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The downfall of Slovenia, and why it matters for Europe

Dark clouds are gathering over Slovenia. lassi.kurkijarvi

The downfall of Slovenia, and why it matters for Europe

The eurozone crisis appears to have a new victim: Slovenia. To avoid the need for a bailout, the IMF has called on the country to immediately recapitalise its banks.

This should worry the rest of Europe as, unlike some of the other countries that have received bailouts, Slovenia was no economic basket-case. Until very recently it was considered a success story, the most prosperous and stable of the continent’s post-socialist nations. So how has it come to this?

Slovenia has always been something of an outlier among the former Eastern Bloc. Due to commercial ties with neighbouring Italy, Austria and the rest of continental Europe, its most successful firms (such as Lek pharmaceuticals, or Gorenje home appliances) were internationally competitive even before the disintegration of Yugoslavia. At the same time, the tiny republic was considered to be orderly and law-abiding. As the saying goes, “laws were written in Belgrade, read in Zagreb and implemented in Ljubljana”.

The Slovenian success story continued after independence throughout its transition to democracy and a market economy. Slovenia’s GDP grew on average by 4.5% per year in 1993-2008. Its GDP per capita rose from less than half of Western Europe to 87% of the EU average in 2009.

This was not achieved at the expense of social justice: inequality was comparable to Scandinavia in the mid-2000s, the unemployment rate stayed particularly low and the gender gap with respect to earnings was one of the narrowest among OECD countries. Accession to the EU and the adoption of the Euro were relatively straightforward.

The downfall

The picture in 2013 could not be more different. Five years into the Great Recession, Slovenia’s economy is in a shambles. GDP in 2009 fell by 7.9%, a recovery failed to materialise, and in 2012 the country entered a double dip recession. The economy is forecast to shrink a further 2% this year.

Public finances are in disarray, with a large deficit and a public debt that has doubled since the crisis began. After the construction sector collapsed and numerous labour-intensive manufacturing firms closed down, the unemployment rate climbed from just above 4% in 2008 to more than 10%. As Slovenian financial institutions struggle with bad loans worth some 22.5% of GDP, an international bailout may become inevitable.

So how did the most successful post-socialist country so precipitously become one of the sick men of Europe? A peculiar mix of four factors, some dating back to the immediate post-independence period, have contributed to the unexpected downfall.

Political paralysis

Breaking away from Yugoslavia to create a new country was a daunting task for Slovenia’s rulers. As a consequence, consensual decision-making and broad coalition building became the norm. During the 1990s, the left-liberal and right-conservative blocs saw their ideological differences compressed by the common goal of accession to the European Union.

This changed in 2004 when a centre-right coalition headed by Janez Janša of the Slovenian Democratic Party was voted into power, beginning a decade of political polarisation and policy paralysis. Electoral competition became toxic, the relationship with the social partners deteriorated and public protests multiplied.

Reforms have proven impossible to achieve. The austerity programmes launched by both Borut Pahor’s Social Democrats and Janša’s second government ended in no confidence votes against the two executives. Political failures to respond to the crisis means the country skipped four years of restructuring and fiscal consolidation.

Too gradual?

Instead of adopting the shock therapy that inspired finance ministers in post-communist Poland or Hungary, Slovenian policy makers opted for a gradual programme of liberalisation, privatisation and stability in the early 1990s.

Gradualism preserved social peace, maintained social equality and provided a safety net for the losers of transition. However, in the long-term it proved to be a double-edged sword, resulting in the dilution of much-needed reforms.

Tertiary education became inefficient, the labour market excessively rigid and the judiciary effectively paralysed. The privatisation of state-owned enterprises slowed down. Due to high bureaucratic hurdles, Slovenia managed to attract only a risible share of foreign investments.

Low-skills, low-tech

Contentious politics and the failure to privatise much of its productive assets led Slovenian manufacturing into a low-skills, low-technology trap.

As international orders dried up in 2009, labour-intensive manufacturing firms were the first to collapse, leading to a big drop in GDP. The competitiveness of Slovenian firms further declined during the crisis; the value added per employee does not exceed the EU average in any sector. The technology and skills required to produce Slovenian exports is now lower than in most other new EU members.

Cheap credit and the Euro-crisis

Since 2009, Slovenia has been stuck in an inextricable credit crunch. The cheap credit available for management buyouts was used for ownership consolidation and not for restructuring or technological upgrades. This led to widespread bankruptcies and the need to refinance most Slovenian financial institutions (state-owned Nova Ljubljanska Banka alone lent some €5.8 billion).

Of course, Euro-area dynamics did the rest. As banks have to be saved by individual member states, Slovenia found itself in a catch-22. It needed to raise more money but due to soaring costs of debt refinancing, the country found its access to international financial markets barred at a time it was most needed.

Too late?

The situation in 2013 is therefore dramatic. It is now probably too late for politicians and the social partners to sober up and vigorously pursue the elimination of the country’s structural weaknesses. As Slovenian long-term bond yields are so high (making borrowing expensive), the caretaker government of prime minister Alenka Bratušek may have to accept a bail out.

This would be perceived as a national tragedy in itself. But it may also engender the perverse dynamics of recent rescue-cum-retrenchment packages that forced the economies of Greece, Spain and other recipients on to their knees. Very dark clouds hang over a country that styles itself as the “sunny side of the Alps”.