VISEGRAD BLOG: Slovakia can't afford another four wasted years

VISEGRAD BLOG: Slovakia can't afford another four wasted years
Jaguar Land Rover's car assembly plant in Nitra, Western Slovakia. / JLR
By Robert Anderson in Prague December 11, 2023

A decade ago, The Economist magazine predicted that the Slovak economy would soon overtake that of its traditionally wealthier Central European neighbour, the Czech Republic. Following neoliberal reforms by Mikulas Dzurinda’s 1998-2006 governments, Slovakia’s “Tatra Tiger” economy had attracted a wave of foreign direct investment (FDI) and seemed much more dynamic than its sclerotic former federation partner. Slovak gross domestic product (GDP) per capita on a purchasing power basis soared from 43% of the European Union (EU) average in 2000 to 78% in 2015, closing in on Czechia at 87%.

It didn’t happen. Last year, 30 years after the split of Czechoslovakia, Slovak GDP per capita had actually fallen back to 68% of the EU average, compared to now 91% for Czechia, making it the third poorest country in the bloc after Bulgaria and Greece.

Economists point out some technical issues with these convergence figures but no-one disputes that Slovak growth in the 15 years since the 2008 global financial crisis has been very disappointing.

This year growth has only been slightly better than its neighbours at an estimated 1.3%, according to the European Commission. It forecasts an acceleration to 1.7% next year and 2% in 2025, but this is still a far cry from the 8.9% growth Slovakia enjoyed in 2006.

Many economists blame the stagnation on Robert Fico’s three governments, with his populist leftist Smer party enjoying a total of 12 years in power since 2006.

At the end of October, after winning the September 30 general election, Fico began his fourth term. It already looks clear that Fico’s new government will not prioritise economic reform, and will once again just tread water.

“The whole strategy is to maintain the status quo,” says Michal Vasecka, head of the Bratislava Policy Institute. “As other countries are stepping up, we are sleeping.”

Bare larder

This time, however, is different, economists warn, if only because it is the first time the populist strongman has come into office when the larder is bare.  He will not be able to splurge because the government budget deficit is expected to be 6.5% of GDP this year, the highest figure in the EU.

The deterioration in the budget deficit is also the worst in the EU after Hungary. It is largely the result of handouts by the 2020-2024 centre-right governments to fight the downturn caused by the 2020-23 pandemic and to mitigate the energy price rises sparked by the 2022 Russian invasion of Ukraine.

Before the election, Slovakia’s Council for Budget Responsibility and the outgoing technocratic caretaker government had called for the next cabinet to reduce the deficit by more than 1pp a year over its term, warning that otherwise the government could end up paying €2.5bn a year to service its debt.

Economists also warned that Slovakia would be forced to impose budget cuts under the EU’s Stability and Growth Pact next year, and the government could also be forced to run a balanced budget in 2026 under the country’s debt brake law.

Fitch also sounded a warning by downgrading Slovakia to 'A-' last week.  "The downgrade reflects the deterioration of the state of public finances and the unclear progress of consolidation," the credit rating agency said.

The new government has brushed aside these concerns. It has just announced a series of populist measures including a rise in pensions this year (costing €600mn), subsidies for mortgage holders next year, and a continued freeze in gas prices (costing €1.25bn).

The new Smer finance minister, Ladislav Kamenický , only plans to cut the deficit next year by 0.5pp (or €600mn) compared to this year’s figure to around 5.9% of GDP.

Moreover, the belt-tightening, amounting to nearly €2bn next year, is almost entirely focussed on tax rises and financing dodges, rather than spending cuts.

The government has avoided cuts to the welfare state or increases in VAT, which would hurt its mostly poorer voters. The key elements are instead a supertax on bank profits (raising €336mn), and a shift of some second pillar pension contributions back into the state-controlled first pillar (raising €365mn).

At the start of their term, when many governments would carry out their toughest budget tightening measures, the new government is instead just offering populist gestures. 

Looking ahead, it says it will cut the deficit to around 5% of GDP in 2025 and 4% in 2026 but the only measures currently being discussed are a more progressive income tax and higher property and environmental taxes. These are undoubtedly necessary but fall far short of the transformation required.

Luckily, Slovakia does not face any immediate crisis in public finances, given that public debt is low by EU standards. Fitch projects the government debt/GDP ratio to rise from 57.8% at the end of 2022 to 65.5% by the end of 2025.

Recent government bond sales have actually been at tighter spreads, with a yield of under 4% at the auction last month.

Nevertheless, Slovakia has the worst long-term demographic trends in the bloc, which will push up pension and health costs and reduce tax and social contributions.

At the same time the government needs to spend more on defence, build infrastructure, invest significantly in the country’s woeful education and health systems, and switch the economy onto a green and higher value-added track.

New model required

Transforming the economy is the greatest challenge. The Dzurinda government’s reforms built a low-wage, low-tax model that attracted FDI, particularly into the automotive sector. This drove economic growth that helped Slovakia catch up with its neighbours and ease its chronic unemployment problem.

Under Fico, Slovakia then became the only one of the Visegrad Four (V4) countries of Central Europe to enter the Eurozone in 2009, giving the reassurance of European Central Bank control of monetary policy and banking supervision.

Yet since then reform of the business environment has stalled under Fico’s populist governments, which have alternated with fractious centre-right coalitions. Moreover, the weaknesses of the Dzurinda model have become more and more apparent.

The Dzurinda governments and their successors  invested little in infrastructure or the fabric of the state, particularly the health and education systems.  Nor did they use EU funds properly to tackle the country’s deep regional inequalities, worsened by the poor infrastructure.

Though the country still manages to attract manufacturing investments – with Volvo’s €1.2bn car plant in Eastern Slovakia and the Gotion/Inobat battery plant the pick of the latest successes –  it ranks low in terms of competitiveness and productivity.

Slovakia remains overly dependent on its big foreign car assembly plants and their investments. The auto sector, which produced 1mn cars last year, represents a massive 40% of industrial production. It proved a vulnerability in the global financial crisis and could be again.

The country has failed to develop an ecosystem of domestic small and medium-sized enterprises (SMEs) that could provide an independent boost to investment and innovation.

Slovakia also lacks a vibrant start-up scene, including venture capital funds and a functioning stock market. Slovakia finished the second worst of the EU countries in the Global Innovation Index.

The weakness of the SME sector lies behind the country’s productivity gap. Fitch says Slovakia's labour productivity was the third lowest in the EU at 73.3% of the EU average at end-2022, and it has visibly decreased over the last decade.

Michal Simecka, leader of the liberal Progressive Slovakia party, told bne IntelliNews before the election that one of his priorities was to reform the business environment to help SMEs grow. “We need to help companies upgrade and scale up to be able to export,” he said.

Brain drain

Another looming problem is the brain drain of graduates and professionals, put off by the lack of interesting job opportunities and low wages. Almost one fifth or more than 30,000 Slovak students are studying abroad, and many do not return after their studies. In total almost 10% of Slovaks are living abroad, often in Czechia, which is double the rate of other OECD countries.

“We can’t attract highly qualified graduates,” says Martin Barto, chairman of the stock exchange. “We don’t have the jobs for them here.”

“We have to have a new model which would create new space for talented people, using new technologies,” he says.

This brain drain is already creating skills shortages. “We need more people because a lot of very good people are going abroad,” Alexander Matusek, head of the ZAP automotive association, told bne IntelliNews.

An outgoing minister in the technocrat caretaker government warned bne IntelliNews before the election that the brain drain will only get worse if Fico gets back in. “It means that the future of this country would be stopped for decades. The smartest and bravest will leave,” he said.

Relatively low wages are one cause of this exodus, with real wages still falling after the price spike following the outbreak of the Ukraine war. Food prices are the most expensive in the region apart from Estonia. Those close to the Polish border buy food there, which is a quarter cheaper than in Slovakia.

According to Vasecka, housing costs in Bratislava are so out of kilter with real incomes that some workers are now choosing to live in nearby Vienna and commute, while in the regions people often commute across the border to earn a higher wage. “So of course people are frustrated,” he says. “They are not living a decent life.”

Vasecka argues that the general disappointment with the pace of economic convergence with Western Europe has led to a wider disillusionment with the EU and liberal democracy.

“Slovakia has turned in recent years into the most anti-Western society in CEE, the most pro-Russian and pro-Putin society, the most anti-American, and a strong believer in conspiracy theories, with a very low mutual trust both on the horizontal and vertical levels,” Vasecka wrote in an op-ed for bne IntelliNews last week.

Up to now Fico has benefited from this malaise, which feeds populism, and he may be content for it to continue, but if Slovakia is to progress it cannot afford another four wasted years.