SERBIA INVESTMENT CLIMATE ASSESSMENT

Transcription

1 THE WORLD BANK SERBIA INVESTMENT CLIMATE ASSESSMENT DECEMBER 14, 2004 Finance and Private Sector Development Unit (ECSPF) Europe and Central Asia Region The World Bank

2 CURRENCY EQUIVALENTS (As of January 13, 2004) Currency Unit: Exchange Rate: US$1 = WEIGHTS AND MEASURES The metric system is used throughout this report FISCAL YEAR ABBREVIATIONS AND ACRONYMS BEEPS CODB CLDS EBRD ECA EIU EU FIAS FDI GDP GNI HBS ICA ILO LFS MAEWS MCI MoE MoF MoJ MoLSA MoT OECD PICS PRSP SAA SAM SME SOE SOF TFP WDR WEF WTO Business Environment and Enterprise Performance Survey Cost of Doing Business Project Center for Liberal and Democratic Studies European Bank for Reconstruction and Development Europe and Central Asia Region Economist Intelligence Unit European Union Foreign Investment Advisory Service Foreign Direct Investments Gross Domestic Product Gross National Income Household Budget Survey Investment Climate Assessment International Labor Organization Labor Force Surveys Monitoring, Analysis and Early Warning Signal Ministry for Capital Investments Ministry of Economy Ministry of Finance Ministry of Justice Ministry of Labor and Social Affairs Ministry of Trade Organization for Economic Cooperation and Development Productivity and Investment Climate Survey Poverty Reduction Strategy Paper Stabilization and Association Agreement Serbia and Montenegro Small and Medium Enterprise State Owned Enterprises Socially Owned Firms Total Facto Productivity World Development Report World Economic Forum World Trade Organization Vice President: Country Director: Sector Director: Sector Manager: Task Manager: Shigeo Katsu Orsalia Kalantzopoulos Fernando Montes-Negret Gerardo Corrochano Itzhak Goldberg 2

3 TABLE OF CONTENTS EXECUTIVE SUMMARY...6 CHAPTER 1: INTRODUCTION...18 CHAPTER 2: PRODUCTIVITY, OWNERSHIP AND THE INVESTMENT CLIMATE IN SERBIA AND WORLDWIDE...21 CHAPTER 3: MACROECONOMIC CONTEXT AND INVESTMENT CLIMATE PRIORITIES...32 CHAPTER 4: LEGAL, REGULATORY AND INSTITUTIONAL FRAMEWORK...39 Ownership, Entry, Competition and Exit...39 Contract Enforcement...46 Regulatory Burden...50 CHAPTER 5: FACTOR MARKETS...55 Access to Finance...55 Labor Market...63 Land Issues...70 CHAPTER 6: KEY POLICY RECOMMENDATIONS...73 BIBLIOGRAPHY...78 Appendix 1: Factor Analysis...81 Appendix 2: Comparing TFP across countries using firm-level data...83 Appendix 3: ICA Reference Data...96

4 Acknowledgements: The report was prepared by Itzhak Goldberg (Team Leader), Branko Radulovic and Professor Mark Schaffer with the assistance of Katarina Stanic, Alexandra Drees-Gross, and Jasna Vukoje. Comments from Andrew Stone, Ardo Hansson and Roy Pepper, peer reviewers, and Mamta Murthi, Peter Kyle and Ali Mansoor are acknowledged. We would like to thank Deputy Minister Vlatko Sekulovic for very helpful suggestions as well as to participants of the Employment Growth Forum, organized by the Center for Liberal Democratic Studies (CLSD) in Belgrade where ICA was used as a key background paper. Finally, we would like to thank Qimiao Fan and Alberto Cruisciolo for their support through World Bank Investment Climate Capacity Enhancement Program and to participants of the GDLN session on Access to Finance and Contract Enforcement Workshop for very useful discussions. 4

5 INVESTMENT CLIMATE AT-A-GLANCE Serbia and Montenegro Croatia Poland Bulgaria MACROECONOMIC GDP growth (annual %) GDP per capita, (constant 1995 US$) 1,830 5,440 3,770 1,720 Foreign direct investment, net inflows (% of GDP) Trade (% of GDP) Inflation, GDP deflator (annual %) Gross capital formation (% of GDP) Gross domestic savings (% of GDP) TRADE AND BALANCE OF PAYMENTS Imports of goods and services (% of GDP) Exports of goods and services (% of GDP) Total debt service (% of exports of goods and services) Current account balance (%of GDP) STOCK MARKETS Stocks traded, total value (% of GDP) Stocks traded, turnover ratio (%) Market capitalization of listed companies (% of GDP) BUSINESS REGULATIONS Number of procedures to start business* Number of days to start business* Cost to start business (in % of GNI)* Number of procedures to enforce contracts* Number of days to enforce contracts* 1, , INFRASTRUCTURE Energy use (kg of oil equivalent p.c) 1,507 1,771 2,344 2,428 Internet users (per 1,000 people) Mobile phones (per 1,000 people) Roads, paved (% of total roads) Telephone mainlines (per 1,000 people) GOVERNANCE AND OVERALL REGULATORY QUALITY Index of economic freedom** Government effectiveness*** Regulatory quality*** Rule of law*** Corruption*** POPULATION, HEALTH, AND LABOR Population, total 8,160,000 4,465,000 38,626,000 7,965,000 Life expectancy at birth, total (years) 72,7 73,8 73,8 71,8 Mortality rate, infant (per 1,000 live births) Age dependency ratio Health expenditure, total (% of GDP) Unemployment, total (% of total labor force) SOURCE: All data are for drawn from the World Development Indicators Database, 2004, World Bank, unless otherwise noted. Data are for , except for paved roads (1999) *Data are from Doing Business Database, Private Sector Advisory Service, World Bank Data for starting business are for 2004 and for contract enforcement for 2003 **Data are from O Driscoll, Gerald and Edwin J. Feulner, Mary Anastasia O Grady, 2003 Index of Economic Freedom, Heritage Foundation, Measures of economic freedom (or the absence of government coercion or constraint on the production, distribution, or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty itself) based on the unweighted average of 10 categories (that are aggregates of 50 economic variables). Each factor is scored according to a grading scale that is unique for that factor. The scales run from 1 to 5 with a score of 1 signifying an institutional or consistent set of policies that are most conducive to economic freedom. ***Data are from Kraay, Aart, Daniel Kaufmann, and M. Mastruzzi, Governance Matters III: Governance Indicators for , The governance indicators in are measured in units ranging from about -2.5 to 2.5, with higher values corresponding to better governance outcomes (data are for 2002). 5

6 EXECUTIVE SUMMARY Objectives The objective of this Investment Climate Assessment (ICA) is to (i) provide Serbian experts in academia and in government, as well as Bank staff, with an empirical analysis of the investment climate in Serbia; and (ii) to discuss policy options, based on this analysis, for creating an enabling environment conducive to private sector development, thereby increasing and maintaining enterprise productivity and profitability leading to sustainable growth. The study is part of a Bank-wide effort, managed and funded by the Investment Climate Unit of the Investment Climate Department (CICIC), to analyze the effects of various characteristics of the investment climate on productivity in an international context. One of the main messages of this ICA is the need to increase investor confidence in Serbia; the ICA identifies a number of policies that, if implemented, could improve the perception of Serbian investment climate. In particular, it should be stressed that reversals in policy and lack of respect for property rights on investors that have already invested in Serbia could cause serious harm. Background In the 1990 s, the loss of markets, international isolation, armed conflicts, and interruption of long-established production relations left a dire legacy for the Serbian economy. Three years have passed since the October 2000 velvet revolution in Serbia and the establishment of the first government in January 2001 that lasted until February During these three years, the investment climate was heavily affected by political instability. Several major policy steps conducive to a better investment climate were implemented: fiscal stability and trade liberalization were achieved; tax code reforms were carried out; the company law was amended to eliminate preregistration inspections; a privatization law was adopted in 2001 and amended in 2003; leasing, collateral and concessions laws were introduced in 2003; and tax reforms were implemented in Accordingly, 4,000 new small enterprises and 20,000 shops have been opened. In addition, around 1,000 mostly medium-sized enterprises were sold in auctions and circa 25 large enterprises were sold by an international tender to major international strategic investors. Yet, the remaining investment climate reform agenda is huge and presents the new government with major challenges. With Bank and other donor support, the authorities began to take important actions in all of the above mentioned policy areas. As will be shown below, the ICA recommends that the new government continue on this path ( stay the course ) and support the next generation of reforms to improve the country s investment climate. Moreover, while in the initial reform agenda, program design and legislation played a key role, the short to medium priorities described above require implementation capacity and the maintaining and building of new institutions, such as the Privatization Agency, the Business Registration Agency (a one-stop shop for leasing, collateral and company registration), Foreign Investment Agency (SIEPA), the SME agency, Bankruptcy Administration unit within the 6

7 Privatization Agency, a supervisory agency for bankruptcy administrators, and a powerful Competition Authority. The ICA reflects the increased emphasis in Serbia on the development agenda. This emphasis is natural for an economy that has largely completed the initial stage of its economic program, by focusing on stabilizing the economy, carrying out urgent reconstruction, implementing first generation reforms such as price and foreign exchange liberalization, and laying the foundations for second generation reforms.. As in other transition economies in Eastern Europe, the second stage which focuses on ensuring long-term economic stability, sustainable growth, and employment creation, has proven to be more challenging. Initial progress in key areas of reform has been uneven. Significant advances have been made in opening the country to trade and investment, the management of public finances, tax policy, privatization, bank resolution, energy, the labor market, pensions and social assistance. In most areas, however, the reforms are still far from complete, and in several areas (e.g., public administration, health, competition policy), the reform process has hardly begun. 1 Moreover, Foreign Direct Investment (FDI) an important indicator of the investment climate has yet to play an important role for the private sector in Serbia. FDI per capita in Serbia in was US$200 in comparison to US$1,400 in Croatia US$560 in Bulgaria, US$460 in FYR Macedonia, and US$419 in Romania. Foreign investors share the views of their domestic peers that Serbia is a risky place in which to invest. The World Economic Forum Global Competitiveness Report ranked Serbia 77 among 102 countries in terms of its overall competitiveness. For attracting FDI and local investment, the new government must, at the very least, ensure consistent treatment of the first group of investors which bought companies in tenders and auctions. With high risk and without abundant natural resources, almost all FDI in Serbia in the first period was related to privatization. These brownfield investments could play a key positive role in moderating the perception of risk for new potential greenfield investors. However, this will happen only if the current brownfield investors find the investment climate acceptable and are treated fairly. The experience of investors, such as Henkel, LaFarge, Pharmaco, Philip Morris, so far is worrisome. 2 Investment Climate Priorities and Policy Implications An empirical analysis of circa 400 Serbian firms in 2003 conducted for the ICA shows that the productivity level of privatized firms is about 90 percent higher than that of socially-owned firms; the productivity level of new private firms is over three times higher. Privatized firms are 15 percent more likely to make profits than sociallyowned firms; new private firms are 33 percent more likely 3. These strong empirical 1 For a more extensive review of reform performance during , see World Bank (2003), Recent Progress on Structural Reforms a document prepared by the World Bank for the Donor Coordination Meeting in November The experience of Henkel, one of the world leaders in the detergents sector, is particularly illustrative. Henkel acquired the chemical (detergent) company Merima, in an open tender. Recently Henkel had been asked to pay tax on the severance payments for Merima s employees, notwithstanding that Henkel agreed with the Government about the severance pay package as part and parcel of the privatization deal. Other major investors (LaFarge, Pharmaco, Philip Morris) underwent a similar experience. 3 The better performance of some privatized firms may simply reflect the fact that only employees in the better firms decided to take their firms private. The results for new entrants, however, are unambiguous: new private firms in Serbia are more productive, more profitable, and growing more rapidly than socially-owned firms. 7

8 results imply that a continued commitment to private ownership and a supportive business environment, facilitating new private entry or via privatization, supporting the rights of owners and creditors, is an engine to increased profitability and productivity of enterprises and therefore should continue to be a key policy priority. Sustainable economic growth can only come from investment by the private sector. Thus, issues related to the investment climate are key to putting the country on the road to long term prosperity. While the government in Serbia has made progress in implementing business enabling reforms such as liberalization and deregulation of foreign trade and investment, privatization, simplification of the tax regime, and modernization of the labor legislation, it has yet to focus on the related institution building that is necessary. The implementation of recently drafted legislation aimed at improving business entry, corporate governance, access to finance, and business exit has yet to start and requires extensive institutional building to take effect. In view of the limited capacity of the government and the decreased foreign assistance, the prioritization of investment climate reforms and implementation efforts is critical. Based on the surveys, experiences of foreign and local investors, the ICA proposes the following priority areas. Goal #1: Strengthening contract enforcement. The court system in Serbia is markedly pro-debtor. Weak judicial capacity also increases the backlog of cases, and encourages firms to use courts only as a last resort. Accordingly, firms rely more on personal relationships and are less willing to deal with new customers and suppliers, which in turn, limits the number of transactions and also limits market dynamism. Weak contract enforcement contributes to uncertainty and non-transparency that create fertile ground for corruption. Goal #2: Increasing access to credit. Lack of access to credit limits businesses to using only their own funds, retained earnings, or money borrowed from friends and family. This constraint limits market dynamism in a post-conflict and post-socialist environment in which retained earning have not yet been accumulated. The lack of access to credit through banks and other formal financial institutions removes an important motive for businesses to formalize thus contributing to the persistence of the informal economy. Goal #3: Reducing the regulatory burden. The regulatory burden is the consequence of a series of government actions and polices such as a legacy of inefficient and anti-market laws and ministerial regulations, complex company registration, frequent multiple and overlapping inspections or lengthy certification. This regulatory structure distorts and hinders market development, and, for those businesses who succeed in becoming viable, create opportunities for corruption (the bribe tax) and wasting of businessmen s time (time tax). Administrative harassment and corruption as well as the unpredictability of business rules, and the unfairness in their application represent a serious problem. Improvement of the quality of regulation by streamlining, improving transparency and market-friendliness, and consistent application should also reduce the so-called time and bribe taxes mentioned above. In addition, increasing the tax administration capacity to support rule-based tax collection rather than punishing successful businesses is an important goal Goal #4: Strengthening property rights in land and reducing labor rigidities. An ongoing unresolved issue is the failure to adopt a legal framework for dealing with the 8

9 nationalized property and the claims for restitution. The failure to resolve the restitution issue regarding both land and other properties, although easy to understand in view of the recent political history (the Law was ready just before the assassination of PM Zoran Djindjic) continues to create uncertainty and deters many real estate and other investors from investment. The restrictions on use and state ownership and control of urban land (particularly construction land) are major obstacles for the construction and services sectors. The Serbian land administration system is in a very poor state, with most of the apartments in Belgrade and other cities not registered. Analysis and removal of the remaining burdensome construction permits procedures deserve the immediate attention of the authorities. The proposed amendments to the labor law will introduce very detrimental labor rigidities. They include the obligation to conclude a collective agreement for employers who have more than 10 employees and administratively setting the level of minimum wages to 50 percent of the average wage, making dismissal for economic reasons more difficult or costly. The introduction of these rules would bring Serbia back on the list of the countries with the most rigid labor market; please see specific recommendations. Goal #5: Facilitating entry, change of ownership, competition and bankruptcy.schumpeterian creative destruction, facilitating entry and exit, is especially important in the post socialist industrial structure, in which restructuring and bankruptcy are channels for a dynamic entry of small new enterprises. The process, whereby bad firms exit and new ones replace them is an important condition for the sustainability of growth in Serbia. - Sub-goal #5.1 Stop backsliding in privatization. Retroactive actions to undo legal privatizations could undermine the confidence of investors. Major changes in the Privatization Law, such as those now discussed by the Parliamentary Privatization Committee also will undermine investors confidence. - Sub-goal #5.2 Build bankruptcy institutions. Reallocating the capital and human resources of un-restructured and failing firms requires a framework for bankruptcy and liquidation that frees the tied-up capital for alternative, higher productivity uses. - Sub-goal #5.3 Start building a powerful competition authority. Trade liberalization by opening the markets to foreign competition, together with the privatization and establishment of SMEs, may not be sufficient to bring about competitively structured markets and the resulting competitive conduct of business operations. Specific policy recommendations based on the analysis are presented below. Specific Policy Recommendations Based on a discussion of the priorities, ICA proposes that the following steps be taken by the government to achieve its goals: Goal #1: Contract Enforcement 9

10 The legal framework simplifying contract enforcement procedures should be further developed and applied. The new Law on Execution Procedure 4 and the the new Law on Civil Procedures have been adopted in November The introduction of new concepts the establishment of appropriate treatment of debtors and creditors, coupled with non-repressive acceleration of enforcement procedures is expected to help clear the backlog in the courts and facilitate doing business in Serbia. The performance of bailiffs should be strengthened. By-laws on bailiffs should be adopted followed by training. This should strengthen their skills and lower the possibility of delaying the execution and corruption. Court resources should be improved. 5 Education of judges should be a priority. As the new legislation will broaden the competences of the commercial courts their enforcement benches should undergo additional training. Besides the state of the Serbian court system is such that urgent resources for training of judges and court personnel in the area of case filing and tracking systems, etc. are needed. Information-sharing systems should be improved. Although Serbia has established public credit registry, it ranks among the 10 countries worldwide in which the legal and regulatory environment is least conducive to information sharing. Therefore it is important to better coordinate and facilitate operations of enforcement benches, and strengthen the link between commercial court enforcement benches and the competent registries (registry of securities, pledge registry and organization for coercive compensation). Effective usage of court statistics should be developed and used. Empirical data are necessary to identify bottlenecks in court performance and give policymakers information where reforms are needed most. This would improve court administration and case management systems. Removal of non-dispute cases from the courts. The new registration system in Serbia will transfer business registration away from the courts to the Business Registration Agency freeing up judges time to deal with proper disputes. Goal #2: Access To Credit Pass a new Mortgage Law and establish the Mortgages Registry. The development of sustainable mortgage finance is still deterred by problematic enforcement of contracts unsuitable legal framework and underdeveloped practice. 4 The Law on Enforcement Procedure is being prepared by a Working Group appointed by the Minister of Justice in It is clear that successful implementation of the law will depend upon the other reforms in this area. USAID will provide US$15 million for reform of commercial courts, and putting the right legal framework in place is a precondition for court reforms. 10

11 Establish and streamline a publicly accessible leasing registry. Amendments that will reflect changes with respect to the introduction of VAT also should be prepared. Increase the volume of the credit lines at unsubsidized interest rates and only through financial intermediaries that meet minimum eligibility criteria. However, such credit lines only makes sense if Serbia maintains macroeconomic stability and further develops sound financial sector and prudential regulation with improved supervision. Establish a sound legal framework for the emergence and operations of investment funds to encourage savings while protecting investors, especially non-institutional non-sophisticated investors. Introduce improved disclosure and financial reporting of state-supported funds (the Development Fund, the Guarantee Fund and the Transition Fund). Linking the disbursements of severance pay from the Transition Fund and other budget subsidies should be based solely on the fulfillment of the Restructuring Plan prepared by the Privatization Agency. Goal #3: Regulatory Burden Introduce public consultation on new laws as a rule, not as an exception. There is a need to introduce public hearings and public discussion of laws and decrees. Recently, the Regulatory Reform Council initiated reform of the Rules of Operations of the Government to establish mandatory public discussion. This could significantly improve the transparency of policy making by bringing in a wider range of affected interests. The Government has already conducted several successful public consultation processes, such as a public-private sector dialogue on the draft Leasing Law, the Company Law, the Business Registration Law and the Bankruptcy Law. Enhance the capacity of the Regulatory Council to implement Regulatory Impact Analysis (RIA). The objective of RIA is to reduce the cost of regulation on the economy and to improve the performance of new laws, by checking the need for and impacts of proposed actions before they are adopted. Regulatory reform should not be regarded as a one-time measure, but as a continuous process. In order to improve the quality of regulations and to anticipate their impact on the economy, the Government has introduced as a mandatory step an expanded justification statement for all laws and other regulations that explains the expected benefits and costs of the actions, including the results of public consultations, which will have to precede each law or regulation. A step-by-step approach based on an OECD model and expertise is recommended to build the capacity for RIA into its policy processes. The effectiveness of the inspections system should be improved. The amendments to existing legal regulations should clearly define and separate the currently overlapping responsibility areas of market inspection vis-à-vis other inspection authorities 11

12 The national system for accreditation and certification should be adjusted to meet EU standards and technical norms. An incomplete system of accreditation, certification, and conformity assessment pose a serious barrier to the unhindered flow of goods and services. Since the country is aiming for EU accession, a solution to the problem of technical obstacles lies in adopting EU norms relating to the standards and technical regulations. The adoption of European solutions in this area would enable the development of a recognized system of accreditation, standardization and conformity assessment. Goal #4: Strengthening Property Rights In Land And Reducing Labor Rigidities The Denationalization Law should be based on the following general principles: (i) compensation will be done, as a matter of general policy, through bonds, and will be substantially in accordance with principles of 2001 Privatization Law; (ii) compensation will be done in a fiscally prudent manner; and (iii) to avoid the creation of new injustices, the legally owned non-state property shall not be restituted (in kind) to original owners; other forms of compensation will be used. The resolution of the restitution process should be based upon the best practice from the other transition countries, (not jeopardizing privatization process and taking into account the fiscal impact. Accelerate the legalization of buildings that are already recognized by most authorities. Accelerate the ongoing work on the land administration system, supported by the World Bank Cadastre Project. The newly proposed amendment to the Labor Law requiring collective labor agreements in businesses with as few as 10 employees and the clauses regarding employee rights in bankruptcy should be abandoned. Goal #5: Facilitating Entry, Ownership, Competition Change And Bankruptcy. Continue the rapid implementation of the Laws on Business Registration and on the Business Registration Services Agency (BRSA). The Government should also continue to build the capacity the agency, which will house the company, leasing and collateral registries. Establish the institutions, raise the resources and train the personnel required to build the Supervisory Agency and the unit which will serve as administrator of socially-owned companies. Although the new Law on Bankruptcy was adopted in July 2004, the Law alone is not expected to improve creditor rights unless the institutions are established and unless the Government shows the political will to initiate bankruptcy proceedings in its role as creditor of SOEs through the tax administration, the electric power company (EPS), and state-owned banks. In view of the experience of other post socialist economies where bankruptcy cases were fraught with collusion among bankruptcy administrators, judges and creditors, the creation of a specialized institution that will take over bankruptcy administration of a socially- or state-owned enterprise is promising if properly implemented. 12

13 However, the Government did not decide in which agency the specialized institution would be located. Given its weakening capacity, if the Privatization Agency is selected, it will need significant help to implement this new task. Yet, the agency s new management is reluctant to use foreign consultants while it keeps losing its best local professionals. Adopt the new Competition Law. Adoption of a new Competition Law, expected in 2005, is necessary but far from sufficient for its implementation and impact. The latter requires a powerful and independent authority that will have the power to deny firm mergers and set maximum prices for monopoly products (sometimes at the behest of the monopoly or the cartel). Most difficult for the competition authority will be to order and oversee the break up of companies that abuse their dominant position, in particular of those companies controlled by the most powerful vested interests in the economy. In essence, the establishment of such an authority will not be an easy task, and it is unlikely that the authority will be fully operational for several years. The Government should agree with the European Union (EU) about the draft of the Law and start building the capacity of the authority by organizing training for the future officials. 13

14 Development Action Plan Area Recommended Actions Responsibility Priority Short-term (less than 1 yr) Prepare an action program and build local capacity to conduct Regulatory Impact Analysis (RIA). GoS, Council on Regulatory Reform (CRR), Legislative Secreteriat High Strategy and framework for deregulation Establish procedures for public consultation with major affected groups on new draft laws and other major regulations. Introduce amendments to the Rules of Operation of Government. GoS, CRR, Legislative Secreteriat High X Business registration Establish the Central Registry of Regulations with positive legal security within the Government and enable free internet access to regulations. Establish and build the capacity of the Business Registration Agency (capacity building should include data transfer and updating; creation of the unique identifying number for each business that will serve government needs). New Company Act has been adopted (Law on Economic Entities) - lowering minimum capital requirements. GoS, MOJ, CRR SBRA, MOE, MOF, CRR MOE Medium High High X X Enact the new Competition Law. MOT High X Competition Approve a Law to establish a Competition Authority. MOT Medium Ensure sufficient funding in the budget for the Authority to carry out its functions effectively and independently. MOT Medium 14 Timing Medium-term (1 to 3 yrs) X X X X Long-term (over 3 yrs)

15 Business exit Licensing and Inspections Inspections Certification and Standardization Enforce the new Bankruptcy Law. Capacity building of a specialized bankruptcy trustee agency to act as trustee of bankrupt SOEs. The Government will initiate bankruptcy proceedings in its role as creditor of SOEs. Further deregulation measures should include reducing the number of documents and authorizations necessary to obtain a license and limiting the involvement of branch ministries in the licensing process. Deregulation efforts should be extended to incorporate the activities of local authorities in the areas related to issuing licenses and permits. The Government should narrow the scope of work of the market inspection to reduce any duplications and shift the focus of the market inspection on consumer protection issues. The Government should reconsider the minimal technical requirements for performing specific activities and the rules defining the procedures to be used by the inspections. The national system for accreditation and certification should be adjusted to meet EU standards and technical norms. Commerical Courts and PA MOE, PA MOE CRR, MOT, other ministries CRR, MOT, other ministries MOT MOT National Accrediation Body, National Standardization Agency 15 High X High X Medium X Medium X Medium X Medium X Medium X Medium X

16 Contract Enforcement Access to finance The Law on Enforcement procedures and the Litigation (Civil Procedures) Law have been adopted. The performance of bailiffs should be strengthened. By-laws on bailiffs should be adopted and followed by training. Court resources should be improved. Training of judges and court personnel in the area of case filing and tracking systems is needed. Information-sharing systems should be improved and effective usage of court statistics should be developed.. An anti-corruption strategy should be devised. Remove non-disputed cases from the courts. Freeing up judges time could also be achieved through alternative dispute resolution (ADR) mechanisms including a variety of methods for resolving disputes outside the formal judicial process. The Government should adopt a new Mortgage Law. Several proposals related to the establishment of the National Mortgage Insurance Corporation should be cautiously revised. A streamlined and publicly accessible collateral and leasing registry should be established. Amendments to the Law on Financial Leasing that will reflect changes with respect to the introduction of VAT also should be prepared. Consider an increase in the volume of the IFIs credit lines at unsubsidized interest rates and only through financial intermediaries that meet minimum eligibility criteria. MOJ MOJ, Commercial Courts MOJ, Commercial Courts MOJ MOJ and Business Associations MOF MOF, MOE NBS 16 High Medium High Medium Medium High High - X X X X X X X

17 Labour Land and Real Estate Performance of state-support funds needs to be audited, and rigorous mechanisms for controlling the funds activities should be established. The Government should adopt credit bureau and privacy legislation in order to support an effective, broad-based credit bureau with full credit information..the Governent should resist attempts to significantly change the 2001 Law in ways that would introduce distortions. To improve labor mobility, National Labor Office should improve the information sharing system Introduce legislative amendments and changes that are required to improve the perception of security of tenure, the real property market financing and to attract foreign investors (these should include the change of the urban land concept provided by the current Constitution). Draft and adopt the Law on Denationalization. Consider decreasing the real estate transfer tax that would help rationalize real estate transactions. Prepare a study on improving administrative procedures in the process of acquiring construction land and suggest necessary measures. Evaluate the current Law on Urban Planning and Construction and recommend amendments if necessary. MOF MOF, SBA MOLSA MOLSA, National Labor Office MCI MOF MOF MCI MCI, RGZ 17 High High High High High Medium Medium Medium X X X X X X X X X

18 CHAPTER 1: INTRODUCTION Background and Objective Three years have passed since the October 2000 velvet revolution in Serbia and the establishment of the first government in January 2001 that lasted until February During these three years, the investment climate was heavily affected by political instability. In particular, the country experience uncertainty related to the future of the union of Serbia and Montenegro and the future status of Kosovo; the ICTY Hague criminal tribunal; and doubt about the country s creditworthiness. After the assassination of Prime Minister Djindjic in March 2003, the situation deteriorated into a stalemate in Parliament, disintegration of the ruling coalition, a collapse of the government, and new parliamentary elections which took place in December These events have increased the difficulties of moving ahead with the necessary reforms. In the 1990 s, the loss of markets, international isolation, armed conflicts, and interruption of long-established production relations have left a dire legacy for the Serbian economy. In the economic sphere, several major policy steps conducive to a better investment climate were implemented: fiscal stability and trade liberalization was achieved; tax code reforms were carried out; the company law was amended to eliminate pre-registration inspections; a privatization law was adopted in 2001 and amended in 2003; leasing, collateral and concessions laws were introduced in 2003; and tax reforms were implemented in Accordingly, 4,000 new small enterprises and 20,000 shops have been opened. In addition, around 1,000 mostly medium-sized enterprises were privatized. Yet, the remaining investment climate reform agenda is huge and presents the new Government with major challenges. The objective of this Investment Climate Assessment (ICA) is to (i) provide Serbian experts in academia and in government, policy makers, as well as Bank staff conducting policy dialogue with the Government, with an empirical analysis of the investment climate in Serbia; and (ii) provide policy options for creating an enabling an environment conducive to private sector development, thereby increasing and maintaining enterprise productivity and leading to sustainable growth. With Bank and other donor support, the former Government began to take important actions in all of the above mentioned policy areas. As will be shown below, the ICA recommends that the new government continue on this path ( stay the course ) and support the next generation of reforms to improve the country s investment climate. What is the Investment Climate? Work to improve the investment climate is recognized as a key pillar of the World Bank Group to promote economic growth and poverty alleviation in developing countries. The World Development Report 2005 defines the investment climate as the factors in a particular location that shape the opportunities and incentives for

19 firms to invest productively, create jobs, and expand. Essentially, it is the economic, institutional, legal and cultural environment in which firms operate, and as such it has many dimensions: geography, competition, institutions, security of property rights, taxation, the operation of the markets for capital and labor, and so on. Some factors are difficult or impossible for governments to influence. But in most dimensions of the investment climate, governments have a powerful or decisive influence (Figure 1). Figure 1: Policy uncertainty dominates microeconomic constraints Infrastructure 8% Finance 5% Crime 3% Skills 3% Courts 3% Policy uncertainty 33% Corruption 11% Regulation 11% Tax 23% Source: World Development Report 2005, World Bank. (Investment Climate Surveys in 49 countries, based on rankings by country) Structure and Methodology of the Serbia ICA The Serbia ICA systematically analyzes the conditions for private investment and enterprise growth, drawing on the experience of local firms to identify the areas where reform is most needed to improve the private sector s productivity and competitiveness. Much of the analysis takes place at two levels. First, the ICA assesses the country climate, drawing on the many datasets now available (Box 1) to compare Serbia across countries or groups of countries. Second, the ICA analyzes in detail various aspects of the investment climate in a country-specific context. This level of analysis draws on a wide range of evidence and sources, including but not limited to evidence gathered at the firm level. The report reviews all aspects of the investment climate, but, in order to be useful to experts and decision makers, it focuses on the subset of those barriers that can be influenced or changed through policy measures. 19

20 Box 1: Background on Surveys used in the ICA 6 Productivity and Investment Climate Survey (World Bank): PICS utilizes a standard core questionnaire intended to calculate firm productivity. The PICS sample conducted in Serbia is different from the standard one as it does not cover exclusively manufacturing. The survey was administered to managers of firms and consisted of a core set of questions as well as several modules that can be used to explore specific aspects of the country s investment climate and links to firmlevel productivity. The core survey had 11 sections: General information about the firm: ownership, activities, and location; Sales and supplies: imports and exports, supply and demand conditions, and competition; Investment climate constraints: evaluation of general obstacles; Infrastructure and services: power, water, transport, computers, and business services; Finance: sources of finance, terms of finance, financial services, auditing, and land ownership; Labor relations: worker skills, status and training, skill availability, over-employment, unionization, and strikes; Business-government relations: quality of public services, consistency of policy and administration, customs processing, regulatory compliance costs (management time, delays, bribes), informality, and capture; Conflict resolution/legal environment: confidence in legal system and resolution of credit disputes; Crime: security costs, cost of crimes, and use and performance of police services; Capacity, innovation, and learning: utilization, new products, planning horizon, sources of technology, worker and management education, and experience; and Productivity information: employment level, and balance sheet information (including income, main costs and assets). The sample size was relatively large with 408 firms and includes a representative sample of the composition of the Serbian economy. The PICS survey was undertaken in the aftermath of the assassination of the Prime Minister at a time when the country was experiencing a great deal of uncertainty, so the survey results must be viewed in this light. Business Environment and Enterprise Performance Survey (EBRD and World Bank): The BEEPS utilizes a standard survey instrument applied to nearly all countries in Eastern Europe and Central Asia, thus ensuring comparability. BEEPS II is a follow-up of an earlier BEEPS effort. In Serbia the BEEPS II survey had a sample size of approximately 230 firms in 2002 (BEEPS I did not cover Serbia). Generally, the sampling strategy in BEEPS II differs from that of the PICS, as the sample design of the BEEPS is highly skewed toward smaller firms. Cost of Doing Business Project (World Bank): The Cost of Doing Business Project investigates regulations that enhance business activity and those that constrain it. Quantitative indicators on business regulations and enforcement are being gathered to allow comparisons across more than 130 countries over time. The indicators are based on assessments of laws and regulations, with input from and verification by local experts. Information is gathered from surveys of experts rather than firms. The questionnaire is administered to local professionals experienced in their fields, such as corporate lawyers and consultants for business entry, or litigation lawyers and judges for contract enforcement. 6 PICS 2 was initiated before the Memo of Understanding (MOU) arrangement between the World Bank and EBRD on the BEEPS. In Serbia, PICS was programmed by the Bank in advance of the MOU with the EBRD, hence had to be grandfathered. However, it should be acknowledged that BEEPS 2 was a collaborative effort under the MOU, and that Serbia is exceptional in having both a detailed PICS 2 and the BEEPS. 20

21 CHAPTER 2: PRODUCTIVITY, OWNERSHIP AND THE INVESTMENT CLIMATE IN SERBIA AND WORLDWIDE Introduction This chapter provides an overview of Serbia s investment climate in an international context. First, we examine how Serbia compares to other countries, in particular to other transition economies, in terms of its output and productivity. Second, we review which characteristics of firms worldwide are associated with high productivity and strong performance, show how investment climate variables affect productivity, and show how the characteristics of firms worldwide affect complaints about the investment climate. Third, we show which Serbian firms have high productivity and are growing quickly, and present the investment climate constraints that they face, using the PICS sample of over 400 Serbian firms. TFP, Productivity, and Serbia in the International Context Total factor productivity (TFP) is a multi-factor productivity measure that represents the efficiency of the firm in transforming factor inputs into outputs. A firm that has a high level of TFP is one that can produce a high level of output for given quantities of capital and labor. TFP can be affected by wide range of factors: technology, managerial quality and incentives, corporate governance, government policies, and, of course, various dimensions of the investment climate. TFP is usually analyzed in a production function or growth accounting framework. One approach is to account for the contribution of measured inputs, and label the residual how much output is produced taking into account the volume of inputs as an estimate of TFP. Another approach is to estimate the production function to try to measure the additional factors that affect productivity and output: when a characteristic of firm such as private ownership is associated with higher output, we say that after accounting for the contribution of the factors of production (capital and labor) to output, private ownership has a positive impact on TFP. Increases in the level of TFP of firms are an essential feature of economic growth: rich countries are countries with firms that are highly productive. This section demonstrates how TFP at the firm level is related to GDP per capita at the country level, and compares the level of TFP in Serbian firms with the levels in comparator countries. These comparisons use the large PICS-BEEPS dataset of about 27,000 firms from 50 countries. 7 To obtain estimates of the average TFP level by country, the production function equation is first estimated on country-averages: averages were calculated for firm 7 Estimating TFP requires measures of capital and output. For both PICS and BEEPS we could use the book value of fixed capital as a measure of the capital input; value added, however, is available in PICS but not BEEPS. We therefore used sales as the measure of output. The production function estimations were generally acceptable, however, and the strong correlation between estimated TFP and GDP per capita reported below is a good validation check of the results. See the appendix for further discussion. 21

22 capital, labor and output were calculated for each of the 55 country surveys, and a regression estimated using these 55 observations. Appendix 2 contains further details on the methodology and results of the analysis. The basic estimation results are reported in column 1 of Table 1; the coefficients in the parentheses show the productivity gaps between Serbia and selected countries. Croatia, Hungary, Poland and Slovenia all had higher TFP than Serbia in 2002 or The TFP residuals as defined above are plotted in Figure 2 versus GDP per capita. The figure shows the strong positive correlation between country-average TFP and GDP per capita: richer countries have more productive firms. 9 Table 1: Basic TFP regressions using country-survey-averages and firm-level data (manufacturing only) Regression on countrysurvey-averages Regression on firms with country-survey dummies Fixed capital 0.574** 0.387** Labor 0.445** 0.663** Country survey dummy variables included No Yes Selected estimates of relative TFP Benchmark: Serbia 2002=0 Croatia 2002 Hungary 2002 Poland 2002 Poland 2003 Slovenia 2002 Number of observations [0.612] [0.817] [0.543] [0.938] [1.146] 55 country-survey-averages based on 14,687 firms 0.798** 0.922** 0.717** 1.087** 1.347** 14,687 firms ** significant at the 1 percent ; heteroskedastic-robust standard errors; [ ] indicates estimate based on a residual The figure and the table also show that Serbia is well below its East European peers in productivity. Croatia is a natural comparator country. The country-survey-averages TFP regression implies that the productivity of Serbian manufacturing firms in the BEEPS 2002 survey is 61 percent 10 below that of Croatian firms; the gap based on the PICS 2003 survey is even greater, 93 percent behind Croatia. 11 The TFP gaps with other leading East European countries are as big or bigger. In column 2 of Table 1 we show an estimation of the production function which uses the same PICS-BEEPS dataset as the country-averages estimation but with dummy 8 Table 3.1 reports TFP gaps relative to Serbia in The TFP estimates for firms in the Serbian PICS 2003 survey showed lower productivity levels than in the Serbian BEEPS 2002 survey: the estimated gaps were for the regression using country-survey averages (column 1) and for the regression using country-survey dummies (column 2). The latter figure was not statistically significantly different from the Serbia 2002 benchmark. 9 The results also confirm that TFP estimates are feasible using the input and output measures available. 10 In log percentages, e 0.61 =1.84, so this means Croatian TFP is 84 percent higher than Serbian TFP using standard percentages =