## Change in Population in North Macedonia and the Western Balkan Countries

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---

### Key findings and overview
- The population of North Macedonia has been steadily declining over the past two decades and is projected to continue to decline into the foreseeable future largely because of emigration.
- The 2021 population census revised the population down by around 11 percent relative to its previously estimated values.
- The UN World Population Prospects (2024 Revision) projects the population of North Macedonia to decline by around 4 percent by 2030.
- Estimates by the statistics office of North Macedonia (SSO) project the population to decline by almost 9 percent by 2030.
- Staff estimates that the population decline would create a drag on output growth of around 0.5 percentage points.
- Increased emigration, potentially driven by further EU integration, presents a downside risk to the outlook as it could further worsen population dynamics.
- Productivity-increasing structural reforms, active labor market policies, new business support, and labor participation support can boost potential output and help offset some of the negative impact of migration.

*Sources: UN 2024 Revision of World Population Prospects; SSO; IMF staff estimates.*

### Potential output projections (methodology and quantitative assumptions)
- Production function and output per capita:
  - Y_t = A_t K_t^{α_t} L_t^{1−α_t}; output per capita expressed as Y_t / N_t = A_t^{1/(1−α_t)} (K_t / Y_t)^{α_t/(1−α_t)} (L_t / N_t).
- Capital:
  - Constructed with the perpetual inventory method: K_t = (1−δ_t) K_{t−1} + X_t.
  - Initial capital: K_0 = X_0 / (ḡ_X + δ_0) where ḡ_X is average growth of gross fixed capital formation.
  - Capital projected to 2030 using IMF WEO values; beyond 2030 assumed constant capital-output ratio (steady-state), producing a sharp drop in the capital and output growth rate in 2031 which should be taken as indicative of long-term growth potential rather than a year-by-year forecast.
- Labor:
  - Constructed from historical employment trends and projected as the sum of labor by age and sex subgroups.
  - Population subgroups taken from UN World Population Prospects dataset using the Medium Forecast scenario.
  - Total labor stock: L_t = Σ_{a,s} LPR_{a,s,t} × (1 − u_{a,s,t}) × N_{a,s,t}/N_t.
  - Participation and unemployment projected with convergence dynamics:
    - LPR_{a,s,t} = (1 − ξ_{a,s}^L) LPR_{a,s,t−1} + ξ_{a,s}^L LPR̄_{a,s},
    - u_{a,s,t} = (1 − ξ_{a,s}^u) u_{a,s,t−1} + ξ_{a,s}^u ū_{a,s},
    - Convergence rate parameter ξ_{a,s}^X is set to 2.5 percent based on historical convergence of labor participation in the pre-pandemic period.
    - Long-run steady states for each group are taken to be the EU average values in 2023.
- Total factor productivity (TFP):
  - Constructed as a Solow residual: A_t = Y_t / (K_t^{α_t} L_t^{1−α_t}).
  - TFP follows IMF WEO values until 2030; thereafter g_t^A = (1 − ξ_A) g_{t−1}^A + ξ_A ḡ_A with ξ_A = 2.5 percent and ḡ_A = 1 percent.

### Projection results and implications
- Employment effects:
  - Despite convergence of participation and unemployment rates, population dynamics dominate; employment becomes a drag on output growth of around − 0.5 percentage points by 2030.
  - The model compensates for some employment decline with higher TFP growth; capital deepening contributes less to growth over the horizon.
- Projection caveat:
  - The capital-output steady-state assumption beyond 2030 yields a sharp drop in projected growth in 2031; this should be interpreted as indicative of long-run potential, not annual precision.

### Comparison of labor markets in the Western Balkans and the EU
- Labor participation and unemployment:
  - Labor participation rate in North Macedonia is around 65 percent, considerably below 75 percent in the EU.
  - Unemployment in North Macedonia fell from about 26 percent to 13 percent over the past decade, similar to other Western Balkan countries, but remains around twice as high as in the EU.
- Potential offset via labor market improvements:
  - A back-of-the-envelope calculation indicates that closing the gap with the EU by increasing participation by around 10 percentage points and lowering unemployment by around 7 percentage points would increase potential output by around 25 percent (≈75%×(1−6%)/65%×(1−13% )−1).
  - Closing one-third of the gap would be more than enough to offset the projected loss in population by 2030.
  - Efforts to close these gaps would likely strengthen incentives for individuals to remain in the economy.
- Gender gap:
  - Most of the labor participation gap between North Macedonia and the EU is explained by the low labor participation rate of women.

### Box: Gender market gaps (key statistics and implications)
- 2023 gender labor participation gap in North Macedonia: about 21 percentage points (p.p.).
- Western Balkans average gender participation gap: 18.7 p.p.
- EU average gender participation gap: 8 p.p.
- Women's employment rate gap in North Macedonia: 16 p.p.
- Regional comparisons: Kosovo gender gap 31 p.p.; Bosnia and Herzegovina 22 p.p.
- Wage gap: 2018 wage gap was around 15.3 percent in North Macedonia, compared to 13 percent in the EU.
- Other points:
  - Women in North Macedonia are less likely to be unemployed than men among active workers, unlike the EU where the reverse holds in some cases.
  - Men are more likely to be informally employed than women in North Macedonia.
  - Wider gender gaps are driven by inadequate education at lower levels, caregiving burdens (lack of affordable quality childcare, parental leave policies, cultural norms), tax burden on secondary earners, and sectoral composition.
- Potential gains from closing gender gaps:
  - Employment is projected to decline by around [4 percent] by 2030, which could be mostly offset by closing the gender gap between North Macedonia and the other Western Balkan countries and completely offset by closing one-third of the gender gap with the EU.
  - A back-of-the-envelope calculation implies that closing the gender gap completely could increase potential output by ΔY_t/N_t ≈ ΔL_t/N_t =14.4%.
  - Closing gender employment gaps could significantly increase economic development, help address labor shortages, and improve productivity.

### Modeling labor markets and migration: structural multi-country model
- Model features:
  - Structural multi-country model of labor markets with endogenous migration (building on Ayerst and Zhang, 2025).
  - Households transition between employment, unemployment, and inactivity and can relocate across countries.
  - Household decisions: whether to be inactive or search (based on personal preferences such as value of leisure and economic factors such as wage and job-finding probability).
  - Unemployed workers search for vacancies; matches produce revenues shared by worker and firm through bargaining.
  - Migration decisions weigh idiosyncratic locational preferences, bilateral migration costs (e.g., moving costs), and economic factors (e.g., probability of finding work, wage).
  - Equilibrium describes flows across inactivity, unemployment, employment, and cross-country migration as functions of economic variables.
- Use of the model:
  - To study the impact of further EU integration on emigration and labor market outcomes.
  - To evaluate how increased emigration from EU integration could have negative impacts, and how these can be offset by productivity improvements and targeted policies (structural reforms, active labor market policies, business support, labor participation measures).

### Model estimation and scenarios for EU integration
- Estimation and calibration:
  - Model parameters are estimated for 35 European countries, which includes the EU countries, six Western Balkan countries, Türkiye, and Switzerland, over the 2011 to 2019 period.
  - The labor market is matched to data on transitions between inactivity, unemployment, and employment; labor market tightness; and net PPP-adjusted wage rate.
  - Bilateral migration costs are set to match bilateral migration flows; missing data moments over 2011–2019 are interpolated using economic relationships.
- EU integration scenarios:
  - Two scenarios simulated for North Macedonia:
    - Migration costs reduced only between North Macedonia and EU countries.
    - Migration costs reduced and labor productivity increased.
  - Calibration:
    - Reduction in migration costs is calibrated to match a doubling of the emigration rate (consistent with empirical evidence in Ayerst et al. (2025) between EU member countries).
    - Increase in productivity is calibrated to match an increase in output-per-capita of around 30 percent (consistent with evidence reported in IMF (2024)).

### Simulated impacts of EU integration (key findings)
- Without productivity improvements:
  - Reduction in migration costs leads to a decline in wages and output-per-capita.
  - Labor market outcomes worsen (labor participation, employment, unemployment).
  - Population declines from increased emigration.
  - Mechanism: domestic firms face more competition from foreign firms → higher wage rage at the cost of profits → lower profits reduce firms’ willingness to post vacancies → unemployment rises.
- With productivity improvements:
  - Productivity raises both wages and profits for workers and firms.
  - Increased incentives for participation and for firms to post vacancies increase job finding and employment.
  - Creates pull factors: unemployed workers more readily find employment and employed workers receive higher wages → disincentivizes emigration and incentivizes immigration.
  - Net impact: population is relatively unchanged while output-per-capita increases.
- Important caveat: productivity may not fully offset the increase in emigration but can lead to increased immigration and improved labor market performance that offset negative impacts on output-per-capita.

### Policy experiments to boost potential output and support the labor market
- Four broad policy classes simulated; experiments show broadly similar impacts on key outcomes:
  - Structural reforms:
    - Modeled as a one percent increase in the production of matched firms and workers.
    - In practice: reduced misallocation of factors, reduced financial constraints, increased investment from improved rule of law and reduced corruption, reduced informal sector competition.
  - Active labor market policies (ALMP):
    - Modeled as a 10 percent increase in the matching rate between unemployed workers and vacancies.
    - In practice: job search assistance, vocational training, lifelong learning, youth training and apprenticeship programs.
  - Business support (SME):
    - Modeled as a 10 percent reduction in the vacancy cost of new firms entering the market.
    - In practice: reduce bureaucratic barriers to firm entry, one-stop shops for business registration, improved access to digital public services.
  - Labor participation (LP) policies:
    - Modeled as a 10 percent reduction in the benefits from inactivity, increasing the relative value of working.
    - In practice: access to quality child and elder care, flexible work arrangements, programs to help out-of-the-labor-force individuals reenter the labor market.
    - Model limitation note: reducing home production benefits to inactive and unemployed workers (used in the simulation) leads to some counter-intuitive results with emigration for this experiment.
- Policy prioritization and monitoring:
  - Policymakers should focus on policies with the largest potential impact relative to implementation cost and combine policies with careful monitoring and updating.

### Conclusions and policy discussion (key implications)
- Demographic and output risks:
  - A declining population driven by emigration threatens to drag down potential output growth.
  - Based on UN projections, higher emigration is projected to lead to a decline in the working-age population and is expected to shrink employment by around 0.5 percentage points going into the future.
  - Without counteracting measures, the decline in employment is projected to drive a similar decline in potential output.
- Policy effectiveness:
  - Large structural barriers exist in worker productivity, matching efficiency, and the cost of creating new vacancies compared to European countries.
  - Policies targeting these areas could lift labor market quality and boost potential.
- Gender gap as a policy lever:
  - The gender gap in North Macedonia is around 21 percentage points, compared with 18.7 in the Western Balkan countries and 8 in the EU.
  - Closing the gender gap with the Western Balkan countries by 2030 would offset most of the projected loss in employment from emigration.
  - Closing the gender gap with the EU would offset the loss in employment projected up to 2050.
  - Policy measures to close the gender gap could include increasing access to affordable childcare, improving education investment in women, aligning parental leave policies with EU standards including introducing mandatory paternity leave, and removing tax disincentives for multi-income households.

*IMF staff: "Change in Population in North Macedonia and the Western Balkan Countries", April 8, 2025.*

---

### Migration, macro-financial linkages, and vulnerability in the Western Balkans

- Migration drivers and remittances:
  - Emigration is driven primarily by economic factors: high unemployment (particularly among youth), limited career prospects, and wage disparities with the EU.
  - Main destination countries: Germany, Italy, Slovenia, and Austria.
  - Remittances:
    - Kosovo: highest contribution from remittances of around 17 percent of GDP.
    - North Macedonia: Central Bank calculations suggest remittances could be three times higher than reported, around 14 percent.
  - Dependence on remittances increases vulnerability to economic downturns in the EU.
  - Data challenges exist in measuring remittances (cash versus formal channels).
- Foreign Direct Investment and trade:
  - EU-based companies accounted for 58 percent of the FDI stock in the Western Balkans as of 2023.
  - North Macedonia: around 67 percent of its FDI originates from EU countries, including approximately 9 percent from Germany.
  - Export-oriented FDI supports sectors: automotive, chemicals, machinery, electronics, and transportation.
- Financial linkages, euroization, and banking:
  - Euro-denominated deposits and loans range from between 36 percent to about 58 percent in the Western Balkans.
  - North Macedonia: around 40 percent of both deposits and loans occur in foreign currency despite a denarization strategy.
  - Foreign bank ownership ranges between 65 percent to 84 percent; an average of 47 percent of this ownership comes from the EA.
  - EA ownership shares (end-2023): Serbia 64 percent, Bosnia and Herzegovina 54 percent, North Macedonia 53 percent, Kosovo 52 percent.
  - Evidence of significant interest rate pass-through from euro area monetary policy linked to degree of financial euroization.
- Monetary and exchange rate regimes:
  - Kosovo and Montenegro: full euroization.
  - Bosnia and Herzegovina: currency board pegged to the euro.
  - North Macedonia: stabilized arrangement with de facto peg to the euro; price stability is primary objective.
  - Albania and Serbia: inflation-targeting frameworks with free (Albania) and managed (Serbia) floating exchange rates.
  - Flexible exchange rates (Albania, Serbia) afford more capacity to absorb external shocks; rigid arrangements limit exchange rate adjustments and increase reliance on internal mechanisms.
- Energy sector vulnerabilities:
  - Energy intensity of WB economies still exceeds the EA average.
  - North Macedonia relies on energy imports for over 60 percent of its needs.
  - Energy weight in North Macedonia CPI at 10 percent.
  - North Macedonia experienced the region's largest inflationary spike of 20 percent during the recent commodity-driven inflation surge.
  - Global energy price shocks account for 20 to 30 percent of inflation variance at the 1 to 2 year horizon in Bosnia-Herzegovina, Kosovo, and North Macedonia.
  - Global energy price shocks cause significant and persistent deterioration in the trade balance for the most energy intensive and import dependent countries (particularly Serbia and North Macedonia).

### BGVAR estimations and spillover evidence
- Model and identification:
  - Bayesian Global Vector Autoregressive (BGVAR) model with stochastic volatility; sample 2007:1 to 2024:3.
  - Shocks analyzed via Generalized Impulse Response Functions (GIRFs); report medians and peak response medians with 68 percent credible intervals.
- Real activity spillovers:
  - Euro area real activity shocks significantly impact WB economies; linked to integration in European global value chains (GVCs).
  - North Macedonia: largest effect on industrial production of 0.96 percent.
  - Supply-side shocks from Germany, particularly to automotive sector, drive North Macedonia’s large response.
  - Manufacturing exporters’ trade balances improve following EA real activity shocks; North Macedonia shows the largest and most sustained improvement (lasting up to one year).
- Financial spillovers:
  - Euro area private credit shocks tend to boost credit in the region with varying significance.
  - Serbia: strongest rise in credit of 0.67 percent.
  - Euro area equity price shocks have limited impact; North Macedonia sees only a 0.34 percent increase in equity-related response.
- Monetary policy transmission:
  - Euro area policy rate changes transmit strongly across the Western Balkans; transmission depends on monetary autonomy and euroization.
  - Industrial production declines in fully euroized economies:
    - Montenegro: -1.6 percent
    - Bosnia-Herzegovina: -1.1 percent
    - North Macedonia and Serbia: -0.5 percent
  - Transmission aligns with rapid EA retail rate pass-through.
- QE spillovers:
  - QE transmission to the Western Balkans is relatively muted and predominantly indirect via EA real activity, inflation, and financial markets.
  - QE indirectly boosts industrial production in Bosnia and Herzegovina and Serbia, with a borderline significant effect in North Macedonia.
- Energy price shocks:
  - Inflation increases by approximately 1.5 to 5.2 percent in response to a 1 percent rise in the energy commodity price index, with peak impacts between the third and fourth quarters before tapering in the second year.
  - Sharpest inflationary spikes: Bosnia-Herzegovina, Kosovo, and North Macedonia; smallest impact: Albania.

### Policy implications for deeper euro area integration and resilience
- Spillovers and policy coordination:
  - Euro area monetary policy creates significant spillovers, limiting scope for independent monetary policies in the Western Balkans.
  - Gradual financial integration should be pursued with strong institutional frameworks and increased cross-border supervisory cooperation with EA regulators.
  - Strengthening policy coordination with the Eurozone will become increasingly important as business cycle comovement intensifies.
- Monetary policy and macroprudential tools:
  - Reducing financial euroization can improve monetary policy space.
  - Leveraging flexibility in inflation-targeting frameworks and enhancing transparency can strengthen policy independence and credibility.
  - Appropriate use of macroprudential and foreign exchange liquidity management tools can provide space for monetary policy, mitigate financial stability risks, and reduce capital flow volatility.
- Energy shock response:
  - Monetary policy may need to react more decisively to energy price shocks to prevent unanchored inflation expectations.
  - Structural resilience measures: reducing energy intensity, diversifying energy sources, improving energy efficiency.
  - Social and fiscal measures: strengthen social safety nets and deploy targeted fiscal policies, including temporary subsidies for low-income households to cushion energy price volatility.
- Trade and GVC strategy:
  - Strategic approach to GVC integration to reduce concentrated dependencies and diversify trade partners.

*Source: IMF staff (content unit as provided).*

### 1. Change in Population in North Macedonia and the Western Balkan Countries _______ 3

### 1. Change in Population in North Macedonia and the Western Balkan Countries

### Key findings and overview
- The population of North Macedonia has been steadily declining over the past two decades and is projected to continue to decline into the foreseeable future largely because of emigration.
- The 2021 population census revised the population down by around 11 percent relative to its previously estimated values.
- The UN World Population Prospects (2024 Revision) projects the population of North Macedonia to decline by around 4 percent by 2030.
- Estimates by the statistics office of North Macedonia (SSO) project the population to decline by almost 9 percent by 2030.
- Staff estimates that the population decline would create a drag on output growth of around 0.5 percentage points.
- Increased emigration, potentially driven by further EU integration, presents a downside risk to the outlook as it could further worsen population dynamics.
- Productivity-increasing structural reforms, active labor market policies, new business support, and labor participation support can boost potential output and help offset some of the negative impact of migration.

*Sources: UN 2024 Revision of World Population Prospects; SSO; IMF staff estimates.*

---

### Potential output projections (methodology and quantitative assumptions)
- Production function: Y_t = A_t K_t^{α_t} L_t^{1−α_t}; output per capita expressed as Y_t / N_t = A_t^{1/(1−α_t)} (K_t / Y_t)^{α_t/(1−α_t)} (L_t / N_t).
- Capital:
  - Constructed with the perpetual inventory method: K_t = (1−δ_t) K_{t−1} + X_t.
  - Initial capital: K_0 = X_0 / (ḡ_X + δ_0) where ḡ_X is average growth of gross fixed capital formation.
  - Capital projected to 2030 using IMF WEO values; beyond 2030 assumed constant capital-output ratio (steady-state), producing a sharp drop in the capital and output growth rate in 2031 which should be taken as indicative of long-term growth potential rather than a year-by-year forecast.
- Labor:
  - Constructed from historical employment trends and projected as the sum of labor by age and sex subgroups.
  - Population subgroups taken from UN World Population Prospects dataset using the Medium Forecast scenario.
  - Total labor stock: L_t = Σ_{a,s} LPR_{a,s,t} × (1 − u_{a,s,t}) × N_{a,s,t}/N_t.
  - Participation and unemployment projected with convergence dynamics:
    - LPR_{a,s,t} = (1 − ξ_{a,s}^L) LPR_{a,s,t−1} + ξ_{a,s}^L LPR̄_{a,s},
    - u_{a,s,t} = (1 − ξ_{a,s}^u) u_{a,s,t−1} + ξ_{a,s}^u ū_{a,s},
    - Convergence rate parameter ξ_{a,s}^X is set to 2.5 percent based on historical convergence of labor participation in the pre-pandemic period.
    - Long-run steady states for each group are taken to be the EU average values in 2023.
- Total factor productivity (TFP):
  - Constructed as a Solow residual: A_t = Y_t / (K_t^{α_t} L_t^{1−α_t}).
  - TFP follows IMF WEO values until 2030; thereafter g_t^A = (1 − ξ_A) g_{t−1}^A + ξ_A ḡ_A with ξ_A = 2.5 percent and ḡ_A = 1 percent.

---

### Projection results and implications
- Employment effects:
  - Despite convergence of participation and unemployment rates, population dynamics dominate; employment becomes a drag on output growth of around − 0.5 percentage points by 2030.
  - The model compensates for some employment decline with higher TFP growth; capital deepening contributes less to growth over the horizon.
- Projection caveat:
  - The capital-output steady-state assumption beyond 2030 yields a sharp drop in projected growth in 2031; this should be interpreted as indicative of long-run potential, not annual precision.

---

### Comparison of labor markets in the Western Balkans and the EU
- Labor participation and unemployment:
  - Labor participation rate in North Macedonia is around 65 percent, considerably below 75 percent in the EU.
  - Unemployment in North Macedonia fell from about 26 percent to 13 percent over the past decade, similar to other Western Balkan countries, but remains around twice as high as in the EU.
- Potential offset via labor market improvements:
  - A back-of-the-envelope calculation indicates that closing the gap with the EU by increasing participation by around 10 percentage points and lowering unemployment by around 7 percentage points would increase potential output by around 25 percent (≈75%×(1−6%)/65%×(1−13% )−1).
  - Closing one-third of the gap would be more than enough to offset the projected loss in population by 2030.
  - Efforts to close these gaps would likely strengthen incentives for individuals to remain in the economy.
- Gender gap:
  - Most of the labor participation gap between North Macedonia and the EU is explained by the low labor participation rate of women.

---

### Box: Gender market gaps (key statistics and implications)
- 2023 gender labor participation gap in North Macedonia: about 21 percentage points (p.p.).
- Western Balkans average gender participation gap: 18.7 p.p.
- EU average gender participation gap: 8 p.p.
- Women's employment rate gap in North Macedonia: 16 p.p.
- Regional comparisons: Kosovo gender gap 31 p.p.; Bosnia and Herzegovina 22 p.p.
- Wage gap: 2018 wage gap was around 15.3 percent in North Macedonia, compared to 13 percent in the EU.
- Other points:
  - Women in North Macedonia are less likely to be unemployed than men among active workers, unlike the EU where the reverse holds in some cases.
  - Men are more likely to be informally employed than women in North Macedonia.
  - Wider gender gaps are driven by inadequate education at lower levels, caregiving burdens (lack of affordable quality childcare, parental leave policies, cultural norms), tax burden on secondary earners, and sectoral composition.
- Potential gains from closing gender gaps:
  - Employment is projected to decline by around [4 percent] by 2030, which could be mostly offset by closing the gender gap between North Macedonia and the other Western Balkan countries and completely offset by closing one-third of the gender gap with the EU.
  - A back-of-the-envelope calculation implies that closing the gender gap completely could increase potential output by ΔY_t/N_t ≈ ΔL_t/N_t =14.4%.
  - Closing gender employment gaps could significantly increase economic development, help address labor shortages, and improve productivity.

---

### Modeling labor markets and migration: structural multi-country model
- Model features:
  - Structural multi-country model of labor markets with endogenous migration (building on Ayerst and Zhang, 2025).
  - Households transition between employment, unemployment, and inactivity and can relocate across countries.
  - Household decisions: whether to be inactive or search (based on personal preferences such as value of leisure and economic factors such as wage and job-finding probability).
  - Unemployed workers search for vacancies; matches produce revenues shared by worker and firm through bargaining.
  - Migration decisions weigh idiosyncratic locational preferences, bilateral migration costs (e.g., moving costs), and economic factors (e.g., probability of finding work, wage).
  - Equilibrium describes flows across inactivity, unemployment, employment, and cross-country migration as functions of economic variables.
- Use of the model:
  - To study the impact of further EU integration on emigration and labor market outcomes.
  - To evaluate how increased emigration from EU integration could have negative impacts, and how these can be offset by productivity improvements and targeted policies (structural reforms, active labor market policies, business support, labor participation measures).

---

*Italic source attribution: IMF staff: "Change in Population in North Macedonia and the Western Balkan Countries", April 8, 2025.*

### 10.      The model is estimated to match labor market flows and bilateral migration flows for

### 10.      The model is estimated to match labor market flows and bilateral migration flows for

### Model estimation and calibration
- Model parameters are estimated for 35 European countries, which includes the EU countries, six Western Balkan countries, Türkiye, and Switzerland, over the 2011 to 2019 period.
- The labor market is matched to data on:
  - transitions between inactivity, unemployment, and employment;
  - labor market tightness (measured as the ratio between the vacancy rate and unemployment rate);
  - net PPP-adjusted wage rate.
- Bilateral migration costs are set to match bilateral migration flows between countries, allowing the model to replicate observed migration patterns.
- Missing data moments over the 2011–2019 period are interpolated using economic relationships as described in Ayerst et al. (2025).

### Examining further EU integration: scenarios and calibration
- Two EU integration scenarios for North Macedonia are simulated:
  - Migration costs reduced only between North Macedonia and EU countries.
  - Migration costs reduced and labor productivity increased.
- Calibration details:
  - Reduction in migration costs is calibrated to match a doubling of the emigration rate (consistent with empirical evidence in Ayerst et al. (2025) between EU member countries).
  - Increase in productivity is calibrated to match an increase in output-per-capita of around 30 percent (consistent with evidence reported in IMF (2024)).

### Simulated impacts of EU integration (key findings)
- Without productivity improvements:
  - Reduction in migration costs leads to a decline in wages and output-per-capita.
  - Labor market outcomes worsen (labor participation, employment, unemployment).
  - Population declines from increased emigration.
  - Mechanism: domestic firms face more competition from foreign firms → higher wage rage at the cost of profits → lower profits reduce firms’ willingness to post vacancies → unemployment rises.
- With productivity improvements:
  - Productivity raises both wages and profits for workers and firms.
  - Increased incentives for participation and for firms to post vacancies increase job finding and employment.
  - Creates pull factors: unemployed workers more readily find employment and employed workers receive higher wages → disincentivizes emigration and incentivizes immigration.
  - Net impact: population is relatively unchanged while output-per-capita increases.
- Important caveat: productivity may not fully offset the increase in emigration but can lead to increased immigration and improved labor market performance that offset negative impacts on output-per-capita.

### Policy experiments to boost potential output and support the labor market
- Four broad policy classes are simulated; experiments show policymakers have a range of options with broadly similar impacts on key outcomes.
- Structural reforms:
  - Modeled as a one percent increase in the production of matched firms and workers.
  - In practice: reduced misallocation of factors, reduced financial constraints, increased investment from improved rule of law and reduced corruption, reduced informal sector competition.
- Active labor market policies (ALMP):
  - Modeled as a 10 percent increase in the matching rate between unemployed workers and vacancies, all else equal.
  - In practice: job search assistance, vocational training, lifelong learning, youth training and apprenticeship programs.
- Business support (SME):
  - Modeled as a 10 percent reduction in the vacancy cost of new firms entering the market.
  - In practice: reduce bureaucratic barriers to firm entry, one-stop shops for business registration, improved access to digital public services.
- Labor participation (LP) policies:
  - Modeled as a 10 percent reduction in the benefits from inactivity, increasing the relative value of working.
  - In practice: access to quality child and elder care, flexible work arrangements, programs to help out-of-the-labor-force individuals reenter the labor market.
  - Model limitation note: reducing home production benefits to inactive and unemployed workers (used in the simulation) leads to some counter-intuitive results with emigration for this experiment.

### Conclusions and policy discussion (key implications)
- Demographic and output risks:
  - A declining population driven by emigration threatens to drag down potential output growth.
  - Based on UN projections, higher emigration is projected to lead to a decline in the working-age population and is expected to shrink employment by around 0.5 percentage points going into the future.
  - Without counteracting measures, the decline in employment is projected to drive a similar decline in potential output.
- Policy effectiveness and prioritization:
  - Large structural barriers exist in worker productivity, matching efficiency, and the cost of creating new vacancies compared to European countries.
  - Policies targeting these areas could lift labor market quality and boost potential.
  - Although the simulated policies target different labor market stages (participation, job finding, productivity of the match), they have similar macroeconomic impacts.
  - Policymakers should focus on policies with the largest potential impact relative to implementation cost and combine policies with careful monitoring and updating.
- Gender gap as a policy lever:
  - The gender gap in North Macedonia is around 21 percentage points, compared with 18.7 in the Western Balkan countries and 8 in the EU.
  - Closing the gender gap with the Western Balkan countries by 2030 would offset most of the projected loss in employment from emigration.
  - Closing the gender gap with the EU would offset the loss in employment projected up to 2050.
  - Policy measures to close the gender gap could include increasing access to affordable childcare, improving education investment in women, aligning parental leave policies with EU standards including introducing mandatory paternity leave, and removing tax disincentives for multi-income households.

*Source: IMF staff calculations and simulations as described in the chapter text.*

### 8.      Emigration has been a defining socio-economic challenge for the Western Balkans,

### 8.      Emigration has been a defining socio-economic challenge for the Western Balkans

### Migration, Emigration Drivers, and Remittances
- Emigration is driven primarily by economic factors: high unemployment (particularly among youth), limited career prospects, and wage disparities with the EU.
- Main destination countries: Germany, Italy, Slovenia, and Austria.
- Visa liberalization and planned mobility enhancements prior to EU accession are policy-related contributors, but economic incentives are the primary drivers.
- Brain drain is a major concern, weakening human capital development in the region.
- Remittances:
  - Have become an important source of household income and stable BOP inflows.
  - Kosovo: highest contribution from remittances of around 17 percent of GDP.
  - North Macedonia: Central Bank calculations suggest remittances could be three times higher than reported, around 14 percent.
  - Dependence on remittances increases vulnerability to economic downturns in the EU.
- Data challenges: accuracy and methodology issues (cash versus formal channel transfers) affect measured remittance magnitudes.

### Foreign Direct Investment and Trade Linkages
- The European Union is the dominant source of FDI in the Western Balkans.
  - As of 2023, EU-based companies accounted for 58 percent of the FDI stock in the Western Balkans.
  - North Macedonia: around 67 percent of its FDI originates from EU countries, including approximately 9 percent from Germany.
- North Macedonia’s export performance benefits from targeted attraction of export-oriented FDI in automotive, chemicals, machinery, electronics, and transportation.

### Financial Linkages, Euroization, and Banking Sector Structure
- Euroization and FX exposure:
  - Euro-denominated deposits and loans range from between 36 percent to about 58 percent in the Western Balkans.
  - North Macedonia: around 40 percent of both deposits and loans occur in foreign currency despite a denarization strategy.
- Foreign bank ownership:
  - Ranges between 65 percent to 84 percent of the banking sector in Western Balkan countries.
  - An average of 47 percent of this ownership comes from the EA.
  - EA ownership shares (end-2023): Serbia 64 percent, Bosnia and Herzegovina 54 percent, North Macedonia 53 percent, Kosovo 52 percent.
- Financial spillovers:
  - Foreign presence provides access to EA capital and liquidity, increasing spillovers through financial channels.
  - Evidence of significant interest rate pass-through from euro area monetary policy linked to degree of financial euroization.

### Monetary and Exchange Rate Regimes, Reserves, and Policy Autonomy
- Regime diversity:
  - Kosovo and Montenegro: full euroization (euro as exclusive legal tender).
  - Bosnia and Herzegovina: currency board pegged to the euro.
  - North Macedonia: stabilized arrangement with de facto peg to the euro; price stability is primary objective with some limited scope to deviate for countercyclical policy.
  - Albania and Serbia: inflation-targeting frameworks with free (Albania) and managed (Serbia) floating exchange rates.
- Monetary autonomy implications:
  - Countries with flexible exchange rates (Albania, Serbia) have more capacity to absorb external shocks and exercise monetary autonomy.
  - Rigid arrangements (currency board, de facto peg) limit exchange rate adjustments and increase reliance on internal mechanisms (fiscal discipline, structural reforms, wage flexibility).
- Foreign exchange reserves:
  - Countries with scope for independent monetary policy have increased FX reserves to bolster credibility and resilience.
  - Holding sizable FX reserves in euro is increasingly challenging and sometimes costly in negative interest rate environments.

### Energy Sector Vulnerabilities and Price Channels
- Energy intensity and generation:
  - Energy intensity of WB economies still exceeds the EA average despite declining trend.
  - Reliance on outdated, emission-intensive fossil-fuel based generation is significant; Albania is an exception relying almost entirely on hydropower.
- Energy import dependency and CPI weight:
  - Most WB countries generate more energy domestically than the euro area, reducing vulnerability; North Macedonia relies on energy imports for over 60 percent of its needs.
  - Energy constitutes a significantly larger portion of CPI in the Western Balkans, nearly double that of the euro area; North Macedonia energy weight in CPI at 10 percent.
  - North Macedonia experienced the region's largest inflationary spike of 20 percent during the recent commodity-driven inflation surge.
- Price regulation and subsidies:
  - Administered and subsidized prices (often via state-owned energy companies) can cushion shocks but may increase persistence of inflation due to slow tariff adjustments.

### BGVAR Estimations: Model Setup and Key Empirical Results
- Model and sample:
  - Employed a Bayesian Global Vector Autoregressive (BGVAR) model with stochastic volatility.
  - Sample spans from 2007:1 to 2024:3.
  - Shocks modeled as Generalized Impulse Response Functions (GIRFs) to a 1 percent positive shock to the variable of interest (1 percentage points for interest rates).
  - Report medians and peak response medians with 68 percent credible intervals.
  - Analysis covers euro area real activity, financial conditions (credit and equity prices), conventional and unconventional monetary policy, and global energy prices. Remittances channel excluded due to missing data.
- Key results — real activity spillovers:
  - Euro area real activity shocks significantly impact WB economies; magnitudes linked to integration in European global value chains (GVCs).
  - North Macedonia: largest effect on industrial production of 0.96 percent (roughly twice or more the impact seen in Serbia, Bosnia-Herzegovina, or Montenegro).
  - Supply-side shocks from Germany, particularly to automotive sector, drive North Macedonia’s large response.
  - Manufacturing exporters’ trade balances improve following EA real activity shocks; North Macedonia shows the largest and most sustained improvement (lasting up to one year).
- Key results — financial spillovers:
  - Euro area private credit shocks tend to boost credit in the region, with varying significance.
  - Serbia: strongest and most persistent rise in credit of 0.67 percent, reflecting high share of EA-owned bank subsidiaries and financial euroization.
  - Euro area equity price shocks have limited impact; North Macedonia sees only a 0.34 percent increase in equity-related response.
- Key results — monetary policy transmission:
  - Euro area policy rate changes transmit strongly across the Western Balkans; transmission depends on monetary autonomy and euroization.
  - Fully euroized countries experience full transmission.
  - Industrial production declines most in fully euroized economies:
    - Montenegro: -1.6 percent
    - Bosnia-Herzegovina: -1.1 percent
    - North Macedonia and Serbia: -0.5 percent
  - Transmission aligns with evidence of rapid EA retail rate pass-through.
  - Inflation responses are present but often muted and initially affected by a "price puzzle" in some cases.
- Key results — quantitative easing (QE) spillovers:
  - QE transmission to the Western Balkans is relatively muted and predominantly indirect via EA real activity, inflation, and financial markets.
  - QE indirectly boosts industrial production in Bosnia and Herzegovina and Serbia, with a borderline significant effect in North Macedonia.
- Key results — global energy shocks:
  - Global energy shocks substantially affect headline inflation across WB countries.
  - Inflation increases by approximately 1.5 to 5.2 percent in response to a 1 percent rise in the energy commodity price index, with peak impacts between the third and fourth quarters before tapering in the second year.
  - Sharpest inflationary spikes: Bosnia-Herzegovina, Kosovo, and North Macedonia; smallest impact: Albania.
  - Forecast error variance decompositions (FEVD): global energy price shocks account for 20 to 30 percent of inflation variance at the 1 to 2 year horizon in Bosnia-Herzegovina, Kosovo, and North Macedonia.
  - Global energy price shocks cause significant and persistent deterioration in the trade balance for the most energy intensive and energy import dependent countries (particularly Serbia and North Macedonia).

*International Monetary Fund — Republic of North Macedonia chapter (content unit).*

### 26.      As Western Balkan economies deepen their economic and financial ties with the euro

### 26.      As Western Balkan economies deepen their economic and financial ties with the euro area

### Spillovers from the Euro Area and Financial Integration
- Euro area monetary policy—both conventional and unconventional—creates significant spillovers, limiting the scope for independent monetary policies in Western Balkans.
- Deeper financial integration can support economic development but should be pursued gradually.
- Gradual financial integration requires:
  - strong institutional frameworks,
  - increasing cross-border supervisory cooperation with EA regulators.
- Strengthening policy coordination with the Eurozone will become increasingly important as business cycle comovement intensifies.

### Monetary Policy Constraints and Responses
- Reducing financial euroization can improve monetary policy space.
- Leveraging the flexibility in inflation-targeting frameworks can strengthen policy independence.
- Enhancing transparency and communication could improve policy effectiveness and credibility.
- Appropriate use of macroprudential and foreign exchange liquidity management tools can:
  - provide space for monetary policy,
  - mitigate financial stability risks,
  - reduce capital flow volatility.

### Global Energy Shocks and Domestic Policy Implications
- Western Balkan economies are highly vulnerable to global energy shocks, necessitating a comprehensive policy response.
- Monetary policy may need to react more decisively to energy price shocks to prevent inflation expectations from becoming unanchored.
- Structural measures to enhance resilience include:
  - reducing energy intensity,
  - diversifying energy sources,
  - improving energy efficiency.
- Social and fiscal measures to shield households and cushion impacts:
  - strengthening social safety nets to protect vulnerable households from energy price volatility,
  - targeted fiscal policies, including temporary subsidies for   low-income households, to cushion the social impact of energy price volatility.

### Strategic Trade and GVC Integration
- A strategic approach to GVC integration would enhance resilience by:
  - reducing concentrated dependencies,
  - diversifying trade partners.

### Empirical Evidence and Visuals (as presented)
- The chapter presents empirical spillover analyses, including:
  - Share of CPIVariance Explained by Energy Prices (percent) across horizons (12 periods, 24 periods) for ALB, AMK, RSKV.
  - Figures illustrating spillovers from:
    - Real Shocks to Eurozone Industrial Production,
    - Euro Area Financial Shocks (Credit shocks – top; Equity price shocks – bottom),
    - Euro Area Interest Rate Shocks,
    - Euro Area QE Shocks,
    - Energy Price Shocks.

*Source: IMF staff (content unit as provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1mkdea2025002-print-pdf.pdf_