The problem is not so much that this government will not be able to introduce any significant reforms ahead of the upcoming general elections, but that it did very little in the past three years and is therefore going to pass to the new government a very long reform agenda and a significantly worse economy. Political and social stability have also not improved during the mandate of this government. Finally, the overall circumstances, at home and even abroad, are less than helpful for an ambitious reform program.
How did this current impasse develop? The initial problem was a strategic error of judgment. After the last general elections, in 2008, the government was formed around a policy agenda that was premised on the continuation of high growth, which would support a significant increase in social transfers, centred primarily on significantly higher pensions. Indeed, rather than aiming at the reform of the public and social obligations, they were significantly increased and further increases were promised or expectations spurred. The overall mood was that the transition was all but finished and further significant reforms were not believed to be necessary. It was time to cash in as it were.
This quite inappropriate political program was followed with a slow and defensive response to the crisis which erupted almost immediately after the government was formed and the decisions on the increases of fiscal obligations were taken in the autumn of 2008. Though a standby agreement was negotiated with the IMF, its aims were to stop the run on the banks and to enable the servicing of external obligations. As for the policy and reform agenda, it was almost entirely concentrated on reducing the effects of the increase fiscal obligations. Indeed, during the next three years, the government was mostly concerned with the containment of the fiscal obligations. These efforts culminated with the adoption of the fiscal rules, which were supposed to stop the increase of public debt to GDP ratio and to reduce the fiscal deficit to 1 percent of GDP in the medium term. Throughout the crisis, the government declined to contemplate any serious structural reforms. As a consequence of the crisis, the fiscal problems, and of the passive attitude towards structural reforms, the development in the labour market proved to be catastrophic. For the past three years, employment dropped by about half a million people. The unemployment rate jumped to over 22 percent and there was a sizable increase in inactivity. Still, the fiscal situation did not improve significantly and the newly adopted fiscal rules were flouted almost at the moment when they were introduced into the law. The overall social situation deteriorated markedly and that made reforms even less attractive to the government.
Again, an error in judgment followed. It looked as if the economy would start to improve in 2011 and then grow rather strongly ahead of the 2012 general elections. The government adopted a long term program, Serbia 2020, which anticipated strong growth and a sizable improvement in employment. That optimism proved to be short lived. The first setback was the failed tender to sell Serbian Telecom. The interest was not there and the offered price was far below the one that the government was hoping for (800 million euro rather than 1.4 billion). Then growth prospects dimmed as the external conditions deteriorated. Thus rather than a significant speed up of growth, stagnation is more of a realistic pre-election prospect. If these developments indeed unfold, the labour market picture will continue to deteriorate up until election time, which is expected to take place sometime in late April or early May 2012.
In the remaining half a year or more, reforms cannot be expected. The usual pre-election program of the government is to increase public spending in order to improve its chances to be re-elected. Most of the reforms that are needed are not popular so they come with a large potential loss of votes. But even beyond that, the initial program of the government and its handling of the crisis does not give it a mandate to propose and attempt to carry out really significant and far reaching reforms. It is hard to envisage that they would getsupport, not just in the public but amongst the governing coalition of parties. Besides everything else, the governing parties basically have no clear idea about the reforms that are needed and about the ways in which they would be introduced and implemented.
On top of that, the political debate has so far avoided the crucial reform issues. The opposition parties are not offering alternative programs as they judge that they can win on the lousy record of the sitting government and are not seeking a mandate for reforms from the electorate. The programs that have been offered so far are either fragmentary or populist. There are no comprehensive policy reforms on offer, so there is hardly anything that the electorate has to choose from.
The additional problem is that the reform pressure that is coming from the outside, from the EU and the IMF, does not really go to the root of the problems. The IMF is mostly concerned with fiscal reform, which basically centres on the reduction of spending. Without a change in the structure of spending, however, reduced public expenditures will only lead to a decline in employment and income. Together with that, possible tax reforms would lead to higher burden on labour income, which again may produce more social problems than incentives for investments and employment. The EU, on the other hand, requires reforms that may have long term effects, but will not address the short and medium term problems. In the past, the process of accession to the EU was accompanied with significant increases in foreign investments. This is now unlikely given the developments in the EU economy. Therefore, the reforms need to be targeting economic growth based on different drivers than was the case before.
All that leads to a rather unhelpful state of affairs where the government will not do very much if it does anything at all for the remaining time before the elections. Recent decisions connected with the IMF negotiations, and with the budget revision, indicate that the government will adopt the usual pre-election strategy. It aims to increase current spending and reduce capital expenditures in order to achieve some short term improvement in other segments of the electorate. More of that can be expected in the budget for the next year. Some reforms that redistribute benefits from central to local governments, e.g. the increase of local budgets and an increase in the responsibilities for Vojvodina have either been adopted or will be introduced soon. The implementation of these types of changes usually takes a lot of time and it will really depend on the next parliament and government whether those will be kept, or rather reversed.
Other reforms cannot be expected. Privatization is not going anywhere since the ill-fated attempt of the sale of the Serbian Telecom earlier this year. Also, the reforms that aim at improving the business environment cannot be expected, which is probably the main problem currently and in the medium term. The corporate sector is facing liquidity problems and needs a rather aggressive and sustained restructure, which is unlikely to happen in the remaining pre-election time.
The fiscal and reform of public expenditure is long overdue, but is being pushed down the policy agenda simply because it is becoming more and more demanding as time goes by. Nothing is done. This will be the main legacy of this government. Tax and expenditure reforms could have been easier to do at the beginning of this government’s mandate and reforms in the labour and product markets could have been done speedily under the pressure of the crisis. As those opportunities have been missed, the costs of reforms increased and will be even higher once the new government is in power.
The incoming government will have the choice to either adopt a program of rather radical reforms or to continue to muddle through because of the problems that it will inherit from the current government. If economic growth continues to disappoint, employment will continue to decline and social problems will continue to pile up. This is not an environment in which business can thrive, and indeed the problems of liquidity in the public and the corporate sectors can improve. Thus, the costs of reform may prove to be high for the next government to address quickly and decisively.
In essence, the basic incentive structure of the economy needs to be changed. That means that a far reaching reform of the public sector is needed. The government needs to reform the pension and social security systems and to increase incentives for work and investments. This is not a question of a reduction of budget deficits, which can hardly be achieved anyway with economic stagnation. It is also not something that can be achieved just with a tax reform as long as the level and structure of public expenditures is not changed.
The overall level of tax burden can only be reduced if public spending is reduced. And that means that much of what is currently done by the state needs to be left to households and corporations to do. This should increase the level of savings and thus support investments. Overall, employment levels need to be increased dramatically. In the eight or so years prior to the crisis, growth was predominantly driven by improved productivity, which meant that growth of GDP was accompanied with falling employment. The crisis shaved off another large number of people from the employment list. This needs to change. Growing employment is the key to social and political stability and to economic growth. It needs to take place in the private, and not in the public sector. And needs to be financed by growing domestic savings and driven by exports.
This is the reform agenda for the next government. In the time that is left, the outgoing government will unfortunately go in the opposite direction in the hope that it will be re-elected. As a consequence, it is not clear whether the next government will have the courage to decisively reform the economic system and introduce the pro-growth measures.
CorD Magazine, 03.10.2011.