In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

Abstract

In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

Ten Years on from EU Accession1

A. Introduction

On May 1, 2004, the Slovak Republic joined the European Union, together with nine other countries, seven of which are in Central and Eastern Europe, in the largest enlargement so far. This note provides a brief overview of Slovakia’s transformation over this period. The note is divided into three parts. The first section offers some historical background on the run-up to EU accession. The second part discusses the economic impact of EU accession. The last section highlights the main challenges that Slovakia still faces.

B. EU Membership Catalyzed a Remarkable Turnaround

1. The approach to the EU had a rocky start. When the Velvet Divorce marked the peaceful dissolution of Czechoslovakia on January 1, 1993, the Slovak Republic was early in the transition process to a market economy. The economy was plagued by high unemployment and its productive system was still largely unreformed. Although the European Association Agreement with the EU was signed on October 4, 1993, Slovakia’s first government did not move forward on the necessary economic reforms (Borik and others, 2010). The economic situation started deteriorating. Relatively strong growth early in the transition slowed progressively and eventually stalled. Expansionary fiscal policy led to growing budget and current account deficits and increasing external indebtedness. Tight monetary policy to prevent exchange rate depreciation pushed interest rates up. Crony privatization contributed to the rise of inter-enterprise debt and nonperforming loans in the state-owned banking sector. At the same time, Slovakia was increasingly viewed as an “exception” amongst the Central and Eastern European countries applying for EU membership. Progress in adopting the accession requirements stalled and the Commission was concerned that the rule of law and democracy were not sufficiently rooted (European Commission, 1997).

A01ufig01

Output Growth, Inflation and Unemployment

(Year-on-year percentage change)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Eurostat.
A01ufig02

General Government Deficit and Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Eurostat.

2. The election of a reform-minded government in 1998 turned the tide. In 1998–99, Slovakia was on the verge of a severe economic and financial crisis. The new government, which took office in November 1998, launched a three-pronged strategy based on macroeconomic stabilization, structural reform in the banking and enterprises sectors, and modernization of the legal and institutional framework (Mathernová and Renčko, 2006). Fiscal discipline was gradually restored and government debt was put on a downward path. Credibility was rebuilt, thus paving the way for substantial inflows of foreign direct investment. During 1998–2004, significant and wide-ranging reforms were implemented, covering the pension system, taxation, social benefits, the labor market, healthcare, and fiscal decentralization. Commercial banks were restructured and privatized, allowing the entry into the domestic market of large European players. The sale of state-owned companies was resumed in other sectors of the economy too. This catching-up helped restart EU talks, and Slovakia was able to join the first wave of eastern EU enlargement on May 1, 2004. Slovakia took an important step toward further European integration by adopting the euro on January 1, 2009—a step not yet taken by many other 2004 entrants.

A01ufig03

Current Account Balance and Foreign Direct Investment

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Eurostat.

C. Deeper Integration into the World Economy Spurred Economic Convergence

3. Domestic reforms spurred a deepening of Slovakia’s integration into the world economy. Even before EU accession, the Slovak economy was characterized by a higher degree of openness to trade than other Visegrád countries (Czech Republic, Hungary and Poland). Nonetheless, the importance of international transactions has increased even further over time. The average of exports and imports in 2013 reached almost 90 percent of GDP. Only Hungary has broadly kept pace with Slovakia.

A01ufig04

Openness to Trade

(Average of export and import of goods in percent of GDP)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Eurostat.

4. Participation in global value chains (GVCs) has offered significant opportunities but it poses some risks as well. Substantial foreign direct investments, particularly in the automotive and electronic sectors, have led to a growing participation of the Slovak economy in GVCs. However, the competition from the other Visegrád countries has increased, as they have been able to catch up in terms of GVC participation. In particular, while the backward participation (i.e., the contribution of imported inputs in overall exports) has increased in all four countries, the forward participation (i.e., the contribution of domestically produced intermediates to exports in third countries) has declined only in the case of Slovakia. The different trend in these two indicators suggests that Slovakia has remained specialized in more downstream stages of production than regional peers have, and research shows that the vulnerability of individual countries is heavily influenced by their position in GVCs. Nonetheless, given its high degree of competitiveness, Slovakia has continued to gain export market shares, which has translated into growing trade surpluses and recently pushed the current account balance into positive territory as well.

A01ufig05

Global Value Chain Participation Indeces

(In percent of gross export)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: OECD.
A01ufig06

Share of Goods and Services in World Exports

(In percent)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: OECD.

5. EU accession has been associated with significant catching-up with western European living standards. Until the early 2000s, Slovakia’s per capita income, measured in purchasing power standards, hovered around 50 percent of the EU average. Since then, Slovakia has enjoyed a period of rapid growth that significantly narrowed the per-capita income gap with the EU and the Czech Republic, and enabled it to surpass Hungary and Poland. Looking to a broader indicator of development, such as the UNDP’s Human Development Index, which combines information regarding life expectancy, educational attainment, and income, Slovakia has made steady progress but still scores below more developed European economies.

A01ufig07

Per Capita Income in Purchasing Power Standards

(In percent of EU average)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Eurostat.
A01ufig08

Human Development Index

(Unit value)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: United Nation Development Programme.

6. Capital accumulation and factor productivity have been the main drivers of growth, especially after EU entry. A simple growth accounting exercise, carried out for different periods, shows that capital accumulation and total factor productivity (Solow residual), which measures how efficiently and intensely the inputs are utilized in production, have been the main drivers of output growth for Slovakia as well as the other Visegrád countries. The contribution of total factor productivity has been particularly sizeable in the aftermath of EU entry, reflecting major restructuring and reform of the corporate sector.

A01ufig09

Growth Accounting

(Contribution to growth)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Sources: OECD and IMF staff calculations.

7. However, rapid growth was not associated with significant employment gains. The period between EU entry and the global crisis was the only one in which employment had contributed positively to growth. A similar picture emerges from breaking down per-capita income growth into its five components, namely, labor productivity, capacity utilization of labor, the employment ratio, labor force participation, and the dependency ratio (see Figure 1 and Appendix). Before EU entry, labor productivity broadly grew at the same pace in the Visegrád countries, but in the subsequent years, Slovakia has outperformed its peers. This has been associated with a more intensive use of labor, as measured by hours worked per employee, whereas the other Visegrád countries have experienced a clear downward trend. Such a different pattern may reflect differences in the availability of skilled labor: if finding new workers with the necessary skills is difficult (and taking also into account the costs for training), Slovak firms might have tended to use more intensively the workers at their disposal before increasing employment. Nevertheless, all the countries considered, with the exception of Hungary, experienced an increase in employment in the aftermath of EU entry, although with different intensities. After the 2009 crisis, the employment ratio has declined but still remains above the pre-EU accession level. On the other hand, labor force participation in Slovakia has not significantly changed, whereas it has significantly improved in Hungary and to a lesser extent in the Czech Republic.

Figure 1.
Figure 1.

Breakdown of Per-Capita Income Convergence

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Sources: Ameco, Eurostat, Haver and IMF staff calculation.

8. The removal of barriers throughout the EU fostered outward labor migration, which reversed somewhat with the 2009 crisis. Higher wages and greater job opportunities in Western Europe led to outward labor migration from Slovakia, as well as from other new member states. The number of Slovak workers abroad rose sharply between 2004 and 2007, when it peaked at 177,000 people, or about 7 percent of the economically active population (Kahanec and Kureková, 2014).2 This also helps explain the significant decline in unemployment that Slovakia registered until 2008. Not surprisingly, the largest flows of labor migration originated in the less developed regions of Slovakia, where the probability of unemployment or inactivity is higher.

A01ufig10

Employment Abroad

(In percent of total economically active population)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Slovak Regional Statistics Database.
A01ufig11

Employment Abroad by Region

(In percent of region’s economically active population)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Slovak Regional Statistics Database.

9. The geographic destination and composition of labor migration has changed over time. While the Czech Republic has remained the main destination country, the share of workers there has nearly halved over 2004–13. On the contrary, Austria and more recently Germany have attracted a growing share of Slovak workers, reflecting not only participation in the German supply chain, but also the contribution of the female workforce to the elderly and social care sector. The increase in labor migration to Hungary, the UK and Ireland that emerged in the early 2000s has reversed with the onset of the 2009 crisis, reflecting the deterioration in the economic situation of those countries. While students and fresh graduates seeking foreign experience dominated the first wave of migration, raising concerns about the emergence of a brain-drain phenomenon, in recent years, relatively older workers have represented the lion’s share of labor force outflows.

A01ufig12

Geographical Breakdown of Employment Abroad

(In percent of the total)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: Slovak Regional Statistics Database.

D. Important Challenges Remain

10. Although the first decade in the EU has seen successes, Slovakia faces important challenges to consolidate its position and close the gap with more advanced economies. In particular, the trade collapse during the Great Recession has shown the vulnerability of an export-oriented growth model. The partial reflow of labor migration has exacerbated weak labor market conditions, including high youth and long-term unemployment. Although standards of living have improved, striking regional disparities persist.

A01ufig13

Regional Per Capita Income and Unemployment

(In percent)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Sources: Eurostat and Slovak Regional Statistics Database.

11. A first long-term challenge is to shift from an efficiency- to an innovation-driven growth model (The High Level Reflection Group, 2014). As indicated above, one of the main drivers of growth has been how efficiently and intensively production inputs are utilized. Slovakia has improved its comparative advantage in knowledge-intensive manufacturing as part of GVCs chains but it remains specialized in more downstream stages of production in a few sectors (automobiles and electronics, in particular). This makes Slovakia more vulnerable to global market conditions and shocks. In addition, intense cost competition from neighboring countries puts downward pressure on domestic wages. To move upstream in GVCs and diversify its productive base, Slovakia needs to improve the quality of human capital and invest in research and development, where it compares unfavorably with regional peers.

A01ufig14

Gross domestic expenditure on R&D

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Source: OECD.

12. Actions to improve the business environment and domestic infrastructure could lay the foundations for stronger and more job-rich growth. In Slovakia, the high unemployment rate reflects the faulty working of three key mechanisms: (i) the transition from school to work; (ii) the transition from unemployment back to employment; and (iii) mobility across regions (Duell and Kureková, 2013). To address this situation, wide-ranging policies need to be implemented. The quality of education and training need to be improved in order to better correspond to labor market needs. The ongoing reform of vocational education and training is a step in the right direction. Slovakia also needs to shore up active labor market policies (ALMPs) by bringing total spending more in line with other European countries, improving the composition and cost-efficiency of programs, and strengthening public employment services. Nonetheless, the chronic lack of job opportunities in the less developed regions of Slovakia suggests that ALMPs might be ineffective in reducing regional unemployment unless conditions for business activity are improved. Strengthening infrastructure, especially highways, is critical to promoting investment and job creation in lagging regions. Increased absorption of EU Funds in this area could help. The promotion of clusters, as in Kosice, in less developed regions could improve knowledge and technological transfers between firms and foster a local labor market for those with relevant skills (OECD, 2009). Finally, removing restrictive regulations affecting professional services and retail trades, and reducing state control in a number of sectors, including electricity, gas and railways, would foster competition and help support economic growth.

A01ufig15

Beveridge Curve by Region

(In percent)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A001

Sources: Regional Statistical Office and IMF staff calculations.

References

Appendix. Per-Capita Income Breakdown

The per-capita income of each country can be broken down as follow:

YP=YH×HE×EL×LW×WP

where:

Y = output measured in purchasing power standards

P = population

H = number of hours worked

E = employment

L = labor force

W = working age population (i.e., the population between 15 and 64 years)

The first ratio measures labor productivity (in terms of hours worked). The second ratio provides a measure of capacity utilization of labor. The third ratio is the employment ratio, which by definition is inversely related to the unemployment rate. The fourth ratio is the labor force participation rate. The last ratio provides an indirect measure of the degree of “dependency” in the economy since:

Dependencyratio=(PW)W=PW1

Therefore, the higher the share of working-age population, the lower the dependency ratio.

1

Prepared by Alessandro Giustiniani and Marco Semmelmann.

2

Data are from the Slovak Labor Force Survey, which, however, does not capture long-term emigrants, who are not considered members of household anymore and therefore are excluded. Other unofficial estimates set the number of workers employed abroad in 2007 at about 230,000–250,000 people, or 10 percent of the labor force.

Slovak Republic: Selected Issues
Author: International Monetary Fund. European Dept.