In March 2002 the Federal Republic of Yugoslavia disappeared as its two remaining republics, Serbia and Montenegro, opted for a looser union with their own currencies, economic policies and customs procedures.
While the union retains some federal structures such as foreign and defence ministries and a joint president, other institutions are now autonomous.
Former federal laws such as pensions are being replaced by republican legislation. Since the two republics have long used different currencies – Montenegro replaced the dinar with the Deutschemark in 1999 and then switched to the euro in 2002 while Serbia retained the dinar – a unified pensions system would in any case have been too complex to maintain. Montenegro, the smaller of the two republics with a population of 680,000 against Serbia’s 7.5m, is also proceeding more cautiously than its larger partner.
Montenegro’s new law on pensions and disability, which only covers the first pillar, was approved by parliament this September and comes into effect on January 1, 2004. As elsewhere in the region, an unfavourable demographic trend and decreasing financial sustainability were the main impetuses. “We have an increasing ageing population and reduced working population,” explains Slavoljub Stijepovic, Montenegro’s minister of labour and social welfare. Meanwhile the dependency ratio, the number of workers whose contributions must support pensions payments under the existing pay as you go scheme, has fallen from 2.05 in 1991 to 1.3. “Such an unfavourable relationship doesn’t provide sufficient funds for pensions payments; only 60% is covered by contributions,” Stijepovic adds.
The shortfall for pensions and disability benefits, made up by the budget and other subsidies, amounts to E25m or 1.9% of GDP, with a similar amount paid out to special budget-funded groups such as the police and war veterans.
According to Vladimir Pajovic, an adviser at the Barents Group, which is working as a USAID-contracted consultant for the Montenegrin government, the old system’s loose eligibility criteria made reforms essential. It was relatively easy to take early retirement, while disability pensions were frequently awarded on non-medical grounds and now account for 30% of all pensions. Although this enabled the government to reduce unemployment, it added further to the financial strains. Pajovic estimates that without reforms the burden on the budget would rise to more than 10% of GDP by 2050.
Pension, health and other benefit expenditure, which already consume a disproportionately high 13% of economic output, would be eating up 21% by the end of that period.
The main features of the reform include:
o Raising the retirement age over a period of 10 years from 60 to 65 years for men and from 55 to 60 years for women.
o Changing the indexation from nominal wage growth to the Swiss system of 50% wage growth and 50% inflation.
o A gradual change, over the coming 10 years, of the base pension calculation from 10 best years of service to a points system that will eventually cover 40 years of service.
“The selection of the 10 best years in the old law resulted in significant abuse of the system and a favourable position for white-collar workers, whose wages tend to rise with age, against less skilled workers with a ‘flat’ earnings profile,” notes Pajovic. “The points system has been introduced because it more directly links wages (ie contributions) to future pensions. Unlike the old law, the points formula also treats each year of service equally for men and women.”
The main difference between Montenegro and Serbia’s otherwise similar reforms is that Montenegro is phasing in elements such as the increased retirement age and calculation of final benefits while Serbia’s went into immediate effect. “Montenegro’s economic situation is worse than Serbia’s and an immediate introduction would have had a negative impact on pensioners and other social partners,” explains Stijepovic. “We wanted to have the agreement and support of all our social partners for the reforms.”
One additional benefit of the new law is that will reduce Montenegro’s extensive black economy and bring more contributors into the pensions system. At the beginning of the year 70,000 were estimated to work in the informal, non-tax paying economy against 160,000 in the formal sector. The old pensions system had over the years contributed to the vicious circle here, with the government regularly increasing contribution rates, currently 24%, to fund the pensions shortfall, which in turn created more incentives for workers to be moved off the payroll.
Additionally, as of this April employers have been given tax and contributions exemptions for a year for taking on new workers. This has reduced the informal sector workforce by around 20,600 and also cut the unemployment rate down from 20.6% at the beginning of 2003 to 20% as of the end of September.

Within the formal sector, the new law has also broadened the contributions base to curtail the practice of employers reducing the wage base, and thus pensions and other benefits contributions, on return for payments in kind. Remunerations such as author’s fees, and temporary or occasional job payments are also now subject to contributions.
The first pillar reforms are only the start, as at the beginning of 2004 the government intends to start preparing a second-pillar law. “In 10 years’ time we will have a sustainable pensions system, with regular and increased payments of benefits directly linked to contributions and wage levels. Over this period there will hopefully be no need for further transfers from the budget, which can instead be used for investment projects,” foresees Stijepovic.

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