Growth is strong and macroeconomic imbalances are being reduced, but unemployment remains too high
The Slovak economy is on a high growth path driven by growing foreign direct investment (FDI) inflows, attracted by a favourable operating environment in a country soon to be integrated in the EU. It is striking in that connection that, with labour costs remaining the second lowest in OECD, Slovakia is set to become the top OECD manufacturer of cars per capita next year. Real GDP is growing at around a 4 per cent annual rate, exports are expanding steadily and private domestic demand is robust. The current account deficit has returned to a more easily sustainable level. Wages are rising in line with productivity, keeping inflationary pressures and external imbalances in check while core inflation continues to decline. At the same time, however, the Slovak economy suffers one of the lowest employment rates in the OECD area. Demand for labour remains subdued as local businesses lag the highly productive FDI firms, and domestic services and self‑employment remain underdeveloped. Willingness to work is also undermined by a welfare system which has been extremely generous for a long time. The resulting unemployment, concentrated among the low skilled, the young and the elderly outside the Bratislava area, remains very high (at 17 per cent on a survey basis in the fall of 2003) and will come under additional pressure as a result of job cuts in general government and public utilities.
Economic policy faces three main challenges …
The authorities face three main challenges. First, their aim of joining the euro area as soon as the nominal convergence criteria will have been met on a sustainable basis sets a demanding macroeconomic agenda. A significant reduction in fiscal deficits is required, not only to meet the fiscal rules but also to pursue disinflation objectives without an excessive tightening of monetary conditions that would impact negatively on growth and employment creation. Second, the employment rate needs to be raised through radical changes in the incentives to both supply and demand of labour while maintaining households’ confidence and political support for government policies. The recently introduced legislation to strengthen work incentives should be fully enforced. Third, there is an obvious need to push for smaller and more effective government, against a strong constituency in favour of maintaining the status quo which entails one of the highest shares of general government jobs in total employment among OECD economies. Public sector reform is necessary not only to support fiscal consolidation but also to promote a pro‑growth environment. Radical transformations are needed in the public sector to assert the rule of law, to enforce impartial and reliable business regulations, and to develop more effective infrastructures for education, training and transportation across the territory.
The two determinants of GDP per capita1
1. The surface for each country represents its GDP per capita.
2. Employment over population in per cent.
3. GDP per employed person in current prices using PPPs, US$.
Source : OECD
…which are intended to be met by a bold reform programme…
The new government elected in September 2002 initiated a set of major reforms in the face of these challenges. On macroeconomic policy, the authorities have formally committed to curbing fiscal deficits on a sustained basis, thereby alleviating the burden of economic stabilisation on monetary policy. The independent Central Bank has already been successful in pursuing its disinflation policies, but fiscal consolidation is required to allow for more supportive monetary conditions. The government has also begun to stimulate labour supply and demand with major measures. Welfare benefits available for able‑bodied citizens remaining voluntarily unemployed are being massively reduced, while the retirement age is being increased and pension benefits made dependent on work and contribution history. Employers’ incentives to hire are being strengthened by labour code reforms making both permanent and temporary job creation less costly; and targeted employment subsidies will be introduced in 2004 for the long‑term unemployed. Incentives for small size businesses and the self‑employed have been increased by sharp reductions in both the corporate and personal income tax rates, by easing the regulatory environment for businesses, and by adopting competition and public procurement policies that facilitate new entries.
…where interaction between policies is essential.
Each of the individual components of this bold reform programme ‑‑ launched only a year ago and still in the process of being put into application ‑‑ is important on its own right, but the contribution to overall economic success will be magnified through the interactions among these reforms. The private sector’s response to enhanced incentives for investment and job creation is of central importance, and could well exceed the temporarily adverse impact of fiscal consolidation, net of monetary easing, on growth and employment. More competition and new entry in services should facilitate disinflation and help reduce the inflation gap between tradables and non‑tradables, while labour market reforms should further enhance the nominal flexibility of wages and help monetary policy to attain inflation objectives. The impacts of this reform package on the living conditions of the low‑skilled and long‑term unemployed is a legitimate concern, but short-term strains are expected to be offset by increased employment. Nevertheless, additional measures may be needed. As unemployment rates differ significantly with respect to educational achievement (the proportion of the 25-to-64 year old males in unemployment ranges from 4.5 per cent for those with tertiary education to 44 per cent for those with less than upper secondary education) training policies should focus on improving the re-employment prospects of the disadvantaged groups. The policy challenge, for both growth and equity reasons, is to fully reap the latent synergies between macroeconomic, labour market, business sector and public sector reforms.
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