Dejan Šoškić: Serbia Has Low Performance of Domestic Private Investments

There is room to improve the volumes, and especially the efficiency of these investments. But Serbia has extremely low performance in terms of domestic private investments

“Most important factor that influences Serbian economic performance in recent years is relatively low level of gross investments in Serbian Economy. Simply put, without investments, economy cannot grow”, says at the beginning of the DC interview Dejan Šoškić, Professor at the Faculty of Economics in Belgrade.In its latest analysis, the World

Bank indicates that Serbia will not succeed in achieving a 3.5 percent growth and that the Serbian industry is, as they say, disappointing. What led to a slowdown in GDP growth?
— Investments as part of GDP have been on decline since 2012, coming down as low as around 16% of GDP (in 2015) and slowly rising to around 19% of GDP (in 2018). To put  this in perspective, average level of investments in South East Europe (SEE) is around 23% of GDP, economies that experienced episodes of rapid growth had their investments at a level of at least 25% or even 30% of GDP, and some rapidly growing economies in the world have even higher levels of investments. And this has to be sustainable and maintained for years to see real results in terms of sustainable increase in growth rate of GDP. If we want to get to the root cause of low economic growth, we need to look deeper into the structure of investments. We can break down gross investments into foreign and domestic part. Foreign investments can be divided into foreign direct investments (FDIs) and foreign portfolio investments. Serbia is doing well in terms of FDIs, and portfolio investments are mainly in government securities, since capital market (trading in corporate securities) practically does not work. However, episodes of rapid economic growth in various countries around the world have shown that foreign investments, although important, are not essential for economic growth. Essential is what goes on in the domain of domestic investments. Domestic investments can be divided into public and private. Serbia does not fare well in public investments. There is room to improve the volumes, and especially the efficiency of these investments. But Serbia has extremely low performance in termsof domestic private investments. And these investments are crucial for economic growth of the country. That is also an important factor contributing to low level of growth of credit activity of Serbian banking industry, and explains why banks are turning their activity towards households, mainly consumption, with low impact on economic growth. Low level of domestic private investments means that local entrepreneurs are not investing enough. If we know that part of domestic private sector exists dominantly operating with government sector, and takes part of the pie of domestic private investments, it means that real market oriented, competitive private sector, that is a major pillar of increase of sustainable growth of the economy as a hole, invests even less. This brings us to fundamentals of the problem. Any country that erodes institutional capacity (mainly through excessive and destructive political influence over institutions) faces a realistic possibility that residents (who understand local modus operandi best) may perceive local business environment as incapable of protecting private ownership, contract, and fair market competition. In such circumstances local entrepreneurs do not invest. Eroded institutional capacity, weak rule of law, and high perception of corruption has become a serious limiting factor for higher economic growth in Serbia. Some could say that this is now a wider problem, since Western Balkans cannot really move forward if Serbia, by far the major economy of this group of countries, is trapped in years of low economic growth, and without policies in place that can change growth prospects for the better.

You said recently that local business people must be encouraged to invest. How can that be done?
— Yes, local business people are drivers of domestic private investments that are crucial for economic growth. As we know, these investments are very low in Serbia. Encouragement to invest comes from favorable business environment. This means among other things, effective rule of law, fair market competition, low (no) corruption (not capable to distort market competition), simple business administration, increase in overall institutional capacity, etc. In addition, (much) better excess to finance for micro, small and medium size enterprises, especially if they are part of so-called tradable sector of GDP.

Civil servant salaries and pensions in Serbia went up on November 1st. Is this a good economic decision in the long run?
Not really. To some extent there was room to increase certain salaries, but not in the extent and in a way it has been done. Much more important work has not been done, and that was to introduce higher level of order among salaries in overall public sector, and to give a positive bias towards education, science (research and development), judicial and health care professionals. These professionals have been for years neglected and are of most importance for well functioning of a society as a hole. At the same time, these sectors need to be reformed with the aimto substantially increase their capacity. Well educated, skilful, and healthy individuals are a cornerstone of every competitive economy and can substantially determine the position of a national economy in a global market as well as future wealth of the nation. As for the level of increase of pensions and civil servant salaries, one thing not to forget is that rate of increase of wages should not exceed rate of increase in productivity (plus inflation). If, however, we do this we will increase socalled unit labor costs, hampering competitiveness of the economy, and also increase cost push for inflation. In short, increase in salaries and pensions were a bit higher then should have been.

Although wages are rising, what is the real purchasing power of Serbian citizens? What about a consumer basket; hasn’t its value been growing for years too?
Yes, there is inflation in Serbia, but it is low. And yes, real purchasing power of household income is decreasing due to inflation (measured in Serbia with Consumer Price Index – CPI). However, at the same time, in Serbia we are also delusional with the value of our salaries expressed in Euros, as if that was the real value of our salaries, not the purchasing power of our salaries in terms of goods and services we can buy for our incomes. And this delusion of level of salaries in Euros is promoted even by some politicians. The problem with this is that expression of salaries in Euros neglects inflation in Euros. So when salaries in Euros increase, that does not mean that the living standard has increased, at least not in the same proportion. In addition, if exchange rate is fixed (or appreciating) as is the case in Serbia in past couple of years, we may have so-called real appreciation of local currency (if local inflation is higher than inflation in anchor currency). This has the effect that increase in salaries in Euros, again, does not necessarily mean that there is an increase in purchasing power of our salaries. Since Serbia is on average a very stagnant economy in the past decade, there is no real room for significant real increase of salaries. That is the main reason why we need to invest, and to grow more.

You were the governor of the National Bank for a while. What is your opinion of the current monetary policy of Serbia?
— Monetary policy is for years back, more restrictive than necessary, because effectively it has shifted from Inflation targeting (which is officially still our monetary model) to Exchange rate targeting what the NBS is doing in practice. This has contributed to lower rates of economic growth since 2012. At the same time, almost nothing has been done in the domain of Dinarization which is crucial for Inflation targeting to work. And that also proves that NBS is really not interested in making Inflation targeting work, but rather to fix the exchange rate. Fixing the exchange rate is technically very simple but then effectively there is no monetary policy. But it seems that what is important is that it is very popular. Importers can more easily import and sell on domestic market. Government can have lower levels of debt to GDP levels (since majority of debt is in Euros and Dollars), and can claim that salaries are rising in Euros. Citizens can more easily repay their loans in Euros and pay for vacations abroad. Companies face no fx risk, and even NBS easily brings inflation to low levels since there is no so-called passthrough effect of depreciation into local prices. In a short, everyone seems happy in a short run. However, this has a price. The price is that the most important part of the economy, local producer using local inputs, becomes less and less competitive on local and international markets, and in the long run, economic growth has to slow down. At the same time, trade deficit starts rising, as we now see that it is happening in past couple of quarters, and that can increase current account deficit and gradually bring Serbia back on the trajectory of increasing debt. In short, fixing the exchange rate may be an option for Serbia, but it should be done officially and with understanding that for it to work in the long run, it has to go hand in hand with substantial increase in investments, economic growth and productivity growth.

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