The Trade Competitiveness Challenge

Real wages in Serbia have grown far faster than tradable-sector productivity, eroding the cost advantage that attracted foreign manufacturers. Manufacturing productivity has declined by 13,5% in real terms since 2015, while wages have more than doubled. Serbia's real effective exchange rate has appreciated by over 21% — faster than any CEE comparator except the Czech Republic, which more than matched its appreciation with productivity gains.

A critical contribution to this squeeze undoubtedly comes from the interaction of five policy channels — an FDI-centred industrial policy, a constrained domestic supply response, promotion of non-tradable investment, bilateral infrastructure financing that marginalises domestic firms, and monetary tightening that falls disproportionately on domestic credit. Together, these amount to a "manufactured Dutch Disease" that, without policy change, is likely to constrain growth going forward.

III.1 The Squeeze on the Ground: Labour Market Stress and Market Consequences

Serbia's labour 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, more than accommodating the terms-of-trade loss suffered in 2022. The increase in wages in Serbia was both more sustained and higher — 21,6% in real terms between December 2023 and December 2025 — than generally in comparator countries. Such an acceleration, combined with only a small decline in unemployment which remained around 8 p.p., suggests that there are serious underlying problems beyond normal cyclical friction.

The combination of strong wage growth and persistently high unemployment points to severe structural mismatch, not normal labour market friction. Earlier, throughout the COVID crisis, foreign investment had slowed relatively little, particularly in manufacturing, and formal employment continued growing. After 2021 labour demand accelerated sharply. Cumulative monthly vacancies reported to the National Employment Service surged from 83 thousand in 2021 to 223 thousand by 2024, yet the number of unemployed fell by only 141 thousand over the same period, leaving 371 thousand still unemployed (Figure 1). The labour market is simultaneously too tight for employers and not absorbing available unemployed or inactive workers. Female labour force participation lags far behind male, regional unemployment disparities are vast, and the links between education and employment remain weak — all signs that the problem lies in a structural mismatch between labour demand and supply. Policy may have contributed to both sides of this mismatch.

Moving from aggregate statistics to sectoral trends, manufacturing firms have been singularly squeezed over 2022–2024. With the help of official minimum wage increases, manufacturing wages grew even faster than the economy-wide average: 31% (nominal) 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. The shrinking of the space for capital earnings is dramatic.

Markets are already responding. Closures and layoffs among foreign-owned manufacturers have accelerated, affecting clothing, shoes, wire harnesses and other automotive parts, as well as basic metal products. At least 15 factory closures or major layoffs have been documented across Serbia since 2023 in industries that formed the backbone of FDI-driven manufacturing employment. The rate of unemployment in the second half of 2025 picked up. The pattern is consistent with the cost squeeze: these are precisely the sectors where Serbia's remaining wage advantage has evaporated. SME exporters report shrinking margins and delayed investment; regional disparities noted in the previous chapter are deepening.

A further sectoral disaggregation of this analysis, and of the one that follows in the next section, would be extremely useful for improving policy. Manufacturing is not the entire economy, but in and of itself it is a key sector for competitiveness and development.

III.2 Wages Have Outstripped Productivity — Where It Most Matters for Competitiveness

Aggregate convergence statistics mask a critical sectoral divergence. Serbia's overall productivity and wage convergence with the EU appear roughly aligned, with both taking 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 pinned down or constrained by international markets and competition. This implies that increases in gross value added (GVA) per employee are likely to reflect actual output gains. In non-tradable services, however, prices are closely linked to domestic wages and are not subject to competitive discipline; so the observed rise in GVA per employee could simply reflect price inflation rather than genuine productivity improvement (Nguyen, 2025).

In real terms, manufacturing productivity in Serbia declined by 13,5% between 2015 and 2024 — even as nominal GVA per employee eventually recovered. In CEE countries, non-tradable GVA per employee has generally been growing faster than in manufacturing, but this divergence has been more pronounced in Serbia and has continued to widen. Serbian non-tradable GVA per employee more than doubled over the 2015–2024 period when measured in current prices (see Figure 2), while in real terms it increased by 31%. By contrast, manufacturing GVA per employee in current prices first declined, then started recovering after 2020, and eventually increased by 20% in the same period. Knowledge services recorded a substantial increase of 75% in nominal terms relative to 2015, but only 5% in real terms. Fast export growth in this sector suggests this reflects real gains.

Although the productivity of manufacturing and knowledge services relative to the non-tradable sector declined across CEE economies, the decline was much more pronounced in Serbia. While in CEE economies the productivity of manufacturing relative to the non-tradable sector only slightly declined between 2020 and 2024, in Serbia it declined from 70% to 59%. In the EU27, by contrast, manufacturing is more productive than non-tradable sectors and the ratio has been essentially flat. Furthermore, the relative productivity of knowledge services to non-tradables in Serbia declined from 162% to 142%, while the average decline in CEE economies was more modest, from 131% to 116%.

This sectoral divergence underlies the dinar's fast-appreciating real exchange rate — the declining ratio of foreign to domestic prices combined with the de facto pegged nominal exchange rate. As can be seen in Figure 3, since 2015 it appreciated by over 21%, substantially faster than in any other non-euro CEE country except the Czech Republic. In the Czech Republic, however, the Czech koruna appreciated 25% in real terms over the same period, but this was accompanied by substantially higher real manufacturing productivity gains (28%).

Initially, the faster wage growth was understandable, but the recent real appreciation has effectively wiped out Serbia's average competitive advantage in manufacturing. Amid massive unemployment, wages started off extremely low in comparative terms. They grew while productivity declined, and continued rising even faster once productivity finally picked up after 2020. For example, compared to Croatia and Slovenia — the two structurally most similar cases — Serbia has been losing competitiveness fast: its manufacturing productivity stood at 71% of Croatia's in 2015, but as Croatia's productivity grew faster, by 2024 the ratio had declined to 57%; similarly, Serbia's productivity declined from 45% to 34% of Slovenia's over the same period. Meanwhile, relative wages which stood much lower in 2015 (respectively 39% of Croatia's and 26% of Slovenia's) by 2024 caught up to approximately the same ratio as productivity. This means that the gap between GVA per employee and wages — a large part of which represents the return on invested capital — has been shrinking rapidly. Yet this is the very differential that must generate the investment Serbia needs to close the productivity gap.

The loss of competitive advantage in manufacturing is also present when compared to other CEE countries. Over the last decade, the relative productivity — measured as gross value added per employee — between Serbia and these countries decreased substantially. For instance, in 2015, Serbian manufacturing productivity stood at 150% of Bulgaria's, whereas by 2024 Bulgaria had overtaken Serbia, reducing this ratio to 72%. On average, Serbia's manufacturing productivity amounted to 74% of the CEE peer average in 2014 but fell to only 53% by 2024. Nonetheless, relative compensation per employee between Serbia and the comparator countries increased in all cases except Bulgaria and Romania. In other words, on average, Serbian manufacturers already operate at a cost disadvantage against those countries. The implication is clear: to maintain and regain competitiveness, Serbia needs urgently to begin generating more widespread productivity growth.

In the ICT sector the situation is better, as Serbia is still relatively more competitive on average, but it did lose some competitiveness over the period. While productivity grew slower than in any other CEE economy, declining to some 81% of the CEE average, wages mostly kept pace or grew faster, declining sharply only against Bulgaria. Wages stood as of 2024 at 58% of the CEE average. The other component of knowledge services, professional services, has performed similarly.

III.3 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 Text Box 1). The question is which policies, and through what mechanism.

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 foreign exchange supply from remittances and other informal channels.

The combination of at least five policy channels 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.

First, the fact that industrial policy has been so focused on attracting FDI, rather than also promoting the productivity and investment of the domestic economy, has contributed to a larger share of private investment being financed through foreign capital, increasing the foreign exchange supply and hence demand on the domestic market.

Second, the supply response of the domestic economy has been suppressed by the broadly unsupportive and counter-productive business environment (analysed in Chapter IV). A flexible and responsive domestic economy would have slowed down the increase of domestic prices caused by the inflow of foreign capital. It would also have accelerated GDP growth. However, the burdensome business environment described in the next chapter — including discriminatory tax policies, an uncertain, unresponsive and costly administration — has led to limited domestic private investment and, while it contributed to raising imports, it led to higher domestic prices.

Third, the aggressive promotion of commercial real estate projects has contributed to increasing the share of FDI flowing into non-tradable rather than tradable sectors, which has a direct effect on raising wages and the REER.

Fourth, the choice of financing mechanism for public infrastructure investments, as well as the size of the bricks-and-mortar component in them, has had a similar effect. Public infrastructure investment under bilateral credit contracts, in addition to bypassing standard appraisal and procurement (as documented in Chapter VII), is also conditioned on substantial reliance on foreign implementing companies. These companies bring additional foreign capital mainly invested in real estate and the expansion of construction-sector capacity. The latter increased to around a quarter of total investments, reaching as much as EUR 1,8 billion in 2022. Thus, the share of FDI into manufacturing and knowledge services declined in recent years compared to the 2010s, exceeding 40% only in 2021. The direct engagement of foreign companies also has the effect of marginalising domestic companies. Rather than raising their supply capacity, it suppresses it.

Fifth, the monetary policy that must accompany these policy choices adds a further layer of discrimination against domestic investment and capital. 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. The NBS's tightening affects only bank credit, and bank corporate clients are overwhelmingly domestic companies, with banks being nearly the sole source of external financing (90%) for SMEs. FDI enterprises, by contrast, are largely financed through parent companies or directly with foreign banks and are therefore little affected by domestic monetary conditions. For example, during 2022–2023, when inflation-fighting was most intense, credit to private enterprises was allowed to increase 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 largely unaffected.

Beyond their individual significance, the interaction of these five policy effects is what makes this a macroeconomic problem. Each channel on its own might be manageable. Together, they result in faster growth of domestic prices and wages than international price growth — real exchange rate appreciation. Without a commensurate increase in the productivity of the tradables sector, this means a loss in competitiveness.

III.4 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. When wages exceed what productivity can justify relative to competitor countries, the economy will either stagnate or slide toward a crisis. 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 would also reverse the very convergence in living standards that a decade of growth has achieved; this is the path that Greece had to follow after the Global Financial Crisis.

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, decentralised, 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 and that helps at least some of them become large investors as well; transparent planning that channels public investment where returns are highest; labour 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.

There is conceivably one more path that could keep Serbia's economy growing: that non-tradable sectors become effectively tradable. This may be what the authorities are aiming for — that the continued promotion of Belgrade's role as the regional urban centre, with continued growth of real estate prices and possibly its transformation into a high-budget tourist destination, generates enough growth to keep Serbia's economy out of stagnation. However, in that case, Serbia would be on an unsustainable path of deepening extreme regional and social inequalities.