# **1. Introduction**

During the nine-year period prior to the financial crisis, the economy of Serbia grew at an average annual growth rate of 5%. The financial crisis hit the economy significantly with a reduction of 3.5% of gross domestic product (GDP) in 2009. It impacted all economic sectors except agriculture which remained constant in real terms. The industrial sector shrank by 20%, particularly construction; while services reduced only by 1%.<sup>1</sup> This reduction in GDP was mirrored by a decrease in employment by 7%, mainly focused in industry as well as a decline of 10% in average net earnings in real terms. Manufacturing and construction experienced significant declines in earnings by 10% and 17% respectively.

After the crisis the economy essentially remained stagnant during 2010 and registered a marginally positive growth rate in 2011 (Table 1). Current estimates suggest that the economy likely contracted again in 2012.<sup>2</sup> On the other hand, employment continued falling in 2010 and 2011 at similar rates. The largest losses in the absolute number of the employed have been recorded in the agricultural sector, where total employment fell by more than 10 percent each year. The unemployment rate almost doubled the levels prior to the crisis<sup>3</sup> , and the activity rate fell from 51.4% to 46.4% during the same period (Table 2). However, the average earnings remained stable in real terms.

While the economic contraction was registered primarily in 2009, the poverty impact of the crisis was revealed with a lag. The total incidence of poverty increased from 6.1% to 6.9% in 2008-09 interval; then rising substantially to 9.2% in 2010. This increase was most heavily realized in rural areas. Poverty dynamics were mirrored by the worsening of households’ own assessments of their financial situation in 2010.<sup>4</sup> An analysis of how this economic context, continued deterioration of labor market conditions and lack of Household Budget Survey (HBS) data for 2011 has affected poverty and distribution of welfare during 2011 in Serbia would require a method flexible enough to capture these particularities. In this paper we use a micro-simulation model to evaluate the distributional impact of these restrictions that allows also addressing key questions such as: how are the impacts shared across the distribution, which areas are likely to be impacted and what are the characteristics of those who would become poor as the result of these dynamics? Section 2 provides a brief methodological discussion of the approach, its limitations and assumptions. Underlying household survey data, as well as macroeconomic inputs into the simulations are described in Section 3. In Section 4 we discuss the results of the simulations for poverty and distribution of welfare for 2011. In order to provide context for these predictions, validation exercises are performed in Section 5 using the same method with previous actual data. The results are also compared to projections based on a standard elasticity approach. Section 6 concludes.

> 1 Wholesale/retail trade and transportation declined by 7.5% and 10% respectively.

> 2 The IMF estimates that the economy will contract by about 0.5% in real terms in 2012 (IMF WEO Database, October 2012).

> 3 The unemployment rate increased from 13.6% in 2008 to 23% in 2011.

> 4 Most households (77%) assessed their financial situation as either somewhat or substantially worse than in 2009 according to HBS data.

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