Slovenia and Its Economic Development after Entering the EU - Essay Example

26 May 2008 Slovenia and Its Economic Development After Entering EU EU integration proposes less development countries great opportunities to improve their financial and economic systems and living standards. Before joining the EU, Slovenia had slow economic growth rates and economic stagnation, high inflation rates and poorly developed banking and financial systems. A successful transition to capitalism in Eastern Europe could revitalize Western Europe, but a failed transition would threaten Western Europe politically, economically, and socially ("Euro Area-Another Cyclical Recovery" 24). During the period of integration, the EC can be seen as a mentor to the countries of Eastern Europe. At the same time, the newly free countries of Central and Eastern Europe found that, if they were to establish their economic independence and provide a sound basis for their political independence, they first had to thoroughly liberalize and marketize their economies and stabilize their currencies. Slovenia joined the EU in 2004. And since that time, it has improvised its economic development and reestablished its banking system, balance exchange rates and create new employment places for native citizens. The EC has had policies on employment for decades, but the policies do not constitute a coherent, developed social program. Rather they are a collection of directives adopted in response to a specific concern and requiring minimal amounts of harmonization in national practices. Voting practices in the Council impeded the adoption of more sweeping measures. Because each member state had a veto, with a few exceptions, supporters of an EC social policy fought for the elimination of the veto (Dukes 49). They gained a partial victory with the ratification of the Maastricht Treaty. For Slovenia, the way is now open for a more fully developed EC social policy. A number of characteristics of the workforce in the EC are relevant for policy makers. One is the fact that the EC has a smaller proportion of adults of working age actually working than either of its main competitors. The statistics indicate that a relatively large number of working-age people are dependent on some form of public support. Some people apparently do not work by choice, but many are unable to find work. Following Egert et al (2007): some countries, namely Slovenia started transition with low credit-to-GDP ratios of around 20% in 2005" (201). Transitional banking systems initially tend to operate with very high ratios of reserves to deposits. This is partly the result of the fact that they start out as monobank systems with 100 per cent reserve backing of deposits, partly because of the extreme inefficiency of the payments system, which requires the maintenance of large commercial bank deposits at the central bank, and partly because of the great ease of obtaining central bank credit by commercial banks in the pre-stabilization period (Dukes 49). If this is the path followed then it would be prudent for the first principle of banking system evolution to be that in the short term, the stability of the monetary system must have priority over the freedom of action of the banks themselves in the management of their assets and liabilities. In other words, in the initial phases of the 'main sequence', when supervisory and banking skills are rudimentary, bank regulation needs to be rigorous and based on simple rules. This is because of the vital role of macroeconomic stability in successful economic transition from state ownership and central administration of the economy to capitalism. The usual argument against tight regulation, which stresses that tight regulation leads to disintermediation is largely irrelevant in a context in which people have so little possibility of informed choice between risky and safe banks that the authorities feel themselves obliged to guarantee all deposits. The development of a dual system in which deposits at strictly regulated banks are known to be safe, while loans to unregulated non-bank financial institutions are clearly known to be not guaranteed by government seems healthier than the alternative by which all deposits are a contingent liability of a state budget which has no effective control of the degree of risk to its exposure. In the West, the state tries to limit this exposure by sophisticated and light regulation of the whole of the banking system, but such regulation is likely to be ineffective for a long time because of a lack of skills. In 2005, GDP growth rate was 4% and income per capita - $21,500. On January 2007, Slovenia joined the Euro. In general the Euro bank is seen as an instrument thanks to which the backward country can catch up with, and maybe overtake, the most advanced--Anglo-Saxon--market economies. The Euro bank achieves this aim through 'far sighted plans' which it can elaborate successfully thanks to its 'central vantage point of control' and because its 'capital supplying function' compensates for the 'insufficiency of wealth placed at the disposal of the entrepreneur'. In other words, as was believed to be the case with central planning, the universal bank is supposed to make possible a greater mobilization of savings and their successful application to long-term projects. The aim and the method remain the same, only the institutional instrument is different ("The World Economy" 8). Critics admit that the first threat for Slovenia is that of bad debts in the banking system. For old bad debts, the solution is either a global debt write-off, combined with the introduction of 100 per cent reserve banking for banks which benefit from the write off. The first liberalization would then be to allow them to extend the safest kind of credit available (i.e. for self-liquidating working capital). As skills develop, the kind of loan business permitted would become more varied and longer term, obligatory reserve ratios would be reduced while, initially, capital adequacy ratios would need to be increased (to provide a cushion for greater loan risk, and to prepare for privatization) (Dukes 49). High capital adequacy ratios reduce the rate of return on bank capital. When applied to domestic banks with low skills they constitute a form of insurance for depositors and for the government, which is the ultimate guarantor of deposits in the regulated part of the system ("Euro Area-Another Cyclical Recovery" 24). If applied to reputable Western banks with good banking skills they would be a barrier to entry, and thus a drag on the development of an efficient banking sector. Branches of foreign banks could remain in the unregulated, unguaranteed, part of the system, as long as they were subject to the supervision of their national bank supervisory authorities, and if the capital of the whole bank was legally subject to make good the losses of its domestic branch. Control of capital/ asset ratios in particular requires an ability to assess the degree to which loans need to be written down. "Slovenia might be in the danger zone because the observed growth rates are higher than the one derived from the long-run equilibrium relationship. In addition, they argue that possible credit booms are mainly due to credit expansion to households and not to the non-financial corporate sector" (Egert et al 201). Statistical results show that "the general government deficit in 2007 amounted to EUR 24 million or only 0.1% of GDP. With the routine revision the value of deficit in 2006 slightly increased to EUR 377 million (before EUR 366 million) at the same relative value according to GDP, 1.2%. Deficit at the central level in 2007 was estimated at EUR 98 million or 0.3% of GDP, which is 0.9 of a percentage point less than a year before (EUR 370 million or 1.2% of GDP)" (Statistical Office of the Republic Of Slovenia 2008). 'Reform recessions' are due to the destruction of information capital which results from the large increase in available new technologies. Since it is not known which managers will be efficient in the use of the new technologies, resources are--on average--allocated less efficiently than before the reform, leading to a fall in output (Dukes 49). The fact that output has grown very fast in the private sector in Slovenia while falling in the state sector shows that--given efficient property rights as in the private sector--the destruction of information capital can be made good very rapidly and need not lead to any fall in output ("The World Economy" 8). On the other hand, rapid private sector expansion would not have happened in the absence of the macroeconomic stabilization program, because the financial squeeze on state enterprises was necessary: to 'create space' for the private sector to expand. Also, the financial squeeze helped extend the massive privatization of retail trade in 1990 to those parts of Poland in which most commercial property is socially owned. "At the local government level deficit in 2007 was minimal and amounted to EUR 2 million and the social security funds showed surplus in their accounts at the amount of EUR 75 million or 0.2% of GDP" (Statistical Office of the Republic Of Slovenia 2008). The main reason for substantial decrease of deficit in 2007 was in slower dynamics of expenditure increase (5.3%) in comparison with the increase of revenue (8.3%). The numerous attempts by local authorities at the beginning of 1990 to regulate the activities of shops through rental agreements collapsed in the face of their need for revenue ("Euro Area-Another Cyclical Recovery" 24) The EU integration allows Slovenia to improve trade relations and increase both export and import. To begin with, the benefits of price competition can be realized on the production side only if the supplying firms attempt to maximize profits. Otherwise, establishment of even a competitive market for firms' outputs can worsen things. Privatizing state-owned enterprises, for instance, is not likely to enhance productive efficiency unless accompanied by extensive restructuring which makes cost-effective, profit-maximizing behaviour possible. Such a restructuring has several elements: change of management skills and personnel, provision of appropriate incentives (both short-term and long-term), reform of corporate governance and imposition of hard budget constraints (Fakiolas, 19). The cross-section of experience in transitional economies shows the importance of these factors. The allocative efficiency of the market mechanism can be enhanced by imposing financial discipline upon firms through capital markets and banks (Dukes 49). However, this requires development of complementary institutions. Privatization, for instance, does not necessarily resolve the problem of the 'soft' budget constraint and the pervasive losses that engenders. One of the main advantages of the market mechanism is its low operating or transaction cost. In an efficient market any (anonymous) trader can turn up and either buy or sell as he wishes. The ease of this must be contrasted with alternative, non-market arrangements where time and resources have to be expended in locating counterparties and agreeing terms of trade. However, the paradox of anonymous exchange, which epitomizes the advantages of the seemingly institution-free market mechanism, is that it is probably more institution-intensive that any other form of exchange. Buyers and sellers typically have a number of concerns about any trade, the main ones being the quality of the goods being bought and the price being paid. If the transaction involves passage of time (between, say, agreement of contract and its execution or between delivery of goods and payment), then additional concerns arise, such as: (a) creditworthiness of the counterparty; (b) reliability of the counterparty (to honor the contract rather than renege); (c) external enforceability of the contract; and (d) remedies for contractual breach. For transactions to be successful, whether in the market or non-market mode, these issues must be addressed (Fakiolas, 19). While feasible, such a mode of transaction clearly involves high transaction costs which eventually get factored into the price of the commodity being traded. Consequently trade volumes, and eventually level of economic activity in such high-cost trading environments, are reduced. individual trader who wishes to perform these functions himself. Since these costs are repeated over traders, organizing them through a common source can significantly lower the cost per unit trade. This brings down the overall cost of trades and therefore expands the volume of economic activity. Second, organizing these activities commonly brings scope for specialization and hence further increase in the efficiency of transactions (Jaklic 105). Consider the problem of information. Successful markets require several kinds of information and hence information-processing institutions. First, information needs to be collated about potential demands and supplies. This is what contributes to 'thickness' of markets and to the discovery of competitive prices (that is, prices which ensure that goods come from lowest-cost producer and go to the highest-value consumer). In many transitional economies where coordination of demand and supply was previously done through plans, there were no natural mechanisms (for example business associations, business directories and so on) to facilitate search that produces information about potential trading partners (Dukes 49). There was considerable local variation in prices and, with the partial abandonment of the planning framework, the coordination of inputs and outputs became more difficult. To the extent that the state sector has been privatized it is through the privatization of its physical assets, and not through the privatization of organized state owned businesses (Jaklic 105). In this process--which has been the most important element in the transformation of the Slovenian economy--bank credit has played a very small role. Indeed, on the basis of the Polish case one can perhaps formulate a hypothesis about the microeconomic unimportance of bank credit in the early stages of transition. The market as a selection process has operated through the product market rather than through the capital market. Successful firms have made large profits and thus been able to expand, unsuccessful firms have failed and gone bankrupt. In this way not only successful projects, but also successful entrepreneurs and successful business organizations have been selected, and the information capital of the whole economy under the radically new circumstances of the transition has been increased (Fakiolas, 19). In case of Slovenia, successful stabilization of very high inflation usually involves fixing the exchange rate of the domestic currency, at least for a short period of time. This is because very high inflation causes people to save on real balances--on which they have to pay the inflation tax (Jaklic 105). Fixing the exchange rate means that, for at least a short period of time, people know that the foreign exchange value of the domestic currency will be stable. This can cause the demand for the domestic money to increase sharply, so that a virtuous circle develops: increased demand for domestic money ends the 'flight from domestic money' which is fuelling very high inflation--as inflation falls the demand for money increase further--and so on. A key problem is how to maintain credibility for the new fixed exchange rate without starving the economy of the greatly increased real money balances now desired. If the authorities fail to accommodate this increased demand for money by increased supply, then in the absence of perfect capital mobility, they will cause very high real interest rates to prevail. These can only be avoided if prices fall to such an extent that the given nominal money supply satisfies the demand for real balances at the, new low rate of inflation. If, on the other hand, the authorities increase the supply of money rapidly the danger is that they will undermine the credibility of the stabilization (Jaklic 105). The fact that as a result of the slowness of the development of investment trusts, a large part of the nation's personal savings would lie 'useless' at the monobank need not be feared (Krizanic and Oplotnik 161). In sum, Slovenia improves its economic indexes and trade relations after the joining the EU. Policy making becomes a contributor to integration. The process mobilizes large numbers of people and creates networks throughout the region. The economy in Slovenia depends heavily on the production of goods for the domestic market and for export. Industry produces more than one-third of the gross value added in the economy, and consumes 31 percent of the energy used. The member states of the EU are trading nations that export about 23 percent of their GDP, although they do a large volume of intra-EU trade as well. Works Cited 1. Dukes, P. Europe: Ringing in the New, Remembering the Old Paul Dukes Examines the Historical Roots of This Month's Enlargement of the European Union. History Today, 54 (May 2004), 49. 2. Egert, B., Backe, P., Zumer, T. Private-Sector Credit in Central and Eastern Europe: New (Over)shooting Stars Comparative Economic Studies, 49 (2007), 201-210. 3. Euro Area-Another Cyclical Recovery National Institute Economic Review, 196 (2006), 24. 4. Fakiolas, E. T. 2007The European Union's Problems of Cohesion. New Zealand International Review, 32 (2007), 19-22. 5. Jaklic, M. Symbolic Interactionism Approach to Study Socio-Economic Development in Slovenia. East European Quarterly, 38 (2004), 105-108. 6. Krizanic, F., Oplotnik, Z. Contemporary Economic Growth and the Consumption of Energy Raw Materials. East European Quarterly, 40 (2006), 161-166. 7. Statistical Office of the Republic Of Slovenia. 2008. Retrieved may 2008 from http://www.stat.si/eng/novica_prikazi.aspxid=1172 8. "The World Economy". National Institute Economic Review, 197 (2006), 8-9. Read More