In many economies of the Balkans high formal unemployment is often blamed on insufficient skills in the labor force. But this intuitive diagnosis glosses over two fundamental questions, namely: why are workers not training themselves to find jobs, and why aren’t firms investing in upgrading the skills of their employees? In other words, the market seems to be failing by not allocating resources where high returns can be found. In this blog post, we cast doubt on the diagnosis and look beyond the skills gap explanation to high unemployment in the Western Balkans. But this is not unique to the Balkans. Take the US construction industry, which is among the most productive in the world even though it employs many relatively low skilled workers, often immigrants from Mexico and other Latin American countries, who improved their individual productivity several fold by migrating  – not upgrading skills.
There is no doubt about the problem as throughout the region unemployment – particularly formal – remains unacceptably high. Serbia is a case in point: Out of a population of 7.2 million people and a workforce of 4.5 million, only 710,000 Serbians have a formal, private sector job.  If you add some 380,000 ‘sole proprietors’ – basically people who run mini-shops – you get to around 1.1 million people in the formal private sector. That means that the livelihood of the whole country is built around this 15 percent of the population. Can it really be that firms are still not able to find sufficiently skilled employees in the large remaining pool, especially given that Serbia has decent education results? If finding skilled workers in Serbia is like looking for needles in a haystack, there are surely a lot of needles to be found.
So what does the data say, and can we get a more robust sample than my anecdotal encounter with the cab driver? If there was a major skills gap in the economy, logically there would also be a high premium on those scarce skills. However, trends in wages do not in fact show this to be true. Based on calculations for the Balkan economies in which the Economist Intelligence Unit  collects data, we see that average real wages rose across Bulgaria, Croatia, Macedonia, Romania and Serbia as unemployment went down between 2000 and 2008. After the 2008 crisis, when unemployment rose again markedly, real wages stagnated. The same held for unit labor costs (ULC) which measure the average cost (not just wages) of labor per unit of output (see figure). If a skills shortage existed, then the market would reward skills by offering higher wages.
Since the turn of the century, when this data series begins, there have been two clear periods. From 2000 to 2008 economic output grew – real GDP in the Balkans grew an average of about 6 percent between 2000 and 2008 – while labor costs rose even faster. The skills gap story would have made sense in 2008 when unemployment was relatively high, output growth was fast, and wages were growing even faster. But after, average real GDP growth was just below -0.5 percent, while ULCs continued to rise and real wages remained flat. On the optimistic side, positive growth is returning to the Balkans. On the pessimistic side, ULCs have to fall further (which likely means wages have to fall) before firms begin to hire.
There is enough work in the Balkans and there are enough workers. The challenge is to convert the large amount of work into jobs. Unit labor costs are relatively high in the Balkans. Governments can help by first shifting taxes from labor to consumption. This in turn would help the tradable sector which is not yet performing at its potential relative to non-tradables (including housing). Second, businesses need to be able to operate more easily. Even in the better-performing countries, companies complain about unnecessary red-tape and tedious processes to hire workers with flexible contracts including many international staff that are constraints by arduous visa requirements.
The clues indicate that the skills shortage hypothesis falls short and this has important implications for policy. If you don’t fix the business environment and only invest in skills upgrading then next time you visit a Balkan capital you may be welcomed by cab drivers with a PhD in otherwise deteriorating economic environments.