Remarks by Angel Gurría, OECD Secretary-General
Bratislava, Slovak Republic, 9 February 2009
It is a pleasure to be in Bratislava to present the 2009 OECD Economic Survey of the Slovak Republic.
What better place could there be to talk about the opportunities and challenges of the euro area than in the capital of its most recent 16th member? We congratulate you for having successfully steered your economy into the euro area. This has long-lasting beneficial effects for the population overall. This Survey is written to help make the most out of membership in the currency union.
Global headwinds will slow down growth
When I visited Bratislava for the launch of the last Survey, in early 2007, the world economy was booming and the Slovak economy was on track for the highest annual GDP growth rate in the country’s history. Since then, things have changed for the worse as we all know too well by now.
The headwinds coming from the financial and economic crisis and the sharp slowdown in global activity are weighing on the Slovak economy. Even though adoption of the euro partly shelters the economy against disturbances in the currency markets, growth is significantly affected by the breakdown from demand in major trading partners; not least due to its specialisation in the automobile sector.
Given these developments, our latest official forecast of a growth rate of 4% - which we published late last year – may well turn out to be too optimistic and we will revise it in due course. The latest projections suggest that growth could be as low as 2.5 % this year, and this may not even be the floor yet. However, in relative terms this is not a bad outcome, and the Slovak Republic is likely to remain one of the strongest among OECD economies, reflecting its high potential growth rate.
Notwithstanding all the negative effects of this financial crisis, we will eventually get over it. Thus, we need to look beyond the current doom and gloom and ask what the medium-term structural challenges are for this country. We all know too well that crises offer good opportunities for reform. History shows that reform in response to crisis emerge strengthened from the turmoil. This Survey addresses the most important of these structural challenges.
Adjusting to life in the euro area is the major challenge
The overwhelming issue dominating economic policy in Slovakia over the next years is adjusting to life within the euro area. Two aspects are of importance:
First, adopting the euro means no independent monetary policy as well as no exchange rate flexibility. Dealing with a common monetary policy is a challenge that Slovakia shares with all other members of the currency union. This is important as Slovakia faces the risk of asymmetric shocks, i.e. shocks that hit Slovakia more than other member countries. The slowdown in global car sales and the recent gas crisis are examples of such shocks.
Second, however, the Slovak accession to EMU is special in so far as its income and price level (both stand at around 60% of the euro area average) are lower than in the countries that previously joined the union. The inevitable – and desirable – catching-up process to a higher income and price level poses additional challenges, such as dealing with a temporarily higher inflation rate – which lowers real interest rates – and rapid financial development. In this regard, the mistakes that some other euro area entrants have made can be avoided!
The best answer to both challenges is to make the economy more flexible! The more flexibly wages and prices react to shocks hitting the economy, the lower the loss of output and employment will be. The Slovak government is aware of this and rightly stepped up its plans for structural reforms with its Modernisation Program Slovakia 21, which includes several measures that point in the right direction. But more needs to be done and the Survey recommendations should be understood in this spirit.
Flexibility on labour and product markets
On the labour market, more flexibility means letting wages adjust to local demand developments as best as possible. We therefore advocate to phase out legal extension of wage settlements. In addition, it should be ensured that increases in the minimum wage do not have negative impacts on employment opportunities. On product markets, productivity notably in service sectors should be raised, for example by easing entry conditions to the liberal professions and by swiftly implementing e-government services.
Making the fiscal policy framework more effective
Fiscal policy remains the only macroeconomic policy lever now. It is thus of utmost importance that it is flexible enough to deal with cyclical shocks that cannot be dealt with by the common monetary policy. The current framework does not allow for sufficient flexibility as it requires expenditure cuts if revenues fall short of expectations. In a downturn, this rule may thus act pro-cyclically, prolonging the slump instead of countering it. Instead, the focus needs to be on structural deficits – ideally complemented with multi-year expenditure targets. The medium-term objective of the Stability and Growth Pact may provide a useful yardstick in this respect.
As an aside, implementing a solid fiscal rule – which anchors public expectations regarding the future development of public finances – is particularly helpful in the current crisis. It is important in order to ensure that short-run policy actions do not undermine long-run sustainability. The recent sharp increases in government bond spreads as well as downgrades by rating agencies in euro area countries show that financial markets increasingly care about sustainability.
Keeping the pension system on the right track
Ensuring fiscal sustainability is linked strongly to the pension system. Ageing of the Slovak population will exert substantial pressure on public finances over the coming decades. It is laudable that this issue has been addressed in this country early on with the significant pension reform in 2005.
Now it is important that these achievements are maintained. In this regard, we would strongly advise not to weaken the second pension pillar: make participation in it mandatory for new labour market entrants and refrain from opening up the pillars in the future. Projections in the Survey show that the returns from the second-pension pillar (assuming investment in safe government bonds) are significantly higher than those of the current first pillar for all those with a time to retirement of at least 10 years. In addition, more reforms to the first pillar may be needed, such as raising the retirement age in line with life expectancy.
Adjusting the housing market to life in the euro area
One sector that is affected in multiple ways by the challenges of joining the euro area is housing. This is why this year’s Survey contains a special chapter on this topic.
From a macroeconomic perspective, the housing sector plays a crucial part in financial stability – as has become clear in the current financial crisis which started in the US housing market. In this regard it is important to note that many previous euro area entrants experienced pronounced housing booms that are now resulting in busts: think of Ireland and Spain. For sure, the current crisis will limit or even slightly reverse the substantial house price growth in Slovakia, where the average national price level has doubled since 2005. However, over the medium-term demand for housing is likely to be supported by low real interest rates during the catch-up phase. Thus, it is important that the authorities keep a watchful eye on price developments over the medium term and avoid tax-induced home ownership that can lead to boom and bust cycles.
From a microeconomic perspective, one of the primary roles of the housing sector is to facilitate labour mobility – and this issue is all the more important as a member of the euro area. The Slovak housing sector currently does not fulfil this role very well, not least because an efficient private rental market is missing. This Survey makes several recommendations to improve this situation: phase out the preferential tax treatment of owner-occupied housing, better target public rental housing and expand the housing allowance scheme. More labour mobility would also help to address the issue of long-term unemployment in this country – which remains one of the highest in the OECD.
Ladies and Gentlemen, euro adoption offers huge economic benefits. Not all of them are already visible today and some of them will only start affecting the population over the medium- to long term. As well, these benefits come along with challenges that need to be met.
The OECD stands ready to work with you in order to meet the challenges! We look forward to continuing and broadening our successful collaboration.
My speech provided just a taste of what you will read in the Survey. Its authors and I look forward to your questions.
Thank you for your attention.
Economic Survey of the Slovak Republic 2009