Slovakia’s development model: Limits and strategic alternatives

Slovakia’s economy has fared better during the global crisis than most other economies in the region. However, the crisis has revealed structural vulnerabilities and limitations of the nation’s export and credit-led development model. In particular, strong reliance of the Slovak economy on few export sectors, mainly automobiles, has raised questions on the sustainability of its growth model. What are the possible alternatives?

Photo: CreativeCommons/ Ken Douglas


Contours, vulnerabilities and limitations of the present model

The contours of Slovakia’s present development model emerged after accession talks with the EU commenced in the late 90s. The prior decade’s economic trajectory can be divided into two sub-phases. The early phase of transformation – the early 90s – was characterized by a deep recession and a steep increase in unemployment, but from 1994 onwards, the GDP recovered.

In continuity with state socialism, manufacturing remained the main pillar of the Slovak economy during the Mečiar years. The governments lead by Mečiar’s Hnutie za demokratické Slovensko primarily promoted domestic capital groups, but the Dzurinda governments (1998-2006) broke with previous attempts to create Slovak national capitalism and opted for Foreign Direct Investment (FDI)-led development, because pro-FDI standards were key evaluative criteria for EU accession.  As a consequence, it is mainly foreign capital inflows that have defined the basic traits of the present development model.

FDI was highly concentrated in two sectors: manufacturing and finance. In 2008, the year the global financial crisis began to affect the Slovak economy, manufacturing accounted for 36% of Slovakia’s FDI stock, while financial intermediation (banking and insurance) made up 19.7%. Real estate, renting and business services accounted for 10.9%, and thus were also quite substantial.

The strong growth of credits for the household sector has been a key feature of banking in Slovakia and was the main driving force of growth in the pre-crisis years. From 2004 to 2008, credits to the household sector grew by 35.5%; this was the strongest growth rate among the Visegrád countries. About 70% of household credits were destined for housing, and so they produced a strong real estate boom, which led to strong increases in housing prices. The construction industry received a stimulus from the real estate boom, and it was primarily domestically owned firms that benefitted.

Though private household debt had been rather low at the beginning, by 2008 its rapid growth assumed pre-occupying dimensions, however this was hardly ever publicly discussed. The crisis temporarily dampened the growth of household credits before they picked up again. In 2014 overheating and the first symptoms of an emerging bubble could be observed, and so the National Bank of Slovakia reacted to this by tightening the conditions for real estate credits. The recent experience of many European countries has clearly shown that the credit-led growth of real estate is not a solid foundation for development.

Narrowly specialized export manufacturing has been another major pillar of Slovakia’s development model. The share of the three important export classes – cars, electronic consumer goods and machines – increased from 26.0% to 53.2% between 1995 and 2012. 1 The export production is highly reliant on imported inputs and technology is likewise largely imported. Transnational companies have hardly been engaged in research and development activities in Slovakia and low wages remain the major attraction of FDI.

Narrowly specialized export manufacturing was strongly affected by the steep decline in export demand in 2008/2009 and, thus, proved highly vulnerable to the crisis. In 2009 the contraction of exports was stronger in Slovakia than in the other Visegrád countries and subsequent recovery highly reliant on the performance of the German export industry; while manufacturing employment has recovered much more slowly than production.

In view of these structural limitations and vulnerabilities, the competitiveness of the Slovak industrial model, founded on low wages and low taxes, is not sustainable in the long run. In addition, the regional concentration of manufacturing in Western Slovakia is key to the nation’s uneven regional development patterns. Past industrial growth has not significantly contributed to reducing high unemployment levels in the central and eastern parts of the country.

By reviewing the Slovak development model over the last 15 years, it can be concluded that key problematic features have included excessive reliance on FDI, skewed industrial export structures, significant external vulnerabilities, uneven development patterns and persistently high regional unemployment. In order to deal with these weaknesses, it is necessary that local sources of development are more rigorously tapped and a domestic oriented sector gradually built.

Development from below

The 1970s and 80’s approaches advocating “development from below,” like those by John Friedmann, Dieter Nohlen, Walter Stöhr – or more explicitly inspired by the Latin American dependency theory, Dudley Seers – can serve as conceptual inspirations for the concrete proposals of such a development direction. These approaches developed as a reaction to the failures of the post-war neo-classical and Keynesian strategies of “development from above,” which assumed endogenous causes for regional maldevelopment and proposed external impulses.

Two concepts prevailed between the 1950s and 70s: the expectation that outside demand would stimulate local production and the creation of regional development poles. The first expectation did not always materialize and the development poles often proved to be “cathedrals in the desert,” without significant links to the local economy. Due to the limitations of these regional policies in promoting the development of rather peripheral localities, advocates of development from below emphasized the key role local actors had in strengthening local productive capacities. They argued for a “selective territorial closure” – i.e. forms of protection for regional (or national) production and very specific regionally focused incentives – in order to enable local actors in peripheral regions to build their capacities. In other words, decentralized state structures were to be strengthened.

The context for such strategies is more difficult now than in the 1970s and 80s. Local actors who are engaged in productive activities in peripheral regions have been weakened by the neo-liberal policies associated with EU integration, which have phased out selective promotion and protection policies at the national level. EU regional and cohesion policies do not directly support productive capacity building in peripheral regions, and the EU’s budget is seriously underfunded. Changes in EU policies that could widen selective production policies’ scope, and encourage production friendly regional policies would clearly facilitate a strategic re-orientation of the Slovak development model. However, our proposals are not entirely contingent on this premise.

Building a third development pillar

A key element of our proposal is to strive toward building a third pillar in the Slovak development model that would diversify the economy and make it more resilient to crisis. The productive capacity – both in industry and agriculture in the peripheral regions of the country – eastern, southern and central – should be strengthened. This production would be primarily geared towards domestic, local markets.

Building a social economy – between the public and the private sector – could be one means of such a strategy. For example, new small agricultural and food-producing companies at least partially employing the long-term unemployed could be supported first by state or EU funded grants and later by revolving funds, e.g. micro-credits. In addition, tenders could be designed in ways that supported local production with specific social and ecological characteristics. For example, such tenders could be used by schools and public canteens in order to source healthy and fresh local food. Also the renewal of buildings with the aim of increasing energy efficiency and supporting decentralized and sustainable uses of renewable energy are some other ways which might encourage local production and employment opportunities in peripheral regions.

More generally, public investment should be refocused both towards smaller projects and more peripheral regions. Making local infrastructures more ecologically friendly, or launching public housing projects could dampen the trend towards rising rents and real estate bubbles, and could be areas for public investment. In select cases, direct state involvement in production should also be considered.

Not only the quantity of employment (i.e. the labour force participation), but also the quality should be increased. This suggestion is at least partly related to the quality of Slovakia’s education system. It is commonly admitted that the education system is underfunded and that teacher’s wages are dismally low. The same diagnosis applies to the health system. Qualitatively improved education and health services certainly require both higher funding and higher wages.

Financing development

This poses the question of how such activities should be financed. Existent national development funding institutions should be strengthened, while higher state expenditure would be required too. Slovakia’s tax revenue amounts to only approximately 30% of its GDP 2(see Figure 1). This is one of lowest ratios both in the EU and in the OECD.

There is both a scope and a need for increased taxation. Low taxation is a culprit for the public sector’s weakness, and a limitation to public investment. Bringing Slovakia’s taxation level(s) to the EU average, by increasing property and corporate taxes and making income taxes more progressive, would constitute a major step forward. Reverting the costly privatization of the pension system could be another source of public funds, and (to some extent) European Structural and Investment Funds could be tapped for refocused development projects.

Figure 1: Slovakia’s taxes and contributions as percentage of GDP

becker lesay copy

Source: Institute for Financial Policy

Slovakia’s industrial production is extremely reliant on external demand, while credits are sustaining its domestic housing demand. Increased local wages could play an important role in sustaining demand. Slovakia’s real wage growth lags behind productivity growth (see Table 1), while its wage share is significantly lower than the wage shares of western European countries. There is scope for increasing wages: more vigorous minimum wage policies and collective bargaining structures could be part of an overall offensive wage policy.

Table 1: Slovakia’s real wage growth and real productivity

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Real Average Wages

1,8

1,4

6,4

3,4

6,2

0,9

3,2

3,7

-1,3

-0,9

0,4

Real Labour Productivity

4,3

5,5

4,8

6,1

8,4

2,2

-3,4

6,4

0,9

1,6

2,2

Source: National Bank of Slovakia

Challenges ahead

Slovak development from below and from within would face significant institutional and political challenges both at the national and EU level. The main beneficiaries of a strategic re-orientation – working people, small and medium enterprises, local companies and the self-employed – are politically weakly organized. EU competition and budget rules are obstacles for regionally focused public investment strategies. In addition state administrations have lost expertise in directly promoting productive development.

Refocusing public investment and production strategies is clearly a complicated and long-term undertaking. However, steps towards building a more domestically rooted and inwardly orientated production structure, and a local material and social infrastructure, are both economically feasible and necessary. A more resilient long-term economic structure requires these adequate short-term steps.

Notes:

  1. Baláž Vladimír, “From an assembly shop towards a knowledge economy” in Bútora, Martin et al. (eds): “From Where To Where. Twenty Years of Independence,” Bratislava, p. 579
  2. Institute for Financial Policy of the Ministry of Finance SR, “Tax Indicators,” 15 April 2015.
Joachim Becker

Joachim Becker

is Associate Professor at the Vienna University of Economics and Business.

Ivan Lesay

Ivan Lesay

is Senior Advisor to the Slovak Minister of Finance and Research Fellow at the Institute of Economic Research at the Slovak Academy of Sciences.