A recent working paper, published by EBRD, analyses the extent and evolution of informality and inequality in the Serbian labour market between 2002 and 2007, using data from the Living Standard Measurement Surveys (LSMS). Two surprising results emerge. First, the level of informal employment has risen significantly over the period, despite strong economic growth and the introduction of a range of market-oriented reforms. Second, the level of inequality in earnings seems to have remained more or less constant over the period, in contrast to the experience of other countries at a similar stage of transition. 

In conclusion, the report highlights that their analysis revealed that informal activities are highly significant in the Serbian labour market, and appear to have grown considerably over 2002-07. Nearly 28 per cent of total employment (aged 15-64) was in the informal sector in 2002, and this percentage increased to 35 per cent in 2007. This is a counter-intuitive result, but can be explained by a number of factors. One possible reason is the regressiveness of the wage taxation system that was present since 2001 until 1 January 2007. By imposing a high tax burden on low-income labour, the incentives for employees to join the formal economy diminishes, as they have to give up a significant portion of what they can get working at the same job informally. The reforms on labour taxes and social security contributions introduced at the beginning of 2007 have led to a decrease in the average fiscal burden of employees’ net salaries, but the effects on the level of informal employment remain to be seen. Informal employment was until recently also encouraged by the ease in gaining access to a range of social benefits through the simple act of registering as unemployed with the employment service, while actually working in the informal economy.

A second result of interest is that the level of inequality appears to have remained broadly constant over the period in question, both for formal earnings and in the informal sector, where inequality is particularly pronounced, although some increase has occurred. This is a surprising result, especially in light of the rise in informal activities and the enhanced role of education. Relatively stable earnings inequality in Serbia appears in contrast to findings of Milanović (1998) for other selected transitional economies where a positive relationship between reform and inequality is detected. Other studies also show that most transition countries experienced a large increase in earnings inequality since the transition began (World Bank, 2000). The sharp decline in arrears over the period in question has helped to counteract those forces pushing in the direction of greater inequality.

Lastly, the analysis identifies informality as an important determinant of inequality in 2007, but not in 2002. The informal sector is found to exert a widening influence on earnings inequality, which could be linked to an increased share of employees working informally between the two years in question. However, the most important factor that explains both the level of explained inequality in 2002 and 2007, and contributed to slightly increased inequality over that period, appears to be educational qualification. An increase in wage premiums to education is also found to be the most important factor that was driving the rise in wage disparities in the central European countries (World Bank, 2000).

The results highlight two points that need to be addressed by policy-makers. First, measures taken so far to reduce informality have been a failure. Even though the economy has grown strongly over the present decade, the level of informality has increased, implying both unfair competition to those in the formal sector who are subject to the usual taxes and regulation, and a loss of much-needed revenue to the government. The paper provides evidence that many still find it relatively easy to register as unemployed but continue to work in the informal sector. The recent changes (noted above) on access to health insurance and other benefits should help to improve the situation, but continued vigilance will be needed to ensure that social assistance is targeted at the most needy.

Second, the returns to education have increased over the period. This is an encouraging result in that it brings out the benefits of a greater focus on educational attainment and suggests that the benefits to expending greater resources on schools and universities may be higher than before. Recent research has once again highlighted the strong link between educational attainment and economic growth, particularly in transition countries (see EBRD, 2008), and points to the need for greater government spending in this area.

EBRD