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Why are There No Conditions in Serbia for Economic Growth: Six Reasons for Alarm (I)

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In the year in which the acquiring of a candidate status for membership in the European Union is approaching, Serbia is faced with an outpour of capital, a deep recession and a combined fiscal, debt and financial crisis. The expectations of the new government that, with the nominally promised continuation of reforms and European integrations it would ensure enough external capital and, thus, emerge from the mentioned problems, have so far convinced neither the IMF nor the financial markets. At the level of individual indicators of the World Economic Forum Serbia is among the last five countries. It is time for alarm, writes Dušan Vujović, professor at the FEFA private Faculty of Economics.

After three quarters of 2012 it is clear that the negative economic growth continues. By quarters: -2.5%, -0.6% and -2.2%. Inflation has accelerated up to almost 13% in October and it considerably exceeded the targeted corridor. The balance of foreign trade with goods and services remained at last year’s level, but the deficit of the current balance of payments increased by 19% due to the large drop of remittances (23% or half a billion USD). The drop in remittances is ascribed to the new wave of the crisis in countries where the Serbian diaspora is concentrated.

Much more disturbing is the capital side, where, in nine months’ time a shocking net outpour of around 170 million USD was registered, primarily because of the reduction of credit financing by 282.5 million USD. The main causes are the drop in Serbia’s credit rating (to BB- with negative expectations), the poor macroeconomic performances and the previously announced reduction of the exposure of western banks in the region. The general deterioration of the credit conditions on world financial markets, the political reservations with which the new government was received in the world and the difficulties on the road to Euro-integrations made Serbia’s position additionally difficult.

In other words, the combined hope in the external balance of payments of over three billion dollars in the January-September period of 2012 was financed exclusively through the spending of foreign currency reserves. This is not sustainable on a long term basis. It is necessary to sound the alarm especially in view of the fact that the fiscal deficit has exceeded 7% and the public debt 55% of the GDP.

All this is happening in a year of obtaining the status of a candidate for membership in the European Union. The predecessor countries on the road to EU integration registered an interest by world investors. Serbia is faced with an outpour of capital, a deep recession and the combined fiscal, debt and financial crisis. The expectations of the new government that, with the nominally promised continuation of reforms and European integration it would ensure enough external capital and, thus, emerge from the mentioned problems, have so far convinced neither the IMF nor the financial markets.

The IMF could offer a program provided that a restrictive fiscal policy is conducted, that the concept of targeted inflation continues and that the key non-completed structural reforms are continued. The focus is on the elimination of the Serbian economy’s structural weaknesses: a non-competitive supply, high unit costs of labor, a large and inefficient state. This is not politically popular since it undermines the preelection promises in the social sphere and reduces real income. That is why one can expect long and difficult talks before the government unwillingly accepts the IMF’s conditions, along with the already proverbial respect of the short-term macroeconomic goals and the mild postponing of the painful structural reforms. Precious time without an IMF program is already passing, meaning without access to the IMF’s funds and capital markets.

On the side of structural reforms, like before, the IMF and the World Bank will see the strengthening of the supply in the continuation of privatization, the restructuring of public enterprises and the improvement of the business climate. In principle, these are not bad measures if they are well prepared and carried out. However, after 12 years of reforms we know this is not easy. The numerous privatizations and measures directed towards the improvement of the business climate (including the progress achieved over the past couple of years), produced only partial results. Serbia is still very far from creating an energetic, innovative and competitive private sector that would come to grips with the world, winning over new products and technologies, and endeavoring to have the volume of business operations and exports expand. Quite unfortunately, privatizations have more often been in the news because of suspicious transactions, the sacking of workers and the sell-out of assets than because of successful programs. Facts confirm this impression. Since 2008, lost have been 25000 work places (or 13% of the total employment). There is today a record number of the unemployed (25%) and the constant drop in the share of the production of tradable (meaning potentially export-oriented) goods in the GDP (a reduction by one third since the year 2000).

Serious Blindness

After the agreement with the IMF, is it realistic once again to postpone the reforms and to return to the type of economic growth that existed in the period between 2001 and 2008, this time with greater reliance on EU accession funds? The answer is – no.
At the start of the transition, the inherited economic problems were largely pushed aside in the 2001-2005 period thanks to a large dose of professional and financial support which Serbia received through arrangements with the IMF, foreign assistance, as well as soft and commercial sources of financing. The country’s ability independently to conduct a fiscal and monetary policy was put to the test for the first time in 2006. The government’s confidence was at an enviable level thanks to the fiscal surplus registered in 2005, the large foreign currency reserves (9 months of imports) the expected inflow of remittances and foreign capital. Faced with political and social pressures to raise salaries and to reverse the trend of the growth of unemployment (at the time at the level of 20.9%), the government relaxed the monetary and fiscal policy and allowed a large real appreciation of the dinar.

The resulting GDP growth was entirely based on the growth of domestic elements of the aggregate demand. The growth rates in the 2006-2008 period were lower than expected (3.6%, 5.4% and 3.8%), but this was enough to allow new employment in the public sector, to reduce unemployment (to 18.1% in 2007 and 13.6% in 2008) and considerably to raise salaries. The average wage almost doubled in the period between 2005 (210 euros) and 2008 (402 euros). According to expectations, with an overestimated dinar, the considerable foreign financing and the very poor reaction of the domestic supply, this type of growth, based on domestic spending, led to a large increase in the deficit of the trade and current balance of payments which grew from -10.1% of the GDP in 2006 to -21.6% in 2008.

On the side of the supply this type of growth generated very different sector effects. The sectors that produce non-tradable goods reacted positively to the growth of the domestic demand and they produced around 95% of the total growth of the newly created value. The sectors producing tradable (and potentially export-oriented) goods gave only 5% of the growth. At the middle of 2008 it became clear that this growth model was not sustainable on a long-term basis since it was based on an external and fiscal deficit, the above average growth of non-tradable sectors and imports. The sectors producing tradable goods were too weak and insufficiently reformed to compete with the flood of cheap imported goods and to launch a stronger export orientation. The deterioration brought about by the world financial crisis (primarily through the deterioration of the financing conditions and the drop of the world demand) made acute the issues of the sustainability of this growth model in Serbia, but this did not produce an adequate reaction.


Instead of a continuation of institutional reforms and a radical change of the parameters of the economic policy that would jointly stimulate the growth of export-oriented sectors, an extremely mild opportunist strategy was applied. Taking as a point of departure the still optimistic forecasts of growth in 2009, the high level of the foreign currency reserves and the expected continuation of the inflow of capital, as well as the very low presence of risky financial instruments, it was decided to opt only for a “precautionary arrangement” even though everyone had been familiar with the deep structural weaknesses of the Serbian economy.
The first weakness is the already mentioned chronically poor supply because of: (a) the inherited problems from the past, (b) the late start of the transition, (c) the insufficiently successful privatization, and (d) the poor business climate.

The second weakness is the inefficient labor force. The main problem are the high salaries as compared to the productivity. It is interesting to notice that the high unemployment rate is not lowering the salaries in Serbia. At the same time, trade unions are requesting that salaries be adapted to the growth of the costs of living and the exchange rate trends. This is directly eroding the external competitiveness of Serbian companies, it is endangering growth based on exports and the opening of new jobs, but this is spoken of very little.

The third weakness is the large and inefficient state oriented towards spending and the redistribution of the income, instead of creating conditions for economic growth. The constant fiscal deficits have intensified the macroeconomic tensions.
With such weaknesses Serbia did not manage to generate a dynamic growth based on exports and to mobilize a sufficient amount of national (and especially domestic) savings. Quite the contrary, the growing unit costs of labor and the poor reaction of the domestic supply of tradable goods to the trends of the domestic and export demand systematically pushed the Serbian economy to an inferior path on which a faster growth pace, a lower unemployment level and a stable macro situation can be achieved only with a growth of the foreign debt or the undermining of external stability. In the 2001-2008 period foreign support, the inflow of capital and remittances easily covered the difference between the larger spending and the achieved income.

Depth of Problem

It is obvious that Serbia is suffering from multifold structural problems which, together with institutional and economic-political weaknesses, represent sharp growth limitations.

According to the findings of the World Economic Forum in Davos, for years now Serbia has been around 90th place. Standing behind this bad position is a whole series of even worse indicators on the broader front of institutional reforms. For more than a decade after the belated continuation of the transition, the key market institutions are seriously lagging behind most of the 140 countries in the world which are being monitored. Major weaknesses are present on the market of goods and labor. The quality of the business sector lags behind the comparable countries and the world in general, especially in the “ability to apply new technologies”, “the level of the development of business” and the “ability for innovations”. At the level of individual indicators Serbia is at the very bottom (among the last five countries) in twelve very important spheres:

tabela engl
In combination with the increasingly unstable macroeconomic environment, non-developed and expensive financial mediation, and the poor quality of the key physical infrastructure, this gives quite a gloomy picture of the state of the institutional reforms and the quality of the economic policy in Serbia after the global financial crisis. These reforms require a strong political will, time and a professional capacity. It is necessary immediately to act resolutely. The option of postponing “difficult reforms” for later and for the minefield of structural problems and non-completed institutional reforms to be crossed over on the wave of foreign credits, the inflow of capital and remittances, no longer exists.Apart from these fields, reforms are urgently necessary in at least some 30 fields where Serbia’s indicators are below 112th place, i.e. among 20% of the most poorly graded countries in the world.

Key Limitations of Growth

The elimination of these limitations requires large economic and political costs and it is not technically feasible on a short-term basis. The elimination of randomly selected limitations (according to individual or political wishes) can even produce solutions that can be worse than the starting position. It is a real challenge to determine the causes of the slowed down growth and to define the priorities of the reforms and the economic policy. That is not easy.

Two approaches are the most popular in the world.
The OECD approach takes as a point of departure a clearly defined analytical model of economic growth and economic policy measures. On the one hand, measured is the degree of the use of a country’s working potential (through the true number of realized working hours) and the level of work productivity (through the capital equipment operation and the total factor productivity which catches all the quality aspects – innovations, technical progress, know-how etc.) compared to international standards. On the other hand, assessed are concrete economic policy measures that refer to the degree of the use of the labor force and the level of productivity by certain sectors and regions. The priority fields where the economic policy acts are located at the intersection of dimensions with “low work performances” and “poor economic policy measures” since this is how economic growth is accelerated the most.

The “diagnostics of growth” model offered by famous Harvard economists, Dani Rodrik and Ricardo Hausmann, takes as a point of departure quite a simple diagnostic framework for establishing and eliminating the key limitations of growth. On the one hand, observed are the reasons for the low yields in the real economy (the quality of the infrastructure and labor force, the imperfect nature of the market and interventions by the state), and on the other hand the reasons for the high costs of financing (from domestic and foreign sources). In the implementation of this approach the main responsibility lies with experts and decision-makers in the economic policy. They have to be acquainted well with both theory and practice in order to take into consideration all the open and hidden information necessary to establish the true limitations of economic growth. The diagnostic framework is only a means that helps reach an agreement.

The intention of both approaches is to establish the key limitations of growth and to create a basis for adopting mutually harmonized reforms and economic policy measures that would eliminate true limitations and raise the level of economic growth. The advantages of the OECD method are that it is more firmly defined and more precise in the procedure of measuring and defining the field of priority actions. The weaknesses are the focusing only on one field (work and productivity) and the lack of flexibility in treating the abundance of information. The advantages of the Harvard approach are its flexibility, the catching of a broad specter of possible factors and the use of all available information. The subjectivity of this approach is, conditionally speaking, its main weakness, although the method is transparent and can be subjected to verification in all the stages of its preparation and implementation.

The implementation of the “diagnostic of growth” method on Serbia has produced the following findings:

1. The protection of ownership rights and other key institutions represents the basis of modern market economies and it suffers from numerous shortcomings, but, nevertheless, it does not represent a true limitation of growth in Serbia since companies engaged in the imports and production of non-tradable goods successfully function in the existing imperfect institutional conditions.
2. The real effective exchange rate (REDK) represents a true limitation of growth since it has a negative effect on the operation and growth of companies producing tradable goods, and they are today the key bottle neck for the Serbian economy to move to a sustainable growth path characterized by macroeconomic stability, with a sustainable fiscal and external balance.
3. The equilibrium REDK level is not a universal remedy (panacea) which will resolve all the problems of the sectors producing tradable goods in Serbia. The experience of other countries show that REDK has a strong impact on so-called homogenous goods (standard goods which are the subject of stock exchange business operations). In the case of differentiated industrial products, REDK is only one of the factors determining competitiveness, since acting side by side are the product design, marketing, research and development, and innovations.
4. The limited availability of credits and the high costs of financing have become some of the sharpest limitations of growth in Serbia, both in ensuring current production and trade, and in the financing of investments. Serbia has one of the lowest degrees of monetization and the highest financial and credit margins, this seriously limiting the functioning of the economy and economic growth.
5. The expensive, large and disrupting role of the state has become one of the key limitations of growth. It is creating an inefficient and expensive business environment, directly raising the costs of functioning, not providing and not promoting competition, raising the price of labor and drawing away young, educated people from productive work places in the economy, disrupting financial discipline and pushing out the private sector.
6. Inefficient corporative management and expensive labor force (expressed through the high unit costs of labor or low productivity) are drawing away FDIs and business cooperation, and also eroding the price competitiveness of companies in many sectors. What is necessary are resolute measures in order to eliminate the most important barriers to the growth of productivity (through programs for the training of the employed, better business schools, research and innovations for the needs of companies etc.)

The limitations of growth should be eliminated in the order in which they are mentioned, and as soon as possible, so as to set in motion the motors of growth based on exports.

It is neither with deluding, nor with fire and the sword nor with the random picking through the forest of illogical regulations that Serbia will be able to fight with the outpour of capital, the deep recession and the combined fiscal, debt and financial crisis. A country which is nearing the status of a candidate for membership in the EU is, according to the list of the World Economic Forum, among the last five countries in the world by 12 important indicators of business operations. It is time for alarm and for systematic and concentrated work on eliminating the sharp limitations of economic growth, writes Dušan Vujović, professor at the FEFA private Faculty of Economics in the Business& Finance Magazine.

Business&finance: SME 92/93

december/january 2012/12

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  • 27/12/2013

    Well 2012 was a really bad year with the severe winter (deep snow, subzero temps freezing up parts of the Danube) then the summer drought. 2013 was quite an improvement with exports improving, coverage of imports by exports went up from 59% to around 74% (I forget the exact but it was 70-something percent), and inflation at the end of 2013 was 1%-something.