# **Figure 5. Structural Reforms: Channels and Impact on GDP Growth**

<!-- Start of picture text --> 2.5<br>2.0 Government<br>effectiveness (->TE,K)<br>1.5<br>Human capital Financial<br>(→TE,L) Development (→K)<br>1.0<br>Regulatory quality<br>(→TE,K,L)<br>Labor market<br>0.5<br>Trade tariffs ... regulation (→TE,L) Latest technologies<br>Tax rate (→TE,K,L) (→K,L)<br>0.0<br>-3 -2 Cost to start business -1 0 1 2 3 4 5 6<br>(→K) -0.5<br>Annual real GDP growth (percent)<br><!-- End of picture text --> Distance between Serbia and Germany (0/10=min/max) _Note_ : For each policy variable, the figure shows the distance of Serbia from the frontier (Germany) and the estimated increase in annual growth of real GDP in the process of closing the distance in 20 years (40 for government effectiveness). Variables on the right of the y axis indicate policy areas where Serbia lags behind the frontier: financial development, measured by credit to the private sector as a percentage of GDP (WDI); regulatory quality, which reflects perceptions of the ability of the government to formulate and implement sound policies and regulations for private sector development (WB-WGI); government effectiveness, which reflects perceptions of the quality of public services, the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government's commitment (WB-WGI); availability of latest technology, which captures the perception of survey respondents of the extent to which latest technology are available in the country (WEF); a proxy for the quality of human capital, built as the average years at school weighted by an assumed rate of return to education (Penn World tables); CBR working time regulation index, which measures the extent of regulation of working time (Cambridge CBR); and trade-weighted average applied tariff rate (WEF). Variables on the left of the y axis indicate areas where Serbia has passed the frontier: number of hours to start a business (Doing Business); top marginal income and payroll tax rate (Fraser). Variables not included because of relatively small effects are energy use per capita (WDI) and Internet use (WEF). The EU accession dummy is also not included. The analysis relies on the supply-side methodology, which allows to decompose GDP growth as the sum of separable and independent components (capital, labor, and productivity) and to estimate the impact of key structural reforms for each input channel. The underlying linearity assumption may lead however to under/over estimate the importance of the reforms.

Better educational achievements, hence higher human capital quality, are associated to higher growth through a better use of labor and higher overall efficiency. Even though Serbia’s performance is relatively close to Germany’s, the beneficial effect of investing in raising the quality of human capital is particularly high. The quality of human capital measured as the average years at school weighted by an assumed rate of return to education (Penn World table) is in fact relatively high. Similar findings emerge from the new World Bank Human Capital Index (HCI) report. The HCI for Serbia is higher than the average for its region and income group and what would be predicted for its income level. Yet its low labor market engagement, the increasing skills mismatch, and the large share of youth who are functionally illiterate make it clear that education quality and equity could be improved.<sup>15</sup> And in fact, according to the HCI, the country does not do so well when quality of education is taken into account.

15 Compared to 13.7 percent in 2014, in 2017 29.3 percent of companies reported problems with hiring new workers, mostly due to skills shortages.

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