Regional foundations of national development: Patterns of

economic growth in socialist Yugoslavia

Leonard Kukić,1
London School of Economics, Department of Economic History,
August 2015

ABSTRACT

This article analyses the regional patterns of economic growth in Yugoslavia, probably the most
heterogeneous country in Europe during the post-war period. The failure of the less developed regions
to grow commensurately to their initial levels of income can be attributed to their inability to employ
enough job seekers, and their failure to converge towards the total factor productivity levels of the
more developed regions. In turn, these failures were symptoms of a single underlying problem: a
capital intensity bias inherent to the governing objective of the labour-managed firms. Barriers to
labour mobility, and a regional development policy that consisted of capital transfers buttressed this
bias.

JEL Classification numbers: N14, N94, O11, O18, O47, P25

Keywords: Economic Growth and Development, Economic History, Yugoslavia, Socialism

1. Introduction

The study of diverging development paths in the global economy has long captivated the
interest of economists and historians alike. From this perspective, and set in the post-war
period, Yugoslavia seems as an exceptionally interesting country.  Yugoslavia was often taken
as an example of one of the fastest growing countries in the world until the end of the 1970s,
exhibiting rapid catch-up growth (Balassa and Bertrand, 1970; Horvat, 1971; Sapir, 1980).
During this period, it followed a different institutional path from other socialist economies,
attracting attention from Western economists (Ward, 1958; Domar, 1966; Vanek, 1970;
Meade, 1972; Estrin, 1982). However, during the 1980s, economic growth ceased, and the
country eventually descended into civil war. The existing literature on the economic
performance of Yugoslavia, and more broadly that of eastern Europe, had sought to explain
these developments through analysing the relative contributions of factors of production and
total factor productivity (TFP) to economic growth at the aggregate level (Balassa and
Bertrand, 1970; Sapir, 1980; Nishimizu and Page, 1982; Kukić, 2015).

Nevertheless, in order to understand the developments outlined in the previous paragraph, it

is crucial to acknowledge that Yugoslavia was extremely heterogeneous. Administratively, it
                                                                                                                       
1
I thank my supervisors Max-Stephan Schulze and Tamás Vonyó for essential feedback and support. I had
received valuable comments while presenting at LSE, UCL, Belgrade Banking Academy, and Humboldt
University. All errors are mine.
Email address: l.kukic@lse.ac.uk
 

1  
 
was divided into six Republics (Bosnia-Herzegovina, Croatia, Macedonia, Montenegro,
Slovenia and Serbia) and two Autonomous Provinces (Kosovo and Vojvodina).2 These
regions were divided along ethnic, religious, historical, cultural and economic lines
(Milanović, 1987; Lampe, 2000). As such, Yugoslavs were fond of describing their country
as one with two alphabets, three religions, four languages, and five nations (Horvat, 1971,
p.71).

Treating a highly heterogeneous developing country like Yugoslavia as a single entity entails
an aggregation bias, and can be highly misleading. Put more broadly, one could argue the
same for diverse countries like Brazil, China, India, Russia, and a range of others. As such, in
order to understand the aggregate growth patterns of a country like Yugoslavia, it is crucial to
understand its regional foundations.

The research on Yugoslav regional patterns of economic growth, however, had mostly
focused on comparing basic indicators of regional income inequality, without delving into
their sources, or their implications for aggregate economic growth (e.g. see Pleskovič and
Dolenc, 1982 Milanović; 1987; Bateman et al., 1988; Kraft, 1992). This paper attempts to
reconcile the strands of literature that focus on either aggregate economic growth or basic
regional income disparities, by analysing the sources of regional patterns of economic growth
and, by extension, the regional foundations of aggregate economic growth of Yugoslavia.

Policy makers care about the differences in living standards across regions since they
contribute to overall inequality and can undermine social cohesion and infuse political
tensions (e.g. in Belgium, Italy and Spain). This seems particularly likely in countries where
regional income disparities coincide with the spatial distribution of ethnic groups, as was the
case in Yugoslavia. Indeed, Jović (2001) reports that regional income disparities feature
prominently in the literature that seeks to explain the disintegration of Yugoslavia. Yugoslav
officials were aware of the potential dangers that untamed regional inequality could cause:
reducing regional disparities was a major priority of the regime (Pleština, 1992).3 Bičanić
(1973, p.61) reports that, in the fourth five-year plan (1966-70), the reduction of regional
inequality held third place in the priority list.4 Uniform regional development was not simply
a matter of policy-makers wishful thinking. On the contrary, Yugoslav regional development
policy consisted of massive capital transfers from the more to the less developed regions.

Nevertheless, despite these policy efforts, as shown within an international perspective in

figure 1, initially more developed regions (Croatia, Slovenia and Vojvodina) grew faster than
initially less developed regions (Bosnia-Herzegovina, Kosovo, Macedonia and Montenegro)

                                                                                                                       
2
Kosovo and Vojvodina were part of the Socialist Republic of Serbia, but were solely responsible for their own
economic development.
3
A case to the point is that, After World War II, the state was reorganised along federal lines, with the regional
units approximating the areas inhabited by the major ethnic groups. In doing so, Kaiser (1990) argues that CPY
attempted to heal ethnic tensions through promising political equalisation to the major ethnic groups that
composed the country.
4
The first priority was a “rise in the standard of living and personal consumption”, the second priority was
“strengthening of socialism and development of self-management of direct producers”. Bičanić (1973) also
reports that the reduction of regional inequality generally ranked fourth in the previous five-year plans.

2  
 
in Yugoslavia during the post-war period.5 This is contrary to the experience of other
peripheral European countries at a similar stage of development and trajectory of economic
growth.6 Thus, if it is true that initially lower per capita output levels hold the potential for
faster economic growth than in the more developed regions (Abramovitz, 1986), two
complementary questions arise: First, why did the less developed regions grew slower than
the more developed regions? Second, what were the aggregate implications, as outlined in the
first paragraph of this article, of these regional patterns of growth?

The former question is the focus of this article, while the second question is addressed along
the way. In order to address these questions, while acknowledging the theoretical predictions
on growth and convergence that are espoused later in the paper, this article analyses the
proximate sources of labour productivity growth in Yugoslavia, utilising new estimates of
output, as well as physical and human capital. Official statistics of virtually all economies is
characterised by inconsistent data series. By choosing among them, a researcher can produce
a broad range of results. Consequently, a significant fraction of value added in a paper of this
sort lies in its treatment and exposition of data. Given the constructed alternative data series,
the paper uses standard growth and development accounting methods, as well as simple
econometrics. Since Yugoslavia was overwhelmingly agricultural in the immediate aftermath
of WWII, the accounting methods are adjusted in order to gauge the contribution of structural
change to economic growth, as developed by Vollrath (2009).

It will be argued that the labour productivity of the less developed regions was retarded, as
evidenced by their significantly lower TFP growth rates than in the more developed regions,
due to a capital intensity bias intrinsic to the behaviour of the labour managed firms that
operated in Yugoslavia. The capital intensity bias was at odds with labour surplus in the less
developed regions, and hence their comparative advantage in the production of labour
intensive goods. The capital intensity bias in the less developed regions was buttressed by
low interregional labour mobility, and the regional development policy that focused on the
redistribution of investment finance.

These results can be used to illuminate the aggregate economic performance of Yugoslavia
and, within a broader context, that of other socialist economies. Regarding the “Golden Age”
of economic growth, Kukić (2015) and Sapir (1980) demonstrate that the economic growth of
Yugoslavia during the 1960s and the 1970s was sustained by TFP. The results of this paper
demonstrate that these TFP gains were concentrated in the more developed regions. Thus, in
order to understand why was Yugoslavia the best performing socialist economy given its
level of development (figure 1), one should focus further attention to the economic
performance of Croatia, Slovenia, and Vojvodina.
                                                                                                                       
5
Note that, following the literature, I do not include Serbia in either the more or less developed regions.
Yugoslavia was the largest Yugoslav republic in terms of population and size. As such, it closely tracked the
mean and median in Yugoslavia across a range of development indicators, since it largely formed it.
6
Being a member of the OECD convergence club until the second Oil Shock in 1979, Yugoslavia it was more
similar to peripheral Southern European economies than to other socialist countries. However, unlike peripheral
southern European economies at a similar stage of development, like Greece, Portugal and Spain, where
regional income inequalities generally decreased between the 1950s and the early 1980s, in Yugoslavia regional
disparities had sharply increased.

3  
 
 Figure 1: Economic growth (GDP per capita), 1952-89
6
Average compund annual growth rate, in %

JA
5

Vojvodina

EL
PTSlovenia
Serbia
Croatia ES IT
4

Macedonia
Yugoslavia AT
Montenegro
DE
FI
BG
Bosnia−Herzegovina FRNO
3

RO IR BE
NL
DK
Kosovo HUUSSRCS SE CA
AL UKAU
PO CH US
2

NZ
1

0 2,000 4,000 6,000 8,000 10,000

GDP per capita in 1952, in Int. 1990 GK$

Yugoslavia and its regions Eastern Europe

OECD OECD convergence line

Notes:   Growth rates are logarithmic. OECD countries are those that were members of the club in 1990, Turkey,
however, is excluded.
Sources: For Yugoslav regions see section 4, otherwise, the data is taken from Bolt and van Zanden (2014).

Furthermore, if it is true that labour constraints or frictions were instrumental in causing the
labour productivity slowdown of socialist economies (Weitzman, 1970; Sapir, 1980; Easterly
and Fischer, 1995; Kukić, 2015), low interregional mobility seems as an important factor in
causing labour frictions within Yugoslavia.

This paper contributes to the existing literature on the economic development of eastern
Europe (Allen, 2003; Broadberry and Klein, 2011; Ritschl and Vonyó, 2014), which has
otherwise been neglected by economic historians. Furthermore, if the economic development
of eastern Europe is indeed underexplored in relation to the West (Broadberry and Klein,
2011), then regional development in eastern Europe is unexplored, due to two reasons. First,
beyond the very recent past, the majority of existing studies covering the region had focused
on the general features of economic systems that had no between, and especially no within
country differences. Second, regional data coverage in eastern European countries, beyond
the recent past, is generally scarce, since there were only two federal nations in the region
during the 20th century – the Soviet Union and Yugoslavia.

The remainder of this paper is organised as follows. In the following section, I present the
patterns of regional growth and inequality in Yugoslavia. In section 3, I sketch the theoretical
predictions on regional patterns of growth and convergence, and discuss the approach used in

4  
 
the decomposition of labour productivity. Section 4 follows by a description of the data and
the constructed variables. Sections 5 present the results, while section 6 provides an
interpretation of these results based on a combination of institutional and policy related
factors. Finally, the last section provides concluding remarks that include some wider
implications.

2. Regional patterns of growth and inequality

This section argues that the divergence in regional income per capita in Yugoslavia was a
consequence of increasing divergence in employment rates, and the absence of convergence
in labour productivity levels. Before preceding further, the section present stylised facts on
patterns of regional growth, and the evolution of regional inequality.

Figure 1 indicates that Slovenia, Croatia and Vojvodina grew strongly given their initial
income levels, comparable to Spain, Greece and Portugal, while Bosnia-Herzegovina and
Kosovo performed poorly, indicating increasing polarisation within the country between the
richer and poorer regions.

These growth trends indeed led to income divergence between the Yugoslav regions. Figure 2
plots relative regional income per capita levels. In 1952, the more developed regions (MDRs)
were 1.7 times as rich as the less developed regions (LDRs). By 1990, they increased their
lead to a factor of 2.5. The difference between the most developed region and the least
developed region is particularly striking. Slovenia was initially four times as rich as Kosovo.
By 1990, it became eight times as rich.

Contrast these trends to findings of Gennaioli et al. (2013). They report that, across 107
countries in 2005, the average ratio of income per capita in the richest region to the poorest
region was 4.4. By continent, the highest ratio was 5.6 in South America and the lowest ratio
was 3.7 in Asia. The ratio between Slovenia and Kosovo, however, does not drive the
increasing gap between the richer and poorer regions. Excluding Slovenia from the MDRs
and Kosovo from the LDRs, the income gap between the two regions would still increase
from a factor of 1.2 to a factor of 1.8.

To deal with more sophisticated measures of regional income inequality, figure 3 displays
information on the evolution of regional income per capita and labour productivity inequality
through three measures – the Gini coefficient, coefficient of variation7 and the Theil index. In
regards to regional income per capita inequality, all three measures depict the same trend.

                                                                                                                       
7
 Within  economic  growth  theory,  coefficient  of  variation  is  sometimes  perceived  as  measuring  σ-­‐convergence  
that  occurs  when  the  dispersion  of  income  levels  across  a  group  of  economies  falls  over  time  (Barro  and  Sala-­‐i-­‐
Martin,  2004).  

5  
 
 Figure 2: Regional GDP per capita differentials, relative income levels, 1952-90
8  

RaMo  of  GDP  per  capita  

7  
6  
5  
4  
3  
2  
1  
1958  

1968  

1978  

1988  
1952  
1954  
1956  

1960  
1962  
1964  
1966  

1970  
1972  
1974  
1976  

1980  
1982  
1984  
1986  

1990  
Yeat  

MDR/LDR  (including  Slovenia  and  Kosovo)  

MDR/LDR  (excluding  Slovenia  and  Kosovo)  

Slovenia/Kosovo  

Note: Regions are un-weighted. Serbia is not included in any grouping (see footnote 5).
Source: See section 4.

Figure 3: Regional inequality as depicted by the Gini coefficient, coefficient of variation

(CV) and the Theil index, 1952-89
0.600   0.140  
0.500   0.120  
Gini  index  and  CV  

0.100  
Theil  index  

0.400  
0.080  
0.300  
0.060  
0.200   0.040  
0.100   0.020  
0.000   0.000  

Year  

Gini  index  of  GDP  per  capita   CV  of  GDP  per  capita  

CV  of  labour  producMvity   Theil  index  of  GDP  per  capita  

Note: formal definitions of the Gini coefficient, Theil index and CV are in Appendix A.
Source: See section 4.

Regional inequality increased substantially during the period of rapid economic growth
between 1952 and 1979. During the 1980s, inequality effectively stayed the same since

6  
 
economic growth across all regions ceased.8 To put Yugoslavia’s experience in context; the
average regional Gini coefficient for all OECD countries in 2010 stood at 0.16 (OECD, 2013)
- significantly lower than in Yugoslavia at any point in time. Furthermore, the dispersion of
regional income levels in Yugoslavia was typically higher than it is among the member states
of contemporary European Union. Coefficient of variation of income per capita among the
EU member states in the early 2000s ranged between 0.41 and 0.39, with a downward trend
(Monforth, 2008), while in Yugoslavia, from 1970 onwards, it was higher than 0.45.

The Yugoslav experience is instead more similar to that of regionally heterogeneous

developing countries nowadays. In 2010, in China, India and Brazil, regional Gini coefficient
ranged between 0.27 and 0.29 (OECD, 2013), similar to historic peak value in Yugoslavia in
1979 (0.27). In regards to the evolution of inequality in developing countries, it is difficult to
find common patterns. Milanović (2005) studied, next to the U.S., four developing (quasi)
federations since about 1980. In China, he finds that regional disparities have essentially
remained flat, even though they had sharply fluctuated. In India and Indonesia he finds
increasing inequality, while in Brazil he finds no trend. In contrast, Azzoni (2001) studied
Brazil over a longer period (1939-95), and found overall decline.

Notwithstanding these contemporary similarities and differences in regional inequality levels

and trends, compared to other peripheral European countries at a broadly similar stage of
economic development, Yugoslavia was the only economy characterized by regional income
divergence. Martinez-Gallaraga et al. (2013) find strong regional σ-convergence in Spain
between 1950 and the early 1980s. In Portugal, during a similar period, Gini coefficient for
regional GDP per capita decreased by around 15 per cent (Badia-Miró et al., 2012). Petrakos
and Saratsis (2000) find that regional inequalities decreased in Greece in the 1970s and the
1980s, on the basis of σ-convergence and β-convergence.

Turning back to Yugoslavia, in contrast to regional income per capita trends, inequality of
labour productivity levels effectively stayed the same (figure 4).9 The dispersion of labour
productivity levels initially increased until 1961, before falling to levels similar to the one in
1953 in the subsequent decades.

Since income per capita is a function of labour productivity and the employment rate, it must
follow that, beyond 1961, the increasing wedge between the dispersion of income per capita
and labour productivity levels was due to increasing dispersion of employment rates.10

Figure 4 illustrates this was indeed the case. Between the early 1950s and the mid-1980s,
regional dispersion of employment rates had more than doubled. Figure 4 also shows that this
                                                                                                                       
8
  It   might   be   interesting   to   note   that   within   the   MDRs,   when   using   the   measure   of   coefficient   of   variation,  
there  is  no  evidence  of  increasing  inequality.  It  had  essentially  remained  flat.  In  LDRs,  inequality  had  increased,  
but   it   is   fully   driven   by   Kosovo   falling   further   behind.   If   Kosovo   would   be   excluded   from   the   LDRs,   then  
inequality   in   this   group   of   regions   would   have   also   remained   constant.   It   appears   that   regional   inequality   in  
Yugoslavia  was  mostly  driven  by  the  emergence  of  two  clubs  operating  under  different  growth  regimes.  
16
  In   regards   to   differences   in   labour   productivity   levels,   MDRs   had   approximately   50   per   cent   higher   labour  
productivity  than  the  LDRs  in  1953,  by  1986  they  had  68  per  cent  higher  labour  productivity  than  the  LDRs.    
10 !"#$"# !"#$"# !"#$%#&
 More  formally,  output  per  capita  can  be  defined  as:   = ∗  
!"!#$%&'"( !"#$%#& !"!#$%&'"(

7  
 
trend cannot be attributed to demographic indicators like the ratio of the working age
population to the total population. It was primarily due to the inability of the LDRs to employ
enough job seekers. Before assessing why were the LDRs unable to employ enough job
seekers, it is necessary to assess the determinants of labour productivity in Yugoslavia.

Figure 4: Inequality of demographic indicators, 1950-1990

0.4  
0.35  
0.3  
0.25  
CV  

0.2  
0.15  
0.1  
0.05  
0  
1958  

1968  

1978  

1988  
1952  
1954  
1956  

1960  
1962  
1964  
1966  

1970  
1972  
1974  
1976  

1980  
1982  
1984  
1986  

1990  
Year  

(Working  age  populaMon)/(Total  populaMon)  

Employment/PopulaMon  

Sources: For population; Vitalna Statistika (various years) and Demografska statistika (various years). For
labour; Popis stanovništva (various years).

3. Theory and methodology

3.1. Theory

How can one study regional development and convergence? Due to high interdependence
between regions, this is an unusually complex area of inquiry that involves a multitude of
approaches (Breinlich et al., 2014). To impose structure, some general theoretical predictions
from different schools of thought on growth and convergence can be provided. First, the
textbook Solow-Swan growth model would predict growth and convergence on the basis of
physical and human capital deepening. Poor regions are characterised by capital scarcity of
both types, low productivity, and by extension high marginal products of factors of
productions. Accumulation of factors, due to higher returns, leads poorer regions to grow
faster than the richer regions. In the presence of free mobility of factors of production,
convergence is facilitated by migration of labour to rich regions (where wages are higher),
and by migration of capital to poor regions (where rents are higher), leading to equalisation of
factor prices, and eventually of factor proportions.

Second, endogenous growth models would view the process of convergence through
technological catch-up by poor regions, since importing innovation from abroad is cheaper
8  
 
than re-inventing it domestically. Third, within a framework of structural modernisation with
a long tradition in development economics (Lewis, 1954), a country seizes efficiency gains as
it shifts resources from low productivity sectors to high productivity sectors.11 By extension,
the process of regional income convergence is synonymous with the process of convergence
in economic structures.

In order to acknowledge the aforementioned theoretical predictions on growth and regional

patterns of development, I adopt growth and development accounting methods to decompose
regional growth dynamics and income levels into the relative contributions of inputs and the
efficiency with which those inputs were used, i.e. total factor productivity (TFP).

To assess the contribution of structural modernisation to economic growth and to variation in

labour productivity levels, I apply Vollrath’s (2009) dual economy model. Within a
development accounting framework, Vollrath divides the aggregate economy into two
sectors, agriculture and non-agriculture. I modify his model into a growth accounting exercise
to account for the contribution of factor reallocation gains to aggregate economic growth.
Dividing the economy into two parts is superficial to an extent. Nevertheless, it serves a
useful methodological purpose in estimating the reallocation gains associated with structural
modernisation within a relatively simple framework.

The main advantage of Vollrath´s (2009) dual economy model is that it takes an explicit
account of the marginal product gap between agriculture and non-agriculture. By doing so,
the model acknowledges potential distortions that might diminish the reallocation of
resources between sectors. In turn, elimination of these distortions decreases the sectoral
marginal product gap, yielding efficiency gains as inputs migrate to more productive uses.

The existing literature has, broadly speaking, followed two approaches in estimating the gains
associated with structural modernisation. The first employs some variant of regressing output
on an indicator of agricultural (over) employment (e.g. Temin, 2002). The second strategy
involves choosing a functional form for the relationship between output and structural
modernisation (Stiroh, 2002). Within this approach, shift-share analysis has been widely used
(Broadberry, 1998; Timmer and de Vries, 2009).

Unfortunately, both strands of research typically rely on unrealistic identification

assumptions. They typically do not make a distinction between average and marginal
products, or they either implicitly or explicitly assume that the change in sectoral marginal
product gap mirrors the change in the sectoral average product gap. This is misleading, since
an average product gap can indicate efficiency, rather than in-efficiency. Productivity gains
stemming from a better allocation of resources can be brought about only through a
narrowing of the difference in the marginal product gap between sectors, not due to a
narrowing of the difference in their average products (Herrendorf et al., 2014).

                                                                                                                       
11
Of course, Lewis (1954) and other development economists discussed structural change at the aggregate
country level. Within countries, the dynamics of structural change are more complex, since agricultural labour
from poor regions might migrate to manufacturing and modern services in the rich regions, rendering the effect
of structural modernisation on regional inequality difficult to evaluate.

9  
 
Before proceeding further, it is worth motivating the arbitrary segmentation of aggregate
economy into only two sectors. Growth accounting exercises that are applied to developed
countries often segment the aggregate economy into a multitude of sectors, following the
KLEMS methodology developed by, among others, Jorgenson and Griliches (1967).

I segment the economy into two sectors due to conceptual and practical reasons. In the case
of a developing country like Yugoslavia where, in the immediate post-war period,
agricultural labour formed more than 70 per cent of the total labour force (Popis stanovništva,
1953), it seems appropriate to focus on agriculture and non-agriculture.

The output series at a more disaggregated level can be highly imprecise. As such, I prefer to
opt for more “precise” analysis, rather than a more “detailed” or elaborate analysis. For
example, Staller (1986) reports that, for particular Yugoslav manufacturing branches, the
alternative growth estimates of production can be twice as high as the official ones, or vice
versa. The results of a more disaggregated analysis, therefore, could be highly sensitive to a
choice of a particular data set.

3.1. Methodology

Assume the following Cobb-Douglas production function that describes how aggregate
output within an economy is generated:

𝑌! = 𝐴! 𝐾 ! ! (ℎ𝐿)! !!! (3.1)

where Y is output of an economy at time t, K is physical capital, h is per capita human capital
of the labour force (L). Term hL hence denotes labour augmented by quality (human capital),
while A is the efficiency with which K and hL are used, and denotes total factor productivity.
Finally, 𝜃 is the elasticity of output with respect to physical capital. Assuming constant
returns to scale, 1 −  𝜃 is the elasticity of output with respect to labour augmented by quality,
since 𝜃 + (1 − 𝜃) must sum to 1 (Hall and Jones, 1999).

Assuming perfectly competitive markets, the elasticity of output with respect to physical
capital and labour augmented by quality is measured by the share of compensation paid to
each factor. 12 To allow the existence of differentiated inputs, assume that physical capital is a
weighted average of its sub-inputs:
!
𝐾! = !!! 𝜃!! 𝐾!,!                          (3.2)

where 𝜃!! denotes the elasticity of capital to its sub-inputs or, again, assuming perfectly
competitive markets, it denotes the share of each sub-input in the total payment made to
capital. The last equation adjusts for quality improvements in aggregate physical capital by
weighting the contribution of each sub-input by its average product (Young, 1995). Due to
data limitations regarding private farming, I do not differentiate labour according to different
sub-inputs. I.e., it is not possible to differentiate agricultural labour according to age, gender
and educational attainment.
                                                                                                                       
12
 From  hereafter,  for  simplicity,  I  refer  to  labour  augmented  by  quality  simply  as  labour,  or  human  capital.  

10  
 
Equation 3.1 does not explicitly incorporate efficiency derived from sectoral allocation of
human and physical capital. It is, however, implicitly incorporated in the TFP measure. As it
cannot be directly observed, TFP is residual output that cannot be attributed to physical and
human capital. To an extent, it reflects miss-specified production function and measurement
issues related to required data.

In order to capture efficiency derived from sectoral allocation of human and physical capital,
and to derive the contribution of sectoral inputs and TFP’s to aggregate output, following
Vollrath (2009), aggregate economy in equation 3.1 can be perceived as being composed of
two sectors, agriculture (𝑌! ) and non-agriculture (𝑌!" ):

𝑌! = 𝑌!,! + 𝑌!",!          (3.3)

where:
! ! !!!!!
𝑌!,! = 𝐴!,! 𝑅!,! 𝐾!,! (ℎ𝐿)!,! (3.4)

and:
!
𝑌!",! = 𝐴!",! 𝐾!",! (ℎ𝐿)!!!
!,! (3.5)

where R in the agricultural production function stands for land, 𝛾 denotes the share of land in
agricultural output, 𝛽 denotes the share of physical capital in agricultural output and
1 − 𝛾 − 𝛽 is the human capital share of output. Equation 3.5 is consistent with a long
tradition of modelling agriculture (Hayami and Ruttan, 1970). The production function of the
non-agricultural sector is identical to that of the aggregate economy in equation 3.1, except
that 𝜃 is replaced by 𝛼. Both sectors are thus characterised by constant returns to scale.

With the economy divided into agriculture and non-agriculture, it is possible to acknowledge
a marginal product (MP) gap between the inputs (i) employed in the two sectors, that is:

𝑀𝑃!,!,! ≠ 𝑀𝑃!",!,!      (3.6)

In other words, the model explicitly allows the possibility of frictions that may distort the
reallocation of resources from less productive agriculture to more productive non-agriculture.
Any efficiency, Z, derived from sectoral allocation of resources is estimated as the ratio of
actual to potential output:
𝑦!
𝑍 =                    (3.7)          
𝑦!∗

where potential income (𝑦!∗ ) is a hypothetical output level in the absence of a marginal
product gap. That is, if: 𝑀𝑃!,!,! = 𝑀𝑃!",!,! . The full derivation of potential output is reported
in appendix B, alongside a treatment of the assumptions this exercise entails. Z is an index
that measures the distance of an economy from its production possibility frontier given
sectoral allocation of resources. Z can be interpreted as measuring the percentage of potential

11  
 
output that an economy is actually achieving given its factor endowments and sector-specific
TFP’s (Vollrath, 2009, p.330).

The term capturing the efficiency derived from allocation of resources (Z) can be added to
equation 3.3. In order to express equation 3.3 in per worker terms, it is divided by aggregate
labour (𝐿! ):

𝑌! 𝑌!,! 𝑌!",! 𝑦!
= + + ∗          (3.8)  
𝐿! 𝐿! 𝐿! 𝑦!

Equation 3.8, while taking consideration of equations 3.4 and 3.5, makes aggregate labour
productivity a function of sector-specific inputs (including land), TFP’s, and efficiency
derived from sectoral allocation of resources. To move away from a level analysis and to
conduct a growth accounting exercise, taking natural logarithms yields the following
decomposition of proximate sources of aggregate labour productivity growth:

𝑌 𝑌! 𝑌 𝑌!" 𝑌 𝑦
∆𝑙𝑛 = ∆𝑙𝑛 ∗ ∗ 0.5 + ∆𝑙𝑛 ∗ ∗ 0.5 + ∆ln   ∗          (3.9)
𝐿 𝐿 𝐿 𝐿 𝐿 𝑦

where ∆ stands for the change in a variable between periods t and t-1. Within a growth
perspective, the reallocation gain (last term on the right) is measured as a change in the ratio
of actual to potential income, while the term Y/L*0.5 denotes the sectoral weighting scheme.
The crucial assumption is that an improvement in the ratio of actual to potential income leads
to a one-to-one increase in economic growth.

4. Data

In order to minimise potential measurement problems, the analysis is conducted on the basis
of five benchmark years (1953, 1961, 1971, 1981 and 1986), of which the first four are
centred on labour data derived from population censuses, while the last one is based on an
employment survey.13 While the estimated TFP growth rate is lowered by some choices (e.g.,
when I rely on a slower growing aggregate GDP series to impute regional GDP series), it is
raised by others (e.g., when I substitute a slower-growing physical capital series for the
official data). Through a providing a detailed data analysis, readers can, however, see the

                                                                                                                       
13
I would prefer to use a population census rather than an employment survey to cover the remainder of 1980s
due to higher precision offered by population census by default. Unfortunately, this is not possible. The last
Yugoslav census was conducted in 1991. This is also the year when the country disintegrated. As a result,
separate statistical offices of the successor states published the results of the population census concerning their
own territory. This is not a problem per se, but there are further issues. Kosovo Albanian’s boycotted the
institutions operating within the Socialist Republic of Serbia, including the population census. Therefore, the
results of the 1991 census are highly un-reliable for Kosovo. Furthermore, Macedonian 1991 census was in-
complete, yielding e.g. limited insights on human capital as constructed in this paper. Thus, Macedonia had
conducted another population census in 1994, but given migration induced by ethnic tensions, the data would be
difficult to interpolate backwards.

12  
 
steps I take and decide what problems exist in my methods and what alternatives they would
prefer.

4.1. Output

Net Material Product (NMP), or Social Product (SP) in case of Yugoslavia, was the official
indicator used to monitor economic activity in socialist countries. SP is conceptually
equivalent to GDP. The two measures, however, are calculated differently and yield different
results. SP was calculated only for the productive sector. The non-productive sector that was
excluded from SP consisted of a section of services - government administration, defence,
health-care, education, culture, housing, and financial services.

Over time, productive segments of the non-productive sectors were incorporated into the SP.
For example, publishing activity was added to the SP, which formed the education sector.
However, the Yugoslav statistical bureau, Savezni Zavod za Statistiku (SZS), did not estimate
the output of such (minor) sub-sectors for the whole period. In effect, when the SZS
improved its measurement of the service sector, it concluded that all of the newly discovered
value added occurred in the year in which the new sub-sector was incorporated into the SP.
Furthermore, SZS never revised estimates of output once they had been formally published.

A more troublesome feature of Yugoslav version of national accounts is its gross

inconsistency in the application of the Material Planning System, the socialist equivalent of
the System of National Accounts. As in all internally consistent national accounts, the
reported output by value added and the reported output by expenditure yield the same level of
output. Nevertheless, it is conceptually impossible that the two would yield the same level of
output. Output by value added excluded the non-productive sectors, while output by
expenditure included gross investments incurred in the non-productive sectors.

Furthermore, SP was calculated by subtracting from gross production of the productive sector
only the so-called material or productive costs, including depreciation, while the inputs from
the excluded service sectors were not subtracted, so, as Alton et al. (1992, pp. 6-7) state,
NMP or SP was not a “clean” value-added measure.

In addition to these peculiarities, Yugoslavia, alongside other socialist countries, was

criticised by Western scholars that it inflated output growth (van Ark, 1996). Within a
shortage economy, managers were incentivised by the soft budget constraint to inflate the
value of their output in order to maximise the subsequent allocation of resources. 14

Socialist countries also distorted the value of industrial and agricultural production. Prices
were distorted by setting the prices of industrial goods above world prices, while the prices of
agricultural goods were set below world prices. This was the intention of the development
                                                                                                                       
14
    Furthermore, SZS used the Paasche index to deflate industrial production. A well-known feature of this
index is that it tends to under-estimate inflation, hence overestimating real economic growth. Furthermore,
Staller (1986) reported that SZS, upon introducing new or changed products into the index of industrial
production, used prices prevailing in the second year of production that still reflected costs of development. As
such products were typically rapidly growing, the greater weight they were assigned by prices of the initial
period inflated the growth rate of total industrial production.

13  
 
model pursued by socialist economies, in order to stimulate industrial production Due to the
pricing scheme, this development model created a statistical bias. Economic growth was
inflated since the rapidly growing manufacturing output was assigned a greater weight than
the actual weight. Furthermore, since price distortions over-estimated the marginal product of
industry and under-estimated the marginal product of agriculture, they also inflate the
reallocation gains, as estimated in this paper. Finally, price distortions bias the evolution of
regional inequality. It could be that the more industrial MDRs benefited from price
distortions while the more agricultural LDRs lost.15 This was clearly recognized by Yugoslav
authorities. In 1954, in SZS’s Metodologija za obracun narodnog dohotka (Methodology for
estimating national income), the head of the organization had written:

“As a consequence of a certain economic policy, prices of our industrial goods are above
global market prices, and prices of agricultural goods are below this average… We cannot
know the true contribution of industry and agriculture to income of the country, as long as we
don’t eliminate differences in levels of prices… this is inevitably reflected in income of each
republic, due to differences in their economic structures. Industrially more developed
republics are contributing to the income of the country with a greater share than it
corresponds to the actual state.”16

Due to these statistical issues, I had re-estimated the GDP series of Yugoslav regions. I had
relied on alternative output series created by a group of western scholars centred on the
publication Research Project on National Income in East Central Europe (RPNIECE), and
led by Thad P. Alton from Columbia University. They relied on physical output indicators
published in official sources that they transformed into GNP at factor cost. They consistently
applied western national accounting standards, making their estimates comparable to income
series of market economies. They relied on the method developed by Abram Bergson (1953)
to estimate Soviet national income. Maddison (2010) relied on these series to track the GDP
of eastern European countries during socialism.17

Since the RPNIECE did not estimate GDP at a regional level, I rely on a simple method to
impute it:
!!!
𝑌!,!
𝑌! = 𝑌!"#,! ∗      (4.1)
𝑌!"#,!
!!!

                                                                                                                       
15
  In   the   MDRs   in   1953,   the   share   of   population   engaged   in   agriculture   ranged   between   41   and   62   percent,  
while  in  LDRs  (including  Serbia)  it  ranged  between  62  and  72  percent  (Popis  stanovnistva,  1953)  
16
 Author’s  translation  -­‐  Savezni  zavod  za  statistku  (1955),  Metodoloski  materijali,  br.  61.  Belgrade,  p.  22-­‐23.  
17
 The main limitation of RPNIECE GDP series concerns their treatment of non-market activities. Value added
of sectors like health-care and education has been approximated by the number of employees weighted by factor
costs weights that were composed of compensation to labour. Since measured labour productivity of these
sectors consists of the same figure in the numerator and the denominator, it might be distorted. Nevertheless, the
value added of non-market sectors would be exceptionally difficult to re-estimate, given the absence of detailed
information on the flow of services these sectors were providing.

14  
 
GDP (Y) of region i is equivalent to the sum of agricultural and non-agricultural GDP of
Yugoslavia (𝑌!"# ) that is multiplied by a ratio of sector specific GDP (s) of a region to the
sector specific GDP of Yugoslavia. That is, GDP of a region has been imputed through
estimating its share in the GDP of Yugoslavia at a sector-specific level. Regarding data, the
!!,!
term 𝑌!"# has been taken from RPNIECE, while the ratio !!"#,!
has been taken from SZS.
The underlying assumption is that the official estimates of regional shares in agricultural and
non-agricultural output of Yugoslavia correspond to the actual state.

Table 1 compares the output growth of Yugoslav regions according to official and alternative
data. Yugoslav statisticians inflated the annual output growth across Yugoslav regions
between 0.33 and 0.39 percentage points compared to the alternative estimates, on average.
These are not trivial differences: between 1952 and 1989, SZS estimates of cumulative output
growth are on average 14.5 per cent higher.

For a given amount of capital and labour, with minimal slight of hand, these results imply
that using the newly estimated output series will, on average, decrease the contribution of
TFP to labour productivity growth across Yugoslav regions by 0.37 per cent per annum, as
compared to using the official output series.

Table 1: Average annual growth rate of real output, 1952-89, in %

Official data
Alternative Difference
(SZS)
Yugoslavia 5,11 4,75 -0,37
Bosnia-Herzegovina 4,70 4,33 -0,37
Croatia 4,95 4,58 -0,37
Kosovo 5,17 4,84 -0,33
Macedonia 5,38 5,03 -0,35
Montenegro 5,06 4,71 -0,35
Serbia 5,12 4,76 -0,36
Slovenia 5,33 4,94 -0,39
Vojvodina 5,65 5,32 -0,34
 
Sources: For official output data I use Jugoslavija 1918-1988: statistički godišnjak (1989) and SGJ (various
years), for the rest see the text.
Notes: SZS estimates of output growth are expressed in 1972 dinars, while the newly estimated output growth
rates are expressed in 1990 Int. GK$.

 
4.2. Inputs

The existing data on gross investments and physical capital are the most problematic among
the data series required for the analysis. Similar to output series, gross investments were
likely inflated due to price distortions, and perhaps outright fabrication from enterprises.
Nevertheless, while alternative output series have been produced in response to the criticism

15  
 
of official series, by contrast, there are no existing alternative investment series. As such, I
embrace the Yugoslav statistics on investments, but make systematic adjustments using their
own data.

Aggregate investment series provided by SZS can be disaggregated into residential structures,
non-residential structures, equipment and other. A finer subdivision is not possible given the
data availability. I have decided to omit the category other since it includes expenditure on
product research and training of personnel, which should not be considered as part of
physical capital. Furthermore, it included changes in the value of stock, while Madžar (1985)
reported that, in the presence of high inflation of the 1970 and the 1980s, these values have
been inflated. The exclusion of the category other is not a minor adjustment, since it
decreases total investments by approximately 10 per cent across Yugoslavia.

At a sector-specific level, non-agricultural physical capital input is subdivided into three

categories, residential structures, non-residential structures and equipment. Agricultural
physical capital, next to non-residential structures and equipment, includes cattle as a separate
capital input.18 Annual net capital stock is estimated using the standard perpetual inventory
method with geometric depreciation:

𝐾!,! = 𝐾!,!!! 1 − 𝛿! + 𝐼!,!        (4.2)

where the capital stock K in period t of type i depends positively on the value of capital stock
in the previous period and positively on gross investments (I) in the current period, while
negatively on the depreciation rate, 𝛿. The depreciation rates are taken from Hulten and
Wykoff (1981) estimates for detailed asset type.19

There are two ways of initialising the capital stock series. One method would be to estimate it
independently given the initial value of gross investments, the average period growth rate of
investments, and the depreciation rate. Another method would be to initialise it using a
benchmark survey, such as an industrial census or a national wealth survey. Given a
sufficiently long horizon over which the capital stock can form, the initial value is un-
important (Young, 1995; Hsieh, 2002; Caselli; 2005). In this paper, since detailed gross
investments by type are not available before 1952, I can allow an interlude of only one year
between the initialisation of the capital stock series and the period of analysis (1953-86). Due

                                                                                                                       
18
Livestock has been estimated independently for each benchmark year. Livestock that forms agricultural
capital consists of cattle that is not used for slaughter, e.g. for draught power and breeding. The volume of cattle
is taken from SGJ (various years), while the price for each type of livestock is based on 1972 export prices
provided in Statistika spoljne trgovine (1973). Including cattle increases the value of agricultural capital stock in
Yugoslavia by a factor of nine in 1953. To the extent that livestock that was exported was of higher quality than
the remaining one, applying export prices over-estimates the value of livestock. Unfortunately, price series for
livestock traded domestically were not reported in price surveys.
19
I take an un-weighted average of the assets likely to be found within each sector-specific capital input. This
un-refined approach yields depreciation rates of 15.1 and 3.7 per cent for non-agricultural machinery and non-
residential structures, respectively, and 17.1 and 2.4 per cent for agricultural machinery and non-residential
structures, respectively. Depreciation rate for residential structures is assumed to be 1.3 per cent, as in Hsieh
(2002).

16  
 
to this reason, I prefer to initialise capital stock using existing national wealth surveys, rather
than by a statistical guess-estimate.20

Table 2 presents the newly estimated capital stock series in Yugoslavia. It reveals a
significantly higher growth rate of capital stock in the LDRs, which is highly indicative of
strong regional convergence in physical capital. Between 1952 and 1989, compared to the
official data, the growth rate of physical capital is on average 2.6 percentage points lower on
an annual basis, albeit with significant differences among the regions. With a 0.4 capital
share of income, this difference implies a 1 percentage point lower contribution of physical
capital to labour productivity growth in Yugoslavia, on average. The significant difference
between the official and alternative capital stock growth cannot be solely attributed to the
treatment of the category other. An additional factor is that the alternative data includes
housing, while official data does not.21 Furthermore, SZS used either, or in combination,
lower depreciation rates to estimate the capital stock, different indexes, or simply inflated
data.

Table 2: Average annual growth rate of real capital stock, 1952-89, in %

Official data Alternative Difference

Yugoslavia 6.60 4.04 -2.56
Bosnia-Herzegovina 6.96 5.10 -1.87
Croatia 6.45 3.76 -2.69
Kosovo 7.97 5.09 -2.87
Macedonia 7.56 4.70 -2.86
Montenegro 10.30 5.92 -4.39
Serbia 6.21 4.51 -1.70
Slovenia 6.12 3.81 -2.31
Vojvodina 6.85 3.28 -3.57
Sources: SGJ (1991) for official data, for alternative data see the text.
Notes: SZS estimates of capital growth are expressed in 1972 dinars, while the newly estimated output growth
rates are expressed in 1990 Int. GK$.

Of all the data series required for the analysis, official labour statistics are the most reliable.22
Table 3 reports labour supply growth in Yugoslavia. Between 1953 and 1986, the growth rate
of the number of workers was modest. Quantity of workers expanded the most in Slovenia,
                                                                                                                       
20
In a series of publications, Vinski (1957; 1978) had estimated the national wealth in Yugoslavia. Ivo Vinski
had used official capital stock estimates for the “productive sectors”. His greatest contribution lies in estimating
capital stock series for housing, and other “non-productive sectors”.
21
Excluding housing would yield a 1.1 percentage point average annual difference between alternative and
official data.  
22
I measure labour by effective hours worked, i.e. by excluding sick leave, vacation leave and maternal leave,
but including overtime and similar categories. For non-agriculture, effective hours worked are reported by SZS.
They are however not reported for private farming, but they can be imputed from Gollin et al. (2014). They
report that, on an average global scale, non-agricultural workers tend to work 10 per cent more hours than
agricultural workers - I assume the same was the case in Yugoslavia.

17  
 
by 28 per cent, while the number of workers actually decreased in Croatia and Vojvodina.
Measured in total hours worked, labour supply decreased in all regions, except in Slovenia. In
some regions, like Croatia and Vojvodina, it decreased by approximately 20 per cent. Given
the negative expansion of the labour supply, the statistics imply that labour productivity in
Yugoslavia grew faster than aggregate output.

These results seem odd in light of the common claim that socialist growth was driven by the
expansion of capital and labour (Krugman, 1994), but can be readily explained. First,
between 1953 and 1986, the amount of yearly hours an average labourer spent working
decreased by approximately 25 per cent. The increased amount of time devoted to leisure is
similar to trends in other European countries during the post-war period (Huberman and
Minns, 2007). Second, as further elaborated in section 6, a significant fraction of Yugoslav
labour moved to Western Europe in search for higher wages, draining the domestic supply of
labour.

Table 3: Growth of labour supply between 1953 and 1986, 1953=100

Total hours
Headcount
worked
Yugoslavia 106.1 86.9
Bosnia-Herzegovina 102.9 85.1
Croatia 97.2 80.0
Kosovo 117.6 96.1
Macedonia 116.3 95.4
Montenegro 117.5 98.2
Serbia 108.7 88.4
Slovenia 128.1 104.5
Vojvodina 96.6 78.4
Sources: Popis stanovništva (1953; 1961; 1971; 1981), ILO, and SGJ (1987).

Labour is augmented by quality through the mincerian approach. The popular Barro and Lee
(2013) dataset on average years of schooling is the only existing dataset that incorporates
Yugoslav regions. Since it reported schooling achievements in only a subset of Yugoslav
regions, I had re-estimated average years of schooling for all regions. Average years of
schooling for sector-specific labour are constructed from population censuses.23 Table 4
                                                                                                                       
23
Agricultural average years of schooling are unfortunately not available for 1986. They are, however, available
for the non-agricultural sector. To interpolate average years of schooling for agricultural labour, I run a simple
OLS by regressing the agricultural years of schooling (𝐸! ) on non-agricultural years of schooling (𝐸!" ) over a
panel of four benchmark years for which sector-specific years of schooling are provided in the population
censuses (1953; 1961; 1971; 1981). I obtain the following coefficients: 𝐸!,! = −2.59 + 1.29𝐸!",! .
Incorporating the known average years of schooling of the non-agricultural labour in the equation solves the
missing average years of schooling of the agricultural labour.

18  
 
reports the aggregate results. In 1953, there were significant differences in educational
attainment among the Yugoslav regions. By 1986, these differences had decreased
(measured by standard deviation), since the LDRs experienced a significantly higher growth
rate of average years of schooling. These results strongly imply that Yugoslav regions
converged in terms of human capital.

Compared to the newly estimated data, Barro and Lee (2013) report significantly lower
annual growth rates of schooling achievements in Croatia and Serbia. To an extent, the two
data series are not comparable, since Barro and Lee (2013) data reports educational
attainment of those that are aged above 15 years, while the alternative data considers the
average years of schooling of those that are employed. An intriguing difference between the
two series is that for 1953 the alternative data reports lower average years of schooling, while
one would expect that people that are employed tend to have a higher educational attainment
than those that are not. The reason for this that Barro and Lee (2013) relied on the
Demographic Yearbooks of the United Nations that reported educational attainment from a
higher degree of aggregation than the Yugoslav statisticians constructed in their censuses. In
case of Yugoslavia, and for that matter for developing countries at large, this lead to a
systematic over-estimation of educational attainment, since it neglects a large segment of
population that never participated in any formal education.

Table 4: Average years of schooling in Yugoslavia

1953 1986 Annual growth rate, in %

Alternative Existing Alternative Existing Alternative Existing
Yugoslavia 3.13 - 9.23 - 3.28 -
Bosnia-Herzegovina 1.89 - 9.26 - 4.81 -
Croatia 3.65 4.48 9.48 7.79 2.89 1.68
Kosovo 1.60 - 8.83 - 5.17 -
Macedonia 2.34 - 9.03 - 4.10 -
Montenegro 3.05 - 10.00 - 3.59 -
Serbia 2.73 4.39 9.03 7.94 3.63 1.80
Slovenia 5.44 5.86 9.83 10.07 1.79 1.64
Vojvodina 4.02 - 9.10 - 2.48 -
Standard Deviation 1.11 0.67 0.37 1.04 1.02 0.07
Notes: Existing (data) refers to the Barro and Lee (2013) dataset. Average years of schooling in the Barro and
and Lee dataset are estimated for those that are older than 15 years. Serbia in the Barro and Lee dataset includes
Vovjodina and, at least during the socialist period, Kosovo. The remaining regions, currently countries, are not
available.

                                                                                                                                                                                                                                                                                                                                                                                 
 

19  
 
Average years of schooling are turned into mincerian human capital through adjusting for the
returns to education as in Hall and Jones (1999), which is assumed to be piecewise linear.
The return to education under 4 years of schooling is taken to be 13.4 per cent, between 4 and
8 years of schooling it is taken to be 10.1 per cent, and above 8 years of schooling it is taken
to be 6.8 per cent. 24

Turning to the final input, the value of land is estimated by calculating its net present value
(NPV). As transactions of agricultural land were heavily constrained, prices of it are not
available. NPV is then the only available method of estimating the value of land. It is
calculated in the usual manner:
!
𝐿𝑅!
𝑁𝑃𝑉! = !
         (4.3)
1+𝑖
!!!

where n is the length of the economic life of a unit of land, i is the discount rate and LR is
land rent that is equivalent to gross income derived from cultivating land, less the cost of
production involved. Similar to Butzer et al. (2010), I assume that the economic life of a unit
of land is 30 years and that the discount rate is 5 per cent.

Gross income derived from land is approximated by the purchasing price of wheat at “farm
gate”.25 This excludes any transportation and trade costs that do not belong in the agricultural
costs of production. These prices are applied to the total production of wheat, irrespective of
whether wheat was sold commercially or consumed at farm. Due to collapse of Yugoslavia in
1991, to calculate gross income derived from land beyond 1960, I estimate the present value
of future returns up to 2001. Using data from 1950 to 1989, gross income derived from land
is regressed on the time trend variable. Subsequently, the time trend variable is used to
predict the average future net returns for each year in which the NPV of land is calculated.
Finally, to obtain the value of land rent, gross income is transformed into net income by
adjusting for agricultural cost of production. 26

4.3. Factor shares

The sector-specific income compensation of labour and capital is estimated using data from
the national accounts. For the purpose of measuring income shares, value added is measured
from the perspective of the producer, which involves removing indirect taxes on the value of
output (e.g. sales taxes) (Young, 1995). Given the Yugoslav national accounts, the concept of
value added used in this paper is midway between output at factor cost and output at market

                                                                                                                       
24
Since there is remarkably little evidence on returns to education in agriculture, I assume that the returns to
education are identical in agriculture and non-agriculture.
25
In Yugoslavia, most of arable land was used to cultivate wheat, between 60 and 70 per cent throughout the
post-war period (Jugoslavija 1918-1988: statistički godišnjak) .
26
  SGJ (various years) provides annual estimates of agricultural household’s gross income and expenditure
related to agricultural activity. From these estimates, the average cost of production was approximately 80 per
cent of gross income throughout the post-war period. This is quite similar to the often-made assumption that
cost of production is between 70 and 80 per cent of gross income in agriculture. Given these assumptions, any
increase in NPV of land must be due to an increase in agricultural productivity.  

20  
 
prices.27 Labour compensation includes all wages, salaries, supplements and employer
contributions towards social insurance. Agricultural labour compensation also includes the
value of natural consumption, i.e. the imputed value of agricultural products that are
produced and consumed at farm. Assuming constant returns to scale, capital share is
calculated as one minus the estimated labour share.

In non-agriculture, the estimated average share of capital is 0.43, which is similar to what is
often assumed of socialist economies (Easterly and Fischer, 1995). In agriculture, the
estimated average share of capital in agriculture is 0.19. Given the data availability of
Yugoslav national accounts, it is not possible to estimate the land share of agricultural output.
Instead, I take the land share from Boyd (1987). Through estimating the Yugoslav
agricultural production function, he reports that the land share of agricultural output is 0.24.28
Given these factors shares, the labour share in both sectors is identical (0.57).

Turning to differentiated capital inputs, sector-specific income shares of capital sub-inputs

are estimated through the approach taken by Oliner and Sichel (2000). Intuitively, the
nominal stock of capital earns a gross rate of return which includes the real rate of return,
depreciation rate and capital gain or capital loss. The product of the nominal capital stock and
the gross rate of return yields the income generated by capital which is then divided by
nominal output in order to obtain the income share of specific capital type.29 Given the
heavily distorted interest rates in Yugoslavia (Uvalić, 1992), following an either ex-ante or
ex-post method of estimating the real interest rate would be difficult. Instead, I take the
approach by Young (1995). I.e., I vary the real interest rate until the income share of each
capital type in each sector is equal to my estimates of sector specific aggregate capital shares.

5. Results

5.1. Growth accounting

Table 3 shows sources of labour productivity growth in Yugoslavia during 1953-86.30. The
last column depicts the standard deviation of a variable across the regions. For Yugoslavia, of
the annual 5.02 per cent growth in aggregate output, the growth in labour productivity
contributed 5.43 per cent, while the remainder was due to negative growth of the labour

                                                                                                                       
27
However, note that I use value added at market prices to measure the growth of output, due to the assumption
that market prices reflect better the relative scarcities and values of aggregate output components (Young,
1995).
28
I apply these factor shares to all Yugoslav regions since, unfortunately, it is not possible to estimate sector-
specific factor shares at a regional level.
29
Formally, with perfect foresight, the income share µ of an asset type j is estimated as: 𝜇! =   [𝑟   +   δ!   −
 𝜋!  ]𝑝!  𝐾!  /𝑝! 𝑌! , where r denotes the real rate of return common to all capital types within a specific sector, δ
and K as before denote the depreciation rate and the capital stock, respectively, while 𝑝 denotes the price level
and pY denotes the nominal output of sector s. Finally, 𝜋 measures the rate of capital gain or loss and is
measured as the inflation rate of specific capital type relative to sector specific output inflation rate. As in Oliner
and Sicherl (2000), the inflation rate is estimated as the three year moving average.
30
The contribution of agriculture to aggregate labour productivity growth was minor. As such, I prefer to ignore
the sectoral contribution to aggregate growth for clarity of exposition.  

21  
 
supply. Within a European post-war perspective, these labour productivity growth rates are
very high (see table 12.7 in Crafts and Toniolo, 2010).

Table 5: Sources of growth, 1953-86, in %, per annum

        YUG   BIH   CRO   KOS   MK   ME   SRB   SLO   VOJ   SD  

Aggregate  output   5,02   4,72   4,82   5,15   5,32   5,22   4,92   5,39   5,37   0,26  
Aggregate  labour   -­‐0,41   -­‐0,49   -­‐0,67   -­‐0,12   -­‐0,15   -­‐0,06   -­‐0,37   0,14   -­‐0,73   0,31  
Labour  productivity   5,43   5,21   5,49   5,27   5,46   5,28   5,29   5,25   6,10   0,29  
Of  which:  
                 
   Physical  capital   2,26   3,53   2,17   2,85   2,56   3,00   2,32   1,65   1,79    
0,63  
   Human  capital   1,01   1,28   0,94   1,30   1,16   1,12   1,07   0,64   0,82   0,23  
   Land   0,26   0,20   0,28   0,13   0,01   -­‐0,16   0,25   0,30   0,32   0,17  
   Reallocation  gains   0,42   0,51   0,42   0,30   0,53   0,77   0,38   0,46   -­‐0,05   0,23  
   TFP   1,47   -­‐0,31   1,69   0,69   1,21   0,55   1,26   2,20   3,23   1,08  
Share  of  labour    
                 
productivity  growth  due    
to:                    
 
                 
   Factors  of  production   0,65   0,96   0,62   0,81   0,68   0,75    
0,69   0,49   0,48   0,16  
   Reallocation  gains   0,08   0,10   0,08   0,06   0,10   0,15   0,07   0,09   -­‐0,01   0,04  
   TFP       0,27   -­‐0,06   0,31   0,13   0,22   0,10   0,24   0,42   0,53   0,19  
Note: YU=Yugoslavia, BIH=Bosnia-Herzegovina, CRO=Croatia, KOS=Kosovo, MK=Macedonia,
ME=Montenegro, SRB=Serbia, SLO=Slovenia, VOJ=Vojvodina, and SD=standard deviation.

Table 5 further decomposes the sources of labour productivity growth by the contribution of
physical and human capital, the reallocation gain associated with a more efficient sectoral
allocation of human and physical capital, and TFP. The main source of growth in all regions,
expect in Slovenia and Vojvodina, was the accumulation of physical capital. As indicated by
figure 5, the LDRs experienced a much greater contribution of physical capital deepening to
labour productivity growth than the MDRs. Among the MDRs, the highest annual
contribution of physical capital deepening to labour productivity growth was 2.17 per cent in
Croatia, while the lowest annual contribution of physical capital among the LDRs was 2.56
per cent in Macedonia. It is apparent that in terms of physical capital deepening the LDRs
converged towards the MDRs.

The accumulation of human capital followed a similar pattern as the accumulation of physical
capital. The expansion of human capital across the regions was a significant source of
growth, as well as an important source of labour productivity convergence. The highest
annual contribution of human capital deepening to labour productivity growth among the
MDRs was 0.94 per cent in Croatia, while the lowest annual contribution of human capital

22  
 
among the LDRs was 1.12 per cent in Montenegro. The contribution of land was of relatively
minor importance in all regions, albeit with some differences.31

The reallocation of resources was a less important source of growth than the expansion of
human capital. In Bosnia-Herzegovina, Macedonia and Montenegro, structural change
significantly boosted labour productivity growth, in the order between 0.51 and 0.77 per cent
per annum. The reallocation gains generally seem to be higher in the LDRs than in the
MDRs, indicating that structural change contributed towards labour productivity
convergence. By including reallocation gains, I am able to eliminate one quarter of
conventionally measured TFP, on average. Among regions, by including reallocation gains, I
can eliminate most of conventionally measured TFP in Montenegro – more than half of it.

Finally, there was a strong variation in regional TFP growth rates. The standard deviation of
TFP is highest among all the sources of growth. In Slovenia, TFP was the main source of
growth, while in other regions it was the second most important source of growth. It is
evident that regional differences in TFP growth rates diminished regional labour productivity
convergence. The lowest annual growth rate of TFP among the MDRs was 1.69 per cent in
Croatia, while the highest annual TFP growth rate among the LDRs was 1.21 per cent in
Macedonia. Bosnia-Herzegovina even experienced negative TFP growth rates.

Across all regions except Slovenia, the growth of labour productivity growth was mostly due
to the expansion of factors of production, similar to the general finding in the economic
growth literature that most of output growth across countries can be accounted by input
growth (for a literature survey, see Hsieh and Klenow, 2010).. Nevertheless, as analysed in
the preceding paragraphs, there was a strong regional variation to it. In Kosovo as a
maximum, the share of labour productivity growth due to the expansion of factors was as
high as 81 per cent, while in Slovenia as a minimum, the share of labour productivity growth
due to the expansion of factors of production was 40 per cent. These results imply that TFP
gains were mostly concentrated in the MDRs.

Table 6 confirms it. Total Yugoslav TFP growth was concentrated in Croatia, Serbia,
Slovenia, and Vovjodina. For that matter, Croatian, Slovenian and Vojvodinian percentage
share of Yugoslav TFP growth was significantly higher than their corresponding share in
GDP and labour. These results can be used to illuminate the aggregate economic performance
of Yugoslavia. In their comparison of the growth performance of ten rapidly growing
countries at a similar stage of development, Balassa and Bertrand (1970) found that
Yugoslavia ranked among the top 2-3 countries, during 1953-65, in terms of output and TFP
growth. If this is true, the results of this paper demonstrate that these TFP gains were
concentrated in the MDRs, since the LDRs experienced at best modest TFP growth rates.

                                                                                                                       
31
 I  am  hesitant  to  attach  much  meaning  to  land  due  to  complexity  of  estimating  the  value  of  it  in  the  absence  
of  market  indicators.  In  anycase,  TFP  growth  would  be  higher  if  I  would  drop  land  as  a  separate  factor  of  
production,  while  the  regional  variation  in  TFP  growth  would  be  even  larger.  

23  
 
 Table 6: Regional percentage shares in the total TFP growth of Yugoslavia, output level, and
labour stock, 1953-1986 averages

Share of Share of
Share of labour
TFP growth GDP
Bosnia-Herzegovina -3,02 13,78 15,10
Croatia 29,45 25,96 22,98
Kosovo 1,02 2,12 3,59
Macedonia 4,44 5,46 7,04
Montenegro 0,74 1,93 2,06
Serbia 21,96 24,96 29,68
Slovenia 24,53 15,89 10,15
Vojvodina 19,30 9,90 9,41
Notes: The “share of TFP growth” does not sum up to 100. The contribution of a region to the Yugoslav TFP
growth rate has been weighted by that region´s share in Yugoslav GDP, since it is impossible to estimate
regional shares in aggregate TFP. As such, the results provide a lower bound approximation of the contribution
of MDRs to aggregate TFP, since one would assume that the distribution of TFP was more concentrated in the
MDRs that GDP implies.

5.2. Development accounting

Since TFP grew faster in the MDRs than in the LDRs, TFP was certainly a mitigating factor
in regional labour productivity convergence. To determine what percentage of regional labour
productivity variation was due to TFP, it is necessary to establish a hypothetical labour
productivity level a region would have if it a) had Slovenian sector-specific TFP’s
(productivity leader) and b) maximised its labour productivity over the sectoral allocation of
resources.32 This TFP measure incorporates a subset of income variation due to misallocation
of resources: Nevertheless, I found that the share of income variation due to misallocation of
resources is in-significant.

Table 7: TFP as a source of regional labour productivity differentials, in %

TFP
1953 34,9
1961 67,5
1971 81,7
1981 82,3
1986 84,6

                                                                                                                       
32
  I   divide   the   variation   in   the   hypothetical   (logarithmic)   labour   productivity   levels   by   the   variation   in   actual  
(logarithmic)  labour  productivity  levels.    

24  
 
In 1953, TFP accounted for 35 per cent of regional labour productivity variation. By 1971,
raw TFP accounted for more than 80 per cent of labour productivity variation. This is much
higher than what cross-country development accounting exercises typically find. For
example, Caselli (2005) and Vollrath (2009) report that TFP accounts for around 50 per cent
of cross-country income differences.

6. TFP and the capital intensity bias

The failure of the LDRs to grow commensurately to their initial levels of income was due to a
single underlying problem: a capital intensity bias that was embedded in the behaviour of
Yugoslav labour-managed firms.

Labour-managed firms were formally established in the early 1950s, due to the desire of the
Yugoslav communist leadership to distance the country from the Soviet Union following
their fallout in 1947/8. Work councils of labour-managed firms, supposedly representing the
interests of workers, could, in conjunction with the local government, hire and fire the
managers of the enterprise and decide, to a degree, on marketing and production processes of
an enterprise. Over time, workers were granted rights over the income derived from fixed
assets, which could be subsequently distributed to wages or investments (Estrin, 1982).

The governing objective of Yugoslav labour-managed firm caused a tendency towards a

relatively high capital to labour ratio, irrespective of the relative scarcities of the two factors
of production. Ward (1958), Domar (1966), Vanek (1970), and Meade (1972) argued that
labour-managed firms maximised income per worker, which implies that firms attempted to
maximise productivity of the currently employed labour. With low rental rate of capital, that
objective was achieved through capital deepening. The rental rate of capital was made low
through setting interest rates to chronically low or even negative levels, and pervasive credit
rationing (Uvalić, 1992). Furthermore, the state revenue structure relied on labour income
taxation that had decreased the cost of capital relative to labour (Bateman et al., 1988).
Hence, capital accumulation, facilitated by cheap capital, led to income accumulation, and
therefore a larger income for the members of the labour-managed firm. A logical
consequence is that one would expect large disparities in income levels of workers with
similar characteristics among firms that differ in their capital to labour ratios. Indeed, these
disparities had been well documented (Vanek and Jovicic, 1975; Estrin, 1982).

The capital intensity bias seems particularly anomalous in the LDRs, since they were
characterised by the abundance of labour. For example, from the mid-1960s, the Kosovo
unemployment rate was higher than 20 per cent, while the unemployment rate in Slovenia
ranged between 1 to 4 per cent, according to official statistics. Furthermore, capital was made
particularly affordable in the LDRs due to a regional development policy that focused on the
redistribution of savings from the MDRs to the LDRs.33 On average, according to official

                                                                                                                       
33
Bateman et al (1988) argue that policy makers feared that mobile capital would flow to the more developed,
higher productivity regions, buttressing regional inequality. As such, federal authorities transferred capital

25  
 
statistics, federal aid was equivalent to more than 10 per cent of gross investments in Bosnia-
Herzegovina, and approximately equivalent to 20 per cent of gross investments in Macedonia
and Montenegro. In Kosovo, these transfers amounted on average to approximately 60 per
cent of gross investments, reaching extremely high levels in the 1980s.

Since the contribution of capital deepening to economic growth in the LDRs was much
higher, while overall labour productivity gains were of similar magnitude to those in the
MDRs, one would expect that, at the regional level, the marginal products of capital and
labour were not necessarily negatively correlated with productivity, as the Solow growth
model would imply. This would in turn imply a misallocation of capital in the LDRs, and
hence have implications on TFP. Indeed, table 8 demonstrates that, at a regional level, there
is no evidence of a negative correlation between the marginal products of physical capital
(MPK), human capital (MPH), and labour productivity. For that matter, the correlations are
actually positive, and the correlation between MPH and labour productivity is strongly
positive, ranging between 0.84 and 1.

Table 8: Correlation between the marginal product of physical capital (MPK), human capital
(MPH), and labour productivity, average of 1953-86

MPK and labour productivity MPH and labour productivity

Actual data 0,66 1,00
Counterfactual data 0,11 0,84
Notes: counterfactual data provides a lower bound estimate of a positive correlation between the marginal
physical product of an input and labour productivity through keeping TFP and the other input constant at their
initial 1953 levels. The marginal product of physical capital is calculated as; 𝑀𝑃𝐾 = 𝐴𝛼𝐾 !!! (ℎ𝐿)!!! , while
the marginal product of human capital is calculated as; 𝑀𝑃𝐻 = 𝐴𝐾 ! (1 − 𝛼)(ℎ𝐿)!! .

Of course, in the long-run, such perverse relationships would tend to disappear, as labour
would move to firms or regions where it can realise a higher marginal product, arbitraging
away productivity differentials, provided that entry of labour into firms is free, and provided
that there are no barriers to interregional mobility of labour. Both conditions, however, do not
seem to have hold in Yugoslavia. Entry of workers into firms was not free, since existing
workers of labour-managed firms were discouraged from employing new workers, since
income would have to be shared among a larger number of workers.

Concerning interregional migration in Yugoslavia, table 9 shows the magnitude of it.

Compared to OECD countries, Yugoslav interregional migration was low, if not very low.
                                                                                                                                                                                                                                                                                                                                                                                 
through budget transfers to regional authorities, earmarked for the expansion of public amenities. Furthermore,
the 1965 reforms included the establishment of the Federal Fund for Crediting Accelerated Development of In-
Sufficiently Developed Republics and Autonomous Provinces (Federal Fund). The Federal Fund was a vehicle
which redistributed savings from the MDRs to the LDRs. The Federal Fund supported investments in the poorer
regions through funds that were raised by taxing the enterprises of the richer regions.

26  
 
With the elimination of travel restrictions during the mid-1960s, approximately 10 per cent of
the Yugoslav labour force migrated to Western Europe - primarily to (western) Germany as
“guest workers”. Arguably, when faced with a choice of whether to migrate to another region
or another western European country, a prospective Yugoslav migrant opted for the latter,
due to higher pecuniary benefits. Strong cultural differences among the Yugoslav regions
certainly lowered the relative physic costs of migrating to another western European country,
as opposed to migrating to another Yugoslav region. Of course, low interregional migration
was itself a symptom of intrinsic barriers to new labour entry into labour-managed firms.

Table 9: Interregional migration in Yugoslavia and a selected group of OECD countries

(migrants as percentage of total population

Yugoslavia (1989) 0.25

Bosnia-Herzegovina 0.50
Croatia 0.17
Kosovo 0.19
Macedonia 0.12
Montenegro 0.43
Slovenia 0.18
Vojvodina 0.26

Selected OECD countries

(1987) 2.0

Australia 1.6
Canada 1.5
Finland 1.6
France 1.3
Germany 1.1
Italy 0.5
Japan 2.6
Norway 2.6
Sweden 3.9
United States 2.8

Note: Serbia is not reported in Cviki et al. (1993). OECD average is un-weighted.

The sketched narrative of this section, coupled with the growth and development accounting
results, suggests that investments in the LDRs were channelled to in-efficient uses or,
alternatively, that the magnitude of investments in the LDRs was in-efficiently high, given
the amount of profitable investment projects that were available. If so, one would expect that
the capital intensity bias, coupled with barriers to labour mobility, caused the retardation of
productivity in the LDRs, as measured by TFP. Indeed, the literature provides a large amount

27  
 
of stories depicting the un-sustainability of heavy industries in the LDRs, which lay in their
comparative disadvantage sectors.34

Notwithstanding anecdotes, it is possible to test the relationship between the extent of the
capital intensity bias and TFP, by regressing TFP growth rate on the investment rate, at a
regional level. The rationale is simple: if capital intensity bias retarded TFP growth rate in the
LDRs, then one would expect a negative relationship between investment rates and TFP
gains. The regression is estimated with robust standard errors to account for
heteroskedasticity, and period effects to account for common regional shocks, like business
cycle fluctuations. It controls for a host of variables - importantly, it includes unemployment
rate as a proxy control variable for labour abundance, or idle labour - as well as dummy
variable determining whether a region was a recipient of federal aid or not.

Presented in table 10, the estimation is conducted for two samples. In Model I, the dependent
variable, logarithmic TFP growth, is estimated for four periods: 1953-61, 1961-71, 1971-81,
and 1981-6. To increase the amount of observations, Model II estimates annual logarithmic
TFP growth as a three year moving average. The coefficient on the investment rate is
remarkably similar in both samples. On average, according to columns I and III, a region with
a one percentage point higher investment rate achieved a 0.07-0.08 percentage lower TFP
growth. Since the investment and unemployment rates might be jointly determined, or they
might measure the same underlying capital bias, columns II and IV report the interaction term
between the investment and unemployment rates. Across both samples, the coefficient on the
investment rate roughly doubles to (-) 0.13-0.14. As a robustness test, dropping the
unemployment rate from both specifications does not change the results in any significant
way. Furthermore, since it might be more meaningful to analyse the deviation of region-
specific TFP from the Yugoslav average, Appendix C reports the regression results when
TFP growth is normalised by its standard deviation. The statistical significance of the
investment rate remains.

To put the empirical results in context, the coefficients on the investment rate imply that, for
example, Montenegro, the region with the highest average investment rate, would had
boosted annual growth rate of TFP between 1.8 and 3.5 percentage points if it, in a
counterfactual world, had instead the same investment rate as Slovenia, the region with the
lowest average investment rate. Of course, counterfactual labour productivity dynamics are
more complicated, since a decrease of the investment rate would decrease the contribution of
capital deepening to economic growth. One can further complicate the counterfactual analysis
by acknowledging that, beyond directly stimulating output, TFP indirectly stimulates output,

                                                                                                                       
34
For example, with up to 23,000 employees, the Trepča mining enterprise in Kosovo, was once one of the
biggest companies in socialist Yugoslavia. Palariet (2002) reports the rise and demise of Trepča: “The golden
age was one in which employment, direct and indirect, expanded massively and the combine paid (by local
standards) a decent wage. Yet the 'golden age' was a mythological era, when Trepča depended on the principle
of non-accountability, in which investment and current deficits were funded externally. So long as the funding
kept rolling in, the incapacity of Trepča to support itself was nobody's problem. Easy funding came to an end in
the 1980s, and with it Trepča´s 'golden age'... Because of Trepča´s incapacity to generate funding of its own for
investment, all investment funding had to be financed externally, by fund providers who did not anticipate that
they would see any return on (or of) their capital."

28  
 
through increasing the marginal product of capital, given the investment rate. As such, in the
absence of a credible identification strategy, the regression results do establish exact
causality. Nevertheless, the explanatory power of the model provides strong credence to the
hypothesis that capital intensity bias had a highly significant impact on differential regional
TFP trends.

Table 10: TFP regression, balanced panel data

        Model  I       Model  II  

        I   II       III   IV  
Investment  rate   -­‐0.0731***   -­‐0.1299***   -­‐0.0756***   -­‐0.1388***  
 
(0.0211)   (0.0214)   (0.0217)   (0.0379)  
 
Unemployment  rate   0.0454   -­‐0.1342**   -­‐0.0864*   -­‐0.2847***  
 
(0.0281)   (0.0548)   (0.0482)   (0.0792)  
 
Initial  labour  productivity   -­‐0.0002   0.0002   -­‐0.0000***   -­‐.0000***  
 
(0.0050)   (0.0004)   (0.0000)   (0.0000)  
 
Initial  human  capital   0.0344*   0.0435**   0.0356*   0.0407**  
 
(0.0174)   (0.0131)   (0.0194)   (0.0184)  
 
Aid   0.0028   0.0083   0.0035   0.0082*  
 
(0.0054)   (0.0053)   (0.0044)   (0.1857)  
 
Interaction  term   0.4644   0.4763**  
     
(0.1336)   (0.1857)  
     
N   32   32   248   248  
 
F     8.22   14.77   7.99   8.66  
 
2
R    
    0.7239   0.8192       0.5652   0.5886  
Notes: The dependent variable is logarithmic TFP growth. Robust standard errors are reported in the
parenthesis. The model is estimated for non-agriculture, that is, it excludes agriculture, due to the absence of
labour–managed firms in private farming. Significance levels: * p < 0.1, ** p < 0.05, *** p < 0.001.

6. Concluding remarks

Among the eastern European countries, Yugoslavia was often studied as a case of an
economy exhibiting rapid catch-up growth, and exhibiting an even faster descent into
stagnation and violent dissolution. Nevertheless, while we now know a great deal about
regional economic performance among western European countries for the whole of the
twentieth century, comparatively speaking, we know very little about regional development
in eastern Europe. This paper attempts to fill an important gap in our knowledge of this facet
of European economic development by providing a detailed quantitative study of labour
productivity in Yugoslavia, probably the most heterogeneous country in Europe during the
post-war period.

29  
 
The analysis reveals that the failure of the less developed regions to grow commensurately to
their initial levels of income can be attributed to their inability to employ enough job seekers
and their failure to converge towards the TFP levels of the more developed regions. In turn,
these failures were symptoms of a single underlying problem: a capital intensity bias inherent
to the objective governing the behaviour of the labour-managed firms. In the less developed
regions, barriers to labour mobility and a regional development policy that focused on capital
transfers buttressed this bias.

These results can be used to illuminate the aggregate economic performance of Yugoslavia.
Until the 1970s, the comparatively impressive productivity performance of Yugoslavia was
driven by Croatia, Slovenia, and Vojvodina. TFP gains realised in these regions might be
indicative of larger issues related to scale or specialisation economies (which are not
accounted for in a constant-returns framework), industrial location, and market potential. In
the context of the gradual integration of Yugoslavia into the global economy, studies that
account for both Heckscher-Ohlin type (factor endowments) and New Economic Geography
type (market access) interactions between region and industry characteristics would offer a
promising explanatory framework for understanding the aggregate economic performance of
Yugoslavia.

Furthermore, since various authors have emphasized the role of labour in the retardation of
labour productivity in socialist economies during the 1970s and the 1980s (Weitzman, 1970;
Sapir, 1980; Kukić, 2015), enquiries about the accumulated aggregate inefficiency caused by
(regional) labour immobility are required.

In regards to the economic performance of diverse developing countries like Brazil, China,
India, and Russia, the experience of Yugoslavia demonstrates the potential insights that can
be obtained through the analysis of regional foundations of national development.

30  
 
References

Official sources

Savezni zavod za statistiku (1955-89), Demografska Statistika [Demographic Statistics],

Beograd: Savezni zavod za statistiku.

Savezni zavod za statistiku (1982-89), Investicije [Investments], Beograd: Savezni zavod za

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Appendix A: Regional inequality measures

The Gini coefficient is computed as:

! !
1 1
𝐺= 𝑦! − 𝑦!                  (A. 1)
2𝑦 𝑛(𝑛 − 1)
! !

where 𝑦! and 𝑦! are the income per capita measures of region I and j, respectively. n is the
number of regions, in this case eight, and 𝑦 is the un-weighted mean income per capita of
eight Yugoslav regions. Gini coefficient varies from 0 – under which all regions would earn
identical income per capita – to 1, where one region would earn all income per capita, while
other regions nothing.

The coefficient of variation of income per capita levels between the regions is defined below.
It is often taken to measure σ-convergence:
σ
CV =                                      (A. 2)  
𝜇

where σ stands for standard deviation and 𝜇 for mean, or in this case, logarithm of Yugoslav
income per capita.

The Theil index is calculated as follows:

!
1 𝑦! 𝑦!
𝑇= 𝑙𝑛                  (A. 3)  
𝑛 𝑦 𝑦
!!!

where 𝑦! denotes income per capita of region I, 𝑦 denotes un-weighted mean income per
capita of eight Yugoslav regions and n stands for the number of regions.

Appendix B: Optimisation of Vollrath´s (2009) dual economy model

In this paper, the primary function of dividing the economy into two parts is to identify the
reallocation gains associated with a transfer of factors from agriculture to non-agriculture.
Stated and subsequent assumptions about production functions and technological parameters
serve to identify and then to remove the gap in marginal productivity of physical and human
capital across sectors. It is important to re-instate that efficiency gains stemming from a better
allocation of factors can be brought about only through a decrease in sectoral marginal
product gap, not due to a decrease in the average product gap. This follows from a standard
competitive equilibrium in multi-sector neoclassical growth models where the marginal
product of factors across sectors must be equal (Herrendorf et al., 2014). With these aims in
sight, equations 3.3 and 3.4 in the text can be expressed in per worker terms by dividing them
by aggregate labour (𝐿! ):

36  
 
 ! ! !!!!!
𝑌!,! 𝑅! 𝐾! (ℎ𝐿)! ! !!!!!
= 𝐴!,! 𝑘!,! 𝑞!,!          (𝐵. 1)    
𝐿! 𝐿! 𝐿! 𝐿!

! !!!
𝑌!",! 𝐾! ℎ𝐿 ! !!!
= 𝐴!",!,! (1 − 𝑘!,! )! 1 − 𝑞!,!          (𝐵. 2)
𝐿! 𝐿! 𝐿!

where 𝑘!,! is the share of total physical capital employed in agriculture and 𝑞!,! is the share
of total human capital employed in agriculture. Note that equations B.1 and B.2 concern
themselves with the share of human capital employed in agriculture (ℎ𝐿!,! /ℎ𝐿! ), rather than
the share of labour engaged in agriculture (𝐿!,! /𝐿! ). It is important to stress this distinction
because differences in sectoral marginal productivity of labour may not reflect inefficiency if
agriculture and non-agriculture differ in endowments of human capital (Vollrath, 2009, p.
328).

With sector-specific production functions established, the (static) problem is to calculate a

hypothetical aggregate level of income per worker (𝑦!∗ ) that would be maximised over the
share of physical and human capital employed in agriculture (𝑦!∗ = max!!,! ,!!,! 𝑦! ). Given
equations 4.6 and 4.7, the identity 𝑦!∗ = max!!,! ,!!,! 𝑦! can be expanded into:

! !!!!!
𝑦!∗ = max Ω!,! 𝑘!,! 𝑞!,!   + Ω!",! (1 − 𝑘!,! )! (1 − 𝑞!,! )!!!          (𝐵. 3)
!!,! ,!!,!

where for notational simplicity;

! ! !!!!!
𝑅! 𝐾! (ℎ𝐿)!
Ω!,! = 𝐴!,!          (𝐵. 4)
𝐿! 𝐿! 𝐿!

and:
! !!!
𝐾! (ℎ𝐿)!
Ω!",! = 𝐴!",!          (𝐵. 5)
𝐿! 𝐿!

First order conditions of equation 4.8 require identical marginal productivity of human and
physical capital in agriculture and non-agriculture. Differentiating sector specific output with
respect to human capital employment share in both sectors yields:
! !!!! !!
(1 − γ − β)Ω!,! 𝑘!,! 𝑞!,! = (1 − 𝛼)Ω!",! (1 − 𝑘!,! )! 1 − 𝑞!,!          (𝐵. 6)

and doing the same with respect to physical capital employment share gives:

!!! !!!!! !!!

βΩ!,! 𝑘!,! 𝑞!,! = 𝛼Ω!",! (1 − 𝑘!,! )!!! 1 − 𝑞!,!          (𝐵. 7)

37  
 
Assuming that 1 − γ − β is equal to 1 − 𝛼, i.e. that the labour share of output is identical in
the two sectors, equation B.6 can be solved for the share of human capital engaged in
∗
agriculture that would maximise the aggregate income per worker (𝑞!,! ):

∗
1
𝑞!,! = !/!
         (𝐵. 8)
Ω!",! (1 − 𝑘!,! )!
1+ !
Ω!,! 𝑘!,!

Any increase in non-agricultural TFP to agricultural TFP (embedded respectively in Ω!",!

and Ω!,! ) implies a shift of human capital out of agriculture. The same holds for the
employment share of physical capital. Furthermore, and more implicit, under the assumption
that 𝛼 (non-agricultural physical capital share) is greater than 𝛽 (agricultural physical capital
share), any increase in aggregate physical capital stock implies a shift of human capital out of
∗
agriculture. The income maximising share of physical capital employed in agriculture (𝑘!,! )
is found by substituting equation B.8 into B.7:
!/(!!!) !/(!!!)
∗
𝛽 Ω!,!
𝑘!,! =          (𝐵. 9)
𝛼 Ω!",!

Holding factor shares constant, income maximising share of physical capital employed in
agriculture depends on the ratio of, broadly conceived, agricultural to non-agricultural
productivity (Ω!,! and Ω!",! ). Given factor shares, equation B.3 can now be solved to obtain
the potential income per worker in each region at each point in time, holding constant the
aggregate levels of human and physical capital, the value of land and sector-specific TFP’s.

Assumptions

It seems appropriate to consider some assumptions of the model that appear too restrictive
and might affect the results of this paper. Within the context of a socialist economic system,
the assumption of perfectly competitive markets seems rigid. Yugoslavia was certainly
characterised by markets that were in-perfectively competitive. As such, factor shares do not
necessarily reflect the elasticity of output with respect to each input, and the technological
parameters might be miss-measured. In particular, to the extent that monopoly profits are
reflected in capital income, the elasticity of output with respect to capital will be overstated
(Young, 1995). In regards to labour, to the extent that wages were supressed within a socialist
regime to release finance to fund investments, the elasticity of output with respect to labour
will be under-estimated.

The assumption of constant returns to scale might poorly describe either agriculture or non-
agriculture, or both. The premise of New Economic Geography is based on increasing returns
to scale. If, for example, non-agriculture was characterised by increasing returns to scale,
perhaps due to externalities among physical and human capital, I would over-state TFP, as
TFP would capture externalities brought about by factor accumulation. Conversely, if

38  
 
agriculture was characterised by decreasing returns to scale, the decomposition exercises
would under-state TFP.35

The estimated reallocation gain is an intrinsically static measure of structural modernisation.

In the model, there is no dynamic interaction between sector-specific physical and human
capital, and TFP. For example, in a static setting, the transfer of human capital from
agriculture to non-agriculture decreases the marginal product gap by increasing the marginal
product of human capital in agriculture, while decreasing it in non-agriculture, leading to an
increase in aggregate efficiency. In a dynamic setting, physical capital would follow human
capital in response to a more efficient allocation of human capital, which would diminish the
decrease in the marginal product gap. TFP could also respond perhaps due to externality
effects. Thus, within a dynamic setting, reallocation gains would be higher than within a
static setting. This paper might then under-state actual reallocation gains and over-state TFP
growth.

As a reminder, reallocation gains are determined as a ratio of actual to potential income,

where potential income is simulated. Estimated potential income does not reflect potential
changes in relative prices arising from demand effects. A shift of factors from agriculture
would decrease agricultural production, leading to an increase in agricultural prices, which
would increase the marginal product of the remaining factors. Neglecting demand effects
would thus over-estimate the reallocation gains. Nevertheless, Vollrath (2009) reports that
simulated changes in relative prices have a minor impact on measured reallocation gains.
Furthermore, this appears to be an unlikely issue within a socialist system where prices were
administered.

Finally, the model neglects costs that are associated with migration. For example, next to
pecuniary costs, labour migration involves physic costs. Nevertheless, it is important to
distinguish efficiency gains from the perspective of aggregate economy, and welfare
implications at individual or societal level. This paper does not deal with welfare
implications.36

                                                                                                                       
35
Boyd (1987) estimated that the elasticity of Yugoslav agricultural output with respect to each input summed
to 0.99. Thus, at least with respect to agriculture the assumption of constant returns to scale seems appropriate.
36
For Yugoslavia, Kukić (2015) deals with the viability of the assumption of the Cobb-Douglas production that
elasticity between capital and labour is 1. He argues that unit substitution between capital and labour seems
valid.

39  
 
Appendix C

In table C.1, the dependent variable is logarithmic TFP growth standardised by the standard
deviation. Otherwise, it is identical to table 10 in the text. The investment remains negatively
associated with TFP growth, and remains strongly statistically significant.

Table C.1: TFP regression, panel data,

        Model  I       Model  II  

        I   II       III   IV  
Investment  rate   -­‐5.8666***   -­‐9.0031***   -­‐3.0116***   -­‐4.8536***  
(1.2971)   (2.6481)     (0.8370)   (  1.4071)  
Unemployment  rate   1.3456   -­‐8.5745     -­‐5.3291**    -­‐11.1121***  
(3.1823)   (8.9861)     (2.3515)   (  4.0320)  
Initial  labour  productivity   -­‐0.0027   0.02114      -­‐0.0001***   -­‐0.0002***  
(0.0746)   (0.0750     (0.0000)   (0.0000)  
Initial  human  capital   1.7395   2.2428*      1.0217    1.1690  
(1.3843)   (1.2555)     (0.8246)   (0.7982)  
Aid   0.1230   0.4280     0.0932   0.2280  
(0.6687)   (0.7625)     (0.2379)   (0.2438)  
Interaction  term   25.6448      13.8975  
  (0.186)       -­‐8.5855  
N     32   32     248  
  248  
F     8.71   12.42     1.57   1.75  
R2       0.468   0.5081       0.1842   0.1982  

40