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MACRO NOTES

Slovakia's growth - how can it be put in higher gear?

My previous column was devoted to the greatest structural economic problem Slovakia currently faces - high unemployment. What can Slovakia do to avoid being in first place in unemployment tables for the region?
In the long run, Slovakia can either cut real wages or increase its long-run 'potential' growth. Since cutting wages rarely makes any government too popular, the second alternative is more attractive. Hence, the question then appears to be: What can Slovakia do to increase its potential growth?
Economic theory suggests that in order to increase growth, one should increase either inputs (both physical capital and labour) and/or productivity. As for labour, an increase in the number of people working alone would not get you a higher living standard (which is usually proxied by GDP per capita).


Ján Tóth

My previous column was devoted to the greatest structural economic problem Slovakia currently faces - high unemployment. What can Slovakia do to avoid being in first place in unemployment tables for the region?

In the long run, Slovakia can either cut real wages or increase its long-run 'potential' growth. Since cutting wages rarely makes any government too popular, the second alternative is more attractive. Hence, the question then appears to be: What can Slovakia do to increase its potential growth?

Economic theory suggests that in order to increase growth, one should increase either inputs (both physical capital and labour) and/or productivity. As for labour, an increase in the number of people working alone would not get you a higher living standard (which is usually proxied by GDP per capita).

One can increase the willingness of people to work more and harder by lowering the marginal tax rate (currently very high at 42%). As for capital, there is a limit to the amount of investments that a small open economy can support. This limit is called the exchange rate.

A textbook example of 'overinvestment' was provided by the former government, which used high fiscal deficis and government guaranteed to boost investment. However, these investments had dubious returns and often required an increase in imports without really increasing the export potential of the country. The result was a 10% adjustment in the exchange rate and koruna flotation. Hence, it makes much more sense to let the private sector invest (e.g. through foreign direct investment ).

Productivity - the best way to increase living standards

Increasing productivity is the best way to accelerate potential growth. Economists list possible ways to boost productivity as including: better allocation of resources, higher quality of institutions, social capital, and an open banking sector and economy.

If free resources are allocated to industries with growth potential alone, productivity will increase. This is what happens in countries with more developed banking sectors. Therefore, one should applaud the current government for going ahead with bank privatisation.

What remains in Slovakia is to improve banking supervision and the protection of minority shareholders' rights, and to increase activity and legislative efficiency on capital markets. All of these measures would help the economy restructure.

It is wrong to expect the government to implement restructuring in a more optimal way. In fact, experience so far has shown that the "industrial policy" of Slovak authorities was not only unhelpful, but rather directly encouraged negative trends. Hence, private sector-driven restructuring (with the help of profit-maximising banks and foreign direct investment) seems to be the way to go.

Institutions play a crucial role, too. Poor-quality decisions on the part of authorities, and their insufficient capacity for producing the work required, is a result of today's public sector wage and salary policies. An audit of state organs, and the implementation of public administration reform, could offer some hope here.

Education is traditionally considered to be important. Even though basic education in Slovakia compares well with developed countries, key fields for improvement are university education in areas such as management and economics. In today's Slovakia, education abroad seems to be the only alternative for management and economics students. An injection of motivation and resources (through the introduction of tuition fees) could create higher demand for jobs at universities.

Last but not the least, the economy's openness could support growth provided macro-economic policies remain sound. It makes sense to specialise in your comparative advantage, and therefore the country should maximise the openness of its economy.

This would preclude using import tariffs and quotas as well as various "certificates". Since foreign direct investment could play a natural role here (owners would maximise profits by focusing on exports and using Slovakia's comparative advantages), one could argue for giving clear preference to skilled foreign firms over local ownership.

Ján Tóth is chief economist at ING Bank in Bratislava.

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