Europeanization vs

FRANJO ŠTIBLAR: March 31, 2008
franjo.stiblar@pf.uni-lj.si Economic transition of Slovenia

As a republic of the Socialist Federal Republic of Yugoslavia (SFRY, 1945-1991) Slovenia was its most developed federal entity, while Yugoslavia was the most developed and democratic among Communist countries in Eastern Europe (and in the world). [1]

At the same time, Yugoslavia lagged far behind capitalist economies of the West with GDP per capita at close to 2500 $ at the moment of collapse in 1991. Slovenia has double that figure, while Kosovo achieved only 1/7 of Slovenian number. Despite a very intensive development policy support to less developed entities in Yugoslavia, difference between the least and the most developed entity did not change during 45 years of communist regime. Regarding social indicators of development (such as schooling, health indicators, social protection), differences were much smaller (around 1 to 3) indicating huge redistribution of national income.

Different attempts at economic reform in Yugoslavia did not succeed because they ultimately required the change of economic system into market economy based on private ownership and democratization of political system into parliamentary democracy and that was not allowed by party elite- Tito’s partisans which won the war against Germans and Italians on side of allies. After early enthusiasm of people of after second world war was utilized in high growth and fulfilment of relative low aspirations of people in mid-1960s, further catching-up required qualitative changes in the system, which were never allowed. Instead, country went from one economic reform to another, inventing along the way a specific system of associated labour and self-managed economy (to replace stochastic forces of market !?) and society as a whole. Foreign loans helped economy in the second half of 1970s bringing Yugoslavia into the group of the 15 highest indebted developing countries. After Tito’s death in 1980, Yugoslavia soon proclaimed inability to service external debt and went through very restrictive period of collapse in standard of living. Besides economic difficulties, 1980s brought also political crisis, in which two views for the future were confronting each other. More developed republics in the Western part of country (led by Slovenia and supported by Croatia) wanted liberalization of economic and political life, entities in the Eastern part under leadership of Milošević wanted to retain existing communist regime and controlled economy. In the beginning of 1990s, with Milošević winning the situation in Yugoslavia, Slovenia and Croatia opted for independence, followed by other republics later.

In June 25, 1991 Slovenia (and Croatia) proclaimed independence. The two weeks of military activities followed on territory of Slovenia with federal army wanting to retain control over borders. Around 60 people were killed before 3-months temporary ceasefire was reached under the European Union mediation in Brioni on July 7, 1991. When three months passed, Slovenia introduced several measures of independence, important among them being introduction of own currency Tolar. In short period of several weeks the rest of Yugoslav National Army left Slovenia. Milošević needed them for future military activities in other parts of former Yugoslavia, where Serb minorities were large and in concentrated in the regional centers, while Slovenia was nationally homogeneous with 92% of population being Slovenes, only 2% being Serbs and even them scattered all around Slovenia.

The war which started first in Croatia and then in Bosnia and Herzegovina, lasted between 1992-1995 and was stopped by Dayton Agreement in December 1995. Military clashes continued in Kosovo in 1998 and were stopped by bombardment of Serbia by NATO in March-June 1999 and overtaking the control of Kosovo by NATO forces, later added by UN forces. In 1999-2007 Kosovo was protectorate under UN Council resolution 1244 and it proclaimed independence in February 2008. In meanwhile Montenegro opted for independence from Serbia by referendum in May 2006 and proclamation of independence in June 2006. Thus, Serbia remained decreased to more or less national borders, with its region Vojvodina still having quite a significant share of minorities.

Slovenia started from a relatively good position of market economy, openness to the West in trade. Early legislation, including constitutional laws introduced market economy based on prevailing private ownership. But, Slovene capitalism was always with “human face”. Transition was gradual, as radical measures were not needed to make irreversible changes. Even before independence during second half of 1980s Slovenia’s economy separated itself form Yugoslav and introduced economic reforms in direction of market and private ownership.

Gradual approach was opted in transition despite the opposition from the IFIs and foreign advisors. As Slovenia’s economy was solid enough and did not need foreign financial support for transformation, there was no need for IMF money and its conditionality arrangement. Thus as the only member among transition countries Slovenia was able to opt for independent sui generis approach in transition. It was strongly criticized by foreign advisors, IMF and the World Bank, until the latter did not publish report on Slovenia in 2004 commending it as the model of economic and social transition to be followed. We in Slovenia do not see our approach as a model for others (special circumstances require adaptation) and would not like to be next “darling of the West” among transition countries, as all the darlings in the past after proclamation as such faltered later on.

In transformation of the economic system privatization of socially owned enterprises was mix of voucher and paid (tender) privatization building on foundation of workers’ ownership. The large companies and financial institution became state owned and many of them still are (without significant negative consequences for their performance). Marketization at home proceeded relatively quickly, while in external relations liberalization of trade account happen very quickly, liberalization of capital account was gradual thus helping country to avoid the world financial crisis in late 1990s.

Economic policy consisted of managed exchange rate policy, prudent monetary policy (with the use of sterilization of excess foreign exchange inflow) and prudent fiscal policy (with budget deficit between 1 and 2% of GDP on average). The main reason for choosing managed floating exchange rate (instead of its use as nominal anchor) was lack of foreign currency reserves immediately after independence.

Despite that, after inflation quickly declined to below 10% until 1995 and from 1993 on growth of GDP picked to average 4% rate. At the same time external account remained close to balance. Both domestic and external debt did not increase significantly. With reasonable sensitivity for social issues, Slovenia succeeded to retain strong middle class (quarantee for political stability) and prevented impoverishment of critical population groups: farmers, retirees, young, unemployed.

Part of sui generis approach to transformation of the economy is cautious approach to selling of domestic blue chips to foreigners. Slovenia was not in need for cash for financing budget and was rich enough to being able to finance restructuring of companies and banks using domestic budget resources (the way it is used in Western developed market economies). Thus, country still keeps some of its blue-chips in majority domestic ownership which makes a good basis to protect national identity, interests and economic sovereignty. In difference to all other transition countries, which lost their economies and financial sectors to foreigners thus becoming peripheries of the EU centers, Slovenia retained some blue-chips in its domestic ownership with aspiration to retain at least position of semi-periphery in the EU (similar to other less developed members of original EU-15, like Portugal, Greece etc.).

Slovenia was late comer in integration of former communist countries into the Western associations. The membership of UN, IMF and the World Bank happens in 1992. A delay is due to its late start as independence was proclaimed for the first time in its history only in mid-1991.

Thus, for instance, Central European first wave transition countries created FTA among themselves, they were quickly proclaimed candidates for the EU (and NATO) and obtained significant financial support from the EU, before Slovenia was able to follow them in the second half of 1990s. But, candidacy to the EU finally came and Slovenia was among 8 first wave EU enlargement transition countries which joined the EU together with Malta and Cyprus in 2004. In the same year Slovenia joined NATO, while other Central European countries did that several years before. In difference to that and delay in OECD membership (Slovenia became candidate only in 2007 although it is much more developed and stable as most of its recent new members), Slovenia became a founding member of the WTO, established in 1995.

During transition period, Slovenia was the only country that did not experience financial crisis (according to The Economist), managed to restructure enterprises relatively smoothly and retain social protection of population. All reforms were undertaken gradually, taking into account general public consensus for them. Only recently, in 2004-2005, an attempt was made at shock introduction of liberal economic policies and changes in the system, but it was rejected after opposition from all stratums of society.

Slovenia became a candidate country for the EU membership later than other first wave transition countries (only at the turn of century). Being the most developed among t5hem and with the most stable economy, it was easy to get invitation and to join the EU in May 2004. From today’s poi9nt of view it seems easy, but it took a lot of effort (internalizing the whole legislation of the EU named Acquis Communautaire, making adequate structural reforms in the economy, political liberalization according to Kopenhagen criteria, etc.).

Immediately after that Slovenia expressed the wish to join the European Monetary Union EMU (which means introducing Euro as legal tender) by entering the ERM2 regime in June 28, 2004 (Exchange rate Mechanism, which requires two years of stable exchange rate of domestic currency to Euro) as one of the economic criteria to join the EMU. Besides exchange rate condition, there are four other conditions to be fulfilled if country wants to join the EMU: low inflation (not higher than the average of three lowest inflation rates in the EU plus 1 percentage point), low long term interest rates (not higher that the average of three lowest long term interest rates in the EU plus 1.5 percentage points), sustainable budget deficit (below 3% of GDP) and reasonable public debt (below 60% of GDP).

In June 2006 it was decided that Slovenia (as only among 3 candidates at the time) fulfils required criteria of inflation, interest rates, budget, public debt and exchange rate. In July 2007 country was invited by the European Council to join the EMU. The entrance happened on January 1, 2007, after preparation for introduction of new currency was successfully completed. In “big bang” approach Slovenia introduced Euro after only 14 days of double currency system. Exchange of domestic Tolars for Euros is possible ad infinitum with the Bank of Slovenia. In difference to experience of some early members of Euroland introduction of Euro in Slovenia contributed only 0.3% to inflation during first half of 2007. Later on, however, things changed.

Economic Environment

Slovenia macroeconomic performance in 2007 was much more similar to the performance of other transition countries, than in years before. The sui generis equilibrated development approach was lost. Higher growth was accompanied by higher des-equilibriums. Also, with increased inequality in income distribution Slovenia is following socially undesirable developments of other transition countries, from which it used to distinct itself.

In 2007 Slovenia continued transition in its priority macroeconomic goals from stability with lower growth to higher, but less stable growth. Record numbers were achieved for the whole 16 year independence. Thus, the 6.1% GDP growth was the maximum for the whole period, 6.7% December to December inflation was the highest in this decade, the current account deficit of 4.9% of GDP was the highest, the number of unemployed (67000 in February 2008) is the lowest after start of transition and the general government achieved budget surplus of 0.1% of GDP, which is only the second time during independence (in 1993 surplus was 0.3% of GDP).

The record growth in 2007 did not necessary bring higher welfare to the most of the population, as income inequality increased significantly. Increased Gini index of inequality is due to gains for rich people from buying shares in second largest bank (and earning over 40% in few days), high yearly managers rewards and decreased highest tax rates from 50% to 41%. At the same time, for people with fixed income and unskilled workers with collective contracts retained nominal incomes unchanged, but their real incomes declined as the highest price growth was achieved in food prices (over 12%).

According to revised data the GDP growth in 2006 was 5.7% and by preliminary. High growth is continuing in 2007 with 6.5% rate of growth in the first half and forecasted over 6% growth for the entire year. Annual average inflation rate was 2.5% in 2006, but accelerated in the entire 2007. In 2007, a new member of the European Monetary Union (EMU) Slovenia had the highest inflation among all 13 member countries. Unemployment rate by was 6.0% at the end of 2006 and declined to 5% in 2007. Despite increased employment labour productivity grew by 4.5% in 2006, while slower growth was achieved in 2007. In the 2007 current account deficit reached over 1650 Million €, which is by far a record number for the entire independence period. The EMU membership and introduction of Euro as official currency apparently took its toll. With domestic economic boom budget deficit has disappeared. It was 0.9% of GDP in 2006, while surplus of 0.1% was achieved in 2007 according to preliminary data.

In 2007, the long run dynamics of domestic aggregate demand was strong. It was led by investment demand and exports (terms of trade had improved in comparison to 2006), while government expenditures grew the least. Business optimism was high with levels of export and overall orders being high.

Among sectors, industrial production was growing steadily; supported by the strong growth in construction, trade, and transportation. Acceleration of wages increased the differences between sectors, which are expected to be corrected at the beginning of 2008 thus contributing to additional inflationary pressures.

In 2007, the acceleration of bank credit was at record rates, led by credits to enterprise sector but interest rates remained stable. Marketization, turnover and indices in the Ljubljana Stock Exchange achieved historic record numbers at the mid-2007 but, declined significantly since. They are supported by expansion of bank credits. Enormous growth of portfolio investment abroad is financed largely by foreign credits, which caused increased external indebtedness.

(Area: 20.000 square km; population: 2 million; GDP: 33.3 billion EUR in 2007; 16532 € per capita)

Sources: EIPF, National Statistical Office, Bank of Slovenia, IMAD, EIPF, Ljubljana

External Environment

In 2008, the financial uncertainties in the world economy will have effect on Slovenian economy, despite the fact that in the last 12 months country’s terms of trade improved and business expectations remain favorable. Solid growth persisted in the world and especially in the EU, with positive effect for export of Slovenia. The hike of world prices of commodities (food and oil) and higher interest rates will contribute to higher inflation in Slovenia, while stronger Euro has less significant effect on its external balances due to country’s overwhelming orientation towards intra-EMU trade.

External environment will worsen to certain extend for Slovene economy in 2008. Average prices of oil will be higher (burden for oil importer), interest rates will slowly increase, at least in Euro area), prices of commodities, including food will increase further and Euro (domestic currency for Slovenia from January 2007) is appreciating

In 2008, according to the newest forecast GDP is expected to grow by 4.8% (and in 2009 by 4.3%), inflation will decelerate to 3.5% on average, or 4.2% year on year basis, budget deficit should be around 0.5% of GDP, while current account deficit should decrease to close to 3% of GDP. Unemployment rate is expected to fall slightly further towards 5%. The growth of all components of final demand will decelerate, especially investment and exports. Due to parliamentary elections in Fall 2008 public expenditures are expected to grow thus worsening budget balance. Personal consumption is also expected to decelerate slightly.

Monetary aggregates will continue with a less strong growth. If world prices of commodities and oil continue to grow, economic activity in Slovenia will slow down.

Further slow down of activity and return to stability is expected for 2009 with GDP growing at 4.3%, inflation declining to less than 4%, current account deficit declining to below 2% of GDP, while budget deficit remaining modest.

Policy Issues and Uncertainties

At the beginning of 2008 the critical points in Slovene macroeconomic performance are inflation and external balance. Different reasons are listed regarding accelerated inflation in 2007 and verdict will probable come in 2008. Some economists blame domestic market imperfections and lack of competition (or cartel bargaining) as a predominant micro economic reason, other speak about macroeconomic reasons. Overly strong final demand, led by budgetary financing of highway construction, is overheating the economy. Third group claims that inflation was mostly imported through higher world prices of wheat and oil. Some blame introduction of Euro at the beginning of 2007, but its effects in the first quarter were very small. In all, deceleration of inflation is expected in 2008.

With budget in balance for the first time in 15 years the second critical issue of macroeconomic policy relates to the current account deficit and increased external indebtedness. With current account deficit expected to decline towards 3% of GDP (still unprecedented for Slovenia) the causes are increased trade deficit (exchange rate policy measures are not available anymore) and increased debt service payments. Gross external debt is higher that yearly GDP of Slovenia, while net external indebtedness approaches 20% of GDP. Foreign loans, which contributed to increased indebtedness helped to finance public investments (highways) and participation of domestic players on stock exchange. Decline of stock exchange indices (in Slovenia it lost over 1/3 of its maximum value around one year ago, and even more in South East European stock exchanges where Slovenians invested heavily) will negatively affect Slovene investors.

In addition, overly strong expansion of financial and monetary aggregates, especially bank credits, raises some concerns despite the fact that it is still partly a result of catching-up in monetization of the Slovenian economy. When domestic and foreign loans finance expansion of stock exchange which is totally out of proportion with economic growth, risks of hard landing are increasing. Situation is similar with bank financing of managers’ buy-outs of their companies as the form of recent, consolidated, phase of privatization in Slovenia. It used to be morally and socially questionable ten years ago, because it implies buying shares with the help of bank credits, while the same shares are used as collateral in advance, and repaying loans later with the profits of the firm, which will flow to the newly created shareholders of the same firm. Now, it seems to be acceptable, although this leads to so called “taicoonization” of the economy, which is well known negative outcome of privatization in other transition countries. Until now, it was almost non-existent in Slovenia.

Slovenia’ presidency of the EU in the first half of 2008 is having a positive effect on economic activity due to higher budget expenditures and more foreign visitors. In addition, general parliamentary election towards the end of 2008 will cause increased public expenditures by government including increases of wages.

[1] More on that in author's: »The Rise and Fall of Yugoslavia«, in Techova A.. ed.: Central Europe in the Twentieth Century, Ashgate, Aldershot, 1997, pages 61-83

Growth rate:	2000	2001	2002	2003	2004	2005	2006	2007e	2008p
GDP (in %)	4.1	2.7	3.5	2.7	4.4	4.0	5.7	6.1	4.8
Inflation (average) / y/y	8.9	8.4	7.5	5.6	3.6	2.5	2.5	4.2/ 6.7	4.2
Balance of Trade Mill €	-1493	-998	-612	-954	-1360	-1268	-1553	-2038	-1800
Current Account Mill €	-583	38	247	-196	-720	-547	-857	-1652	-1100
Unemployment rate, ILO /domestic	7.0	6.4	6.4	6.7	6.3	6.5	6.0	5.0 / 7.7	5.0/7.5
Foreign Exch. Reserves ( mill. €)	4705	6514	7842	7703	7484	8833	8005	728*	900
External debt gross ( mill €) / net debt	9490	10403	11484	13259	15271	19566	23895	34007/ 5768	35000/ 6000
Budget balance/GDP	-1.3	-1.3	-2.9	-1.4	-1.3	-1.1	-0.9	+ 0.1	-0.5

Economic Environment

GDP (in %)

Balance of Trade Mill €

External Environment

Policy Issues and Uncertainties