WORLD BANK GROUP Boosting Foreign Direct Investment November 2021 Kosovo Country Economic Memorandum  1 Kosovo Country Economic Memorandum Boosting Foreign Direct Investment Table of Contents Acknowledgments 5 Abbreviations  6 Executive Summary 7 Foreign Direct Investment in Kosovo: Trends and Challenges 9 Evolution of FDI Inflows 10 Greenfield Investment Announcements 11 Composition of FDI Inflows  12 FDI Inflows by Sector 13 FDI Inflows by Investor Motivation 14 FDI Inflows by Source Country 15 Effect of COVID-19 on FDI 16 Determinants of Competitiveness  19 Economic Factors  21 Market Size and Growth 21 Industry Structure 21 Infrastructure 22 Human Capital 22 Policy and Institutional Factors 22 Macroeconomic Factors and Political Risk 22 Microeconomic Factors 23 The Investment Reform Agenda 27 Area 1: Sharpening the Focus of FDI Attraction and Retention Efforts through a New FDI Strategy  28 Area 2: Enhancing Investor Services by Empowering KIESA  30 Area 3: Increasing Investor Confidence by Reestablishing an Effective Investor Grievance Mechanism  33 The Reform Action Plan 36 Annex 39 Annex A. Improving Investment Incentives 40 Annex B. FDI Sector Scan 42 Annex C. Good Practice in the Design and Implementation of an Investor Grievance Mechanism 43 Annex D. Kosovo’s Performance on the Western Balkans 2018 Regional Investor Survey 44 Annex E. Standards of Investor Protection 46 References 47 2  Figures Fig 1.1  FDI inflows into Kosovo, Fig 2.1  Annual labor costs in Kosovo Fig 2.6  Kosovo’s performance on 2007–20 p.10 and selected comparators, key business environment Fig 1.2  Net FDI inflows into Kosovo and by skill level, 2019 p.20 measures relative to comparators, 2004–19 p.11 Fig 2.2  Kosovo’s performance comparators p.25 Fig 1.3  Greenfield FDI as share of on market and industry Fig 3.1  Kosovo’s performance GDP in 2003–19, in Kosovo determinants of FDI relative on investment attraction and comparators p.12 to comparators, 2019 p.21 and promotion relative to Fig 2.3  Kosovo’s performance on average for six Western Fig 1.4  FDI inflows into Kosovo, by type infrastructure and factor Balkan countries p.31 of investment, 2012–20 p.12 input determinants of FDI Fig 3.2  Kosovo’s performance on Fig 1.5  FDI inflows into Kosovo, by relative to comparators p.22 investment protection and sector, 2007–19 p.13 Fig 2.4  Kosovo’s performance retention relative to average Fig 1.6  Shares of number of for six Western Balkan on macroeconomic and greenfield FDI project countries p.33 political risk determinants of announcements in Kosovo, FDI relative to comparators Fig B.1  Sector scan framework for by motivation and subsector, p.23 selecting priority subsectors Percent p.14 Fig 2.5  Kosovo’s performance on for FDI promotion p.42 Fig 1.7  Effects of COVID-19 on entry and establishment of a global FDI inflows and FDI business relative to average announcements, 2015–20, for six Western Balkan USD billion and Percent countries p.24 change p.17 Tables Boxes Table 3.1  Staff and financial Table D.2  Results of 2018 regional Box 1.1 The Dunning typology of FDI resources of investment investor survey on motivations p.15 promotion agencies in performance of Kosovo Box 1.2  How has COVID-19 affected Kosovo and comparator and average for six Western investors in Kosovo? p.16 groups p.31 Balkan countries on Box 3.1  Could Kosovo benefit Table 3.2  Investment policy and investment attraction and from a post-COVID-19 promotion reform action promotion (percent) p.44 reconfigurations of global plan p.36 Table D.3  Results of 2018 regional value chains? p.29 Table A.1  Results of 2018 regional investor survey on Box 3.2  Ireland’s focused investment investor survey on performance of Kosovo and strategy p.30 performance of Kosovo average for six Western Balkan countries on investment Box 3.3  What does KIESA do? p.30 and average for six Western Balkan countries protection and retention Box 3.4  Investor grievance on investment incentives (percent) p.45 mechanisms in Ethiopia, (percent) p.40 Table D.4  Results of 2018 regional Bosnia and Herzegovina, and investor survey on Georgia p.34 Table D.1  Results of 2018 regional investor survey on performance of Kosovo Box A.1  Measuring the costs and performance of Kosovo and average for six benefits of incentives for FDI and average for six Western Balkan countries p.41 Western Balkan countries on investment incentives on investment entry and (percent) p.45 establishment (percent) p.44 Table E.1  Standards of investor protection p.46 Table E.2  Level of investor protection provided by Kosovo’s Foreign Investment Law and international investment agreement p.46  3 © 2021 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. 4  Acknowledgments This note was prepared by the World Bank Group Investment Policy and Promotion Team. Its main authors are Harald Jedlicka, Jana Krajcovicova, Yan Liu, Dayo Ojaleye, and Zenia Rogatschnig. Linda Van Gelder (Country Director, Western Balkans); Massimiliano Paolucci (Country Manager, Kosovo and North Macedonia); Jasmin Chakeri (Practice Manager, Macroeconomic, Trade, and Investment), and Zhenwei Qiang (Practice Manager, Finance, Competitiveness, and Innovation Global Practice) oversaw the work. This note has been prepared as part of the Kosovo Country Economic Memorandum led by Aslı Şenkal (Senior Economist, Task Team Leader). The note benefited from comments from Enrique Blanco Armas (Lead Economist), Ivan Anton Nimac (Lead Private Sector Specialist), and Blerta Qerimi (Senior Private Sector Specialist). The team is grateful to the Ministry of Trade, Entrepreneurship, and Industry; the Kosovo Investment and Enterprise Support Agency (KIESA); and private sector institutions for their support for the analysis.  5 Abbreviations BPS World Bank business pulse survey CEFTA Central European Free Trade Agreement EU European Union FDI foreign direct investment GVC global value chain ISDS investor–state dispute settlement IT information technology KIESA Kosovo Investment and Enterprise Support Agency LSI Law on Strategic Investments NCED National Council of Economic Development SME small and medium-size enterprise VAT value-added tax 6  Executive Summary Foreign direct investment (FDI) can bring many benefits to Kosovo’s economy, creating more and better jobs and spurring greater and more resilient economic growth. FDI can provide access to regional and global value chains (GVCs) that support value-added exports. It can increase productivity, through technology transfers, higher quality standards through backward linkages with domestic suppliers (Javorcik 2004), and enhanced competition. Many transition economies have used FDI as a pillar of their structural transformation and modernization efforts. Over the past several years, North Macedonia and Serbia have benefited from rising FDI and actively integrating into GVCs. Bosnia and Herzegovina has also benefited, albeit to a lesser degree. As a result of FDI, these economies have also improved the technology structure and skill intensity of their exports (World Bank 2019f ) and increased productivity. Once they achieved a critical mass of FDI, they put in place policy frameworks aimed at maximizing domestic linkages and spillovers. The small number of firms in Kosovo that include FDI are more productive than other firms, and they were more resilient in the wake of the COVID-19 economic recession. Domestic small and medium-size enterprises (SMEs) alone cannot address Kosovo’s high structural unemployment and lift growth to a path that will provide a faster convergence to the living standards of the European Union (EU). On average, enterprises with significant foreign shareholding in Kosovo have more formal employees, are more productive and capital intensive, and pay higher wages than domestically owned companies. Firms that are globally integrated through FDI and exports dealt with the shock better than domestic-oriented firms, confirming the importance of FDI in fostering economic growth, resilience, and job creation. Kosovo has received very limited FDI inflows in recent years. After a short period of growth in the early 2000s, Kosovo’s total FDI inflows have been stagnating at a low level since 2015. FDI inflows have been consistently lower than regional comparators’, in both absolute terms and relative to the size of the economy. Greenfield investments, which tend to have the greatest impact on employment, have also been lower in Kosovo than in regional and structural peer groups. In Kosovo, FDI inflows have been concentrated in sectors that provide limited potential for productivity spillovers and benefits to the domestic economy. FDI flows have been concentrated largely in non-tradable, domestic market– seeking sectors such as construction and real estate. There is very limited FDI in export-oriented or higher-value-added manufacturing and services sectors, which tend to have greater impact on innovation, productivity gains, and job creation. Structural constraints limit FDI attraction, especially greenfield FDI. The weak rule of law remains a particularly problematic area for investors. Kosovo’s investment legislation and regulations generally adhere to EU standards, but implementation remains weak (World Bank 2017b), because of insufficient institutional capacity, shortcomings in the judicial system, limited transparency in policymaking processes, and weak regulatory enforcement. Kosovo has undertaken reforms to improve the business environment, but important gaps remain. Frequent power outages, low human capital, inadequate infrastructure, poor governance, and regulatory uncertainty also restrict FDI inflows. Limited international recognition and shifting domestic policy priorities are a challenge to investors and the swift implementation of reforms. Since Kosovo gained independence, the government has taken steps to integrate its trade and investment flows within the region. In 2007, Kosovo signed the Central European Free Trade Agreement (CEFTA) agreement. In 2015, it ratified the Stabilization and Association Agreement (SAA) with the European Union (Official Journal of the European Union 2016) and agreed to a European Reform Agenda (Republic of Kosovo 2016) in which promoting FDI and improving the business environment are priorities. Kosovo’s National Development Strategy, released in 2016, highlights the business environment (as pillar three of four) and includes promoting FDI among its policy objectives. The Common Regional Market action plan, which Kosovo agreed to in 2020, aims to make the Western Balkans region more attractive for investment and trade. Attracting higher FDI could pave the way for a faster economic recovery from COVID-19. The COVID-19 crisis creates both challenges and potential opportunities for FDI and GVCs in the region, including in Kosovo. The pandemic and FDI megatrends have the potential to lead to the nearshoring of some value chains—for medical equipment and other manufactured items, for example—including some in Kosovo’s target industry segments. Kosovo needs to adopt proactive policies to strengthen its investment competitiveness and investor outreach in order to unlock more and higher-quality FDI. In parallel, reforms to enhance political stability, step up the control of corruption, and strengthen regulatory quality will be needed. Reducing infrastructure and human capital gaps are also key to boosting FDI. Kosovo’s young population, competitive labor costs, low tax rates, high levels of Internet access, proximity to an affluent and large market, and relative ease of doing business represent major strengths for attracting FDI. This note proposes an ambitious reform agenda that can help improve Kosovo’s investment competitiveness and investor outreach. It proposes a step-by-step reform program for unlocking the full potential of FDI for economic growth and job creation in Kosovo that the government can implement in the short to medium term. The note is structured in three sections. The first section looks at Kosovo’s FDI performance and assesses the quantity and quality of the FDI attracted so far. The second section benchmarks Kosovo’s locational FDI determinants, considering a set of macroeconomic and microeconomic indicators for its overall FDI competitiveness. The third section combines the findings from the first two sections with an in-depth assessment of Kosovo’s policy, legal, and institutional framework for investment to propose a targeted reform agenda and policy action plan to help attract more and higher-quality investments to Kosovo.  7 1. 01 Foreign Direct Investment in Kosovo: Trends and Challenges Foreign direct investment (FDI) can bring many benefits to host countries and spur their economic growth and participation in global value chains (GVCs). It is the largest source of external finance for developing countries, contributing more than remittances or official development assistance (World Bank 2020d). Beyond the direct financial benefits, empirical studies find that FDI can be a significant contributor to job creation and help boost domestic firms’ productivity through demonstration and linkages effects (Javorcik, 2004, 2008; Javorcik and Spatareanu 2008; Havranek and Irsova 2011; Irsova and Havranek 2013; Liu, Wang, and Wei 2009). It can also contribute to deeper trade linkages and improved access to technology, managerial practices, and skills (Saurav and Kuo 2020). Evolution of FDI Inflows Kosovo’s FDI performance can be divided into three periods (figure 1.1): • A short period of growth from 2004 to 2007. Before the 2007/08 financial crisis, Kosovo received increasing FDI inflows and project announcements, in line with the global and regional increases in FDI that took place following the first wave of European Union (EU) integration. Kosovo privatized many industries during this period, including in the energy, metal, postal, and telecom sectors.1 • An extended period of contraction from 2008 to 2015. The 2007/08 financial crisis set back FDI, and structural impediments held back the revival of FDI inflows in the years that followed. Despite expectations of economic reforms as a result of national independence in 2008 and the signing of the Central European Free Trade Agreement (CEFTA), FDI inflows as a percentage of GDP fell 38 percent between 2007 and 2011, a much steeper decline than in Kosovo’s regional comparators, among whom the decline was 23 percent.2 FDI continued to decline between 2011 and 2014, despite implementation of many Doing Business reforms. The euro zone crisis; the slow pace of privatization in Kosovo’s manufacturing, telecom, and energy sectors in 2012; and internal political instability, fragile institutions, the perception of high levels of corruption, and perceived inefficiencies in the domestic legal framework deterred FDI (Sahiti, Ahmeti, and Sahiti 2020). • A phase of timid growth from 2016 to 2019. Ratification of the Stabilization and Association Agreement (SAA) with the European Union in 2016 improved Kosovo’s attractiveness for FDI. It liberalized Kosovo’s trade with all EU member states; strengthened regional cooperation, by further aligning its political and economic policies with EU member states; and set the stage for the implementation of an institutional framework to increase Kosovo’s competitiveness (Pula, Loxha, and Elshani 2017). From 2016 to 2019, the value of FDI inflows increased 24 percent. Figure 1.1 FDI inflows into Kosovo, 2007–20 500 millions of euros 450 441 384 400 370 369 341.7 350 309 287 280 300 272 255 254.6 250 229 220 200 151 150 100 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Central Bank of Kosovo. Benchmarking Kosovo’s FDI performance with comparators shows significant room for improvement. FDI inflows were lower in Kosovo than in its regional comparators (figure 1.2), both in absolute numbers and relative to the size of its economy. Since 2008, FDI inflows as percentage of GDP were consistently lower in Kosovo (4 percent of GDP in 2018) than in regional peers (6 percent of GDP). 1 Between 2003 and 2014, privatization in Kosovo generated an estimated €660 million in revenue (Dobra and de Vries 2016). 2 This note refers to the following comparator groups: Regional comparators: Albania, Bosnia and Herzegovina, Montenegro, North Macedonia, and Serbia. Structural comparators: Albania, Armenia, Moldova, North Macedonia, and the Kyrgyz Republic. Aspirational comparators: the Czech Republic, Estonia, Latvia, Lithuania, Slovenia, and Uruguay. 10 Foreign Direct Investment in Kosovo: Trends and Challenges Figure 1.2 Net FDI inflows into Kosovo and comparators, 2004–19 a) Millions of dollars 5,000 Kosovo millions of dollars Regional Structural 4,000 Aspirational 3,000 2,000 1,000 - 2004 2007 2010 2013 2016 2019 b) Percent of GDP 14 Percent of GDP 13 Kosovo Regional 12 Structural 10 Aspirational 8 6 4 2 2 0 2004 2009 2014 2019 Source: World Bank 2020d Note: See footnote 2 for the countries in each comparator group. Greenfield Investment Announcements Greenfield FDI announcement data reveal the most recent trends and investor sentiments and allow for the benchmarking of sector-level data with comparator countries. 3 The number of recently announced projects across sectors can be a useful complement to FDI inflow data derived from Central Bank statistics, which may lack the level of detail needed to conduct sectoral-level analysis. Greenfield FDI announcements in Kosovo were on the rise before the 2007/08 financial crisis, with announced capital investment peaking at $1.4 billion in 2008. They have declined ever since. During 2003–19, Kosovo recorded significantly fewer project announcements per year (5 on average) than its aspirational comparators (49), regional comparators (29), or structural comparators (10). In addition, the average size of announced greenfield FDI projects in Kosovo was small, averaging just $181 million in the 2003–19 period. Average announced investment amounts increased 69 percent in 2016–19, but they remained much lower in Kosovo than in comparator countries. Relative to the size of its economy, Kosovo recorded 11 greenfield projects for each $1 billion of GDP between 2003 and 2019; regional, structural, and aspirational comparators recorded 18, 14, and 17 greenfield projects, respectively (figure 1.3). 3 Greenfield project announcement data (including both the number of projects and their capital expenditure or value) is based on the Financial Times’ fDi Markets database, the most comprehensive database tracking greenfield announcements of FDI projects. Greenfield project announcement data do not capture all greenfield FDI projects, and capital expenditures and job creation figures are often estimated. These data do not therefore correspond directly to data derived from central bank statistics. They are nevertheless useful for understanding trends and comparing FDI across countries. Foreign Direct Investment in Kosovo: Trends and Challenges 11 Figure 1.3 Greenfield FDI as share of GDP in 2003–19, in Kosovo and comparators Aspirational 17 Structural 14 Regional 18 Kosovo 11 0 2 4 6 8 10 12 14 16 18 20 Number of greenfield projects per $1 billion of GDP Source: Greenfield FDI data are from the Financial Times’ fDi Markets database; GDP data are from World Development Indicators. Note: See footnote 2 for countries in each comparator group. Composition of FDI Inflows Kosovo’s FDI inflows consist primarily of equity earnings (new investments). Between 2012 and 2018, reinvested earnings and debt instruments were consistently lower than equity earnings, suggesting that FDI companies do not reinvest in expansion within Kosovo (figure 1.4). This finding may reflect the nature of Kosovo’s FDI, which is primarily in real estate and offers limited expansion opportunities, as well as the young and fragile nature of Kosovo’s economy. Investors tend to be cautious and often concentrate their investment in a limited number of activities in fragile economies. They also tend to commit to smaller projects and create fewer jobs (Ragoussis and Shams 2017). Comparing these data with greenfield FDI announcements, which can be presumed to be equity investments in most cases, suggests that a combined effort aimed at growing both new investment and reinvestment is merited. Figure 1.4 FDI inflows into Kosovo, by type of investment, 2012–20 700.0 Millions of euros 600.0 138.2 500.0 137.7 131.7 180.9 99.8 91.8 400.0 129.0 94.0 96.2 117.3 128.7 177.8 154.9 78.5 300.0 156.8 119.0 314.3 99.4 278.1 277.4 109.2 200.0 211.3 195.3 181.1 199.4 165.3 177.8 100.0 0.0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Equity other than reinvestment of earnings Reinvestment of earnings Debt instruments Source: Central Bank of Kosovo. 12 Foreign Direct Investment in Kosovo: Trends and Challenges FDI Inflows by Sector Kosovo’s FDI inflows are concentrated in non-tradable service sectors. About 43 percent of all FDI inflows between 2007 and 2019 went into the real estate sector (figure 1.5); ¤1.7 billion went into real estate, renting, and related business activities, driven largely by investments by the diaspora. Other important service sectors receiving FDI included financial services, construction and transportation, storage, and communications. Investments in non-tradable sectors are not generally associated with high productivity gains or significant benefits, such as the transfer of technology, the development of linkages, and positive spillovers to the economy. Figure 1.5 FDI inflows into Kosovo, by sector, 2007–19 500 Millions of euros Other services and activities Real estate activities Financial and insurance activities 400 ICT Accommodation and food service activities Transportation and storage 300 Wholesale and retail trade Construction Electricity, gas, water 200 Manufacturing Mining and quarrying Agriculture, forestry and fishing 100 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 -100 Source: Central Bank of Kosovo. Kosovo has received very limited FDI in the manufacturing and agriculture sectors, which are key to accelerating economic upgrading and participation in GVCs (World Bank 2020f ). Between 2007 and 2019, manufacturing accounted for 9.2 percent of total FDI inflows (¤365 million). The Central Bank of Kosovo does not break down the manufacturing sector by subsector, but the Kosovo Investment and Enterprise Support Agency (KIESA) estimates that the sector is composed primarily of apparel (54 percent), textiles (36 percent), and leather products (10 percent), some of which Kosovo exports. A case study by the World Bank (2017) validates the KIESA estimates. Manufacturing FDI experienced negative net inflows in 2014 and 2018. The agricultural sector accounted for only 1 percent of total FDI inflows over the 2007–19 period. Kosovo’s agriculture sector offerings for investors would appear to be strong: 53 percent of its land is considered arable; the climate and soil quality are good; production costs are low, with relatively cheap labor and competitive prices for agricultural inputs; and access is open to the CEFTA and EU markets. Despite these advantages, the sector has attracted very limited FDI, because of issues related to land tenure and the fragmentation of agricultural land plots. Despite mineral reserves in the northern part of the country and the passage of a law to privatize state-owned mines, Kosovo has experienced negative inflows into mining and quarrying activities (Gërxhaliu 2017). The mining sector requires significant initial capital investment (Gërxhaliu 2017). Concerns about political instability as well as disputes over territories with large mineral reserves increase uncertainty around investment in this sector. Between 2007 and 2010, the mining sector attracted ¤84 million in FDI inflows. Since then, FDI inflows have been negative (see figure 1.5). The Mining Strategy of the Republic of Kosovo 2012–2025 emphasizes the favorable conditions for economic valorization of mining resources and attempts to attract investment (through completion of the legal and regulatory framework). It has not yet resulted in an increase in FDI inflows, however. Foreign Direct Investment in Kosovo: Trends and Challenges 13 FDI Inflows by Investor Motivation Figure 1.6 classifies FDI inflows into Kosovo by investor motivation. It is based on greenfield FDI announcement data and Dunning’s typology of investor motivations (box 1.1). Figure 1.6 Shares of number of greenfield FDI project announcements in Kosovo, by motivation and subsector, Percent Market seeking E ciency seeking Resource seeking investments Financial services Metals 35 9 Food & Beverages IT services 5 3 Consumer electronics Building Telecom 9 materials 3 Textiles Automotive 3 components 3 and OEM 2 Chemicals Pharmaceuticals Transportation Real 3 estate Renewable energy 2 2 1 Business services 1 7 Other Coal, oil & gas, and minerals 3 3 Leisure & entertainment 1 Source: Financial Times’ fDi Market database. Note: Figures are average percentages for 2003–19. 14 Foreign Direct Investment in Kosovo: Trends and Challenges Two-thirds of FDI announcements in Kosovo between 2003 and 2019 were market seeking, 29 percent were efficiency-seeking, and only 3 percent were resource-seeking. Within the market- seeking segment, financial services was the largest subsector (35 percent). Within the efficiency- seeking segment, metal processing (9 percent) and food and beverages (5 percent) were the strongest subsectors. FDI in market-seeking sectors has limited links to Kosovo’s exports and limited potential to increase participation in GVCs. In order to maximize the benefits of FDI for the domestic economy, Kosovo needs to diversify its FDI attraction efforts and attract more investments in efficiency- seeking sectors. These investments tend to create more and better jobs and facilitate access to regional and global value chains. Box 1.1  The Dunning typology of FDI motivations The typology of FDI developed by Dunning (2009) distinguishes four motivations for FDI: • Strategic asset seeking: This type of investment occurs when a multinational enterprise acquires assets that will promote the firm’s long-term strategic objectives. Strategic asset–seeking investment usually takes the form of mergers and acquisitions. • Natural resource seeking: This type of investment is driven by investors’ interest in accessing resources in the host country (hydrocarbons, minerals, wood, agricultural products). It can be a point of entry into the international economy and an impetus to developing local supporting industries. Although it can generate significant exports, it can also have negative effects on the host country, including high reliance on a single industry, exposure to volatility in commodity prices, and Dutch disease. • Market seeking: This type of investment provides goods and services to individuals, businesses, and other entities within the host country. It is motivated by the size and characteristics of the domestic market of the host country. It represents a potentially more inclusive form of economic activity than natural resource– seeking investment and can be useful for fostering economic upgrading and diversification. Such investment can also help create competition within the domestic economy. • Efficiency seeking: This type of investment has the greatest potential for transforming the host country’s economy. It is also the most difficult type of investment to attract. Efficiency-seeking investment is export oriented and occurs when the investor seeks to increase the cost-efficiency of production by taking advantage of factors that improve the competitiveness of the enterprise. Greater productivity of labor, preferential access to export markets, and rationalization of international production patterns are some of the factors motivating this type of FDI. FDI Inflows by Source Country FDI to Kosovo comes predominantly from source markets with a strong diaspora presence. They include Germany, Switzerland, the United Kingdom, Turkey, Austria, and the United States, along with countries in the region (Albania and Slovenia). In fragile economies, it is common for FDI to be concentrated in countries with diaspora. Kosovo should broaden its target market outreach in order to diversify external risks and tap into additional markets for FDI. Foreign Direct Investment in Kosovo: Trends and Challenges 15 Effect of COVID-19 on FDI COVID-19 and other megatrends are reshaping the global landscape for FDI (box 1.2). The pandemic has presented unprecedented shocks to FDI, global trade flows, and GVCs, with varying effects across sectors. Global trade is estimated to have fallen 8.5 percent in 2020, with 8.4 percent growth expected in 2021 (IMF 2021). The impact of COVID-19 on FDI has been stark (figure 1.7), and it may persist longer than the impact on global trade. FDI flows collapsed in 2020, contracting 42 percent, from $1.5 trillion in 2019 to $859 billion in 2020 (UNCTAD 2021); greenfield FDI flows declined 35 percent in 2020 (UNCTAD 2021). The level of FDI—the lowest since the 1990s—is more than 30 percent below the levels following the financial crisis of 2008/09. As the path of the pandemic remains uncertain, it is difficult to predict when FDI will rebound. Box 1.2  How has COVID-19 affected investors in Kosovo? The COVID-19 pandemic has hurt firms and investors in Kosovo. In the first half of 2020, 95 percent of surveyed investors in Kosovo described the impact of the crisis as negative, and almost 60 percent indicated that it might affect their ability to survive (American Chamber of Commerce in Kosovo 2020b). Attracting FDI could facilitate faster recovery and improve resilience to shocks. Results of the COVID-19 Business Pulse Survey demonstrate that firms with foreign shareholdings in Kosovo were and expect to be less affected by the COVID-19 pandemic than domestic firms (box figure 1.2.1). Before the pandemic, firms in which more than half of shareholders were foreign were larger, more productive, and more capital intensive, and they paid higher wages (World Bank, 2021). FDI firms also employed more skilled workers than domestically owned firms and had fewer unpaid workers—a proxy for informality. Higher FDI would thus not only aid the economic recovery, it would also create a more resilient private sector. Box figure 1.2.1 Average change in sales relative to baseline in Kosovo, April 2019–April 2020 Exports -50.9 Exporters -55.5 Non-exporters FDI -43 Firms w/ foreign share holding -55.2 Domestic firms Sector -63.1 Shutdown sectors -51.8 Non-shutdown sectors -70 -60 -50 -40 -30 -20 -10 0 Percentage change in sales Apr 2020/Apri 2019 Source: World Bank BPS 2020 16 Foreign Direct Investment in Kosovo: Trends and Challenges Figure 1.7 Effects of COVID-19 on global FDI inflows and FDI announcements, 2015–20, USD billion and Percent change a) Quarterly FDI Inflows b) Announced greenfield USD bil (LHS) 700% YoY Total capex (LHS) YoY Change Change (RHS) (RHS) 700 150% 300 100% 600 100% 250 75% 500 50% 50% 200 400 25% 0% 150 300 0% -50% 100 200 -25% 100 -100% 50 -50% 0 -150% 0 -75% Q2 Q2 Q2 Q2 Q2 Q2 Q3 Q3 Q3 Q3 Q3 Q3 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020 Source: World Bank 2020a. The changing global landscape for FDI presents new challenges as well as new opportunities for Kosovo’s FDI attraction efforts. Shrinking global FDI flows will intensify competition among locations and require countries to put in place more effective investment promotion programs to reach out to potential investors. But the rethinking of global production networks and supply chains by multinational enterprises holds significant opportunities for attracting investment flows targeting nearshoring to the European market. In a July 2020 survey by EY, 90 percent of managers of multinational firms indicated that they expected a major change in their investment strategies after 2020, and 83 percent of firms said reported they would nearshore to low-cost areas. Kosovo could position itself as a prime nearshoring destination to EU markets. A December 2020 World Bank survey of multinational enterprises indicated that firms in Europe and Central Asia experienced adverse impacts on supply chain reliability less than firms in any other region (Saurav et al. 2020). The COVID-19 pandemic has also shown just how dependent the global manufacturing industry is on China and motivated countries and multinational firms to consider diversifying their offshore destinations. Rising labor costs in China as well as diversification needs are already driving some apparel and leather firms to relocate (Javorcik 2020). Kosovo’s close proximity to EU member countries, its young and multilingual workforce, and its relatively low wages position it well to exploit nearshoring trends. To take full advantage of these opportunities, Kosovo needs to adopt proactive policies to strengthen its investment competitiveness and put in place targeted outreach programs to promote itself to investors looking for nearshoring opportunities. To leverage its proximity to the European Union, Kosovo needs to realign its FDI policies with post-COVID-19 realities, review sector priorities for FDI attraction, and address binding constraints for FDI attraction. It will also be important to make progress on long-standing reforms, including strengthening KIESA and improving investor grievance management. Foreign Direct Investment in Kosovo: Trends and Challenges 17 2. 02 Determinants of Competitiveness What are the main drivers of Kosovo’s FDI performance? Which factors could help Kosovo attract new investment in the post-COVID-19 era? This section benchmarks Kosovo against its regional, structural, and aspirational comparators on a set of indicators that the literature has identified as key FDI determinants. The factors are grouped in two broad categories: (a) economic fundamentals, including market size and growth, industry structure, infrastructure, and human capital and (b) policy and institutional fundamentals, including macroeconomic and microeconomic factors. Since its declaration of independence in 2008, Kosovo has made progress on several factors that are known to contribute to FDI growth. Joining CEFTA eliminated tariffs for all industrial goods within a short phase-out period and substantially reduced tariffs for a large number of agricultural goods. It also motivated improvements in the financial environment, liberalization, tax policy, macroeconomic policies, road infrastructure, economic stability, and the banking system (IFME 2019). Kosovo significantly improved its Doing Business score (Priority 2.a. in the European Reform Agenda), from 63.0 in 2015 to 73.2 in 2019. Policy reforms improved investor entry and establishment procedures for businesses, and a number of de jure reforms improved investor protection, as discussed below. Merchandise trade increased only modestly, however (World Bank 2019l). More needs to be done to make Kosovo more competitive. Benchmarking Kosovo’s performance against aspirational, regional, and structural comparators reveals both strengths and weaknesses in investment competitiveness.4 The country’s greatest strengths are its young population; its high levels of Internet access, low inflation rate, and low external debt; the relative ease of starting a business and obtaining credit; and lower labor costs than regional comparators (World Bank and WIIW 2019) (figure 2.1). Figure 2.1 Annual labor costs in Kosovo and selected comparators, by skill level, 2019 9,000 Production - Maintenance operative/Operators (highly skilled) Euros Production operative/Assemblers/Operators (skilled) 8,155 Production operative/Operators (unskilled) 8,000 6,983 7,000 6,226 5,890 5,756 6,000 5,413 5,331 5,043 5,000 4,572 4,635 4,324 4,394 4,157 3,915 3,821 4,000 3,702 3,227 3,052 3,000 2,000 1,000 0 Kosovo The Republic of Bosnia and Albania Serbia Montenegro North Macedonia Herzegovina Source: World Bank 2019k. 4 The benchmarking includes a wide range of endowment, economic, policy and institutional factors that the literature documents as affecting both the quantity of FDI and its characteristics. It is based on internationally available indicators from the World Bank Doing Business Report, World Bank Enterprise Surveys, Worldwide Governance Indicators, and other datasets. 20 Determinants of Competitiveness Policy and institutional weaknesses are the main factors limiting Kosovo’s FDI competitiveness. Kosovo significantly underperforms all three comparator groups on political stability, control of corruption, and regulatory quality. In addition, its domestic market is small, the level of informality is high, electricity and transportation infrastructure are insufficient, the level of education of the workforce is inadequate, and export performance is weak. These findings suggest that Kosovo needs an accelerated investment climate reform agenda aimed at reducing risks to investors while maximizing investment opportunities in its economic sectors that may offer enough reward compared with risk. Such opportunities can be identified through a sector benchmarking assessment. Economic Factors Economic fundamentals are the most important determinants of FDI (Blonigen 2005; Saini and Singhania 2018). An economy’s market size and growth, industry structure, infrastructure, and human capital largely determine the type and volume of FDI inflows. Market Size and Growth With a population of 1.8 million, Kosovo is slightly smaller than the average regional, structural, or aspirational comparator. Its GDP per capita is slightly lower than regional comparators and more than 0.6 standard deviations below the average for its aspirational comparators. The World Bank estimates that poverty fell from 24.4 percent in 2017 to an estimated 21.4 percent in 2019 based on the US$5.5 UMIC poverty line (World Bank 2019e). As a small market, Kosovo can attract only a limited volume of market-seeking FDI. Its real potential lies in export-oriented FDI. This type of FDI has the potential to boost exports, GVC participation, and productivity and create skilled jobs for Kosovo’s youth. FDI could be motivated to enter Kosovo by improving cost and quality factors, such as the availability of skilled labor, finance, and infrastructure, as well as by making sector-specific improvements. Further integration with CEFTA and the European Union would reduce the time and costs of imports and exports. Industry Structure Kosovo’s economy is characterized by a weak industrial sector and the presence of many small firms, including a large number of informal entities. The manufacturing sector contributes only about 10 percent of GDP, much lower than the 16 percent of aspirational comparators. The small share is both a cause and a result of limited FDI inflows into the sector. About 63 percent of firms in Kosovo identified practices of the informal sector as a main constraint, more than two standard deviations more than in all three comparator groups. Figure 2.2 Kosovo’s performance on market and industry determinants of FDI relative to comparators, 2019 a) Market size and growth b) Industry structure Population, GDP GDP per capita GDP per Agriculture Industry Manufacturing Services Informality total (current US$) (current US$) capita growth 1.0 Standard Deviation 0.1 (annual %) Standard Deviation 0 0 -0.1 -0.2 -1.0 -0.3 -0.4 -0.5 Regional -2.0 Structural -0.6 Aspirational -0.7 -3.0 Source: Data from World Development Indicators and World Bank Enterprise Surveys. Note: See footnote 2 for the list of comparators. Determinants of Competitiveness 21 Infrastructure Kosovo has relatively good Internet access and electricity coverage, but firms perceive electricity and transportation as major constraints. Kosovo’s electricity supply options are highly constrained because of the limited availability of renewable energy and the country’s aging and unreliable ignition- fired generation plants. More than 92 percent of electricity generation comes from coal (Energy Community Secretariat 2019). Electricity demand has far outpaced supply in recent years. As a result, power outages are frequent, and power shortages severely disrupt business operations. Low railway and motorway density and inadequate air transportation limit Kosovo’s connections to the rest of the world. The poor quality of infrastructure exacerbates infrastructure gaps (IMF 2018) (figure 2.3). Figure 2.3 Kosovo’s performance on infrastructure and factor input determinants of FDI relative to comparators a) Infrastructure b) Factor inputs Individuals using Access to Electricity Transportation Total natural Human % of firms Labor Inadequately the Internet electricity a major a major resources Capital provide regulation educated (% of population) (% of population) constraint constraint rents Index training as a major workforce 1.5 (% of GDP) constraint a sa major Standard Deviation constraint 0.0 Standard Deviation 1.0 -0.5 0.5 0 -1.0 -0.5 -1.5 -1.0 -2.0 -1.5 -2.5 Regional -2.0 Structural Aspirational -3.0 -2.5 -3.5 -3.0 Source: Data from World Development Indicators and Enterprise Surveys. Note: See footnote 2 for the lists of comparators. Human Capital Kosovo’s human capital index is below that of its regional and aspirational comparators, and the share of firms providing formal training is significantly lower. As a result, 44 percent of firms in Kosovo identified an inadequately educated workforce as a major constraint, twice the level of regional comparators. Policy and Institutional Factors Government policies and institutions play a key role in attracting FDI. The 2019 World Bank Global Investment Competitiveness Survey of the locational decision-making factors of 2,500 multinational corporations shows that political stability, macroeconomic stability, and an enabling legal and regulatory environment are the top three considerations when such firms decide where to invest (World Bank 2020b). Macroeconomic Factors and Political Risk Limited industrial capacity results in a persistent and a large trade deficit in Kosovo. Imports account for 56 percent of GDP in Kosovo, roughly on par with comparator countries (about 60 percent). Exports as a share of GDP, however, are only 26 percent of GDP, only half the level in regional and structural comparators and far lower than the 66 percent of aspirational comparators. 22 Determinants of Competitiveness Political instability, corruption, and ineffective governance deter FDI. Kosovo underperforms on all five of the following indicators: rule of law, regulatory quality, control of corruption, government effectiveness, and political stability (figure 2.4). Corruption perceptions are high, the rule of law is weak, and regulatory quality is subpar, and frequent government changes have led to increased uncertainty. Controlling corruption, limiting the burden of bureaucracy, and providing transparency and accountability in the political system are all important channels for encouraging multinationals to bring capital into developing countries (Kurul and Yalta 2007; Bénassy-Quéré, Coupet, and Mayer 2007). Fragile institutions create uncertainty, discouraging investors from committing to large projects; as a result, they create fewer jobs for every dollar they invest in politically stable countries (World Bank 2018). Figure 2.4 Kosovo’s performance on macroeconomic and political risk determinants of FDI relative to comparators a) Macroeconomic b) Political risks External Inflation, Exports of Imports of Rule of Regulatory Control of Government Political debt stocks consumer goods and goods and Law Quality Corruption E ectiveness Stability 0.4 Standard Deviation (% of GNI) prices services services (annual %) (% of GDP) (% of GDP) 2.0 Standard Deviation 0 1.5 1.0 -0.4 0.5 0 -0.8 -0.5 Regional Structural -1.2 -1.0 Aspirational -1.5 -1.6 Source: Data from World Development Indicators and Worldwide Governance Indicators. Note: See footnote 2 for the lists of comparators. Microeconomic Factors Kosovo outperforms comparators on the time required to start a business and obtain credit; however, because of difficulty in dealing with construction permits and obtaining electricity it lags the compators. Reforms have reduced the number of procedures and days required to establish a business; as a result, it now takes less time to start a business in Kosovo than in comparator countries.5 Kosovo does not screen investments, have licensing restrictions specifically for foreign investors, or set minimum capital requirements and grants foreign firms the same treatment as local firms. Out of 190 economies in 2020, Kosovo ranked 160th in dealing with construction permits and 90th in obtaining electricity. 5 In 2002, the government established a one-stop-shop and a Business Registers Agency. It later expanded the coverage of one-stop processes. In 2003, it eliminated business registration fees. In 2015, it joined the Hague Apostille Convention, which allows for foreign public documents issued in one of the signatory countries to be certified for legal purposes in all the other signatory states. In 2018, it simplified the procedures for registering employees and introduced online business registration. The Kosovo Business Registers Agency allows investors to complete business registration, tax registration, and voluntary value-added tax (VAT) registration. Determinants of Competitiveness 23 Figure 2.5 Kosovo’s performance on entry and establishment of a business relative to average for six Western Balkan countries Western Balkans 6 average Kosovo 20% Process of obtaining a land lease 27% Ease of hiring and bringing in expatriate sta 33% and process of obtaining work permits for expatriate sta 36% Transparency of business registration 48% procedures 55% Process of obtaining investment approval 36% and permits to start a business 27% Policies on foreign investors to enter into 45% joint ventures with local firms in your sector 44% Ability of foreign-owned companies to 49% operate in your sector (policies on foreign ownership restrictions) 36% 0% 10% 20% 30% 40% 50% 60% Percent of investors rating performance as good or very good Source: World Bank 2019g.  Note: Western Balkans 6 refers to Albania, Bosnia and Herzegovina, Kosovo, North Macedonia, Montenegro and Serbia. Firms in Kosovo identify competition from the informal sector, corruption, and political instability as the biggest obstacles. They cite corruption and political instability as the top two main obstacles in 2019; nearly 30 percent of all firms and 20 percent of foreign firms identified practices of the informal sector as the biggest obstacle for their operations (Figure 2.6). 24 Determinants of Competitiveness Figure 2.6 Kosovo’s performance on key business environment measures relative to comparators a) Doing Business indicators b) Biggest obstacles to FDI Distance to Time required Enforcing Getting Credit Corruption Political Informal Transportation frontier score to start a contracts total score instability sector business 1.0 Standard Deviation 1.2 Standard Deviation 1.0 0.5 0.8 0.6 0 0.4 -0.5 0.2 0 -1.0 -0.2 Regional -1.5 -0.4 Structural Aspirational -0.6 -2.0 Source: Data from Doing Business and Enterprise Surveys. Note: See footnote 2 for the lists of comparators. Overcoming these obstacles requires that Kosovo take measures that boost investor confidence and increase cooperation from the many public and private stakeholders that can influence the effort. In developed economies, traditional investment promotion agencies often lead such efforts. In young and fragile economies, they are unlikely to have the capacity or clout to do so. They are an important part of the technical team, but efforts also need to involve respected leaders from the public and private sector with strong knowledge of the country’s target sectors.6 All public and private stakeholders need to be involved in positioning Kosovo on the map of international investors and ensuring that international investment contributes to policy objectives, including productivity growth, exports, GVC participation, and job creation. 6 In Haiti, for example CTMO-HOPE, a tripartite commission of business, labor, and government, led the effort to maximize the benefits of a US law granting preferential access to Haitian-made apparel. Determinants of Competitiveness 25 3. 03 The Investment Reform Agenda This section outlines an ambitious reform agenda that can help improve Kosovo’s investment competitiveness and investor outreach in the short term. The agenda takes into account FDI megatrends and proposes a step-by-step reform program for the government that can be implemented in the short term to unlock the full potential of FDI. The proposed reforms are informed by the in-depth assessment of Kosovo’s FDI performance and investment competitiveness (sections 1 and 2 of this note) and a detailed review of Kosovo’s legal and regulatory framework, policies, and institutions for investment. The reform agenda sets out three main areas for government action: Area 1 Area 2 Area 3 Sharpening the focus of FDI Enhancing investor services by Increasing investor confidence attraction and retention e orts empowering Kosovo’s investment through reestablishing an e ective through a new FDI strategy promotion agency (KIESA) investor grievance mechanism Area 1: Sharpening the Focus of FDI Attraction and Retention Efforts through a New FDI Strategy Countries that are successful in their efforts to attract FDI have a well-coordinated approach and investment strategy. An investment strategy sets out clear targets and objectives for FDI attraction and retention that are derived from the country’s overarching development objectives, such as economic diversification, job creation, sector development, technology transfer, and skill development. It also sets out the path toward attracting the types of investments that would help attain these goals and prioritizes sectors for FDI based on an assessment of competitiveness and alignment with the country’s national development objectives (World Bank 2020b). Kosovo does not have in place an FDI strategy outlining the government’s FDI objectives and guiding the national investment promotion effort. Two strategy-level documents provide a framework for the development of an investment attraction and retention strategy: • The 2016 National Development Strategy acknowledges the importance of a conducive business and FDI environment for economic development. Its pillars are human capital, the rule of law and good governance, the development of competitive industries, and the development of infrastructure. It considers increasing FDI a key intervention area and envisions strengthening KIESA, developing an FDI strategy, providing incentives for strategic investors, and targeting and incentivizing diaspora investors through matching grants. It provides a reference for the development of but cannot substitute for a national investment strategy. • The 2018 Law on Strategic Investments (LSI) prioritizes projects that meet minimum investment thresholds in certain sectors and attempts to stimulate, attract, and create conditions for the implementation of strategic investments in Kosovo. It establishes administrative procedures and criteria for evaluating, selecting, implementing, and monitoring strategic projects and determining the procedures for granting use of the property of the Republic of Kosovo.7 Without setting specific priorities and targets for investment attraction, the LSI cannot substitute for a national investment strategy. The following steps can help guide the development of a practical, investor-centric, action- oriented investment strategy: 1. Conduct a rapid sector scan to determine sectors and segments with high potential for FDI attraction.8 This scan includes assessing the competitiveness of sectors and value chains in Kosovo to determine (a) their feasibility (or readiness) for investment promotion and (b) their desirability (their potential contribution toward achieving overarching policy and economic development goals, See Annex B for further details). The sector scan is not about picking winners for broader industrial policies; it identifies sectors for FDI promotion based on Kosovo’s comparative advantages and development objectives, taking into consideration broader global trends. The FDI sector scan would also confirm the competitiveness of target sectors selected by previous government strategies and allow for revisions, as needed, in light of the changing landscape for FDI as a result of COVID-19 (Box 3.1). 2. Align FDI and private sector development policies with the identified sector priorities. Investors in Kosovo are particularly concerned about the lack of rule of law and contract enforcement (American Chamber of Commerce in Kosovo 2020a). Aligning sectoral policies and addressing constraints identified by the sector scan can unlock the full potential of sectors for investment attraction. Investment climate reforms will be needed to improve investor confidence. 7 See Law No. 05/L-079, on Strategic Investments in the Republic of Kosovo as published in the Official Gazette of the Republic of Kosovo, No. 6, February 8, 2017. 8 See annex B for a summary of a sector scan methodology developed by the World Bank Group; see table 3.2 for links to practical examples of sector scans. 28 The Investment Reform Agenda 3. Clarify the role of economic zones in promoting FDI. The main objectives of the Law on Economic Zones (2013) are to spur foreign and domestic investment, production, job creation, income, and regional and spatial development; promote the competitiveness of Kosovo’s goods and services; and ensure competitive markets. Economic zones can take the form of industrial parks, technology parks, and business incubators.9 Kosovo’s economic zones consist of 10 industrial parks, 2 of which (Drenas and Shtime) are full; others are still under development. KIESA establishes and manages economic zones. The presence of manufacturing firms in these zones is a good sign,10 but there is no strategy around the location of the economic zones, the sectors, the GVCs in which they seek to attract FDI, or the promotion of agglomeration effects among businesses that could spark the emergence of new industries—often the motivating factors for creating economic zones in the first place. Box 3.1  Could Kosovo benefit from a post-COVID-19 reconfiguration of global value chains? No consensus has yet emerged on how GVCs will look after COVID-19. Some economists believe that there will be little significant change; others believe that COVID-19 has been a wake-up call for a new balance between risk and reward for GVCs (Javorcik 2020). It is possible that Kosovo could benefit from GVC reconfigurations in several sectors. Kosovo could, for example, leverage its locational and cost advantages to attract FDI to develop large apparel manufacturing clusters that serve the European market. The pandemic could serve as an opportunity for transitioning the apparel industry toward sustainable sourcing and digitalization. Kosovo’s young population offers a low-cost workforce that is essential for certain segments of the apparel industry. The apparel sector is already the second-largest industry in Kosovo (after mining); the labor-intensive nature of the sector could create abundant new job opportunities. Ideally, Kosovo would increase its adoption of digital technology to become more competitive in its capacity and production planning. Automotive components is another sector that could benefit from nearshoring and the existence of an already strong regional cluster. As major automakers diversify their sourcing, they may prefer nearby sources, to reduce the risk of disruption and increase supply chain agility. Geographic proximity to markets and low labor costs make Kosovo competitive in this sector. Kosovo could also benefit from an already booming regional automotive cluster in Slovenia and Serbia. Kosovo already has automotive component technology, capacity, and sufficient knowledge to support original equipment manufacturer plants at competitive cost. Upgrading infrastructure might be needed to attract FDI in automotive components. Supply chain reconfiguration and the emergence of new technologies (such as 5G) could offer Kosovo an opportunity to develop its information and communications technology (ICT) industry. A pool of highly educated and multilingual information technology (IT) professionals makes Kosovo competitive in attracting ICT–related FDI. Kosovo has high Internet penetration and provides low-cost but high-quality telephone and Internet services. The following steps can help implement the investment strategy: 1. Focus investor outreach and promotion efforts on the sectors identified in the sector scan as ready to promote and mobilize the full resources of KIESA to attract investment in these sectors. Equip KIESA with the necessary budget, resources, and tools to fulfill its mandate. 2. Establish an effective governance and coordination mechanism to implement the investment strategy. Identify champions from the public and private sectors with strong knowledge of Kosovo’s target sectors to ensure monitoring and results (Whyte and Griffin 2014). Ireland, a highly successful investment destination in Europe, has such a strategy and mechanism in place (box 3.2). 9 Under the Law on Economic Zones, economic zones are established under the Customs and Excise Code, which provides for industrial parks equipped with necessary infrastructure (roads, transport, and public services with or without industrial buildings designated for industrial development) and technological parks designed to accommodate enterprises with high tech needs, which usually have close relations with a university or a business incubator. 10 Sectors include manufacturing (pharmaceuticals, elevators, paper bags, textiles, metal products, and electric poles from concrete, quartz and marble tiles) and services (vegetable pickling, glass processing, metalworking, wood, plastic recycling, and carpentry) (KIESA website, accessed in July 2020). The Investment Reform Agenda 29 Box 3.2  Ireland’s focused investment strategy Ireland’s investment strategy links the country’s objectives for investment attraction to its broader economic objectives for job creation and target industries. It is implemented by the Irish Industrial Development Agency (IDA), established in 1969, at a time when Ireland was not viewed as an attractive investment destination. Ireland’s most recent FDI strategy, “Winning: Foreign Direct Investment 2015–2019,” was developed in the challenging post– financial crisis period to spur growth and contribute to Ireland’s broader goal of full employment by maximizing FDI performance. It was developed in line with Ireland’s Department of Jobs, Enterprise, and Innovation’s policy on FDI. The strategy ensured broad-based buy-in by soliciting inputs from a wide range of stakeholders, including the IDA board. Its recommendations were confirmed through engagement and discussions with existing and potential clients. This strategy and previous strategies target key sectors and business activities, allowing Ireland to develop self- reinforcing clusters with extensive job creation in key areas. As of 2018, Ireland had created 124,000 jobs in international and financial services; 64,000 in life sciences; and 22,000 in computers, electronics, and optical equipment. Having a clear strategy has also allowed Ireland to ensure that development objectives are achieved. In January 2020, IDA announced that it had achieved all of the targets of its 2015–19 strategy. It reached an all-time high in the number of people employed in multinational corporations (245,096), attracted 1,209 investments, and increased regional investment by 50 percent, making it the most successful investment period for Ireland to date. Sources: IDA Ireland 2015, 2020; Ecorys 2013; and World Bank 2020c. Area 2: Enhancing Investor Services by Empowering KIESA Global experience shows that the right institutional arrangements can increase FDI (World Bank 2019a). There is strong empirical evidence that investment promotion agencies can help increase FDI inflows, attract better-quality FDI, deepen connections to GVCs, and transform economies (World Bank 2020b). When properly staffed and resourced and equipped with adequate governance mechanisms and tools, these agencies can play a key role in leading a country’s investment attraction and retention efforts. KIESA is the main agency mandated to attract and retain investments in Kosovo (box 3.3). It faces multiple challenges related to insufficient strategic alignment and focus; ineffective governance arrangements; and limited financial, human, and technical resources. Box 3.3  What does KIESA do? KIESA is the first point of contact for entities interested in investing in Kosovo. According to its website (KIESA 2020a, 2020b), it informs potential investors on legislation and physical infrastructure; receives, reviews, and evaluates applications provided by economic zone developers; cooperates with municipalities on the creation and establishment of economic zone–related infrastructure; promotes and facilitates investments; and reviews complaints from businesses about economic zones and the Drenas Business Park. It is also responsible for determining the tasks of agencies that need to be involved in strategic investments, harmonizing and coordinating activities for documentation by agencies, technically assessing applications for strategic projects, and providing investment entry and establishment services for strategic investors. Investors must submit their requests for strategic investor status to KIESA, but it is the Interministerial Committee for Strategic Investments that evaluates, selects, implements, and monitors strategic investment projects and determines their status. KIESA helps collect and request additional documentation; as the focal point for information on investors, it can recommend rejecting or accepting an application. KIESA has two directorates. The Private Sector Promotion Directorate focuses on investment, export, and strategic investment promotion. The Private Sector Development Directorate supports SMEs and works with economic zones. KIESA’s budget and staff levels fall well behind those of benchmark countries. The agency has only five staff working on core investment promotion–related activities, including servicing strategic investments, facilitating reinvestments, and providing investment attraction and post-investment services (table 3.1). Its staff numbers for investment promotion are lower than the average for regional comparator countries as well as for the broader Europe and Central Asia Region and Kosovo’s income group. Of the agency’s total annual budget of ¤1 million, only ¤70,000 is dedicated to investment promotion. This share is significantly lower than in comparators. Although higher budgets do not automatically lead to better results, the average annual investment promotion agency budget in upper- 30 The Investment Reform Agenda middle income countries is $21.4 million and the average investment promotion agency budget in low- income countries is $2.4 million; Kosovo falls well below both averages (WAIPA and WBG 2020). Table 3.1  Staff and financial resources of investment promotion agencies in Kosovo and comparator groups Group Budget Number of full-time Number of full -time Percentage of professional (millions of professional staff professional staff for staff working on investment dollars) promotion promotion Kosovo 0.08* 21 5 24 Average of regional comparators1 4.7 41.4 11.8 29 Average of Europe and Central Asia 2 29.7 114.2 78.6 69 Income group High 30.6 104.5 66.7 64 Upper-middle 21.4 52.5 23.5 45 Lower-middle 4.7 200.1 24.3 12 Low 2.4 34.5 7.8 23 Sources: Calculations by authors based on data from WAIPA-WBG (2020) and KIESA. *Approximation based on the European Central Bank’s average exchange rate from Euro to USD in 2020 (1.142). Note: 1. Albania, Bosnia and Herzegovina, Montenegro, North Macedonia, and Serbia; Bulgaria, Croatia, Estonia, Latvia, Lithuania, Slovak Republic, and Slovenia. 2. Survey results include Western Europe. The results of recent investor surveys highlight the importance of improving key areas of investor service provision in Kosovo. A survey of foreign direct investors in the Western Balkans region conducted by the World Bank Group in 2019 revealed the need to strengthen the services provided by KIESA, which more than a third of investors rated poor or very poor.11 KIESA’s scores were below the regional average for the six Western Balkan economies across all key dimensions (figure 3.1). Figure 3.1 Kosovo’s performance on investment attraction and promotion relative to average for six Western Balkan countries Western Balkans 6 average Kosovo Quality of facilitation services 27% (e.g., guiding investors through site-location decision-making process, influencing investor’s location choice) 44% Quality of outreach services or proactive promotion 24% (e.g., persuading potential investors to seriously consider a particular location as part of their investment plans) 39% Quality of information provided by investment promotion agency 25% (e.g., detailed and accurate sector information, economic informa- tion, information on taxes, information on business opportunities) 35% 0% 10% 20% 30% 40% 50% Percent of investors rating performance as poor or very poor Source: World Bank 2019g. Note: Western Balkans 6 refers to Albania, Bosnia and Herzegovina, Kosovo, North Macedonia, Montenegro and Serbia. 11 Survey results included 16 foreign investors in Kosovo. Investors rated each economy’s performance on each topic as very good, good, average, poor, very poor or not applicable to them. The Investment Reform Agenda 31 Enhancing the effectiveness of Kosovo’s investment services offering requires strengthening KIESA’s staff, budget, data tools, processes, and governance structures. KIESA needs a larger budget and more staff dedicated to investment promotion activities. It also needs strategic support from the Prime Minister’s Office, improved strategic and technical guidance from the lead ministry for investment, and partnerships with other line ministries and respected private sector experts with strong knowledge of the country’s target sectors. The following steps can help strengthen KIESA’s capacity for investment attraction and retention: 1. Review and evaluate the number of KIESA’s mandates, and sharpen the focus on delivering core investor services. The world’s most successful investment promotion agencies are highly focused. Assigning an agency multiple functions is not recommended, especially if limited budget and resources may divert attention from its remit. KIESA’s mandate is unusually broad, covering investment, exports, tourism, SMEs, and the promotion of economic zones. Much of its attention goes to supporting implementation of the LSI and developing and servicing economic zones. KIESA plays a very important role in facilitating and coordinating procedures related to strategic projects. However, investors are concerned about its capacity to process applications and service investors (American Chamber of Commerce in Kosovo 2020a). The development of economic zones is a resource-intensive task that includes liaising with municipalities and customs on the establishment of economic zones and providing information, assistance, and advocacy services. KIESA should focus its resources on investment promotion and reassess the agency’s institutional set-up accordingly. 2. Develop a corporate strategy or plan. Unlike successful investment promotion agencies, KIESA does not have a well-defined corporate strategy or business plan. A new strategy should be developed to describe KIESA’s contribution to national FDI objectives and priority sectors; align its organizational structure to the strategy; define an implementation plan, core investor services, and tools to monitor and evaluate investment results and resources; and create a framework for its partnerships, including with sectoral experts in the private sector and public agencies, including the Ministry of Economy, the Ministry of Finance (on investment incentives), the Ministry of Foreign Affairs (on international investment agreements), and municipalities (on investor servicing). 3. Improve reporting lines and governance structures. The decision to move KIESA to the planned Ministry of Economy, Employment, Trade, Strategic Investments Entrepreneurship, and Industry was reversed. There were discussions about putting KIESA under the Prime Minister’s Office, a move that could potentially give it high-level government support and greater funding for investment promotion, assuming it would be tasked with implementing large parts of the investment strategy. The shifting preferences about the reporting and location of the agency within the government undermine the effectiveness of the agency and leave it in a state of nongovernance. A detailed institutional assessment of KIESA’s reporting lines would help determine which option would work best for the agency and identify the legal steps required, if so determined, to place it within the Prime Minister’s Office. 4. Improve governance through a board of directors. According to best practice, a board of directors should be composed of public and private stakeholders and serve as the cornerstone of governance, by providing strategic guidance and oversight. KIESA has only a consultative board, made up of representatives from various ministries, that is not engaged in the agency’s governance. The continued absence of a permanent director leaves the agency highly vulnerable to political cycles (EC 2019). 5. Provide KIESA with budget and staff resources that allow it to fulfill its mandate in investment promotion. KIESA’s budget for investment promotion activities is much lower than that of its peers. The government should ensure that the agency has sufficient and sustained funding over a three- to five-year period. 6. Scale up service provision to investors. KIESA needs to reinforce its investment promotion as well as aftercare services to investors. The 2016 Aftercare Report conducted by KIESA in collaboration with the Kosovo Chamber of Commerce and the British Embassy shows that only 1 investor out of 250 surveyed indicated that it became aware of potential investment opportunities in Kosovo through KIESA (the smallest share of all options, including other Internet sources and the Kosovo Chamber of Commerce). KIESA could boost its investment promotion services by developing an outreach program to target investors across priority sectors and subsectors, define target outputs to be achieved from each marketing channel, and estimate the resources required for each. 32 The Investment Reform Agenda Area 3: Increasing Investor Confidence by Reestablishing an Effective Investor Grievance Mechanism Strong investor protection guarantees are key to enhancing investor confidence and attracting FDI (World Bank 2020e), particularly in contexts with high perceived political risk. Investor grievance mechanisms provide a channel for investors to address concerns before they become disputes, preventing costly investor state disputes. Kosovo faces challenges with regard to investor protections. A 2019 survey of foreign direct investors in the Western Balkans Region undertaken by the World Bank Group shows that half of the interviewed firms rate the ability of the government to handle investor grievances in a timely manner as poor or very poor. This score is lower than the regional average of the Western Balkans Six economies. In addition, more than 40 percent of the investors interviewed indicated that transparency and predictability in the conduct of public agencies was poor or very poor in Kosovo. On the positive side, Kosovo scores well compared with other Western Balkan countries when it comes to the stability and predictability of its laws. Figure 3.2 Kosovo’s performance on investment protection and retention relative to average for six Western Balkan countries Western Balkans 6 average Kosovo Government coordination with private sector 40% 57% Existence of e ective processes for consultation 25% on proposed laws and regulations 18% Ability of government to respond in timely and 33% e ective manner to investor grievances 48% Existence of free trade agreements and 12% investment treaties 22% Clarity of definitions of basic standards and qualifications of rights and provisions in 15% international investment agreements 9% Ease of repatriating profits, dividends, management fees, and other foreign exchange 11% transactions 5% Transparency and predictability in conduct of 40% public agencies 41% Risk of occurrence of nontransparent or arbitrary 35% government conduct 32% Stability and predictability of laws 48% 22% Risk of breach of contract with government 18% 14% Risk of expropriation, confiscation, or other acts 14% a ecting the investment 9% 0% 10% 20% 30% 40% 50% 60% Percent of investors rating performance as poor or very poor Source: World Bank 2019g. The Investment Reform Agenda 33 Investor survey results suggest that Kosovo provides sufficient investor protections through its legal framework; the challenge is enforcement.12 This finding is in line with the results of a review of the legal framework governing investments conducted by the World Bank Group, which found that Kosovo’s Foreign Investment Law is mostly in line with international good practice.13 It serves as the principal law protecting, promoting, and encouraging foreign investment and the basis for rights and guarantees to foreign investors willing to invest in Kosovo.14 The lack of an effective investor grievance mechanism leaves Kosovo vulnerable to potential investor–state dispute settlement (ISDS) claims. Investor grievances have led to at least two investment arbitration cases in Kosovo.15 The basis of the first case (ACP Axos Capital GmbH v. Kosovo 2018), which the International Centre for Settlement of Investment Disputes (ICSID) dismissed, was alleged lack of compliance with expropriation and failure to accord fair and equitable treatment. The second case (Mabco Constructions SA v. Republic of Kosovo, ICSID Case No. ARB/17/25), which is pending, involves the acquisition of shares in a company in the tourism sector. Reducing regulatory risks at the source is critical not only to attract, retain, and expand investments in host countries but also to prevent potentially costly ISDS disputes. An investor grievance management mechanism is an early warning and tracking mechanism designed to identify and resolve complaints or issues that may arise from government conduct. It collects data; identifies patterns on the source of government-generated political risks affecting investments; and quantifies investment retained, expanded, or lost as a consequence of addressing or not addressing those political risks. The mechanism ensures that governments respond to investor grievances in a timely and suitable manner, in accordance with the country’s laws, regulations, institutions, and international investment agreements. It also filters potential disputes based on their merits, protecting the state against frivolous claims. Box 3.4 provides examples of mechanisms implemented by other countries. Box 3.4  Investor grievance mechanisms in Ethiopia, Bosnia and Herzegovina, and Georgia Ethiopia set up an investor grievance management mechanism in order to reduce the cancellation of investment projects after their registration with the Ethiopian Investment Commission. A Grievance Management Unit comprising three staff was established within the Ethiopian Investment Commission, reporting directly to the commissioner. The unit has its legal foundation in the newly adopted Investment Proclamation. Sections 25–27 of the Investment Proclamation allow investors to lodge complaints. It states that the Ethiopia Investment Board, an interministerial body, serves as the escalation mechanism. As of March 2020, the unit had registered eight grievances and resolved four. The timely resolution of grievances led to the retention of about US$ 238 million in investment. An automated investor grievance management tracking tool has been set up to help the lead agency track the grievance resolution process and monitor its results (World Bank forthcoming). Bosnia and Herzegovina: Bosnia and Herzegovina faced a number of problems with reinvestment and investor concerns that went unaddressed because no system was in place that resolved investor issues as they arose. A targeted aftercare program was implemented through a collaborative network of institutions, including municipalities, that works at all levels to identify investor concerns and ensure they are addressed. In the first two years of operation, the aftercare activities of the collaborative network resulted in an almost 20 percent increase in investor issue resolution and allowed for over $25 million in reinvestment (World Bank 2019b; 2019d). Georgia: The mandate of the office of the Business Ombudsman (BO) is to resolve grievances between firms and government agencies. The BO helps firms by providing legal advice and written opinions and by advocating for firms within other government agencies. Although the BO has its own budget and is approved by Parliament by suggestion of the Executive, it is still able to participate within governmental meetings. In fact, for many years the BO sat in Cabinet meetings. This approach enabled it to be highly effective in addressing grievances with other government agencies. The fact that the BO could escalate any matter to the highest political instance empowered it to negotiate with other government agencies involved in grievances with investors (World Bank 2019d; Government of Georgia 2017). 12 See annex E for an overview of standard investor protections. This section draws on analysis from World Bank (2019i). 13 LAW No. 04/L-220 On Foreign Investment as published in the Official Gazette of the Republic of Kosova / No. 1 / 09 January 2014, Pristina. 14 The Law on Strategic Investments (LSI) applies to investors investing in priority sectors. It operates in parallel with the Foreign Investment Law (FIL), creating confusion over whether the protections provided in the FIL also apply to strategic investors (as defined by the LSI). The LSI provides a special right to expropriate socially owned land for the benefit of investors (Law No.03/L-139 on Expropriation of Immovable Property) but does not define what qualifies as social ownership. The government may wish to review the LSI and FIL to provide a single framework for investments, in order to ensure consistency of the level of protection guaranteed and adjust the LSI’s clause on expropriation to avoid the view of the state as an executor of investors’ preferences at the expense of citizens’ rights. 15 This analysis on disputes and investment arbitration draws on World Bank (2019h). 34 The Investment Reform Agenda To track and resolve investor grievances, Kosovo established a Systemic Investor Response Mechanism in 2015. The mechanism was discontinued in 2017 because of political changes (World Bank 2019h). A working group established by the National Council of Economic Development (NCED) served as the lead agency for handling investor complaints with public institutions. It still functions in principle, but the working group has issued no recommendations and there is no systematic collection of investor grievance data in Kosovo. The following steps can help develop and implement a fully functioning and legally mandated investor grievance mechanism designed in line with good practice: 16 1. Verify the NCED in its role as lead agency, or identify a different agency to coordinate the grievance management mechanism. The lead agency will coordinate problem-solving processes and share relevant information with national, subnational, and sector-specific agencies that may be more likely to generate or become involved in investment grievances. 2. Adopt the legal foundations that empower the lead government agency for the grievance mechanism and elaborate its mandate through implementing regulations. The lead agency should advocate for the implementation of decisions to resolve grievances and have a mandate to advocate for broader reforms to improve investment conditions. 3. Establish an internal grievance tracking system to capture detailed information on grievance cases in a systematic manner. At a minimum, the system should capture the nature of the case, the authorities involved, submitted documents, actions taken, timelines, and decisions made. This system would allow the government, particularly the lead agency, to follow up with investors but also authorities in the framework on the actions taken. The tracking system would also capture information about investments at risk because of grievances, as well as investments and jobs retained for the Kosovo economy as a result of resolving grievances. This information has a strong signaling effect for both investors, showing that the government takes their issues seriously and resolves them. It helps retain existing investors in Kosovo and sends a strong message to potential investors. 4. Provide and publish regular analytical reports about the submitted grievances, to help formulate policy priorities and options and feed them into the political system. The analysis should be based on detailed data collection on complaints, such as the size of the business, the activities and sector of the complainant, the location, and the level of government involved. 5. Launch investor information campaigns. Chambers and councils can help raise awareness of the mechanism among their members. Demonstrated results will go a long way toward making the grievance management mechanism a trusted and credible option for investors. To further boost investor confidence, Kosovo could also consider adopting a new model international investment agreement that is in line with the provisions of the Regionally Accepted Standards developed under the Common Regional Market agenda. Kosovo has signed 10 international investment agreements, which generally include the core investor protection guarantees.17 However, these agreements are more in line with old-generation agreements, which grant protection to investments only once they are established and reserve the right to admit investments in accordance with local laws.18 Adopting the language of new-generation international investment agreements, which are more detailed in their description of substantive guarantees and further incorporate a series of reservations and exceptions to the assumed commitments, would provide Kosovo with more policy space and safeguards against frivolous claims (World Bank 2020d). A model bilateral investment treaty (BIT) would be useful in guiding the negotiation of new BITs and renegotiation of old BITs in line with international best practice standards. It would help ensure alignment with relevant European investment standards and policies, which is key for attracting investors targeting nearshoring to European markets. 16 See annex C for guidelines and good practices. 17 Nine of which are Bilateral Investment Treaties (BITs) and one of which is a Treaty with Investment Provisions (TIPs). 18 The temporal scope of an IIA determines whether the treaty applies to investments and/or measures pre- dating the treaty. Some new generation IIAs provide not only for investment protection but also for investment liberalization by granting protections to investors in the pre-establishment phase. The Investment Reform Agenda 35 The Reform Action Plan Table 3.2 provides an overview of the main reform actions identified in this note. Table 3.2  Investment policy and promotion reform action plan Reform Adopt and implement a national FDI strategy and action plan that will accelerate investment growth and COVID-19 recovery. Priority level High Actions a. Review priority b. Identify barriers to c. Focus investor d. Establish an sectors for investment investment in priority outreach and effective governance attraction and confirm sectors, prioritize promotion efforts on and coordination realistic priority sectors reforms, and align new sectors identified; mechanism in light of the changing policies needed roll out aggressive underpinning strategy landscape for FDI to improve their investment promotion implementation triggered by COVID-19 competitiveness. program. pandemic and other FDI megatrends. Timeframe for Short term Short term Medium term Short term implementation Responsible Entity/ Prime Minister’s Office, Ministry of Industry, Entrepreneurship and Trade, Interministerial Committee Entities for Strategic Investments, KIESA Resources An FDI strategy for Ireland: Driving Recovery and Sustainable Growth 2021–2024 Annex B of this report (Overview of an FDI Sector Scan) Growth and Jobs in Slavonia, Baranja, and Srijem: Rapid Diagnostics Reform Empower KIESA as national lead agency for investment attraction. Priority level High Actions a. Enhance KIESA’s b. Develop a corporate c. Strengthen d. Strengthen e. Develop and strategic alignment business plan for KIESA governance framework KIESA’s operational implement a focused and focus through a that identifies priorities for KIESA by putting effectiveness by outcome-oriented, more clearly defined and annual targets. in place a board of enhancing its financial, proactive outreach mandate focused on directors and clear human, and technical program targeting investment promotion. reporting lines to a resources. a small number of ministry or the Prime sectors aligned with Minister’s Office. Kosovo’s strategic priorities. Timeframe for Short term Short term Short term Medium term Medium term implementation Responsible Entity/ Prime Minister’s Office, Ministry of Industry, Entrepreneurship and Trade and Industry, KIESA Entities Resources Strengthening Service Delivery of Investment Promotion Agencies: A Comprehensive Investor Services Framework “Increasing the Development Impact of Investment Promotion Agencies” in Global Investment Competitiveness Report 2019/2020 State of Investment Promotion Agencies: Evidence from a WAIPA-WBG Joint Global Survey 2020 Investor Outreach in Tunisia IDA Ireland COVID-19 Response Plan 36 The Investment Reform Agenda Reform Establish an effective investor grievance mechanism to enhance investor confidence and reduce regulatory risk. Priority level High Actions a. Verify the NCED b. Adopt the c. Establish an internal d. Launch investor in its role as lead legal foundations grievance tracking information campaigns agency, or identify a empowering the lead system to capture to ensure private sector suitable lead agency government agency detailed information awareness of the to coordinate the for the grievance on grievance cases in a mechanism. grievance management mechanism, and systematic manner, and mechanism. elaborate its mandate publish regular analytical through implementing reports about the regulations. submitted grievances to formulate policy priorities and options. Timeframe for Short term Medium term Short term Short term implementation Responsible Entity/ Prime Minister’s Office, Ministry of Industry, Trade and Entrepreneurship, KIESA, National Council of Entities Economic Development Resources Annex C of this report (Good Practice Principles for the Design and Implementation of an Investor Grievance Mechanism) Case studies in box 3.4 of this report. Reform Enhance Kosovo’s legal framework governing investments. Priority level Medium Actions a. Adopt a model bilateral investment treaty that is in line with the provisions of the Regionally Accepted Standards for international investment agreement negotiations developed under the Common Regional Market agenda Timeframe for Medium term implementation Responsible Entity/ Ministry of Industry, Entrepreneurship and Trade, ministries involved in negotiating international treaties Entities Resources Regionally Accepted Standards for International Investment Agreement negotiations in the Western Balkans Six Morocco Model BIT Example The Investment Reform Agenda 37 Annex Annex A. Improving Investment Incentives Kosovo offers a range of fiscal incentives to foreign and domestic investors, including tax deductions and exemptions and customs duty exemptions or deferrals. Most of these incentives focus on agriculture, manufacturing, and some services sectors.19 The government also offers nonfiscal and regulatory incentives to strategic investors and economic zone entities. The main benefit of the Law on Strategic Investments (LSI) is the possibility it provides to grant the use of land and public property to strategic investors. Parliament needs to approve the transfer of socially owned and publicly owned properties for use in strategic projects.20 Strategic investors also benefit from accelerated administrative procedures for obtaining licenses, permits, and authorizations; assistance and an accelerated procedure for examining applications from KIESA; and support on access to basic infrastructure and land, in accordance with the Law on State Aid. The Law on Economic Zones (2003) and its administrative acts grant incentives in the form of reduced utilities (electricity, water, telephone, Internet) and rent as well as zone-specific custom duty and tax exemptions, in line with EU requirements.21 Information on Kosovo’s incentives and eligibility is transparent. In 2020, the Ministry of Finance published an inventory of incentives. It provides clarity and transparency for investors on the legal basis of incentives, their design, the award process, the administration of incentives, and the sources of such information.22 Survey results shows that 41 percent of investors rate transparency and access to information on incentives in Kosovo as good or very good (table A.1). Table A.1  Results of 2018 regional investor survey on performance of Kosovo and average for six Western Balkan countries on investment incentives (percent)   Kosovo Western Balkans 6 average Measure Poor or very Average Good or very Poor or very Average Good or very poor good poor good Availability of incentives on corporate income tax 31.8 27.3 18.2 27.8 26.6 23.5 (exemptions, reductions, tax credits/allowances) Availability of incentives on customs duties or VAT 27.3 31.8 18.2 24.0 27.1 24.0 for imports of goods (exemptions, reductions, etc.) Availability of nontax or financial incentives 40.0 10.0 15.0 34.4 16.9 11.5 (subsidies, matching grants, reduced-rate loans) Predictability of tax and incentive policy 22.7 31.8 18.2 31.3 32.4 14.0 Transparency and access to information on 18.2 13.6 40.9 22.9 27.1 28.6 incentives (clear laws and regulations, information on eligibility criteria, etc.) Ease of accessing incentives (simple and fast 32.3 25.5 15.2 45.0 10.0 20.0 processes and procedures for awarding and benefitting) Source: World Bank 2019g. The award process may involve some discretion and administrative complexity. According to the survey, investors do not find the incentives policy predictable or easy to access.23 About one-third of incentives are awarded automatically; the other two-thirds involve some level of discretion, which could include the need for additional authorizations or the approval of additional non-incentive- 19 Agricultural incentives are largely customs duty and value-added tax (VAT) exemptions for agricultural inputs and products for further processing, as well as customs duty exemptions and VAT reductions for capital goods and a VAT exemption for water used in the agriculture sector. Within manufacturing, incentives focus on VAT and customs duty exemptions for the import of raw materials and machinery. Incentives also provide customs duty exemptions for the import of IT equipment and an excise duty exemption for energy sources in the manufacturing sector. Within the services sector, most incentives are VAT exemptions or tax reductions on the purchase of IT equipment. 20 According to Article 24 of the law, the maximum period of the right to use the property is 99 years, with the possibility of extension. 21 The incentives inventory published by the Ministry of Finance does not list zone-specific incentives. 22 The list updated information that was available in the 2013 incentives inventory published on the KIESA website. 23 Investors in the broader WB6 region also cite this problem. 40 Annex related applications. Best practice entails limited discretion in the administration of incentives. The administration of incentives is spread across several agencies and ministries.24 Housing the oversight and administration of incentives within the Ministry of Finance generally allows for the most clarity. The investment promotion agency then provides information services related to the incentives. The main area requiring attention is monitoring and evaluating of the effectiveness of incentives. The government is conducting a cost–benefit analysis of its customs duty exemptions, a scheme that has been in place since 2018, to assess its effects on employment, skills, and exports. Such an analysis should prove useful, as tax incentives do not generally yield cost-effective outcomes. When incentive programs are not monitored, governments face a high risk of low efficiency and effectiveness in the attainment of policy goals. Kosovo’s investment incentives could be improved in the following ways: 1. Introduce clear, specific, measurable, actionable, realistic, and time-bound (SMART) policy objectives for each incentive program, and conduct a cost-effectiveness assessment of incentives. Such analysis could inform the design of incentives targeting specific sectors and subsectors and facilitate specific segments of efficiency-seeking FDI and FDI linkages, in line with Kosovo’s investment strategy. 2. Introduce legislation mandating the regular review of all incentive programs. The review should determine their relevance and economic benefits relative to their budgetary and other costs, including long-term impacts on resource allocation. A legislative requirement for review helps ensure that the reporting of tax expenditures is not done on an ad hoc basis or subject to political will or pressure. 3. Target incentives based on investment or other performance measures rather than profits. International experience shows that investment-linked tax incentives—such as investment allowances; credits for investment, staff training, and research and development; and accelerated depreciation of prioritized types of capital (such as technology)—tend to be more cost-effective than tax holidays (Kronfol 2020). Choosing the right instruments is critical to targeting investment in activities or behaviors can help the government achieve its development objectives, such as increasing the supply of skilled labor. 4. Simplify the procedures for applying for incentives through automatic approval and risk-based audits. Country experiences show that automatic approval of tax incentives to investors who meet eligibility criteria helps reduce discretionary decision making and increases investor certainty, as long as the eligibility criteria are objective and clear (World Bank 2019c). The tax authorities should verify and conduct audits to reduce misuse. Morocco publishes a detailed account of tax expenditures as part of its annual budget (box A.1). Box A.1  Measuring the costs and benefits of incentives for FDI A tax expenditure analysis assesses the corporate and indirect taxes that would have been due from a given company in the absence of incentives, based on information from the tax authorities on individual companies’ tax returns. Collecting and publishing these data increase the transparency of incentives and enable policy makers and other stakeholders to better assess their cost. Countries such as Colombia, Morocco, and South Africa follow this practice. Morocco publishes a detailed account of tax expenditure as part of its annual budget, showing expenditure by tax instrument, type of beneficiary, and industrial sector. Its detailed report also contains information on the types of incentives granted, their legal basis, the intended objectives, and eligible beneficiaries. Source: World Bank 2018b. 24 These institutions include the Ministry of Industry and Trade; Customs; the tax administration; and the Ministry of Agriculture, Forestry and Rural Development, with some incentives administered by multiple agencies. Annex 41 Annex B. FDI Sector Scan An FDI sector scan assesses the potential of sectors and subsectors to attract FDI. It is different from an assessment of the overall competitiveness or growth potential of sectors. This type of scan assesses sectors and value chains to determine their (a) “feasibility,” or readiness for investment promotion, and (b) “desirability,” or potential contribution toward achieving a country’s overarching policy goals. Feasibility criteria consider a country’s attractiveness and competitiveness as a location for investment relative to alternative locations based on cost, quality, and other competitiveness criteria. Desirability criteria consider whether FDI in the sector or subsector has the potential to meet a country’s long-term economic and social development objectives. It would examine potential contributions to job creation, productivity enhancement, export growth and diversification, domestic value addition, and other factors. A third dimension a scan assesses is FDI demand—the extent of existing or potential future global or regional FDI flows in sectors and subsectors. Figure B.1 provides an example of a sector scan framework. Figure B.1 Sector scan framework for selecting priority subsectors for FDI promotion Priority sectors should be both beneficial for the country and profitable for investors Value of FDI (Desirability) FDI in some sectors may o er attractive opportunities for investors, but add little value to the region FDI in high-import categories or processing exports for global markets may sound beneficial, but make little sense for investors Attractiveness of Value Proposition if they are products that are more (Feasibility) economical to produce or process elsewhere Source: World Bank, Global Investment Climate Unit. An FDI sector scan also identifies sector-specific investment barriers and obstacles for competitiveness. It helps identify investment barriers and supports the design of targeted reform actions to make the sector more attractive to investors. The sector scan is not about picking winners for broader industrial policies; it identifies sectors for FDI promotion based on Kosovo’s comparative advantages and development objectives, while taking into consideration broader global trends. 42 Annex Annex C. Good Practice in the Design and Implementation of an Investor Grievance Mechanism The following provides key good practice guidelines in designing and implementing an investor grievance mechanism to track and address investor issues as they arise. • Empowerment of a lead agency: There should be a government agency with power and attributions ideally conferred by regulation that is responsible for implementing IGM. The Lead Agency should coordinate problem solving process and the diffusion of relevant information to national, subnational and sector-specific agencies more likely to generate or become involved in investment grievances. • Early alert mechanism and tracking tool: Early alert mechanism enables the lead agency to learn about the existence of problems as soon as they arise. The Lead Agency’s response can be proactive (e.g., Lead Agency visits the private sector) or reactive (e.g. private sector communicates with the Lead Agency). Once a problem is identified, it is captured by the tracking tool that also monitors the investment at risk due to the problem. It monitors whether the problem is resolved and how much investment is retained and expanded as a result of the resolution of the problem. • Legal and economic assessment: It is crucial that the grievance be analyzed from an economic and a legal perspective before the lead agency coordinates with other agencies to resolve the grievance. The economic assessment estimates the potential impact of the grievance in terms of the amount of investment and the number of jobs at risk. The economic assessment is complemented by a legal analysis to determine the likelihood of liability of the host state should the grievance escalate into a full-blown investor-state dispute. • Problem Solving Methods: Based on the political economy of the country, IGM would empower the Lead Agency to use different problem-solving methods to directly address and negotiate a solution with the agencies involved in the problem. These methods range from simple exchanges of information to mechanisms of peer pressure or legal advisory opinions. • Political Decision Making: Often the lead agency may not have the political authority to discipline another peer agency. In this case, the problem is elevated to higher political levels, such as the ministerial cabinet and in some countries special ministerial councils chaired by the president or prime minister. Once a decision is taken at this higher level, the Lead Agency monitors and tracks the resolution, positive or negative, and the impact on investments. Source: World Bank forthcoming. Annex 43 Annex D. Kosovo’s Performance on the Western Balkans 2018 Regional Investor Survey The Western Balkans 2018 Regional Investor Survey was implemented to support better understanding of private sector perceptions of the key policy barriers to regional investment in the WB6 economies. The survey results stem from a series of in-depth interviews conducted in-person or over the phone with business executives from over 80 companies, which were undertaken over the course of several months through the end of 2018. Table D.1  Results of 2018 regional investor survey on performance of Kosovo and average for six Western Balkan countries on investment entry and establishment (percent)   Kosovo Western Balkans 6 average Measure Poor or very Average Good or very Poor or very Average Good or very poor good poor good Ability of foreign-owned companies to operate 0.0 22.7 36.4 10.8 11.5 48.8 in your sector (policies on foreign ownership restrictions) Policies on foreign investors to enter into joint 4.4 13.0 43.5 6.7 17.2 44.9 ventures with local firms in your sector Process of obtaining investment approval and 18.2 27.3 27.3 27.6 17.4 35.8 permits to start a business Transparency of business registration procedures 9.1 4.6 54.6 8.8 21.5 48.4 Ease of hiring and bringing in expatriate staff and 18.2 9.1 36.4 21.8 22.2 33.4 process of obtaining work permits for expatriate staff Process of obtaining a land lease 13.6 13.6 27.3 21.9 22.1 20.0 Source: World Bank 2019g. Table D.2  Results of 2018 regional investor survey on performance of Kosovo and average for six Western Balkan countries on investment attraction and promotion (percent) Kosovo Western Balkans 6 average Measure Poor or very Average Good or very Poor or very Average Good or very poor good poor good Quality of information provided by investment 34.8 17.4 21.7 24.7 21.5 19.3 promotion agency (e.g., detailed and accurate sector information, economic information, information on taxes, information on business opportunities) Quality of facilitation services (e.g., guiding investors 43.5 13.0 17.4 26.6 25.7 14.0 through site-location decision-making process, influencing investor’s location choice) Quality of outreach services or proactive promotion 39.1 13.0 17.4 24.0 19.7 15.0 (e.g., persuading potential investors to seriously consider a particular location as part of their investment plans) Source: World Bank 2019g. 44 Annex Table D.3  Results of 2018 regional investor survey on performance of Kosovo and average for six Western Balkan countries on investment protection and retention (percent) Kosovo Western Balkans 6 average Measure Poor or very Average Good or Poor or very Average Good or poor very good poor very good Political risk and adverse regulatory changes Risk of expropriation, confiscation, or other acts affecting 9.1 22.7 31.8 13.9 28.2 37.9 the investment, such as revocation of licenses Risk of breach of contract with government (such as non- 13.6 18.2 31.8 17.6 29.1 28.3 honoring of investor-state power purchase contract) Risk of occurrence of nontransparent or arbitrary 31.8 18.2 13.6 34.8 20.1 21.8 government conduct Stability and predictability of laws 21.7 26.1 30.4 47.8 25.3 14.5 Transparency and predictability in conduct of public 40.9 22.7 9.1 39.6 22.9 17.2 agencies Legal framework for Investment Existence of free trade agreements and investment treaties 21.7 21.7 30.4 12.2 26.5 33.1 Clarity of definitions of basic standards and qualifications 8.7 21.7 26.1 14.8 23.4 26.8 of rights and provisions in international investment agreements Ease of repatriating profits, dividends, management fees, 4.6 18.2 31.8 11.0 20.4 48.1 and other foreign exchange transactions. Grievances Ability of government to respond in timely and effective 47.8 21.7 8.7 33.2 29.9 18.9 manner to investor grievances (before grievances become legal disputes) Consultations with private sector Existence of effective processes for consultation on 18.2 27.3 13.6 25.3 35.8 19.6 proposed laws and regulations (processes include adequate minimum times for consultation, publication of comments received, and requirement to respond to comments) Government coordination with private sector 56.5 13.0 13.0 40.2 23.0 19.8 Source: World Bank 2019g. Table D.4  Results of 2018 regional investor survey on performance of Kosovo and average for six Western Balkan countries on investment incentives (percent)   Kosovo Western Balkans 6 average Measure Poor or Average Good or Poor or Average Good or very poor very good very poor very good Availability of incentives on corporate income tax (exemptions, 31.8 27.3 18.2 27.8 26.6 23.5 reductions, tax credits/allowances) Availability of incentives on customs duties or VAT for imports 27.3 31.8 18.2 24.0 27.1 24.0 of goods (exemptions, reductions, etc.) Availability of nontax or financial incentives (subsidies, 40.0 10.0 15.0 34.4 16.9 11.5 matching grants, reduced-rate loans) Predictability of tax and incentive policy 22.7 31.8 18.2 31.3 32.4 14.0 Transparency and access to information on incentives (clear 18.2 13.6 40.9 22.9 27.1 28.6 laws and regulations, information on eligibility criteria, etc.) Ease of accessing incentives (simple and fast processes and 32.3 25.5 15.2 45.0 10.0 20.0 procedures for awarding and benefitting) Source: World Bank 2019g. Annex 45 Annex E. Standards of Investor Protection Table E.1 provides an overview of the six fundamental or core guarantees that should form part of a robust investment protection framework. Table E.2 provides an indication of whether Kosovo’s foreign investment law or international investment agreements provide a higher level of protection, the same or similar level of protection, or a lower level of protection. Table E.1  Standards of investor protection Standard Description Fair and equitable treatment The purpose of requiring fair and equitable treatment of investments is to protect investors against serious abuse and arbitrary or discriminatory actions by host states. Some versions of this obligation simply require the state to provide fair and equitable treatment; others combine the standard with additional requirements for “full protection and security.” Many investment laws and most international investment agreements provide a minimum standard of treatment to investments of investors. Nondiscrimination Good international practice guarantees that foreign investors are treated the same way as domestic investors. The clause may cover all investment phases, including the establishment phase, or be limited to the operational phase. Most favored nation The most favored nation clause is a specific nondiscrimination provision for foreign investors guaranteeing nondiscriminatory treatment across all foreign investors. Transferability of convertible A fundamental investor right is the guarantee that convertible currency, as defined by the IMF, can be accessed and currency abroad assets freely transferred abroad. The assets are usually described in a list that includes profits, dividends, interests, capital gains, proceeds from the sale of the investment, payments arising from expropriation compensation, and other assets. Expropriation and A fundamental investment protection is to allow expropriation only under certain conditions. The expropriation compensation decision should be based on public interest and the provision of fair, prompt, and effective compensation. The expropriation clause generally covers direct and indirect expropriation. Indirect expropriation includes measures that have an effect that is equivalent to expropriation even though there is no formal transfer of title or outright seizure. Dispute resolution A determination of how disputes between foreign investors and host states are resolved. 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