“Tatra Tiger” May Be Endangered by Opposition to Market Reforms

This article appeared on on June 11, 2006.

On his recent visit to Bratislava, Tony Blair expressed his “great admiration” for Slovakia’s economic reforms. But as Slovaks head to the polls next weekend, the future of the country’s economic reforms hang in the balance. The 17 June parliamentary elections will be the second most important since Slovakia’s independence in 1993. In 1998, the Slovaks had to choose between the autocratic rule of the then Prime Minister Vladimir Meciar and democracy. They chose the latter. This year they will have a choice between the economic liberalism advocated by the current governing coalition and a populist socialism advocated by the left. The current government is far from perfect, but the alternative is much worse.

Since winning the 2002 election, the centre-right coalition government of Prime Minister Mikulas Dzurinda has managed to improve Slovakia’s microeconomic environment by eliminating many unnecessary business regulations. In 2004, Slovakia adopted a 19% flat personal income and corporate tax rate; VAT is also set at 19%. The dividend tax and most tax exemptions were eliminated. As a result of those reforms, Slovakia ranked among the top 20 countries with the best business conditions in the World Bank’s Doing Business in 2005 report.

In another radical move, the pay-as-you-go pensions system, which faced serious long-term financial shortfalls, was partially privatised. Roughly 1.1m people, or 50% of eligible workers, have already opted for personal retirement accounts. Many more are expected to switch before the deadline of 30 June.

Slovak macroeconomic performance improved as well. Cumulative foreign direct investment to Slovakia rose six-fold between 1998 and 2005. The list of foreign investors included a number of blue chips such as Citibank, Ford, Motorola, US Steel and Whirlpool. Much of the investment flew to the auto industry. South Korean Hyundai and French Peugeot are building factories in Slovakia and the country is expected to become the world’s largest car producer per capita by 2008. Economic growth accelerated from a low of 1.5% in 1999 to 6.1% in 2005. By comparison, the Czech, Hungarian and Polish economies grew at 6%, 4.1% and 3.2% respectively. According to the Eurostat statistical agency, the EU economy as a whole grew by a mere 1.6%. No wonder Slovakia is now known as the “Tatra Tiger”.

Unemployment, which used to be one of the most pressing problems in Slovakia, fell from 18% in 2000 to 11% in 2005. Over the course of last year, real incomes per person rose by 6.2%. Incomes are catching up with the rest of the region. After adjusting for purchasing power, in 1993, Czech GDP per person was 54% higher than that in Slovakia; by the end of 2004, that difference had fallen to 33%.

Yet despite those successes, the member parties of the governing coalition are deeply unpopular, and so is Dzurinda himself. One reason for their unpopularity was the belt-tightening that accompanied economic liberalisation. Not surprisingly, welfare dependants, who were used to generous handouts that the current government reduced, are among the most dissatisfied.

More serious are the accusations of corruption among government officials. Two ministers were forced to resign after being accused of misusing public funds for private benefit. Government procurement, despite substantial reforms aimed at greater transparency, continues to be much abused. The free media has an important role to play in promoting clean government but it is sometimes forgotten that the Slovak media was not always free to write about the behaviour of public officials.

Robert Fico, the leader of the left-wing opposition, is to be congratulated for his efforts to keep the current government transparent and accountable. The same cannot be said of his determination to reverse many of Dzurinda’s market-friendly policies. He has bashed pro-market reforms and called for “solidarity” that he hopes to pay for by reinstituting a progressive income tax and different VAT rates on different products, as well as increasing the corporate tax rate. He also wishes to abolish the compulsory enrolment of new workers in the private part of the new pensions system. The flexibility of the labour market, the most important contributor to the rapidly declining unemployment rate, is likely be constrained as well. Aside from their negative effect on economic growth, Fico’s policies would significantly compromise the business-friendly image Slovakia now enjoys.

Fico points to the socialists in the Czech Republic, who managed to combine a relatively high rate of growth with more extensive welfare provisions. He misses one crucial point, however. Historically, the Czech lands have always been richer than Slovakia. Moreover, economic liberalisation carried out by Vaclav Klaus in the early 1990s enabled the Czech Republic to grow richer faster than Slovakia, which eschewed substantial economic reform until 2002. Today, the Czech government is reaping the benefits of Klaus’s reforms; wealth creation should remain the priority in Slovakia.

Aside from Fico’s populist rhetoric and dubious policy proposals, there are serious questions about the “gravitas” of his economic team. His shadow finance minister is Igor Sulaj - an amiable accountant with questionable readiness for office. After being repeatedly caught getting his facts wrong, Sulaj now refuses public debates for fear of further embarrassment. Another of Fico’s economic advisers is Professor Peter Stanek, who advised the Meciar government and is, therefore, partly responsible for the economic crisis of the late 1990s.

The current government hopes to counter Fico’s appeal with the voters by adopting, among other things, lower taxes. By 2010, Dzurinda proposes that the personal income and corporate tax should fall from 19% to 15%. The Christian Democrats, Dzurinda’s erstwhile coalition partners, want the tax rates to fall to 14%.

Dzurinda must do more to tackle the question of corruption. He should commit to supporting new measures aimed at curtailing corruption, including the repeal of parliamentary immunity for politicians and the overhaul of government procurement procedures. Bearing his personal unpopularity in mind, Dzurinda should also announce that he will not seek the premiership again and endorse his capable and highly regarded finance minister Ivan Miklos.

Failing that, the polls show Fico’s party alone will receive about a third of the vote, which is roughly as much support as all the pro-market parties put together can count on. That means that the unlikely kingmaker will be Vladimir Meciar, whose party enjoys support of 12% of the public. Ironically, the future prosperity of the Tatra Tiger will depend on the inclusion in the government of a man who brought Slovakia to the brink of economic meltdown. But that may be necessary to keep Fico out of power - it may be a price worth paying.