The model of economic growth must change

On the day we spoke with Vladimir Vučković, the work of his former colleagues from the Fiscal Council - Pavle Petrović, Danko Brčerević and Slobodan Minić - was published under the title "Economic Development of Serbia: Between Building Institutions and the Trap of Medium Development". Vučković was a member of the Fiscal Council for 10 years, and today he is a leading economics lecturer and the director of the career development program of the Mokrogor Business School.

"With these trends and attitude towards institutions, Serbia is doomed to failure. An economic model that sees its support in the state, closely connected domestic elites and foreign investors driven by cheap natural and human resources - can only bring short-term macroeconomic gains. In the long term, such an approach inevitably leads to stagnation, because it increasingly subordinates the economy to a privileged elite that stifles competition, innovation and social mobility.

Therefore, only deep reform, i.e. building an inclusive institutional system can change the trajectory of a country that has been operating well below its capabilities for too long. It will not be easy, because it penetrates the very foundations of the existing order and directly hits the interests of powerful and entrenched structures. However, the construction of such a system, which rests on the rule of law, competitive market competition, clear, predictable and equal rules for all, is the only way for Serbia to ensure stable economic prosperity and join the high-income countries", write Petrović, Brčerević and Minić.

With Vladimir Vučković, we are talking about exactly that trap - why a country, after reaching a certain level of development, simply cannot progress further without "thick" changes.

VLADIMIR VUCKOVIĆ: It's good that that question is coming back, because it is very relevant for us and for others. It is about countries getting stuck at some level of development between 10.000 and 15.000 dollars GDP per capita. They manage to get there, but beyond that it is very difficult and they get trapped there. On the negative side is the fact that only a third of the countries managed to overcome it in the last 20-30 years. It is positive that all the countries from Central and Eastern Europe, with which we are most often compared, succeeded.

We feel that we are there somewhere without the fuel to go above $14.000-$15.000.

The World Bank points to that, as do the authors you mentioned, and this is also the general opinion of the professional public: we had some fuel that is slowly being depleted. When you enter the structure of economic growth, you can see that it was a consequence of the state's investment activity, foreign direct investments, and we can practically stop there.

Why? State investments boosted construction activity, foreign direct investments boosted, among other things, mining, and the only thing that appeared off the radar was the ICT (Information and Communication Technologies) sector. It was the only one that had autonomous growth beyond the activities of the state and foreign investors. I would say that is not unusual for the first stage of development, but the problem is - what to do next. Now is the right time to talk about it. We can no longer count so much on the activity and investments of the state, because they are already at around seven percent.

WEATHER: But we have Expo., who will have two more-three years to push those investments.

In the fiscal strategy, the state plans to keep it at seven percent of GDP, so there is no growth that would push it further. It was easy for us to make those investments grow in the previous 10-15 years, because at one point they fell to only 2,5 percent of GDP, now they are seven. Even if the state executes everything it plans, which will not be easy, we will still not have an impulse from there. Foreign direct investments are already falling, last year they were slightly positive - when the inflow of new investments and the outflow of capital, dividends and profits are deducted, it came down to only 300 million euros, while they were almost two billion euros. The big question is what will happen to the inflow of investments due to the crisis in Europe and the world, due to our increasing labor costs in euros, because we are no longer so competitive, so investors can move away from here, as we already have cases, as well as whether our political and social situation will turn some away. All that remains to be seen.

So - you can no longer count on the state, it's difficult on foreigners, and then the question is - what about the domestic private sector. This is a topic that has been talked about for several years, and now is the right time to at least begin to eliminate the causes of the weak domestic private sector. We have never solved those causes, it is about that famous story about institutions.

Indeed, we did not solve them neither in the previous 15 years, nor in the nineties, nor after the Second World War - we actually need to finally cross that step and become a country where the private sector and entrepreneurship are dynamic, where they develop and where something else like the IT sector emerges.

photo: marija janković

And in order for that private sector to develop, people need to be free to think, to invest, and for that they need contract protection, stability - both macroeconomic and political - as well as feeling that they can market their products beyond public policies and official politics. Here, the first impulse of business people is to tie themselves to the government, because they see the opportunity to get jobs there, and we need the exact opposite: a large number of companies that are founded even without such a business concept.

Petrovic, Brčerević and Minić also state the average number of companies based on a thousand inhabitants: We have about 30, and in Central and Eastern Europe 79 companies. So, we are not ready for those things yet.

That's not good. Hope is given by a period that we had and which in the last 20-30 years is, we can say, a "golden age" for us, that is somewhere from 2018 to 2023-24 in terms of average results, where we grew somewhat faster than the environment, from Central and Eastern Europe. Somehow, a revival could be seen after the fiscal consolidation, because, along with favorable international winds, that entrepreneurial impulse also appeared.

It was an ideal situation. - zero interest rates, plenty of money...

That's right, there were those things, of course, inflation started after the corona, but from 2015 to 2020 it was felt. Then people started breathing and growing, although not enough, and even though we are talking about traditional sectors of the economy. But it turned out that it can also be done in our country, as long as entrepreneurs are allowed to develop a little.

The other day, the president said in an interview on RTS, roughly, if we were to do an economic feasibility assessment, we would never build anything. So, it was all built as it was without any thought about whether it was necessary, how and how much is needed, when will it pay off... Less and less-more arbitrary: for example, for the Expo, there was never any discussion about why it was being built, why not something else?, we already had the situation from 2019 again. years, when the president simply appeared on television and said what would be built according to theirs (private) the plan that was then called "Serbia 2025".

That is an important question - what is being done and what is the selection of priorities. Little progress is being made in terms of transparency, because now both in the fiscal strategy and in the budget we have at least listed projects that the state wants to do - now you can see different sections of roads and the like, so we can at least discuss it a little more than before. But the second part – why it is done – still remains questionable. None of us can be expert enough, nor should we evaluate every road section, every airplane purchase, every government project, like the Expo, like the national stadium. It is the state that should prove that we need it, regardless of what we think. But there is no such thing.

I would not agree that it is impossible to prove it and give an explanation why a certain project is profitable, because in cost-benefits analysis, there is a methodology that evaluates the effects in the long term, and for everything that is an economic and non-economic indicator - and this can be translated into an economic indicator. So, if we build something in Serbia that is run as an Expo, even though it doesn't have much to do with it at first glance, maybe it doesn't have immediate economic profitability, but if we predict that some activity will develop there, so that it will bring some value, then we can project it and include it in the result.

If we had that kind of calculation and explanation, we could sit back and cool our heads and say - okay, this is convincing, or maybe this is too optimistic. This way, we are left to believe or not believe the state at its word, which is not good, and then we automatically turn out to be someone who supports or is against some state project. We convince ourselves with words whether we need that national stadium or subway or not. In that essential sense, we have no progress. It is the state's obligation to provide that type of analysis, and then we look much more coldly at whether it is profitable or not.

What are the consequences of such a state economic policy?

So far we have had a positive consequence in terms of mathematically getting a higher growth rate. If you raised public investments from 2,5 to 7 percent of GDP, that had to be reflected in a higher growth rate.

You could also build a pyramid and you would get a higher growth rate.

He would have gotten some result, maybe not quite like the pyramid, if nothing happened around it, because in that period we had some undoubted priorities: to finish the highways, there was not much that could go wrong. Now we are already on the field - do we really need all that or not. And because of this, a more careful analysis is much more necessary than a few years ago.

Let's say "bursts" - we can talk based on our own impression and feeling, whether we need it or not, from whom we will defend ourselves, but if I saw some analysis that said: states invest regardless of whether they are in NATO or not, especially if you are not in NATO, then you invest more, so let's see some military doctrine, so if we know that there is a strategy, we would have much more confidence that it is really necessary. This is how we get the impulse to criticize.

This way of investing - and we saw it in the Novi Sad canopy - carries with it great risks of corruption. For that Belgrade railway - There were more than 130 subcontractors in Subotica, so the price increased... How much citizens actually lose due to so much corruption - assumed, since we don't have any court cases yet?

There is again an assessment that was made earlier. In the best days and periods, we "revolve" around a growth rate of around four percent. This is also the case in this "golden sub-period", and if we had better institutions, which include the issue of corruption and the rule of law, it would be five percent without any problems. Therefore, one percentage point or 25 percent - the growth would be so much higher and so much more money would be in the system - thus wages would also be higher - so that we can have a more orderly state.

It manifests itself on many levels. Empirical evidence, both here and in other researches, shows that emigration is much higher from countries where the situation in the state is not settled. It is logical, but there is also a bill for it. Therefore, there would be much less than the 40.000 people who leave Serbia every year, or many more people would return than half, approximately, as estimated - if only we had a more orderly country. And that is the channel through which we would have a greater incentive for domestic growth.

We evaluate this on the basis of the hard work of journalists and the discovery of various omissions, as well as on the basis of what some international and domestic organizations measure and where it can be seen - from the World Bank's global management indicators, the perception of corruption, Transparency, the report of Reporters without Borders, the degree of economic freedom of the Heritage Foundation... This shows that we are poorly ranked, which is not good, and what is even worse is that in the last 10 years, as a rule, we have regressed. So, just in the period when that exhausted way of growth should be replaced by the domestic sector, we have worsening conditions for the business of that domestic sector.

It doesn't take much to see what should be the focus of problem solving. Always "the next two weeks are crucial", but this year really has to be a turning point, while we still have some results. We clearly see that model is coming to an end, so we need to move to the next phase and address it slowly - which would start to produce results. We must not talk about how, in two or three years, we will have a recession again, so we have to reduce salaries and pensions, so we are debating about the percentage reduction and the like. Everything has been known for some time, now there is light on it - fix the country in order to create the conditions for progress and to finally get out on the green branch.

photo: marija janković

If it doesn't get fixed, What's next for us??

If this is not improved, we will first have a period of moderately good growth rates, where the matter will not be exposed immediately. This year we will have about three percent GDP growth, next year maybe the same. If the situation in the world does not deteriorate, based on this real growth, we will perhaps have some improvement in income and pensions, but the next crisis will come, which will expose the fact that we no longer have budget reserves or strength in the economy to grow further, and then we will again talk about whether salaries from the budget sector will grow at all or only by two percent, or whether they will have to decrease, as in 2014.

The seeds of a future situation are always sown today. Economists are boring because they keep bringing the story back to healthy growth fundamentals. Because without that there is nothing - everything else is a redistribution of an ever smaller cake. We had that statement - that the growth model must change - at least three times during my career, which has lasted almost 30 years.

Whenever the cycle ends, the question is always raised: at the end of the nineties, it was clear that everything had to change, to reintegrate the country. Then from 2000 until 2006-2008. there was a huge current account deficit and spending was based on privatization. At that time we said "the model must change", and the crisis of 2008 exposed all that. However, immediately after that, we embark on profligate budget spending and say that the model has to change. Because the model hasn't changed, in 2014 we got to the point where salaries and pensions are being cut to bring things back to normal.

Then, in 2015, we took a step forward and it continues until today. This is what we have now - the state has become a little more tidy, foreign direct investments are coming, the corona has disrupted it a little, but again now we are talking - the model must change. So, on four occasions - at the end of the nineties, 2008, 2014 and now - we have been saying that the model of economic growth must change, and during all that time the state actually dictates our living and business conditions: through privatization, through borrowing, through the inflow of capital, through the encouragement of foreign investments, through the fact that it has always used every budget reserve to the maximum for the payment of salaries and pensions. During my professional career, the private sector was never in the focus of the state, never - neither to create conditions and equal rules for everyone, nor to reduce taxes, levies and contributions to work a little more in conditions of a high budget reserve - this was only timidly done occasionally, nor to ultimately build the infrastructure to the end, all except roads.

Da, but the local roads are in a disastrous condition.

That's right, local roads, energy, communal infrastructure... It's never been done and it's unfortunate.

You mentioned how much wages in the public sector have been rising in the last few years, It's similar with pensions.. Are such increases creating a problem for us somewhere??

It goes to the upper tolerance limit, to the limit of sustainability. We have an arrangement with the IMF and sound fiscal rules for wages and pensions - the mass of pensions and wages is kept at around 10 percent of GDP. That's the maximum - it hasn't crossed the maximum ceiling, but everything is staying in the red zone. The total deficit is three percent of GDP, and it should not be that much, it is not desirable for Serbia. It can be less than two percent and it should have been, but it wasn't. So that everything is kept under control, but on the verge of breaking. God forbid that another external crisis occurs, that public revenues fall, then the question would arise as to how to keep it at that 10 percent of GDP. At the very least, growth would have to be much slower, if I'm not talking about the reform of wages in the public sector and pay grades that haven't been there for many years, and were talked about so much. Despite that mass, which did not exceed the limit of sustainability, we did not tidy up the yard in that part.

There is also the eternal question of the exchange rate of the euro against the dinar.

Economists often say that it is better for the exchange rate to slide a little, to grow, than to be fixed. As a rule, the public frowns, because people, even businessmen, are often satisfied with this stable exchange rate. But again, there can be a situation where, instead of there being slight movements every year by a dinar or two, the euro goes from 117 to many dinars higher, in a short term. We constantly have a deficit in exchange with the world, and it is a well-known story that we covered it primarily with foreign direct investments. We can see that things are turning around there as well. The National Bank of Serbia has large foreign exchange reserves, but it is already beginning to spend a little of them and to intervene in the foreign exchange market. What if the environment is so bad that the inflow of capital dries up and foreign exchange reserves are increasingly consumed? Then we would come to a situation where there is no more foreign exchange for stability.

Where would that deficit be covered from??

Either from borrowing or by moving the exchange rate. Neither is good if it is sudden. It is better to think in time. Whenever there are episodes where the exchange rate can go up, the National Bank should let it happen. Truth be told, we had plenty of capital, so the NBS intervened on the other side, we can't blame them much.

But it is not their mandate to hold a fixed exchange rate.

No, the mandate is prices, but it is also done through a stable exchange rate. When it comes to labor costs in Serbia, they would not have increased so much if the exchange rate had gone up. In euros, our earnings would look smaller - which is not very good politically, and not very good in people's minds - but they would be realistic. We would have a real increase in wages in Serbia, objective, and not that doping that the exchange rate adds to the whole story.

If we continue to keep the fixed exchange rate, and the situation kept getting worse, What awaits us next??

This situation can last as long as the balance of payments balance is more or less there, but if there is an ebb of capital, then the exchange rate can suddenly go up, which would not suit anyone. Even those who advocate depreciation do not think that it should happen suddenly, but that it should be a controlled process. If it happens suddenly, then it is not good for anyone, it is a new instability, which can encourage a further increase in prices, people would hesitate to invest... Control of all those processes is very important, and that is forgotten when we are in a good period. Then these things slip out of our focus, but it's like with the body - it's not enough to strengthen only the arms - you have to take care of your legs, heart and stomach, so you take care of everything when conducting economic policy.