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Slovakia: Elections Will Determine Economic Fate of an EU Outlier

Marshall L. Stocker, CFA - 6/16/2006

Fifteen years after the communist government of Czechoslovakia was overthrown in the bloodless Velvet Revolution, the emergent Slovak Republic is awash in every color but red. Today, visitors to Slovakia’s capital, Bratislava, will see buildings once left unpainted in the uniformly gray color of solidarity, now bedecked in a full palette of colors, again save for red. As this decorative trend sweeps through the country-side, so too are the effects of Slovakia’s economic reforms sweeping Slovaks to prosperity. Yet, an imminent national election will determine whether these reforms are an end-point or the foundation for further liberalization of an economy that once epitomized Marx’s theory of centralized planning.

Having joined the European Union (EU) in May 2004, Slovakia’s recent economic performance makes it an outlier both geographically and economically. After a steady stream of reforms to liberalize the economy, unemployment now stands at 16 percent, nearly double that of the EU’s, but down from a 1999 high of 17.7 percent. Slovakia’s rate of inflation has fallen from a 1999 high of nearly 30 percent to 5.3 percent in 2005 and the Slovakian koruna has appreciated nearly 20 percent versus the Euro in the same period. Most telling, Slovakia recorded real GDP growth, the leading-indicator of socio-economic improvement, of 5.5 percent in 2005, more than triple the EU’s anemic 1.6 percent growth rate. Given the economic stasis plaguing “Old Europe,” Slovakia is indeed an economic outlier.

To improve socio-economic well-being, Slovakia has relied on broad economic reforms which were begun under Prime Minister Mikuláš Dzurinda and were stewarded by Finance Minster Ivan Mikloš. The first of three notable reforms was the implementation of a flat tax. At 19 percent, the tax rate on corporate and personal income is the lowest amongst EU member states. Another feature is that dividends are not taxed. On its website, the Slovakian Embassy describes the tax code as having “an unusually high degree of efficiency, transparency and non-distortiveness.” Real estate transfer tax, donation tax, and inheritance tax have also been eliminated. For low income families, personal income below 1.6 times the poverty rate is completely exempt from income tax. A second reform, privatization of the pension system, also places Slovakia in a minority of progressive nations for only 25 countries have dispatched with pay-go systems that are now turning into Ponzi schemes. The government is predicting 75 percent of eligible workers will opt for private pensions by the June 30 deadline. At a pension reform conference held by the Slovakian Hayek Foundation, government administrators noted that by the year 2020 the value of private pension accounts would equal 30 percent of GDP. Thirdly, labor and business regulations have been reformed to increase the number of allowed working hours to 48, accommodate temporary employment contracts, create greater flexibility in hiring and firing, and reduce the number of days to start a business from 103 in 2003 to 25 in 2005. Slovakia’s recent economic success is not lost on the statist members of the EU. Andreas Tzortzis of The Christian Science Monitor reported last year that the currently embattled French politician Nicolas Sarkozy said: if the new states were "rich enough" to introduce a flat tax they would not need EU funds and that France and Germany desired to harmonize tax rates within the EU to bring flat-tax rebels under a unified code.

Given the success of recent economic reforms, Slovakia now faces the electoral temptation to rest on its laurels. On June 17, Slovaks will vote in a national election to determine which party will steer future economic policy. Having won a second term in 2002, Slovakia’s reformist Prime Minister Mikuláš Dzurinda of the Slovak Democratic and Christian Union (SDKU) will star in a snap election against the socialist leader Rόbert Fico of the Third Way party (SMER). As SMER leads the polls with 32.4 percent support, a left coalition would likely lead to an abandonment of fiscal constraint and limited progress in furthering reforms. SMER’s popularity rests in the discontent from the once comfortable communist laborers who are now buffeted by the temporary dislocations created by Slovakia’s tectonic shift towards a market-based economy. Fortunately, SMER appears increasingly unlikely to be able to form a coalition government as the party’s poll numbers have recently dropped. One reason is that Slovaks old enough to remember communist rule are weary of foisting socialism on their children. Likewise, Fico is increasingly inconsistent in his positions and appears more populist than principled, a characteristic not favored by Slovaks. Conversely, a weak showing by Dzurinda and his coalition members may empower Vladimir Mečiar of The Movement for a Democratic Slovakia (HZDS). Mečiar has championed economic reforms, overseen the privatization of public industries in the 1990’s, and tellingly was blacklisted for being an enemy of the late Czechoslovakian Communist Party. However, a former Prime Minister plagued by scandals, corruption, and isolationism, Mečiar would only be the lesser of two evils if faced with a Fico led coalition. Clearly, the best outcome for Slovakia would be for Dzurinda to again form a center-right coalition to pursue the further reforms that are critical to maintaining GDP growth above five percent.

Future targets for reform should include exceptionally high payroll taxes equal to 48.6 percent of gross income. Such oppressive labor taxes continue to support black market employment and limit job creation. Likewise, political corruption must also be targeted. Though corruption is waning, it but still remains palpable as officials reward cronies with government contracts and expedited regulatory reviews.

As Slovaks head to the polls, they should remember that economic reform not socialist dogma is necessary to continue bringing both prosperity and color to their country.