Making Competitive Business Environment: The Case of Serbia

By Rok SPRUK

Serbia has emerged as a post-communist economy. Economically, the country has severely suffered from periods of high inflation, double-digit unemployment and rachitic output. The environment for doing business has been marked up by unfriendly conditions for investors, offering poor protection of private property against the expropriation. In macroeconomic terms, Serbian central bank has accelerated a move towards the stabilization of inflation shocks relative to the volatility of the GDP in forecasting annual growth. Despite the lack of discipline in targeting inflation, whether it be in terms of searching a nominal anchor, or in terms of disciplined pursuit of rules rather than discretion with respect to policy actions of the central bank. Five-year average compound annual GDP growth of Serbia currently stands at an internationally enviable 5,2 percent; a noteworthy respect with regard to GDP convergence and growth outlook in the long-run macroeconomic perspective. Periods of severe economic depression, low GDP and prosperous outlook of market performance have made Serbia a place in particular interest of international economic community. As Serbia is getting forward in both economic and political integration, there is becoming a space for improvement in macroeconomic performance, such as preserving low inflation through undistorted policy of inflation targeting undertaken by the central bank. To achieve this target, the central bank as a monetary policymaker, is ought to absorb a central measure of independence to sufficiently meet its targets. Since 2000, Serbia has made significant progress, output has increased by 40 percent with a composed 8 percent GDP growth in 2004. With regard to global competitiveness, the share of private sector in the GDP has steadily increased which is an important aspect of anchored aggregate tax burden in benchmarking Central and Eastern European countries.

The Role of Economic Freedom

There is a high degree of confidence and agreement upon economic analysts and policymakers about the role of macroeconomic climate in a long-term agenda of supporting GDP growth as the primary aim of an economy with cyclical fluctuation and notably accelerated GDP convergence in the context of an economy in transition. Serbia is no exception to that rule However, the data regarding the degree of economic freedom is hardly available in case of Serbia as internationally recognized surveys about the state of economic freedom is methodologically still not graded. However, the signs of progress are notably visible. Not to praise the actions of macroeconomic policymakers ought not to be praised to much as the data analysis conducted by international organizations have, in the case of Serbia, shown the lack of efficiency of public administration arose from unexpectedly high government spending fueling the fiscal wedge by adding the burden of punitive tax rates to the sources of productive behavior and its compounded components such as capital gains.

Sweden’s Path to Prosperity

During 1890 and 1950, Sweden sustained one of the most rapid growth rates in the world and by 1950 it emerged as the wealthiest country in Europe. During that particular period which yielded an enviable standard of living as well as one of the highest per capita GDP in the world, Swedish fiscal policymakers instituted a restrictive fiscal policy whereas the aggregate tax burden never exceeded 12 percent of the GDP. Sweden’s economic performance stagnated from 1970s onwards. Fiscal policy of that time relied on the experiment of intrinsic aggregate demand given the fact that in 1986 marginal tax rate on individual income exceeded the rate of 90 percent. Consequently, budget deficits soared and public debt moved closely in line with 70 percent of the GDP. Sweden thus slid into the spiral of inflation pressures and concerning structural parameters. By 1992, Sweden’s GDP decline reached the historical record low and the country which once reached the 3rd place in OECD’s Prosperity League shrank to 14th place by 2003 respectively.

The Need for Further Tax Reform

As the objective of the tax system depends on the revealed preference of the policymakers to deliver certain goals, the taxation of corporate and personal income significantly affects the GDP growth. As the notion of the Laffer curve says, the higher the tax rates, the less revenue. According to the lesson of the Laffer curve, one could believe that the optimal tax rate on any source of productive behavior is 50 percent, but recent evidence has shown that the foremost horizontal scale of corporate or personal income tax is between 11 and 18 percent, depending on the details of economic growth, recent experience, business cycle, investors’ behavior, and estimated forecasts regarding the macroeconomic performance. It should be noted that the real aim of tax reform is not to benefit certain group of population but to reduce aggregate tax burden since the benefit of revenue-neutral tax rates, meaning that income is treated equally regardless of the size, is huge and positive to the course of dynamic growth. The benefits from low taxes on capital and individual income are several-fold. One of the benefits observed in many countries, including Serbia, is that lower rates on productive behavior result in less attractive tax evasion, thus generating more revenue from larger tax base reflected from reduced aggregate tax burden measured as percentage of the GDP. As government spending is a particular concern for Serbia in the long-run, the experience of other countries or even more importantly, the conclusions of economic research and empirical evidence, suggest that pro-growth macroeconomic policy is best designed through curbing the inflationary pressures, restrictive fiscal policy and revenue-neutral tax system with possibly flat-rated taxes and no exemptions, deductions or specific allowances as the abovementioned reasons for the emulation of growth-supportive macroeconomic policy is the most obvious reason to pursue a stable environment for doing business and meeting macroeconomic ends attached to global challenges and opportunities.