The previous chapter showed that Serbia’s convergence with the EU, while real, has been slow and uneven — productivity growth has lagged behind what the high levels of investment should have produced, and governance indicators have been diverging. This chapter looks more closely at how this manifests in the structure of the economy, and argues that the policies which produced the growth are themselves generating a competitiveness squeeze whose consequences are already visible.
The strong growth in wages that lifted consumption and sustained GDP growth in 2025 even as investment faltered had been building for a while, strongly outstripping the growth in the economy’s actual productivity. This, we argue, is a result of policies and governance shortfalls that “manufacture” a peculiar form of Dutch Disease, whereby large capital inflows into non-tradables and low-productivity manufacturing drive up domestic demand while governance dysfunction prevents the domestic supply side from responding, ultimately driving up costs.
The Squeeze on the Ground: Labor Market Stress and Market Consequences
Serbia’s labor market reveals a structural dysfunction that goes beyond the post-inflation wage catch-up observed across the region. Real wages accelerated sharply once inflation subsided in mid-2023, partly accommodating the terms-of-trade loss suffered in 2022, and rose approximately 12.4% over the period. However, the fact that such wage growth was possible despite unemployment remaining above 8% points to something deeper.
The labor market simultaneously exhibits extreme tightness for employers while large pools of potential workers remain outside formal employment. Employment reached its lowest point in 2014 at 1.845 million, while the unemployment rate had peaked two years earlier, in 2012, at 24%. Recovery was gradual at first, then accelerated to 2.5% annually during 2017-2021 with the help of large employer incentives. By 2021, unemployment had fallen to 10% while the inflow of new vacancies had risen to 82,000. Subsequently, in only three years (2021-2024), new job openings surged to 223,000 while the number of unemployed fell by only two percentage points to 370,000. This extraordinary tightness — with a vacancy-to-unemployment ratio approaching 0.6 — put strong pressure on wages even as the unemployment rate remained at 8%, reflecting severe structural mismatch: female labor force participation lagging far behind male, vast regional unemployment disparities, and institutional failures in labor mobility and education-employment linkages.
The gap between what firms must pay workers and what they can charge customers captures the competitiveness squeeze in its most concrete form. With the help of official minimum wage increases, manufacturing wages grew even faster than the economy-wide average: 31% between 2022-2024, with an additional 13.4% in 2025. Yet producer prices in manufacturing rose only 2.5% over the same period, plus 0.9% in 2025 — leaving no room to pass costs to prices.
Markets are already responding. Closures and layoffs among foreign-owned manufacturers accelerated sharply, affecting, based on press reports, at least 8,000 jobs in 2025, mostly concentrated in automotive components and textile industries in southern Serbia.1 The driver is not only sluggish EU demand but also rising domestic costs. In some of those cases companies are relocating to North Africa — particularly Morocco and Tunisia — where labor has acquired the necessary skills at much lower cost. The geographic concentration of these closures — Nis, Leskovac, Vranje, Vlasotinac, Doljevac — deepens the regional disparities already noted in the previous chapter. Of particular concern is SME export performance: 2022-2025 marks the first period since 2015 in which SMEs have substantially lagged total goods exports. Domestic SME nominal revenues increased only 3.7% between 2022-2024, while their exports declined approximately 3.3%. This matters because these firms are more embedded in domestic value chains, employ more people per unit of capital, and are more geographically dispersed than large FDI manufacturers. Their difficulties signal a problem in the broad base of the economy, not just in footloose assembly operations.
Wages Have Outstripped Productivity — But Only Where It Matters for Competitiveness
Aggregate convergence statistics mask a critical sectoral divergence. Serbia’s overall productivity and wage convergence with the EU appear roughly aligned — both would take approximately 30 years to reach the EU average at current rates. However, to assess competitiveness one must focus on the tradable goods sector, where prices are set or constrained by international competition and an increase in GVA per employee is likely to reflect actual output gains. In non-tradable services, prices are closely linked to domestic wages and are not subject to competitive discipline; rising GVA per employee may simply reflect price inflation rather than genuine productivity improvement.
The divergence between tradable and non-tradable productivity is sharper in Serbia than in any of its CEE peers, and it has been accelerating. Manufacturing productivity grew only 20% between 2015 and 2024; first declining until 2020, then recovering annually from 2021-2024. Non-tradables GVA per employee, by contrast, more than doubled over the same period. More recently, manufacturing productivity declined from 72% to 62% of non-tradable productivity in just three years (2021-2024), a steeper fall than in any CEE peer and from an already lower starting point. In the EU27, by contrast, manufacturing is actually more productive than non-tradable sectors and the ratio has been essentially stable. Knowledge-intensive services, composed of ICT and professional services, tell a more positive story, with GVA per employee increasing 72% since 2015 and standing 53% above non-tradables by 2024. Fast export growth suggests this reflects real gains. However, IT wages have essentially caught up with CEE levels, and further increases can only be sustained by continued productivity growth, especially at a moment when AI disruption introduces substantial uncertainty about the sector’s trajectory.
What this sectoral divergence describes is, in fact, Serbia’s fast appreciating real exchange rate. It increased faster than in any other CEE country except the Czech Republic, which increased its productivity even faster.
Serbia’s faster wage growth relative to CEE countries was initially understandable, due to wages being at extremely low levels during a period of massive unemployment. But this growth diverged from productivity dynamics, and the consequences for competitiveness are already visible in direct comparisons with Serbia’s closest peers. Manufacturing wages initially grew while productivity declined, and continued rising even faster once productivity finally picked up, eroding Serbia’s manufacturing cost advantage. For example, compared to Croatia and Slovenia, the two structurally most similar cases, Serbia has been losing competitiveness fast: its manufacturing productivity relative to Croatia declined from 77% to 56%, and relative to Slovenia from 47% to 34% over the observed period. Meanwhile, relative wages by 2024 caught up to approximately the same proportions as relative productivity. This means the gap between GVA per employee and wages, most of which represents investor earnings, has been shrinking rapidly. Yet this is the very differential that must generate the investment Serbia needs to close the productivity gap.
Croatia and Slovenia were the countries against which Serbia’s cost advantage lasted longest, their wage-productivity ratios being the least advantageous relative to Serbia’s. Even so, that advantage has now been exhausted. Against Poland, Romania, and Bulgaria, Serbian wages have already reached higher relative levels than what relative productivities can justify — on average for the five. Serbian manufacturers already operate at a cost disadvantage against those countries. The implication is clear: to maintain and regain competitiveness, Serbia needs to urgently begin generating more widespread productivity growth.
A Manufactured Dutch Disease
Critically, the real exchange rate appreciation documented above cannot be reversed through nominal currency devaluation — it is a structural phenomenon produced by real policy choices (see Box 1). The question is which policies, and through what mechanism.
Box 1: Why Nominal Devaluation Cannot Solve This Problem
Despite popular belief, the NBS is not artificially “keeping the dinar strong.” On the contrary: given large capital inflows (FDI, remittances, infrastructure financing), the central bank intervenes to prevent even faster appreciation than already observed.
If the NBS engineered a nominal depreciation against the euro, this would immediately raise dinar prices of imported goods and inputs. Given Serbia’s import dependence for energy, intermediate goods, and capital equipment, this feeds through to domestic inflation. Wages rise to maintain purchasing power, domestic prices adjust upward, and the economy returns approximately to where it started in real terms — having accomplished nothing except price instability.
Real exchange rates are determined by structural factors such as productivity levels, capital flows, sectoral composition, and institutional quality. The Czech Republic’s experience illustrates the contrast: its koruna appreciated 19.8% in real terms over the same period, but this was accompanied by substantial manufacturing productivity gains. Serbia’s appreciation occurred alongside stagnating manufacturing productivity. The solution requires structural reform, not monetary manipulation.
Serbia’s competitiveness squeeze is a predictable result of systematic policy choices that exacerbate the effects of a balance of payments structure that was always quite generous in structural foreign exchange supply from remittances and other informal channels. The combination has produced what amounts to a manufactured Dutch Disease — not from resource extraction crowding out manufacturing, as in the classical case, but from policy-driven capital inflows into non-tradables and low value-added manufacturing. These generate strong demand pressures that the domestic supply side cannot absorb because it is hampered by governance shortcomings.
The mechanism operates as follows: large FDI concentrated in non-tradable sectors and low-value manufacturing pushes up domestic demand and wages; fiscal incentives that systematically favor foreign over domestic capital exacerbate these pressures while suppressing domestic supply response; infrastructure investment, executed largely by foreign companies under bilateral contracts, imports capacity rather than building it domestically; and monetary tightening required to contain the resulting inflationary pressures falls disproportionately on the domestic firms that should be expanding. Each channel reinforces the others. Together, they drive the real exchange rate appreciation documented in the previous section.
FDI composition has been consistently weighted toward non-tradeable services sectors pushing those prices and wages up with no international market discipline. Throughout the period since the early 2010s, FDI into tradable sectors excluding mining — even including all knowledge services — has never exceeded approximately 34% of annual FDI inflows. Construction capacity expansion alone took approximately 16% of 2025 FDI inflows, driven by non-residential construction and commercial real estate linked to the public investment surge. Mining FDI, primarily Chinese investment in eastern Serbia copper and gold operations, is technically tradable but strongly stimulates non-tradable activity through local demand creation. When manufacturing FDI came, it focused primarily on maximizing employment in low-value activities — wire harnesses and textiles — that are singularly unlikely to have productivity enhancing effects on the domestic economy.
The fiscal architecture of investment support compounds the demand pressure while suppressing the domestic supply response. The design of incentives creates systematic discrimination: large foreign investors receive subsidies and tax advantages that are effectively unavailable to domestic SMEs, which face full tax burdens and minimal support, as later chapters document in detail.
Similarly, public infrastructure investment under bilateral credit contracts not only bypasses standard appraisal and procurement, but also comes with strings that compound the supply-side suppression. These are recorded as capital inflows and FDI, and they create additional domestic demand pressures while marginalizing domestic businesses. These mechanisms are also discussed later, in the investment chapter.
Monetary policy, finally, adds a fourth layer of discrimination that necessarily complements fiscal choices. As fiscal policy and capital inflows generate increased demand, the National Bank must tighten monetary expansion to contain inflationary pressures. But this tightening falls unevenly. Bank corporate clients are overwhelmingly domestic companies, and banks provide approximately 90% of SME external financing. FDI enterprises, by contrast, are largely financed through parent companies or directly with foreign banks. They are therefore little affected by domestic monetary conditions. During 2022-2023, when inflation-fighting was most intense, credit to private enterprises increased by only 1.1 percentage points of average annual GDP (approximately EUR 765 million) while FDI inflows amounted to 13.0 percentage points (approximately EUR 9 billion). Precisely when domestic firms needed credit to expand capacity in response to demand pressures, they faced the tightest constraints — while foreign-owned firms continued unaffected.
The interaction of these four channels is what makes this a macroeconomic problem rather than a collection of individual policy shortcomings. Each channel on its own might be manageable. Together, they create faster growth of domestic prices and wages than international price growth — real exchange rate appreciation.
The Path Forward
The policies described above have driven Serbia’s real exchange rate to a level that, without change, is likely to constrain growth going forward. The arithmetic is unforgiving: when wages exceed what productivity can justify relative to competitor countries, the economy either adjusts or stagnates. There are only two ways to restore competitiveness. One is to reduce domestic wages and costs — a path that is not only politically and socially extremely painful, but that would reverse the very convergence in living standards that a decade of growth has achieved. The other is to raise productivity — broadly, across sectors and firm sizes, and sustainably over time.
Productivity growth is clearly the desirable path. But it is not a simple one. It requires precisely the kind of coordinated, decentralized, rules-based institutional effort that Serbia’s current governance model is least equipped to deliver: targeted support that reaches SMEs rather than only large investors; transparent planning that channels public investment where returns are highest; labor market institutions that reduce mismatch and increase mobility; education systems that respond to employer needs; and a regulatory environment that rewards efficiency rather than political connections. In short, it requires the executive to function reliably and predictably across dozens of institutions simultaneously — something that, as the following chapter documents, it currently does not do.
Finally, one cannot rule out that the continued promotion of Belgrade’s role as an urban regional centre, with continued growth of real estate prices and possibly its transformation into a high-expenditure tourist destination, succeeds in keeping Serbia’s economy out of stagnation. However, in that case Serbia would be on an unsustainable path of deepening regional and social inequalities.
Footnotes
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Based on press reports of closures and layoffs among foreign-owned manufacturers in southern Serbia during 2025. ↩