) in the wake of crisis, and increase in postcrisis period (73.86%). interestingly, in case of bosnia and herzegovina there was recorded rise of credit euroization in the wake of crisis (73.6%) and decline in post crises period (64.61%). however, the trend of credit de-euroisation occurred in post-crisis years, with the number of fx loans being lower than the one in pre-crisis years. the similar trend was occurred in macedonia. specifically, credit euroization increased by 1.45% in the wake of crisis and a decline of 7.13% in post-crisis period. figure 5. credit euroization, between 2000 and 2015 source: imf country reports, different issues figure 6 shows some interesting differences in the percentage of liabilities euroization in selected countries in pre-crisis, crisis, and post-crisis period. serbia (77.5%) and croatia (77.5%) are considered countries with very high euroization ratios across the years, while the data on albania (41.4%) and romania (43.25%) shows the lowest values when compared to the other countries. figure 6. liabilities euroizations, between 2000 and 2015 source: imf country reports, different issues 0 10 20 30 40 50 60 70 80 pre crises in wake after crises 0 20 40 60 80 pre crises in wake after crises mehmed ganić, alina dizdarević, agim mamuti 51 the overall euroisation trend in serbia was high, with a sharper increase in post-crisis years in comparison with the pre-crisis period. the rise of euroisation liabilities was also experienced in the economy of albania, reaching 41.4% in pre-crisis period, 48.7% in the wake of crisis, and 52.13% in post crises period. in case of croatia, the increase in liabilities’ euroisation was recorded during the financial crisis (77.55%), to slightly decline in post-crisis period to the value lower than the one in pre-crisis years (72.58%). macedonia, bosnia and herzegovina, and bulgaria experienced the same trend in liabilities’ euroisation. thus, there was an increase in liabilities’ euroisation during the crises, with de-euroisation trend in post-crisis period. however, the number of foreign currency denominated liabilities remained higher than the one in pre-crisis period. in the case of romania there was a different trend when compared to other countries considered in the study. as figure 6 reveals, there was liabilities’ de-euroisation in romania in the wake of financial crisis (43.25%). after the crisis, the euroisation trend occurred again, but the value remained lower than the one before the crisis (44.13%). finally, we included an indicator euroization index (ei) used by roeinhart, rogoff and savastano, 2003 and imf in our study to measure overall level of euroization or asset substitution. figure 7 presents average ei across countries between 2000 and 2015. most countries of western balkans are high-euroization countries with notable exception of romania. a closer look at the data reveals that all countries of the western balkan (with exception of romania, macedonia and bosnia and herzegovina) increased its euroization ratio from pre crises to post crises period. figure 7. euroization index (ei), between 2000 and 2015 source: imf country reports, different issues although the phases of the euroization are similar by countries there are some striking differences among them. first, while the euroization ratio is increasing continuously as of pre crises period until post crises period (in albania, croatia, serbia and bulgaria), the decline of the extent of euroization (in romania, macedonia and bosnia and herzegovina) starts in post crises period. second, the euroization ratio has recovered significantly better in albania (9.29%) and croatia (6.9%) from the crisis than in serbia (3.72%) and bulgaria (1.72%). third, while the trend of euroization slowed during the global crisis, its level is still high in some countries as follows: croatia (60.67%), serbia (67.08%), bulgaria (42.57%) and macedonia (41.19%). student’s t-test is employed to explore the variations in the level of de euroization the countries of the western balkan region over the three sub periods. it examines statistically 0 10 20 30 40 50 60 70 albania croatia macedonia serbia romania bulgaria bosnia and herz. pre crises crises post crises 52 economic analysis (2017, vol. 50, no. 3-4, 43-54) different from one to another sub periods (before of the financial crisis, in wake of the financial crisis, and after the financial crisis).the means for the three sub periods are the same for selected variables is tested as the main hypothesis. the following hypothesis is tested: h0: μ1 =μ2= μ3 where μ1 is the mean for pre-crisis period (2000-2007), μ2 is the mean for post-crisis period (2008-2009) and μ3 is the mean for (2010-2015). it compares the average deposit euroization, credit euroization, liability euroization and euroization index calculated for pre-crisis period with the average the ratios calculated for crises and post crises period. a hypothesis test examines critical values associated the mean with test statistics. our basic assumption: if p-value is less than or equal to the significance level (p≤ α = 95% confidence interval for the mean of a group), the null hypothesis is rejected. and vice versa if p-value ≥ α, the null hypothesis is not rejected. table 1 below provides a summary of a student’s ttest results for the three sub periods under review. table 1. student’s ttest results pre-crisis (20002007) crisis (20082009) p-value* crisis (20082009) post crisis (20102015) p-value* pre-crisis (20002007) post crises (2010-2015) p-value deposit euroizatio n 50.86% 51.07% 0.95 51.07% 51.86% 0.84 50.86% 51.86% 0.71 credit euroizatio n 62.98% 66.08% 0.22 66.08% 63.73% 0.31 62.98% 63.73% 0.71 liability euroizatio n 57.39% 61.60% 0.27 61.60% 60.59% 0.79 57.39% 60.59% 0.20 euroizatio n index 41.51% 45.10% 0.30 45.1% 45.8% 0.84 45.51 45.8% 0.09 *α =95%,p=0.05 source: author`s elaborations on data from imf country reports, different issues analysis of the results by student's t-test for dependent samples has shown that there is no significant difference in means of before, in wake and after the financial crises for our variables. analyzing the average values for our variables, before, during the crisis and after the crisis, a statistically significant difference is not found (p> 0.05) and mean values has remained almost unchanged over time. accordingly, our main hypothesis is accepted. conclusion the study aimed at investigating the changes in the extent of deposit, credit, liability and asset substitution before, in the wake of crises, and after the latest financial crisis in seven western balkan countries. findings our study indicates that overall the deposit euroization in the postcrisis period are higher than their pre-crisis levels in three countries (albania, croatia and serbia). while this decrease is more pronounced from the crisis to post-crisis period for macedonia and romania, the deposit euroization for bosnia and herzegovina has increased from crisis to post crises period. the trend with deposit euroisation was quite different in croatia, where the increase in fx deposits occurred in the wake of the crisis, which was preceded by the sharp decrease in crises period. mehmed ganić, alina dizdarević, agim mamuti 53 also, overall credit euroization has increased in the post-crisis period in croatia, romania and bulgaria over crisis period levels. the study found that the credit euroisation of bosnia and herzegovina was affected by the financial crisis in the way that the number of fx denominated credits increased in the wake of crisis, while after the crisis there was a trend of decline of credits held in foreign currency. in macedonia, the crisis influenced on the fall of credits held in foreign currency in post crises period in comparison to crises period. when the liability euroisation is taken into consideration, macedonia and croatia had the situation of the sharp decrease of the fx liabilities in post-crisis period, while in albania the euroisation of liabilities sharply increased during and after the crises. the level of overall euroisation measured by euroization index in all four countries was high over the years and it is still sizeable in some of selected countries with exception of romania, macedonia and bosnia and herzegovina. furthermore, student t-test results indicate that there is no significant difference in means of before, in wake and after the financial crises at level of western balkan region. in overall, this study does not find any significant evidence on significantly increases or decreases in currency substitution for the region sub-samples. references barajas, a. and bueno, a. m. 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(2003). debt intolerance. brookings papers on economic activity, vol 34. winkler, a., mazzaferro, f., nerlich, c., & thimann, c. (2004). official dollarisation/euroisation: motives, features and policy implications of current cases. frankfurt: european central bank. world bank (2017). global financial development database (gfdd), wahington d.c. article history: received: october 12, 2017 accepted: november 10, 2017 ea_2019_2 doi: 10.28934/ea.19.52.2.pp128-136 scientific review the modelling of tax influence on macroeconomic framework in spain vera mirović1* | branimir kalaš1 | jelena andrašić1 1 university of novi sad, faculty of economics, department for finance and accounting, subotica, serbia abstract the study provides an empirical analysis of tax impact on selected macroeconomic aggregates in spain from 1996 to 2016. the objective of this research is to determine how tax forms effect on macroeconomic framework of spanish economy. the analysis includes the impact of direct taxes such as personal income tax, corporate income tax and tax on property as well as social contributions. on the other hand, gross domestic product per capita, unemployment, inflation, investment and government expenditures are selected as the main macroeconomic determinants and present dependent variables in defined models. results of defined model show that tax revenue growth, personal income tax, tax on property and social security contributions significantly affects the gross domestic product per capita. further, personal income tax and corporate income tax have a significant impact on unemployment, investment and government expenditures. findings show that the intensity of personal income tax' effect is higher on investment and government expenditures compared to corporate income tax. in addition, present tax structure does not have a significant effect on inflation, which can be explained by fact that indirect taxes are more related to inflation than direct taxes. key words: direct taxes; structure; macroeconomic aggregates; ordinary least squares model jel classification: b40, h20, h21 introduction tax forms should take an important place in the economic policy of each country. the level and share of taxes in the economy must be adequately defined so that taxes would be in function of growth and enable optimum functioning of the economy. any increase in taxes can potentially have a negative influence on the main macroeconomic indicators. however, tax cuts can result in lower revenues, which mean lower public funds, or resources needed to meet public expenditures there are numerous tax forms that are related to income, profits, ownership and value of assets, turnover, consumption, as well as to imports and exports in the course of performing economic activities. what type of tax is present in a particular country depends on the level of its economic development. boadway and pestieau (2002) state that personal income tax and consumption tax are classified as key tax forms in taxation systems around the world. when tax forms are used as a proxy for fiscal policy, engen and skinner (1999) listed several mechanisms of tax influence on economic growth. namely, taxes can decline investments and slow down growth in labour supply by distorting labour-leisure choice in favour of leisure. in addition, it is necessary to mention that a higher level of tax burden can distort the effective use * corresponding author, e-mail: vera.mirovic@ef.uns.ac.rs vera mirović, branimir kalaš, jelena andrašić 129 of human capital (tosun and abizadeh, 2005). looking at the tax structure in spain in past twenty years, tax on goods and services, personal income tax and social security contributions are the most generous taxes in this economy. namely, these three taxes consists almost 30% gross domestic product at an average level and over 80% of tax revenues in spain. this is similarly trend compared to other countries, especially oecd countries and these taxes are the basis of tax structure in spain. the need for research is reflected in providing information support and giving guidance to economic policymakers in the observed country about the influence of direct taxes on macroeconomic aggregates such as gross domestic product per capita, unemployment, inflation, investments and government expenditures. in addition to determining the impact of tax forms on selected macroeconomic aggregates, as well as the nature of their relationship, there is a motive to show how the current tax structure influences on the macroeconomic framework in analyzed period. literature review there are many studies that have analyzed the impact of taxes on macroeconomic variables in order to dominant research is related to economic growth. when it comes to economic growth, myles (2000) defined as the fundament for increasing prosperity of the economy. petrov and trivić (2018) determined sustainable income as a measure of growth and a trajectory to a developed state that can sustain over a very long period. many papers are focused on relationship between tax forms and economic growth (abizadeh, (1979); helms, (1985); chelliah, (1989); barro, (1990); bleaney et al. (2001); lee and gordon, (2005); furceri and karras, (2007); arnold, (2008); arnold et al. (2011); ferede and dahlby, (2012); gale et al. 2015; li and lin, (2015); grdinić et al. 2017; andrašić et al. 2018; mcnabb, 2018). lee and gordon (2005) analyzed seventy countries for the period 1970-1997 and found that corporate income tax is related to lower economic growth. namely, their results showed that a cut in a corporate tax rate of 10% enhances annual gross domestic product growth per capita by 0.64%. similarly, furceri and karras (2007) found that an increase of tax share in gdp leads to a decline of gdp per capita in twenty-six oecd countries in the period 1965-2007. however, tax on property is an only tax, which has a significant influence on gross domestic product per capita although other tax forms such as personal income tax, corporate income tax, social security contributions, and tax on goods and services negatively affect the gross domestic product per capita. in addition, arnold (2008) confirmed the negative influence of taxes on economic growth in order to income taxes is generally related to lower economic growth than taxes on property and consumption. in an analysis of oecd countries, macek (2014) pointed out personal income tax, corporate income tax and social security contributions cause the highest damage to the economic growth in these countries. li and lin (2015) analyzed the effect of sales tax on economic growth in the united states from 1960-2013 and estimated the long-run and short-run elastic coefficients of sales tax on growth. their findings are that economic growth is negatively related to sales tax in the long-run, although this tax has positive effects in the short-run. in addition to relationship between taxes and economic growth, there are studies that examined their potential influence on unemployment, inflation, investments and government expenditures. the argument that higher labour taxes result in a higher unemployment rate is widely presented in public finances. daveri and tabellini (2000) researched the relationship between labour tax and unemployment in eu countries in the period 1965-1995. their findings confirmed that an increase in labour tax of 14% leads to an increase in unemployment of 4%. zimmermannova et al. (2016) found a negative correlation between personal income tax and unemployment in czech republic, which implies that higher revenues are related to the smaller level of unemployment. poterba and rotemberg (1990) researched tax rates and inflation rate in united states, united kingdom, france, germany and japan in the period 1981-1986. their findings confirmed a positive correlation in united states and japan, and negative correlation in the other three countries. value added tax is often related to inflation and price movements, 130 economic analysis (2019, vol. 52, no. 2, 128-136) where gabriel and reiff (2010), as well as benkovski and fadejeva (2014), confirmed the significant effect of this tax form on inflation rate. it is an essential relationship between taxes and government expenditures where taha and logahtnan (2008) confirmed that the decrease in tax rates could lead to a decline of government expenditures. similarly, zortuk and uzgoren (2008) found bidirectional causality between government expenditures and tax where 1% increases enhance tax by 0.8%. methods and materials for the purpose of this study, authors used secondary data of oecd revenue statistics for the period 1996-2016. in order to determine the impact of direct taxes on selected macroeconomic aggregates such as gross domestic product per capita, unemployment, inflation, investment and government expenditures. table 1. review of explanatory variables variable symbol calculation source tax revenue growth trgrowth annual growth rate oecd personal income tax pit % share of gdp oecd corporate income tax cit % share of gdp oecd tax on property top % share of gdp oecd social security contributions soc % share of gdp oecd gross domestic product per capita gdppc u.s. dollars oecd unemployment unm annual rate imf inflation inf consumer price index imf investment inv % share of gdp imf government expenditures ge % share of gdp imf source: authors' illustration models can be presented as: gdppct=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5unmt + β6inft + β7invt + β8get+ …et (1) unmt=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6inft + β7invt + β8get+ …et (2) inft=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6unmt + β7invt + β8get+ …et (3) invt=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6unmt + β7inft + β8get+ …et (4) get=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6unmt + β7inft + β8invt+ …et (5) where are gdppc gross domestic product per capita, trgrowth tax revenue growth, pit personal income tax, cit corporate income tax, soc social security contributions, unm unemployment, inf inflation, inv investment, ge government expenditures, β0 the constant term, β the coefficient of the independent variables and e the error term of the equation. empirical results this section provides descriptive information for explanatory variables, as well as trends of macroeconomic aggregates and direct taxes. in addition, correlation matrix is presented in order to identify the nexus between tax structure and macroeconomic framework in spain. vera mirović, branimir kalaš, jelena andrašić 131 table 2. descriptive statistics variable mean std. dev. min max trgrowth 4.9619 5.9678 -10.4 11.3 pit 6.8857 0.4151 6.2 7.6 cit 2.7428 0.7788 1.8 4.7 top 2.2952 0.3968 1.7 3.2 soc 11.6476 0.2159 11.1 11.8 gdppc 4.3719 0.1370 4.17 4.55 unm 16.4714 5.8497 8.22 26.1 inf 2.3805 1.3441 -0.5 4.08 inv 24.7371 3.9217 19.14 31.33 ge 41.9833 3.2041 38.27 48.09 source: authors calculation figure 1. trends of macroeconomic aggregates in spain source: authors based on imf database the average gdp per capita is 24491 usd which is higher than eu average, but worrying is a decreased trend from 2008. firstly, gdp per capita was 35725 usd in 2008 and in the next eight years felt for 9409 usd. further, it can see that unemployment was growing trend from 2007 to 2016 where the highest rate of 26.1% was recorded in 2013. however, positive fact is unemployment is decreased in the last four years for more than 9% compared to 2013. also, inflation is relatively stable where the greatest price level was 2008, which is positively correlated with economic growth in spain (gdp growth rate was 1.12%). it is a recorded average inflation rate of 2.38% what is higher than most member countries in eu whose had null or zero price level. the average shares of investment and government expenditures are 24.74% and 41.98% of gross domestic product. it's indicative that when investment share increased the gdp growth rate was higher. on the other hand, when share of government expenditures exceeds 45% of gdp, economic growth was slower and smaller measured by annual gdp rate. 132 economic analysis (2019, vol. 52, no. 2, 128-136) figure 2. trends of direct taxes in spain source: authors based on oecd revenue statistics figure 2 shows the movement of direct taxes in spain in the observed period 1996-2016. tax revenue had the highest growth in 2005 where it increased by 11.3%. after that, tax revenue had declined trend, especially in 2008 year, where they fell by 10.4%. this negative trend is a consequence of the global economic crisis that slowed down economic activity in the world. in past five years, average growth of tax revenue was 2.7%. looking at the tax structure, personal income tax and social security contributions have the greatest share of gross domestic product in this country. the average share of personal income tax is 6.9% of gdp, while revenues collecting of social security contributions consists 11.7% of gdp. on the other hand, corporate income tax and tax on property have an average percentage share behind 3% of gdp in the analyzed period. table 3. correlation matrix variable trgrowth pit cit top soc gdppc unm inf inv ge trgrowth 1.00 pit -0.32 1.00 cit 0.45 -0.25 1.00 top 0.35 -0.05 0.79 1.00 soc -0.13 -0.29 0.45 0.49 1.00 gdppc -0.55 0.47 0.08 0.41 0.51 1.00 unm -0.36 0.59 -0.85 -0.60 -0.59 0.07 1.00 inf 0.31 -0.35 0.42 0.12 0.25 -0.23 -0.60 1.00 inv 0.52 -0.59 0.88 0.69 0.51 -0.11 -0.95 0.54 1.00 ge -0.60 0.62 -0.80 -0.57 -0.36 0.34 0.91 -0.57 -0.92 1.00 source: authors calculation based on correlation test, it can see a negative relationship between tax revenue growth and gross domestic product per capita, as well as personal income tax and social security contributions are positively correlated with gross domestic product per capita. results show that direct taxes are significantly correlated with unemployment, while on the other hand, these tax forms are not correlated with inflation at the significant level of 0.05. also, tax revenue growth, corporate income tax, tax on property and social security contributions are positively correlated with investment. finally, the nexus between taxes and government expenditures is significant, except social security contributions. vera mirović, branimir kalaš, jelena andrašić 133 table 4. model validation and specification tests model i model ii model iii model iv model v bp/cw test 0.7046 0.5222 0.0716 0.0669 0.2801 dw test 1.1644 1.8774 2.3257 1.9407 1.7755 rr test 0.2359 0.2280 0.0615 0.2256 0.1225 source: authors calculation based on results from table, it can notice that model is adequately defined in terms of econometric preconditions such as heteroscedasticity, autocorrelation and misspecification of the model. based on breusch-pagan/cock weinsburg test, models do not have a problem with heteroscedasticity (p-value > 0.05). also, dw test show there is no autocorrelation in residuals as well as rr test reflects the model correction. after we examined the fundamental assumptions of the appropriate determined model, the analysis includes the impact of direct taxes on macroeconomic aggregates in spain from 1996 to 2016. table 5. model estimation model i ii iii iv iv variable gdppc unm inf inv ge trgrowth -0.0112** (0.0028) -0.0471 (0.102) 0.0551 (0.0625) 0.0504 (0.0554) -0.102 (0.0726) pit 0.128** (0.0369) 4.957** (1.323) -0.134 (0.810) -3.692*** (0.718) 3.112** (0.942) cit -0.0470 (0.0294) -6.102*** (1.054) 1.235 (0.645) 3.135*** (0.572) -2.555** (0.750) top 0.219** (0.0585) 1.976 (2.098) -2.299 (1.284) 1.191 (1.138) 0.0219 (1.492) soc 0.234* (0.0819) -4.989 (2.938) 1.730 (1.798) 1.245 (1.594) 0.207 (2.090) c 0.444 (1.038) 52.42 (37.24) -15.23 (22.79) 24.07 (20.21) 25.60 (26.49) n 21 21 21 21 21 r-sq 0.876 0.913 0.381 0.943 0.853 adj r-sq 0.835 0.884 0.174 0.924 0.804 rmse 0.056 1.996 1.221 1.083 1.420 standard errors in parentheses * p<0.05, ** p<0.01, *** p<0.001 source: authors calculation as we can see, model i manifests significant impact of tax revenue growth, personal income tax, tax on property and social security contributions on gross domestic product per capita. also, tax revenue growth and corporate income tax have a negative influence on gross domestic product capita, while personal income tax, tax on property and social security contributions positively affect the gross domestic product per capita. results show that social security contributions and tax on property have the highest impact where their change of 1% raises gross domestic product per capita by 0.22% and 0.23%. model iii determines the impact of direct taxes on unemployment where personal income tax and corporate income tax have significant influence. looking at the character of their impact, tax revenue growth, corporate income tax and social security contributions negatively affect the unemployment, while personal income tax and tax on property have a positive influence. compared to the previous model, corporate income tax and social security contributions cause the highest change of the unemployment rate in these countries. an increase of 1% of these taxes declines unemployment 134 economic analysis (2019, vol. 52, no. 2, 128-136) by 6.1% and 4.99%. model iii reflects the influence of direct taxes on inflation where tax revenue growth, corporate income and social security contributions positively affect the price level. on the other hand, personal income tax and tax on property have negative influence on inflation. as we can see, there is no significance of direct taxes impact on price level. in model iv, personal income tax and corporate income tax have a significant impact on investment compared to other tax forms. simultaneously, these taxes cause the highest change of investment share in the gross domestic product, where a 1% increase of personal income tax declines investment by 3.69%. likewise, corporate income tax raises investment by 3.13% at the significant level of 0.05. finally, model v examines the impact of direct taxes on government expenditures and shows a significant influence of personal income tax and corporate income tax. tax on property and social security contributions positively affect the government expenditures, but there is no statistical significance. on the other hand, personal income tax positively affects the government expenditures where 1% increase of this tax raises government expenditures by 3.11%. corporate income tax has opposite influence where 1% increase declines government expenditures by 2.55%. reliability and validation of these results are confirmed by the adequate defined model as well as fact that the value of r-squared is above 80% expect model iii. conclusion the study has researched the impact of direct taxes on the macroeconomic framework in spain from 1996 to 2016. empirical analysis has included ols model which has estimated the influence of tax revenue growth, personal income tax, corporate income tax, tax on property and social security contributions on main macroeconomic aggregates such as gross domestic product per capita, unemployment, inflation, investment and government expenditures. based on results of the ols model, tax revenue growth, personal income tax, tax on property and social security contributions have a significant influence on gross domestic product per capita. in addition, personal income tax and corporate income tax have the greatest impact on unemployment, investment and government expenditures. for example, personal income tax has a higher impact on investment and government expenditures compared to corporate income tax. findings of these models show a significant influence of direct taxes on macroeconomic aggregates, except inflation where current tax structure does not have significant effect on inflation rate in this country. this is logical because indirect taxes are more related to inflation than direct taxes. the contribution of the study is reflected in the fact that we have ensured the quantitative measurement of tax forms and analysis has enabled informatical support for policy makers about which tax forms are important for macroeconomic framework in spain. also, the originality of paper is manifested in fact that there are no studies, which analyzes particular tax structure in spain in terms of macro influences of direct taxes. the study has provided a better understanding of the 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"the relationship between the taxation and government expenditure in turkey bounds test approach". banks and bank systems, 3(1): 57-62. article history: received: june 11, 2019 accepted: september 2, 2019 ea_2016_1-2 udc: 005.331 005.311.11:303.62 jel: l29, o31 cobiss.sr-id: 224802316 original scientific paper employees' perceptions of their leaders golubović-stojanović aleksandra1, belgrade university, faculty of organizational sciences, belgrade. serbia radović-marković mirjana2, institute of economic sciences, belgrade, serbia vujičić slađana, faculty of business economics and entrepreneurship, belgrade, serbia stevanović mirjana, faculty of business economics and entrepreneurship, belgrade, serbia abstract – this paper presents the research about employees and the leaders who are included in leading the organization, as an important segment of the modern business. the aim of this research is to show the real picture about presence new strategies of leaders in the organizations, as well as the analysis of the perception of employees about their leaders. the research in business organizations conducted on the sample of leaders and employees. the construction of high-quality questionnaire represents the important segment of modern statistical and business researches. the issues in questionnaire construction are very complex and they are in the focus of all statistical and research methodologies. it was conducted on the sample of at least 250 examinees (employees) in bigger companies in serbia. research results showed that understanding communication satisfaction, with its link to job satisfaction, should provide an ability to better target resources to improve communication satisfaction issues. key words: leader’s strategies, employees, communication introduction some of the greatest researchers of these fields highlight that creativity and innovation are the key of development and success of modern organizations, business systems, governments as well as non-profit organizations (mumford et al. 2012:3). while earlier researchers focused on scientists and their organizations to survive in the highly competitive environment (jung, chow & wu, 2003), researchers have made an effort in understanding the factors and mechanisms which improve or inhibit creativity in the organizations (shalley, zhou & oldham, 2004). based on relevant literature, steier and sundgren (2005:68) determined five major organizational factors which affect creativity in the business environment based: organizational climate, organizational culture, leadership styles, resources, skills, structure and organizational systems. 1 aleksandragolubovicstojanovic@gmail.com 2 this paper is an unpublished part of ph.d. thesis of aleksandra golubović-stojanović written under supervision of her mentor prof. dr mirjana radović-marković golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 37 one of basic issues in the research of organizational creativity is defining and measuring of dependent variables. this paper contributes to actual literature by researching the relationship of leaders and employees, including applications of some new leadership strategies and innovations and expanding the understanding of the manner which supports leaders’ creativity and includes them in discovering of new possibilities for organizational innovations, as creativity and innovation are very important parts of development processes. new leadership strategies and their influence of employees’ communication are explored relatively poorly, which leads us to an evident need for systematic, detailed, qualitative case studies that should give answers to this question. therefore, the idea of creativity and leadership practice remain an important part of scientific programs whose aim is to improve creativity as the key process. this research is based on the need to determine how some leaders manage to incite employees' creativity. literature overview the leaders are the key of the modern organizations efficiency. since the second part of the xx century great attention is focused on the researching of the leadership. hunt (1991) claimed that exist more than 10 000 empirical studies which have been done under the subject of leadership. yukl (1998) broadly defines leadership as influence processes affecting the interpretation of events for followers, the choice of objectives for the group or organization, the organization of work activities to accomplish the objectives, the motivation of followers to achieve the objectives, the maintenance of cooperative relationships and teamwork, and the enlistment of support and cooperation from people outside the group or organization. education and training have a large role in human development by teaching people to improve themselves and actively participate in building a nation (radović marković et al., 2012) kirkpatrick and locke (1991) emphasize following leaders’ characteristics as the most important for the achieving of success: • energy as a desire for prove, ambitiousness, endurance, initiative, • honesty and integrity, as reliability, trust, extroversion. • leaders’ motivation, as a desire for the domination to realize common goals, • self-confidence as a faith in your own capabilities, • the ability to perceive, as intelligence; ability to summarize and interpretation of large number of information, • understanding of job as understanding of complete sector, reliable technical support. • creativity as originality, • flexibility as ability to adapt to the needs of followers and the requests of certain situation (p. 48-60). the best leaders need to be attentive, motivational, and supportive (radović-marković, 2007). also, leaders must be conscious of what is perceived by others and develop • strategies that are proactive in building success (radović-marković, et al. 2013). 38 economic analysis (2016, vol. 49, no. 1-2, 36-47) subject and issue of the research the subject of the research in this paper is managers’/leaders’ creativity which implies creative approaches to management that are expressed through their leadership strategies as well as their effect on the employees’ creativity and organizational innovations of organizations themselves. the starting point of this paper is a creative leader who has the crucial role in encouraging and strengthening employees’ creativity and creative thinking and this is one of the basic conditions of good acceptance and implementation of new leadership strategies, as well as changes and innovations in the organizations, which is the subject of the research of this doctoral thesis at the same time. the main question, this is issue of this research is whether leaders apply some new strategies or not and, if they apply them, how they affect communication and employees’ creativity in the organizations/companies through two levels of observation – individual and group, by means of defined variables and mechanisms. research method in this chapter, we will describe methodology used in this paper, including research contest, data collection, analysis techniques as well as results. while defining the research plan, it was decided to base the research on collection of primary data by means of a questionnaire (communication satisfaction questionnaire) composed of closed questions. summing up the results should give us a real picture of existence or absence of leadership, employee creativity, marketing and organizational innovations… in business organizations, the research was conducted on the sample of leaders and employees. minimum 256 examinees (employees) participated in the research in larger cities of serbia, namely belgrade, nis, novi sad, cacak and kragujevac. employees and leaders were interviewed by the method of a standard questionnaire which requested from the employees (examinees) to evaluate the importance of and satisfaction with certain activities of the organization in order to determine the relation (communication) between employees and leaders as a key of success of each organization. some researchers claim that leaders increase the employees’ creativity by supporting their creativity and motivating them to participate in the creative process (amabile et al. 1996; tierney, 2009), while studies on a leader’s influence on creation of psychological conditions which lead to creativity are rare. therefore, one of the goals of this paper is to expand the existing understanding on how leaders, using their strategies, affect the employees’ communication and their creativity through processes and mechanisms and which processes bridge leaders’ behavior on all levels within the organization. total number of examinees was 256, including 49 leaders of the chosen organizations and 207 employees who cooperate with a leader directly. questionnaire in order to examine hypothesis, we created two questionnaires – one for the leaders of the researched organizations and one for the employees. all questionnaires are confidential, golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 39 for the sake of general security and protection of the employees. the data about gender, age, level of education, working experience in the cultural institution as well as total years of service were common for both questionnaires. the questionnaire intended for leaders consists of 12 variables and each of these variables contains 5 questions – 60 questions in total. the answers to the questions are in the form of a likert scale: 1 – i completely disagree 2 – i mostly disagree 3 – undecided 4 – i mostly agree 5 – i completely agree variables examined in this questionnaire are: guiding vision, relationship with employees, motivating the employees, inspiring the employees, open communication, power, coercion, manipulation, directive management, transparency of communication, monitoring, control, “leads by example” and focus on interpersonal relations in the team. besides this, leaders had an additional question in which they had to evaluate their own leadership style based on the offered descriptions – coaching style, cross-cultural, situational, transformational or autocratic. socio-demographic variables were examined as well: gender, age, education, type of organization (production or service providing), sector – private or public, salary, years of service, years of service on a particular position, how many times they changed current position, if they have a partner and kids. the employees filled 3 questionnaires: 1. questionnaire about satisfaction with communication (communication satisfaction questionnaire (csq), (c. w. downs and hazen (1977)) it has 37 questions in total – 7 variables of which each variable contains 5 questions and 2 additional questions on general satisfaction with communication and productivity. the answers to the questions are in the form of a lakert scale: variables examined in this questionnaire are: communication climate, relationship to superiors, organizational integration, media quality, horizontal and informal communication, organizational perspective and personal feedback 2. the questionnaire contains 10 variables in 3 categories of variables, 50 questions in total: this questionnaire examined variables of communication: type of communication (written, oral, in person, by phone, by e-mail…), problems in communication, non-verbal communication, communication channels … variables of a leader were examined by means of this questionnaire as well: relationship with a leader, freedom at work , to what extent the employees feel that a leader uses their potentials to the maximum. this questionnaire examined variables of the employees, too: motivation, loyalty to the organization, identification with organization. questions about dominant types of communication contain different offered answers, while the answers to other questions are in the form of a likert scale: 40 economic analysis (2016, vol. 49, no. 1-2, 36-47) public leadership questionnaire it contains 29 questions in total, distributed on 5 variables, with the answers in the form of a likert scale. in theoretical research, we used the data collected by the analysis of relevant scientific, professional and modern literature in the field of management, leadership, psychology and organizational innovations. inductive and deductive methods of conclusion have been used for creation of questionnaires and data analysis. quantitative statistical methods have been used, namely: • correlation method • analysis of variance research procedure the research was conducted by means of online questionnaire on the website: www.kwiksurveys.com. leaders and employees who belong to the teams lead by the leaders filled these questionnaires. questionnaires for leaders were electronically connected with the questionnaires for the employees from their team. questionnaires were filled anonymously. in this doctoral thesis it was planned to examine managers/leaders in 49 chosen organizations as well as their closest, direct cooperatives. total number of examinees in this research was 256, including 49 leaders from the chosen organizations and 207 employees who cooperated directly with the leaders. among them, there were marketing managers, commercial managers, public relations managers, production managers, lawyers. all of them were permanently employed. a) structure of examinees (age, gender, education) table 1. structure of the total number of examinees number of leaders percent of leaders leaders 49 19.1 employees 207 80.9 total 256 100.0 chart 1. total number of examinees the ratio of female and male examinees, the leaders, is 49% to 44.9% golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 41 table 2. ratio of female and male examinees (leaders) gender number of leaders percent of leaders men 22 44.9 women 24 49.0 total 49 100.0 table 3. gender structure of examinees (employees) gender number of employees percent of employees men 92 44.4 women 98 47.3 table 4. employees’ education education number of employees percent of employees secondary education 34 16.4 faculty/college 40 19.3 bachelor’s degree 48 23.2 master’s degree 39 18.8 magister’s degree 6 2.9 specialization 3 1.4 total 207 100.0 table 5. average age of employees average age standard deviation minimum maximum 36.7529 10.20257 23.00 71.00 table 6. leaders’ education education number of leaders percent of leadesr secondary school 3 6.1 faculty/college 5 10.2 bachelor’s degree 11 22.4 master’s degree 18 36,7 magister’s degree 7 1,3 specialization 2 4,1 table 7. the average age of leaders average age standard deviation minimum maximum 39.8043 7.90673 28.00 65.00 as for the age of employees, all examined leaders are 40 or more. in order to check theoretical aspects of leadership, communication, motivation in the function of improving organizational success which were mentioned above, we checked the sample of 50 chosen business companies. 42 economic analysis (2016, vol. 49, no. 1-2, 36-47) speaking of the level of examinees’ education, the results are very encouraging. none of the examinees stopped his/her education after primary school, but they continued their education. the lowest level of examinees’ education is finished secondary school – 34 (16.4%) of the examinees from the employees’ group and only 3 (6.1%) from the leaders’ group. 40 (19.3%) examinees from the category of employees have graduated from the faculty/college, 48 (23.2%) have bachelor’s degree, 39 (18.8%) have master’s degree, 6 (2.9% of the examinees) are magisters and 3 (1.4%) examinees have finished specialization. the leaders in the organizations in which the research was conducted also have master’s degree (18 leaders or 36.7%), 7 leaders (1.3%) are magisters, while 2 examinees (4.1%) have specialization. these very positive results can testify to education of the people employed on key positions in the examined organizations, in relation with their expertise and knowledge, which have been previously identified as important segments of individual creativity b) organizational sector table 8. organizational sector sector number of organizations percent of organizations private 43 87.8 public 3 6.1 total 49 100.0 some authors (oldham & cummings, 1996; tierney & farmer, 2004) showed in their researches that expertise was proportional to the years of service and it could explain variations in the employees’ creativity and communication and therefore we examined the employees’ years of service in the chosen organizations (table 9), as well as leaders’ total years of service (table 10). based on this research, we came to the conclusion that leaders were averagely 14 years employed in the examined organizations. the years of service in certain company may imply identification with the institution as well as knowing of its organizational climate, building of positive and deeper relationships with the employees, including also knowing of formal and informal forms of communication which exist in the organization. leaders were averagely about 4,5 years on that position and they changed the company in which they work at least once. as for the employed in the examined institutions, their average years of service were about 9 years and they were on the same position for about 3 years. just like their leaders, they also changed the company in which they worked at least once. table 9. total years of service of the examinees (employees) average standard deviation minimum maximum years of service 9.2294 7.52670 0.00 40.00 years of service on the current position 3.2941 3.98317 0.00 20.00 how many times they changed position 1.2412 2.00755 0.00 14.00 golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 43 table 10. total years of service of the examinees (leaders) speaking of monthly salaries, 75.5% leaders have above average salary and 16.3% have average salary (table 11). table 11. total monthly salary of the examinees (leaders) salary number of leaders percent of leaders below average 0 0 average 8 16,3 above average 37 75,5 speaking of monthly salaries of the employees, 39.1% has above average salary, 25.6% have average salary and 15.9% have below average salary. (table 12). table 12. total monthly salary of the examinees (employees) salary number of employees percent of employees below average 33 15,9 average 53 25,6 above average 81 39,1 key results and their explanation the main goal of this research was to perceive the influence of leadership (leadership style) as well as new leadership strategies which a leader applies to motivate and award the employees in order to improve organizational success. the examinees’ attitudes show that leadership style has a significant effect on their everyday work and environment in which they work, which is confirmed by the examinees’ answers in which better relationship with the leader is pointed out as one of important elements. personal responsibility and participation in decision-making are significant regulator of relationships between the employees, as they are mandatory and undisputed for achieving of general organizational goals, which is confirmed by the employees’ answers. average standard deviation minimum maximum years of service 14.8478 7.63025 3.00 42.00 years of service on the current position 4.1739 3.83727 .00 19.00 how many times they changed position 1.5000 1.64317 .00 6.00 44 economic analysis (2016, vol. 49, no. 1-2, 36-47) table 13. leadership strategies strategies average (maximum is 5) standard deviation guiding vision 4,01 ,52 relationship with employees 4,48 ,41 motivating 4,37 ,38 inspiring 4,34 ,53 open communication 4,53 ,40 power, coercion 2,16 ,72 manipulation 2,65 ,91 directive management 2,32 ,91 transparency of communication 4,04 ,66 monitoring, control 3,57 ,80 “leads by example” 4,20 ,73 focus on interpersonal relations 4,40 ,46 one of possible interpretations of such results is that employees are mostly satisfied with communication and relationship to their superiors, as the average of their answers to satisfaction with communication is 3,60, while standard deviation is 0,71. standard deviation is a measure which shows average variation of the values from arithmetic mean, i.e. in this case average satisfaction with communication. it is the average deviation from arithmetic mean. if it is lower, this means that the values are close to average, and if it is higher, the values vary more. all desirable strategies are above 4 of 5 and all undesirable values are low. as we can conlude based on the data from the table, the employees are not very satisfied with organizational perspective (3,36), which is indicated by standard deviation amounting to 0,99. the higher standard deviation, the bigger dissatisfaction of the employees. this is one possible interpretation. another possible interpretation is that the sample we used was not random, but occasional, so that we may have included similar employees in the research, while a part of the reason may be that the majority of employees worked in the organizations from private sector, which could cause their similar behavior. table 14. employees’ satisfaction with communication satisfaction with communication average (maximum is 5) standard deviation communication climate 3,60 ,92 relationship to superiors 3,97 ,81 organizational integration 3,53 ,87 media quality 3,57 ,86 horizontal and informal communication 3,77 ,79 organizational perspective 3,36 ,99 perfonal feedback 3,43 ,97 satisfied with communication 3,60 1,12 evaluation of their own productivity 4,16 ,74 total satisfaction with communication 3,60 ,71 golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 45 table 15. employees’ satisfaction with communication with their leader average (maximum is 5) standard deviation relationship with a leader 4,04 ,88 freedom at work 3,91 ,70 leader exploits their potentials 3,69 ,76 motivation 4,04 ,70 loyalty 3,78 ,89 identification with organization 3,64 ,80 based on the obtained results, it can be seen that the employees mostly have good relationship with their leader (average is 4,04 and standard deviation is 0,88). as we can conclude based on the data given in the table, the employees do not have strong identification with the organization in which they work, which implies that they are not loyal to the organization itself, but they are strongly motivated to stay and work in that organization. we cannot be 100% sure about this, but in the organizations in which there are no possibilities for advancement, loyalty is on the lower level as well as motivation of the employees to stay in that organization. conclusion this research contributes to the literature theoretically and methodologically. it examines leadership strategies and their influence on the employees’ communication at all levels in the organization. the obtained results show that good communication has the effect on the organizational success itself. they also show that the employees are mostly satisfied with communication and relationship with their superiors, which results in their higher motivation and loyalty to the organization in which they work. our research has provided the findings which suggest that new leadership strategies have an effect on the employees’ communication at all levels in the organization. furthermore, we have explained the methods and mechanism through which leaders encourage creativity of their employees on individual, group and organizational level. the results of this research highlighted the importance of communication climate as the characteristic which explains the organizational perception supporting innovations. leadership strategies and styles shape organizational climate which results in a positive relation between good communication of a leader with his/her employees and organizational success. according to the obtained results, we can conclude that the employees are mostly satisfied with communication and relationship with their superiors. from the obtained results it can be seen that the employees mostly have good relationship with their leader, but their identification with the organization in which they work is not strong, which brings us to a conclusion that they are not loyal to the organization itself, but they are strongly motivated to stay and work in that organization. we cannot be 100% sure about this, but in the organizations in which there are no possibilities for promotion loyalty is smaller as well as the employees’ motivation to stay in it. 46 economic analysis (2016, vol. 49, no. 1-2, 36-47) based on this research, we think that creative approaches in management are necessary, not only in private organizations but also in public, governmental and non-governmental agencies. references andrews, p. h., & herschel, r. 1996. organizational communication: empowerment in a technological society. boston: houghton mifflin. amabile, t. m. 1996. creativity in context. boulder, co: westview frone, m., & major, b. 1988. “communication quality and job satisfaction among managerial nurses.“ group & organization studies, 13(3): 332-347. goldhaber, g. 1983. 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(1986). “communication satisfaction, job satisfaction, and job performance.” human communication research, 12(3): 395-419 radović marković, m. 2007. “women leaders: case study of serbia.” in the perspective of women’s entrepreneurship in the age of globalization, ed. mirjana radović marković, 87-95. iap, charlotte. radović marković, m., grozdanić, r. kvrgić, g., marković, d.,vujičić, s. 2012. “new educational strategies versus the traditional methods.” international review, 1-2. radović marković, m., salamzadeh, a., razavi, mostafa. 2013. „women in business and leadership: critiques and discussions.“ the second international scientific conference on employment, education and entrepreneurship, belgrade, serbia, pp. 19-31. available at ssrn: http://ssrn.com/abstract=2349488 rou, alan, dž. (2008.) kreativna inteligencija. beograd: clio shalley, c. e., zhou, j., & oldman, g. r. 2004. “the effects of personal and contextual characteristics on creativity: where should we go from here?” journal of management, 30: 933–958. tierney, p., & farmer, s. m. 2002. “creative self-efficacy: its potential antecedents and relationship to creative performance.” academy of management journal, 45(6): 1137-1148. yukl, g. (1989). “managerial leadership: a review of theory and research.“ journal of management, 15. golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 47 kako zaposleni percipiraju svoje lidere? rezime – ovaj rad predstavlja istraživanje o zaposlenima i liderima koji su uključeni u vođenje organizacije, kao važan segment savremenog poslovanja. cilj ovog istraživanja je da pokaže pravu sliku o prisustvu novih strategija lidera u organizacijama, kao i analizu percepcije zaposlenih o njihovim liderima. istraživanje u poslovnim organizacijama sprovedeno je na uzorku lidera i zaposlenih. izrada visokokvalitetnog upitnika predstavlja važan segment modernih statističkih i poslovnih istraživanja. pitanja u upitniku su veoma kompleksna i u fokusiraju se na sve statističke i istraživačke metodologije. istraživanje je sprovedeno na uzorku od najmanje 250 ispitanika, zaposlenih u većim kompanijama u srbiji. rezultati istraživanja su pokazali da zadovoljstvo komunikacijom, koje je povezano sa zadovoljstvom samim poslom, treba da obezbedi mogućnost da se bolje usmere resursi za poboljšanje pitanja zadovoljstva komunikacija ključne reči: liderske strategije, zaposleni, komunikacija article history: received: 28 june, 2016 accepted: 29 june, 2016 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp92-102 scientific review social responsibility of banks in the function of comparative advantage on the market milica raičević1* | dijana medenica mitrović 2 1 faculty of business studies “montenegro business school”, mediterranean university, podgorica, montenegro 2 faculty for business management bar, bar, montenegro abstract the business operation of companies is not neutral and is not perceived any more in terms of profitable operations, but also in terms of whether it is beneficial for the society. social responsibility contributes to improving relationships with key stakeholders, thus contributing to the long-term sustainability of the company. the paper points out to the positive link between corporate social responsibility (csr) and the reputation of the bank. without csr, neither the improvement nor the expansion of banking operations is possible. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a strong comparative advantage on the market. the paper gives a theoretical and practical overview of the concept of corporate social responsibility (csr), with a focus on the banking sector. in the theoretical part, the term csr is defined, as well as its significance and special features regarding the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its characteristics in terms of csr. the empirical part includes the qualitative analysis, based on the data available on the official sites of banks operating in montenegro. based on the collected internet data, an analysis of the factual situation was carried out, conclusions were given and recommendations have been made for the implementation of the csr concept with a view of improving the competitive position of banks on the market. through qualitative analysis of the available data, the advantages and disadvantages of corporate social responsibility of banks in montenegro were considered, as well as which csr activities are most represented and which still have the capacity to be improved and involved in the marketing strategies of the banks in montenegro. key words: social corporate responsibility, banks, reputation, marketing jel classification: n20, g20 introduction the turbulence of the environment, market changes that represent the process today, not just the business event as they once did, have led to the need for companies to re-examine themselves and to supplement their business strategy in order to gain competitive advantage in the market. in order to gain a competitive advantage they should focus on the people, that is, the need to increase the number of people who use their products and services or more simply believe in them. in order to be successful in a dynamic services market companies must delivered superior value to target customers who become more demanding, and choose products/services rationally, analysing relation between price and quality. the competitiveness of companies in the financial sector is largely based on fostering customer loyalty, integrating * e-mail: milica.raicevic@unimediteran.net milica raičević, dijana medenica mitrović 93 various communication channels, reducing operating costs and good risk management (domazet, stošić and hanić, 2016). in the last ten years, in the literature, as well as in the practice, the concept of social responsibility has started to develop, which focuses on the support to the community in which the business operations are carried out, and in return, these companies are recognized by the community as the companies which should be trusted, which is one of the ways in which the companies can contribute to their growth and their competitive advantage. banks, as a specific phenomenon by itself which has a specific way of generating profit, have realized that they have to incorporate the concept of social responsibility into their business strategy, in order to differentiate and gain a competitive advantage in the banking sector, which is characterized by an increasing number of banks and tougher competition in the financial market. the paper views the concept of social responsibility, the banks in montenegro, as well as the implementation or introduction of this concept in their operations. moreover, a positive correlation between corporate social responsibility (csr) reputation of the bank has been pointed out. the without the social responsibility of banks, it is not possible to improve or extend the banking operations. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a serious comparative advantage on the market. the initial hypothesis: the application of the concept of social responsibility is an important factor for achieving competitive advantage and strengthening the position of banks in the financial market, all through the creation of services that will improve and expand banking activities, to create satisfied consumers who are loyal. auxiliary hypotheses are: 1. the willingness of banks to invest in csr activities will increase the confidence in banks by customers and the community 2. developing awareness of the importance of csr for company business and training and inclusion of employees in csr activities provides for a higher level of business and better reputation 3. socially responsible activities address the problem for which the state does not have sufficient financial resources, which also affects the strengthening of the reputation of the bank 4. improving the business environment creates the conditions for developing the competitiveness of banks and strengthening their position in the financial market, and therefore profit. the paper gives a theoretical and practical overview of the concept of csr and its application in the banking sector. in the theoretical part, the term csr is defined, its significance and specific qualities related to the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its features in terms of csr. the empirical part covers qualitative analysis, on the basis of the data available from the official websites of the banks operating in montenegro. on the basis of the data collected from the internet, an analysis of the factual situation has been conducted, conclusions have been drawn and recommendations have been made for the application of the csr concept in order to improve the competitive position of banks on the market. through the qualitative analysis of the available data, the advantages and disadvantages of social responsibility of banks in montenegro have been studied. it has been analysed which csr activities are the most prominent, and for which there is still the space to be improved and involved in the marketing strategies of banks operating in this area. in the end, it has been pointed out that the awareness of the benefits the csr brings to the company has not still been developed in montenegro. the socially responsible practice is often perceived as an unprofitable and impractical activity. in recent years, in the banking sector, socially responsible activities are growing in importance and have a tendency towards growth. 94 economic analysis (2018, vol. 51, no. 1-2, 92-102) the social responsibility of banks is significant for the montenegrin economy and society, because socially responsible banking activities contribute to the improvement and advancement of the existing situation in certain segments which the country has insufficient resources to support. banks carry out their socially responsible activities through activities in the fields of education, health care, culture, sports, environment protection, and work with people with disabilities. in conclusion, the banks have a dual role, they are both promoters of socially responsible behaviour and institutions investing in those areas of vital importance, for which the state does not have enough resources. the csr of banks represents a serious comparative advantage in the market, because the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro and actively engage in solving problems at both the local and the national level. theoretical aspects of social responsibility of banks in montenegro defining the concept of corporate social responsibility social responsibility is now perceived as an inevitable part of the company's operations and one of the market differentiation options. in this context, social responsibility or corporate social responsibility (according to the world business council for sustainable development) can be seen as "the commitment of business units to contribute to sustainable economic development, cooperation with employees, their families, the local community and society as a whole aimed at improvement of the quality of their lives”(saraiva and serrasqueiro, 2007). this would mean that the concept of social responsibility does not perceive as the opposing sides, on the one hand, the people, the community and the environment, and on the other hand, the economic goals of the company. the concept of social responsibility would mean that the company assumes responsibility for the impact of its own activities on all the stakeholders of the company, as well as on the environment (zelenović, 2015). moreover, it should be emphasized that csr is not the same for every company, but that the business operations according to this principle depends on the size of the company, the economic region, the market and the actual operations of the company. as noted, the operations based on the corporate social responsibility principle connect and enhance the relationships between the company, stakeholders and the environment, and combines them into a single whole that generates benefits both for the company itself and for the meeting of the current needs of future generations. so the most famous model regarding the csr is the model of the pyramid presented by caroll (1996), according to which if the company is to be socially responsible, then it needs to be financially stable (to be profitable), then legally responsible (to respect the laws of the state and markets), then ethically responsible (to operate in accordance with the moral and ethical norms of the society, community and the market) and ultimately to have a philanthropic responsibility (to be a good citizen). when we talk about when the concept of social responsibility dates back, we could say that, from a historical point of view, it dates back to the thirties of the last century, and as the subject of research of experts and interested individuals, somewhat later, sometime to the nineties, when companies accept the contemporary concept of social responsibility and implement it into their business strategy so that the activities they carry out create value for the company's owners, on the one hand, and for a wider community, on the other. significance and characteristics of corporate social responsibility numerous questions are raised regarding the concept and implementation of corporate social responsibility. some of them are related to the actual implementation of this concept in the company's operations and they relate to whether social responsibility is cost-effective or not and whether it should be considered as a cost or as an investment (stojanovi-aleksić and allies milica raičević, dijana medenica mitrović 95 2016). the given questions cannot be answered either with yes or no, but the answers require perceiving the things from different angles. the concept of social responsibility can be viewed from the aspect of the impact that the company operating in accordance with the given concept has on the enterprise and the society. this would mean that the responsible behaviour earns praise, that is, produces positive effects with the public which can be seen in the long run and can create a positive image or improve the existing one. thus, the sense of security and confidence is created among the interested individuals and groups, which creates a positive effect on the actual operations of the company. this means that the concept of social responsibility creates a positive effect on the company through the activities that contribute to the positive image, and the image creates confidence among the stakeholders, which contributes to the increase of the value of company’s shares, greater market share, competitive advantage etc. the study carried out in the usa has shown that the factors related to the social responsibility have almost the same effect on the company's reputation as some traditional factors such as quality, price, usage etc. (stojanovi-aleksić and allies 2016) it should also be taken into account that there is another aspect that reflects the importance of social responsibility, and that is the reporting on corporate social responsibility which should be included in the results and reporting on the company's overall business operations. when we talk about the activities, that is, the areas that the concept of social responsibility entails, we would say that it is the promotion of social goals (humanitarian work), the interconnection between marketing activities and social goals (part of the revenue is allocated for solving the problems of vulnerable groups), volunteer work (voluntary work aimed at supporting and actively participating in a community-run activity) and corporate philanthropy (the company's contribution through humanitarian activities) (stojanovi-aleksić and allies 2016). specific phenomenon of social responsibility in the banking sector the above mentioned prompted us, when talking about social responsibility, to think first about the relationship between csr and profit-making companies, which perceive this concept as a way of contributing to the community, on the one hand, and of gaining greater competitive advantage, on the other hand. the banks generally did not have a need for such a concept. this is due to the fact that they are independent financial institutions that take care of their finances independently, as well as the fact that they are intermediaries in the economy and have no need to care about the profit. however, due to the development of the market, increase in the number of participants in the banking market and increase and creation of new banking services, banks had to find a way to improve their reputation, develop trust among customers, restore the trust through various activities that would be receptive to people's eyes and ears. the assets of the company are not worth without customers, the task of managing services marketing is not only to attract new, but also to retain existing customers. new customers can be attracted only by delivering superior service, the role of marketing is to create a superior offer and ensure customer satisfaction, but also to anticipate the future needs of its clients, only satisfied customers can be loyal to a given organisation (hanic, domazet, 2012).thus the banks have realized that the concept of social responsibility provides an opportunity for expansion and improvement of their business operations. they can incorporate this concept into their defined strategy and thus, through the csr activities, gain competitive advantage in the banking market. by implementing socially responsible activities, the banks become an active part of the community in which they operate (zelenović, 2015) through the following: • promotion of social goals through a financial contribution or other types of contribution to develop or solve a particular social goal, • general well-being marketing when a certain amount of revenue is allocated for the achievement of a social goal 96 economic analysis (2018, vol. 51, no. 1-2, 92-102) • corporate social marketing assistance in development, implementation of campaigns which contribute to raising the awareness of the health, the sick, environmental protection ..., • corporate philanthropy – making direct contributions to a charitable or social activity, • community volunteer work voluntary work of employees and partners, • socially responsible business practice adopting and implementing the business practice that supports a social goal which should improve the life of the community (both the people and the environment) (kotler, li, 2009). based on the above, market changes and behaviour in the banking sector have led to the situation where the banks behave in the following way (vunjak, kovačević, 2006): • customer orientation because he/she is the most important person • the client is the purpose of the banking business • respecting the wishes and demands of the clients • a higher marketing concept • customer service quality. the motive for introducing the concept of social responsibility appears at different levels (zelenović, 2015): • internal ethics processes in banks and • external ethics consequences of banking actions. practice of social responsibility of the banks in montenegro the empirical framework of social responsibility of the banks in montenegro banks, as independent financial institutions, have focused on the care about their finances until recently. the bank is perceived solely as a recipient and provider of banking services, whose employees dominate the clients, without the adequate system of rewards and without paying a particular attention to the competition and customer requirements. the turbulent environment, the saturation of consumers by marketing advertising of various forms, has imposed the need for incorporating the socially responsible operations in the strategies of banks, as the necessary prerequisite for acquiring and maintaining the competitive advantage. they must not be focused solely on profit, but must be socially responsible, and take care of the environment. this raises the question of whether company can be both environmentally and socially responsible and profitable at the same time (domazet, kovačević, 2018). the whole community benefits through the activities of corporate social responsibility and the clients are becoming aware of this. by associating their products and services with the solving of a particular social problem, the banks do their promotion and encourage customers to buy their products or services. banks can demonstrate corporate social responsibility by providing the financial resources for raising awareness of a social problem, encouraging campaigns for behavioural change, engaging in local initiatives, humanitarian actions, financing and implementing the business practice for environmental protection or improvement of community life. all of these activities can be carried out by the bank itself and in cooperation with public sector partners, profit and non-profit organizations. moreover, the bank encourages and supports both its employees and partners to help local organizations and actions through voluntary work. implementation of csr activities is increasingly under pressure, both internal and external, to apply a strategic approach. the bank needs to choose what it will focus on and how to link its philanthropic and other initiatives to its business goals and tasks. the goal of milica raičević, dijana medenica mitrović 97 investing in various forms of socially responsible strategies is the strengthening of the bank’s reputation. through its reputation, the bank creates barriers to its competitors, sends a message that its services are of high quality, improves its market position, which contributes to profit increase. at the level of the economy, such operations encourage increased competitiveness and transparency in business, encourages trust and partnerships with the target public. the goal of reputation is not that a bank is liked but to create its value through business success and the solving of community problem which the state cannot solve alone. changes in the way of thinking and behaviour have led to more customer-orientated banks today, respect for customers' wishes and demands, introduction of a higher marketing concept and an increase in service quality. today, even conventional banks are participating in the actions that are of general welfare to the community. some of these activities are as follows: local scholarships and sponsorships, financing in the field of sports, health care, culture, more affordable housing loans, financing of some traditional events in the community, etc. although the positive effect of applying the csr concept in the banking operations has already been recognized, this concept is still inadequately implemented in a wider scope in montenegro, although the trend towards the growth of csr activities has been present in recent years. the reason for this can be found in the still underdeveloped awareness of the benefits of socially responsible practice, since such practice is often perceived as unprofitable and impractical experience. the common approach to corporate social responsibility is usually limited, defensive and unrelated to the actual strategy of the bank. the csr activities should be aimed at enhancing the relationship between employees and customers (as key stakeholders) so that they do not abandon the bank. according to the official data of the central bank of montenegro, 15 licensed banks operate in montenegro. the data on corporate social responsibility of banks is available on the official websites of seven montenegrin banks, which suggest that a little less than half of the banks have recognized the importance of informing the stakeholders of this aspect of bank operations. the csr data is available for the following banks: 1. societe generale bank montenegro ad 2. prva banka crne gore ad podgorica 3. nlb banka ad podgorica 4. addiko bank ad podgorica 5. erste bank ad podgorica 6. crnogorska komercijalna banka ad podgorica member of otp group 7. hipotekarna banka ad podgorica on the basis of available data on the official websites of montenegrin banks, it can be concluded that socially responsible activities are mainly focused on the fields of health care, education, sports, culture and the promotion of environmental protection. analysis of the state of corporate social responsibility of the banks in montenegro analysis of the state of corporate social responsibility of the banks in montenegro was made on the basis of secondary data, available on the official websites of the banks operating in our territory. below is an overview of the key objectives and activities of the seven banks, which publish the information on their csr activities on their websites. societe generale montenegro bank indicates, as the objective of its csr activities, the support for projects in the field of health care, education and culture which are useful for citizens and society over a longer period of time. the social community has acknowledged the efforts of this bank and in 2011, 2012 and 2015 societe generale montenegro, as a socially 98 economic analysis (2018, vol. 51, no. 1-2, 92-102) responsible company, was given the iskra award for philanthropy for the overall contribution of the bank to the montenegrin society and for its contribution to inclusive education. the bank is also the winner of the naturally equal award received for the best practice in achieving gender equality in montenegro (http://www.societegenerale.me/mne/o-nama/o-societegenerale-banci-montenegro, accessed on 17.03.2018.). the activities of the bank focused on healthcare activities included cash donations for the purchase of necessary resources for the montenegro clinical centre and the institute for children's diseases, as well as for procurement of medical and sanitary equipment for healthcare institutions, primarily for health care centres and general hospitals in the territory of montenegro. in this way, the bank contributes to the creation of better conditions for the strengthening of health care and the care about the public health. the bank is also active when it comes to monetary donations and cooperation with nongovernmental organizations dealing with the problems of children with developmental disturbances, people with disabilities, children suffering from cancer, as well as women victims of violence and juvenile mothers. with these donations, the bank draws attention to this group of women and children and actively participates in an effort to improve the position of women and children in the montenegrin society. societe generale bank also directs its socially responsible activities towards the support for inclusive education (donations to the stimulation room in elementary schools, financing instruction manuals for improvement of the teaching process within the inclusive education). through donations for educational tools in kindergartens, the construction of children's playgrounds, presents for pupils who walk to school from rural areas, the concern is shown for young people and improvement of conditions in educational institutions. the bank also organized a student competition on the topic of corporate social responsibility, which contributes to the development of awareness of the importance of corporate social responsibility among this target group. within the activities aimed at environmental protection, the bank supported the activities of greening of certain parts of the capital. another action with the same goal was the purchase of electric bicycles for employees and clients. numerous activities include humanitarian aid for the most deprived families, donations for the library of the blind, as well as numerous sponsorships for art exhibitions of montenegrin artists. prva banka crne gore has actively participated in the realization of socially beneficial projects since the very beginning of its existence. it is recognized by its support for projects of national significance in the field of health care, culture, sports, as well as support for humanitarian and other projects that have an impact on raising the quality of life of the citizens in montenegro (http://www.prvabankacg.com/o-nama/drustvena-odgovornost/, accessed on 17.03.2018.). some of these projects by which prva banka crne gore confirms its strategic commitment to corporate social responsibility include: the ulcinj's greening project, sponsorship of the women's handball team of montenegro at the world championship in denmark, a donation for the internal ward of the bar hospital. nlb montenegro bank promotes its socially responsible operations through sponsorships or donations to cultural, sports and entertainment events as well as environmental protection projects. the largest and most significant sponsorship projects of nlb banka are: sponsorship of the budućnost basketball club, the as tennis club, the main sponsor of the national parks of montenegro, which has been its partner since november 2010 within the project 'obradujmo prirodu' (make the nature happy), which contributes to raising awareness of the importance of environmental protection and conservation of protected natural areas for future generations (https://www.nlb.me/me/nlb-banka/opste/sponzorstva-i-donacije, accessed on 17.03.2018.). milica raičević, dijana medenica mitrović 99 for several years, addiko bank ad podgorica has been allocating funds in a planned manner, within its budget, to support the local community, where it carries out its activities, through the support for the work of educational and healthcare institutions, and events aimed at promoting and preserving social values through the fields of culture, arts, non-commercial sports activities (https://www.addiko.me/o-nama/drustvena-odgovornost/sponzorstva-idonacije/, accessed on 17.03.2018.). the most significant activities include: donations to children and adolescents with developmental disturbances; cooperation with non-governmental organizations and primary schools to support children with autism spectrum disorders; donations to children suffering from cancer; donation to the institute for children's diseases for the supply of equipment for the orl ward. in cooperation with the red cross, it participates in humanitarian actions for socially vulnerable citizens and in voluntary blood donation activities. among numerous activities the following are also worth mentioning: donations to the fire department in tivat; assistance for the purchase of equipment for the national team of the special olympic games of montenegro; baskets for the school gym in žabljak; equipment for primary and secondary schools in kotor and tivat; procurement of exercise equipment in the gym of the junior team of the "jadran" water polo club; a donation aimed at improving the social inclusion of children and youth with developmental disturbances and people with disabilities; donations of children's books to libraries in podgorica and kindergartens in kotor and tivat; sponsorship of the sea dance festival. as a modern and practical bank focused on customers and their needs, addiko has also provided the festival's visitors with various opportunities to make simple financial transactions on-site. the sea dance festival payment card and the addico bank card was the official payment instrument at the sea dance festival, and addiko bank has also provided an atm for cash withdrawals for all visitors (https://www.addiko.me/onama/drustvena-odgovornost/sponzorstva-i-donacije/, accessed on 17.03.2018.). what seems interesting is the fact that all the activities listed on the website of addiko bank were conducted in the period from november 2016 to december 2017. erste banka actively and consistently contributes to the re-building of the value system, the development of society and culture in the country by initiating, acknowledging and providing organizational and financial support to the activities, projects, organizations and institutions acting in the same direction. erste banka gives its contribution to: the culture and arts, education, sports, social inclusion and environmental protection (https://www.erstebank.me/sr_me/footer-stanovnistvo/o-banci/sponzorstva-i-donacije accessed on 17.03.2018.). one of the ongoing programmes listed on the website refers to the best of south east programme: study in graz –development and further education programme, as well as international work experience for talented and dedicated graduates and students from montenegro, bosnia and herzegovina, croatia , macedonia, slovenia and serbia. crnogorska komercijalna banka bases its corporate social responsibility on supporting independently or as a partner the realization of projects in the field of culture, arts, science and sports. aware of the importance of entrepreneurial initiative in culture, ckb has supported the representative editions of the cid publishing house (economic, literary, legal, anthropological, historical) which has published important studies from the history, culture, nature of montenegro, as well as numerous capital translations (http://www.ckb.me/marketing-ipr/marketing-i-pr.69.html accessed on 17.03.2018.). ckb sponsors or participates in the organization of various events (concerts, mimosa festival, world savings day), gives donations in the field of health care, education and science, paying special attention to children and young people, through the scholarships to the best, but also through the ckb donations to the unicef projects. the support for sports clubs in football, basketball, handball, karate, and cooperation with the montenegrin water-polo national team are some of the csr activities of crnogorska komercijalna banka. ckb has recognized the importance of financing in the field of cinematography (film festival hercegfest) and arts. 100 economic analysis (2018, vol. 51, no. 1-2, 92-102) moreover, for the first time in montenegro ckb ensures the financing of renewable energy sources aimed at continuous improvement of efficient and sustainable economic, social and ecological environment (http://www.ckb.me/marketing-i-pr/marketing-i-pr.69.html accessed on 17.03.2018.). hipotekarna banka ad podgorica is the winner of the special award "iskra" for corporate philanthropy in 2016. the award has recognized the contribution and importance of corporate social responsibility of hipotekarna banka ad podgorica, which has several directions: investment in health care improvement, investment in culture, care for the elderly, investment in youth education and general contribution to the community. some of the csr activities of hipotekarna banka are: donations of books to educational institutions in montenegro; scholarships and the provision of international practice to the best students; procurement of reanimation vehicle for the needs of the institute for emergency medical assistance; together with the partners, the donations of vehicles for the transportation of patients on dialysis of the montenegrin clinical centre; participation in the donation to the clinic for gynecology and obstetrics; in cooperation with the non-governmental sector, the donations to the nursery home in bijelo polje; the general sponsorship of the montenegrin national theatre; donations of funds for the construction of a swimming pool in nikšić; sponsorship of the made in ny jazz festival; organization of panel discussions "live globally, work locally”(http://hipotekarnabanka.com/o-banci/vijesti accessed on 17.03.2018.). results of empirical research the overall goal of sustainable development is the long-term sustainability of economy and the environment, which will be achived by integrating economic, environmental and social aspects of the decision-making process (domazet, kovačević, 2018). adequate socially responsible activity of banks contributes significantly to the improvement and advancement of the existing situation in those segments of society and the local community which the state has either insufficient interest or resources to support. from the previous analysis of the state of corporate social responsibility of banks in montenegro, it can be seen that some banks are aware of their social responsibility, which is demonstrated through financial investments in certain activities. some of the most prominent activities include: inclusive education, work with people with disabilities, health care, education, sports, culture, environmental protection, work with the youngest, which are all segments of our society, for which insufficient funds are allocated from the state budget. table 1. csr activities of the banks in montenegro bank csr activity societe generale banka mne prva banka crne gore nlb bank mne addiko bank erste bank crnogorska komercijalna banka hipotekarna banka health care x x x x education and science x x x x x inclusive education x x social inclusion x x x x culture x x x x x x x sports x x x x x x arts x x x x environmental protection x x x x source: authors' analysis 18.03.2018. milica raičević, dijana medenica mitrović 101 banks have a dual role: the role of promoters of socially responsible behaviour and institutions investing in those areas of vital importance for community development, for which the state does not have enough resources. in this way, the banks are directly involved and become a partner to the country in solving strategic social issues, both at the local and the national level. banks also have some benefits from csr initiatives, namely: building a strong corporate reputation, contributing to overall business goals, attracting and retaining motivated workforce, supporting marketing goals, establishing strong relationships in the community, etc., which contributes to the comparative advantage of certain banks in the market. given that these activities are just some of those available to the banks in the area of corporate social responsibility, we hope that corporate social responsibility will develop in montenegro in the forthcoming period, and that the banks will also be in a position, through the appropriate selective credit and interest rate policy, as well as the establishment of special funds, to have a direct impact on the companies to behave in a more responsible manner. given that montenegrin banks are predominantly in foreign ownership and that the csr represents a serious comparative advantage on the market, the foreign banks which implement the csr send their customers a clear message that they are ready to stay in montenegro and actively engage in solving problems both at the local and the national level. conclusion as the conclusion of the paper and the conducted research, it is suggested that the concept of social responsibility and supplementing the bank's business strategy with it, can have multiple benefits for the bank itself, i.e. its competitive advantage in the banking sector, as well as for the improvement of the community and hence greater customer satisfaction. by introducing this concept, a positive image is built in the market, and thus a greater degree of trust is created in the operations of the bank by all interested individuals and groups. the paper analyses the concept of corporate social responsibility, its positive effect on the above-mentioned entities, the introduction of this concept into the strategy and business policy, the specific phenomenon of the bank and its operations, and the contributions that the introduction of this concept makes both for the bank and for all stakeholders of the bank. the results obtained by empirical research in montenegro indicate that banks carry out their socially responsible activities through the activities in the fields of education, healthcare, culture, sports, environmental protection, and work with people with disabilities. the conclusion is that banks have a dual role, they are both promoters of socially responsible behaviour and institutions that invest in those areas of vital importance, for which the state does not have enough resources. it was then concluded that the csr of banks constitutes a serious comparative advantage in the market, since the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro, and actively engage in solving problems both at the local and the national level. the contribution of this paper is reflected in the fact that through a qualitative analysis a breakdown has been given of the activities and areas in which the csr of banks in montenegro is present. an analysis of csr activities can be helpful to decision-makers in the marketing sector of banks in deciding how to use csr as one of the leverages for gaining the comparative advantage in the market. we have also defined in the paper what characterizes the csr of the banks in montenegro, what are the advantages and what are the shortcomings in the past csr practice of banks, and in which direction the csr of banks should be improved. the contribution of the paper is also reflected in the analysis of what is the extent of the impact of csr activities on the generation of a higher profit of banks. moreover, new opportunities for future research have been opened, and one of them concerns the strategies that banks use in the implementation of corporate social responsibility. 102 economic analysis (2018, vol. 51, no. 1-2, 92-102) references carroll, archie. 1996. business and society: ethics, sustainability and stakeholder management, cincinatti ohaio: south-western collage publishing domazet, ivana, đokić ines and 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article history: received: april 2, 2018 accepted: june 6, 2018 microsoft word 2010_1_2.doc scientific rieview future stance of currencies in the international monetary system kotlebova jana*, economic university in bratislava, faculty of national economy, department of banking and international finance, slovak republic udc: 348.246; 339.743 jel: f31; g15 abstarct – the current global crisis is a manifestation of global imbalance. higher creation of savings in emerging economies compared to developed countries; higher investments of developed economies in comparison with developing countries; the current account deficit of the balance of payments in developed countries as opposed to the current account surplus of the balance of payments in emerging economies create new conditions for future stance of currencies in the international monetary system. the future aspect of the international monetary system is, at present, a major topic of discussion for monetary authorities as well as supranational institutions. the intention of this contribution is to highlight the main trends in its development key words: global imbalance, savings, investment, foreign exchange reserves, balance of payment, importance of currencies for the international market, international monetary system introduction we are in the fourth year of existence of the current global crisis, whereby the claim that it is in its final stage, is delivered with great prudence. according to the world economic outlook of the international monetary fund in october 2009 “after contracting by about 1 % in 2009, global activity is forecast to expand by about 3 percent in 2010, which is well below the rates achieved before the crisis”. global imbalance the global economy has been transformed from the so-called bipolar world, where countries were explicitly divided into rich and poor, and global economic growth was determined by developments in the usa and europe, into a world that can be described as multipolar, in which emerging and developing economies have been assigned a significant role from a global perspective. menbere tiruneh workie (2007, 29) since 2004 the global economy has vaulted to the current account surplus of the balance of payments thanks to developing countries. developed economies demonstrate a current account deficit of the balance of payments. the graph outlines the imf forecasts, which indicate the time at which the current account of the balance of payments in the aftermath of * tel.: 00421 905 225 931, e-mail: jana.kotlebova@euba.sk economic analysis (2010, vol. 43, no. 1-2, 61-69) 62 the global financial crisis should gradually decrease in the advanced economies, whereas further export growth is expected in emerging and developing economies. graph 1. development of the current account of balance of payments in major country groups ( % of gdp) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -2 -1 0 1 2 3 4 5 6 % o f g d p em erging and developing econom ies advanced economies source: author’s own processing, data from www.imf.org (2009 and 2010 – forecast of imf) if we compare savings and investment in the major country groups of the world, we can notice, that investments in advanced economies are not covered by the creation of savings; on the contrary, in the case of emerging economies and developing economies savings exceed investments. the basic breakdown of countries into two groups can thus indicate the fact that investments in more developed parts of the world are created because of the savings of less developed parts of the world. if we look at the global data, we can notice that investments and savings stand almost on the same level, which could testify to the maintenance of global equilibrium; however, a detailed analysis of these data, according to other subgroups, can lead to interesting facts. the unambiguous conclusion of the analysis of the relationship between savings and investment is that the driving force of the current global economy is the savings in the developing world and the newly industrialized asian economies. this tendency should be supported in the future by the fact that in these countries there is a strong population kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 63 growth, which creates space for the future growth of consumption and demand, which creates the prerequisites for their further economic growth. graph 2. the development of savings and investments in developed and emerging economies as % of gdp 15 20 25 30 35 40 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 % o f g d p advanced econom ies investment advanced econom ies gross national savings emerging and developing economies inves tm ent emerging and developing economis gross national savings source: author’s own processing, data from www.imf.org (2009 and 2010 – forecast of imf) foreign exchange reserves since 2005, it has been possible to monitor the higher creation of foreign exchange reserves in emerging and developing economies rather than in developed economies. the largest foreign exchange reserves (data to june 2008) are held by china (1.7 billion usd), japan (0.97 billion u.s. dollars), russia (0.55 billion usd). economic analysis (2010, vol. 43, no. 1-2, 61-69) 64 graph 3. development of foreign exchange reserves in the world since 1995 to present 0 1000000 2000000 3000000 4000000 5000000 6000000 7000000 8000000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 in m ill io n s o f u s d advanced economies emerging and developing economies total foreign exchange holdings source: author’s own processing, data from www.imf.org foreign exchange reserves are used to cover imports, foreign exchange interventions and balancing the movements in the capital and financial accounts of the balance of payments. as a result of more frequent financial crises in emerging economies, these incentives have been completed in order to protect the economy from the threat of loss of international liquidity (mainly due to a sudden outflow of capital). the main source of foreign exchange reserves in these countries is the net income from international trade and capital movements. graph 4. structure of global foreign exchange reserves from 2000 to present 0 10 20 30 40 50 60 2000 2001 2002 2003 2004 2005 2006 2007 2008 % usd gbp jpy chf eur other source: author’s own processing, data from www.imf.org kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 65 after the launch of emu, there has been a visible increase of the eur in the foreign exchange portfolio and a drop in dollars. however, the u.s. dollar still continues to hold a strong position in the currency structure of the foreign exchange portfolio (about 65%). importance of currencies for the international market when talking about international currencies, we are interested in the extent to which a certain currency is used outside the domestic economy (the place of its issuance). some authors, for example, e. g. lim, refer to it as a currency that is used ʺoutside the domestic economy by non-residents for transactions with residents of the domestic economy or with residents of third countriesʺ e. g. lim (2006). another approach attributes an international attribute to the currency based on its scope of usage as a currency of debt denomination issued by non-residents on the capital market. the european central bank assesses the international role of a particular currency based on the extent to which this currency is used as denomination for various financial assets and liabilities outside the area of its issuance, as a nominal anchor, reserve and intervention currency for central banks in certain third countries and as a parallel currency used by private agents in some geographically adjacent economies. at the same time, it assesses its importance as a currency (vehicle currency) in some segments of the global foreign exchange market. therefore, it assesses two major aspects: a) the importance of the currency for the international bond market, foreign exchange market and the international market for goods and services, b) the importance of the currency for third countries. the largest issuers in the international bond market are the globally operating financial institutions and corporations. as foreign currency denomination, they mainly use usd, eur or gbp. the international debt securities in usd are issued by european banks and corporations, whereas these securities in eur are issued by investment banks and corporations from the united states, great britain and some european countries outside the euro area. the importance of the international bond market in total activities of the international global capital market has fallen due to the development of further financial markets that are open to foreign investors. therefore, the international bond market is becoming a less significant indicator of a currency of international importance. central banks in emerging economies and sovereign wealth funds have become large global investors, and have become increasingly active in the issuance of government bonds, corporate bonds and shares in third countries. the stock market has gained a considerable market share and therefore, it dictates the denomination of its own assets, and the international role of currencies. for example, ch. thimann (2009, 10) in his study argues that: a) the international bond market is excessively denominated in usd and eur, and accounts for about 80% of the market, while on the dollar market segment eur emissions account for 60%, on the eur market the emissions from the usa and non-euro area countries account for 70% of emissions, economic analysis (2010, vol. 43, no. 1-2, 61-69) 66 b) the international bond market is relatively narrowly structured, financial institutions constitute 80% of the market, businesses, governments or international institutions account for the rest 20%, c) the choice of currency has been significantly influenced by entrepreneurial motives (control of balance, project financing, taxes) and by short-term cyclical factors (exchange rate predictions and interest rate differential). the international bond market, from the perspective of the narrow supply of debt instruments, does not have such a significant impact on the evaluation of the currency position as on the international currency. in a broader definition of supply of debt instruments, however, its impact on the role of currency in an international context is more significant, according to the imf data; up to 11.2 trillion usd bonds are held abroad out of the total volume of bonds (18.4 trillion u.s. dollars), whereas in the narrow definition, it is only 7.8 trillion usd. in comparison, foreign holdings of shares account for 8.8 trillion usd. graph 5. issuance of bonds with variable rates of interest by currency denominations 0 1000000 2000000 3000000 4000000 5000000 6000000 7000000 8000000 9000000 d ec .2 00 0 d ec .2 00 1 d ec .2 00 2 d ec .2 00 3 d ec .2 00 4 d ec .2 00 5 d ec .2 00 6 d ec .2 00 7 d ec .2 00 8 s ep .2 00 9 b il. u s d us dollar euro yen pound sterling sw iss f ranc canadian dollar other currencies floating rate total source: author’s own processing, data from www.bis.org kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 67 graph 6. issuance of bonds with fixed rates of interest by currency denominations 0 2000000 4000000 6000000 8000000 10000000 12000000 14000000 16000000 18000000 d ec .2 00 0 d ec .2 00 1 d ec .2 00 2 d ec .2 00 3 d ec .2 00 4 d ec .2 00 5 d ec .2 00 6 d ec .2 00 7 d ec .2 00 8 s ep .2 00 9 bi l. u s d us dollar euro yen pound sterling swiss franc canadian dollar other currencies straight fixed rate total source: author’s own processing, data from www.bis.org the previous graphs can be used to monitor that the euro is used as a currency denomination of bonds to a much greater extent than the usd. this tendency in the world started to create the euro in 2002 (commercial papers and bonds with floating interest rates), in the case of other debt securities, two years later, in 2004. the biggest difference with the preference of the euro as denomination against the usd has been recorded in bonds with variable interest rate. a few years ago, there were concerns about a tripolar monetary system in which three currencies were to play a key role usd, eur and the japanese yen. the current approach to the usage of currencies in the bond, foreign exchange and commodity markets in the world, however, suggests an entirely different trend. graph 7. development of the main pair usd/eur 0,8 0,9 1 1,1 1,2 1,3 1,4 1,5 1,6 1,7 i/ 99 v /9 9 ix /9 9 i/ 00 v /0 0 ix /0 0 i/ 01 v /0 1 ix /0 1 i/ 02 v /0 2 ix /0 2 i/ 03 v /0 3 ix /0 3 i/ 04 v /0 4 ix /0 4 i/ 05 v /0 5 ix /0 5 i/ 06 v /0 6 ix /0 6 i/ 07 v /0 7 ix /0 7 i/ 08 v /0 8 ix /0 8 i/ 09 v /0 9 ix /0 9 source: author’s own processing, data from www.ecb.int economic analysis (2010, vol. 43, no. 1-2, 61-69) 68 if we were to comment upon the first question, then, for example, m. d. chinn and j. a. frankel(2008, 4) argue that the usd will lose its position as the main currency due to the fact that the eur is a much more serious rival than the mark or yen used to be in the past, and the usa have already had a chronic current account deficit of the balance of payments for 25 years and 35 years of usd depreciation. it is assumed that this will happen in 2015. conclusion all the previously mentioned factors indicate the fact that the future development of the international monetary system will not continue in its conventional manner, but it will be fully affected by the approach of developed countries to developing world. on the question of the relationship between the usd and the euro there have been several discussions. jean-claude trichet (president of the ecb) has said that the further depreciation of the usd is unacceptable for the euro area since it would mean the artificial overvaluation of the euro, whose exchange rate would not reflect the real economic development of the euro area, which would cause additional risks to maintain its stability in the future. of course, it is necessary to take into account the further progress of economic integration in other regions of the world. for example, the countries of the gulf in 2010 are planning to launch a monetary union with a common currency. at present, the composition of a common currency basket is being analysed. the risk is that these countries are major oil exporters, and they have already joined the trade in this commodity in a currency other than usd, which in the future could mean a further depreciation of usd. similar integration schemes can also be observed in africa and asia, but their implementation is a matter of the distant future. as for the chinese yuan, china is among the economies with the highest foreign exchange reserves, increasing exports and high savings creation. moreover, in the past, they purchased large amounts of bonds denominated in usd, much of which is approaching maturity. moreover, the recovery of the u.s. economy is not realised in such a pace as it was planned by an optimistic scenario. the g20 requested, for example, the european commission to accelerate a further expansion of the euro area countries, which would protect their economies against the excessive volatility of exchange rates due to the financial crisis. the answer by the ec, however, to this proposal was unequivocal; the euro area would not abandon its enlargement strategy based on the fulfilment of the maastricht criteria, since it considers price and financial stability as its main priority. commenting upon the future outlook of the international monetary system there have been several discussions. perhaps, the proposal of france and great britain on the creation of the bretton woods ii system, which would again mean a return to the gold standard, whereas the main currency should be the imfʹs special drawing rights (sdrs). although this proposal is more or less criticized. major opponents argue that the imf membership (185 countries) is very different today than it was at its birth, since emerging and developing countries are more represented than developed ones, while those given the growing debts kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 69 can be a threat to the restoration of international stability. moreover, the triffin paradox, which is well known for the bws i failure, should be remembered. the increase in current account deficits of the balance of payments associated with the growth of public debt does not guarantee the basis for the international monetary system, which must meet the stability and other features such as liquidity and symmetry in international monetary relations. in regard to foreign trade in goods and services, the dominant currency denomination of transactions is still the american dollar, but here we can see a downward trend. changes in the exchange rate alternate the value of mutual obligations and claims of the parties entering into business. the future international monetary system has to meet three basic functions liquidity, symmetry and stability in the international monetary relations, which requires a unique management style. it is necessary to revisit the basic principles of the functioning of market mechanism in conditions of a globalizing economy, since the latest trends such as liberalization, both economic and financial integration point to the fact that the market is not always able to regulate shocks, to which the global economy is exposed. references aizenman, j., chin, m. d. and ito, h. 2008. “assessing the emerging global financial architecture: measuring the trilemma’s configurations over time.” nber working paper 14533, cambridge december 2008 chinn, m. d. and frankel, j. a. “the euro may over the next 15 years surpass the dollar as leading international currency.” nber working paper 13909 . cambridge april 2008, p. 4 kotlebová, j. and chovancová, b. “medzinárodné finančné centrá (zmeny v globálnej finančnej architektúre).“ bratislava: iura edition 2010 lim, e. g. “the euro’s challenge to the dollar: different views from economists and evidence form cofer (currency composition of foreign exchange reserves) and other data.” imf working paper no 06/153, washington: imf, june 2006 obstfeld, m., shambaugh, j. c. and taylor, a. m. “financial stability, the trilemma, and international reserves.” nber working paper 14217. august 2008 thimann, ch. “global roles of currencies.” ecb working paper no 1031, frankfurt: ecb, march 2009, p. 10 woodford, m. “globalization and monetary control.” nber working paper 13329, cambridge workie, m. t. “dynamika svetovej ekonomiky v roku 2006 a perspektívy na roky 2007 a 2008: globálny pohľad.“ in: vývoj a perspektívy svetovej ekonomiky – prínos informačných technológií a hrozby klimatických zmien. workie, m. t. bratislava: eú sav 2007, isbn 978-80-7144-159-5, p. 29 received: 6 january 2010 article history: accepted: 19 march 2010 ea_2015_1-2 udc: 005:336.761.5(4)"2010/2013 jel: c10, c14, g10, g35 cobiss.sr-id: 216163596 original scientific paper towards and effective financial management: relevance of dividend discount model in stock price valuation mugoša ana1, university of montenegro, school of economics, podgorica popović saša2, university of montenegro, school of economics, podgorica abstract – the aim of this paper is to analyze the relevance of dividend discount model, i.e. its specific form in stock price estimation known as gordon growth model. the expected dividends can be a measure of cash flows returned to the stockholder. in this context, the model is useful for assessment of how risk factors, such as interest rates and changing inflation rates, affect stock returns. this is especially important in case when investors are value oriented, i.e. when expected dividends are their main investing drivers. we compared the estimated with the actual stock price values and tested the statistical significance of price differences in 199 publicly traded european companies for the period 2010-2013. statistical difference between pairs of price series (actual and estimated) was tested using wilcoxon and kruskal-wallis tests of median and distribution equality. the hypothesis that gordon growth model cannot be reliable measure of stock price valuation on european equity market over period of 2010-2013 due to influence of the global financial crisis was rejected with 95% confidence. gordon growth model has proven to be reliable measure of stock price valuation even over period of strong global financial crisis influence. key words: dividend discount model, gordon growth model, stock valuation, european equity market introduction valuation as a strategy is especially crucial in corporate finance whether it is the study of market efficiency, analysis of stock returns, or evaluation of different investments in process of capital budgeting. it is very important to assess current and future company’s profitability in order to estimate its real market value. once the stock value is determined, the investors will be able to decide whether the stock is overvalued or undervalued, which will consequently affect their investment choices and profit opportunities. knowing how to estimate the value of a company and understanding its determinants seem to be prerequisites for making prudent investment decisions. 1 teaching assistant, university of montenegro, school of economics, j. tomasevica 37, suite 415, 81000 podgorica, montenegro, e-mail: ana.mugosa@ac.me (corresponding author) 2 associate professor, university of montenegro, school of economics, j. tomasevica 37, suite 211, 81000 podgorica, montenegro, e-mail: sasap@ac.me 40 economic analysis (2015, vol. 48, no. 1-2, 39-53) company valuation incorporates different goals, such as increasing value by changing financial and dividend policies, investment strategies or creating profitable portfolio that will generate high returns and therefore increase value of money invested. as noticed by damodaran (damodaran, 2006: 3) there are four approaches to valuation: 1. discounted cash flow valuation analysis of asset present value, calculated by discounting its expected future cash flows, at the rate that reflects the risk of future cash flows. 2. liquidation and accounting valuation – valuation of existing assets or business of a firm based on accounting estimates and book values. 3. relative valuation valuation of comparable assets price relative to a common variable, such as earnings, sales and etc. 4. option pricing model an alternative or choice that becomes available with a business investment opportunity. real options can include opportunities to expand and terminate projects if certain conditions arise amongst other options. this paper focuses on discounted cash flows analysis at european equity markets applied on stock price valuation. when considering stock investment, investors can, in general, expect two types of cash flows: dividends and the price at the end of holding period. based on the assumption that stock will be held indefinitely or that the expected price of stock is determined by future dividends, the easiest way to estimate the present value of stock is to discount its expected cash flows or dividends. dividend discount models (ddm) are widely used in practice even though their reliability is often tested. the common application of ddm has been caused particularly by the fact that the investors’ received return was the most incoming form of dividends in the past century. on the other hand, recent studies point out the importance of capital gains on investors’ total returns and the need for method’s combination in valuation process. however, our goal is to analyze whether stable ddm, i.e. this specific form of the gordon growth model (ggm), is reliable in stock valuation of the publicly traded european companies, using the year 2009 as a referent year for stock price estimation. therefore, we posit as follows: ggm cannot be used as a reliable measure of stock price valuation in european equity market over the period of 2010-2013 due to influence of the global financial crisis. the prices are estimated over period of four years, from 2010-2013, and, then, compared to the actual values in that period. computing differences between estimated and actual prices and testing their statistical significance, we will observe whether ggm gives accurate estimates for future value of stocks. the paper is structured as follows: section ii reviews the literature of previous empirical analyses. section iii describes the theoretical approach. section iv explains the data and methodology employed. section v presents empirical results while section vi offers concluding remarks. literature review mid past century, lintner (lintner, 1956) has discovered the importance of dividend interviewing managers from 28 companies and observing that long-term payout ratio was targeted. this means that companies tried to maintain a stable pattern in future cash-flows mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 41 toward shareholder or dividends. brav et al. (brav et al., 2005) widen the study and find that managers do focus on a steady growth rate of dividends rather than a consistent payout ratio. analyzing the bank of montreal over a period of more than 120 year, foerster and sapp (foerster and sapp, 2005) compare the actual share price to the expected price using several of the most commonly used fundamental valuation methods. the results showed that dividend discount model (ddm) and gordon growth or constant growth model (ggm) both perform well at explaining the observed price for one firm that has a long history of paying dividends. these models perform better than commonly used earnings based models. apparently, fundamental analysis can be applied and results in accurate estimates of future stock price or expected returns. the relationship between volatility of earning and abnormal return was widely studied and analyzed in the past century (ou and penman, 1989; lev and thiagarajan, 1993). these studies demonstrated that the analysis of certain fundamental financial signals is very useful in stock price evaluation. abarbanell and bushee (abarbanell and bushee, 1997) find that risky portfolio that is created based on company’s ranking using fundamental information can generate average cumulative abnormal return of 13%. the announcement of future earnings and dividend growth positively affects the present value of stock. shiller (shiller, 1981) and famma and french (famma and french, 1988) argue that the volatility of stock prices is excessive and difficult to be explained by dividends. they state that variations in prices are much more expressed than variations in dividends. even dividend yields are much more prone to volatility than absolute dividends. so the evident problem is that there exists a significant difference between potential dividends and actual dividends, which additionally undermines and challenges the dividend discount models. the first to point out this problem are fama and french (fama and french, 2001). they demonstrate the significant gap between payout ratios at the end of the seventies and at the end of the nineties of the the xxth century (from 67% to 21% on average). these declines were only in a small part affected by company’s characteristics. the scholars explain that possible reasons could be investors will to reinvest earnings or increase in idiosyncratic risk. in the context of dividends payout decline, baker and wurgler (baker and wurgler, 2004) provide an explanation based on behavioral finance. during periods of high dividends fads, the payout ratios are high, whilst in periods of low dividend fads, payer valuations decline. these scholars argue that companies’ dividend policies are synchronized with the periods of fads, and that dividend proxies explain on average 30% of changes in propensity to pay variable. this means that behavioral fads are the first-order determinants of disappearing dividends. deangelo, deangelo and skinner (deangelo, deangelo and skinner, 2004) argue that dividends on aggregate level have not decreased. the dollar supply of dividends does not mimic the trend of the disappearing dividends. the cause of disappearing dividends can be found among smaller companies which represent fewer payers on the market and are not interested in paying dividends. grullon and michaely (grullon and michaely, 2002) reach same results, meaning that payouts to shareholders in the form of repurchases and 42 economic analysis (2015, vol. 48, no. 1-2, 39-53) dividends have not declined. the results are supported by evident growth of repurchases since low changes (us sec, rule 10b-18) for firm repurchasing shares. nevertheless, dividend discount models are widely used as there are variations of basic model. the gap between the potential and actually paid dividends could be narrowed by redefinition of the cash flow paid as dividends including stock buybacks or, even, including earnings as proxies to dividends (damodaran, 2006). theoretical consideration dividend discount model (ddm) the basic principle of dividend discount model is simple stocks trade from which investors expect future cash flows or dividends and expected price in case the stock is being sold. in order to compare the profit and cost of investment, this model uses time value of money to determine the present value of stock (based on discounted value of future cash flows). this generated value is called intrinsic value of stock as it is determined through fundamental analysis without including external factors such as its market value. if an investor buys a stock and holds it for one year, than the value of stock could be calculated as follows: ek pd p + + = 1 11 0 (1) where, d1 – expected dividend at the end of first year, p1 – value of stock at the end of first year, ke – cost of equity. because we do not have infinite required information on expected dividends, the stock is valued in two stages. the first stage determines the value of expected dividends based on available information over analyzed period, and the second stage determines terminal value or the last price. considering both stages, the model can capture the effects of dividends as well as capital gain on stock price (foerster and sapp, 2005). in general, for the period of n years, the value of stock represents the sum of the present value of discounted expected dividends over n years and selling price at end of the nth year: n e n n e n ee k p k d k d k d p )1()1( ... )1()1( 2 21 0 + + + ++ + + + = (2) since the assumption that the expected price is determined by future expected dividends, the present value of stock held by an investor through infinity is: ∑ ∞ = + = 1 0 )1(n n e n k d p (3) mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 43 where, dn – expected dividend per share in period n, ke – cost of equity. as already noticed, the model calculates in a simple manner the present value of stock by using two variables – expected dividends and cost of equity. in order to calculate expected dividends, it is necessary to estimate future growth rates, by which the dividend will increase in the future. the cost of equity can be measured in various ways, but in majority of cases it is derived from capital asset pricing model (capm). different assumptions on dividend future growth caused the formulation of various dividend discount models: • ddm with zero growth • ggm • two and three stage ddm brief explanation of those models follows. dividend discount model with zero-growth basic assumption of zero-growth ddm is that dividends are constant forever with no growth. present value of stock, whose dividends are constant over time, will be equal to the present value of dividends, in perpetuity. if d1 is the constant dividend which is expected to be paid through infinity (d1=d2=….=dn), and if ke is cost of equity, then the present value of stock p0 can be expressed as: ek d p 10 = (4) zero growth model represents the simplest ddm and assumes no inflation, no variation in cash flows, and no change in other external factors influencing future cash flows. dividend discount model with stable growth – the gordon growth model (ggm) assuming that dividends grow at stable rate (rate that can be sustained indefinitely), gordon (gordon, 1959; gordon and shapiro, 1956) formulated the model known as gordon growth model, which can be used to value a firm that is in a stable state. this model evaluates stock prices by using the constant growth of dividends in perpetuity. this means that the stock will be held by the investor indefinitely. therefore, stock price can be valued as follows: gk d p e − = 10 (5) where, d1 – expected dividend one year from now (next period) 44 economic analysis (2015, vol. 48, no. 1-2, 39-53) g – infinite future constant growth rate in dividends ke – cost of equity, where ke > g since the dividend growth rate is constant, it is expected that earnings grow at the same rate as dividends. additionally, a growth rate which is stable has to be less or equal to the growth of gnp. the model implies that the stable infinite growth rate cannot be more than 1% or 2% greater than the growth rate of economy (damodaran, 2004). in case when dividends grow at variable rate or when companies do not pay dividend, then other models must be applied, such as the valuation of free cash flow or residual income as well as twostage or a three-stage model (foerster and sapp, 2006). damodaran (stern nyu 2014) estimates the upper and lower end of stable growth rate by following: upper end: long term inflation rate + growth rate in real gnp lower end: long term inflation rate + growth rate in real gnp damodaran estimates that the lower and upper end for stable dividend growth rate in the us is from 5%-8%, and, if the company is multinational, the real growth rate will be the growth rate of the world economy, which is about one percent higher. the limitation of the model is obvious in that it relies on the basic assumption of stable dividend growth. its assumption is difficult to prove, especially considering cyclical companies with high earnings deviations and volatility. nevertheless, in specific cases when earnings are volatile but dividends on average have a constant growth rate, the gordon’s model could be applied. to summarize, gordon growth model can be reliable in price valuation of companies whose growth rate is less or equal to nominal growth of economy, as well as for companies which have strategically defined future long-term stable dividend policies. two-stage and three-stage dividend discount model when companies are unable to meet the assumption of stable dividend growth, stock can be valued using techniques of two or three-stage dividend growth (damodaran, 2004). these models can be applied on companies that grow by certain, in most cases, higher rate in initial phase and have a stable growth rate in subsequent long-term period. two-stage dividend discount model can be defined as follows: value of the stock = pv of dividends during extraordinary phase + pv of terminal price, or n hge n s t s hge s k p k d p )1()1( ,1 , 0 + + + = ∑ = , where n nsge n n gk d p )( , 1 − = + (6) where, ds = expected dividends per share in year s, ke = cost of equity (hg: high growth period; st: stable growth period), pn = price (terminal value) at the end of year n, mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 45 g = extraordinary growth rate for the first n years, gn = steady state growth rate forever after year n. unlike classical two-stage growth model, the h-model was derived by fuller and hsia (fuller and hsia, 1984), where the initial period is characterized by decline in growth rate and than follows a stable pattern in a steady state over the long-term period. the three-stage dividend discount model represents a combination of two-stage and h-model, providing that company has high growth in initial phase, decline in rate in transition period and, afterward, a stable rate in the last phase (infinity). the limitations of these models are determined by the question of how to define the length of initial growth phase; by the sudden transformation of initial growth rate to stable rate; and by cases of companies retaining profit and paying lower dividend in certain phases. in that context, these models can be suitable for companies that have modest growth rates that can be easily transformed to stable rates; companies that pay the majority of free cash flow to equity (fcfe) to shareholders; or companies that are specific and expected to grow higher in initial phase and be moderately stable afterwards. data and methodology we analyzed firm-level data of 4,788 publicly traded companies on the european equity market off of the new york stern university website (stern nyu 2014). due to the lack of data on dividend per share paid, 2009 was used as referent year for price estimation. the prices were estimated starting from year 2010 up to year 2013. the aim of this paper is to analyze whether gordon growth model (ggm) is reliable in stock valuation, comparing the estimated with the actual stock price values and testing the statistical significance of price differences. statistical difference between the two price series (estimated and actual) is tested using the tests of equality (equality of average value and variance). in order to apply ggm, total available number of companies was reduced by excluding companies following the criteria: • bank, financial, insurance, reinsurance and real estate companies, due to global financial crisis, • where ke< g, • with dividend yield = 0% , and • with g < 0 (payout ratio > 100%). after following these criteria, we end up with the sample of 199 companies. cost of equity is estimated using capm – the required return equals risk free rate increased by the product of company’s beta and market premium. risk free rate of 3.68% represents ecb 10 year aaa-rated euro area central government bonds issued in 2009, whilst the market premium risk in 2009 amounted 5.2% (european central bank, 2014). using companies’ individual betas from the damodaran’s database, we generated ke for each single company from the sample. in gordon’s model, payout ratios of dividend paying companies tend to be stable, which means that growth rate of dividend g equals growth rate of earnings. earnings will increase when a portion of net earnings is retained and when companies invest. this results in 46 economic analysis (2015, vol. 48, no. 1-2, 39-53) conclusion that growth rate of earnings, and therefore dividends, is a function of retention ratio (1 – payout ratio) and return on retained earnings (rore). because the details of future investment projects are not publicly available, it is difficult to estimate the ratio of return on retained earnings. therefore, it is often assumed that the future projects will have the same expected rate as those from previous years. in that case, the expected project rate can be estimated using historical data of return on equity (ross, westerfiled and jaffe, 2002). dividend growth rate is estimated as product of return on equity (roe) and retention ratio: g = roe * retention ratio (7) again, using companies’ individual roe rates and retention ratios from the damodaran’s database, we generated gfor each single company from the sample. calculating the corresponding cost of equity ke and dividend growth rate g, and discounting the initial dividend from the year 2009, the gordon growth model was applied in price estimation for the period of 2010-2013. table 1 reports the descriptive statistics of estimated firms’ prices from the sample. from the results, it is evident that the data time series does not have normal distribution, which, consequently, implies the use of nonparametric tests of time series equality – wilcoxon signed-rank test and kruskal–wallis tests. table 1. descriptive statistics of estimated an actual prices in observation period 2010-2013 p1e p2e p3e p4e p1a p2a p3a p4a mean 93.07947 99.73328 106.9354 114.7341 42.39884 31.15342 36.90675 45.23538 median 9.963856 10.40862 11.07812 11.79068 13.01000 9.800000 10.44000 13.40000 maximum 4183.969 4619.661 5100.722 5631.878 1814.500 1080.560 1423.490 1387.260 minimum 0.002846 0.003006 0.003175 0.003354 0.043000 0.047000 0.037000 0.090000 std. dev. 382.4551 415.7875 452.4644 492.8274 141.2007 87.77031 110.2661 115.2178 skewness 7.968668 8.138462 8.311607 8.487132 10.45366 9.283313 10.33518 8.543701 kurtosis 76.12060 79.49674 82.96460 86.50087 127.5103 106.2840 127.6493 95.17107 jarque-bera 46438.48 50717.55 55310.96 60201.82 132168.5 91310.29 132374.2 72862.90 probability 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 sum 18522.81 19846.92 21280.15 22832.08 8437.369 6199.530 7344.444 9001.840 sum sq. dev. 28961832 34230091 40535361 48090019 3947653. 1525318. 2407405. 2628477. observations 199 199 199 199 199 199 199 199 wilcoxon two-tailed signed-rank test is applied when comparing two series or populations with paired observations. this test is an alternative to paired t-test in cases when mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 47 data time series and the differences between observations are not normally distributed. wilcoxon test does not only incorporate the sign differences analysis, but also tests their magnitude. this process is done by considering the ranks of these differences. the null and alternative hypotheses of wilcoxon signed-rank test are defined as follows: h0: µa-µe = 0, or the median difference between populations is zero h1: µa-µe ≠ 0, or the median difference between populations is not zero suppose we have independent and identically distributed data x1, x2, . . .,xn from some symmetric continuous distribution. then, the assumptions of wilcoxon non-parametric test are (taheri and hesamina, 2013): • independence of differences (i.e., changes in prices are mutually independent) • identical distribution (the data are paired and come from the same population) • continuity (the continuity assumption assures that ties are impossible, and is • necessary for the point estimate and confidence interval) • symmetry. in order to calculate the wilcoxon t statistic, the difference d is calculated for each pair of data (d=x1-x2). the second step involves the rank of differences absolute values. in the next step, the ranks of the positive and negative differences are summed. the wilcoxon t statistic is defined as the smaller of the two sums of ranks (aczel, 1999: 689): (8) where, ∑(+) is the sum of the ranks of the positive differences and ∑(-) is the sum of the ranks of the negative differences decision rule: if the test statistics t is less than the critical point from the table, for a given level of significance, the null hypothesis is rejected. the kruskal-wallistest represents a non-parametric alternative to one-way anova in cases when the data time series and the differences between observations are not normally distributed. this test is an analysis of variance, using ranks of the observations rather than the data themselves. it is possible to conduct it under the assumption that the measurement scale is an interval and that populations are continuous (meyer and seaman, 2011). the null and alternative hypotheses for k population of the kruskal-wallis test are defined as follows: h0: µa-µe = 0, all k populations have the same distribution h1: µa-µe ≠ 0, not all k populations have the same distribution the kruskal-wallis h statistics is given by the following formula (aczel, 1999: 696): 48 economic analysis (2015, vol. 48, no. 1-2, 39-53) (9) decision rule: if the h statistics is too large, exceeding the critical point for a given level of significance, the null hypothesis is rejected. empirical results in order to test the reliability of ggm, the research hypothesis was defined as follows: gordon growth model cannot be reliable measure of stock price valuation in european equity market over period of 2010-2013 due to influence of the global financial crisis. our expectations are negative, taking into consideration that the global financial crises (gfc) started in 2008 and that our referent estimation year was one year after the crisis. the effects of gfc were the highest one year after. when we consider the effects of gfc, we assume several changes: • decline in free cash flow to equity value, • decline in dividends value, • decline in payout ratios, • decline in dividend and earnings growth rate, • decline in market capitalization, • increase in risk premium of securities, • increase in market premium of securities. the summary of empirical results, with probabilities assigned to each test by the observation period 2010-2013, is given in the next table. table 2. summary of empirical results, 2010-2013 method probability (p-values) 2010 2011 2012 2013 wilcoxon/mann-whitney 0.4167 0.4162 0.7657 0.5646 wilcoxon/mann-whitney (tie-adj.) 0.4167 0.4162 0.7657 0.5646 med. chi-square 0.2701 0.9201 0.9201 0.6162 adj. med. chi-square 0.3161 1.0000 1.0000 0.6884 kruskal-wallis 0.4164 0.4159 0.7653 0.5643 kruskal-wallis (tie-adj.) 0.4164 0.4159 0.7653 0.5643 according to the assessed probabilities, shown in table 2, and corresponding t and h statistic of the wilcoxon signed-rank and kruskal-wallis test (see appendice, a-1, a-4), we accept the null hypothesis with 95% confidence (α=5%) and conclude that there is no statistically significant difference between the estimated and actual prices medians and distribution over observation period 2010-2013. mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 49 concluding remarks reliability of gordon growth model in stock price valuation is confirmed on the sample of 199 publicly traded eu companies. referent year 2009 was chosen due to the lack of data on dividend per share paid. gordon growth model showed to be reliable measure of stock price valuation even over period of strong global financial crisis influence. our confirmation of these results relies on two assumptions: • first, only 11.5% of the companies from the sample have the growth rate greater than 8%. this means that the growth rate of the majority of the companies is inside the interval of damodaran’s lower and upper end for stable growth (5%-8%). the first assumption may make us conclude that the majority of companies from our sample represent mature companies with stable growth and high payout ratio. • second, as discussed in literature review, dividends were representing major cash flow and return to shareholders in the xxth century and these models performed better than commonly used earnings based models. we assume that this trend continues in the xxist century and, therefore, it is reliable to measure stock prices using different types of dividend discount models. finally, as our focus on assessment of the model was the stable dividend growth rate, further research could involve analysis of the reliability of gordon growth model by taking into account firms with stable leverage and beta over time; firms that pay out dividends that are high and come close to free cash flow to equity. references abarbanell, jeffrey and brian bushee. 1997. “fundamental analysis, future earnings, and stock prices”, journal of accounting research, 35(1): 1-24. aczel, amir. 1999.complete business statistics. mcgraw-hill international editions, fourth ed. baker, malcolm and jeffrey wurgler. 2004. “appearing and disappearing dividends: the link to catering incentives”, journal of financial economics, 73(2): 271–288. brav, alon, john r. graham, campbell r. harvey and roni michaely. 2005. “payout policy in the 21st century”, journal of financial economics, 77(3): 483-527. damodaran, aswath. 2004.damodaran on 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pp.1-49. foerster, stephen r. and stephen g. sapp. 2005. “the dividend discount model in the long-run: a clinical study”, journal of applied finance, 15(2): 55-75. fuller, russell j. and chi-cheng hsia. 1984. “a simplified common stock valuation model”, the financial analysts journal, 40(5): 49-56. gordon, myron j. 1959. “dividends, earnings and stock prices”, the review of economics and statistics, 41(2): 99-105. gordon, myron j. and eli shapiro. 1956. “capital equipment analysis: the required rate of profit”, management science, 3(1): 102–110. grullon, gustavo and roni michaely. 2002 “dividends, share repurchases, and the substitution hypothesis”, journal of finance, 57(4): 1649–1684. lev, baruch and ramu s. thiagarajan, s. r., 1993, “fundamental information analysis”, journal of accounting research, 31(2): 190-215. lintner, john. 1956. “distribution of incomes of corporations among dividends, retained earnings and taxes”, the american economic review, 46(2): 97-113. meyer, patrick j. and michael a. seaman. 2013. “a comparison of the exact kruskal-wallis distribution to asymptotic approximations for all sample sizes up to 105”, journal of experimental education, 81(2): 139-156. new york university stern, http://people.stern.nyu.edu/adamodar/new_home_page/data.html (accessed april 13, 2014) new york university stern, http://people.stern.nyu.edu/adamodar/pdfiles/ddm.pdf (accessed april 29, 2014) ou, jane a. and stephen h. penman. 1989. “accounting measurement, price-earnings ratio, and the information content of security prices”, journal of accounting research, 27(supplement): 111-144. ross, stephen a., randolph w. westerfield, r. and jeffrey jaffe. 2002.corporate finance, mcgraw-hill, 6th edition. shiller, robert j. 1981. “do stock prices move too much to be justified by subsequent changes in dividends?”, the american economic review, 71(3): 421-436. taheri, mohmoud s. and gholamreza hesamian. 2013. “a generalization of the wilcoxon signed-rank test and its applications”, statistical papers, 54(2): 457-470. mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 51 appendix: detailed empirical results, 2010-2013 table a-1. statistical tests of equality between actual and estimated stock prices, 2010 test for equality of medians between series date: 06/01/14 time: 12:40 included observations: 199 method df value probability wilcoxon/mann-whitney 0.812208 0.4167 wilcoxon/mann-whitney (tie-adj.) 0.812208 0.4167 med. chi-square 1 1.216080 0.2701 adj. med. chi-square 1 1.005025 0.3161 kruskal-wallis 1 0.660389 0.4164 kruskal-wallis (tie-adj.) 1 0.660389 0.4164 van der waerden 1 0.349390 0.5545 category statistics > overall variable count median median mean rank mean score p1e 199 9.963856 94 194.8141 -0.029281 p1a 199 13.01000 105 204.1859 0.029282 all 398 10.82336 199 199.5000 2.95e-08 table a-2. statistical tests of equality between actual and estimated stock prices, 2011 test for equality of medians between series date: 06/01/14 time: 12:43 included observations: 199 method df value probability wilcoxon/mann-whitney 0.813079 0.4162 wilcoxon/mann-whitney (tie-adj.) 0.813079 0.4162 med. chi-square 1 0.010050 0.9201 adj. med. chi-square 1 0.000000 1.0000 kruskal-wallis 1 0.661806 0.4159 kruskal-wallis (tie-adj.) 1 0.661807 0.4159 van der waerden 1 1.074622 0.2999 category statistics 52 economic analysis (2015, vol. 48, no. 1-2, 39-53) > overall variable count median median mean rank mean score p2e 199 10.40862 100 204.1910 0.051353 p2a. 199 9.800000 99 194.8090 -0.051353 all 398 10.10757 199 199.5000 5.03e-08 table a-3. statistical tests of equality between actual and estimated stock prices, 2012 test for equality of medians between series date: 06/01/14 time: 12:44 included observations: 199 method df value probability wilcoxon/mann-whitney 0.298042 0.7657 wilcoxon/mann-whitney (tie-adj.) 0.298042 0.7657 med. chi-square 1 0.010050 0.9201 adj. med. chi-square 1 0.000000 1.0000 kruskal-wallis 1 0.089089 0.7653 kruskal-wallis (tie-adj.) 1 0.089089 0.7653 van der waerden 1 0.211050 0.6459 category statistics > overall variable count median median mean rank mean score p3e 199 11.07812 100 201.2211 0.022758 p3a 199 10.44000 99 197.7789 -0.022758 all 398 11.01800 199 199.5000 2.98e-07 table a-4. statistical tests of equality between actual and estimated stock prices, 2013 test for equality of medians between series date: 06/01/14 time: 12:45 included observations: 199 method df value probability wilcoxon/mann-whitney 0.576040 0.5646 wilcoxon/mann-whitney (tie-adj.) 0.576040 0.5646 med. chi-square 1 0.251256 0.6162 adj. med. chi-square 1 0.160804 0.6884 kruskal-wallis 1 0.332324 0.5643 kruskal-wallis (tie-adj.) 1 0.332324 0.5643 van der waerden 1 0.160077 0.6891 category statistics mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 53 > overall variable count median median mean rank mean score p4e 199 11.79068 97 196.1759 -0.019818 p4a 199 13.40000 102 202.8241 0.019822 all 398 12.03400 199 199.5000 1.82e-06 prema efektivnom finansijskom menadžmentu: relevantnost modela diskontovanja dividendi u vrednovanju akcija rezime – cilj rada je analiza relevantnosti modela diskontovanja dividendi, tj. njegove specifične forme u procjeni vrijednosti akcija poznate kao gordonov model rasta. očekivane dividende mogu predstavljati mjeru slobodnih novčanih tokova prema akcionarima. u tom kontekstu, model je koristan u ocjeni uticaja faktora rizika, kao što su kamatne stope i stope inflacije, na cijene akcija. procjena vrijednosti primjenom ovog modela je veoma važna za investitore orjentisane na vrijednost kompanije , tj. isplatu očekivanih dividendi. na uzorku od 199 javno trgovanih evropskih kompanija, u periodu od 2010.-2013. godine, upoređene su ocijenjene i stvarne cijene i testirana je statistička značajnost njihovih razlika. testiranje razlika parova cijena (stavrnih i ocijenjenih) je izvršeno primjenom wilcoxon i kruskal-wallis testova jednakosti srednjih vrijednosti. hipoteza da gordonov model rasta ne može biti pouzdan u procjeni vrijednosti akcija na evropskom tržištu kapitala, u periodu od 2010.-2013. godine, zbog uticaja globalne finansijske krize, je odbačena u intervalu povjerenja od 95%. rezultati su pokazali da je gordonov model rasta pouzdan u procjeni vrijednosti akcija, čak i u periodu jakog uticaja globalne finansijske krize. ključne reči: model diskontovanja dividendi, gordonov model rasta, vrednost akcija. evropsko tržište akcija article history: received: 12 may, 2015 accepted: 8 june, 2015 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp149-162 original scientific paper fiscal adjustments in the european union versus west balkans economies: evidence from heterogeneous panels olgica glavaški1* | emilija beker pucar1 1 university of novi sad, faculty of economics subotica, department of international and european economics and business, subotica, serbia abstract this paper empirically assesses heterogeneity of fiscal adjustments in the european union and west balkans economies, in the circumstances when debt crisis renewed the questions when and how governments adjust their public expenditure. the research covers sample of 28 european union economies and 5 west balkans economies over the period 1995-2018. the results based on pmg panel model point to weak fiscal sustainability with significant fiscal adjustments, in average 28.18 % of deviations from equilibrium relationship are corrected in one year. moreover, the research provides heterogeneous evidence of public expenditure adjustments to long-run equilibrium relationship in european union and west balkans economies. according to the results, candidates and potential candidates for european union membership have improved their public finances, however, accession process does not lead to automatic convergence of these economies and fiscal sustainability assessment key words: fiscal adjustments, european union economies, west balkans economies, heterogeneous panels jel classification: c33, h50, h62 introduction the essence of fiscal sustainability framework is the question of time and way to undertake fiscal adjustments. the question of time is related to the phases of business cycle, whether to adjust in expansion or recession phase, while the way is connected to the question whether to cut public expenditure or to raise the taxes, and finally the effects of fiscal adjustments on gdp growth. recent papers in this theme showed that there are fewer costs of fiscal adjustments based on public expenditure in comparison to fiscal adjustments based on austerity measures, and that way of fiscal adjustment is more important in comparison to state of the cycle (alesina at al. 2016). therefore, the research question in this paper is related to the problem how governments of european economies adjust their public expenditures in circumstances of limited capacities of economies, and in some cases overindebtness. focus is on european union economies which are faced with unique monetary and heterogeneous fiscal policies, due to lack of supranational fiscal rules. defined fiscal policy framework with maastricht treaty (1992), stability and growth pact (1997), and fiscal compact (2012), still leave room for heterogeneous fiscal adjustments and fiscal (ir)responsibility in european union economies. special attention in this paper is dedicated as well to west balkans economies which are in the accession phase to * corresponding author: olgicai@ef.uns.ac.rs glavaski.olgica@gmail.com 150 economic analysis (2020, vol. 53, no. 1, 149-162) european union and fiscal adjustments that those economies undertake in order to fulfill defined goal for membership. heterogeneity in the sample is important as well due to eu accession dynamic, namely, each west balkans economy movement forward eu membership is dependent on own results achieved. therefore, fiscal sustainability and heterogeneous fiscal adjustments based on flow model are estimated in this paper using westerlund cointegration test, mean group (mg), pooled mean group (pmg) estimators. the results point to weak fiscal sustainability in european union and west balkans economies and provide heterogeneous evidence of fiscal adjustment of public expenditure to long-run equilibrium relationship. purposed fiscal adjustments in order to assess fiscal sustainability are distinguished from ad hock changes in public expenditure that have reduced efforts for sound fiscal policy. the organization of the paper is as follows. after the introduction, next section briefly shows literature review related to the question of fiscal sustainability and fiscal adjustment. in the next section are defined hypotheses, methods and data. the following, comparative analysis of fiscal variables in the european union and west balkans economies are represented. in the next section, the estimation results for fiscal adjustments using panel cointegration analysis with heterogeneous parameters are given. the last section contains of the main conclusions and policy recommendations. literature review fiscal sustainability and fiscal adjustments have been issued to the debate in european economies and worldwide, especially in the last three decades. the most often are the studies with the aim to estimate fiscal (un)sustainability using time-series analysis, or panel data models with the focus on different groups of economies, while some studies are oriented toward estimation of fiscal reaction function. in the pioneer papers of modern fiscal sustainability concept, the analysis is often based on usa fiscal sustainability and fiscal adjustment. two traditional approaches of fiscal sustainability are identified. first is based on papers from hamilton and flavin (1986) and wilcox (1989), and it is related to the empirical analysis of public debt and primary deficit stationarity. namely, intertemporal budget constraint could be satisfied when the value of public debt corresponds to the sum of future primary surpluses and when present value of public debt approaches zero in infinity. that could be analysed using stationarity test, so when primary deficit is stationary process, fiscal sustainability is achieved and the condition for intertemporal budget constraint is fulfilled. second approach is based on papers from hakkio and rush (1991) and quintos (1995) the cointegration analysis between public expenditure and public revenues. hakkio and rush (1991) showed that if public expenditure and public revenues are integrated of order 1, these two variables could be cointegrated. if the cointegration parameter b is 1, fiscal sustainability is assessed, otherwise, is unsustainable. however, quintos (1995) relaxed previous assumptions, distinguishing strong sustainability condition (when cointegration parameter is b=1, and first difference of fiscal debt is stationary process), from weak sustainability condition (when cointegration parameter is in the range from 0 to 1, and second difference of fiscal debt is stationary process). among the first papers which have analysed fiscal sustainability and fiscal adjustment using these concepts in european economies in the frame of time-series analysis are caporale (1995), vanhorebeek and van rompuy (1995), and further papadopoulos and sidiropoulos (1999), santos bravo and silvestre (2002), afonso (2004), greiner, koeller, and semmler (2004), krejdl (2006), neaime (2015). however, due to relatively lower power of tests proposed for timeseries, in comparison to tests defined for panel data, and due to availability of longer panel datasets in the recent years, panel analysis is more frequently used. rault and alfonso (2007) analysed sample of 15 eu economies for the period 1970-2006 using unit root tests of first and second generation, banerjee and carrion-i-silvestre test (2006), westerlund and edgerton olgica glavaški, emilija beker pucar 151 (2007) cointegration test. the results showed that fiscal policy is sustainable for the eu-15, as well as in the two separated sub-periods 1970-1991 and 1992-2006, and that public expenditure adjusts to long-run equilibrium relationship. in the paper from the year 2015, afonso and rault showed that fiscal sustainability is questionable in some eu countries in the period 1960-2012. in this paper, analysis are undertaken using seemingly unrelated regression sur method, suradf test for level of integration, westerlund (2007) test for cointegration, polled mean group pmg method and common correlated effects cce method. however, we have remarked that bohn (2007) harsh critique the way of fiscal sustainability analysis – based on unit roots and cointegration, pointing out that any finite order of integration of public expenditure, public revenues and public debt leads also to intertemporal budget constraint fulfilment, namely “absurdly weak” sustainability (when the order of integration is m). bohn emphasises that the best option for fiscal sustainability testing is error-correction model, namely, analysis whether fiscal reaction function are determined by level of indebtedness. moreover, fiscal sustainability concept based on flow models (between public revenues and public expenditure) is implemented for different groups of countries and period of time. beside european economies, fiscal sustainability in oecd economies is often subject of investigation. alfonso and jalles (2012) analysed fiscal sustainability in oecd countries in the period 19702010, taking into account structural breaks parallel with cointegration analysis in time-series and in the panel. results show that fiscal sustainability is questionable in majority of countries, and that weak sustainability exists in some countries. in the paper from 2015, afonso and jalles using sample of 18 oecd economies in the period 1970-2010, analysed fiscal sustainability by modern econometric techniques, pesaran cips test, pedroni cointegration tests, fmols method, identifying that accumulation of public debt is the main disturbing factor of fiscal sustainability in this group of countries. westerlund and prohl (2007) undertook dols and fmols methods to estimate non-stationary panels, taking into a consideration structural breaks for 8 oecd countries in the period 1977-2005. chow (2013) as well used fmols and dols methods for heterogeneous panels to estimate fiscal sustainability in 28 countries in the period 1981-2011. author concluded that weak sustainability exists in the analyzed sample and emphasised advantages of methods for heterogeneous panel estimation. josifidis et al. (2018) as well emphasise the importance of heterogeneity in the sample of european union economies, namely, the study provides evidence of heterogeneous effects of different public policies on fiscal sustainability in eu-28. on the other hand, ehrhart and llorca (2008) showed fiscal sustainability in six south-mediterranean countries, while campeanu and andreea (2010) analyzed fiscal sustainability and fiscal reactions in central and eastern european countries, distinguishing economies which fiscal adjustments could improve the ability to run a primary surplus, from economies with opposite responses. kumar, leigh, and plekhanov (2007) focused on fiscal consolidation in oecd economies, identifying short-run and long-run effects of fiscal adjustments on economic activity; short-run effects could be contractionary, while long-run could be expansionary. yang, fidrmuc, and ghosh (2015) confirmed contractionary effects of fiscal adjustment in oecd economies in the short-run, and in line with the results of alesina (2016), authors show that spending-based fiscal adjustments lead to smaller output losses in comparison to tax-based fiscal adjustments. summing up all the findings in the literature, there are two main concepts of fiscal sustainability analysis (stationarity analysis and cointegration analysis) and relatively novel methodology based on multicointegration analysis (engsted, gonzalo, and haldrup, 1997, and camarero, carrion-i-slvestre and tamarit, 2013). there also different econometric techniques for estimation, different groups of countries and length of time dimension in studies, and therefore, there is no common conclusion related to fiscal adjustments and strong/weak fiscal sustainability versus fiscal unsustainability in analysed groups of countries. 152 economic analysis (2020, vol. 53, no. 1, 149-162) hypotheses, methodology and data taking into a consideration conclusions from the literature review, especially critiques of stationarity and residual-based cointegration tests in paper of bohn (2007), in this paper we estimated error-correction model and heterogeneous short-run adjustments in the sample of 28 european union economies and 5 west balkans economies in the period 1995-2018. following research hypotheses are tested: h1: cointegration relationship between flow variables exists in homogeneous parameters ‐ fiscal sustainability exists in the sample of european union and west balkans economies. h2: short‐run fiscal adjustments to equilibrium long‐run relationship are heterogeneous in the sample of european union and west balkans. the research methodology in this paper is based on heterogeneous, nonstationary panel data framework, which allows the analysis on fiscal adjustments across west balkans and european union economies and differences over the time. the sample contains the data on 33 economies, namely 28 european union members and 5 west balkans economies (albania, bosnia and herzegovina, montenegro, north macedonia, and serbia) over the period 1995-2018. an important goal in this paper to estimate heterogeneous fiscal adjustments to long-run cointegration relationship (hypotheses 2), and therefore, preferable models are proposed by pesaran, shin, and smith (1999) mean group (mg) or pooled mean group (pmg) estimator. panel error-correction model is described as: ∆𝑙𝑡 𝛷 𝑡 𝜃 𝑙𝑔 ∑ 𝜆∗ ∆𝑙𝑡 , ∑ 𝛿 ∗ ∆𝑙𝑔 , 𝜇 𝑢 (1) where, 𝛷 is error-correction parameter, indicating speed of adjustment to long-run equilibrium relationship, 𝜃 is long run relationship, 𝜆∗ is coefficient of lagged dependent variable, 𝛿∗ is short-run parameters for each panel unit, 𝜇 represents individual effects. mg is based on estimation of n time-series regressions and averages coefficients, while pmg is based on equal long-run relationship across all panel units and averaging of coefficients (short-run adjustments). in order to find out whether the restriction related to homogeneous long-run relationship in pmg model is true, hausman test is used. if long-run relationship is homogeneous, namely, if the restriction in pmg model is true, the estimates are efficient and consistent. in opposite, pmg method provides inconsistent estimates. mg model assumes heterogeneous long-run equilibrium relationships, and provides consistent estimates in both cases. short-run adjustments are heterogeneous in both models. the source of data is world economic outlook (april 2019), namely, international monetary fund. used software is stata 13. comparative analysis of fiscal variables in the european union economies versus west balkans economies there is no doubt relating the diversity of fiscal behavior in group of european union economies and west balkans economies through the period of 1995-2018. although the west balkans economies are geographically surrounded by european union member states, european perspective of these economies are determined by overall economic, structural and political reforms. west balkans economies have passed the long way since the end of the 1990s till today and managed to make significant progress (about financial structure, see in janković, 2019). according to the strategy to strengthen the european union by 2025, serbia and montenegro could complete the accession process in a 2025 perspective, for albania and north macedonia the commission is ready to prepare recommendations to open accession negotiations, while for bosnia and herzegovina, the commission will give the opinion (european commission 2018). moreover, european commission defined six flagship initiatives related to specific actions which olgica glavaški, emilija beker pucar 153 could improve their position in accession process. the specific interest in this paper is related to fiscal adjustments in west balkans economies in comparison to european union economies, and their progress in this field is estimated as follows by the european commission for the year 2019: for albania still remains essential to ensure effective, efficient and transparent functioning of public finance management; bosnia and herzegovina should adopt strategy for public administration and public finance management, and establish monitoring framework in order to ensure financial sustainability; in montenegro is undertaken public financial management reform in 2018, however, budget transparency have to be ensured; north macedonia improved public finance and transparency, however, composition of public expenditure worsened which threatens fiscal sustainability; related to serbia, it is emphasized weakness in public finance management and in defined fiscal rules, together with the need to improve competitiveness (domazet, zubovic and lazic, 2018) . differences do not exist only between european union economies and west balkans economies. the fiscal balance could be used in order to measure differences among economies in the context of fiscal sustainability, and the range is from −32.5 % of gdp in the year 2010 in ireland to 6 % of gdp in luxemburg in the year 2006. it turns out that important differences already exist in the sample of eu members, and certainly between eu members vs. (potential) candidates’ economies. average fiscal balance per annum for all analyzed economies shows two years as extremes: 2007 the lowest fiscal deficit was achieved (−0.2 % of gdp), and 2009 the highest fiscal deficit was achieved due to influence of global instability (−6.3 % of gdp). according to this, it is assumed heterogeneity within the sample and differences during the analyzed period. using data related to public expenditure and public revenues, the situation is as follow. in european union members, public revenues share in gdp on average were stabile during analyzed period of time, while public expenditure share in gdp fluctuated (figure 1). namely, in the period before global instability, public expenditure in average decreased, and achieved fiscal balance in average in the year 2007. global crisis caused higher indebtedness in the period 2008-2010, which accompanied with decrease of gdp in the years of global crisis determined sharp increase of public expenditure (7.7 p.p. in average of european union members). in the period 2011-2018, fiscal balance positions of european union member economies were improved. on the other hand, during analyzed period of time, west balkans economies on average have experienced lower public revenues and public expenditure in comparison to european union economies. public expenditure share in gdp in west balkans economies had similar path as in member states, while public revenues fluctuated more. this could be related to the fiscal reform in west balkans economies. 154 economic analysis (2020, vol. 53, no. 1, 149-162) figure 1. public expenditure and public revenues in the group of european union and west balkans economies source: authors. beside observed distinctions between european union and west balkans economies, profound analysis could indicate individual differences within each group. in european union economies during the period 1995-2018, public revenues varied from 25.77 % of gdp in ireland in 2018 to 57.341 % of gdp in sweden in 1996, while average public expenditure fluctuated from 25.73 % of gdp in 2018 to maximum value of 65.046 % gdp in 2010 both in ireland. therefore, ireland was the economy with the highest fluctuations of public expenditure in analyzed period of time. in the west balkans economies fiscal revenues varied from 19.393 % of gdp in albania in 1997 to 54.721 % of gdp in bosnia and herzegovina in 1999, and public expenditure from 28.229 % of gdp in albania in 2012 to 57.503 % of gdp in bosnia and herzegovina in the year 1999. this indicates important differences between two groups of economies and within two groups, emphasizing that although all analyzed economies belong to european continent and all economies are member or in the accession phase to european union, it is necessary to analyze specificities of each country’s fiscal adjustments, namely, it is important to use heterogeneous coefficient in panel estimations. testing fiscal adjustments in the european union versus west balkans economies econometric framework for fiscal sustainability and fiscal adjustment estimation is selected taking into account potential problems of heterogeneity, nonstationarity, and cross-sectional dependency in the panel. in the beginning, anova f-test and welch f-test are used to test the variability for each economy for key variables. the results showed heterogeneity in analyzed sample in the most important fiscal sustainability variables (results are shown in table 1). next, cross-sectional dependency is tested using pesaran cd test in the pre-estimation phase for all variables (table 1), and results indicated that in all cases null hypothesis of cross-section independency has to be rejected. detected dependency is expected due to the fact that all 20 25 30 35 40 45 50 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 20 16 20 17 20 18 public revenues eu28 public expenditure eu28 public revenues wb public expenditure wb olgica glavaški, emilija beker pucar 155 economies in the sample are members of european union or in the accession phase, and certainly linked by strong institutional framework (customs union, common market, common agricultural policy, tax harmonization, and finally, monetary union). although a large degree of the competencies are directly related to the level of european union, fiscal policy is not unified. therefore, mechanisms of fiscal deficit reduction could not be the same, but given that it is directed by the same framework, the similarities must exist. this could explain the existence of cross-sectional dependency and heterogeneity in the model. table 1. variability testing in countries and pesaran cd test variables anova f‐test welch f‐test cross‐sectional dependency test teststat. pvalue teststat. pvalue cdtest pvalue correlation aps. (corr.) fiscal deficit 7.22 0.000 13.1202 0.000 25.80 0.00 0.297 0.370 public revenues 234.5 0.000 424.055 0.000 5.79 0.00 0.051 0.346 public expenditure 95.82 0.000 165.78 0.000 24.02 0.00 0.213 0.342 public debt 54.96 0.000 224.897 0.000 6.2 0.00 0.77 0.507 source: authors’ calculation. cross-sectional dependency in the sample, conditioned the use of second generation panel unit root test – pesaran cips test (2007). westerlund and prohl (2007) showed that inclusion of trend in the model when all variables are represented in the form of gdp share is redundant, so decisions are made on the basis of models with constant, and according to akaike information criteria to determine optimal lag in model. results of pesaran cips test (table 2) indicated that variables are nonstationary. next, the stationarity of variables first differences is tested, and results of pesaran cips test showed stationary of variables in first differences, namely, all variables in the model are integrated of order 1. results of pesaran’s unit root test indicate assessment of fiscal sustainability, due to difference stationarity of fiscal deficit, while first order of integration of public revenues and public expenditure is the base for cointegration analysis. table 2. pesaran unit root test cips test ho: i(1); h1:i(0) l a gs model with constant a level of variables first difference of variables 𝑍 𝑡̅ -statistika (cips) p-value 𝑍 𝑡̅ -statistika (cips) p-value public revenues 0 -1.527 0.063 -22.596 0.000 1 -2.546 0.050 -14.264 0.000 2 1.355 0.912 -7.525 0.000 public expenditure 0 -1.920 0.027 -20.617 0.000 1 -0.824 0.205 -11.768 0.000 2 -0.530 0.702 -7.098 0.000 public debt 0 3.039 0.999 -15.115 0.000 1 -0.154 0.288 -8.025 0.000 2 2.956 0.987 -3.565 0.005 source: authors’ calculation. 156 economic analysis (2020, vol. 53, no. 1, 149-162) results based on heterogeneous panel coefficients according to the results of possible heterogeneity in the model, as well as cross-sectional dependency, the analysis is continued using westerlund (2007) cointegration test, between variables integrated of order 1, public expenditure and public revenues. in application of westerlund (2007) cointegration test an important assumption is related to the causality of variables. in the equation proposed in section related to hypothesis and methodology, causality is defined from public expenditure to public revenue, indicating uncompleted control of public expenditure, namely hypothesis “spend and tax”. in order to check causality nexus, granger causality test, and dumitrescu-hurlin (2012) test for heterogeneous causality in panels are undertaken (table 3). table 3. causality testing granger test public expenditure doe not granger cause public revenues fstat. p-value 4.39461 0.0127 dumitrescu and hurlin causality test in heterogeneous panels public expenditure does not homogeneously cause public revenues w-stat. �̅�stat. p-value 3.72899 2.97950 0.0029 source: authors’ calculation. results of granger-lee and dumitrescu-hurlin (2012) tests for heterogeneous causality in panels are presented in table 3, indicating that causality goes from public expenditure to public revenues, and that heterogeneous causality exists. therefore, westerlund (2007) test is a good solution for cointegration testing, due to the fact that one of the assumptions of westerlund test is existence of heterogeneous panels, and in this case, causality is heterogeneous and goes from public expenditure to public revenues. table 4. westerlund (2007) cointegration test test values z‐values p‐values bootstraped p‐values h0: no cointegration h1: at least one panel unit is cointegrated gt -1.989 -5.594 0.000 0.023 ga -7.214 -4.309 0.000 0.013 h0: no cointegration h1: all panel units are cointegrated pt -10.417 -6.412 0.000 0.010 pa -6.008 -9.885 0.000 0.005 aic selected lag length: 1; aic selected lead length: 2. source: authors’ estimation. the results in table 4 are for the assumption “spend and tax”, while the lead and lag lengths structure are chosen using aic criteria, for the model with constant. due to the fact that crosssectional dependency exists in panel, westerlund (2007) test could provide relevant conclusion only after bootstrap procedure. robust p-values are calculated using bootstrap procedure in 400 steps. conclusion related to westerlund test using group mean tests (gt and ga) and pooled panel tests (pt and pa) is that at least one panel unit is cointegrated or all panel units, and therefore is necessary to estimate heterogeneous coefficients with the intention to find out in which panel units (countries) exist cointegration, and in which countries not. mean group and pooled mean group methods are furthermore used to estimate long-run equilibrium relationship between public expenditure and public revenues, as well as short-run olgica glavaški, emilija beker pucar 157 fiscal adjustment to long-run relationship, according to empirical instructions proposed by blackburne and frank (2007). table 5 represents only homogeneous coefficients in model. according to the results of homogeneous coefficients in both cases cointegration vector is significant and between 0 and 1: 0.496 in mg model and 0.475 in pmg model. using quintos (1995) terminology, these results indicate weak fiscal sustainability in european union and west balkans economies. in comparison of two methods, higher long-run coefficient is estimated for mean group method, as well as fiscal adjustment. namely, fiscal adjustment in mg model is 0.3473, indicating that 34.73% of deviations are corrected in one year, while short-run fiscal adjustment in pmg model is -0.2818, showing that 28.18% of deviations are in average corrected in one year. however, hausman test for long-run relationship homogeneity showed that pmg method provides optimal specification, with consistent and efficient estimates. table 5. homogeneous coefficients of mg and pmg estimators for european union economies and west balkans economies in the period 1995-2018 dependent variable: log public revenues homogeneous long‐ run relationship (𝜽) ∆𝒍𝑬 𝝁𝒊 error correction (𝜱𝒊) coef. p‐value coef. p‐ value coef. p‐ value coef. p‐ value mg 0.496121 0.000 0.07643 0.163 1.1432 0.000 -0.3473 0.000 weak fiscal sustainability pmg 0.475849 0.000 0.09007 0.009 0.83392 0.000 -0.2818 0.000 weak fiscal sustainability hausman test for long‐run relationship homogeneity hausman test statistics 0.04 p-value 0.8381 ardl (1,1) source: authors’ estimations. tabela 6. heterogeneous coefficients of pmg estimator for european union and west balkans economies in the period 1995-2018 dependent variable: log public revenues error‐correction (𝜱𝒊) ∆𝒍𝑬 𝝁𝒊 countries coeff. p-value coeff. p-value coeff. p-value european union economies austria -0.632 0.001 0.119 0.334 2.1402 0.002 belgium -0.345 0.000 -0.046 0.459 1.1779 0.001 cyprus -0.244 0.085 -0.427 0.009 0.7525 0.001 estonia -0.878 0.000 0.010 0.939 2.7521 0.000 finland -0.143 0.154 -0.012 0.847 0.5002 0.168 france -0.247 0.020 -0.163 0.264 0.8461 0.022 germany -0.012 0.908 0.016 0.830 0.4448 0.906 greece -0.181 0.044 -0.089 0.770 0.6126 0.032 ireland -0.137 0.243 0.264 0.002 0.2931 0.367 italy -0.422 0.002 -0.009 0.936 1.4018 0.003 latvia -0.252 0.098 0.1853 0.100 0.6817 0.092 lithuania -0.164 0.225 0.1797 0.086 0.4190 0.173 luxemburg -0.101 0.307 0.1496 0.004 0.3542 0.312 malta -0.202 0.040 -0.240 0.196 0.5840 0.041 netherlands -0.174 0.141 -0.059 0.473 0.5715 0.151 portugal -0.312 0.001 -0.304 0.040 0.9839 0.001 slovak republic -0.256 0.044 0.3095 0.012 0.7167 0.050 158 economic analysis (2020, vol. 53, no. 1, 149-162) slovenia -0.459 0.017 -0.0681 0.521 1.4587 0.025 spain -0.228 0.024 -0.547 0.008 0.648 0.034 bulgaria -0.286 0.046 0.1345 0.251 0.8122 0.046 uk -0.076 0.491 -0.278 0.045 0.2322 0.406 croatia -0.406 0.017 0.7084 0.001 1.2804 0.021 hungary -0.237 0.037 -0.1668 0.277 0.7651 0.043 poland -0.403 0.023 0.3739 0.123 1.2206 0.025 romania -0.361 0.023 0.255 0.039 0.7091 0.032 czech republic -0.184 0.087 0.2534 0.048 0.5811 0.176 denmark -0.194 0.050 -0.410 0.594 0.6744 0.061 sweden -0.218 0.048 -0.011 0.901 0.7521 0.052 west balkans economies albania -0.451 0.010 0.775 0.001 0.5200 0.034 bosnia and herzegovina -0.157 0.276 0.224 0.040 0.5268 0.284 montenegro -0.381 0.007 0.643 0.000 1.2177 0.008 north macedonia -0.438 0.003 0.203 0.115 0.9835 0.006 serbia -0.193 0.412 0.630 0.000 0.3020 0.402 source: authors’ estimation. pmg estimates show that exist significant long-run equilibrium relationship in the sample (european union and west balkans economies in period 1995-2018), and weak fiscal sustainability (table 5). according to error-correction in the model, 28.18 % of deviation from equilibrium is in average corrected in one year. table 6 shows heterogeneous fiscal adjustments estimated by pmg method. based on results, fiscal adjustments are the highest in estonia and austria, while the most weak but significant fiscal adjustment is estimated for greece. although with expected sign, fiscal adjustments are not significant in some economies in the sample, which could be interpreted differently. for instance, in germany and luxemburg, fiscal adjustment in terms of public expenditure adjustments to long-run equilibrium relationship, is not significant because of existence of opposite hypothesis in this economies, “tax and spend”, and higher average public revenues in comparison to average public expenditure. in other economies it could be due different fiscal policy framework (welfare state such as finland), or because of the influence of global instability (ireland). for west balkans economies individual fiscal adjustments are more intensive than average fiscal adjustment, namely, 45.1% in albania, 38.1% in montenegro, 43.8% in north macedonia, showing that west balkans economies have some progress in the period 1995-2018 related to fiscal adjustments and stabilization of public finances. results indicated that fiscal adjustments for serbia and bosnia and herzegovina are not significant. this result for serbia is in line with the paper of andrić, arsić, and nojković (2016) which showed that corrective actions of government in serbia were insufficient before and after global crisis, and provided empirical support to the fiscal fatigue hypothesis. for the bosnia and herzegovina, in the report for 2019, european commission estimated fiscal policy as vulnerable to inefficiency and waste, and emphasized need for fiscal adjustments, especially in building-up sufficient fiscal buffers. the relevance of the results is analysed by robustness check in time dimension by reduction in the analysed period. years 1995 and 1996 are excluded from the model, in order to test robustness and whether introduction of stability and growth pact in 1997, significantly changed results. estimated model is presented in appendix (tables 1a and 2a) and confirms validity of the results heterogeneous fiscal adjustments and weak fiscal sustainability in european union and west balkans economies. average fiscal adjustment is higher in comparison to the baseline model, namely, 30.34% of deviations are corrected in one year, meaning convergence after the adoption of stability and growth pact in 1997. finally, it is concluded that hypothesis 1 and 2 are confirmed: weak fiscal sustainability exists in the panel of european union and west balkans economies according to homogeneous olgica glavaški, emilija beker pucar 159 coefficients, while fiscal adjustments to long-run equilibrium relationship are heterogeneous in the sample; namely in some economies fiscal adjustments are negatively and significant with different magnitude of influence, while in others is defined ad hock. conclusion this paper empirically assesses heterogeneity of fiscal adjustments in european union and west balkans economies, in the circumstances when debt crisis renewed questions when and how governments adjust their public expenditure. the research covers panel of 28 european union economies and 5 west balkans economies over the period 1995-2018. the paper operates within non-stationary, heterogeneous panels using flow relationship. the results based on pmg model point to weak fiscal sustainability and that in average 28.18 % of deviation from equilibrium relationship is corrected in one year. moreover, the results provide heterogeneous evidence of public expenditure adjustments to long-run equilibrium relationship in european union and west balkans economies. the highest significant values are estimated in austria and estonia, and the lowest significant value in greece, while fiscal adjustments are insignificant in some economies, due to influence of global instability or fiscal policy framework. results showed that accession process for west balkans economies does not lead to automatic convergence of countries and fiscal sustainability assessment, although significant fiscal adjustments are noted in albania, 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(2015). “macroeconomic effects of fiscal adjustment: a tale of two approaches.” journal of interntional money and finance, 57 (october2015): 31-60. olgica glavaški, emilija beker pucar 161 appendix table 1a. robustness check: pmg estimator for european union and west balkans economies in period 1997-2018 dependent variable: log public revenues homogeneous long‐ run relationship (𝜽) ∆𝒍𝑬 𝝁𝒊 error correction (𝜱𝒊) coef. p‐value coef. p‐value coef. p‐value coef. p‐value mg 0.46855 0.000 0.0485 0.347 1.2827 0.000 -0.3672 0.000 pmg 0.28402 0.000 0.10185 0.059 1.3888 0.000 -0.3034 0.000 hausman test for long‐run relationship homogeneity hausman test statistics 0.27 p-value 0.3120 ardl (1,1) source: authors’ estimations. tabela 2a. robustness check: heterogeneous coefficients of pmg estimator for european union and west balkans economies in the period 1997-2018 dependent variable: log public revenues error‐correction (𝜱𝒊) ∆𝒍𝑬 𝝁𝒊 countries coeff. p-value coeff. p-value coeff. p-value european union economies austria -0.6080 0.001 0.248 0.025 3.1661 0.001 belgium -0.225 0.099 0.0311 0.444 1.1865 0.097 cyprus -0.227 0.005 -0.479 0.079 1.0475 0.002 estonia -0.460 0.011 0.298 0.018 2.1045 0.011 finland -0.703 0.000 -0.083 0.166 3.7644 0.001 france -0.059 0.558 -0.417 0.796 0.3147 0.554 germany -0.135 0.349 0.0235 0.755 0.6911 0.348 greece -0.201 0.091 -0.149 0.693 0.6126 0.032 ireland -0.076 0.526 0.295 0.000 0.2109 0.656 italy -0.197 0.137 0.1522 0.161 1.1011 0.136 latvia -0.168 0.170 0.232 0.026 0.6762 0.170 lithuania -0.157 0.248 0.1191 0.117 0.5995 0.220 luxemburg -0.294 0.050 0.1281 0.006 1.5122 0.051 malta -0.285 0.010 -0.062 0.722 1.3007 0.009 netherlands -0.288 0.072 -0.067 0.458 1.4340 0.071 portugal -0.268 0.013 -0.266 0.097 1.3196 0.012 slovak republic -0.214 0.083 0.3711 0.003 0.9347 0.084 slovenia -0.909 0.000 -0.0542 0.460 4.3751 0.000 spain -0.350 0.008 -0.572 0.006 1.5689 0.009 bulgaria -0.245 0.086 0.1936 0.104 0.9923 0.087 uk -0.400 0.002 -0.416 0.001 1.6591 0.001 croatia -0.371 0.032 0.779 0.000 1.8821 0.033 hungary -0.205 0.088 -0.175 0.224 1.0348 0.089 poland -0.548 0.005 0.2833 0.264 2.5643 0.006 romania -0.401 0.017 0.260 0.015 1.2981 0.016 czech republic -0.190 0.311 0.234 0.181 0.9165 0.299 denmark -0.282 0.077 -0.405 0.606 1.5071 0.079 sweden -0.153 0.104 -0.028 0.763 0.8064 0.107 west balkans economies albania -0.488 0.005 0.376 0.046 0.999 0.002 bosnia and herzegovina -0.279 0.288 0.244 0.007 1.4301 0.008 162 economic analysis (2020, vol. 53, no. 1, 149-162) montenegro -0.318 0.011 0.722 0.000 1.5587 0.012 north macedonia -0.264 0.085 0.580 0.643 0.860 0.101 serbia -0.030 0.751 0.686 0.000 0.1528 0.738 source: authors’ estimation. article history: received: august 6, 2019 accepted: september 27, 2019 microsoft word 2009_1_2.doc administrative practice in nigeria: implications for national development m. a. omolaja, president, international college of management and technology, ayetoro-yewa, nigeria jel: h83,n47 abstract – administration cannot be practiced in isolation of the culture of the society. this assertion implies that the knowledge, attitude, societal norms and orientation which people hold epitomize their administrative philosophy and the way it is practiced. administration in nigeria is practiced in ways and manners which will benefit the administrator and in most cases not in the best interest of the common man. whether in the private sector or in the public sector, the nigerian administrators would normally use their positions and every other resource at t