This paper focuses on Serbia and Montenegro’s Poverty Reduction Strategy Paper (PRSP). Through the process of developing the Poverty Reduction Strategy, national indicators in line with the Millennium Development Goals have been identified. The poverty reduction strategy for the Union focuses on establishing conditions for dynamic and equitable economic growth, through the creation of a stable macroeconomic environment and favorable investment climate to create employment, reduce economic vulnerability, and establish key programs to directly promote employment among the poor.


This paper focuses on Serbia and Montenegro’s Poverty Reduction Strategy Paper (PRSP). Through the process of developing the Poverty Reduction Strategy, national indicators in line with the Millennium Development Goals have been identified. The poverty reduction strategy for the Union focuses on establishing conditions for dynamic and equitable economic growth, through the creation of a stable macroeconomic environment and favorable investment climate to create employment, reduce economic vulnerability, and establish key programs to directly promote employment among the poor.


Towards the end of 2002, the Government of the Republic of Serbia initiated the development of the Poverty Reduction Strategy Paper (PRSP) for Serbia. The initial platform, strategic options and the preparation process of this strategy and its implementation were all defined in the Interim PRSP, approved and adopted by the World Bank and the International Monetary Fund.

The PRSP, together with the Republic of Serbia Reform Programme, represents part of the overall development strategy of Serbia, within the wider framework of Serbia and Montenegro’s accession to the European Union.

The PRSP is also part of the Government’s Framework for International Support and Developmental Cooperation, as well as a plan of activities for the achievement of the United Nations Millennium Development Goals.

The importance given to poverty reduction by the new democratic Government of Serbia has already been clearly expressed in its first reform document “A Reform Agenda for Serbia (2001)” featuring three main objectives:

  • The establishment of a modern state based on the rule of law, including the fight against corruption and organized crime;

  • The revitalization of the economy through the introduction of market-oriented reforms;

  • The fight against poverty and the improvement of the social protection system for the most vulnerable groups.

In line with the UN Millennium Development Goals, the PRSP defines poverty as a multi-dimensional phenomenon that in addition to representing insufficient income to cover basic needs, also includes a lack of employment opportunities, and inadequate accommodation and access to social protection, health, educational and communal services. These aspects are particularly important in the case of vulnerable and socially excluded groups. The other key elements characterizing poverty are lack of access to a healthy living environment and natural resources, above all clean water and air.

The PRSP represents a holistic plan of activities aimed at reducing key types of poverty by creating financial and other preconditions and by offering everyone the opportunity to secure an existence for themselves and their families. Serbia has sufficient human, financial and natural resources to eliminate - in a relatively short period of time and relying on its own strengths with the assistance of the international community - the most acute forms of poverty, particularly present in underdeveloped regions and concentrated among the most vulnerable groups.

Poverty in Serbia, apart from having similarities with other countries in transition and developing countries, also has many specific features:

First, widespread poverty is a relatively new phenomenon, caused by the dramatic drop in GDP and the living standards of citizens in the 1990s, as a consequence of the former authoritarian regime, international isolation, severe economic sanctions, negative economic consequences evoked by the disintegration of the former Socialist Federal Republic of Yugoslavia, wars in the neighbouring countries, and NATO bombing.

Secondly, the latest research on the scope and causes of poverty clearly indicates that poverty in Serbia, besides being concentrated in the traditionally under-developed South and Southeast regions, due to dramatic economic and social changes in the 1990s, has spread to other regions as well. On the other hand, poverty mostly affects socially vulnerable groups (children, the elderly, persons with disabilities, refugees and internally displaced persons, Roma, the rural population and uneducated people). For that reason, the basic empirical findings that show that 10.6% of inhabitants or 800,000 individuals are poor, should serve only as a starting point for the development of the full PRSP, since only a small shift in the poverty line increases the percentage of the poor to 20% or 1,600,000 people.

Thirdly, under such highly unfavourable economic and social conditions, the new Government resolutely initiated a painful, but unavoidable process of transition towards a modern, market-oriented and open economy. The process of modernization, restructuring and privatisation of the economy as well as the rationalization of non-economic activities which is ongoing, has caused some additional social problems, through numerous redundancies and the creation of new “pockets” of poverty, which have been concealed up to now.

The characteristics and profile of poverty in Serbia point to the following three main directions in the formulation of the Poverty Reduction Strategy:

  • In the first place, a strategy of dynamic economic growth and development, with an emphasis on job creation in the private sector. The increase in economic activities and greater international competitiveness of the domestic economy will lead to an increase in GDP, the creation of new jobs, better incomes and real sources for financing social and other public needs. This is a key development direction and the priority for Serbia, and is the only way to improve the lives of citizens and at the same time eradicate poverty permanently. This implies the continuation of the policy of macro-economic stability, the creation of an environment attractive to foreign investment and the mobilization of domestic investments; accelerated restructuring and privatisation which will revitalize those state/socially-owned enterprises capable of becoming market-oriented and competitive; the creation of a business environment for the development of entrepreneurship and faster development of small and medium enterprises; development of the control functions of the state which would legalize the so-called grey economy; a resolute battle against corruption and organized crime; and the efficient working of state institutions – legal, executive and judicial authorities.

  • The second strategic direction is the prevention of new poverty that will result from the modernization and restructuring of the economy and rationalization of the state and its basic functions. In line with the orientation towards market and other reforms, new employment opportunities need to be offered to these groups. The state with its institutions (including the National Employment Agency, the republic and regional agencies for SMEE development, and the education system) in close cooperation with municipal authorities and local communities, through its own activities and the mobilization of non-governmental organizations, and with the expected assistance of the international community, should offer retraining incentives and opportunities. Significant economic and social efforts will be required, particularly in the regions with a traditional and non-profitable economic structure. Considerable financial resources represent a necessary, but not a sufficient condition.

  • The third strategic direction implies an efficient implementation of existing programmes, as well as defining new ones and measures and activities directly targeting the poorest and the most vulnerable groups (children, the elderly, persons with disabilities, refugees and internally displaced persons, Roma, the rural population and uneducated persons), particularly in the least developed regions. The goal of these activities is to initiate a long-term process of empowering vulnerable groups to move out of poverty, through the development of new market-oriented skills, and the provision of minimum standards of living. From the aspect of the most visible poverty, this will enable not only the survival of these groups, but also their equal access to employment, health care, education and utilities, as well as protection of their basic human rights. The permanent improvement in the overall economic and social status of the most vulnerable groups will, more importantly, prevent the recurrence of poverty within the same social groups.

The PRSP will be financed from fiscal resources, budgetary savings and additional resources with the financial assistance of the international community. This will enable the indicative costs presented in the PRSP to be reflected within the Medium-Term Expenditure Framework. In this way, the fight against poverty will find its place among Government efforts and in the preparation of annual budgets. This will enable the setting of realistic fiscal targets within financial and other constraints, and the commitment towards maintaining macro-economic stability in the country. At the same time, the “resource gap” (missing funds) will be identified, in order to define alternative scenarios for poverty reduction and the prevention of basic forms of poverty depending on the extent of support offered by the international community.

The PRSP consultative and participative process, and its adoption and implementation, are characterized by an integrated approach, aimed at:

  • National ownership of the PRSP;

    Inclusion of all relevant stakeholders in the implementation of the PRSP;

  • Efficient and transparent information dissemination;

  • Efficient monitoring of the PRSP as a whole and in its individual aspects by means of adequate and internationally comparable indicators.

This multi-dimensional approach to the alleviation of poverty, apart from significant financial resources, requires great organizational efforts, coordination between the Republic and local levels, the definition of sectoral and other priorities, strong cooperation between state institutions, civil society and the international community, professional support, and above all, a sincere willingness and readiness of all participants to participate actively and responsibly in the entire process.


1. Main Causes of Poverty in Serbia

In the past decade (1990-2000), the fall in the living standards of the population and the increase of poverty in Serbia resulted in the first place from a great fall in economic activity. Gross Domestic Product (GDP) in 2000, both overall and per capita, was less than half the level achieved at the end of the 1980s. Such a fall in economic activity was a consequence of a ten-year general political and economic crisis.

The main non-economic factors in this crisis were the break-up of the former Yugoslavia, wars in the region, the international isolation of the country, and NATO bombing. The main internal crisis factors originated from the interruption of the process of social and economic transformation as a consequence of reviving traditional forms of social integration and the degradation of political culture with the crumbling of socialism. All this caused a lack of political will to carry out radical institutional reforms and, consequently, slowed down the development of market institutions and of a state based on the rule of law.

The secession of the former Yugoslav Republics led to the dissolution of the FRY single market and a drastic fall in the inter-republic and foreign trade of FRY (inter-republic trade between FRY and former Yugoslav republics accounted for 40% of GDP, while trade with other countries accounted for 20% of GDP39). In addition, a considerable proportion of the infrastructure and production capacities were destroyed by NATO bombing in 1999, which had an additional unfavourable impact in terms of a fall in production and employment. Poor economic results in this period were additionally aggravated by the inappropriate economic policy which caused high inflation rates in certain years of the previous decade and the so far unprecedented hyperinflation in 1993. The hyperinflation for its part led to great impoverishment of the population and the expansion of the grey economy which became the main means of survival for the majority of the population. The difficult economic and social situation was additionally aggravated by the great influx of refugees and internally displaced persons, whose number in some years reached 10% of Serbia’s population. Apart from this, the living standards of part of the population were also affected by the (temporary) inability to dispose of their income and property in the former Yugoslav republics. The number of citizens with greater social needs grew, while the economic capacity of the state to meet these needs was in constant decline, so some of the most vulnerable groups had great difficulty coping with the consequences of the economic crisis.

The most important factor in the growth of poverty was the fall in per capita income since inequality in income distribution was relatively stable during the previous decade. During this period, official unemployment increased. There was also hidden unemployment since the number of the employed decreased more slowly than the sharp fall in economic activity. At the end of the period, hidden unemployment reached the level of about one third of total employment. This situation in the labour market caused a fall in real incomes and arrears in their payment generating poverty for the majority of the population.

In the period 2000-x2002, the establishment of macro-economic stability and the real increase of GDP (around 4-5% annually), as well as the increase in wages and other income in real terms, caused growth in consumption and living standards.40 In spite of the elimination of price disparities in 2001 and 2002, prices remained relatively stable, living standards increased in real terms and poverty was reduced. Despite the falling trend, the level of poverty is still relatively high, with the percentage of the population near the poverty line being particularly critical.

The picture of poverty is additionally burdened with 480,000 refugees and internally displaced persons.41

Causes of Poverty

-Historical Outline -

Folk tradition very clearly distinguishes the causes of the emergence of poverty, and treats them differently. These causes can be classified into several main groups: 1. fateful, 2. inherited, 3. personal and 4. general.

Fateful poverty is the consequence of “force majeure” and it is very difficult or impossible to eliminate. Whatever one did, worked hard, created things, the result would always be negative. Something will always happen that will devalue one’s efforts and leave the individual who had put his efforts into it without the rewards merited.

“Force majeure” that prevents one from getting away from poverty is called Misery. In the Slavic folk tradition it is represented as a supernatural being who travels around the world, attacking and torturing people. It is possible to eliminate this kind of poverty, “to take misery off one’s back”, as the saying goes, only if one’s own or one’s ancestors’ sins are tracked down and atoned for.

Inherited poverty is frequent, and folk tradition is full of data and stories about poor families. This kind of poverty was very much present among the Serbs and one can freely say that it can be applied to the majority of poor people in Serbia. However, the fact is that this poor stratum has decreased over time. “Escape from this kind of poverty” has always met understanding both from individuals and from the broader community. The “escape” was fully divergent, i.e. it developed in different directions. One could change residence, find a job, become educated, save, work hard or move to a richer environment. According to folk stories collected and published by Vuk Karadžić, one could run away from inherited poverty by working, getting educated, and acquiring knowledge and awareness.

Personal causes of poverty are numerous and very clearly classified in folk tradition. Idleness, irresponsibility, laziness, prodigality, alcoholism, and gambling are the main causes of one’s poverty. There is no understanding for such poverty and the common belief is that those individuals should not be given any material assistance because it is a futile effort. They are believed to be guilty for their own condition; therefore they have to find a way out by themselves. Miloš Obrenović had a similar opinion, and he did not consider poor “a good-for-nothing, a lazybones, a drunkard and the like, whom I never forgave and who are not to be forgiven for anything.”

General reasons for poverty are consequences of natural disasters, economic crises or political events (wars, loss of privileges and position, state robbery). They are usually temporary and related to persons affected by some of these events. For those who become impoverished under such circumstances, if they have no personal guilt, there is great understanding among people, because they are “guilty without guiltiness” and the common opinion is that they should be given necessary assistance by the broader community and the state. They do not lose their reputation and the common belief is that they should be helped as soon as possible; also, that they will soon recover.

In the 19th century, and in some places even later, there was an institution called the “village basket” in which everyone allocated certain amounts of wheat after harvest, according to their ability and yield. That wheat would be given to the poor to feed themselves during winter and spring or when crops failedl. The village chieftain would decide with the most distinguished heads of households who would have the right to use the wheat.

In former times the state was usually not blamed for poverty, and it was not responsible for fighting poverty. The common belief was that it depended on the person himself whether he would be a poor or a rich man and that his success in life basically depended on his own efforts. Thus Čedomilj Mijatović advised the young that they would best succeed in life if they stuck to traditional virtues, such as honesty, diligence and thrift (1892).

2. Scope of Poverty in Serbia

2.1. Definition of Poverty and Basic Poverty Indicators

In this section, poverty in Serbia is analysed on the basis of the Survey on the Living Standard of the Population (SLSP) that was carried out in May – June 2002 on the territory of Serbia (without Kosovo and Metohija). The main sample comprised 6,386 households or 19,725 persons. This is the largest and the most comprehensive survey on living standards carried out up to now in Serbia.42 In this section poverty is primarily observed as insufficient consumption, while other sections look at the multi-dimensional phenomenon of poverty relying on all available empirical and qualitative analyses.

In 2002, poverty in Serbia was for the first time defined by using household consumption as the main aggregate in poverty measurement.43

The poverty line was defined in two steps. In the first step the food poverty line was defined as the line of absolute poverty on the basis of a minimum consumer food basket and the minimum average daily calorie intake. This was based on the consumption structure from the Survey on the Living Standard of the Population (SLSP) and adjusted to the nutritional recommendations of the FAO (Food and Agriculture Organization), a daily average of 2,288 calories.44 The minimum consumer basket for a four-member45 household, defined according to regular standards, amounted to 7,605 dinars a month. The second step defined the complete poverty line that, as well as expenditures on food, included also expenditures on other things (clothes and shoes, hygiene and household goods, transportation, health, and education). It was defined as the total consumption of those households whose food consumption equals the minimum consumer basket. In that way the poverty line of 4,489 dinars by consumer unit was defined. Consumer unit allows for the differences in consumption of adults and children as well as for shared household costs.46 Thus every individual whose monthly consumption by consumer unit is below 4,489 dinars is considered poor. About 10.6% of the population of Serbia or 800,000 individuals were below this poverty line in 2002, because their consumption by consumer unit was on average less than 4,489 dinars or 72 USD.47 a month, i.e. 2.4 USD a day (Table 1). The SLSP analyses show that the depth and severity of poverty are not high and that is consistent with the fact that inequality in income distribution in Serbia is not high.48.

Table 1.

Poverty Indicators in Serbia in 2002

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Source: SLSP 2002.

Distribution of population in Serbia in 2002. according to the level of consumption per consumer unit

Citation: IMF Staff Country Reports 2004, 120; 10.5089/9781451833539.002.A003

However, the concentration of population around the poverty line is high. Just a small shift of the poverty line upwards significantly increases the percentage of the poor. Consequently, the population group situated just above the poverty line is at risk of poverty, under the influence of external shocks, such as macroeconomic instability, job losses as a result of transitional economic reforms, etc. Because of that, the population situated just above the poverty line was also analysed since a small fall in real earnings and other revenues or the growth of real unemployment, could significantly increase the share of the poor in the coming period. For that reason, it is considered that the 20% of the population with consumption on average less than 5,507 dinars a month, is at risk of falling below the poverty line.49

The SLSP shows that in 2002, about 800,000 people in Serbia were poor and about 1.6 million were at risk of falling below the poverty line. Observed by households, 10.3% or about 250,000 households in Serbia lived in poverty, and 19.5% or about 474,000 households were at risk of falling below the poverty line.

The picture of poverty in Serbia is even more sombre than this suggests, since the data discussed do not include all the refugees and internally displaced persons who are more affected and vulnerable than those with permanent residence in Serbia. Figure 1 illustrates this, showing clearly that refugees and internally displaced persons who are included in the SLSP are at much greater risk of poverty50 than Serbian citizens. It is also necessary to mention that this survey does not include either Roma or the 25,000 people living in collective centres, who certainly belong to the most vulnerable group.

Figure 1.
Figure 1.

- Relative Poverty Risk of Refugees and Internally Displaced Persons in Serbia in 2002.

Citation: IMF Staff Country Reports 2004, 120; 10.5089/9781451833539.002.A003

Source: SLSP 2002.

Arising from all these aspects, a rough estimate indicates that around a million people in Serbia are below the poverty line and more than two million are at risk.

Poverty in Serbia has become a rural phenomenon, as in the majority of other transition countries.51 This can be explained by the fact that the growth of employees’ earning and pensions in real terms, which represent a dominant source of income of the population in the urban areas, was relatively higher than the growth of other income sources. The other causal factor concerns difficulties in trying to encourage modern institutional practices in areas with a prevalence of traditional cultural patterns. The rural population was significantly poorer than the urban population since the poverty index of the rural population was almost twice as high as the poverty index of the urban population, while their relative poverty risk was about one third higher than the average of the total population. The depth (gap) and severity of poverty in rural areas was also higher than in urban areas. If the population at risk of falling below the poverty line is observed, it can be noted that the difference between the urban and rural population and the depth of their poverty are smaller.

2.2. Poverty Trends

Comparison of the level of poverty in 2002 with previous years. In order to form an adequate picture of the trend of poverty over a longer period, poverty in 2002 was measured in relation to income, since poverty surveys from 1995 to 2000 were also based on household income due to a lack of adequate information on consumption. For the sake of comparability, household income was defined in the same manner as previously. For the same reason the poverty line was established on the basis of the FBS consumer basket, as in former studies on poverty. The line was set at 3,560 dinars per consumer unit. HBS (Household Budget Survey) consumer units were applied to SLSP data. In this way, all three elements needed for the poverty trend analysis were made comparable. This did not, however, eliminate differences inherent in the data sources themselves (SLSP and HBS), namely, the differences in the sample and the questionnaire.52 This is why a comparison of poverty in 2002 with previous years can only be used as an indication of possible tendencies.

Despite these methodological limitations, there are certain indications that poverty in Serbia has been reduced, since 14.5% of the population was poor according to their incomes in 2002, compared to more than a third of the population in 2000 (Table 2). The real growth in GDP, wages, pensions and other income has stimulated the growth of household income (and consumption) and a decrease in poverty. However, although the share of the poor in the total population has fallen, they need much more income to reach the poverty line. That means that the poor were much poorer on average than two years previously, and poorer than in 1995.

Table 2.

Changes in poverty levels in relation to income in the period 1995-2002

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Note: The revenues of the population are defined in a comparable way for the observed period and expressed in terms of consumer units from the Household Budget Survey (HBS). The Consumer Basket defined by the Federal Bureau of Statistics was used as the poverty line for the whole period observed (1995-2002).The data for 1995 refer to the Federal Republic of Yugoslavia according to: Posarac, S.: Human Development Report Yugoslavia (1997), while for the period 2000-2002, they refer to Serbia without Kosovo and Metohija.Source: HBS for the period 1995-2000, SLSP for 2002.

Who is Poor?

- Historical Outline-

Classical poverty when one starves to death because one literally has nothing to eat or when an individual is not capable of providing for mere existence was very, very rare in the country of Serbia. Serbia was never a country in which people died from hunger; it has rather been a “paradise for a poor man” (Herbert Vivian, 1897).

There are many documents, starting from the Old Testament, that speak about poverty, the poor and their protection, but there are usually no concrete data on who is considered to be poor, where the line that divides the poor from others is and what it consists of. However, in the Byzantine document Prochiron (reference law), published in Constantinople in the 9th century, it is stated who is considered to be poor and thus not eligible to be a witness: “a poor man does not give testimony, and poor is the one who does not have property of fifty small coins.” This is one of the first documents that define the poverty line by monetary value.

At a later date, it was again property that served as a line that reflected poverty status. Thus Prince Miloš Obrenović, asking in 1837 that taxes “should not be difficult for the poor”, considered poor the one “who is really poor, who is honourable and diligent but has no land, the one who has children or is made poor in some other honourable way.” He freed from direct taxes poor people with small children, who had no land but had to feed their families by working as day labourers. So, not having land was for Miloš the necessary but not sufficient condition to consider someone to be poor; the additional condition was that he/she had small children.

From the above examples it can be seen that the line dividing the poor and non-poor was defined by having or not having land or property.

2.3. Regional Component of Poverty

The region with the largest share of the poor is Southeast Serbia, particularly in its rural areas. Rural areas of Southeast Serbia are twice as vulnerable to the risk of poverty compared to the average of the entire population, while the population of urban areas is in a much better position since their poverty risk is almost at the average level. Not only is the rural population of Southeast Serbia the poorest, but also poverty in that region is the deepest and most severe. Western Serbia is the next region with an above average poverty risk, particularly the rural areas in which the poverty risk is higher than the population average by more than a third (+35.8%). The depth and severity of poverty in the rural parts of Western Serbia are also greater than the average. The data lead to the conclusion that the population of the rural areas of Southeast and Western Serbia are the most vulnerable. It represents 14% of the entire population and one quarter of the total number of the poor. One of the reasons for such an unfavourable picture in these two rural areas of Serbia should certainly be sought, among other things, in the much larger share of elderly, one-person and two-member households that were significantly poorer than other households. When the category of the vulnerable is considered, a very similar picture of regional distribution of poverty is obtained.

2.4. The Most Vulnerable Categories of the Population

Gender aspects of poverty. Poverty was approximately equally distributed between men and women since the percentage of poor men and women is almost identical (see Annex). Accordingly, the structure of the entire population by gender represents at the same time the gender structure of the poor population. The situation is the same among the vulnerable. This means that economic discrimination against women (see Anex, Table A1) was not manifested among the poorest population (the average consumption of women below the poverty line was the same as the average consumption of men). However, a number of other indicators (see Annex) point to the unfavourable economic and overall position of women.

Observed by age, the elderly (65+) were the poorest. Their poverty risk was 40% higher than the population average, and the depth of their poverty was also much greater than the average (Annex). They represented 17.7% of the total population and almost a quarter of the total number of the poor. Pensioners made up the largest share in the category of old persons (69%), particularly in urban areas, while other groups had smaller shares: supported persons (22%), agricultural workers (7%) and others (2%).

In considering poverty among pensioners, it is noteworthy that agricultural pensioners, particularly in rural areas, were much more affected than other pensioners, having a poverty risk twice as high as the general population average and facing significantly deeper and more severe poverty compared to other pensioners. Their situation worsens the overall picture of poverty among pensioners since their pensions are extremely low and were very much in arrears.

Children and poverty. The next category with an above average poverty risk is that of children. 12.7% of the population in this age group were poor, and their relative poverty risk was 20% higher than the population average. However, the share of children of this age group in the poor population is much lower than the share of the elderly, reaching 10.3%. Although children do not represent a significant proportion of the poor (because of their low share in the total population), their poverty was relatively deep in comparison to other age groups. The distribution of the share of the population at risk of falling below the poverty line in the total population according to age does not differ from the age distribution of the poverty index.

Poverty was more present in households without children than in households with children (Annex).53 The poverty risk in households without children was above average (+8.5%), and they made up more than two thirds of the poor. The depth and severity of their poverty was close to the average. Observed according to the household size, the most affected were households of five and more members (poverty risk of +26.3%), while observed according to household composition, poverty was most present among single-person and two-member elderly households.

The most affected were elderly two-member households since their poverty risk was almost two thirds higher than the general population average.54 They made up 12.2% of the total number of poor households, and the depth and severity of their poverty was much greater than the average.

Finally, it is necessary to point out that the categories of households that were most exposed to poverty correspond to those whose economic and material situation was the worst (population at risk of falling below the poverty line).

Link between educational level and poverty. It is easy to draw the conclusion that the share of the poor falls with the rise in educational level. People who are at greatest risk of poverty are primary school dropouts. The poverty risk in the case of these people was twice as high as the general population average and the depth and severity of poverty was significantly greater than in the case of people with higher educational levels.

Highly educated persons (college and university level) were not subject to the risk of poverty as their poverty risk was below average. Only 2.9% of college graduates and 2% of those with a university degree were poor. Such a distribution of poverty related to education level demonstrates that education pays off, since it is rewarded by the labour market. A very similar picture can be seen when the category of the vulnerable are observed by educational level.

Table A3 in the Annex shows poverty by social and economic status according to self-declaration. The poverty indicators differ significantly according to socio-economic status and the type of settlement.

Among participants appearing in the formal labour market, the unemployed were at greatest risk of poverty (59.4% higher than the population average), and also of the deepest and most severe poverty. Individuals employed in the formal labour market had a below-average risk of poverty. When observed according to type of settlement, the unemployed in the rural areas were the most vulnerable, since their poverty risk was twice as high as the general population average or 39.4% higher than the average of the rural population. In contrast, those formally employed in urban areas whose poverty index was more than two times lower than the population average and 38.6% lower than the average of the urban population were in the most favourable economic position.

On the basis of these results, we can conclude that the categories of population in Serbia who are at greatest risk of poverty are:

  • 1. The uneducated;

  • 2. Unemployed and supported persons;

  • 3. Elderly people (65+) and children;

  • 4. Households with five and more members;

  • 5. Elderly single-person and two-member households, particularly in rural areas;

  • 6. Agricultural pensioners, particularly in rural areas;

  • 7. The population of rural areas of Southeast and Western Serbia;

  • 8. In addition, various research and other analyses show that Roma, internally displaced persons and refugees, as well as persons with disabilities, belong to the vulnerable groups exposed to the highest poverty risk.

2.5. Income/Consumption Inequality

2.5.1. Basic Income/Consumption Inequality Indicators in Serbia in 2002

Basic income and consumption inequality indicators are shown in Table 3. The Gini coefficient, based on per capita consumption and on the consumer unit, reached the value of 30, while it was somewhat higher when calculated for income.55 The Decile Relationship shows that the consumption by consumer unit of the poorest person in the last decile was 6.7 times higher than that of the richest person in the first decile.

Table 3.

Basic Inequality Indicators in Serbia in 2002.

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Source: Branko Milanovič, Poverty in Serbia in 2002, Ministry of Social Affairs.

Income inequality in 2002, measured by the Gini coefficient, increased compared with the two previous years (Table 4) by about 6 Gini points (both per capita and by the consumer unit).56

Table 4.

Income Inequality in Serbia in the period 2000 - 2002.

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Source: HBS 2000 and SLSP 2002.

Income inequality in Serbia corresponds approximately to the average value of the Gini coefficient for the group of selected transition countries (Table 5). In comparison twith the countries of the former Yugoslavia, income inequality in Serbia is between the levels in Bosnia and Herzegovina, Macedonia and Slovenia, on the one hand, and Croatia, on the other. The value of the Gini coefficient in Serbia, equalling 33, is situated within the value span of these countries which range between 26 and 36.

Table 5

Comparison between inequality of incomes in Serbia and selected East European countries (countries are ranked according to the Gini coefficient, on per capita basis)

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Note: For Bosnia, Croatia and Byelorussia - incomes without imputed rent.Source: Branko Milanović, Poverty in Serbia in 2002, Ministry of Social Affairs.

In comparison with other countries in transition, inequality in Serbia is somewhere between the values recorded in the Central European countries that have an inequality level below 30, and the Republics of the former Soviet Union (Estonia and Russia - close to 40).

2.5.2. Breakdown of Income/Consumption Inequalities

Labour earnings are the most important source of total income (45.5%) and represent the largest share in total income inequality (47% or 15 Gini points57). After labour earnings, a smaller share in total income is attributable to pensions (16.3%), natural consumption (12.8%) and incomes originating from agricultural property (11.4%). Pensions and natural consumption are characterized by lower inequality than total income, and their share in total inequality amounts to 12.7% and 11% respectively or 5.3 and 3.5 Gini points. Income from agriculture has a relatively high concentration index (46.1), so that it accounts for 16.5% of total inequality. Other income sources contribute to a far lesser extent to total inequality.

2.6. Transfers necessary for raising the consumption level of the poor

Under the assumption of perfect targeting, and of the Government opting for the provision of (passive) social assistance to the poor as the only measure, it would have been necessary to provide 9.1 billion dinars (Table 6) or 1% of GDP58 (not including administrative costs of payment of assistance) in order to eradicate poverty in Serbia in 2002. This is in addition to the amount of assistance already provided to the poor through material support to families (MOP). Since the assumption of perfect targeting is unrealistic, the actual funds necessary for the elimination of poverty might be several times higher than this minimum amount. If the targeting of social assistance to the poor were 70%-60%, it would be necessary to provide between 11.8 and 12.7 billion dinars for the elimination of basic poverty.59

Table 6.

Passive transfers necessary for raising the consumption of the poor population to the poverty line level

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Source: SLSP 2002.

However, a permanent solution to the problem of poverty in Serbia, as defined by the PRSP, requires an active and multi-dimensional response to this challenge, not a passive one.

It follows that the calculation of the minimum financial resources necessary for the elimination of basic poverty must include a wider range of measures including health care and educational measures, incentives for raising income and the employment rate, the creation of a favourable environment for entrepreneurship and private sector development, and proactive social support and social inclusion of vulnerable groups.

3. The influence of economic growth on poverty reduction

The projections of the poverty trend until the year 2010 are based on the assumption that inequality between spending and GDP growth in real terms of 5% per year will remain unchanged.60 During the period, personal consumption, which is directly linked to the dynamics of poverty, would rise on average 1.9% a year in real terms (see section 1.3.1 on macroeconomic projections). During the first sub-period (2003 – 2006) real growth of personal consumption would be somewhat slower (1.4%) compared to the second sub-period (2.3% from 2007 to 2010). Such growth of personal consumption by 2006, with no change in inequality, would reduce the poverty rate by 20%, while the percentage of the vulnerable would drop by 18% (Table 7). The fall in the poverty rate would be accompanied by an improvement in the depth of poverty. A rapid rise in personal consumption in the second sub-period would accelerate poverty reduction. Thus the percentage of the poor and the population at risk of falling below the poverty line in 2010 would be almost halved compared to 2002, under the assumption of unchanged inequality.

Table 7.

Projections of poverty in Serbia 2003-2010

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Note: Consumption inequality remains unchanged.Source: SLSP 2002

The graph below shows the possibility of a considerable decrease in poverty (from 10.6% in 2002 to 6.5% in 2010) with the assumption of an average annual growth in GDP of 4.5% and the growth of personal consumption of 1.9% a year, as well as the set of scenarios for the less ambitious growth of personal consumption of 1% a year.


Poverty projections according to different trends of personal consumption and inequality coefficient

Citation: IMF Staff Country Reports 2004, 120; 10.5089/9781451833539.002.A003

The graph displays three basic scenarios of inequality of consumption and two scenarios of growth of personal consumption (1% and 1.9% a year). The first scenario of inequality exhibits no changes in the Gini coefficient of inequality (at the level of 0.31) in the period observed. The second predicts a moderate rise in the Gini coefficient to 0.34 in 2010; at 1.9% annual growth in personal consumption the level of poverty is 8.6%. The third predicts a drop in the coefficient to 0.28 in 2010; at 1.9% annual growth in personal consumption the level of poverty is 5.2%. The second set of scenarios predicts a less optimistic rise in personal consumption – at zero change in inequality the poverty rate in 2010 is 7.8%; at a rise in inequality of 1.2% a year, the rate is 10.8% and if inequality falls by 1.4% a year the poverty rate in 2010 will be 6.5%.

The assumption of unchanged inequality means that the poor benefit from economic growth in the same way as the average population. If the inequality in consumption dropped in the period observed, at the same rate of average growth of personal consumption of 1.9% a year, the alleviation of poverty would exceed that exhibited in Table 7. This means that the poor would benefit more from economic growth than the average population. On the other hand, a rise in inequality with the same rate of consumption growth would lead to a rise in poverty in Serbia.


1. Macroeconomic Framework and Factors of Sustainable Economic Growth

Although a multidimensional definition of poverty has been used, the level of consumption is still a critical factor for determining the poor and the vulnerable. Because of this, increased consumption by the poor will reduce poverty, but also positively influence economic growth.

Because total national consumption is an important element of total production (GDP), consumption by the poor will probably increase with the growth of production as long as inequality in society does not increase, and the foreign, domestic and debt balances remain the same. In other words, economic growth will, under these conditions, ensure economic opportunities for the poor, in the form of employment or increased income, which will enable them to overcome poverty.

Achieving internal and foreign economic balance (getting the fiscal and balance of payments deficit under control) is not only a condition for the poor to benefit from economic growth. It is also a precondition for achieving sustainable economic growth, while a loss of control would lead to macroeconomic instability and would have a negative effect on economic growth.

1.1. Macroeconomic Policy

During 2001-2002 macroeconomic stability was established and basic structural reforms were initiated. This is a firm base for the continuation of the reforms and establishing medium-term growth as a framework for poverty reduction. Macroeconomic policy was directed towards the removal of the basic misbalance and towards creating the basis for medium-term sustainable macroeconomic stability. Complete price liberalisation (except for infrastructure service prices) was introduced.

Monetary policy was directed towards controlling inflation which arose as a result of price liberalisation, and after that as a result of correcting price disparities and changes within the tax system. The money supply followed strong re-monetization and it was created mainly through foreign currency inflow. Only a small amount of currency emission was used to cover the fiscal deficit. The price liberalisation set foreign currency exchange rates at the market level, the flexible exchange rate was introduced, as well as convertibility on current transactions (Article VIII, IMF). By the NB policy, the nominal exchange rate was kept at a constant level during the last two and a half years, which led to considerable real appreciation of the Dinar.

One of the consequences of the real appreciation of the Dinar is that salaries have increased in Euros. On one hand, this lowered the competitiveness of the economy and on the other hand, it increased the purchasing power of the population in buying imported products. All this obviously had an averagely good influence on the rich, but at the same time just a small effect on improvement of the status of the poor.

With the price liberalisation policy, one of the main sources of the inherited quasi-fiscal deficit was corrected. The prices of infrastructural services were increased, so now they mainly cover direct costs of production. The electricity price was increased four times and has reached the sum of 4 cents per kWh, which covers operating expenses. The price which will enable the Serbian power generation economy to work normally is 4.5 cents per kWh. A significant correction of the utility service price was also achieved. The correction of price disparity is a significant condition for medium-term sustainable macroeconomic stability, because it decreases public expenditures on direct and hidden subsidies. Establishing price parity of infrastructure services is significant for rational resource usage and for achieving sustainable medium-term growth. On the one hand these measures had a negative effect on the poor, but on the other hand they released budgetary resources, which enabled the government to increase the level of direct support through better targeted programmes such as social protection and pensions.

Fiscal policy was interwoven with fiscal reform, and their goal was to enable necessary adjustments and public revenue and expenditure reform, and to create the necessary institutions. The basic measures in that direction were the introduction of a single sales tax rate (20%), and so called gross salaries as a tax base. The single sales tax rate contributed to the removal of arbitrariness. Its introduction represents a good base for the planned introduction of value added tax in 2004.

During 2002-2003, because of the negative effects of these measures on the poor, the Government annulled sales tax on some of the most important food articles and communal services.

Gross salaries now include the total income of employees (lunch, vacation bonus, etc.) as a base to determine taxation and incomes, so the actual labour costs were stated, and labour taxes according to sectors were balanced. In the medium term, this measure should lead to better labour allocation and to the restructuring of inefficient sectors, which should encourage sustainable growth. In the short term, it had a negative effect on employees in non-productive sectors (textile etc.), because most of their low salaries were gained through items which were not previously included in the tax base

The basic changes in public expenditures were directed towards better management of expenditures (introduction of the non-budget items into the budget, explicit budgeting of subsidies, defining fund deficits and providing budgetary transfers to cover them, etc.), providing regular payments (including pensions) and the reduction of payment arrears (social assistance), introducing the transition fund to support the people most affected by the reforms, larger increases in salaries in the education and health sectors compared to the public sector in general, etc. Most of these measures improved the status of vulnerable groups.

1.2. Basic Macroeconomic Indicators

The following macroeconomic indicators should determine the relative position of Serbia regarding development and poverty, its macroeconomic performance during the first two years of stabilization and finally its initial position for future medium-term growth.

There are two basic factors which determine the level of poverty in a country: the spending p.c. (per capita) level and inequality in distribution. The spending level is closely linked to the level of the gross domestic product (GDP) p.c. defined according to purchasing power, while inequality in distribution is measured by the Gini coefficient.

Since there are no estimates of GDP by purchasing power in Serbia, GDP according to the current exchange rate will be used. See Table 1.

Table 1
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The unemployment rate is determined according to data from the Employment Bureau.

The GDP p.c. is the same as in Romania and Bulgaria, but is less than half that in Croatia and Hungary. The next indicators of spending are average salaries and pensions: salaries are higher than in Bulgaria and Romania, probably pensions as well because they are connected to salaries.

In spite of macroeconomic stabilization and the commencement of the reforms, during the first two years of transition the Serbian economy recorded significant GDP growth (Table 2), even if the high growth of agriculture in 2001 is excluded. The transitional recession affected only industry, which after the period of inactivity in 2001, began to grow in 2002.

Table 2% in
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This suggests that transitional recession should not be expected in future reforms, and it seems that Serbia can follow the path of sustainable growth. It is obvious that the major production decrease in the 1990s and the accompanying low level of capacity usage caused the already very low level of production to fall to the minimum.

A very high real increase of average salaries was also recorded. Part of the increase was caused by the increase in unemployment (see Table 1), which excludes people with very low salaries. In addition we must take into account the effects of the decrease in contributions on salaries of 10% which turned into a rise in net salaries. Finally, mistakes in registering salaries happen very often, taking into account that the system of salaries that did not include benefits (for public transport, lunch bonus etc) was supplanted by the system which does includes them. In the light of all this, previous official data certainly overestimate the real rise in salaries. But a real salary increase does exist, which means an improved status of employees. The above-mentioned average salary increase in foreign currency, should be also included.

After the price liberalisation at the beginning of the programme, and after correcting price disparity, inflation was brought under control, so its further medium-term decrease is possible.

In 2001 and 2002 there were relatively high growth rates together with a drop in employment, which, at first sight, seems paradoxical. This is mainly due to the fact that those who lost their jobs had hardly been working at all.

In the medium term, the sustainability of stabilization that has been achieved can be valued on the analysis of internal (basically fiscal) and economic trade imbalance. The review of basic indicators is given in Table 3.

Table 3
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Public revenue and expenditure represent consolidated values in the Serbian territory; this includes the Republic, Federal, and local communities’ budgets and funds. In 2001, there were already plans for significant fiscal adjustments with a deficit of approximately 3.5%. The actual deficit was less than half of that (1.5%), primarily due to the postponement of expenditures related to the servicing of foreign debt and the support of reforms. The result for Serbia was an unrealistically low level of public expenditures (39.5%). The total amount of public expenditures appeared in 2002, and it increased public spending to 46.1% of GDP, which represents a large sum for an economy in transition (see Table 7).

The fiscal deficit remained fairly moderate (3.6%) and by the standards of the EBRD represents a moderate risk. On the other hand, the existence of a relatively significant primary deficit (deficit that does not include interest payments for public debt servicing) presents a risk of unsustainable increases in public debt. Therefore, the primary deficit should basically be covered by non-credit resources (privatisation, donor funds and income from issued money), in order to prevent the explosion of debt. The public debt is very large (92.5%), and for the most part it represents foreign currency debt: old foreign currency savings and foreign debt.

It follows that mid-term fiscal sustainability does not leave room for the increase of public spending in GDP, and requires that fiscal deficit be financed mainly from privatisation. This would enable a decrease in public debt to a sustainable level and, along with the expected moderate fiscal deficit, lead to medium-term internal sustainability, with low inflation.

Serbia’s external economic position looks critical for the maintenance of medium-term macroeconomic stability. The current balance of payments deficit is high for both years (see Table 3). In 2002 the deficit equalled 12% of GDP, which in the medium term would be hard to maintain and falls into the critical zone according to the basic criteria of the EBRD. The main cause of the large deficit is the very low level of exports, which is now at half the level of Serbian exports in 1990; or between one third to one half of Bulgarian or Croatian exports relatively speaking (in terms of GDP) (see Table 8).

The foreign debt in comparison to GDP is fairly high, but not critically large (the borderline is 80%). However, with a high current balance of payments deficit and its coverage with new loans, the foreign debt could become unsustainable.

Therefore, a critical problem with medium-term macroeconomic sustainability is represented by the size of the current balance of payments deficit and its financing. This refers to the crucial role of export growth and foreign direct investment. The large real appreciation of the Dinar and the consequently high level of labour costs expressed in foreign currency certainly do not aid exports or foreign investment.

Finally, medium-term growth will crucially depend on the rates of investment. Serbia achieved very low levels of investment in 2001 and 2002, almost half that of the other economies compared to (see Table 1). Therefore, to achieve the desired growth, it is necessary to provide conditions for a significant increase in rates of investment within the Serbian economy.

1.3. Medium-term sustainable growth

The analysis of sustainable growth should provide a consistent macroeconomic framework for the medium term, and examine the sustainability and risk of the projected growth, and the determinants that define its size.

1.3.1. Macroeconomic projections and their sustainability
Rise in production, investments and savings

Keeping in mind the expected rate of growth of the real GDP of 4–5%, the medium-term macroeconomic implications are now considered.

The following Table projects the trends of the nominal GDP in Serbia and its possible structure.

Table 4.

- GDP and its structure

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Total spending (domestic demand): personal, public and investment, is larger than GDP for the sum of the export and import of goods and services deficit. This spending must be decreased over a period of time so as to provide foreign economic sustainability, i.e. to decrease the balance of the goods and services deficit. The basic structural change aimed at involves the relationship between personal spending and investment. The rate of investment should significantly increase in the medium term, from 14% to 25% of GDP, and in that way attain a level comparable to the countries in transition (see Table 1). This requires a relative decrease in personal spending (to 71%) and a decrease in material expenditures for public spending (to 15%) of three percent. Consequently, personal spending should realistically grow at an annual rate of 1.8%, and public spending at the rate of 2.2%, which is considerably lower than GDP growth.

The relationship between the share of economic (private) and public investments in fixed capital can be appraised based on the well-known structure of investment in 2002: from a total of 14% investments in GDP, 12.1% make up fixed fund investments, and from that 10.1% are economic (private), and 2% public investments.

In view of the fact that investments are financed by domestic savings and foreign influxes, domestic savings can be estimated by taking away the current balance deficit (meaning the influx of foreign resources) from the investment.

Table 5.

– Domestic savings


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It follows that for sustainable medium-term growth it is necessary for the Serbian economy to achieve a higher level of investment supported by a large increase in domestic savings. With regained confidence in the financial and banking sector, the transfer of domestic savings will be initiated as well as the transfer of money currently engaged in the grey economy into the formal economy. This is a precondition for achieving the projected rise in domestic savings.

Mid-term Internal Balance: Fiscal Projections

The medium-term internal balance is decisively determined by fiscal sustainability. Medium-term fiscal projections are given in Table 6.

Table 6.%GDP
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The projections take into account the above-mentioned imbalance. The share of consolidated public revenues in Serbia in GDP should decrease by 1.3 percentage points, to 41.2% in 2010. Public expenditures should drop by 3% down to 43.1% of GDP at the end of the period61. Consolidated revenue and expenditures in the medium term are acceptable in relative terms.

The fiscal deficit falls from 3.7% to 2% of GDP which is modest and acceptable. The primary deficit is eliminated in the medium term, although it is not negligible until 2006. The fiscal deficit is principally financed from the privatisation income projected at 2% to 3% of GDP. Since the incomes exceed the primary deficit, the share of public debt in GDP is considerably reduced to the level of 47% at the end of the period.

A comparative survey of public revenues, expenditures and deficits, displayed in Table 7, shows that the medium-term fiscal projections discussed above are reasonable.

Table 7.%GDP
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The risks involved in medium-term fiscal sustainability are primarily tied to the projected income from privatisation and its use for the coverage of the deficit. That is, in the event that the primary deficit is covered by a new debt, this would lead to a non-sustainable growth of public debt. Preliminary research indicates that projected income from privatisation is achievable.

Another risk originates from the question whether or not it is possible to maintain the scope of public spending within the projected framework. Aggregate comparisons between the initial state in 2002 and the confirmed budget for 2003 on the one side, and international comparisons on the other, suggest that that is possible. However, this should be confirmed by a more detailed analysis of public expenditures in Chapter II. The projected level of public income is achievable.

Medium-term external balance of payments equilibrium

It has already been pointed out that the basic macroeconomic imbalance in Serbia’s economy represents a large deficit in the current foreign balance of payments, caused by the disproportionally low level of exports. The projections of the current deficit have previously been used for calculating the amount of domestic savings. The sustainability of the projections is now discussed.

Table 8.%BDP
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A very high current deficit remains until 2006, and 10% of GDP (EBRD) can be taken as a critical limit of medium-term sustainability. Apart from the extent of the deficit, the length of its sustained existence also poses a risk.

Financing the projected current deficit should show whether it is sustainable to continuously produce a high deficit in the medium term. Sustainability demands that foreign direct investment should play a key role in financing the deficit. The share of such investment in GDP should range between 5% and 7%. In absolute amounts, these investments should range between 1.3 billion to 1.6 billion USD a year.

A high share of foreign direct investment is necessary to maintain the flow of loans for financing the deficit at an acceptable level in relation to the sustainability of the foreign debt. The projected debt for financing the current deficit thus drops from 4% to 1% of GDP.

All this makes the foreign debt sustainable. That is, the share of foreign debt in GDP falls from 66% to 51% (the critical level is 80%), while the debt servicing rate amounts to 20% at most (the critical value being 25%). This, of course, is possible since two thirds of the debt was written off by the Paris Club. It is also expected that debts to the London Club, and to Russia, China and others will be successfully reprogrammed, and this was taken into account in the above assessment.

1.4. Sustainability of projected economic growth: sources of growth

The previously outlined medium-term macroeconomic projections are based on the assumption of 5% real growth. A significantly lower rate would bring high risks because some basic factors, like the servicing of foreign debt and public spending, are almost independent of the scope of production. Therefore, slower growth of production would mean proportionally larger public expenditures and a higher fiscal deficit on the one hand, and a larger rate of foreign debt servicing on the other.

The latest projections of the IMF (July, 2003) basically assume the same rate of growth as does this analysis. A growth rate of 4% in 2004 and 4.5% in 2005 is predicted. Although our projections are given for a growth rate of 5%, they would in fact be sustainable for every rate between 4% and 5%. Two other important elements of the macroeconomic framework, external sector and fiscal, are also basically consistent with these two analyses.

In the following part of the document, we shall discuss how realistic the projected growth is in the wider context of the impact of the reforms on growth, based on the accumulated experience of transitional economies, as well as the question of whether the projected macroeconomic framework can serve as a basis for the projected level of growth.

The growth survey in 13 European countries over the transition period (1989 to 2001) brings out three basic points relevant to the assessment of the medium-term growth rate in Serbia. In the first place, all the countries have gone through a sharp transitional recession with a significant fall in production. Secondly, after passing through the transitional recession, a certain number of countries were able to achieve continuous growth in production (Hungary, Poland, Slovakia, etc) while others (Bulgaria, Romania, Czech Republic, etc) have entered into yet another recession. Finally, the highest level of medium-term growth achieved is approximately 5%.

The Serbian economy recorded a larger fall in production during the 1990s than took place in the transitional countries being considered. With the start of stabilization and reforms Serbia achieved growth in production, while the recession was felt partly in industry (see Table 2). It follows that the economy has gone through transitional recession and that it can ascend onto the path of medium-term growth. A decisive element for the achievement of high medium-term growth is that the growth is continuous, that is to prevent either a balance of payments or an exchange rate crisis, i.e. a fiscal crisis that would tip the economy into recession.

Comprehensive econometric research of transition economies shows that basic determinants of their growth were: a low inflation rate, a decrease in public spending, and reforms. A decrease in the inflation rate, i.e. establishment of macroeconomic stability, led to the increase in the growth rate. The influence of public spending on growth is shown in the relative (in terms of GDP) size of the fiscal deficit, i.e. moderate public spending. It was confirmed that a larger fiscal deficit, i.e. relatively higher public spending, causes a decrease in the rate of growth. Finally, structural reforms led to the acceleration of growth. The degree of liberalization, the index of small and medium enterprise privatisation, private sector share in GDP etc. were used as reform indicators. Empirical research also explained the phenomenon of transitional recession: reforms at first lead to a decrease in the growth rate, and later to its increase.

Based on the correlations for the sample set of transition economies, it is possible roughly to project the potential growth rate of Serbia’s economy, bearing in mind the previously stated presuppositions on macroeconomic stabilization and public spending (Table 6), as well as on the corresponding dynamics of reforms. Since the largest part of the fiscal deficit will be financed from privatisation income, while only a small part will be covered by loans, i.e. non-inflationary sources, it follows that the inflation rate can be significantly reduced from 19% in 2002 (Table 2) to 5% after 2005. The reform dynamics are planned in such a way as to achieve the level of “weaker” EU membership candidates in 2006. Such dynamics of fiscal and macroeconomic adjustment on the one hand and of structural reforms on the other show, on the basis of the experience of other transitional economies, that medium-term average growth in Serbia of 5% a year is ambitious but feasible.

Public investments in infrastructure

A part of the total investments, which are to support medium-term growth, are public investments. They are only a small part of overall investment, but apart from their direct impact on growth in production, they also have an indirect effect through creating a favourable environment for investment and growth in production. The share of capital expenditure in the public expenditure of Serbia is low. Therefore, above-average growth is planned for the medium-term period. There should be a relative increase from 2% to 4% in the share of GDP, thus achieving a level comparable to international standards.

It is estimated that around one third of the overall investment62 in Serbia in the period 2004–2006 will be directed to infrastructure (transport, energy, telecommunications, postal service, utility infrastructure). These investments will be financed from:

  • Resources of the enterprises in the above-mentioned sectors (their own resources and commercial loans),

  • Budgetary resources (republic and local budgets), and

  • Expected donor funds and soft loans.

It is estimated that the entire necessary resources for investing in telecommunications and the postal service will be provided from commercial sources (national and borrowed). Modernization and construction in other infrastructure activities will to a great extent depend on budgetary resources, donor funds and soft loans.

According to the assessments, the allocations from budgetary resources (republic and local budgets) for infrastructure (transport, energy and utilities) and housing in the next three years will amount to 2% of GDP on average, which equals around two thirds of the overall budgetary investments. Apart from infrastructure, some 1% of GDP will be allocated from budgetary resources for health care, education, public administration, and security.

The resources of enterprises from these sectors, as well as budgetary resources, are not sufficient investments, and the financial performance of enterprises and of the state do not allow for borrowing under commercial terms. The decrease in donor funding and soft loans would considerably slow down the investments, which would in turn hinder the modernization of these sectors. Besides infrastructure, housing also requires soft loans. Such loans would have multiple positive impacts on economic activity and employment. The share of donor funding and soft loans amounts to some 20% of the overall infrastructure investments.

Foreign direct investments

Foreign direct investments are the crucial element for sustainable medium-term growth. They directly contribute to the growth of production, and they make it possible to establish external and partly internal balances in the medium term. Thus, in the previous projections foreign direct investments are the main source for covering the current balance of payments deficit. They also generate large growth in exports, as shown in the experience of transitional economies. A significant growth in exports and financing of the current balance are the main planks of the medium-term foreign economic sustainability of Serbia. Foreign direct investments, through tender privatisation, will represent a significant source of fiscal deficit coverage, which will contribute to the establishment of the internal balance in the medium term.

Table 9.

- Cumulative foreign direct investment (FDI) per capita (USD)

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Cumulative FDI p.c. for Serbia and Montenegro pertains to the period 1997-2010.

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Cumulative FDI p.c. for Serbia and Montenegro pertains to the period 1997-2006.

The projected level of foreign direct investment, as already mentioned, is approximately 1.3 – 1.6 billion USD, that is, around 5–6% of GDP. In order to assess the amount of foreign investment, we compare cumulative values per capita for the preceding period (1989 – 2002) in advanced transitional states with the projections for Serbia and Montenegro (1997 – 2010). We also compare investment planned for Serbia and Montenegro until 2006 with total realized investment in less advanced transitional economies.

There is scope for many improvements in this area, taking into account the extremely low levels of Serbian exports. The projected considerable rise in exports from 19% of GDP to 35% in 2010 means, for example, that Serbian exports in 2006 should reach over 6 billion dollars, which roughly corresponds to the amount of exports achieved in 1990. Comparison with the neighbouring economies (Table 10) also shows that the planned rise in exports can be achieved and this, together with foreign direct investment, presents the main strategic option for Serbian economic development.

Table 10.%GDP
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2. Fiscal Limitations in Poverty Reduction Strategy Implementation


An effective public fiscal management process is critical for ensuring the success of PRSP implementation. In particular, the budget and fiscal management system should be the main tool through which public expenditure implications of PRSP policies are translated into budget activities.

2.1. Recent Trends in Fiscal Policy

Substantial fiscal adjustment has taken place in the last two years within the context of the stabilisation programme begun by the government in 2001. Fiscal adjustment involves redefining the role of government (away from being the direct producer of goods and services towards providing social security, investing in and maintaining economic infrastructure, and establishing a legislative and regulatory framework for private sector activity), incorporating all public sector expenditure into the budgetary process, reducing budgetary arrears and fiscal gaps in social insurance funds, as well as increasing revenue mobilisation.

The purpose of this fiscal adjustment has been to constrain the fiscal deficit. Subsidies to enterprises and capital investment have been reduced, whilst transfers to the population, in the form of social benefits, have increased in importance. Nonetheless, implicit subsidies to enterprises remain.

2.2. Recent Trends in Public Revenues

Consolidated public revenues in Serbia in 2002 reached the level of 42.7% of GDP which is somewhat higher than other countries in the region63. The share of consolidated public revenue in GDP in Serbia is probably somewhat over-stated due to the under-stating of GDP because of the incomplete inclusion of the private sector and the greater extent of the grey economy in relation to the comparison countries. Based on the share of the consolidated public revenues in GDP, one can conclude that the tax burden in Serbia, compared with other European transition countries, is moderate.64 With the exception of the contribution on salaries, one can make the same conclusion by comparing tax rates of other transition countries. The uniform sales tax rate is 20% (considering exemptions, the average weighted rate amounts to 16%-17%), the rate of the tax on salaries is 14%, and contributions on employee and employer’s salaries are 33.6%.

Within the structure of public revenue in Serbia, taxes and contributions on salaries dominate (approximately 15.5% of GDP) and consumption taxes (close to 15% of GDP). The share of corporate income taxes is substantially smaller than in other countries in transition.

In 2002 the share of public revenue in Serbia’s GDP increased by five percentage points compared to the 2001 level. The main generator of this growth in the share of public revenue is the increase in payments made, which is especially evident with sales tax and excise duties. In addition to the increase in the number of payments made, the abolition of discretional exemptions and reductions in the tax base for particular sectors and companies also contributed to the growth of public revenue share in GDP. The increase in the share of customs revenues, despite the significant decrease in customs rates, is a consequence of the increase in the value of import share in GDP as well as the increase in the share of consumer goods in the imports.

The planned fall in the share of public revenue in GDP in 2003 is a consequence of fiscal relief of the economy that was implemented in the second part of 2002, and above all else includes:

  • Significant decrease in tax rates on financial transactions and the exemption of loan transactions from payment of this tax;

  • Decrease in tax rates on gain from 20% to 14% and the introduction of significant incentives for investment and employment;

  • Expansion of exemptions from sales tax.

Furthermore in 2003 growth in the level of payment collection is expected, especially on retail sales tax, due to the introduction of the obligation to issue and receive bills as well as the introduction of fiscal cash registers.

Table 1.

Consolidated public revenues


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Recent Trends in Public Expenditures

The share of public expenditures in GDP in 2002 in Serbia closely corresponds to the level that successful countries in transition (Hungary, Czech Republic, Poland, Slovenia and Slovakia) had in the mid-nineties. Within the structure of public expenditure65 by economic classification the most significant share was that of pension expenditures and social programmes, as well as expenditure for salaries. In comparison to successful countries in transition Serbia had an above average share in expenditure related to earnings and pensions, while the share of expenditures related to interest rates and capital investment was below average.

The share of consolidated public expenditures in GDP in 2002 increased by 6.4 percentage points compared to the previous year. Observed from the point of view of economic classification, the main generators of growth of public spending are the increase in pensions, salaries, reconstruction costs and servicing of debts.66 In the case of pensions, the growth in share is the consequence of what is referred to as transferred growth67, while for salaries a significant factor is the slower growth of prices than projected (it was agreed with trade unions to increase salaries in accordance with the projected growth of prices).

Table 2.

Consolidated public expenditures – economic classification % GDP

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In comparison to other countries in transition, in 2002 Serbia had an above average share in expenditure for defence, while the education expenditure was below average68. Expenditures for health and social care are at the level of the average for the region.

Table 3.

Consolidated public expenditures - functional classification


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In the first two years of transition Serbia achieved a relatively low level of fiscal deficit in comparison to other countries at the beginning of transition. The low level of fiscal deficit in 2001 is a consequence mainly of the better collection of public revenue than planned and the absence of foreign debt servicing, while in 2002 the main cause of the low level of deficit is the commitment to solid fiscal policy, which creates a favourable base for macroeconomic stability and growth.

A slight increase in the deficit since 2001 has been facilitated by the increase in availability of external resources and receipts from the privatisation process. Nonetheless, government policy is to keep the deficit at or below 3% of GDP.

Table 4.

Total and primary fiscal deficit


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The total estimated domestic and foreign public debt at the end of 2002 was approximately 14.2 billion USD, which is 92.2% of GDP. This total includes the sum of the unregulated debts (London club, debts to other countries that are not a part of the Paris club as well as the total sum of foreign debt from the region of Kosovo and Metohija). It is estimated that, upon reprogramming, these debts will be partly written off whereupon the relation between the public debt and GDP will be 70-75%, depending on the reprogramming conditions. Furthermore economically consistent70 servicing of the obligations of debtors from the region of Kosovo and Metohija would additionally decrease the ratio between the public debt and GDP.

2.1.1 Impact of Recent fiscal Trends on Poverty

Total expenditures for the protection of the poor in Serbia equal approximately 4% of GDP, which is close to the average value for countries in transition. The most significant item of social protection, not including pensions, is the expenditures for child protection. Following that are the expenditures for taking care of those who lost their jobs during the process of restructuring (transition fund), and the expenditures for assistance to the unemployed and families living in poverty.

Table 5.

Expenditure for protection of the poor in Serbia


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1) This includes social expenditures at the federal level, at the level of local communities and the unemployment fund.

Changes in sales tax and income taxes during 2001 have had a direct impact on living standards and poverty.

The introduction of a uniform sales tax rate at the beginning of 2001 caused a one time increase in prices of basic vital products that were previously taxable at lower rates, which temporarily worsened the living standard of poorer classes. At the time that the uniform sales tax rate was introduced the only exemptions were for the purchase of bread and public utilities. The initial list of products that are free of sales tax was later expanded so that at the beginning of 2003 this tax exemption list included basic food products, utilities, basic medicine, etc.

At the introduction of Value Added Tax (VAT) in the first half of 2004, a decision will be made on the number of VAT rates (one or several rates, a uniform rate with exemptions for a certain number of products etc).

Decreases in taxes and contributions on salaries by ten percentage points had directly allowed an increase in average salaries by approximately 10% along with unchanged expenditures on work units. The growth of average salaries due to the decrease in fiscal burdens on salaries on average had more than compensated for the increase of expenditures because of the transfer to a uniform sales tax rate.

The beginning of state debt servicing toward the population (old foreign currency savings, large debt to pensioners) contributes to the alleviation of poverty. The relevance of government debt servicing toward the population is noticeable through the fact that in 2003 the total payments for this purpose will be approximately 1.7% of GDP. The social implications of public debt servicing are especially important due to the fact that a significant part of these debts are paid off to the poorer and older part of the population.

In the period 2004-2005 the third tax reform phase should be carried out, with the purpose of harmonizing the tax system of Serbia with tax systems of EU member countries.

2.3 Medium-Term Expenditure Framework

The Government’s medium-term fiscal policy is to maintain fiscal stability through further fiscal tightening, ensuring better use of existing resources, increasing revenue mobilisation, and providing tax incentives and other reform measures designed to stimulate business activity.

The medium-term fiscal parameters are intended to be based on the Ministry of Finance’s medium-term budgetary framework, set out in the Budget Memorandum which was approved in June 2003. These included, for the first time, sectoral expenditure ceilings for the 2004–2006 period, consistent with a realistic overall resource framework, within which sector ministries are expected to contain their budget requests.

The main objectives for the setting of the basic MTEF fiscal parameters for the medium term include:

  • Lower recurrent spending to make more room for greater investment provision.

  • Ensure no arrears and settle any existing arrears.

  • Tax relief (expanding the list of vital products and services exempted from the sales tax).

  • Tax relief to stimulate investment.

  • Decrease subventions.

  • Faster real increases in wages for priority sectors.

It is necessary for the level of public expenditure within the medium-term period to be defined in a way that supports71 the implementation of the most significant macroeconomic goals - fast growth and economic stability. This implies lower tax rates to encourage domestic and foreign investors. Low taxes and a sustainable deficit imply a level of consolidated fiscal expenditures that could in the medium term, at best, reach the level of the regional average. More precisely, the medium-term framework should provide for the realisation of long-term sustainable fiscal policy and state solvency. State solvency is usually expressed through the condition that the discount value of future primary surpluses be larger or equal to current values of the public debt. Fulfilling this condition practically means that gradual decreases in the primary deficit and its transfer into the zone of positive values (primary surplus) must necessary be planned within the framework of medium-term projections72.

The decrease in the share of the public debt to less than 60% of GDP represents an indication that long-term fiscal sustainability is secured. With the assumption that the existing debt toward the London Club and government creditors is written off to a significant extent and that the question of debt for the region of Kosovo and Metohija be solved in an appropriate manner, the public debt in the second part of this decade would fall below 60% of GDP. The realization of revenue from privatisation of 2–3% of GDP, would allow for the larger part of the fiscal deficit to be covered by non-credit resources in the next couple of years, primarily from privatisation revenue. Considering that foreign and domestic debts will be rapidly paid off within that time period, this would allow for the decrease in the absolute level of public debt.

The medium term fiscal framework includes the expected and planned changes in the structure of public spending. Changes in the structure of public spending are partly exogenously given. For example, adopting a Law on Domestic Public Debt Servicing (old foreign currency savings, Jugoskandik, Dafiment) as well as signing the agreement on reprogramming with foreign creditors as a whole defines the expenditures on the basis of current public debt servicing. Other changes reflect the priority changes (decrease in military share and increase in the share of education and capital investment in GDP), increase in productivity in the public non-profit sector (decrease in the share of labour costs in GDP), coordination of rights with economic possibilities and population (pensions), and progress in privatisation and economic restructuring (subsidy and restructuring expenditures). In some cases the contribution of specific sectors in GDP will remain fairly steady but within the future period there will be intensive changes within the sector itself. This is, for example, the case with health care whose total expenditures, financed by the state will increase by the same rate as GDP, but there will be significant changes within the sector that will result in better quality service and higher productivity (rationalization of institutional network, reducing number of employees, better equipment).

Basic changes within the structure of public expenditures considered from the point of view of economic classification are relative decreases in the share of salaries, pensions, subsidies, restructuring expenditures and social protection, and the increase in the share of capital investments and the expenditures related to public debt servicing.

Table 6.

Consolidated public expenditures - economic classification


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With reference to the points outlined above it seems that the implementation of sustainable fiscal policy (low tax rates, low fiscal deficit, decrease of the ratio between GDP and public debt, larger expenditures for education, etc.) requires a gradual reduction of public expenditure intended for the social protection of the poor.

The reduction of social protection expenditure share in GDP in 2006 compared to 2003 would amount to 0.4 percentage points. Considering the estimated growth of GDP by 4-5% in the period 2003-2006, the above-mentioned reduction of expenditure for social protection implies its real growth at the rate of 1.4% annually. Given that the most important rights within social protection are index-linked to the cost of living, the expenditure for social protection per beneficiary would remain unchanged in real terms. The increasing of the expenditure amount along with a constant level of expenditure per beneficiary (other conditions remaining unchanged) enable the growth in the number of beneficiaries (vulnerable groups identified in the Poverty Reduction Strategy), that is, the introduction of new types of social protection. The expected gradual reduction of transitional forms of social protection (transition fund, severance payments) makes additional room for new beneficiaries, that is, new types of social welfare. Regarding economic purposes of expenditures for Poverty Reduction Strategy implementation, the dynamics of pension expenditures are relevant. The plan is to cut the share of pension expenditures in GDP by 0.5 percentage points by 2006. The basic assumption that this plan is based on is that the average pensions will grow in real terms by 2.5% annually, while GDP will grow by 5%. To achieve this it is necessary to provide the appropriate pension indexation rule.

Changes in the structure of public spending according to functional classification include the decrease in the share of expenditures for defence, social expenditures and the growth of the share of expenditures for economic issues, education, health care and public services.

Concerning the implementation of the Poverty Reduction Strategy, changes in health care and education expenditure are relevant. According to the plan, by 2006 the share of health care expenditure in GDP will increase by 0.2 percentage points, while education expenditure will increase by 0.4 percentage points. Taking into account the projected growth of GDP of 5% annually, health care expenditure growth in real terms would amount to an average of 6.3% annually, while growth in education expenditure would amount to 8.6%. However, in terms of optimization of public expenditure and the reform of these sectors, the change of expenditure structure within them is decisive. The expenditure structure change means in the first place that average salaries grow in real terms as fast as GDP (that is 4–5% annually), and, on the other side, that total labour costs grow more slowly than GDP because of the necessary reduction in the workforce.73 In addition to the control of the real increase in salaries, it is necessary to make significant rationalizations of the network of health care and educational institutions. Fast real growth of the level of public expenditure for education and the school system, along with strict control of labour costs and rationalization of the network of health care and educational institutions would enable significant growth in expenditure intended for implementation of reforms and improvement of equipment in institutions in health care and education. All of the above-mentioned changes would result in improved quality of and better access to services in education and the school system.

Table 7.

Consolidated public expenditures-functional classification


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Table 8.

Revenues, expenditures and deficit


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The implementation of the outlined scope and structure of public spending involves a number of risks and uncertainties. The uncertainties are related to the non-existence of the officially adopted reform programmes for some of the main spenders of budget resources: health, education, defence, and internal security. There is also a significant portion of existing foreign debts (London club, debts toward Russia, China, Kuwait, Libya, etc.), that is not regulated and as a result the conditions of their servicing are still not known.

The basic risks in the implementation of a sustainable level of public spending are related to the following:

  • Slower average GDP growth rate than projected,

  • Significant one-off devaluation of the currency exchange rate,

  • Significantly smaller influx of foreign investments than projected and lower income from the privatisation process,

  • Expansion of potential government obligations based on the loans for reconstruction and restoration of the infrastructure,

  • Impositions for war damages.

Some of these risks are interconnected so that with their appearance together a large number of negative scenarios could develop. For example, the low level of foreign investments combined with small amount of revenue from privatisation could generate economic stagnation with preserved stability or alternating periods of growth and recession.

2.4. Fiscal reforms

Sustained fiscal stability will be made possible only by the continuation of the process of fiscal reforms. The Government initiated the process of fiscal reform in order to improve the use of scarce public resources and ensure that Serbia’s public finance system is suited to a modern and efficient public service within a market economy. Measures undertaken have included:

  • Adoption of a modern Law on the Budget System based on international best practice, covering: (i) budget comprehensiveness; (ii) the introduction of a strategic budget phase in the overall process (prior to the start of the annual budget process); (iii) requirement for budgetary parameters to be medium-term in nature; (iv) strengthening of the functional/programme-related classification to facilitate the link between policies and budgets;

  • Specification of a longer budget calendar which allows more time for analysis and scrutiny by Parliament;

  • Adoption of Law on Public Procurement and formation of Public Procurement Agency;

  • Implementation of wide-ranging tax reforms, including rationalisation of tax structure and improvements in tax administration;

  • Improved budget format, based on an international standard classification structure;

  • Reform of the payments system, including introduction of Treasury system;

  • Better budget reporting required to Parliament and introduction of external audit of the budget;

  • Stricter Parliamentary review of the financial plans for the extra-budgetary social Funds.

Thus, the budget system is introducing more rigorous professional and political verification of demands made by the budget users, as well as better correlation between the plans for spending and accepted social and macroeconomic goals. In the phase of budget implementation and plans for social insurance funds, the application of regulations decreases the possibility of abuse and waste of resources. The application of the law on public procurement introduces competition into the buying of goods and services, which, with the given expenditures, secures better supply and quality of services. The application of this law is especially important from the point of view of social protection because it secures better quality services in health and education within the given level of expenditures.

The Government is committed to undertaking further fiscal reforms in order to ensure sustained fiscal and macro stability and to facilitate implementation of the PRSP.

  • Further payment reforms, including expansion of Treasury operations;

  • Strengthen tax administration, including establishing regional Large Tax Payers office and preparing for the introduction of VAT, improved tax audits and introduction of self-assessment;

  • Continuation of tax reform measures including: (i) abolishing a large number of taxes that are unfavourable in terms of allocation, lack transparency, and impose high administrative requirements whilst at the same time failing to generate significant fiscal yields, e.g. financial operations tax; (ii) simplifying direct taxes, such as the income tax; (iii) increasing receipt of periodic property taxes and abolishing taxes on securities; and (iv) abolishing significant numbers of compensations and replacing them by appropriate taxes.

  • Improve budget formulation, including: (i) introducing/strengthening a Medium-Term Expenditure Framework (MTEF) based on a comprehensive resource framework and three-year sectoral ceilings; and (ii) undertaking resource allocation reviews

  • Other public expenditure reforms, including: adopting a new Pension Law to introduce more appropriate indexation of benefits and increasing the retirement age

As is discussed below, the budget should be the main mechanism through which the priorities of the PRSP are translated into funded activities. This will require development of the explicit link between budgets and policies/activities at the sector level. In particular, sector ministries will need to restructure their budgets by: (i) undertaking a strategic policy review/analysis for each sector and sub-sector, setting out the key policy objectives and priority policies for the sector/sub-sector; (ii) carrying out a detailed review of key expenditure programmes within sectors/sub-sectors, including a comprehensive analysis of the activities currently supported by budgetary resources; (iii) identifying measures to improve efficiency of resource use; and (iv) strengthening capacities for budget analysis and planning.

3. Transition to a market economy

3.1. Establishing conditions for private sector development

3.1.1. Reform and Economic Growth

Theoretical and empirical research has shown that there is a significant link between reform and economic growth. The nature of the link between these two phenomena is such, that radical and all-inclusive reform aimed at the creation of an integral market (creating a real market economy) is a precondition for rapid economic growth. The key to this is that all-inclusive reform creates a business environment which is attractive for private capital investment, especially for foreign direct investment.

There are two important types of reforms:

  • The first includes economic policy reforms which will facilitate the development of the market economy, encourage efficiency in resource allocation and attract new private investment, both domestic and foreign.

  • The second is institutional reform, which should create new and stable rules of the game and lead to their consistent and unbiased enforcement.

In short, this institutional reform should lead to the creation of market and democratic institutions and should also establish the rule of law. All this leads to the reduction of transaction costs, especially in capital transactions. If this takes place in Serbia, more new private direct investments (especially foreign) may be expected.

The link between reform and economic growth, and thus the link between reform and poverty is of key importance for overcoming poverty. That is why it is important to answer the question of the sources of political incentives for the initiation, formulation and implementation of reforms. The political economy of reform considers different configurations of political forces (for and against reforms) as well as their political and reform outcomes.

The existence of different political forces is natural and expected. Reform measures are not neutral, there are both winners and losers, and individual welfare is also influenced. Along with the changes of phases within reform, the roles of winners and losers also change – those who profited from the first phase of the reform may become losers in the second phase. There are at least two types of losers. The first type are influential losers and the second are the ones who are not (usually the poor). From this point of view, one should be aware of the fact that powerful resources are available to the influential losers, which can be used to stop the reform at a level far from a fully-fledged market economy.

The experience of East European transition has shown that the biggest winners and advocates of reform are private entrepreneurs and the middle class and that maintaining the course of reform depends on the ability to create coalitions of interest within these two groups. However, this would not have been possible if social consensus and a new form of social solidarity had not been established – different from the statist and protectionist solidarity that existed under socialism. An important element of this new awareness, i.e. cohesion, was the resistance of East European countries to Soviet domination, which had not existed in FRY.

From the perspective of the political economy of the reform, compared to the situation in most East European countries, there are particular circumstances in Serbia. The problem is that some of the reforms were conducted during the 1990s, before democracy was established. Influenced by the impending collapse of the old (socialist) regime, they lacked a clear concept and a wish to create a fully-developed market economy. The real reform started with the democratic changes in October 2000. The most significant reform policies were based on the well processed experiences of East European countries in transition. The first phase of this reform, based on the reform of economic policies, has been carried out over the last two years.

The reform started by forming a large reform coalition, which in time began to crumble. However, regardless of all the pragmatism needed for the implementation of reforms within the limited resource framework, stable democracy is necessary for building mechanisms and institutions that will additionally advance and maintain the basic social consensus.

The recent events (since 12 March 2003) constitute a new political turning point for the reform in Serbia. The assassination of the Prime Minister and the government reaction that followed created new political incentives, removing the limitations on conducting a complete institutional reform and enabling the reform of the justice system, the introduction of the rule of law and a resolute fight against organised crime.

3.1.2. Privatisation and restructuring of the real sector

Privatisation of the Real Sector

The privatisation of the real sector in Serbia is being conducted by applying a model based on sales conducive to good corporate governance, with increased efficiency, attracting new investment. The model itself is relatively complex and requires a long period of preparation, not only for conducting the whole process but for every single transaction as well. Besides this model, privatisation of the real sector should include the completion of the privatisation of enterprises partially carried out under previous privatisation models.

Full privatisation, effected by creating concentrated private ownership, leads to the increase of enterprise efficiency, but very often at the cost of a lot of people losing their jobs. This consequence of privatisation has made government make quite strict demands on the “social programme” when applying the model for tenders, namely that investors provide for the surplus manpower. It is clear that such a demanding policy has shown negative results in attracting foreign investors, though it represented a good transitional model in terms of reaching a social consensus, so important for Serbia. Therefore the new policy (starting with the recent change of the Law on Privatisation), will not be so demanding.

Concerning the acceleration of the privatisation process in Serbia, with the fixed institutional costs being already borne (creation of legislation and constitution of institutions), an acceleration of the process may be expected, especially the acceleration in auctions. Over the next two years privatisation of the state-owned enterprises can be expected.

Restructuring of the Real Sector

According to the current privatisation programme, a number of large enterprises in Serbia (especially socially-owned holding companies), which have a long track record of financial losses, should be restructured prior to privatisation. It is estimated that restructuring is a precondition for successful privatisation through sales.

This type of restructuring means the fragmentation of such enterprises, in order to form a number of smaller enterprises. The basic idea is to create smaller enterprises with some business opportunities, which can be privatised, while the rest would be liquidated. Studies on the restructuring of large enterprises are being carried out, and it can be expected that, following the recommendations of these studies, pre-privatisation restructuring will be conducted in 2004. Since the restructuring is often linked to considerable political problems (risks) and manipulations, good programmes and persistent collective negotiations are needed to carry out this process successfully.

Short-term considerations show that restructuring will slow down the increase in production and cause decreases in employment. A large part of the unemployment which will be created is just hidden unemployment as shown by research on the informal economy and a number of employees of those enterprises are actually employed within the informal sector. The important thing is that, by the restructuring process, a healthy economic core is preserved and the reform dynamic accelerated. The long-term considerations show that liquidation of some of the existing enterprises, which are being restructured, will release resources (real capital in the first place) that can be used for new enterprises, especially small and medium, which will favourably influence economic growth and employment. In this way, the sections of the restructured enterprises with business opportunities will be able to make faster progress.

The new law on bankruptcy (to be adopted in the end of 2003) will significantly further the restructuring process by enabling the liquidation of enterprises which cannot be privatised due to the lack of business opportunities and accumulated debts.

3.1.3. Infrastructure and private sector growth

Infrastructure is a precondition for economic growth. Inadequate supply of infrastructure services discourages investment, thus lowering economic growth rates and, in turn, fostering poverty. The phenomenon can be observed both at the national level (national infrastructure systems such as telecommunications, the electrical power industry and highways) and at the local level, whether it is local branches of national infrastructure systems (such as local telecommunications networks) or public utility systems (such as water supply or heating).

Apart from an overall increase in the supply of infrastructure services, the problem can also be addressed by making the process itself more flexible, that is, by allowing for investor participation in the construction of the infrastructure network in keeping with his own needs. In addition, urban planning control of the realization of the investment needs to be more flexible in order to encourage investment.

The reform of infrastructure services, investment in them and the increase in their supply has, as has already been argued, a favourable direct and indirect impact on poverty alleviation. Moreover, construction work stemming from investment in infrastructure services increases the demand for unskilled (unemployed) labour, and the proportion of the poor in this group is above average.

The reform of infrastructure services in Serbia has just begun, so investment work so far has been mainly carried out on the renovation of existing infrastructure, financed from public resources. The reform requires a completely new legislature, new regulatory regime and specialized institutions to carry it out. So far these issues have not been given priority in the reform process in Serbia.

Reform in the area of infrastructure services allows for private investment, thereby raising their supply. Taking into account the low amount and poor quality of infrastructure services in Serbia together with the neglect they sustained during the 1990s, investment of private capital (probably mostly foreign) is the necessary precondition for their further development.

Pricing policy in the field of infrastructure services (electrical power and gas supply, water supply) is an important issue for the poor. In the case of electrical power, which is a key problem for them, it is suggested that all the prices should be increased through the reform of the tariff system to reflect the real (market) costs, while the poorest households should be granted subsidies, provided that they rationalize their consumption. At the same time, financial support for switching over to cheaper means of heating is envisaged74.

3.1.4. Reform and Development of the Financial and Capital Market

Financial Sector

Contemporary empirical research has shown that the development of the modern financial sector provides incentives for economic growth and enables a decrease in inequality in income distribution. This means that the development of the modern financial sector has a beneficial effect on poverty.

The inherited state of the banking sector in Serbia caused development to take place in two directions. One was bankruptcy and liquidation of the largest domestic insolvent banks. This was successfully accomplished and none of the predicted major problems occurred. The other was attracting foreign banks to establish new banks in our country. The entry of the foreign banks and the formation of completely new banks proceeded slowly. To some extent, this was because of the National Bank policy that insisted on the privatisation and possible take-over of the incumbent domestic banks.

Regardless of the results achieved, the supply of loans (under favourable conditions) for small and medium enterprises, i.e. small private entrepreneurs, is still modest. One of the causes is insufficiently developed mortgage legislation, which prevents the financial sector from obtaining solid security. This solid security would diminish investment risk, which would cause interest rates (risk dividend) to decrease. Adoption of the Law on Mortgage on Immovables entered into Registry, the Law on the Guarantee Fund, the Law on Financial Leasing, Law on Concession and their efficient application is very important for the further development of the financial sector and economic growth.

Capital Market

One of the basic preconditions for a fully operational market economy in Serbia is the creation of an efficient capital market. This means accelerated economic growth and a decrease in poverty. Creating an efficient institution of this kind enables efficient trade in stocks (securities), and efficient trade of property rights on capital. For the efficient allocation of capital as a factor of production, the protection of private property rights of a capital owner is crucial. This is also important for economic efficiency and dynamic economic growth. These two are the base for overcoming poverty.

It is also crucial that, as soon as possible, laws on investment funds and other laws regulating financial markets, as well as the new company law, should be enacted. These laws will enable better protection of capital owners (especially minority shareholders), and will improve corporate governance and capital investment.

3.1.5. Reform of the business environment

Establishing a conducive business environment

With the aim of improving and stabilising the business environment, the Government of Serbia initiated an ambitious legal and administrative reform (see Annex – The Report on Legislative Activities of the Government of the Republic of Serbia). The main principle of the present reform is to bring Serbian legislation in line with European legislation, creating at the same time an environment conducive for economic growth within the private sector. The key elements of these reforms are securing and attracting foreign investment, increasing local investment by removing legal and administrative obstacles to the establishment, registration and successful operation of businesses, including the simplification of the tax regime and inspection services. Full implementation of the Law on Public Procurement and adoption of the proposed set of anti-corruption and anti-trust laws are also important elements of this reform.

Foreign trade liberalization

Theoretical works and voluminous empirical research have shown that liberalisation of foreign trade leads to real income increases and the acceleration of economic growth, and it has a neutral effect on income distribution. That makes foreign trade liberalisation an important element of the strategy for overcoming poverty.

Foreign trade liberalisation in Serbia has stopped somewhere in the middle. After the initial reforms in 2000 and 2001, which led to the cancellation of non-tariff import barriers, lowering of the tariff rate, and simplification of the foreign trade transaction procedure, everything has come to a halt, so the rate of duties is still quite high. One of the causes was political pressure by certain domestic producers, whose low efficiency made it impossible for them to face import competition successfully. Further liberalisation may be expected during the process of foreign trade harmonisation between Serbia and Montenegro, i.e. the implementation of the harmonized Action Plan in the next two years, as well as in the process of joining the World Trade Organization which has been initiated. The effective liberalisation has also been achieved through numerous bilateral agreements on free trade zones with neighbouring countries as well as with other trading partners (such as the European Union, Russia, etc).

Foreign trade liberalization, i.e. the removal of export and import barriers, represents the key precondition for the establishment and strengthening of regional economic cooperation. This process commenced with the signing of bilateral free trade agreements, and it would be further strengthened by the creation of a regional customs union (probably by accession to the EU), which would make this region increasingly attractive for foreign direct investment and thus increase the rate of economic growth in Serbia.

Product Market

The most important reform of the Serbian product market is the introduction of new competition (antitrust) laws and the establishment of institutions to enforce these laws. This will enable the elimination of non-competitive market structures and behaviours (such as cartels), which will lower prices and increase the real income of all consumers, including the poor.

Labour Market

Institutional reforms of the labour market in Serbia should enable more efficient interaction of supply and demand for this factor. The first among the planned reforms is the reform of the Labour Market Office and the establishment of a network of employment agencies, which should improve information exchange. In the field of labour demand the timely circulation of information is very important, as well as the creation of incentives for employers to hire more people. In the field of labour supply, labour mobility and adjustment are crucial, that is, the unemployed should be encouraged to adjust to market needs.

The legal basis of this reform is a new Law on Employment (2003). After that comes the hard work of building institutions, especially creating the network of employment agencies. Strengthening the rule of law in the economic sector

The rule of law is an important precondition for the protection of private property rights and the supervision of the execution of contracts. Only in this way will conditions be created for private capital investment and the acceleration of economic growth. It is crucial that the rights of investors and creditors should be protected and not the rights of debtors. The present sluggish, inefficient, and even biased judiciary gives privileges to debtors rather than to creditors.

3.1.6. Reform of Public Finances and Poverty

Reform of the public finance system affects poverty in two ways. Direct effects are: the increase in the efficiency of income redistribution efficiency, so transfers to the poor are also more efficient, which reduces poverty. Indirect effects are the successfully reformed system of public finances and the policy of relatively low tax rates, i.e. low burdening of economic subjects, which are a significant part of an environment suitable for private capital investment. This increases economic growth as a basic precondition for overcoming poverty.

During the last two years in Serbia, some important moves have been made in the area of public finance reform, which were directed towards increased efficiency of revenue collection, controlled money flows and efficient management of public expenditures. In the field of revenues, sales tax rates were unified. In the field of expenditures, control of subsidies to large enterprises was established, and quasi fiscal deficits were eliminated.

All-inclusive institutional reform is still to be conducted, together with capacity building of the tax administration and the implementation of the radical tax reform, based primarily on the introduction of value added tax, as the basic form of indirect tax, which should generate significant fiscal revenue and reduce the scope of the grey (informal) economy. The acceleration of this reform will create an environment conducive to private investment, so that increases in the economic growth rate can be expected. This will certainly have positive effects on poverty reduction.

During 2003 the formulation of a radical tax reform that should introduce significant changes into public finances has been taking place in Serbia. The basic element of the reform is the introduction of the Value Added Tax that should substitute for the sales tax as of 1st January 2004. In addition, this tax reform is expected to abolish a great number of taxes that are unfavourable in terms of allocation, lack transparency, and impose high administrative requirements while at the same time failing to generate significant fiscal yields, as is the case with the financial operations tax. Direct taxes, such as income tax, will be simplified and become easily collectable. The new policies in the field of property tax will result in the increase of the receipt of periodic property taxes and the abolition of taxes on securities. Finally, a great number of compensations (typical fiscal mechanisms inherited from socialism) should be abolished and replaced by appropriate taxes. The aforesaid changes, together with other elements of tax reform in Serbia that have not been specifically mentioned here, will enable the creation of a modern tax system to stimulate economic growth and create conditions for poverty reduction in Serbia.

3.2. Building Strong Public Institutions

3.2.1. Public Administration
Present Status and challenges

The previous regime left Serbia with a legacy of politicised and fragmented administration, ill-suited to performing the framework-setting role that public administrations are expected to play in modern democracies.

With Serbia’s transition to a market economy, the role of the government sector has fundamentally changed from one of providing all economic and social services to that of:

  • ensuring an appropriate legislative and regulatory framework for economic activity, particularly by the private sector;

  • providing an enabling environment (e.g. through reducing unnecessary bureaucratic impediments) to facilitate the development of a vibrant private sector; and

  • either contracting or being the direct service provider in areas in which the market fails to produce the right level of services at a socially acceptable price (e.g. public health services).

The new role of the public sector should be focused on the delivery of key services as well as ensuring that the necessary framework is in place for the market to function in a satisfactory manner. This implies a close partnership between all stakeholders in society including all levels of government, the private and civil sector including the media, labour unions, employer associations, NGOs, etc. Such a government needs to be results-oriented, transparent and accountable with respect to both the delivery of services and the effective use of public resources. This implies the need to set clear standards within each area of public activities and establish continuous monitoring of the implementation of activities and projects.

The main goal of activities in the public sector is to meet citizens’ needs. This implies active participation by citizens in the process of design, implementation and monitoring of services. Therefore, there is a need to affirm the approach based on citizens’ needs.

Successful functioning of the system as a whole requires partnership and collaboration at all government levels (central and local), as well as teamwork. These relations imply strong decentralization of competences and finances, strengthening the rule of law by the state, the market model of the economy, and market principles.

A number of challenges face the public sector “central and line ministries and local administrations” in adapting to the needs of the market economy. These include:

  • Frequent changes at the top (ministry level) often lead to changes in the senior managerial ranks (e.g. assistant ministers / heads of sections and to a lesser extent department heads). It is difficult for senior management to propose and implement institutional reform if they (and their staff) do not know how long they will be in post.

  • High turnover of staff, which results in ministries and agencies being unable to hold on to key skills, particularly in new skill areas. Highly skilled staff, particularly senior policy and managerial staff, tend to be tempted away by the private sector, aid agencies or technical assistance projects to work as consultants.

  • There is a lack of appropriate technical skills to match the new roles required by market reforms. This shortage of skills is exacerbated by the high turnover of staff, where those with appropriate skills have tended to leave the public sector faster than other staff.

  • Demoralisation of staff, caused by low salaries, lack of resources to carry out the task at hand; no delegation of clear responsibility; lack of professional development and career opportunities, and frequent changes of senior staff. This is exacerbated by the lack of a functioning and neutral staff recruitment and promotion process.

  • Weak management in ministries and agencies, which tends to be dominated by a hierarchical and command-and-control approach and lack of transparency and coherence in decision-making processes. Poorly targeted staff training.

  • Ministry structures ill-suited to the needs of the public sector in a market economy. Over-emphasis on technical work and relatively limited attention paid to the development of policy and strategy.

  • Weak co-ordination of initiatives, projects and information flow within and across sectors, and between government agencies and ministries working within the same or related fields.

  • Weak central government co-ordination mechanisms, and limited capacity within the General Secretariat to support the leadership functions of the Prime Ministers and the Government in their collective efforts as a united body. This makes it demanding to co-ordinate, oversee and to ensure accountability.

  • Since it has been important to launch reforms quickly in many individual areas of the administration, adequate attention may not always have been given to how various measures would affect each other and their total effect. As a result, a large number of new bodies and agencies have been established in addition to the existing administrative structure, and it has not been restructured and adapted. Consequently, in some cases, this has resulted in more complex administrative structures.

  • Ensure an efficient and rapid implementation of new and revised legislation and thereby ensure a sufficient and clear institutionalisation of the reforms.

Goals and strategic directions

An efficient public administration reform is a key condition for the successful and rapid transition of Serbia to a modern society with a viable economy.

A well-organized and competent public administration is a key factor for a successful integration into the European Union. The SAp and the EIp are the single most vital catalyst for reform during the coming period due both to their importance and to the massive task of making all legislative and administrative procedures compatible with EU standards and the “acquis communautaire”.

In response to these challenges, the Government has begun a number of initiatives in recent years. In particular, a number of new laws have either been put in place or are being prepared in order to modernise the public administration, including, the Law on General Administrative Procedures, the Law on Administrative Disputes, the Law on Administrative Courts, the Law on Public Administration and the Law on Civil Servants. However, implementation of these laws is weak due to fragmentation of responsibilities and unclear leadership. As a result, a single strategy for the overall public administration reform in Serbia has not been adopted. Thus, there is a risk that some of aspects of the abovementioned laws will have to be revised if they are to be adopted before a strategy.

At the same time, a number of specific reform projects are taking place within some ministries, including the introduction of human resource management systems, the development of project management skills, the establishment of a change agent, and limited capacity building in ministries. However, these initiatives are not well co-ordinated and are not supported by the strengthening of central co-ordination mechanisms.

It is necessary to ensure the provision of a dynamic, efficient and transparent public administration which is well suited to the appropriate role of Government in a market economy and which will support the development of an active private sector through the provision of a transparent and accountable legislative and regulatory framework.

The strategy on public administration reform is being prepared, and includes the following elements:

  • Strengthening the central co-ordination mechanisms of the Government including the support function of the PM and the Government with the objective of facilitating the effective and efficient performance of the Government’s collective duties.

  • Improving the pay and grading system. This will involve changing the pay structure, rationalising and/or introducing the grading system and reducing the overall public sector wage bill.

  • Improving human resource management. This will include introducing transparent and merit-based systems of recruitment and promotion, review and appraisal. It will also include modern management structures and the development of staff training programmes. Strengthening public sector institutions is an integral part of the EU’s Stabilisation and Accession Process (SAP).

  • Improving the efficiency and relevance of ministries and agencies through restructuring and improvements in human capital development. These will follow functional reviews of institutions to identify the main aims and activities of each remaining ministry/agency, set out the appropriate structure which best meets these functions and the most suitable level of staffing and skill requirements, and identify efficiency measures.

  • Strengthening anti-corruption measures to improve the delivery of basic public services. This will involve regularising out-of-pocket payments for services through setting, monitoring and enforcing the list of such fees and charges. It will also involve gradual increases in the salary levels of key public sector workers, within the context of the overall reform of the public sector salary structure.

  • Improving communications within and across ministries and agencies through appropriate use of information technology.

  • Strengthening public procurement. Following the adoption of the Law on Public Procurement, there is the need to adopt supporting procurement systems and procedures.

  • Identifying a public administration reform champion. The establishment of a State Administration Reform Council within Government to act as a political/strategic decision-making is in progress.

  • Establishing the function of an ombudsperson to act on behalf of the public in relation to state institutions and public services.

3.2.2. Corruption and Poverty

The direct influence of corruption on poverty lies in the fact that public services, which should be a public good, become a paid service. The purchasing power of the poor is small so they are especially sensitive to the existence of corruption. They cannot afford expensive public services that should be free. In other words, corruption discriminates against the poor and has direct negative effects on poverty.

Corruption prevents the proper functioning of legally prescribed procedures for exercising rights, by enabling those who are well-off to exercise even rights they are not entitled to, while the poor, regardless of entitlement, are prevented from exercising their rights. Additionally, this weakens public trust in the impartiality and independence of government bodies, and blocks the operation of institutions.

The indirect effects of corruption on poverty are far more significant. In the first place, corruption does not only involve redistribution in favour of the person carrying it out, it also incurs its own costs since a corrupt deal calls for real resources. This inevitably leads to economic inefficacy (lowering the effectiveness of resource allocation), since it incurs considerable transaction costs. These are, in turn, transferred to end users which leads to rises in prices and falls in the purchasing power of all consumers, especially the poor.

Theoretical and empirical research has shown that corruption decelerates economic growth by lowering its rate, and dynamic economic growth is the precondition for overcoming poverty. The basic cause of this effect is in the fact that a higher level of corruption discourages foreign investors, and has a significant influence on the total amount of investment and the growth rate; this is especially true for developing countries and states in transition. Discouraging investment reduces the economic growth rate with considerable unfavourable effects on poverty.

Finally, a special kind of corruption is political corruption which leads to state capture. In such cases individuals misuse executive and legislative powers in a corrupt manner in order to influence policies and laws in keeping with their own private interests rather than the interests of society as a whole. Policies and laws adopted in this way actually hamper economic development and drastically increase poverty.

Although comparisons of the intensity and the extent of corruption across different states are methodologically questionable, it is certain that Serbia has inherited a high level of corruption from the period preceding the political change in October 2000. Among the main causes of corruption in Serbia can be listed strong and far-reaching state intervention as well as inadequate state administration, that is, under-qualified and underpaid state officials having broad discretionary powers in the application of regulations.

At the very beginning of its term of office (January 2001) the first democratic Serbian Government announced the fight against corruption to be one of its priorities, though over time the declared and the actual course of politics moved in different directions. This especially holds true for the operation of the Anticorruption Council as the principal body in the suppression of corruption as well as for the preparation of anticorruption laws. However, the state of emergency declared after the president’s assassination and energetic measures undertaken by the Government broke the main levers of organized crime and intensified the fight against corruption.

The non-governmental sector plays an important role in the suppression of corruption. As an example of this we can quote an action plan offered to the authorities by a non-governmental organization.

Action Plan

A successful anti-corruption struggle demands a comprehensive approach, consistent and sustained effort and energetic execution resting on predetermined responsibilities and regulations. The main elements of the anti-corruption programme are:

Source: CLDS: Corruption in Serbia, 2001
3.2.3. Judicial System and Justice

The state of emergency, established upon the assassination of the Prime Minister Zoran Ðinđić, provided certain political incentives and removed some obstacles to the reform process. However, it is important for reform not to relate only to the criminal judiciary, i.e. the fight against organized crime, which has naturally been given priority, but also to the civil procedure, i.e. those parts that are crucial for regular and unhindered performance of business activities.

The importance of the state being based on the rule of law entails the creation of a system of norms that would enable the establishment of modern state institutions, implementation of decentralization, protection of basic human rights and liberties, building of democratic relations and strengthening of the independence of judicial authority whose reform should be oriented towards higher professionalism, depoliticisation, strengthening of ethical codes and modernization.

Accessibility to justice is one of the key dimensions of social welfare and poverty reduction, and it has a strong impact on citizens’ satisfaction and their identification with the legal, political and social system. This area represents a big reservoir to draw on for the humanization of society and its democratisation, but is also an area of strong conflicts of interests and power. Many obstacles and much resistance can therefore be expected regarding reforms in this area.

The authoritarian regime which ruled by abusing rights has left as its legacy long-lasting disorder and the absence of the rule of law, it disrupted the principle of the hierarchy and subordination of legal acts, and promoted a proliferation of legal regulations and imprecise and conflicting legal norms and loopholes in the law, which created a wide area for arbitrary decision-making, for great discretion in evaluations and thus also for abuse.

Many holders of judicial functions and activities agreed to political intervention and influence, departing from the rules of the profession, and thus reducing the law to the position of servant to daily politics and the political interests of the authorities.

Such a state of affairs has provoked a deep crisis in the law and the principles of justice. Long-standing negative experiences of citizens related to corruption in this sphere, to different abuses of the law and numerous injustices, resulted in a loss of confidence that values of freedom, equality and justice are attainable. Such a state of injustice has led to the decline of citizens’ legal awareness. Citizens today have a poor knowledge of legal principles and procedures, they hardly know their rights and the methods and mechanisms they can use for exercising these rights.

The strategy of judicial system reform as a universal guarantor of constitutional values implies the adoption of the Constitution and positive laws in harmony with international standards by means of which the legal system is established and basic rights and liberties of citizens are protected, which indirectly means strengthening the principle of the rule of law. The reform includes separation of the judicial branch of authority from the legislative and executive branch, as well as strengthening the independence of judicial authority, raising the quality and effectiveness of the work of courts and other judicial bodies and the emancipation of the judicial professions. This would enable the exercise of rights guaranteed by international instruments that are linked to judicial procedure.

An important part of this reform is the protection of citizens by the Constitution and laws, modernization of the courts and simplification of the procedure, depoliticising of the work of the courts, professionalisation, and strengthening of the system of continuous professional training. Intensive training of judiciary representatives on the application of international norms would lead to the efficient implementation of these norms and improve public awareness of the significance of human rights.

Citizens become the focus of the judicial system and reform has to bring them improved access to courts, a rise in the quality and effectiveness of court proceedings, greater accessibility to justice, and sufficient scope for the evaluation of the performance of judicial bodies.. Range of judicial reforms

In early 2002 a set of five laws relating to the judiciary came into force, designed with the active participation of experts and with respect for professional knowledge, principles and standards, as well as European standards. These Laws are the following: the Law on the Court System, the Law on the Judiciary, the Law on the Judiciary High Council, the Law on Public Prosecution, and the Law on Headquarters and Areas of Courts and Public Prosecutors. These Laws have regulated all-important issues in a new way, providing the basis for demarcation between judicial and other spheres of authority, and thereby reinforcing the independence of the judiciary.

The Law on Courts determines the network of courts, their competences, organization, and modernization. Together with the Law on Ministries, this Law draws a line between judicial authority and executive and legislative authority. The Law on Courts increases the competence of first level courts in order to reduce the excessive work load of second level courts; it introduces the Court of Appeals and Administrative Tribunal, which represents a specific rationalization and modernization of the system.

These Laws adequately regulate the status of magistrates’ courts, which were abused for years as semi-court, semi-administrative bodies for restricting and threatening basic human liberties (including draconian punishment and persecution of the independent media, with arbitrary assessments by the magistrate judge on what “the truth” was, etc.).

In July 2002 the Law on Changes and Amendments to the Law on Judges was adopted. The Constitutional Court of the Republic of Serbia brought in a decision on the annulment of certain provisions of the Law; in March 2003 a new Law on Changes and Amendments to the Law on Judges was adopted, introducing partial changes to some of the questionable provisions (in accordance with the decision of Constitutional Court), while some provisions remained the same. Since in the field of legislation dealing with the organization and functioning of the judiciary some issues are not regulated, there is room for arbitrariness in the interpretation of norms and the assigning of excessive discretionary rights to the executive authorities compared to the judicial authorities.

Status, election, dismissal and establishment of judges’ accountability
  • The status of judges has been considerably strengthened and brought closer (although not made equal) to the status of parliamentarians or representatives of the executive authorities. The judges are guaranteed independence (real and material), job security (re-election is abolished and they are nominated for steady positions). The new Laws have highlighted the principle of the political neutrality of judges and emphasized the ban on their party membership and involvement.

  • The procedure for nominating presidents of courts and their deputies, judges, prosecutors and deputy prosecutors was set out, as well as the criteria and necessary qualities for their selection (expertise and worthiness), and it was put under the crucial influence of the legal profession. As in all developed states based on the rule of law, the right of candidacy was given to the High Judiciary Council as a body whose decisions guarantee the principles and criteria of expertise, since it consists of the most prominent judges, prosecutors, lawyers, experts and other representatives of the legal profession.

  • The control of their work, disciplinary measures and dismissal of judges are specified by new Laws and put under the dominant influence of the legal profession, to prevent abuses of this extraordinarily important Law by everyday politics, which often happened previously (with imprecisely regulated conditions for dismissal, great discretion and arbitrariness in appraisal, dismissal without legal basis or explanation, and application of shortened procedures for the dismissal of judges, etc.). The new Law introduced the Big Personal Council as an independent expert body consisting of 9 prominent judges from the Supreme Court; it is the main disciplinary body responsible for establishing the accountability of judges in respect of possible failings in performance and expertise, and to recommend adequate disciplinary measures.

  • Partial restructuring has been carried out in a large number of courts; a great number of judges have been dismissed or resigned, as well as a number of prosecutors, with a public debate on procedures and methods of implementation and concerns about possible abuses.

Working Conditions of Juridical Bodies

It is necessary to increase the independence of judicial authority in this sphere. The question arises regarding the conceptual place of the Prosecution and the Public Attorney’s Office in the system, their attitude towards the Courts, the Executive authority and the Police, as well as their role in legal proceedings (increased efficiency, quality and independence in work). Many analyses pointed to the Prosecutor’s Office as an operational bottleneck, which is exceptionally exposed to corruption.

The issue of greater material independence for the judiciary was also tackled making the judicial budget part of the state budget, with the active participation and greater influence of juridical bodies (High Judiciary Council) in determining its size in cooperation with the Ministry of Finance and the Government. Independent disposal of resources by juridical bodies will reduce the dependence of the judiciary on executive bodies that still have large competences in court financing, outlays, allotment of apartments, housing loans etc. Further steps

- Adopting the new Constitution, and the forms of decentralization and regionalization, will require organizational and actual adjustment of judicial authority, but it will at the same time provide the best basis for full reform. Some of the most important issues are: the protection of basic human rights and independence of the judiciary, guaranteed also by the signed international agreements and declarations, as well as ensuring constitutionality and the rule of law with elaboration of the place of the constitutional judiciary in the system.

- Further strengthening of the independence of the judicial authority branch, raising the status of judges to that of parliamentarians and representatives of executive authority, introducting a judicial budget as a guarantor of greater material independence of the judicial authority, promoting a continuous process of education and training, as well as improving sensitivity about social issues and problems. In this context, the issue of the relationship between the Ministry of Justice and the judicial system (place, role and competences) should be dealt with consistently with standards appropriate for a state governed by the rule of law and with an independent judiciary.

- Improving the quality, professionalism and working efficiency, strengthening openness of work, improving material and technical working conditions of juridical bodies, creating anticorruption programmes. Introducing information technology (e-government) for increased transparency and higher accessibility to justice: automatic movement of documents, creation of functional databases accessible to citizens through websites for all areas (so far only the registry of companies has been organized as a functional database) etc.

- Reforms should encompass the entirety of process laws that would enable modernization and rationalization of work in this area (civil procedure, penal code, bankruptcy act, company act etc.) and simplify and accelerate these processes, along with strengthening the principle of parties’ equality, banning discrimination in terms of the right to use one’s native tongue in the court procedure, respecting the right to legal remedy etc. In these areas the interests of different groups often collide and therefore strong resistance is expected.

- The reform should introduce new professions, such as: notary public, magistrate, judiciary police, court crier, bankruptcy commissioner, and ombudsman. Their introduction requires the existence of schools for these professions, as well as permanent education and training.

- The codification of professional ethics is an exceptionally important part of this reform. It implies professionalisation, strengthening of ethical codes, and different attitudes towards citizens and parties as service users. Measuring the quality of work of juridical bodies, the satisfaction of citizens regarding “accessibility to justice”, and continuous improvements to the quality and effectiveness of the work are important parts of this whole reform.

- Relations between the judiciary and citizens imply a restored public confidence in this branch of the authority. Cheap and easy access to the judiciary, the reduction and eradication of corruption, the control of the level of court fees (setting up the system of free-of-charge legal assistance) and exemption of socially vulnerable categories from payment of court fees (instituting rights for the poor) are some of the important principles of this reform. An important part of these processes is the continuous improvement in the public legal awareness along with disseminating knowledge about their rights and methods of exercising and protecting those rights.

3.2.4. Decentralization of Local Self-Government

The new Constitution of the Republic of Serbia is currently being prepared. It is expected that this process will result in the new distribution of competences between different levels of government (Republic of Serbia, potential regions, local government).

The Poverty Reduction Strategy project in Serbia cannot not be successfully implemented if the relationship of cooperation and partnership between the State and the local governments has not been established. The problems of poverty can be identified most easily in the local communities, while the poverty reduction programmes could be created in the best possible way on the basis of suggestions from citizens, local organizations and NGOs, including the most efficient way of implementing such projects. At the same time, it is very important for central government to be responsible for the promotion and development of mechanisms and activities oriented towards the poor at the national level, including sharing experience with local self-governments.

Local government authorities can establish more direct relations with the citizens, they can more easily move them and motivate them for the creation of private and public arrangements and partnerships, they can create an environment attractive for capital investment and for initiating different development projects These competences and functions of the local authorities are among their most important competences and give them the opportunity to be entrepreneurial. Current status

There is a general impression that adequate attention is not being paid to issues of social policy and poverty reduction in society, and concretely in municipalities, and also that there is no consistent strategy in this area.

The key legal framework meant to govern the operation of local government bodies is the Law on Local Self-Government enacted in February 2002, and the municipal charters in compliance with the above Law have been passed. This Law has just initiated decentralization, while the forthcoming constitutional reform is to create the normative basis for a further decentralization and a functional reform of all the governmental levels. The process of modernization, and strengthening the status and functional capacities of local government imply a new distribution of competences, and a new type of partnership among the various levels of government, new forms of coordination and the establishment of new financial arrangements, together with the strengthening of local government financial autonomy (fiscal federalism). Regulations on municipalities and other types of territorial organization, public administration, property, local finances etc. are a precondition of reform in this area.

Local Government Competences

The set of local government competences comprises all the key dimensions necessary to ensure the conditions for a better life for citizens. The new Law on Local Self-Government has expanded the scope of the original competences of local government, and it has precisely defined both the original competences and those newly entrusted to it. The significant original competences of municipalities include the provision of utility services such as the supply of water and gas, sewage, sanitation, collection and disposal of garbage, the traffic infrastructure and the road network, in addition to the areas of elementary education and primary health care, cultural institutions and activities, social services, sports, recreation, ecology and environmental protection and finally, stimulating economic development.

In the area of social care, to which the reduction and prevention of poverty belong, the municipal competencies have been transferred from the State to the municipal level, and such jobs are carried out under the supervision of State bodies. Moreover, the original competencies of a municipality include the provision of the expanded entitlements of citizens, and also the development of specific forms of social care and protection. Substantial economic problems reduce the opportunities for major activities in that area.

The above range of competencies makes the local level an important starting point in the implementation of the Poverty Reduction project. The process of decentralization and transfer of competences to the local community level has an additional impact in terms of raising the responsibility of municipal authorities in the realization of human rights.

Organizational Structure and Functions of a Municipality

The present organization of municipal authorities is a classical European assembly-mayor model, with strong elements of a system of unity of authority. The new Law on Local Self-Government, which will come into force on the occasion of the next local elections in 2004, provides for two new optional models of organization: the mayor-assembly model, and the assembly-manager model.

The following diagram illustrates the new organizational structure and relations among the most important bodies of a municipality.

The Law on Local Self-Government introduces the city manager, civic defender (ombudsman) and chief architect (urban planner) as new institutions. The city manager proposes projects that stimulate economic development, increase chances for entrepreneurship at micro level to become reality, with constant empowerment of entrepreneurial initiative and creation of private-public arrangements and partnerships. His job would also be to encourage and coordinate investments and to secure the attraction of capital, as well as to initiate amendments of regulations which make the realization of business initiatives difficult. The Civic Defender (Ombudsman) protects collective and individual rights and interests of citizens and represents an additional institution for strengthening citizens’ confidence in justice and the rule of law. Thereby necessary preconditions for the creation of an efficient control and monitoring mechanism are established. The job of the Chief Architect involves creation and control of construction standards and preserving urban spaces and their environment. These three institutes are optional and each municipality decides on a certain arrangement of authority, in conformity with its particular circumstances, assembly decision, statute and other acts.

In this way a certain organizational flexibility of the local government model is introduced, and the functioning of the entire institutional framework has been strengthened.

In many cases, municipal administration is still inefficient, with an inadequate qualification structure for public servants, poor equipment and outdated working methods. The new Law on Public Administration introduces its modernization.

Local Finances

Traditionally, the Serbian municipalities used to have their own property, but it was taken away from them and transferred to the state following the Property Law of 1995. This act has seriously jeopardized the position of the municipality as a legal and economic entity.

Legal regulation of municipal property is linked to the passing of a set of laws that should solve some open questions (restoration of dispossessed property to private persons and pubic entities, registration into cadastral registries, and so on), but any further postponement would leave municipalities dependent on the central government and would interfere with the very essence of reforms. Nevertheless, the new laws have helped the course of reform in several ways. The municipalities have been given several new taxes, a portion of tax funds has been redistributed in favour of the local governments, and the municipalities have been given an opportunity to raise loans, which has resulted in an almost doubling of local self-government revenues in the period 2001-2002.

Some 35% of the total municipal revenues originate from resources partly or totally controlled by local government, which represents a considerable share, compared to other countries in the region. However, in order to create a more efficient system of local government financing, existing local government revenues need further strengthening.

One of the major problems is that the system of local government financing is to a large extent based on part of the sales tax (30% comes from this source), because Serbia is obliged soon to substitute this tax with the Value Added Tax (VAT), in accordance with EU standards. Upon the introduction of this tax, the system of local government financing will have to undergo radical changes, because VAT cannot be allocated according to the place of collection (as was the case with sales tax).

Further steps towards reform would imply the restoration and protection of local government property, and a greater financial autonomy of local government with the right to establish tax rates. That would secure an opportunity to the local governments, by creating an attractive tax environment and providing services of a better quality, to attract capital and investment to their territories, and thus to encourage economic growth as one of the ways of resolving the problem of poverty. Another part of the reforms would mean the establishment and strengthening of the partnership between the central and local governments in the distribution of goods and financial resources, which is indirectly a part of efforts to establish a developmental model of decentralized market re-distribution.

Direct Democracy and Participation of Citizens

Regarding the immediate democratic institutions, the Law provides for a civic initiative, a citizens’ open meeting and a referendum. However, in reality, the level of citizens’ participation is very low: they have no information about most important municipal affairs, local authorities do not see citizens’ participation as a prerequisite for successful work, there is no transparency, and the scope for citizens’ influence is too limited, which leads to great apathy and passivity. Problems and Constraints

Due to the lack of a strategic approach at the macro level, a consistent strategy for poverty reduction does not exist at the municipal level either. The majority of municipalities have so far performed such jobs just mechanically as assignments transferred by the State, and without a greater involvement in developing strategic plans, or towards creating and implementing new projects and programmes. In practice, the municipalities have reacted only from time to time and temporarily in assisting the most urgent and difficult cases. Such a state of affairs has primarily resulted from poor economic capacities which do not allow effective and efficient resolution of the problem, but also from insufficient democratic awareness, institutional weaknesses etc.

The Role of the Self-Government in priority sectors of the PRSP

The municipal assembly is only to take over the role of leader and to initiate strategic, developmental, intersectoral work with other actors in the municipality, in several sectors: education, health care, the private sector, employers, labour unions, social welfare centres, labour market, Refugee Commissariat, NGOs etc. For the purpose of institutionalising sustainable strategic and intersectoral work more and more municipalities will establish socio-economic councils.

Social welfare and social assistance. The most significant implementers of social protection activities in municipalities are local governmental bodies, Social Welfare Centres, a certain number of social institutions, and the numerous humanitarian and non-governmental organisations.

A Social Welfare Centre is a municipal authority specifically established for the purpose of carrying out such assignments, and it is the main carrier and implementing agent of social policy at the municipal level. In the municipality, there is a number of typical humanitarian organizations (the Red Cross and others) and NGOs, which perform that type of activities. The Commissariat for Refugees and the Employment Bureau also collect some data, and carry out analyses that may be relevant in dealing with problems of poverty.

Education. Primary education falls within the new competences of local governments (provision of infrastructure and buildings, as well as foundation rights), for which local governments must prepare themselves. The new Law on Primary Education will specify the distribution of the competences and financing between the state and the local governments.

The most important stakeholders in the sphere of education are the municipal authorities (Assembly, executives bodies and the Secretariat for Education), as well as schools, professional educational organizations and NGOs dealing with educational issues. Users of services (students and parents) have an important place in the reform of the education system. It is thought that the introduction of a per capita financing system for schools would raise the quality of their work.

The new laws create the possibility for alternative school programmes.

Health Care. Primary health care is included in the new competences of local governments (provision of infrastructure and buildings), which entails allocation of funds for carrying out such activities. The current status is slightly improved, but only the new laws in this area will provide for a more specific distribution of competences among various levels of government, as well as the manner of financing (see chapter “Health Care Towards Poverty Reduction”).

Housing and Urban Development Planning. A substantial part of the municipalities in Serbia suffer from chaos in both urban and architectural planning, with non-registered buildings and a lack of planning. There is no accurate data on subtenants and a substantial number of citizens live in inadequate flats (in respect of both conditions and size). See chapter “Regional, Rural, Urban and Housing Aspects of Poverty”.

Local governments have certain operational advantages in identifying both problems and realistic objectives, and creating adequate housing programmes together with citizens. In the area of urban planning, the city urban planner could play a useful role in preventing illegal construction and introducing standards in developing the urban areas.

Functional Relationships

The relationship between the municipal and Republic authorities is satisfactory, but the information exchange from the Republic level to the local one is insufficiently effective and is inefficient. The practice of delivering information through political parties’ channels has not ended and the problem of symbiosis of the state and party (through their bureaucracies) should be raised as one of the obstacles to the implementation of reform processes and modernization.

The relationships between municipal authorities, services and organizations in this area are correct, but there is an evident problem of poor functional links among the actual and potential stakeholders. Furthermore, these relationships are burdened with all the weaknesses of the neglected local governments, such as offices poorly equipped for information technology, a discrepancy between the municipal by-laws and legislation, inadequate skills among the staff, outdated knowledge, a primary focus on political and party issues, too large an influence of individuals and informal lobbies on the decision-making process, poor monitoring of the implementation of projects and activities, as well as the slow implementation of decisions, levelling of remuneration and generally low salaries of staff, poor transparency of work, and a culture of exclusiveness and quite a low participation of citizens. The practice of measuring the efficiency of the work of municipal authorities has not been established at all, so introducing qualitative and quantitative indicators would contribute to improving the quality of work in that area.

The Resources, Human Resources and Equipment

The salaries, various services, equipment, and capital investments in buildings are financed out of the municipal budget, but the lack of financial resources needed for major projects is obvious.

The municipalities lack key experts, those who would deal with the strategy and the development, planning, decision making, organisation, coordinating and controlling of activities. Knowledge and skills are required in order to secure the municipality’s own income (private public partnerships), to create an environment attractive for investments (entrepreneurship, marketing and information sharing), and to include in the development all potentials of the citizens. The training of new personnel (city managers) is of exceptional importance. The existing personnel also require a comprehensive and continuing education in order to understand the nature of social phenomena and the interconnection of the problems to be resolved. Through this training they would be able to develop a greater creativity in their work.

In most cases, municipalities have at their disposal very modest technological equipment, the purchase of which is provided for out of the municipal budget, and all of them lack the means to create a network for a single information system.

The Participation of Citizens and the Local Community

Despite the recent changes and the fact that the current law foresees citizens’ participation in governance and decision-making processes, this is rarely implemented in practice. In the course of the previous 15 years, the autocratic regime caused all the democratic mechanisms of government to deteriorate substantially. Municipal officials and municipal administrations have not yet developed ways of increasing and improving the quality of citizens’ participation. Members of local assemblies and municipal authorities need to be educated on the ways to improve the dissemination of information and achieve higher transparency in their work. At the local elections votes are still predominantly given to political parties and less in response to the effects of the work of officials and their successes.

On the other hand, citizens rarely consider the municipality as a place and a mechanism whereby they could resolve their (in fact, general) problems. Consequently, citizens and municipal authorities remain distant and opposing parties, with separate needs and interests.

It is encouraging that in the majority of municipalities, the authorities have established good cooperation with non-governmental organizations by assisting them both financially and logistically in the implementation of various projects for poverty reduction or prevention, recognising in such projects both common and general interest.

3.3. Global and Regional Integration

3.3.1. European Integration

In addition to a greater degree of democratization, the European integration process represents a key factor for securing stablization in Serbia. Stability is a precondition for the increase in foreign investment and domestic savings, which are also the preconditions for economic development. The inclusion of Serbia in European institutions in the next decades will be a crucial step for further social, economic and political development. The Stabilization and Association Process

The European Commission for the so-called countries of the western Balkans (Albania, Bosnia and Herzegovina, FYR Macedonia, Croatia and Serbia and Montenegro) which are not in the first or the second group of countries to become full members of the EU, has created a stabilization and association process (SAP). This process should gradually prepare these countries for membership of the EU, and should give their governments political encouragement to cooperate with the Commission/Union. In other words, for Serbia and Montenegro (and others as well) the Stabilization and Association process is a first step towards full membership of the EU.

In Serbia and Montenegro, this process has begun with the establishment of a Consultative Task Force FRY-EU which, through a series of meetings in 2001 and 2002 and other activities on preparing the Stabilization and Association Agreement, enabled information exchange, adjustments of local policies and reform of local institutions. One of the results is the establishment of the Office for European Integration at the federal level, i.e. at the level of the state union, in 2001. Now a feasibility study is to be prepared. This study will provide an evaluation of the readiness of the country to begin negotiations in 2004 on the policies that will be part of the Stabilization and Association Agreement. The parts of the agreement on foreign trade liberalization and on opening EU market for the domestic products export are of greatest importance for economic growth and overcoming poverty.

The commencement of work on the Feasibility Study is conditional upon the adoption of the Action Plan for the harmonization of economic systems, i.e. foreign trade policies and regimes between Serbia and Montenegro, which practically boils down to the defining of an Action plan for the creation of a customs union.

The CARDS programme, led by the European Agency for Reconstruction, which encourages reform and transition, is also a part of the process of integration into the EU. Generally speaking, such help creates preconditions for economic growth, and improves it as a tool for overcoming poverty. The CARDS programme itself does not deal directly with poverty or its eradication, i.e. with some specific vulnerable groups, but as the reconstruction requirements decrease, the CARDS funds are progressively used for sustainable economic development.

The focus of the CARDS programme is on building institutions, strengthening administrative capacities, the judiciary and internal affairs, which will basically help create a credible business environment and thus encourage further investment and so have an indirect favourable effect on the suppression of poverty, either through the stimulation of economic growth and job creation or through increasing real revenue of the country and real budgetary funds for the fight against poverty. The European Commission and the member states also provide macro-financial assistance (MFA) in grants and loans for direct budgetary support. This help has the same effects on poverty as World Bank budgetary support by loans for structural adjustment. The first MFA instalment included and amount for payment of arrears to the European Investment Bank.

European integration plays an important role in the successful implementation of the Poverty Reduction Strategy. In the first place, the Stability Pact for South-East Europe will significantly help the process of the return of refugees, which will have a direct positive impact in one difficult area of the poverty issue in Serbia.

Secondly, the European Union in Copenhagen in 2002 and in Brussels in 2003 affirmed “the European perspective” of the West Balkan States, which opened the way for Serbia and Montenegro to take part in the programmes of the Community, especially in the areas of education, professional training and the so-called “twinning” programmes for the transfer of administrative capacities into the European Community. This would directly contribute to the achievement of Strategy objectives, partly through direct financial support for the education system and partly through creating a recognizable European business environment playing a key role both in attracting strategically important investors and in improving the level of security for small enterprises – two cornerstones on which the economic growth of newly accepted members of the European Community rests. To that end, it would be advisable for the creators of the economic policy of Serbia and Montenegro to adopt the principles of the European Charter on small business enterprises, to which we are obliged as signatories of the Solun Declaration.

Thirdly, through direct asymmetric preferential trade arrangements, the European Union directly supports Serbia’s accession to EU market, and thus, indirectly supports employment; it carries out non-inflationary expansionary measures of economic policy towards the Serbian economy.

Fourth, it has been agreed, within the SAA, that cooperation with the West Balkan countries will follow the “step-by-step” principle which means that Serbia and Montenegro have a strong incentive to approach the European Union at the rate at which they are able to bring their regulations into line with the relevant principles and regulations of the EU, in order to further economic growth and indirectly aid the success of the Poverty Reduction Strategy.

Fifth, it should be borne in mind that in the Amsterdam Treaty ratified in Lisbon in March 2000, the Council of Europe came to the conclusion that the level of poverty and social exclusion in the EU itself is too high and that a determined effort must be made towards its eradication by the year 2010. The measures proposed for the implementation of the European Strategy are completely compatible with the measures adopted in the Poverty Reduction Strategy in Serbia. Harmonisation of Economic Policies with Montenegro in the light of the Stabilization and Association Process

Future development of the international integration of Serbia and Montenegro crucially depends on harmonisation of their economic systems and economic policies. After the changes in October 2000, the international economic integration of FR Yugoslavia was not significantly disturbed by the existence of two economic systems, two monetary areas and two customs (foreign trade) areas. But since the new state union of Serbia and Montenegro has been formed, under the patronage of the European Commission, i.e. European Union, it is expected that there should be harmonisation of economic policies. This means that there should be a customs union and the adjustment of certain indirect taxes, especially excise tax. Two main directions of international integration: membership in the World Trade Organization (WTO) and the Stabilization and Association Agreement (SAA), depend on how fast the customs union, i.e. the common market of Serbia and Montenegro, materialises.

At the beginning of June 2003 the Action Plan for the harmonization of the economic policies of member states was adopted to eliminate obstacles to the free flow of people, goods, services and capital. According to the Action Plan, the republics reached a compromise by which Serbia would lower its customs rates, not at once but over the next 18 to 24 months and Montenegro would go on using non-tariff barriers; the foreign trade systems will be brought into line in the following 18 to 24 months. Meanwhile there will be two customs areas and two customs administrations. In addition, duty rates in Serbia will be reduced from 9.4% to 7.1%; the foreign trade system rests exclusively on tariff protection; there are virtually no non-tariff barriers and tariff rates are relatively high. On the other hand, Montenegro has substantial non-tariff protection; relatively low duty rates, but numerous non-tariff barriers (quotas and licences) which are not transparent and which will not be abolished by the Action Plan. The tariffisation of these barriers has not yet taken place, but according to some preliminary estimates, effective protection was lowered from over 20% to below 10%. As for the foreign trade regime, the member states will submit proposals on the Law on Foreign Trade by December 31 at the latest. As they are to be based on the regulations and practices of WTO, harmonization of these documents should not, in principle, pose a problem. The effects of harmonization on poverty should be viewed from the perspective of further liberalization of foreign trade, joining the World Trade Organization and the process of stabilization and greater integration with the EU.

3.3.2. International Financial Institutions

After the political changes of October 2000, Serbia and Montenegro restored its membership in international financial institutions (the International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development, while membership of the European Investment Bank is related to European Union membership).

The International Monetary Fund (IMF)

The membership of Serbia and Montenegro in the IMF was restored in December 2000, while the first Stand-by agreement was concluded in June 2001. At the moment an EFF (Extended Fund Facility) agreement is being conducted. Though the basic IMF role is to give support to the national currency by giving loans as a way of supporting the balance of payments of a country, the significance of the agreement with the IMF is far greater. These agreements are the preconditions for the macroeconomic stability of a country, and what is more important, they are the guarantee that this stability will be maintained. Because of the positive effects that macroeconomic stability has on poverty reduction, membership in the IMF, i.e. an efficient implementation of an appropriate IMF agreement, is a precondition for the reduction.

One of the preconditions for concluding any of the agreements with the IMF is a balanced budget, that is, the curbing of the fiscal deficit, which may limit the possibilities for income redistribution towards the poor. Since the basic strategy for overcoming poverty is the acceleration of economic growth and macroeconomic stability and not income redistribution, the agreement with the IMF is crucial, as it accelerates economic growth.

In the field of relations with the IMF nothing new is expected except the continuation of the implementation of the EFF agreement which will last until March 2005.

The World Bank

Serbia’s membership of the World Bank was restored in May 2001. At the same time, a three-year Transition Support Strategy (TSS) was harmonized and Serbia was admitted to the IDA (International Development Agency). This means that the credits provided by the World Bank will be under concession conditions (with respect to interest, grace period of the credit and terms of payment), which are better than market ones. It was anticipated that Serbia will receive 540 million USD, under TSS, 80% of which will be in the form of structural adjustment credits (SAC). This programme represents direct budgetary support linked to the implementation of planned reforms.

By means of this budgetary support, the budget balance will be maintained and macroeconomic preconditions for accelerated economic growth and consequently, poverty reduction, will be created. This creates preconditions for an increase in the available resources and for increasing the transfer to the poorest, which directly decreases poverty.

TSS expires in the first half of 2004 and will be substituted by the Country Assistance Strategy (CAS). There is a question whether Serbia will be allowed to keep IDA status or whether this status will be changed to IBRD (International Bank of Reconstruction and Development) status under the new CAS. Since IDA credits are granted under more favourable conditions than IBRD loans, it is important to try to keep the present status. The status will be negotiated with the World Bank taking account of the social, economic and political situation.

The European Bank for Reconstruction and Development (EBRD)

Serbia has been a member of the EBRD since January 2001. Recent EBRD activities in Serbia were directed towards creating a business environment suitable for development of the private sector, i.e. creating economic growth. These activities therefore had only indirect effects on poverty. Some direct effects came from investments in infrastructure, especially in utilities, which provided improvements in the basic infrastructure services for the poor.

The European Investment Bank (EIB)

The commencement of cooperation between the European Investment Bank (EIB) and Serbia and Montenegro, has been marked with loans for the rehabilitation of large infrastructure facilities, which have improved the general business environment and provided opportunities for future job creation, but without any direct effect on poverty reduction.

3.3.3 Membership of the World Trade Organization

Membership of the WTO should be considered in the framework of further foreign trade liberalisation and its beneficial effects on poverty, either through the growth of real incomes of all consumers in one country, through encouraging economic growth without any changes in income distribution, or through decreases in the prices of certain products.

Apart from that, membership of the WTO brings most favoured nation status (MFN). This will increase export demands and beneficially affect economic growth. The most important benefit is that the WTO provides the most favourable transition framework.

Finally, membership in the WTO will lead to the conclusion and implementation of agreements on free trade zones, which are important for effective foreign trade liberalisation. These agreements have to be conducted according to WTO regulations. Though the obligation related to these agreements originated from the Stability Pact and not from membership of the WTO, members are obliged to remove any hidden barriers in such agreements.


The reduction of poverty in Serbia depends on the capability of achieving sufficiently high levels of sustainable economic growth, together with an effort to prevent inequalities in the distribution of the national revenue from deepening. Achieving social and economic stability is a precondition for the attainment of this objective. In such a context, the continuation of the process of democratisation as well as the process of European integration, along with maintaining the level of macroeconomic stability which has been achieved are key elements for increasing economic activity and employment, the growth of salaries and the reduction of poverty.

1. Improved Employment Opportunities

The unemployed faced not only the greatest risk of poverty but also the most severe and deepest levels of poverty compared to other actors in the labour market. The proportion of unemployed individuals in a household considerably reduces consumption and increases the risk of poverty.75

1.1 Creation of new employment opportunities

The main objective of the economic reforms in Serbia is the creation of a modern, export-oriented market economy dependent on the private sector and capable of achieving dynamic economic growth and job creation. In such an economy, new employment opportunities as well as opportunities for economic growth will result from increased internal and external demand with the improved competitiveness of Serbian companies and more efficient use of available resources.

To be successful in this task the economy needs a clear ownership structure, strong corporate governance, and better management. In this context the ongoing comprehensive reform of economic legislation and the efficient privatisation process are critical (see Annex for more information on the comprehensive legislative reform currently being undertaken in Serbia).

Through FDI, private investments, the development of an entrepreneurial spirit and the SME sector, it is the objective of the government to increase the share of private ownership in the economy from 42.5 percent in 2002 to 75 percent in 2005. This will result in a dramatic increase in the overall share of workers employed in the private sector where the average salary is higher.

Increased domestic and foreign demand is a mechanism for increasing economic activity and creating new employment opportunities.

Increased internal demand

Increased internal demand will result from a combination of the following factors:

  • increased employment and investment rates through an FDI driven privatisation process;

  • increased employment and investments as a result of foreign direct Greenfield investments;

  • increased purchasing power and domestic savings;

  • increased public investments.

So far the privatisation process has resulted in increased investments in privatised companies at the pledged amount of EUR 567 million. The objective of the privatisation process is to sell up to 70 percent of state and socially owned companies via transparent auctions and tenders. By September 2003, out of 1074 companies offered for privatisation, 843 had been sold. In addition to the above-mentioned investments, this has resulted in a million euros of total privatisation revenue and 253 million EUR for social programmes (severance payment and retraining). A large proportion of the privatisation revenue has come in the form of FDI.

There is also an increase in Greenfield investment. Serbia is rapidly establishing a liberal investment regime. Although structural barriers still persist, the Government endeavours to remove impediments, reform business activity and open the economy to foreign participation.

FDI investments through privatisation and Greenfield investments have a multiplier effect. Demand for local goods and services will increase due to the actual investments and the need for inputs to the production process. In addition the employment of staff will result in increased personal consumption and investments.

The increase in purchasing power is linked to a real increase in salaries. The Serbian average monthly net salary increased to USD 151 in 2002 from USD 90 in 2001 and USD 45 in 2000. As of May 2003, the monthly net salary has further increased to EUR 170.76

As the average salary is higher in the private sector than in public and state owned companies, this trend is expected to continue with the continuation of the reforms towards a market economy based on private capital. The increase in purchasing power is expected to result in an increase in domestic savings.

Public investment is expected to rise in the forthcoming period. This will be accomplished through the improvement of the management of public expenditures with the aim of redirecting budgetary funds which are now used for public spending into investment.

Increased external demand

Increased external demand will mainly be driven by the following elements:

  • liberalization of foreign trade

  • increase in exports

  • strategic position

  • free trade agreements

  • WTO and European Integration

Liberalization of Trade and Free Trade Agreements

Although liberalization of foreign trade in the short term will have a negative effect on existing employment it will have a positive effect on employment in the medium to long term. Liberalization stimulates restructuring, so that companies that are not in a position to withstand the pressures of competition must either adjust or close down. This opens up the economy for the development of new and profitable enterprises which will create new employment opportunities and higher wages.

Increase in exports

Serbia’s integration into the international economic processes and the improvement in exports represents a prerequisite of its development, since it is a small country and therefore bound to have large-scale economic trade with the surrounding countries. Hence the increase in exports will be one of the main generators of economic growth.

Strategic position

It is the objective of Serbia to become the major trading and market centre in South East Europe. It is strategically located within Central East Europe and borders new member states. Serbia is the natural gateway between South East, Western, and Central Europe, positioned at the intersection of Pan European corridors no. 10 and no. 7, on the banks of the Danube, one of the biggest and most important river routes. Together with a well-developed transportation network, this makes Serbia easily accessible.

Free Trade Agreements

Serbia is in the middle of the South East Europe Free Trade Area that enables duty-free access to a market of 60 million people in Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Former Yugoslav Republic of Macedonia, Moldova and Romania. The diversity of the eight countries in the area, in terms of their position, legal environment, growth potential, resources and prices, offers a great opportunity for companies and investors to improve their business performance through regional cooperation. A draft free trade agreement was signed in 2001.

The main points of the agreement are as follows:

  • Liberalization of at least 90% of mutual trade by the end of 2008;

  • An appropriate common set of preferential rules;

  • WTO-consistent provisions for the application of anti-dumping, countervailing, safeguard measures and intellectual property protection;

  • Transparent and non-discriminatory measures concerning public procurement, state aid and state monopolies;

  • Harmonization of trade legislation with that of the EU (especially customs procedures, competition law, company law, company accounts and taxes and banking law).

Serbia and Montenegro is also the only country outside the Commonwealth of Independent States (CIS) that has a Free Trade Agreement with the Russian Federation allowing it access to the market of 150 million people.

In the preceding chapter we discussed European integration and joining the WTO.

Increased Competitiveness as a mechanism for creating new employment opportunities

The National Competitiveness Strategy, the preparation of which is drawing to a close, sets the following priorities:

  • improving the productivity of the private sector, emphasising improvements in quality and added value rather than price-based competition;

  • integration into the international business community so that Serbian companies can develop their business markets and strategic partnerships;

  • building industry clusters in high priority sectors to improve the productivity of the sector and the enterprises, including research and development, human resources and capital markets;

  • improving companies’ access to and productive deployment of financing;

  • attracting strategic foreign investors whose financial and intellectual capital can rapidly accelerate the restructuring of individual firms or provide the foundation for the development of new exporting clusters;

  • actively searching for investors willing to make substantial, long-term investments in plant improvement, worker retraining, and research and development;

  • increasing the capabilities for using existing technologies and innovations to create new competitive advantages;

  • improving market and business skills.

“The comparative advantage of Serbia is reflected in its educated workforce, low wages, functioning infrastructure, cheap overheads, strategic position in the centre of the Balkans, as well as the potential for expanding to other Balkan countries through Serbia.” (The National Competitiveness Strategy).

Increased investments as a mechanism for creating new employment opportunities

A significant determinant of the speed of medium-term growth and thereby the creation of new employment is the share of investment in GDP. From a very low level of 14% a significant increase is expected to a level of 25% as in comparable transition economies. The increase in investment share should mainly be achieved through increasing domestic savings from the current minimal level of 2% of GDP to 17% of GDP.

Improved utilisation of capacities together with a relatively low capital coefficient during the first years of the medium-term period should provide the projected growth rate and the increase in employment opportunities with lower investment rates.

In the 1990s production in Serbia was more than halved, which brought about a proportional fall in the use of capacity. Naturally, some of the capacity meanwhile became obsolete, but the infrastructure remained. Therefore only moderate investment is necessary to boost economic activity.

The aim of introducing tax incentives is to create a highly favourable tax system, encouraging investment, accelerating the development of underdeveloped regions and facilitating employment opportunities. Corporate profit tax is the lowest in the region at 14 percent. Incentives include ten-year tax holidays for investments in fixed assets over 100 million EUR and creating more than 100 work places. Investment in regions of special interest to Serbia is encouraged through a five-year tax holiday. There will be special tax benefits for investments of over 100 000EUR and the permanent employment of at least five workers. Moreover, VAT will replace sales tax in 2004.

Domestic savings and the banking sector

The increase in domestic savings mentioned above will contribute to the development of a healthy banking sector. The first step in the restructuring of the banking sector was a necessary but difficult pruning of insolvent domestic banks. This resulted in the closure of 23 banks out of 98, including the largest four. During the same period a certain number of foreign banks have established themselves and foreign interest is still high. The next step is for the state to privatise nine banks in which it is a majority shareholder, as well as to sell minor holdings in seven other banks. The plan is that most of these banks should be sold to strategic foreign investors, leaving at least two strong domestic banks. This should all contribute to the creation of a healthy and competitive banking system.

Along with the privatisation of banks, it is envisaged that the supervision of the banking system will be strengthened through the adoption of the supervision development plan as well as through the establishment of a supervisory council. As for legal regulations, a law has been adopted requiring the use of international accounting and auditing standards. It is intended to provide necessary preconditions for a reliable banking system which would attract domestic savings and secure their rational use.

The development of the existing institutions (insurance and similar) and the establishment of new ones (voluntary pension funds etc) will open up new opportunities for collecting and augmenting domestic savings. This, together with the banking system, should mobilise the existing and future savings of the population, the sector which is traditionally a net saver. Total saving deposits within the Serbian banking sector have increased several times from a very low level in 2001 to over 1 000 million USD at the beginning of 2003. For the most part domestic savings will be invested in small and medium-sized enterprises which should be, together with foreign direct investment, the main generators of growth.

Public investments

Even though only a small part of overall investments, public investments are important for medium-term growth. In addition to their direct impact on growth, they also have an indirect effect through the creation of a favourable environment for investment and growth. The share of capital expenditure within the budget of Serbia is low. Therefore, above average growth is planned for in the medium term. There should be a relative increase from 2% to 4% of GDP to reach a level meeting international standards.

It is estimated that around one third of the overall investment77 in Serbia in the period 2004–2006 will be directed into infrastructure (transport, energy, telecommunications, the postal service, utility infrastructure). These investments will be financed from:

  • Resources of the enterprises in the above mentioned sectors (their own resources and commercial loans),

  • Budgetary resources (republican and local budgets), and

  • Expected donations and soft loans.

So far more than 1 billion EUR in concessionary loans have been directed into infrastructure: 449 million EUR to transport including 220 million EUR to the road, 127 million EUR to the railway and 127 million EUR to the aviation sectors; 346 million EUR to the energy sector and; 217 million EUR to local level infrastructure (water, central heating and local transport). In addition, around 95 million EUR in concessionary loans have been agreed for investments in the health and education sectors

Investments will support the creation of a revitalised and reliable power sector which aims to become an important electricity exporter in a region with an overall deficit of energy. Currently a new energy law is being drafted which will provide for harmonisation with the EU and fast liberalisation. The creation of joint venture and concession enterprises is encouraged. Potential areas are the development of pipelines, gas storage facilities, and the modernisation of thermal and hydro electro power plants.

As regulatory and market reforms gather speed with the aim of building a modern telecommunications system that will meet the growing needs of a customer-based market economy, the level of investment is expected to increase. By 2005 it is expected that a fully digital network will be established.

It is estimated that the entire necessary resources for investing in telecommunications and the postal service will be provided from commercial sources (domestic and borrowed). Modernization and construction in other infrastructure activities will to a great extent depend on budgetary resources, donor funding and soft loans.

Investments by the state, domestic enterprises, and foreign investors in infrastructure will have direct and indirect impacts on the level of economic activity, employment and poverty reduction. Direct impacts will include GDP growth and higher employment. Multiple effects of infrastructure investment on economic activity result from the fact that in the building of infrastructure mainly domestic raw materials are used. Also, investments in housing and certain infrastructure investments are labour-intensive, which stimulates employment, particularly of the semi-skilled (poorer) labour force. An additional significant contribution to poverty reduction is increased accessibility and quality of services in infrastructure activities.

Construction of infrastructure contributes to reductions in costs and increased efficiency of economic activities in a particular location. Modern infrastructure stimulates commercial investments into the industry and service sectors. Implementation of these investments leads to the improvement of the overall level of development of certain areas which, in turn immediately alleviates poverty. In this context it can be said that investments in infrastructure represent one of the generators of economic activity and employment and therefore of poverty reduction as well.

All these investments will not only contribute to employment during the transitional period but also to laying the foundation for the future.

Foreign direct investments

It is clear that there are still significant obstacles to the entry of new enterprises. These obstacles concern high political and regulatory risks. While significant improvements have been made, substantial legislative and institutional reform is still required. The most important part of this reform is linked to the reform of the legislative and justice system, since uncertainty in this area, including slow enforcement of court decisions, is one of the most important sources of risk for investors.

Serbia has enacted specific legislation outlining guarantees and safeguards for foreign investors. The former Federal Law on Foreign Investment (January 2002) has been formally incorporated into Serbian law (2003) and establishes the legal framework for investment in the Republic. The law eliminates previous investment restrictions; extends national treatment to foreign investors; allows for the transfer/repatriation of profits and dividends; provides guarantees against expropriation; and allows for customs duty waivers for equipment imported as capital-in-kind. In late 2002, the Government of Serbia promulgated new tax incentives for foreign investors.

Since foreign capital is vital to the restructuring of the real sector it is of vital importance to remove barriers and stimulate investor interest. Thus, reform efforts have not been limited to the promulgation of the two foreign investment laws. Rather, the government has understood the need to make reforms to a wide body of laws that will improve the overall business regulatory environment and enable private sector companies to grow and to compete.

Sustainable mid-term macroeconomic stability is another factor that should attract foreign direct investment. It has already been stated that inflation has been brought down to a very low level together with extensive liberalization of prices, that the Dinar was made convertible, foreign trade liberalized, and so on.

Although total FDI levels are still negligible compared to elsewhere in the region, Serbia could easily overtake other countries in Southeast Europe.

Total level of Level of FDI (million USD)

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FDI numbers for 2003, 2004 and 2005 are rough projections

A stimulating investment environment is based on implementation of the so called «12 commandments»: a stable and predictable macroeconomic policy; an effective and honest (incorrupt) government; a large and growing market; freedom of activities in the market; minimum government control; reliable infrastructure; availability of high-quality factors of production; a strong currency; possibility to pay up profits, dividends and interest rates; a stimulating taxation climate; freedom to do business between the markets

Privatisation and investments

The direct effect of privatisation is an initial drop in employment in newly privatised enterprises. However, privatisation also creates preconditions for new, sound private investments. Such investments will lead to the creation of new jobs, though this will take some time. Over time it is to be expected that privatised enterprises will create significant new employment opportunities.

The Law on Privatisation, adopted in 2001, met with general approval as the best law on privatisation in all the former socialist states and has already won a considerable amount of trust concerning the privatisation process.

The sale of large socially owned enterprises is expected to be completed by the end of 2006. The privatisation of large public companies is expected to begin in 2005 depending on the completion of reconstruction, the adoption of relevant regulations and the establishment of regulatory institutions. The work on the draft legislation and setting up the institutions is under way.

Privatisation of small and medium-sized socially-owned enterprises through auction is a precondition for accelerated growth within the SME sector. It is expected that around 800 enterprises will be privatised in this way in 2003 and that in 2004 privatisation of almost all small and medium-sized enterprises will be completed.

During the coming period the state will sell its minority shares in companies that started the process of privatisation under the old regulations and thereby complete the privatisation of these enterprises.

The Ministry of Economy and Privatisation together with the Agency for Privatisation mostly carry out the comprehensive government plan concerning privatisation as well as working on strengthening capacities for this complex task.

Greenfield investments

The experience with transition in Eastern Europe has shown that foreign direct “green field” investments and new direct private investments by domestic investors are the basic vehicle for accelerated economic growth and the creation of new employment.

New enterprises are not under the pressure of the past. They do not have inherited debts, and are organised to maximise profits and economic efficiency. Without these new investments, even the privatisation of existing enterprises cannot provide the projected economic growth and creation of new jobs.

The largest Greenfield investment so far is Ball Packaging which has made a commitment to invest 75 million EUR. Merkator, with an investment of 38 million EUR and plans for further investments in other cities than Belgrade are the largest investor in the retail sector. So far, it has created more than 400 new jobs. Tetra Pack with the investment of 30 million EUR is among the most successful Greenfield investments. The workforce efficiency in this enterprise is high in a European context and they export to Bosnia and Herzegovina, Macedonia, Greece and Germany.

So far the number of newly created enterprises has been smaller than expected. The Ministry of International Economic Relations endeavours to provide the necessary conditions for improvement in the area through an accelerated effort for the development of the investment environment as well as the development of the strategy for the promotion of investment which will be better targeted, based on active measures and simultaneously continuing the effort to enhance the competitiveness of Serbian economy. This will be done in close cooperation with the Ministry of Economy and Privatisation which undertook the task of drawing up the Industrial Strategy for the Republic of Serbia, which, as its essential component, should result in action plans for industrial growth in various sectors, including:

  • The development of smaller industrial units.

  • The sustainability of medium and large industrial units.

  • Promotion of certain industrial sectors.

  • The recovery of industrial enterprises with poor business performance.

  • The development of entrepreneurship.

  • Protecting the environment (promotion of environmentally friendly production).

  • Equal employment opportunities.

  • Promotion of exports.

The SME sector as a mechanism for creating new employment opportunities SME Strategy

At the beginning of 2003, the Government of the Republic of Serbia adopted the document entitled “The Strategy of Development of Small and Medium-Sized Enterprises and Entrepreneurship in the Republic of Serbia for 2003 – 2008”. The primary objective of this strategy is to create a framework for the creation of a sustainable, internationally competitive and export-oriented sector of small and medium-sized enterprises and entrepreneurship (hereafter referred to as SME sector) in the forthcoming five-year period.

In this respect, the Government of the Republic of Serbia defined the development of SME sector till the end of 2007 as its main strategic goal with an increase in the overall number of SMEs from around 270,000 (in 2002) to around 400,000. This involves:

  • Giving precedence to the sectors capable of significantly increasing employment and stimulating economic development: processing of agricultural products, industrial production, tourism, and electronic business (e-business).

  • Strengthening the organized system of support to the SME sector by way of development of the capacities of the institutions of this system at all levels.

  • Elimination of legal obstacles for the operation of enterprises and private entrepreneurs by creating a new legal environment that will facilitate and not hamper the development of the SME sector.

  • Implementation of the reforms of public services in order to ensure more efficient provision of services and significantly reduce the administrative and bureaucratic obstacles encountered by the SME sector.

  • Increasing the competitiveness of the SME sector through programmes for the development of enterprise management and the adoption of systems of quality and innovation.

  • Strengthening links between the education system and the scientific and research system and the SME sector.

  • Stimulating the sale of products and services of the SME sector in the local market through better links between large enterprises and SME activities, such as subcontracting, by creating conditions for greater participation of the SMEs in public procurement and greater sale of consumer goods from the SME sector.

  • Channelling of the grey economy into legal flows.

  • Promotion of activities related to assistance in the development of the SME sector by a continuous media campaign.

SME Financing

The lack of financial resources is one of the most serious problems of small and medium-sized enterprises and entrepreneurs in the Republic of Serbia. Establishing an SME Guarantee Fund, with the aim of providing security to creditors for a part of the loans granted to SMEs which have growth potential but are not bankable will mitigate some of this problem. Therefore, it is important to capitalise this Fund as soon as possible, including with funds provided as international assistance.

The private sector remains a dominant source of financial resources for the development of the SME sector. Therefore as mentioned earlier it is critical that the banking reform is completed as soon as possible.

The creation of a legal framework for the establishment and operation of microfinance institutions would secure greater accessibility of financial resources for poorer citizens and entrepreneurs, by way of microcrediting which allows for more favourable conditions and simpler procedures than bank credits, though the conditions are still strict. In most neighbouring countries, as well as in Montenegro, donors’ willingness to provide resources for microfinancing, through NGOs and other institutions besides banks, has led to the creation of legal conditions for these activities. Microfinancing has also been supported through the “Strategy of Development of Small and Medium Enterprises and Entrepreneurship in the Republic of Serbia for 2003–2008”.

During 2003, access to capital for micro-enterprises and self-employment has significantly improved in certain regions in Serbia. There are now three big financial institutions offering micro loans: ProCredit Bank, Opportunity International and Nacionalna Stedionica.

Implementation of SME strategy

In addition to the Ministry of Privatisation and Economy, the Republican Agency for Development of Small and Medium-Sized Enterprises and Entrepreneurship has national responsibility for the implementation of the strategy.

The regional SME agencies and centres will be providers and catalysts of concrete support to owners and managers of small and medium-sized enterprises and to entrepreneurs. It is therefore a priority to extend and strengthen this network as well as the quality and the variety of services provided. By the end of 2002, ten regional agencies and centres were opened in: Belgrade, Kragujevac, Kruševac, Niš, Novi Pazar, Novi Sad, Subotica, Užice, Zaječar, and Zrenjanin.

At the regional and local level, local authorities will have an important role in the stimulation of SME development, assisted by a network of regional agencies, centres, and offices for the development of SMEs providing information and advisory services and training programmes (either directly or indirectly through qualified business consultants) for the SME sector.

Legalisation of the grey economy and employment

The share of the grey economy in Serbia is still very large. The government objective is gradually to integrate the grey economy into the formal sector. This will not be possible unless conditions are created which will discourage the public, enterprises and workers from operating in the informal market. An optimal strategy for the inclusion of the grey economy combines both incentives and penalties.

Wages in the grey economy are considerably higher than in the formal labour market, to some extent owing to tax evasion. The focus should be on the elimination of barriers to business, which have a destimulating effect and which contribute to the spread of the grey economy. Deregulation of economic activities and more transparent institutions will also have a positive effect on the level of corruption. Therefore the fight against the grey economy in many ways starts with the creation of conditions for a more dynamic development of the overall private sector. The introduction of VAT, the lowering of taxes and contributions together with the widening of the tax base and the improvement of public revenue collection and control (and stricter penalties) will reduce the attractiveness of the grey economy and raise operational expenses within this sector.

The development of small and medium-sized enterprises and entrepreneurship, as well as the increase in the economic efficiency of the enterprises, will bring about an increase in wages and the creation of new workplaces in the formal economy. This will also reduce the attractiveness of the grey economy.

In other words, the dynamics of reducing the grey economy will be closely linked to the dynamics of the completion of the transition policies.

Agriculture as a source of new employment opportunities

Agriculture is of the utmost importance for Serbia since it makes up a quarter of GDP (25.1 per cent in 2001). The sustainable growth of the private agricultural sector will play an essential role in the alleviation of rural poverty. The vision of the future status of agriculture is clearly set out in the Law on Agriculture which provides guidelines for the adoption of programmes and policies, sets benchmarks for monitoring progress, and makes it possible for all within the agricultural sector to make long-term plans with a higher level of security.

It also provides a framework for the policy of agricultural support.

Some of the relevant objectives are:

Improving the profitability of the agricultural and food processing industry will be achieved through applied research and the application of results; through improving the skills of present and future farmers; providing technical and business advice; promoting the exchange of market information.

Health and environmental protection and achieving the status of a country which provides healthy food for the needs of the Republic of Serbia in international trade will be achieved through the control of contagious animal diseases as well as diseases transmitted through food consumption; the control of agricultural pests and diseases; and reducing the side effects of pesticide use, veterinary medications and food additives. Full harmonisation with the EU is set as a long-term goal.

Improving effectiveness and investment in production and processing will be achieved through the completion of the privatisation of agricultural complexes and processing plants.

Encouraging optimal and effective use of production resources yielding best economic effects through the development of market-oriented agriculture and the membership of Serbia in the WTO and the European Union. This demands customs reform as well as various forms of support for agriculture.

Promoting the optimal use of land through the rent and sale system, encouraging the establishment of profitable farms. The rational use of water resources will be ensured through the creation of appropriate agencies and mechanisms ensuring effective management of main river systems, flood protection, maintenance of primary and secondary irrigation systems together with the allocation of rights for the use, management and distribution of water to agricultural producers.

Creating competitive and effective markets for agricultural basic materials and produce, setting prices in line with quality, establishing producers’ marketing organisations, independent product quality assessments, and monitoring monopolistic behaviour in the farm produce markets.

Protection of arable land, habitats, wildlife reserves and support for the production and sale of organic food. Protection will be an integral part of agricultural and rural policies. The support for the production of organic food will be capitalised owing to the low level of use of artificial fertilizers in the preceding period. It will also include adequate standards and certification systems.

Creating conditions for credit support for agricultural producers. Assistance through reformed agricultural counselling services will be provided through help in drawing up business plans as well as creating conditions for the development of organisations and of microfinancing.

The attainment of these objectives will stimulate employment and economic growth, thus improving social well-being in rural areas (with special emphasise on border and mountainous regions which suffer from emigration).

Local development strategies as a mechanism for creating new employment opportunities

The regional differences in the type and structure of unemployment and in competitive advantages suggest the need to find different approaches and policies. Therefore, the overall changes in the economic system aimed at stimulating growth and new jobs should be supplemented by incentives at the local level.

Through local initiatives and measures municipalities can support the development of a conducive environment for the establishment and growth of economic activities, thus increasing the attractiveness of a municipality or a region for domestic and foreign investors.

Hence the Government of Serbia encourages individual municipalities or groups of municipalities to draw up a strategic plan for social, economic, and land development to facilitate business decision-making by potential investors. As of now, the majority of local governments have not developed strategies for the stimulation of employment. It is therefore necessary to draw up development plans on both a municipal and/or an inter-municipal basis that would build upon concepts and policies presented in national strategies and adapt these to local conditions. These planning tools should highlight concrete activities, needs and development goals. Such plans should take into consideration:

  • direct investment into infrastructure with the aim of making the region more attractive for potential investors;

  • self-promotion (activities whose purpose is not only to inform but also to attract interested investors);

  • direct support of economic activities (renting land and facilities along with certain concessions to local and foreign institutions, banks, or insurance companies, setting up of industrial zones, incubator business centres, concessions, exemption from city and municipal taxes, etc.);

  • incentives for the development of small and medium-sized enterprises and entrepreneurship.

Without these local level actions plans, the national PRSP employment strategy will most likely fail when it comes to the creation of new employment opportunities. Initiatives for concrete employment programmes should come from the regional and local level. Decentralization supports the identification of innovative and effective policies for a problem where there are no global recipes.

Local governments should also increase their co-operation with the aim of highlighting and building support for reforms and significant projects.

1.2. The Development of a More Effective Labour Market

1.2.1. Current status and problems
Formal Labour Market and Unemployment

The labour market is the main channel through which economic growth influences poverty, because income from work represents the main determinant of living standards.

The formal labour market in Serbia is has the following characteristics: a relatively low level of employment of the population; a high unemployment rate and its trend of continued growth; high hidden unemployment; a low share of employment in the private sector; low wages; and low mobility of the labour force.

Table 1 shows the participation rates and unemployment rates that are defined in two ways: according to the standards of the International Labour Organization (ILO) and according to self declaration of the respondents. The participation rate calculated as the proportion of the active in the total working-age population (men from 15–59 and women from 15-54 years old), according to the definition of ILO, amounts to 62.2% while, according to self declaration, it is somewhat higher and amounts to 65.2%. However, what is particularly important to emphasise is that the unemployment rate, as defined by the ILO, is considerably lower than the unemployment rate according to the statements.

Table 1.

- Participation and Unemployment Rates in Serbia in 2002

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Note: ILO – International Labour Organization; the unemployment rate was calculated for men from 15 to 59 years of age and for women from 15 to 54 years of age.Source: Survey on the Living Standard of the Population (SLSP) 2002

Where is the difference? The difference is in that that the ILO definition, which provides for international comparability, starts from the assumption that unemployed persons are those who did not work in the reference period, that they actively searched for a job, and were readily available to start working if someone offered them a job. There were 256 thousand such persons, while those who declared themselves as unemployed, a part of whom worked, were 745 thousand78. This means that only a third of the declared number of the unemployed represents the actually unemployed persons. Hence the unemployment rate, according to the ILO definition, which provides for the international comparability and more realistically mirrors the actual state in the labour market, amounted to 8.4%. It is important to mention that this unemployment rate is somewhat lower than the unemployment rate (defined in the same way) calculated using the data from the Survey on the Labour Force (SLF) dated 2002, which amounted to some 11.9%. Also, according to the official data of the Republic Labour Market Bureau, there are more than 900,000 unemployed on the record, so the unemployment rate exceeds 27%.

The long-term trend of a moderate decline in overall employment and the growth of the unemployment rate from the previous decade also continued in the period 2000-2002. Despite the growth of GDP in real terms, overall employment dropped by 1.6% in 2002 compared to 2000. The decline in the overall employment rate in this period was predominantly due to reduced employment in the social and state sector, since the employment rate has grown in the private sector. Employment in the private sector grew in this period by 21.4%, and its share in overall employment grew from 23.8% in 2000 to 29.4% in 2002. In the same period the earnings of employees have grown in real terms by over 50%.

With regard to the trends and the structure of employment, it is important to point to the relative significance of the non-standard forms of employment, such as temporary employment, and occasional or seasonal employment. The data from SLSP indicate that these forms of employment are not negligible as in the previous period, because they represented 28.9% of overall employment79. These forms of employment provide for a higher flexibility in employment and more efficient satisfaction of the demand for work.

Hidden unemployment in government-and socially-owned enterprises, according to some former estimates, amounted to about one third of the employed. High protection of the employed caused inefficient utilisation of human resources, while the employed were protected from competition within their respective enterprises, as well as from competition between the employed and the unemployed. The high costs of dealing with the problem of redundancies of previous policies were borne by the enterprises, which were most often in a very poor financial situation, and therefore they postponed the process of dealing with the issue. Such conditions encouraged the spread of the grey economy among those employees who had full health and social insurance in the formal sector. In the process of structural adjustment, by dismissing those who are redundant, efficiency will be stimulated which will yield growth in the earnings of the actually employed workers, while the hidden unemployed will become really unemployed.

A large number of the unemployed, the those made redundant, as well as a large number of refugees and internally displaced persons, exerted strong pressure on the formal labour market, thus creating a big labour supply as opposed to the low demand for labour80. The big discrepancy between the labour supply expressed by the number of unemployed and the demand for labour expressed by the number of vacancies can be understood through the analysis of quantitative and qualitative factors. The quantitative factors can be analysed through the ratio between the unemployed and the vacancies. The number of actually unemployed in 2002 was on average more than seven times as high as the number of vacancies or the demand for labour. The qualitative factor of the discrepancy is reflected in the fact that, despite this large discrepancy between supply and demand, 16.8% of vacancies remained vacant in 2002. The disproportion between the supply and demand for labour is explained by inadequate qualifications among the unemployed, which does not fully correspond to the qualifications required. This unfavourable process of harmonization of the supply and demand was additionally aggravated by the low geographic mobility of the labour force, which is predominantly the result of unfavourable regional development of the economy and an undeveloped property market.

In line with the decline of the overall employment rate in Serbia, there has been a continuous growth of unemployment in the period 2000–2002. The total number of registered unemployed persons in 2002 was 843 thousand, which is 16.8% higher than in 2000. However, based on the data from SLSP, only one third of the declared number of unemployed represents the actually unemployed persons, in view of the fact that a major number of the registered unemployed persons are registered with the Labour Market Bureau because of their entitlement to health insurance (and pecuniary compensation), but they actually work in the informal labour market. For this reason, we shall proceed with the analysis of the characteristics of the actually unemployed persons based on the data from SLSP, and not of those unemployed who declared themselves as such, while they actively participated in the labour market.

The structure of unemployment is very unfavourable. Its most significant characteristics in Serbia in 2002 are:

Long-term character of unemployment, because over one third of the unemployed have been looking for a job for more than a year. Such a long-term character of the unemployment in Serbia represents a major economic and social problem which may have deep implications both with regard to the obsoleteness of knowledge, and to the rate of use of the available human resources, and in particular to the social repercussions of unemployment.

Dominant share of the youngest age group (15–25 years of age) in overall unemployment (40.7%). This age group had an unemployment rate three times as high as the average unemployment rate (25.9% as opposed to 8.4%). This particularly high unemployment rate indicates that young people in Serbia are in a considerably more difficult situation compared to the countries in transition, but it also implies the waste of human resources of those age groups which should give the greatest contribution to the economic and social development of the society.

It is important to bring to attention another group of the unemployed who are especially at risk – young people. Stimulating economic growth and reducing poverty will also have a side effect of preventing the erosion of the existing labour resources as well as preventing young people from leaving the country. An estimated 300 000 have left the country in the last decade. The aggravating circumstance is the fact that a significant proportion of them are highly educated.

A relatively high share of the group having low educational qualifications (below secondary school qualifications) in overall unemployment. Those unemployed with qualifications below the secondary school level represented 19.2% of the overall number of the unemployed in 2002. Dominant among them are unskilled and semi-skilled workers whose employment will be aggravated in the process of restructuring of the economy and labour force since modern industries require skilled labour. Additionally, the share of the unemployed who had previously been employed amounted to 44% in 2002, and it has been increased due to redundancies.

Compared to the countries in transition, the highest educational qualifications in Serbia, judged by their earnings, are relatively highly valued81 and considerably higher compared to the countries in transition.82 The wages of the formally employed with university qualifications compared to the wages of the employed with secondary school qualifications were higher, ceteris paribus, by 56.2% in 2002.83

On the basis of these results the conclusion may be drawn that investment in human resources, i.e. in education, is one of the ways of escaping poverty, in view of the fact that the labour market rewards higher levels of education.

Unemployment by Gender

The rate of unemployment among women was higher than the rate of unemployment among men (9.6% as opposed to 7.5%). Women in Serbia were harder to employ than men, although the educational status of unemployed women was better than of men (8.3% of the unemployed men and 14.8% of the unemployed women have above the secondary education).

Women in employment in 2002 earned less than employed men, ceteris paribus, by 24.5%. One part of this difference can be explained by the higher number of hours worked by men compared to women. The results indicate that the estimated differences in the earnings of men and women are among the lowest compared to the other countries in transition.

Krstic explored wage determination and the evolution of the gender pay gap in Yugoslavia over the period 1995–2000 using the Labour Force Surveys84. Men had an average pay advantage over women of 9.3% in hourly measures in 1995 and 9.9% in 2002. However, the gender pay gap adjusted for productivity characteristics between men and women (i.e. education, labour force experience, skill level, etc.), appeared slightly larger relative to the unadjusted measure suggesting that characteristics of employed women are probably slightly better than men’s. The ceteris paribus hourly gender pay gap amounted to 11.5% and 16.9% in 1995 and 2002 respectively indicating a significant rise of the ceteris paribus gender pay gap by about one-half. Thus, the slow process of transition to a market economy was not neutral to the wages between males and females. Although the adjusted gender pay differential increased considerably over the observed period, this pay gap is still one of the lowest among transitional countries.

Wages: State/Socially Owned Sector Versus the Private Sector

The wages of employees in the private registered sector compared to the social and state sector were higher, ceteris paribus, by 29.2% in 2002. This ratio between the wages of the employees in privately owned companies compared to the social and state sector is relatively high compared to the standards of other countries in transition85 and can be significant for the attraction and keeping of a high-quality labour force in the private sector.

What are the effects of employment in the private sector on poverty? With a higher share of employed persons in a household, who work in a private registered company, it is noticed that their consumption rises compared to employees in the enterprises that are socially or state owned on average by 18%, and the poverty index is reduced. This effect rises if we go from the poorest to the richest section of the population. On the basis of these results, we may conclude that employment in the private sector is one of the ways to increase income and consumption of a household and take it out of poverty.

The Grey Economy and the Grey Labour Market

Causes of the grey economy

In the ten years of deep economic crisis in Serbia, the grey economy was the main means of survival for a considerable part of the population, a phenomenon which was therefore tolerated by the state and became a deeply rooted pattern of behaviour.

The establishment of macroeconomic stability in Serbia between 2001 and 2003, together with concrete economic policy measures concerning the unification of the currency market, setting up a new banking system, tax reforms, especially reducing the burden on earnings, and deregulation of working relations reduced the impact of the generators of the grey economy in Serbia. However, widely spread corruption and criminality, that is, ineffective operation of the legal system, still stimulate the grey economy.

In Serbia, the grey economy is still one of the main means of survival of the poorest section of the population86, but is also a way to increase profits by avoiding government taxes by those sections of the population who are not at financial risk.

Scope and characteristics of the grey economy

On the basis of data from SLSP, it has been estimated that about a million people in Serbia in 2002 were involved in the grey economy, which represents a little less than one third (30.6%) of those who actively participated in the labour market87. Apart from this, 10.8% of the persons that had a main job (either in the regular economy or in the grey economy) had an additional job in the grey economy. These figures certainly indicate that the grey economy in Serbia is still considerable. Examined by type of settlement, the grey economy was considerably less widespread in the cities (38%) than in other areas (62%), and examined by activity, it was most widespread in agriculture (49%), trade (13%), handicrafts, and services (10%). The grey economy was more widespread among those with lower educational qualifications as opposed to the formal sector, in view of the fact that 48% of people in the grey economy had the lowest educational qualifications, while in the formal sector this percentage is less than half that (22%).

The attractiveness of the hidden labour market lies in the fact that average earnings per hour were 28% higher than in the formal labour market, amounting to 83 Dinars or 1.3 USD. Higher earnings per hour in the informal than in the formal labour market, among other things, emanate from tax evasion. Another important characteristic of the grey economy is that it more adequately rewards educational attainment, in view of the fact that average earnings per hour of those with the highest educational qualifications were more than twice (2.7) as high as the earnings of those with secondary school qualifications, and more than twice as high as the wages of employees with university qualifications in the formal sector88.

Influence of the grey economy on poverty

The incidence of poverty was higher among those working in the grey economy than among those employed in the formal economy. The poverty risk of those employed in the grey economy (Table 2) was more than a third higher than the average poverty risk of the employed population, and the depth and severity of poverty is greater than among those employed in the formal economy. Such a large share of the grey economy among the poor employed clearly indicates that the grey economy is still the main means of survival of a major portion of the poor population.

Table 2.

- Grey economy and poverty in Serbia in 2002 (in %)

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Note: Employed individuals are defined as persons who, in the reference week, did any job for money or any benefit in kind. The data refer to employees over 15 years of age. The relative poverty risk is calculated as a percentage growth (drop) of the poverty index of the reference group compared to the average poverty index of the employed.Source: SLSP 2002.

The main characteristic of the labour market in Serbia is its segmentation into the formal labour market and the informal, i.e. ‘grey’ labour market. A relative inertia in the formal labour market, the recent rigid legislation in labour relations, and low wages and relatively high taxes and contributions on wages in the previous period were the main stimulants for the functioning and spread of the informal labour market. A high degree of discrepancy between the supply and demand for labour, a high hidden unemployment rate and the considerable size of the informal labour market, indicate that the formal labour market does not function adequately, i.e., that it does not allocate human resources optimally. Among poor employees, those involved in the grey economy represented 42% in 2002. Such a high share of the grey economy among poor employees clearly indicates that it is still the main means of survival of a major part of the poor population. The interconnections of the formal and informal components of the labour market confuse the real relationships in the market and make it more difficult for the government to pursue an efficient labour market policy. A high degree of segmentation of the labour market into the formal and informal sectors is of particular importance for the forthcoming reforms and future policy in the labour market.

1.1.2. Goals and Strategic Options for Employment Policy and the Labour Market Starting Points

The basis for the reduction of poverty is improved economic effectiveness and economic growth. More rapid and large-scale employment represents an important goal of this strategy because unemployment is one of the main causes of poverty and exclusion in Serbia. Stimulation of employment does not represent an isolated goal of economic policy but a project of society. For its implementation it