This note compares patterns of domestic investment in Serbia with those in other central and eastern European countries, noting the relationships with external balances. The structure of participation and employment rates suggests a need for analysis of the impact of labor market institutions on youth and women. A further focus on redeployment services would be appropriate. The Serbian banking system, the implications of the structure of Serbia’s economy, the operational framework of monetary policy, and the adoption of an inflation targeting regime have been discussed.

Abstract

This note compares patterns of domestic investment in Serbia with those in other central and eastern European countries, noting the relationships with external balances. The structure of participation and employment rates suggests a need for analysis of the impact of labor market institutions on youth and women. A further focus on redeployment services would be appropriate. The Serbian banking system, the implications of the structure of Serbia’s economy, the operational framework of monetary policy, and the adoption of an inflation targeting regime have been discussed.

III. Employment3

1. This note considers how to improve employment performance in the medium-term. Its approach is exploratory, to identify possible areas for focus, and it anticipates further follow-up work by staff. Labor market institutions, corporate reform, and fiscal policies are discussed.

A. Background

2. Almost 190,000 net jobs have been lost in five years, half of which were in agriculture (Text Table 1 and Table 1). During this period, considerable reclassification of non-agricultural firms by sector occurred due to privatization. So while about 400,000 jobs were lost in the socially owned sector, 50,000 in companies with mixed ownership and 30,000 in national public enterprises, it is not clear precisely to what extent these were reclassified into the private sector due to privatization and improvements in data coverage.

Text Table 1.

Serbia: Employment by Ownership, 2001-06

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Source: Statistics Office.

Includes general government, state- and socially-owned enterprises and enterprises with mixed ownership

Table 1.

Serbia: Employment by Ownership, 2001-06

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Source: Statistics Office.

3. Furthermore, the employment rate is low. In 2005 the overall employment rate stood at 42 percent, well below the EU average of 67 percent. Employment rates for women (33 percent) and the workforce between 55 and 64 years old (35 percent) were also lagging behind EU levels (57 and 50 percent, respectively).

4. Unemployment rates are high and rising. According to the 2005 Labor Force Survey (LFS) the unemployment rate has reached 20.8 percent, up by over two percentage points from 2004 (Text Table 2), notwithstanding a slight decline in labor force participation. A majority of the unemployed (79 percent in 2005) has been without work for over twelve months and women and the young are affected most with the highest unemployment rates (27 and 48 percent respectively).

Text Table 2.

Serbia: Labor Market Developments, Labor Force Survey Data 1/

(number of persons, unless indicated otherwise)

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Source: Statistics Office and World Bank (2006). The survey methodology has been revised in 2004; hence the 2001-03 and 2004-05 numbers are not directly comparable.

The ILO unemployment rate (for age group between 15 and 64) in 2004-05 was 19.5 and 21.8 respectively.

5. Despite high unemployment, real wages have reportedly grown significantly since 2003. Official statistics suggest that real wages have risen by over 40 percent since 2003 (Text Table 3). But there are doubts about the quality of this data. They are based on data from a monthly survey, which covers about 70 percent of registered employment, but excludes small business and is biased towards large companies in the public sector.4 The importance of these omissions, and the likelihood that they cause exaggeration of the growth of wages, is indicated by tax collections data which suggests that the average growth in the base of taxes on wages—the wage bill—since 2003 was in the range of 5 to 7 percent. Though, given declining employment, this is consistent with high wage rises, it is unlikely that the actual wage increases are as high as indicated by the labor force data. Further doubt is cast on the official wage data by evidence from labor force survey suggesting that in 2005 jobs in state- and socially owned enterprises on average paid, respectively, 24 and 12 percent more than in the private sector (World Bank (2006)).

Text Table 3.

Serbia: Components of Unit Labor Cost in Manufacturing, 2001=100

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Source: Statistics Office and Fund Staff Estimates

Through April

6. Reported wage growth suggests compression of profits since 2000. Profit margins in manufacturing (as measured by the ratio of producer prices over unit labor costs, bottom row of Text Table 3) have declined by more than 4 percent over the last five years. And even if the adversity in these trends is exaggerated by faults in the wage data, other evidence suggests heavy loss-making. In 2005 the non-private corporate sector recorded a net loss of over 5 percent of GDP, a major drain on the economy (Text Table 4).

Text Table 4.

Serbia: Profit and losses of enterprises, 2004-05

(In percent of GDP)

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Source: Solvency Center.

B. Options

Labor market policies and institutions

7. Many provisions of the 2005 Labor Law—while formally consistent with EU guidelines5—reflect the desire to protect existing employment. This may discourage new job creation. The Law maintained the basic principles of its predecessor (2001 Labor Law), but featured higher severance payments, introduced retirement gratuity and experience pay, increased non-wage benefits (e.g., more reimbursable expenses, presents for employees’ children), and contained more complicated layoff procedures. Annual leave regulations prescribing leaves of three consecutive weeks and a 12-month limit on fixed-term appointments without a possibility of renewal create further frictions. Many of these steps protect existing employment but discourage new hiring. Given that employment shortfalls predate the 2005 Labor Law, it cannot be said to account for them. But it could compound the difficulties.

8. Inefficiencies are further aggravated by non-market and non-performance-based wage setting in the public sector. At present, wages in the budget sector and public enterprises are defined by coefficient multiples of sector-specific base wages with precise coefficients defined for each job title. Infrequent adjustment of these coefficients and their distance from market principles creates rigidities in the wage structure.

9. The structure of participation and employment rates is suggestive of need for particular analysis of the impact of labor market institutions on young people and women. European experience suggests that participation rates of women tend to increase along with economic growth. Given that female participation is now unusually low, a significant rise in the supply of female labor may occur in coming years. This would compound the already significant supply of young labor—much of which is already openly unemployed. Both factors suggest the need to give particular emphasis in labor market institution design to ensuring appropriate flexibility for these two cohorts of workers. One example is to consider the impact of the minimum wage structure on the young—who at present are covered by the same minimum wage levels as apply to more experienced and productive workers. In respect of female participation, inflexibilities in working arrangements may warrant review.

10. A further focus on redeployment services would be appropriate. The Labor Fund could be more active in identifying skills that are most needed in the private sector (e.g., through surveys) and providing adequate training. Targeted policies aimed at disadvantaged groups, notably women and the young, are also needed.

Corporate sector reform

11. Inefficient corporate structures hinder job creation. State and social ownership slow firms’ expansion even when market conditions are propitious. And in other cases, including the oil sector, state and socially owned firms are expressly protected from open competition. The consequent inefficiencies constitute a tax on all other firms, impeding their expansion and job creation.

12. Concerns in Serbia, however, focus on the job-destructive effects of privatization. Given the overstaffing in many state and socially owned firms and that the weakest of the state and socially owned firms remain to be privatized, these concerns are not without foundation. And the impact is likely to be felt most sharply on older workers.6 But there is nevertheless thus a balance to be struck between addressing the preservation of jobs in the state and socially owned sectors and the creation of new jobs which privatization would encourage, both in the sectors being privatized and in other sectors.

13. The severety of loss making in the state- and socially-owned sectors indicates that privatization cannot be delayed. The losses are draining domestic savings and account for much of the external current account deficit. Accordingly, attempts to preserve jobs in these sectors come at high cost in terms of employment elsewhere in the economy. Furthermore, requirements for purchasers of such firms to maintain existing jobs may impede efforts to sell the firms. And as a number of these already have excess debts—which already stand in the way of swift sales—additional requirements on job preservation may not be feasible.

14. Accordingly, efforts need to prioritize job creation given considerable direct job loss likely from privatization and restructuring. Arrangements in a number of areas should be reviewed from this perspective:

  • Labor law, as noted above.

  • Wage and remuneration setting arrangements, especially in the public sector.

  • Overall macroeconomic and business environment policies to ensure conditions propitious to new domestic and foreign private investment.

  • Tax and social benefit policies pertaining to labor, as discussed below.

Fiscal Measures

15. Appropriately designed temporary social assistance programs, possibly including early retirement, may be considered. And in order to ensure affordability, costs of early retirement programs could be contained by providing lower pension compensation until beneficiaries reach full age-based eligibility.

16. Tax rates may also be adjusted. The government has recently adopted amendments to the personal income tax law and the law on mandatory social insurance contributions with the view to stimulate employment. Specifically, the proposal envisages a reduction of the personal income tax (PIT) on wages from 14 to 12 percent, introduction of personal allowance and two-to-three year exemptions from personal tax and the employer’s portion of social security contributions for previously unemployed and new job market entrants under the age of 30 and over the age of 45 as well as the disabled (see Table 2).

Table 2.

Serbia: Changes to the Personal Income Tax and Social Security Contributions. 1/

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To be effective on January 1, 2007.

17. Reduction of the personal income tax rate on wages could facilitate employment. Some empirical evidence suggests that in countries with imperfect competition and less flexible labor markets, lowering direct taxes on labor may help increase employment. In general, however, the role of tax policy in affecting employment is limited and fixing fundamentals at the core of the unemployment problem, such as labor market rigidities and impediments to private sector development play a greater role.7 The expected fiscal cost of lowering PIT on wages is high (over 1.4 percent of GDP) and should be compensated either by a reduction in current spending or an increase in broad-based indirect taxes, such as the VAT, or a combination of both to preserve macroeconomic stability.

18. However, the effectiveness of the proposed exemptions for the young and near-retirees appears to be unclear. While the measure could help bring the young into the formal sector8, thereby increasing the future tax base, empirical evidence suggests that benefits from targeted wage or social security tax reductions are limited due to the deadweight fiscal costs, substitution, and displacement costs. The deadweight loss occurs because some of the employment to be subsidized by exemptions would have occurred anyway. The substitution effect is the incentive to bias new hiring towards the subsidized groups but at the expense of workers who are not eligible for exemptions. Related to the substitution costs are displacement costs as firms that receive tax relief expand and displace employment in the firms that do not receive tax relief. Even though the legislation contains a provision requiring employers not to reduce the number of employees without exemptions as of September 1, 2006, the effect of exemptions on the overall employment may be minimal as substitution and displacement effects may dominate. Moreover, the floor on the number of employees that a firm has to maintain to qualify for an exemption presents an additional market rigidity. And it will not prevent employers from churning employment as they can replace workers who received exemptions after the specified two-three year period upon exemption expiration with the new beneficiaries. Finally, administering these exemptions could be a major burden.

19. The 2006-2008 National Employment Action Plan, developed in cooperation with the European Agency for Reconstruction (EAR), lays out the government’s strategy in support of the ambitious goal of halving unemployment by 2010. Consistent with EU guidelines, the action plan rightly emphasizes job creation and entrepreneurship, promotion of adaptability and mobility in the labor market, developing human capital and increasing labor supply. The task ahead, given employment challenges, is to turn this into a sufficiently ambitious program of specific reforms.

References

  • Nickell, S. 2004, “Work and Taxes,” paper prepared for the conference: Tax Policy and Employment” organized by CESifo.

  • Stanić, K., 2005, “Registered Employment and Wages – Statistic Data and Trends 2000-05,” in Quarterly Monitor (Belgrade: Center for Advanced Economic Studies).

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  • World Bank, 2006, “Serbia: Labor Market Assessment,” (Washington: World Bank).

  • Zee, H., 1996, “Taxation and Unemployment,” Working Paper WP/96/45 (Washington: Iternational Monetary Fund).

3

Prepared by Tokhir Mirzoev, Eric Mottu and Anna Ivanova, with contributions from Janko Guzijan.

4

See Stanic (2005) for a detailed discussion.

5

EU guidelines (Council decision 2003/578/EC) emphasize job creation (guideline No. 2), but do not explicitly discuss prevention of job destruction in the context of structural reform.

6

For example, World Bank (2006) finds that in Pancevo over a quarter of displaced workers had job tenure of over 30 years and only 6 percent had less than ten years of experience.

7

See, for example, Nickell (2004) and Zee (1996).

8

World Bank (2006) finds that at present young workers mostly find jobs in the informal sector, which employed 43 percent of all workers in 2005.