No reason to be afraid of euro

An interview with prof. Rudolf Sivák, rector of University of Economics in Bratislava about Slovakian experiences with euro.

Financial Observer: It’s been over 3 years since Slovakia joined the eurozone. Was is it a good decision?

Rudolf Sivák: The entry of Slovakia into the Eurozone took place during the period, when the eurozone was hit by the financial and economic crisis. This might have contributed to the modification of the perceptions of the impact of the entry into EMU on the Slovak economy. However, in spite of current turbulences in the global economy and in the monetary union, I believe that the impact of the membership in the eurozone on a small open economy as the Slovak one has been predominantly positive.

The membership in the eurozone has led to the savings in terms of transaction costs for Slovak residents and to the elimination of large part of the exchange rate risk, which represent important benefits of the membership for Slovak citizens and businesses. These benefits have been experienced even from the short run perspective. Also, in the long-run being a member of the monetary union could lead to the increased FDI inflows and increased foreign trade, which would have further positive influence on the economic growth of the country.

Of course, there are costs associated with the membership and they are frequently stressed by the critics of the EMU. However, as I have said there is little doubt that Slovakia as a small open economy benefited from the entry.

Does joining eurozone have any impact on price level? What’s the Slovakian experience?

As I have mentioned above the entry of Slovakia into the eurozone has coincided with the economic downturn in European countries, which was caused predominantly by the adverse demand shock. This economic situation also impacted on the dynamics of the price level in Slovakia after the entry of the country into the monetary union. Official statistics have shown that the immediate impact of the change of the currency on the increase of price level measured by HICP was about 0.15 percent, which is the figure corresponding to the data on the change-over price effect in other countries upon their entry into the monetary union.

When looking at the dynamics of prices of different groups of goods and services, it should be noted that the prices of services (e.g. prices in restaurants, hotels, and prices of other personal services) have increased more than the prices of goods. This is also in accordance with the experience of other countries. After the change of the currency the yearly inflation rate in Slovakia measured by the HICP reached 0.9 percent in 2009 and 0.7 percent in 2010, it increased more dynamically in 2011 only, when the price level increase reached 4.1 percent.

This development of inflation, however, as mentioned before, was influenced by the global economic downturn and to some extent might have counter-acted against the potentially larger effect of the entry into the monetary union on the inflation. At the same time it should be pointed out that the change of the currency was well prepared and went smoothly. People and businesses were well aware of the process; they did not increase their inflationary expectations, which also provided an anchor for the price level.

One of the greatest advantages of monetary union is that it lowers the transaction costs in the economy. That’s obvious but is there any way to precisely estimate these advantages?

Generally, transaction costs are perceived as all costs associated with the market exchange. In transactions across the border they include also the costs associated with the exchange of currencies. They include also the costs of gathering information about the market prices, the costs of preparation and enforcement of contracts, but in a broader sense also political and other costs related to carrying out transactions.

Transaction costs vary from sector to sector. I am not aware that specific transaction costs accounting would be carried out by any official statistical agency. This is understandable taking into account the fact that even though the transaction costs are partially contained in the direct costs of production, they are not recorded as specific cost items in the balance sheets. More importantly, large fraction of transaction costs occurs in a non-monetary form, which makes their accounting even more complex.

However, there has been little doubt that the introduction of a common currency leads to the reduction of transaction costs in the member countries. The estimates point out to the savings of up to 0.5 percent of GDP. Slovak citizens and private entities became well aware of this kind of savings immediately after the entry of Slovakia into the eurozone. Just a small real life example: after the entry into the EMU it became very easy to do cross-border shopping for people from the Bratislava region, which is just a few kilometres away from Austria. The need to exchange the currency disappeared and people are able to compare prices of goods in Austria and Slovakia very easily. Of course, these advantages apply also in the broader context, when carrying out transactions across the Eurozone countries.

Being in the eurozone implies dependency on some international decisions. There have been a big discussion when EU decided to help the indebted countries. Slovakia was not very happy with that. Is there still the resistance in your country in this matter?

In November 2011 one of at that time coalition parties (SaS) refused to vote for the approval of the eurozone bail-out fund in the parliament, which led to the preliminary parliamentary elections in spring 2012. In the next parliamentary voting the eurozone bail-out fund was approved by the Slovak parliament with the support of the leading opposition party (SMER), which supports the European financial stabilization mechanism. This party won 2012 preliminary general elections and obtained such voters’ support, which allowed the party to form the government.

This indicates that large part of Slovak voters support pro-european policies, including the help to countries to deal with their debt problems. Even though the Slovak population might not be excited about the need to implement policies aimed at helping the indebted countries, the majority of people realize that these policies are needed for the stability of our common currency and of our economies. At the same time Slovaks expect that the provided support to indebted countries will be strictly conditioned by the introduction of relevant policies leading to the consolidation of their public finance.

You were strongly hit by the crisis in 2009. Since then the GDP growth in your country seems to be much slower. Is there any prospect that the situation will reverse?

In 2011 Slovakia experienced the GDP growth of 3.2 percent, which even though being lower than that of Poland, was much higher than the growth of GDP in EU-27 (1.5 percent), or in the eurozone countries (1.4 percent). Our other neighbouring countries – the Czech Republic and Hungary – have experienced lower growth rates both in 2010 and 2011. It is true that in 2009 the GDP decrease was high (-4.9 percent) in Slovakia, but it should be noted that in 2009 Slovakia experienced the recession, which came after several years of the dynamic economic growth of its economy.

Also, this recession was predominantly caused by the drop of the demand for Slovak exports, to which Slovakia as a small and very open economy is extremely sensitive.  However, after the one year recession the Slovak economy has picked up and the forecasts for the following years predict moderate growth in spite of the overall expectations of the continued economic decrease in the majority of EU and Eurozone countries.

Recently Slovakia got rid of the flat tax and brought the progressive scale back to life. What was the reason behind that decision? Was the flat tax harming the economy?

The tax changes introduced in Slovakia in 2012 have been primarily aimed at the effort of the government to bring down the budget deficit below 3 percent in 2013.  The measures were also prepared so as to decrease the impact of the fiscal consolidation on lower income groups and strengthen the principle of the solidarity in this economically difficult period. Thus, the problems with the flat tax system per se are not the reason for the introduced changes.

The experience from the pre-crises years, which were associated with the dynamic economic growth, indicates that the flat tax rate has had positive effects on the economic activity in the country. However, the priority of the consolidation of public finances required to introduce these changes. I believe that in the future after the fiscal consolidation is achieved, Slovakia may return back to the flat tax rate system.

Does Slovakia need reforms as much as Poland? We have problems with our social security system, with bureaucracy, unclear tax law and with ageing society…

We can observe that some of the problems we face are similar not only for the countries in the region, but also elsewhere. Slovak population is also aging, which puts the pressure on the social security system, which needs consolidation. This has also been addressed by measures adopted recently in Slovakia. I mentioned the changes in the tax system. At the same time the Slovak government has taken measures to tackle the problem of tax evasion and introduced also measures aimed at increasing the compliance in social security and health care insurance payments. However, these problems do not have only economic, but also ethical dimension.

It is not fair to expect honest people to contribute more and at the same time to tolerate that part of the population evades paying their share. On the other hand, my comprehension is that the Slovak population understands the necessity of the introduced measures and is willing to bear these costs if people can see that they will lead to the desired outcomes. In this respect I would compare the current situation with the period after the split of Czechoslovakia, when Slovak citizens accepted the need for tough restrictions, since they believed that they will bring the results. And they were right.

Which country – in your opinion – will be the leading country in terms of GDP growth in the Central Europe region?

The statistical data show that in recent years Poland has been the country, which has grown most dynamically. Even in 2009, i.e. in the year of the overall economic downturn, Poland experienced a moderate economic growth. However, the estimates of the economic growth of the Polish economy for the following years have become more cautious.  In terms of Slovakia, OECD predicts that the Slovak economy will pick up slowly through 2013 and it is expected to grow by about 3.5 percentage points in 2014.

I believe that in the following years the potential for the dynamic economic growth in the region will be largely determined by the development of the demand for exported goods. It can be expected that the domestic demand will be still restrained by fiscal consolidation measures. Thus, in the following years those countries, which will best adapt to the changed structure of the foreign demand, will have the best potential for the dynamic growth. In this respect I believe that Slovakia will prove its growth potential.

How important is Poland for the economy of Slovakia?

Poland has been our traditional trade partner for years; it has belonged among five largest trade partners of Slovakia. Slovakia and Poland share common past and face similar problems. I believe that the regional cooperation within V4 and joint cooperation projects are very important for the development of our countries. Also, both countries joined the European Union at the same time and the coordination of our positions in the EU is crucial for having our voices heard.

As I said before I believe that  our countries share not only common past, in many respects they have common interests and there exist wide opportunities for further development of the cooperation. Moreover, I have always felt very close to my colleagues in Poland and I believe this feeling is generally shared by Slovak people. We have always felt close to Polish people and we share similar culture. In Slovakia Polish people are not only considered as reliable business partners, but also as very good friends.

By Sebastian Stodolak

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