Republic of Slovenia: Selected Issues

This paper provides a background on the key policy challenges for Slovenia in the euro zone. Then, it assesses the discretionary scope to adjust spending and proposes initial steps to enhance budget flexibility so that fiscal adjustment can be targeted on relatively inefficient spending. This study also discusses the long-term fiscal sustainability position of Slovenia using a generational accounting framework. A simulation of retirement incentives suggests that the pension system will encourage individuals to retire earlier than the statutory full pensionable age. These incentives are stronger for low-income earners.

Abstract

This paper provides a background on the key policy challenges for Slovenia in the euro zone. Then, it assesses the discretionary scope to adjust spending and proposes initial steps to enhance budget flexibility so that fiscal adjustment can be targeted on relatively inefficient spending. This study also discusses the long-term fiscal sustainability position of Slovenia using a generational accounting framework. A simulation of retirement incentives suggests that the pension system will encourage individuals to retire earlier than the statutory full pensionable age. These incentives are stronger for low-income earners.

I. Introduction and Overview

1. This paper 1 provides background on the key policy challenges for Slovenia in the euro–zone: dealing with an inflexible budget and inefficient spending, the effects of an aging population, encouraging labor participation, and more generally, strengthening competitiveness and long–term growth.

2. Euro adoption will place a premium on public expenditure flexibility and efficiency. Chapter II assesses the discretionary scope to adjust spending and proposes initial steps to enhance budget flexibility so that fiscal adjustment can be targeted on relatively inefficient spending. Inefficiencies in public spending are identified using a cross–country approach that maps spending inputs into performance outcomes to construct an efficiency frontier. This analysis suggests that relatively high spending in Slovenia has not achieved correspondingly better outcomes than other EU and new EU–member states (NMS).

3. Expenditure reform is needed to contain large impending age–related spending pressures in Slovenia. Chapter III examines the long–run fiscal sustainability position of Slovenia using a generational accounting framework. With one of the largest demographic shifts in Europe expected over the next few decades, age–related spending will lead to an unsustainable fiscal gap under current policies. The chapter also assesses the impact of policy changes on age–related government spending—in particular, pensions—and the cost of delaying implementation of reforms. The chapter concludes that early measures should seek to reform the pension system on a more systematic basis through an increase in the effective retirement age and a reduction in the generosity of benefits.

4. The aging challenge is exacerbated by the retirement problem in Slovenia, as reflected in very high inactivity rates among the older individuals, and the lowest effective retirement age in Europe. Chapter IV examines incentives to retire for an individual under the Slovene pension system following the 1999 pension reform. A simulation of retirement incentives suggests that the pension system will encourage men to retire earlier than the statutory full pensionable age, which is already low compared to the EU–15. In addition, these incentives are stronger for lower–income earners.

5. As noted in the staff report, labor participation is also low for certain segments of the population. Chapter V examines whether the tax and benefits systems create disincentives to work by calculating marginal effective tax rates (METRs) to assess incentives to work. It also evaluates the impact of a hypothetical tax reform on METRs. The chapter concludes that tax reform should take place simultaneously with a reform of the benefit system to improve incentives to work.

6. Despite improving cost competitiveness and profitability indicators, Slovenia has not made significant gains in export markets. Chapter VI analyses Slovenia’s competitiveness by examining trade specialization patterns and quality indicators for Slovene exports compared to the NMS. Specialization patterns suggest that Slovenia is making some gains in higher technology exports, but the pace of technological and quality upgrading is lagging behind Central European neighbors, which may partly explain the mixed trade performance.

1

We thank seminar participants at the Bank of Slovenia for very helpful comments.