The new SPA-led government took office in July 1997. With the assistance of the IMF and the World Bank, economic stability was rapidly restored through a tight monetary and fiscal policy. Inflation was brought down to 20.6 percent in 1998, and to a negligible 0.4 percent in 1999. The exchange rate was allowed to float. Overseas remittances led to a rapid appreciation of the rate and made a major contribution to stabilizing the economy. The government limited public spending and introduced a broad-based VAT with a rate of 20 percent to contain the fiscal deficit. The current account deficit was also substantially reduced, and foreign exchange reserves rose to a comfortable level. In the following years, monetary and fiscal policy remained prudent under successive IMF agreements (IMF, 1999b).
The regulatory weaknesses in the banking sector were also addressed. The disorder left behind by the pyramid schemes was cleared up, and steps were taken to consoli- date the financial system. One major state-owned bank was liquidated while the two remaining ones, which together accounted for over 70 percent of total banking assets, were restructured, recapitalized, and offered for privatization. The supervisory capacity
of Albania’s central bank was strengthened. In July 1998 the Banking System Law was enacted, which along with the Law on the Bank of Albania passed in 1997 provided the legal framework for banks to operate effectively and for supervisors to perform their responsibilities. Banks with a ratio of non-performing loans exceeding 20 percent were prevented from lending. A functioning Deposit Insurance Agency was created to guar- antee deposits of up to US$ 5’000, covering almost 60 percent of the deposits. Although not all regulations were fully implemented, the improvements boosted confidence in the banking system and led to a spectacular rise of the share of domestic currency deposits in total deposits in the following years (IMF, 1999b, 2003a; EBRD, 2002).
To reduce the state’s control over the economy, the process of privatizing about 520 SMEs was rapidly completed through sales or liquidations. A new Privatization Law, adopted in March 1998, signaled a change in the government’s privatization strategy for large state companies. The emphasis was directed towards finding strategic investors while the use of vouchers was limited to a maximum of 20 percent of the value of each company. However, the implementation of the new strategy was hampered by the lack of interest among foreign investors (IMF, 1999b; EBRD, 2002).
In the key agricultural sector, the land-registration program was accelerated in 1998 as a condition of the IMF’s stand-by agreement. Only a small share of real estate had been properly registered thus far. By March 1999, registration was completed in about 40 percent of the country’s cadastral zones. By the end of 2000, 96 percent of land titles had been issued to their lawful owners. The swift advance of the registration process led to an increase in property sales, with more than 40’000 transactions reported between 1998 and 2000. However, the program slowed down in subsequent years, and unclear land ownership in major urban and coastal areas continued to hinder economic development (EBRD, 2003).
Despite these notable improvements, Albania was far from achieving a process of self- sustained economic development. The state budget continued to depend on concessional financing of international donors. The public administration suffered from inadequate human, technical and material resources. The informal sector threatened the viability of officially registered businesses, while the inadequate functioning of the judiciary opened the door to widespread fraud and corruption. These shortcomings not only affected the government’s capacity to enforce laws and implement reforms, they also undermined the quality of the rule of law, public service delivery, and the effectiveness of public control. In the early stage of transition, relatively little attention had been paid to these institutional shortcomings. The crisis of 1997 pushed governance issues into the limelight, and showed that macroeconomic and structural measures were not sufficient to bring about sustainable development. As a result, the inadequacy of state structures and the lack of political accountability caught the attention of international assistance programs. Strengthening governance thus became the main concern of the international community. Under considerable international pressure to reverse the pattern of weak institution- building, a parliamentary commission was established in September 1997 to draft a new constitution. The commission benefited from substantial international assistance in all stages of the drafting process.
In spite of international efforts to address governance issues, Albania remained en- trenched in divisive and confrontational politics. The new government was dominated by the conservative fraction of the SPA which had a tendency to maintain the authori- tarian governing style of the previous administration, both towards its intra-party rivals as well as towards the opposition. The government persisted in excluding the opposition from the political debate and the negotiation of critical institutional decisions, such as the constitution. In response to this, the DPA boycotted the parliament during a crucial moment of institutional transformation. In the following years, the opposition adopted a disruptive extra-parliamentary strategy by boycotting state institutions, organizing anti-government rallies, and calling for civil disobedience. Albania was thus far away from leaving behind the politics of partisanship and adopting a peaceful framework for competitive politics.
In line with the previous administration, the SPA also tightened its grip over the public sector by undertaking a campaign of political dismissals and appointing political and personal supporters. The politicization of the public sector further undermined any efforts to strengthen Albania’s weak state institutions.
The urgent need for governance reform was once more revealed in September 1998, when a prominent DPA member was assassinated at the headquarters of the DPA in Tirana. The assassination triggered violent protests by several thousand DPA supporters during which the parliament, the government building and the national television were occupied. After days of lawlessness, looting, and vandalism, the government succeeded in restoring order. In response to these events, a new government was formed, led by the young and reformist wing of the SPA that wished to see a freer exchange of ideas across political boundaries.
The new administration successfully pushed forward the constitutional reform. The final document, which was adopted by a referendum in November 1998, provided better separation of power between the executive, the legislature, and the judiciary, and fulfilled the requirements for a model European constitution. Although the enactment of the constitution represented an important symbolic victory for the SPA, the party’s triumph was tarnished by the ongoing parliamentary boycott of the opposition.
The adoption of a new constitution could obviously not prevent governance mal- practices from happening. Many judges continued to be appointed for political reasons while parliamentary deputies faced difficulties in exercising legislative oversight and ful- filling representational functions. Empirical surveys provided evidence that many public officials did not understand their role and responsibilities, and lacked the necessary knowledge about the issues they were supposed to deal with. The surveys further high- lighted the high level of corruption in public life. Customs, the courts, and tax offices were identified as the three most corrupt sectors. The underlying causes of corruption were attributed to political interference, lack of trained personnel, low salaries, and poor management procedures (EBRD and World Bank, 1999; ACER, 2002).
In order to overcome these deficiencies, the government initiated a public adminis- tration reform with the support of the international community. The goal of the reform was to establish a modern legal framework for the civil service, modernize personnel
management, and increase the flexibility of the wage structure. In parallel to these ef- forts, an anti-corruption strategy was elaborated. In the following years, a cascade of legal and institutional mechanisms were decided with the objective to depoliticize public employment, increase professionalism in the public sector, and crack down on fraud and corruption (IMF, 1999b; ACER, 2002).
However, in 1999 the reform momentum was considerably slowed by the conflict in the FRY and the influx of about half a million refugees from neighboring Kosovo. Although the government successfully led Albania through this difficult period, the crisis further exacerbated political uncertainty and deterred foreign capital from deeper engagement in the country. Political uncertainty was further aggravated by the volatile nature of Albanian politics. Continuing power struggles between conservatives and reformists within the SPA led the prime minister to resign in October 1999. Although the reformist camp succeeded in placing its candidate in the chair of the prime minister, conflicts of power weakened the government’s ability to implement reforms.
Efforts were maintained to improve the system of public finance. On the revenue side, an income and corporate tax system was implemented with the objective to strengthen Albania’s revenue base and improve the efficiency of tax administration. A new Customs Code was adopted in April 1999 to combat fraud and corruption in the customs area, which generated about 60 percent of Albania’s tax revenues. The code imposed signifi- cant fines for smuggling and provided the basis for creating an anti-smuggling unit. The code also included measures to apply when corruption of customs officials was detected. On the expenditure side, the introduction of a medium-term fiscal framework in 2000 paved the way for a more strategic and policy-focused budget process. The framework addressed existing shortcomings in the management of budget preparation, coordination between line ministries, budget monitoring and implementation, which had been to some extent responsible for the low levels of public spending on key social services and the depreciation of existing capital assets in the past (IMF, 1999b, 2003a; OECD, 2004a).
Public finances improved somewhat in subsequent years. Total tax revenues in- creased by a quarter in 2000 compared to 1999, reaching 19.3 percent of GDP. This was the highest ratio of government revenue to GDP reached since 1994. The increase in tax revenues resulted mainly from the implementation of the VAT and the recovery in economic activity. The general government deficit decreased from 12.1 percent of GDP in 1999 to 6.9 percent in 2001. Yet the ineffectual and discretionary application of tax laws and government regulations remained a serious problem in subsequent years, and the resulting tax evasion threatened the continuation of the country’s recovery as per- sistent shortfalls in tax revenue affected investments in basic infrastructure, health, and education (IMF, 1999b, 2003a; OECD, 2004a).
After insistent urges from the international community, the government transferred more political power from the central to the local level in order to improve democratic control, increase citizen’s involvement, and bring public services closer to local communi- ties. In 2000, a decentralization strategy was outlined. In a first stage, a package of laws on local financing, physical assets, and local public enterprises was introduced to improve the allocative efficiency of public expenditures, as well as governance and accountabil-
ity mechanisms. The existing 36 district councils were reorganized into 12 regions so as to downsize and consolidate local administrative units. A National Committee for Decentralization was set up to deliberate on the implementation of the decentralization strategy. However, partly due to the nature of the proposed changes and partly due to resistance from the central government, progress on decentralization was slow (ACER, 2002; OECD, 2004a; World Bank, 2004a).