Sub-Alpine Socialism: Slovenia, the next sick man of Europe

By Rok SPRUK

By January 2007, Slovenia adopted Euro as a single currency. In spite of the enthusiasm, a wave of optimism spilled over the economy which recently generated a quarterly GDP growth of nearly 6 percent. A closer analysis depicts that the foremost engine of growth was generated in export sector which remains the wheel of Slovenian economy. In the last two years, economic reforms played the biggest role on the public stage in Slovenia. A group of young and enthusiastic economists proposed real suggestion to accelerate economic development including a fundamental tax reform, labor law reform, the privatization of state-controlled enterprises, and the reform of a broad range of social welfare services funded through the budget. However, the socialist government rejected every proposal and favored the “wish list” of trade unions which rampantly rejected any kind of reform proposals, further pushing the competitive edge of Slovenian economy towards the breakdown in the middle run. There are several strong reasons that predict the worst-case-scenario in the future.

On privatization

Slovenia’s post-communist episode was launched back in 1991, when we nominally shifted away from socialism into market economy. The process was made painful by government intervention which complicated the privatization process by creating a space for openly legal corruption. Insider trading swept capital markets, thereby privatizing companies by giving grants to politically privileged few. Despite, the acceleration in privatization from 2002 onwards, a large part of the economy remained in government hands. In economic theory, we know that the privatization stimulates economic performance practically as well as empirically simply because the allocation of resources in private sector is far more efficient than the one in the public sector, emerging from innovation, risk management and supply-side measures. In Slovenia, only 65 percent of economic activities belong to the private sector while zero-value-added government services without clear neighborhood effects compose 35 percent of the GDP.

On public sector and inefficient spending

As I mentioned above, public sector grabs almost 40 percent of the GDP. Public sector employment and dependency on welfare services is widespread. Nevertheless, there are practical examples reflecting the agony of big government. Employee contribution rate to government-funded health-care schemes equals 22 percent of the gross wage. Health-care and welfare expenditures are huge of course, grabbing nearly a third of the GDP. Health-care system in Slovenia is particularly crucial especially because the distribution system is determined by collective bargaining where trade unions get the biggest slice. In fact, out of entire cost structure in health-care sector, 57 percent of all costs represent the costs of labor. Also, collective wage bargaining is stimulated across the public sector wage comparisons, therefore eliminating the rewards resulted from positive productivity shocks. Also, Slovenian medical chamber de facto imposes price controls of drugs and holds a monopoly position while there is a huge shortage of supply-side and competitive mechanisms in health-care sector which could break-up cost push-ups. Another reason why Slovenia’s crippled health-care sector is near the collapse is the ageing population’s pressure on the performance of health care. The origin of the ageing population lies back in 1991 when technologically redundant employees were given options to retire very early while retirement schemes have been made both generous and beneficial on a permanent basis. Today, Slovenia has one of the youngest pension populations in the world. At the same time, treatment costs of an average 65 years old retiree is four times higher than the treatment of a young person like me. If the ageing pressures remain unchallenged, health-care contribution rate into taxpayer-funded government welfare schemes will double in the next 20 years while fiscal pressures could substantially deepen the budget deficit and trigger public spending rate evenly higher at the same time. One of the most evident signs of inefficient public spending is a centralized system of collective bargaining. Just recently, Slovenian public sector bargained wage increases, sharply cutting the size of absorbed benefits from aggregate productivity created in private sector. In spite of the promises for spending cuts, Slovenian government surged into fiscal expansion, further accelerating the public spending and government consumption. Consequently, fiscal expansion resulted in a substantially growing budget deficit, heating inflation volatility. Not surprisingly, seasonally-adjusted inflation in Slovenia is the highest in the EMU, quarterly standing at 3,5 percent. One of the reasons for such an unusually high inflation is fiscally flavoured with a growing public spending as well as with the monetary adjustment to controlling inflation differently and more responsibly than the Slovenian central bank in the past did, by pushing the depreciation of the local currency and seeking others way to cure the tyranny of inflation than simply breaking-down the growth of monetary aggregates. Export sector set rigid claims to the central bank, saying that the appreciation of the local currency (our former ‘tolar’) could threaten the export competitiveness. This is very far from the truth. Curing inflation would stimulates international competitiveness after over-coming the relative source of the inflation, high cost pressures, emerging from basic inflation notion of “too much money, chasing too few goods”. Surprisingly high inflation in Slovenia is a price which Slovenian society has to pay for the irresponsible actions and reactions of the central bank of Slovenia in the past which relied on manipulations with exchange rate regime, therefore leaving inflation pressures uncontrolled. Consequently, fixed exchange rate regime silently paced the inflation at a lower level and now new monetary transmission system under the operation of the ECB exercises responsible reactions to inflation pressure while in Slovenia, there has been no such thing as reversing high inflation in the long-term perspective. Nevertheless, cost-push shocks do not change the reactions of the central bank in controlling inflation but make it a little bit more complicated to anchor the expectations. Consequently, when interest rates are raised, economic activity declines growth, but lower inflation naturally benefits the output performance in the long run.

Conclusion

The worst case scenario of Slovenia in the future has become frequently possible. Letting public sector wage and expenditure claims soar could dump the effects of aggregate productivity and therefore creating the spiral of inflation pressures which could in turn seriously poison the accumulated savings and hurt the investment and capital formation. Above all, tax burden is very high in Slovenia and so it the regulation. In 16 years of living in a global economy, there has not been a single created multinational company. According to Financial Times, Slovenian education sector is the fourth worst performer in the EU, lagging behind stagnating welfare tombs such as Italy, Greece and Portugal. Also, there is none Slovenian university among top 500 in the world. It is roughly predictable to forecast the reaction to fiscal and structural crisis in Slovenian when ageing pressures and interest-group rent seeking could dampen the sustainability of the public finance and make it uncontrollable, if currently-riding status quo remained in effect and so would Slovenia become the next sick man of Europe.

----------
Rok SPRUK is a supply-side economist and a classical liberal. He currently lives in Slovenia where he works and studies economics and business. He recently won a prestigious award called »Golden Matura«. He is interested in economic growth, international economy, macroeconomics, tax and social security reforms and international competitiveness. In the field of business he is focused on strategic management, financial markets, business models, innovations and new economy. His ideas, writings and post are written on his web log called “Capitalism & Freedom”. You can send Rok an email on rok.spruk@gmail.com
----------