V – Resource Allocation: Building a Structure Able to Withstand Competition

Resource Allocation: Control Rather Than Development

Serbia spends less than it did a decade ago, yet the spending mix increasingly rewards control and megaproject delivery over the capability of people and domestic firms. A comparison with the EU-27 shows that the “security surplus” is almost the mirror image of the “human capital shortfall.”

The Key Finding

The clearest message in the data is that Serbia’s divergence from the EU is driven by composition rather than by size.

Total general government expenditure fell from 47.3% of GDP in 2014 to 43.4% in 2024
But the reduction did not fund a visible shift into education, health, or environmental protection
Instead, Serbia maintained higher spending on public order and safety and on defence
While it remained below EU levels in core people-centred functions

The One-for-One Trade-off

The arithmetic is close to a one-for-one trade-off between control functions and productivity functions:

Security Surplus (2024):

Function	Serbia vs EU-27
Public order and safety	+1.4 p.p. of GDP
Defence	+0.9 p.p. of GDP
Total surplus	+2.3 p.p. of GDP

Human Capital Shortfall (2024):

Function	Serbia vs EU-27
Health	-1.0 p.p. of GDP
Education	-0.9 p.p. of GDP
Environmental protection	-0.3 p.p. of GDP
Total shortfall	-2.2 p.p. of GDP

The near match between these two aggregates points to a structural priority choice: the budget pays for governance and security capacity while it underfinances human capital formation.

Table 1: Functional Structure of General Government Expenditure (% of GDP)

Function	Serbia 2014	Serbia 2024	EU-27 2023	CEE 2023
General public services	5.9	6.9	5.9	5.4
Public order and safety	4.5	4.4	3.0	3.9
Defence	—	2.2	1.3	1.7
Internal affairs	—	2.2	1.7	2.2
Economic affairs and housing	6.5	7.8	7.0	8.3
Economic affairs	—	7.0	5.8	7.3
Housing and communal services	—	0.8	1.2	1.0
Social protection and development	29.0	22.9	31.1	25.6
Social protection	—	17.8	12.9	19.2
Health	—	6.5	6.2	7.2
Education	—	4.7	3.8	4.7
Recreation, culture and religion	—	1.1	0.9	1.2
Environmental protection	—	0.3	0.5	0.8
TOTAL	47.3	43.4	49.0	45.3

Sources: Ministry of Finance of the Republic of Serbia; Eurostat (COFOG)

The 2026 Central Budget: A Concentrated Capital Programme

The draft central budget for 2026 shows a delivery model that relies on transfers and large central projects more than on programmes with measurable capability outcomes.

Table 2: Draft Central Budget 2026 by Economic Category (% of GDP)

Economic Category	% of GDP
Wages	5.85
Goods and services	2.53
Transfers and subsidies	8.72
Capital expenditure	5.38
Debt service	1.92
TOTAL	24.39

Source: Draft central budget 2026; authors’ calculations

Capital Spending Concentration

In the draft central budget for 2026:

Transport and communications: 2.94% of GDP in capital spending
Defence: 1.34% of GDP in capital spending
Together: 4.28% of GDP out of 5.38% total

This means close to four-fifths of capital spending sits in these two headings alone.

The internal scaling shows how far the capital programme is from social and capability infrastructure:

Defence capital spending is about 9.6× larger than education capital spending
Transport capital spending is about 21.0× larger than education capital spending
Education capital accounts for only 2.6% of total central-government capital spending

Sectors with No Investment Component

Several policy areas have almost no investment component:

Social protection: Transfers 5.08% of GDP, Capital 0.01% of GDP
Agriculture and rural development: Transfers 1.07% of GDP, Capital 0.01% of GDP

When a sector’s budget is dominated by transfers and contains almost no capital, spending mainly supports current income flows rather than building assets, systems, and services.

Industrial Policy and State Aid: Scale Over Productivity

The budget choices have increasingly favoured centralised control functions and a narrow capital pipeline, while underfunding the systems that raise productivity through people and local services.

The Core Argument

The state aid architecture creates a structural disadvantage for domestic SMEs because its most fiscally significant instruments privilege size and headline investment volumes over diffusion of capability.

Table 3: Structure of State Aid Programmes by Beneficiary Type (2023)

Programme	Amount (EUR m)	Main Beneficiary
RAS subsidies for direct investment promotion	159.5	FDIs
Corporate profit tax holiday (investment promotion)	274.2	FDIs
Tax incentives for employment promotion	148.7	Both
RAS de minimis programmes	17.7	SMEs
Tax incentives for R&D promotion	7.7	SMEs
Development Fund soft loans and subsidies	10.1	SMEs
Innovation Fund subsidies	12.3	SMEs
National Employment Service programmes	6.9	Both
Total – FDIs only	433.7
Total – SMEs only	54.7

Source: Authors’ compilation

The ratio is stark: €434 million for large investors vs. €55 million for SMEs.

The Corporate Profit Tax Holiday: Scale Bias Embedded in Design

The corporate profit tax holiday functions as the cornerstone of Serbia’s tax-based investment promotion. To qualify, a firm must:

Invest at least 1 billion dinars (around €8.5 million)
Create 100 new jobs

While formally neutral, these thresholds align almost exclusively with the operating scale of large, often foreign-owned corporations. For domestic SMEs, whose expansion typically occurs through incremental investments financed from retained earnings, such benchmarks are largely unattainable.

Serbia is unique in Europe in that it offers investment-related corporate tax relief exclusively for large investments, conditional on very high minimum investment and employment thresholds that effectively exclude SMEs. This design places Serbia at odds with prevailing European practice and contributes to persistently weak domestic private investment.

The Missing Element: Integrated SME Upgrading

SME-oriented instruments are further constrained by fragmented and weakly coordinated design:

Programmes span innovation, digitalisation, skills development, export promotion, and access to finance
But they operate as stand-alone measures rather than elements of a coherent support framework
SMEs must independently diagnose constraints, identify relevant instruments, and navigate multiple procedures

A particularly important missing element is an integrated, staged SME upgrading programme. In many European systems, support begins with an expert diagnostic, then feeds directly into conditional co-financing, followed by implementation support. In Serbia, these steps exist at best as separated instruments with no formal link between them.

Innovation and Diffusion: Underfunded

In 2023:

R&D-related tax incentives and Innovation Fund programmes together: ~€20 million
Corporate profit tax holiday alone: ~€274 million

This disparity signals a policy preference for attracting large projects over upgrading the technological capabilities of the domestic enterprise base.

De Minimis Dominance: A Choice, Not a Constraint

The heavy reliance on de minimis schemes for SME support is often presented as unavoidable — but this is not borne out by European practice. The EU state aid framework explicitly allows for larger, rules-based schemes under the General Block Exemption Regulation (GBER), including investment aid, R&D support, training, and environmental measures targeted at SMEs.

Serbia is not legally bound to confine SME support to de minimis instruments. The current dominance of small, capped SME schemes reflects domestic policy choices rather than external legal obligations.

Building an Improved System

EU Best Practices: Alternative Designs That Work

Italy’s “Nuova Sabatini”

Italy’s Nuova Sabatini scheme (SA.60799) illustrates how state aid can be designed to mobilise private investment more effectively:

Metric	Value
Public budget	€374.8 million
Private investment supported	>€2 billion
Leverage ratio	>5:1

The scheme subsidises interest costs on commercial bank loans rather than financing loan principals. This approach:

Reduces financing costs while preserving private credit discipline
Allows public resources to support a large number of firms
Prioritises Industry 4.0 and digital technologies

By contrast, support for machinery and equipment in Serbia relies primarily on direct grants and public lending through the Development Fund, both constrained by fixed budgetary ceilings.

InvestEU Framework

The InvestEU framework illustrates a rules-based approach that emphasises risk sharing and leverage rather than direct expenditure:

Metric	Value
Budgetary guarantee	€26.2 billion
Investment mobilised	>€372 billion
Leverage ratio	>14:1

Public resources are deployed as guarantees that absorb part of the credit risk borne by financial intermediaries, thereby expanding access to finance for SMEs without replacing private lending.

Just Transition Fund in Silesia

In Silesia, Poland — a region of 4.4 million inhabitants with ~100,000 jobs linked to coal — the Just Transition Fund is deploying €2.4 billion across seven subregions:

Links SMEs to larger anchor projects in emerging sectors (green technologies, hydrogen)
Repurposes ~2,800 hectares of brownfield land into innovation and industrial sites
Combines grant financing with advisory support through InvestEU instruments
Aims to support >2,000 SMEs and create ~27,000 jobs

Proposed Package: Five Measures to Convert State Aid into a Productivity Pipeline

1. Create a National SME Upgrading Pipeline

SME support currently operates as a set of entry points with no sequencing. A productivity policy should establish a staged pipeline:

Step 1 — Diagnostic: Independent assessment of processes, technology, energy use, product-market strategy, and management systems by accredited industry experts, resulting in a standardised upgrading plan.

Step 2 — Co-financing: Conditional co-financing for specific investments that follow from the plan — equipment, digital tools (ERP and production systems), certification, targeted training.

Step 3 — Implementation support: Short implementation phase where needed to ensure absorption.

This sequencing is the missing mechanism in Serbia’s current toolkit. It is also the most direct way to ensure that public support produces measurable productivity gains.

The Export Credit and Insurance Agency of Serbia (AOFI) is currently unable to fulfil its role due to:

Constraint	Serbia	EU Minimum (Slovak EXIM)
Capital base	€70 million	€228 million
State guarantees	No	Yes
Maximum maturity	2 years	2-7 years

Proposal: A targeted amendment to the Law on AOFI to establish a state-backed Guarantee Fund:

Initial capital: €5-15 million
Could support: €50-150 million in annual exports through conservative leverage
Relies on premium income to limit fiscal exposure

3. Reintroduce an SME Investment Tax Credit

Serbia’s current system channels tax-based support almost exclusively toward large-scale projects. Reintroducing an SME investment tax credit would:

Restore equal tax treatment of investment
Lower the effective cost of incremental investment at the margin
Address the structural asymmetry where SMEs finance investment under standard tax conditions while large investors benefit from substantial exemptions

Projected impact (based on conservative simulations):

First year: SME investment increase of 17.5-35%
Medium term: up to 40% increase
Positive spillovers for productivity and economic growth

4. Build an Integrated Access-to-Finance Platform

Despite increased public and foreign investment, domestic private investment in Serbia remains structurally weak:

SME investment: 5-7% of GDP (2019-2023)
EU average: 11-12% of GDP

The gap reflects:

Limited access to finance in a bank-dominated system
Persistent information asymmetries
Weak investment readiness among SMEs

Key statistics:

Only 20% of Serbian SMEs use ERP systems (vs. 43% in EU)
Only 15% report any green investment activity
Investment lending to SMEs declined by 16% in 2023

An integrated platform would:

Improve financial transparency
Benchmark performance
Standardise investment documentation
Reduce perceived risk for lenders

5. Restore Competitive Neutrality

Beyond formal rules, Serbia’s incentive framework is undermined by an informal governance model that systematically advantages large investors:

SMEs navigate complex, slow administrative procedures through standard channels
“Strategically important” projects get direct access to senior decision-makers
Expedited resolution of regulatory issues for large investors

This asymmetry creates a dual-track system where administrative responsiveness varies by firm size rather than by objective criteria.

Solution: Shift from discretionary, personalised facilitation toward transparent, rules-based administrative processes that apply uniformly to all market participants.

Monitoring: Indicators That Reveal Structural Change

Current reporting practices emphasise the number of SME beneficiaries, which obscures the concentration of fiscal resources in large-scale instruments. More meaningful indicators:

Proposed Monitoring Framework

SME share of total state aid volume (not just number of beneficiaries)
- Disaggregate by instrument type: tax expenditures, cash grants, guarantees, de minimis
- Disaggregate by objective: investment, innovation, employment, regional development
Concentration indicators
- Share of total state aid captured by top 10 beneficiaries
- Share captured by the largest single instrument
Sequencing quality
- Proportion of SME support delivered through multi-year integrated programmes
- Programmes that combine diagnostics, co-financing, and implementation support
Leverage ratios
- Private euros mobilised per euro of public support
- For key instruments: guarantees, co-financing, tax credit
Productivity-linked outcomes
- Changes in sales per worker
- Export share
- Energy intensity
- Adoption of digital systems
- Benchmarked against comparable control group where feasible

Conclusion

The evidence points to a state aid system that could do significantly more with existing resources. The core weakness lies not in the overall scale of support, but in its structure and sequencing.

A modest rebalancing of funds, combined with integrated SME upgrading instruments and stronger emphasis on innovation and diffusion, could substantially increase the productivity impact of state aid.

If no structural shift is observed once the new indicators are applied, this would provide clear empirical evidence that the current framework remains structurally unchanged — thereby reinforcing the case for deeper reform.