Commission Report 2002 (Slovakia)

The capacity to cope with competitive pressure and market forces within the Union

The ability to fulfil this criterion depends on the existence of a market economy and a stable macroeconomic framework, allowing economic agents to make decisions in a climate of predictability. It also requires a sufficient amount of human and physical capital, including infrastructure. State enterprises need to be restructured and all enterprises need to invest to improve their efficiency. Furthermore, the more access enterprises have to outside finance and the more successful they are at restructuring and innovating, the greater will be their capacity to adapt. Overall, an economy will be better able to take on the obligations of membership the higher the degree of economic integration it achieves with the Union before accession. Both the volume and the range of products traded with EU Member States provide evidence of such integration.

Slovakia has created a broadly predictable operating environment for economic agents. It has restored macroeconomic stability, although its maintenance is conditional on rapid fiscal measures to counteract re-emerged imbalances. In addition, Slovakia has demonstrated that it can endure difficult and prolonged structural reforms.

Although some progress has been made, there remains scope for a more growthenhancing use of Slovakia's human capital resources. Slovakia suffers from a relatively low employment rate and, as mentioned above, unemployment has risen substantially. Improvements in this situation have been hampered by a broad array of structural shortcomings affecting the functioning of the labour market. Regional mobility could be improved through a reform of the housing market and transport system. Reforms in the health and social-protection systems still have to reduce the relatively high contribution wedge and to remove disincentives for employment creation and acceptance. Inflexibilities in the labour legislation, which have not been helped by the recent amendments to the labour code, add to the problems. Inefficiencies in the labour administration persist. Skill mismatches also play an important role in keeping unemployment high. To foster the competitiveness of Slovakia's already wel-developed human capital endowment and to adapt it to new skill requirements, the education system has undergone several reforms, such as the decentralisation and diversification of service delivery and curricula changes. However, demographic changes and the increased and qualitatively changed demand for secondary and tertiary education, for instance, have not yet been sufficiently reflected in the reforms and the expenditure alignment. School enrolment rates are at 73% for upper secondary education and 20% for tertiary education.

Gross fixed capital formation has increased again and is now apparently predominantly private-sector-driven and supported by the increased involvement of foreign direct investors. Gross fixed capital formation fell sharply in 1999 but has recovered since. In particular in 2001, it rose by 9.6% in real terms and amounted to more than 31% of GDP. Starting from this high base, the growth rate in 2002 seems to be considerably lower and was indeed slightly negative in the first quarter. In sharp contrast to today, investment decisions and credit allocations in the pre-1999 period were determined by distorted incentives, weak corporate governance, and government interference. Today, they take place in a fundamentally improved structural environment, are subject to a considerably hardened budget constraint, and heavily directed by foreign direct investors. In consequence, they should be much more productive and have a distinctly augmented potential to contribute to Slovakia's growth. In addition, extensive foreign participation plays a major role in transferring technological and managerial skills. Foreign direct investment to GDP has considerably increased from below 2% of GDP between 1997 and 1999 to an average of around 8.5% of GDP in 2000-2001 - not only owing to privatisation but also as a result of greenfield investments. Specifically targeted measures to facilitate and encourage such investments have been introduced - sometimes coupled with steps to foster disadvantaged regions. However, the task of ameliorating the general business climate, which is at least equally crucial for attracting foreign investment, is not yet completed.

The transport and telecommunication infrastructure has expanded, while expenditure for research and development declined as a share of GDP. Concerning infrastructure developments, the length of motorways has been increased by 35% over the reference period. However, the removal of road infrastructure bottlenecks is not always pursued in the most efficient way, as for example evidenced by an overemphasis on road construction as opposed to road maintenance. The number of main telephone lines rose by 12%, the number of cellular phone subscriptions by a factor of more than 11 and the number of internet subscriptions by a factor of 3.5. Expenditure on research and development declined from 1.1% of GDP to 0.7% of GDP.

Enterprise restructuring has advanced and profitability has strengthened. Restructuring and the exit of unprofitable enterprises are being fostered by a hardened budget constraint and improved corporate governance. Major ingredients leading to these results have already been mentioned and include the restructuring and privatisation of the banking sector, the still ongoing resolution of the carved-out bad loans, and various legislative changes (commercial code, securities law, bankruptcy framework). Profitability has been successively improving and the dichotomy between loss- and profit-making enterprises has become less accentuated. This is evidenced by an increase of the ratio of value-added in profitable enterprises to that in loss-making enterprises from 2.8 in 1999 to 10.3 in 2001. Nevertheless, the factors conducive to enterprise restructuring need to be further strengthened, as problems remain predominantly in domestically owned enterprises. In addition, a more restrictive and conditional granting or prolongation of state guarantees and subsidies to enterprises would foster restructuring. Arguably, the most challenging remaining public enterprise restructuring project concerns Slovak Railways, which was divided into a network operator and a cargo and passenger transport operator as a preparatory step for the privatisation of the latter.

The service sector has become more important, in particular as regards its share in employment, which has increased from 52% to 57% over the reference period. This was matched by a decrease in the share of agriculture and forestry from 9% to 6%, in the share of industry from 30% to 29% and in the share of construction from 9 to 8%. Looking at its contribution to gross value added, the expansion of the service sector has been somewhat less accentuated. Its share increased from 60% to 63%, whereas the share of agriculture fell from 6% to 5% and the share of construction from 7% to 5%. The share of industry in gross value added remained basically unchanged at 28%.

Support measures for small and medium-sized enterprises have been put in place. They are co-ordinated by the National Agency for the Development of Small and Medium Enterprises (Nadsme). Income tax reductions and specific tax simplifications assist SME development. SMEs contribute roughly 30% of exports and 60% of employment. However, labour market flexibility and legislation do not yet sufficiently cater for the needs of SMEs. The access of small- and medium-sized firms to external financial means is still limited but should improve with the post-restructuring expansion of the banking sector. Legal reforms and their effective implementation, for example with respect to the recently approved collateral legislation, should contribute to fostering banks' willingness to lend to SMEs.

Government interference in the enterprise sector has been markedly reduced, in particular as the government has severed its ties with the banking sector and achieved strong progress in non-financial enterprise restructuring and privatisation. Nevertheless, some remaining public enterprises still receive a considerable amount of subsidies and guarantees.

Slovakia is a very open economy, has reached a high degree of trade integration with the EU, and has increased its competitiveness. The sum of its imports and exports of goods and services has increased from 122% of GDP in 1997 to about 160% of GDP in 2001. Given this figure, the increase of the share of exports to the EU in total exports from 47% in 1997 to 60% in 2001 and the increase of the share of imports from the EU in total imports from 44% in 1997 to 50% in 2001 reflect a very high degree of trade integration with the EU. Apart from sizeable, mostly energy-related, imports from Russia, most non-EU trade is conducted with the Czech Republic. Machinery and manufactured products continue to dominate on the import and export side. Labour productivity has grown significantly in line with accelerated enterprise restructuring. Coupled with wage moderation, this has contributed to Slovakia's external price competitiveness. The real effective exchange rate (calculated on the basis of unit labour costs) depreciated substantially in the period spanning approximately from mid-1997 to end-1999. It roughly remained around or below the end-1999 levels throughout the export boom year 2000 and throughout 2001. The effects of this year's high real wage increases have most recently been dampened by the pre-election weakening of the Slovak crown.

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