Bureaucracy, Corruption Plague Foreign Investment in Bosnia


By every measure, the Internet Cafe here is a wild success.

Sales are enormous. Tables and the bar are packed night after night with high-spending customers. Lunches and Sunday brunch are standing-room only. Business in Bosnia just doesn’t get any better than this.

So why is cafe owner Morgan Sowden, a Briton, bailing out?

“Either I cheat or I give up,” he says.


Sowden and people like him--pioneers in investing in today’s Bosnia-Herzegovina--are confronting exorbitant taxes, burdensome bureaucracy and multiple layers of ever-changing laws that combine to gut even the most successful of enterprises.

Incompetence, corruption and a legacy of 40 years of communism are discouraging foreign investment in Bosnia just at a time when postwar recovery so desperately depends on it.

The rest of Eastern Europe and the former Soviet Bloc spent most of this decade in the painful but profitable transition from state-controlled socialism to free-market capitalism. Now Bosnia is trying to undertake, belatedly, the same post-Communist economic reform while also recovering from a civil war that destroyed infrastructure, idled factories and gave rise to a powerful black market.



Thanks to reconstruction aid, Bosnia’s economy is growing by about 30% a year. But more than two years after the war ended, progress on the economic reform front is glacial, as one diplomat put it. The danger for Bosnia is that potential investors, who initially were willing to grant Bosnia some slack, will begin to grow restless as they see that other countries offer much friendlier business environments.

“The future of this country is in foreign investment,” said senior government spokesman Mirza Hajric. “We want to be an attractive country, and we know we will lose the interest of [Western] companies if we can’t create [proper] conditions.”

Such good intentions, however, are not readily fulfilled. U.S. advisors are working to train Bosnians in everything from basic bookkeeping to the restructuring of the economy. But crucial laws governing privatization, property ownership and foreign investment are meeting vocal resistance from nationalist leaders on all sides who are determined to keep a grip on the economy. Indeed, most of Bosnia’s economy remains in the hands of the state, ruling political parties and their privileged cohorts.

And disputes among Bosnia’s Muslim, Serb and Croat factions blocked two essential tools in the building of an economy: a national currency, which was finally imposed early this year by international mediators, and railways, which still cannot cross ethnic lines.

U.S.-brokered peace accords in December 1995 ended the 3 1/2-year Bosnian civil war and formalized the division of the country into two autonomous “entities": the Muslim-Croat Federation and the Bosnian Serb Republic, also known as the Republika Srpska.

With the Serbs only recently beginning to cooperate with the peace accords, most potential foreign investors have been focusing on the Muslim-Croat half of the country and its capital, Sarajevo.

Sowden, the Internet Cafe owner, represents the difficulties faced by small and medium-sized businesses.

Already well-versed in doing business in Eastern Europe after a stint in Prague, Sowden took an early gamble on Bosnia. Arriving just a month after the war ended, he expected hardships. He planned for the lack of regular water and electricity, keeping buckets on hand for flushing the toilets and making sure the bar had backup lighting. He stored beer outside during winter months in order to have a permanent supply of cold bottles.


What he did not expect was the layer upon layer of bureaucracy and the seemingly deliberate way the government had of making it impossible, and expensive, to do business.


Make that governments, plural. In its postwar development, this half of Bosnia has created jurisdictions at the city, canton, entity and state--meaning all of Bosnia--levels, each of which has some form of taxation and regulatory powers. Because it is all new, laws at different levels sometimes contradict one another and are extremely complex.

As a consequence, Sowden recently found himself hit with a retroactive tax bill going back to 1996. Authorities simply changed their minds about whether a particular duty was applicable to his business, Sowden said.

He was also assessed a payroll tax equal to a full 85% of his employees’ salaries and seven taxes on alcohol totaling roughly 20%, and he must pay 36% to 51% tax on his profit annually--in advance. If he cheated and hid full-time employees or low-balled his profits, he could get off with paying a lot less.

In the end, the law does not allow him to send home to London more than the equivalent of about $1,100 a month. Rather than continue to fight the bureaucrats and lose money, Sowden has decided to hand the popular cafe over to his 25 employees and walk away.

“I expected enormous problems related to the war--these were problems I expected and could deal with,” said the 27-year-old Sowden. “But I lost a different battle from the one I came to fight.”

New Yorker Bethany Lindsley, 33, expresses similar anxieties. She left an art gallery business in Manhattan to move to Bosnia. Last October, she opened Sarajevo’s first Tex-Mex restaurant, Texas, entering into a joint venture with a Bosnian restaurateur. She holds a majority share to maintain control.


Lindsley tackles the challenges unique to her kind of commercial establishment; running a spicy eatery here has meant teaching someone how to pat tortillas out of pasty cornmeal, obtaining a rare supply of avocados and bringing in an occasional bottle of tequila.

But it is the red tape and the resistance to innovation that drive her crazy. In addition to retroactive and sky-high taxes, reams of regulations do not allow her to make changes as simple as paying her employees weekly instead of the prescribed twice-monthly.

“These are not problems from the war,” Lindsley said. “It’s communism, and the inability to recognize change. I hear all the time: It’s not my job, not my fault, this is how everybody does it. . . . I hear ‘no’ so often that it’s really frustrating.”

Still, she is not ready to give up. Having invested no more than she can afford to lose, Lindsley is determined to press on, for now.

The entrepreneurial climate “is not as friendly as it could be, but if you wait for it to be, you lose the opportunity,” she said. “It’s people coming and opening businesses that will make this work.”

The Internet Cafe and Texas are small enterprises, but most major international corporations remain reluctant to commit to Bosnia.

And corporations in serious negotiations with Bosnian partners have encountered some of the same nettlesome obstacles as the little guys.

Many Bosnian leaders display a kind of “you owe me” attitude to visiting business executives. The notion of making Bosnia more attractive to investors is still dwarfed by the interest of these leaders in making a buck.

The Bosnian government sees to it that foreign investors pay top dollar for real estate, telephone lines and nearly every component of setting up shop. Money is then siphoned off to the ruling political party and other off-budget agencies, including a secret intelligence network, diplomats and international monitors say.


When McDonald’s first started negotiating with Bosnia last year, Sarajevo’s foreign trade minister, Hasan Muratovic, demanded that it buy all of its meat, bread and supplies locally. Diplomats surmised that this was a way for the Bosnians to make more money, with Bosnian officials taking a cut each step of the way.

For a while, it seemed that such demands had ruined the deal. But McDonald’s says it continued to negotiate, and gradually the Bosnians have come around. Branimir Lalic, assistant vice president for McDonald’s in Europe, said he expects to open two restaurants in the spring of 1999.

Lalic said many Bosnian leaders are guilty of “very wishful thinking” when it comes to foreign investment. Hurdles erected by the Bosnian authorities are tougher than in Ukraine, for example, where McDonald’s is also preparing to open an outlet.

“The Bosnian officials want the country to come back as fast as possible,” he said. “But they have to understand that foreign investment is not charity. . . . Foreign investors are not asking for gifts, but the Bosnians should be more receptive to the needs of investors [and] make their lives a little easier. A lot of Westerners are lost in these small political games.”

Sarajevo real estate, for example, is overpriced, and that scares away investors too, Lalic said. As a legacy of Bosnia’s recent Communist past, most property is controlled by the government, which in some cases charges prices higher than in downtown Geneva, he said--this in a city that still shows the deep scars of artillery bombardment and where running water is available only periodically.

The first major direct foreign investment in Bosnia is expected to come from German auto maker Volkswagen, which wants to reopen its prewar plant near Sarajevo. After more than 20 months of negotiations, VW is preparing to start production of an Eastern European model called Skoda in a joint venture with United Industry Sarajevo (UNIS), a state-owned Bosnian conglomerate.

Volkswagen’s plant was heavily damaged during the war, and one of the stickiest points in negotiations between the company and UNIS has been who will pay for damages and other outstanding liabilities.

Detlef Wittig, vice chairman of the Skoda unit, which is controlled by VW, recently told reporters in Sarajevo that the auto maker plans a total investment of about $50 million and hopes to employ several hundred people to produce up to 3,000 cars in the first six months.


Some reports indicated that Volkswagen and Skoda could start work as early as April, but Volkswagen spokesmen recently declined to answer questions or provide further information.

When he announced progress in the negotiations last fall, Wittig conceded that Bosnia still lagged in basic laws needed to do business. But he said his company’s prewar experience with some of the same Bosnian players eased the deal.

“We have been doing business in difficult legal frameworks elsewhere,” he said. “The question is, do we wait for everything on the legal side to be resolved? . . . We have been here before. We know the people, and the people know us as well.”