III.2 Rule of Law and the Real Regulatory Environment

Serbia’s path to a functional market economy is constrained less by the absence of good policy ideas than by a persistent deficit in the rule of law. Efforts to strengthen economic fundamentals traditionally concentrate on two pillars: combating corruption and reforming the justice system. Both agendas prioritize a stronger, more independent judiciary, while anti-corruption reforms also seek demonstrable progress from investigation through final judgment.

This reflects the dominant assumption that the quality of the judiciary—the third branch of government—is the decisive determinant of legal certainty.

Beyond the Judiciary

While that lens is fundamental, we believe it is insufficient. A truly independent court system within a reasonable regulatory framework may in theory be able to correct problematic behavior in what economists would call many repeated games. Supposedly, over time economic agents will learn it doesn’t pay.

But this theory does not consider:

The time it may take for collective learning to take place
The damage that may happen along the way

Moreover, with every imperfection of the system, the likelihood increases that what agents are more likely to learn is that life is short, rules are messy, and they’d better get in the game and make money fast while they are in the political power chair—diverging far away from an optimal solution.

The Two Regulatory Environments

A substantial part of the erosion of legal certainty occurs upstream—within the executive and the public administration itself.

Serbian economy functions within two regulatory environments simultaneously:

Environment	Description
Nominal	Defined in laws, strategies and program documents
Real	Constituted by how rules are interpreted, sequenced, delayed, selectively applied, or quietly ignored

Where the gap between these two environments widens, predictability collapses—even when the formal legal architecture appears intact.

Evidence from Business Episodes

Based on a structured review of company-reported “business episodes” gathered through consultations with the private sector, we provide insights into the magnitude and effects of the problem. Each episode documents a specific friction in how laws and regulations are implemented in practice (by ministries, agencies, inspectors, utilities, customs, and local authorities), along with its business impact and proposed fixes.

The material covers 25 distinct companies and points to a clear concentration of pain points rather than a long tail of isolated issues.

Distribution of Implementation Failures

Category	Companies Affected	Key Issues
Cross-border administration	10	Import/export, customs, phytosanitary and veterinary clearances, sampling and laboratory procedures, certificates, quotas and ad-hoc restrictions
Incentive and support architecture	8	Perceived asymmetry between domestic and foreign investors
Administrative execution (permits)	5	Construction and use permits, planning and building procedures, greenfield project processing, institution-to-institution sequencing failures
Energy and state-linked utilities	6	Electricity and energy input pricing, contracting conditions, connection/approval lags
Tax and fiscal implementation	4-5	Tax credits that don’t work as intended, withholding regimes, contribution-related instruments
Human capital and labor	3	Dual education participation, hiring foreign workers

Cross-Border Administration

The operational signature is consistent across sectors—goods get stuck in process, cash gets stuck in guarantees and storage, and commercial commitments become hostage to procedural throughput rather than market demand. From a business perspective, this category is not “trade policy”; it is execution risk with a measurable cost profile.

Incentive Asymmetry

The notes describe a familiar pattern: foreign investors receive tailored packages, facilitation and fiscal relief, while domestic firms operating in comparable segments face a thinner and less predictable toolkit.

The implication is not only competitiveness in the narrow sense; it is expectation-setting. When support is perceived as discretionary and relational, firms rationally treat the system as non-universal and shorten planning horizons.

Administrative Execution Failures

The common denominator is that procedures do not function like integrated operating systems with enforceable timelines:

Approvals are sequential
Responsibilities are fragmented
Data is not shared
No one actor “owns” the end-to-end outcome

The predictable result is, time and again, time risk being structurally transferred to investors and operators—with no evident accountability for delays that often result in very substantial costs.

Meta-Patterns

Two meta-patterns strengthen the diagnosis:

Cumulative exposure: Several firms sit at the intersection of multiple frictions, indicating companies face cumulative exposure across the state interface rather than isolated bottlenecks
Consistent governance logic: Across categories, the cost of institutional fragmentation, slow throughput and discretionary interpretation is systematically pushed onto the private sector—through delays, storage costs, working-capital lock-ups, reputational risk, and foregone opportunities

The binding constraint is less the nominal regulatory framework and more the predictability and neutrality of execution. In this environment, compliance does not buy certainty—and that is precisely why firms discount long-horizon commitments even when formal rules appear stable.

Case Studies

The R&D social contribution exemption was designed to reduce labor costs for companies investing in research and development. The regulation allows employers to be exempt from paying social contributions on R&D salaries, while employees retain full pension rights.

The Problem

In implementation, practice diverged sharply across the Tax Administration. As employees changed jobs, they discovered their retirement insurance contributions had simply not been paid into the PIO system.

The explanation from the Tax Administration: they would “recognize” service years only after an inspection established that the exemption had been correctly applied, at which point contributions would allegedly be entered retroactively.

The Reality

The system operated on the assumption that pension rights would be reconstructed ex post, rather than secured ex ante
Inspections were slow, uneven, and in many cases never conducted at all
Chronic understaffing meant large numbers of files remained unresolved

The Outcome

What was intended as support for innovation becomes a source of uncertainty. Instead of reducing costs and encouraging high-skill employment, the measure creates:

Substantial administrative costs for companies and workers
Financial risk, as it’s unclear whether inspections will approve exemptions, under what criteria, and when

This reinforces the perception that, even when compliance is full, the administration cannot guarantee predictable and timely outcomes.

Case 2: Wind Energy Investment

Investors entering Serbia’s wind-energy projects do not first encounter strategy documents or policy frameworks—they encounter risk.

The Contract Structure

From the very beginning, developers sign binding contracts with EPS that require electricity delivery within a fixed three-year period. The rule is simple and absolute: if the deadline is missed, penalties apply—regardless of the reason.

The Hidden Problem

The sequence of state procedures on which project delivery depends—grid connections, permits, environmental consents, technical approvals—moves through multiple institutions with:

Unclear timelines
No single point of accountability

While administrative processes stall, the contractual clock continues to run.

EPS, although acting in a domain of public interest, does not function as an administrative authority with defined procedures, statutory deadlines, transparency obligations, or appeal mechanisms. It behaves as a contractual counterparty whose position is protected, while investor exposure accumulates.

The Systemic Failure

This is not a market failure. It is a design and administration enforcement failure created by the executive architecture itself: obligations are rigid, but the state machinery on which fulfillment depends is slow, fragmented and insulated from consequence.

Over time, rational behavior follows:

Capital becomes more conservative
Projects slow
Investors begin pricing executive risk into every decision

The broader investment climate reflects the signal: foreign direct investment declined from €600 million in January 2024 to €220 million in January 2025—not because markets became unpredictable, but because the state did.

Case 3: Moravski Market

The Moravski Market was conceived as a local-development instrument. Under EU-funded programs supporting small business and rural producers, the idea was to create a publicly supported marketplace that:

Aggregates local food and craft products
Shortens supply chains
Improves visibility for small suppliers
Helps them reach urban consumers on fairer terms

The Arrangement

Because such initiatives are rarely commercially viable in their early years, the policy design assumed a partnership with local government: the municipality would provide a centrally located public space and co-finance basic operating costs.

On paper, the arrangement looked stable. The city signaled commitment, the project aligned with local-development objectives, and financial support was formalized through annual grants and a co-financing agreement.

The Breakdown

Year	Grant Amount
2023	RSD 800,000
2024	RSD 500,000
2025	RSD 0

A separate contract for RSD 300,000 in co-financing—formally signed and listed in the city’s final accounts—was never paid. The municipality also failed to secure the promised public premises.

The Lesson

The result is not simply financial strain. It is a breakdown of credibility:

A program designed to stabilize local producers becomes itself a source of instability
Formal commitments do not translate into delivery
Businesses observing the case draw a rational conclusion: cooperation with public authorities carries material, unpredictable implementation risk, even when everything is formally agreed