THE TRANSITION OF SLOVAKIA: One Century Compressed Into One

Decade

Ján Oravec

Economic Freedom Network Annual Meeting

Bratislava, October 16, 2003

HISTORY IN BRIEF:

YEAR EVENT

833-906 Slovakia for the first time united together with Bohemia and Moravia in the Great Moravian Empire

1918 Slovakia united again with Bohemia and Moravia when Czechoslovakia was declared an independent state after the collapse of Austro-Hungarian Empire

1939 Slovakia became an „independent“ state under German control, part of Slovakia annexed by Hungary, Bohemia and Moravia became a German protectorate

1945-46 The Soviet Army liberated Slovakia, Bohemia, and Moravia from Nazis, Czechoslovakia re-established, the Communist party lost elections in Slovakia, but did win in Bohemia, and Moravia

1948 Under the impact of increasing Soviet influence the Communists took the power

HISTORY IN BRIEF (cont.):YEAR EVENT

1960 The country was declared a socialist republic with constitutional guarantees of the Communist party to control the government, economy, etc.

1968 A reform movement called the Prague Spring, led by a Slovak Communist, Alexander Dubcek, a new constitution created federal state with two republics and their own governments and Federal Assembly in Prague, Soviet-bloc countries invasion

1989 November 17, peaceful student demonstration, the Communist government resigned, constitutional guarantees ensuring the Communist party the leading role in society was abolished

1990 A multiparty democracy introduced, the first free elections held in June, the country was renamed the Czech and Slovak Federal Republic, the beginning of economic transformation

1993 January 1, the federation was split up into two internationally recognised entities

WHY DIVORCE:1. Due to differences in its industrial structures (dominated by

heavy industry) Slovakia disproportionally hit by the first reform measures

2. Unemployment rates 1989, 1992:

3. Growing disagreements between Czechs and Slovaks over structural reforms, and monetary and fiscal policy mix

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Czech Republic Slovakia

19891992

WHY DIVORCE (cont.):

REACTIONS OF SLOVAKS:

• Some nationalists requiring separation,• Others requiring decentralisation of decision-

making powers

REACTIONS OF CZECHS:

• Let Slovaks pay their own bills, let them go• An American businessman living in Prague:• Klaus was in a position of a general manager of the company

with three subsidiaries (Bohemia, Moravia, Slovakia) allowing top management of a least profitable of them representing a burden on other two to carve it out via management buy-out.

THE SLOVAK ECONOMY ON JANUARY 1, 2003:

MAJOR CHARACTERISTICS:• More industrialised and less agrarian than expected by

foreigners

• Natural resources limited

• Most of industrial raw materials (coal, iron ore, gas) imported from Soviet Union

• Industrial structures built relatively recently

• Industrialisation largely driven by ideological and geopolitical assumptions (missing economic rationality)

• In Slovakia several large heavy industry plants (iron and steel production, heavy engineering, armaments, chemical industry) were built - clearly exceeding capacities of its domestic market

THE SLOVAK ECONOMY ON JANUARY 1, 2003:

MAJOR CHARACTERISTICS (cont.):• Economic activities still concentrated in a few large enterprises that

were hit by a collapse of a COMECON countries market followed by loosing of 2/3 of domestic (Czechoslovak) market

• Due to a necessity to built a new institutional framework necessary for an independent state (many institutions and experts stayed in the Czech Republic) higher transformation costs were expected,

• Extremely negative expectations concerning future performance of the Slovak economy (e.g. immediate depreciation of 3SK/1CZK was expected – today it is 1,3SK/1CZK - and overal early collapse of the whole Slovak economy was „predicted“),

• Bad government (autocratic rather than democratic one) was expected to conduct bad and irresponsible economic policies,

• Slovakia was strongly percieved as an underdog of the region.

THE SLOVAK ECONOMYMAJOR ACHIEVEMENTS ONE DECADE LATER

Three quick facts:

1. in 1989 the Slovak economy was the economy with one of the highest shares of state ownership in the economy in the world, today more than 85 % of a Slovak GDP is generated by private sector.

2. in 1989 the most of the Slovak exports were directed to former COMECON countries, the main export markets for Slovakia today are highly competitive markets of the EU (more than 60 % of total Slovak exports) and CEFTA countries (resulting in 92-93 % share of OECD countries in total Slovak exports),

3. back in 1989 the Slovak economy was dominated by several large companies employing tens of thousands people, during transition process an average size of enterprise has declined significantly and today about two thirds of the Slovak economy are represented by small and medium sized enterprises.

THE SLOVAK ECONOMY2 VERY DIFFERENT PERIODS OF POLICY MAKING

1993 – 1998:1. Originally intended concept of a voucher privatisation was

replaced by direct sells of state property to known buyers (friends, families, loyal people) with all negative consequences: non-transparency, corruption, growing interlinks between political and business elites,

2. Certain sectors and companies were excluded from privatisation (banking, telecom, energy sectors),

3. Politically sensitive prices (gas, electricity, heat, rents, etc.) were not deregulated and companies producing these commodities and services experience serious financial troubles,

4. Restrictive fiscal policy was replaced by expansionary fiscal policy (large public infrastructure investments) with growing budget deficits, and government debt,

THE SLOVAK ECONOMY2 VERY DIFFERENT PERIODS OF POLICY MAKING

1993 – 1998 (cont.):

5. Government borrowing was crowding out private investments (at some point government bonds interest rates exceeded 30 %),

6. Since foreign capital was discouraged the Slovak economy was seriously under-capitalised,

7. Legislative framework was more and more distorted by vested interests (favouring some and discriminating against others),

8. Slovakia was excluded from integration efforts (EU, NATO, OECD) of other transition countries.

THE SLOVAK ECONOMY2 VERY DIFFERENT PERIODS OF POLICY MAKING

1998 – present:

A new government reversed all crucial elements of previously bad policies:

1. Privatisation – open international tenders,

2. Banking, telecom, energy sectors were restructured and privatised by foreign investors,

3. Politically sensitive prices (gas, electricity, heat, rents, etc.) were deregulated and regulatory framework was reformed (more isolated from political influence by establishing of independent regulatory authorities),

4. Large public infrastructure investments were slowed-down intentions to reform public sector declared,

THE SLOVAK ECONOMY2 VERY DIFFERENT PERIODS OF POLICY MAKING

1998 – present:

5. Government bonds interest rates were reduced significantly,

6. Foreign capital attracted by (first) tax holidays and, (more importantly) by efforts to improve business environment,

7. Legislation was liberalised in many areas and sectors in order to comply with international standards,

8. Integration efforts were accelerated and Slovakia is an OECD member since December 2 000, and will become EU and OECD member in 2004.

THE SLOVAK ECONOMYCONCERNS

STRUCTURE OF THE ECONOMY• Vulnerable to external shocks (with its imports dependent on one

country-Russia, and with its exports on business cycle in Western Europe),

• It starts to be too dependent on one particular industry (automotive industry – VW, Pegot, Hyunday?, others?),

SUSTAINABILITY OF REFORMS• Ups and downs in a relatively short period of time• More stability to introduce necessary reforms is needed• Mechanisms to prevent achievements from deterioriating need to be

introducedLAW ENFORCEMENTDependeing on 3 critical factors:1. Legislation and regulation2. Institutions3. People and their values

THE SLOVAK ECONOMYCHALLENGES

1. Privatisation need to be completed (above all, it is important to privatise remaining government stakes in energy sector),

2. Important public sector reforms (pension scheme reform, health-care reform, education reform) will still need strong efforts in order to prevent them from being undermined by unnecessary compromises,

3. Rate of redistribution need to be reduced measured not only by revenues (currently about 30 % of a GDP), but primarily by expenditures (currently 42-45 % of a GDP),

4. In addition to a 19 % flat tax reform to be introduced since January 1, 2004, further improvements of business environment (in legislative, regulatory, and administrative framework) need to be achieved.

5. Slovakia needs to look actively for building coalitions with like-minded European countries in order to bring all important reforms on EU agenda as well.

One Century Compressed Into One Decade

There are four parallel hostorical and non-precedent trasitions Slovakia was forced to face within a period of relatively short period of time between 1993 and 2003 :

1. transition from a totalitarian Communist regime to a multiparty democracy,

2. transition from a federation to an independent state,

3. transition from a centrally planned economy to a market economy,

4. transition from state paternalism to individual responsibility.

Facing just one of these challenges would be more than enough for one generation.

Unemployment Rates in Slovakia 1993-2003

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25

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2003

Unemployment Rates SR-CR 2002-2003

02468

101214161820

Slovakia Czech Republic