The decline could hardly be more dramatic. From 7 % economic growth in 2007 to a 7.8 % decline in 2009. From 22 % public debt as a percentage of GDP in 2007 to 52% of GDP in 2012. In only a few years Slovenia made a “progress” from the best pupil in the class to a country on the verge of bankruptcy. What went wrong?
English version of my OpEd piece in Die Presse. *
One can simply stick to the statistics and blame it on the financial and real estate bubbles. In the booming years between 2004 and 2008, stock values more than tripled and construction sector doubled as a percent in GDP. There were plenty of irrational real estate projects and a number of planned corporate acquisitions and management buy-out attempts carried out at swelled stock prices. Most of them gloomily failed. Both bubbles burst soon after the outbreak of the global financial crisis and all the failed projects ended up in banks’ troubled balance sheets. The amount of bad loans in Slovenian banking sector is estimated to almost 20 % of the GDP, and still increasing.
One can also blame it on the political elite that managed the crisis that miserably. Imagine a country increasing wages in the public sector by 10 % and a minimum wage by 25% just when the crisis hit in in 2009. As pensions and social transfers are indexed to the wages, both of them also increased by the same percent plus the inflation. It was just doomed to fail. And it did. As a consequence, public expenditures increased roughly by 10 %, while crisis-ridden fiscal revenues decreased by the same percent. Budget deficit surged to the annual levels exceeding 6 % of GDP. The government started to borrow heavily abroad just to finance the swelled expenditures that had nothing to do with the crisis resolution, but just with the irresponsible policy mistakes. The government ended it term prematurely in 2011 with the record of additional 7 billion euro (20 % of GDP) of fresh public debt without even tackling the problem of troubled banks or stimulating the economy. The previous government was certainly not the solution, but just another source of the disaster.
Yes, one can blame it on irrational and greedy managers as well as on irresponsible politicians. However, it only explains “how”, but not “why” Slovenia has fallen into a catastrophe. The catastrophe that will probably call for a bail-out by the EU. The story of the Slovenia’s collapse has a much longer tail.
The fundamentals of the crisis-to-come were built into the system long ago. It just needed a trigger to set the things into a downward motion. A useful tool to think about what went so awfully wrong in Slovenia is the institutional analysis. It helps to understand the roots of the crisis by taking into account the set of politically induced economic and political rules that shaped the motives and behavior of the key actors.
How does this apply to Slovenia? Well, under the communism before 1990, the incentives to work and to conduct a business were distorted. You had to be part of the elite to be able to participate in lucrative business. But the system was not only less efficient in terms of economic development, it also created a lot of frustration with the majority of less privileged, especially with those most eager to – but being refused to – enter the political and economic elite.
When the system collapsed in 1990, the incentives and rules were gradually changed. However, there were three crucial “remains” of the old system that determined the economic evolution of the newly established democratic state.
First, there was the “historical memory” of the old institutional system that remained well preserved. It means that for securing and defending the interests of the elite all legal measures were allowed. Therefore, also in the new system it was common that some people were more equal before the law. Market regulation was poor and market entrants or foreign companies had usually hard times to fight against the established incumbent firms ran by well-connected or from the state appointed managers. Judicial system, almost by the rule, has always been, and still is, extremely slow and inefficient in resolving the business disputes where established incumbent firms were involved. Many of foreign companies or new entrants were scared off or driven out of the market.
Second, the previous system took a farewell without a defined property. All that was previously “socially owned” had to be redistributed or to find “proper” owners. Out of many options, the new-old elite decided to redistribute the undefined property in a controlled way. Rightly, the act passed by the parliament was not called privatization act, but rather “act on ownership transformation”. This means that the firms could not be privatized to foreign or domestic bidders, but were simply redistributed. The majority was redistributed to the internal owners, but mostly to the previous managers, who had the right to buy larger stakes in the companies. On the other hand, 40 % of each firm’s shares were simply transferred to two para-state funds. Some of the firms, such as big banks and energy sector, were defined as being the national strategic assets and remained in the state ownership. This is how the old elite had either transferred the ownership to their members (existing managers) or kept it under the state control. Who had the power also controlled more than 50 % of the economy.
And third, after the political turnover in 1990, groups of frustrated individuals from the previous system organized into political parties. They eventually won the first free elections and formed a colorful coalition in 1990, but lost the power only two years later due to the lack of political skills and internal fights. The old elite came back to power and stayed there for additional 12 years. It’s main focus was on protecting the economic interests of the elite and to extract the rents from the companies controlled directly or indirectly by the state. The long-lasting frustrations among the members of new political parties relegated away from the power, but most notably concentrated around the current prime minister Janez Janša, were deepened. It all just waited for a spark to escalate.
Though the system was rigid, it was a stable one. The symbiosis between the old political elite and the managers in only partly privatized firms managed to produce not a spectacular, but still a stable growth with very little volatility.
The things changed dramatically in 2004 when Janez Janša, the symbolic figure of historical frustration, came to power. After taking the power, the main goal of Mr Janša and a circle of his friends was just to make up for what they felt they were historically deprived. Their goal was not to change the institutional system, to improve the incentives, to lift the regulation or to privatize the companies to foreigners. Instead, they took on the Spanish colonization strategy. With taking the power they got the control over the economy. Within one year, most of the big companies controlled by the state got newly appointed supervisory boards and management boards. This was the time to start extracting the rents by using the well-established channels of selected suppliers related to the “friends”. This was the time to take the control over the national TV and radio broadcasting. It was the time to take control over the major newspapers. In a chain of deals the government was “swapping” the stakes in the biggest retailer Mercator for the stakes in the two largest newspapers. Of course, these stakes were “parked” with the companies with close personal ties to the government.
And this was the time to grab the property and to ensure a long-term property. This was the period of global economic boom during the 2004 – 2007, Slovenia just joined the EU and money became extremely cheap. On the one side, firms started to invest in risky businesses, while managers – either politically sponsored or with the consent of the new government – started to take on loans for management buy-outs. On the other side, the managers belonging to the old elite got nervous of being replaced or deprived. To secure their privileges and property they engaged in a parallel process of privatization by buying out the state shares at high market values. Banks, most of them being either majority state owned or controlled by the state, assisted in supplying huge amounts of loans under extremely favorable conditions and by taking the overvalued acquired shares as a collateral. During the 2004 – 2007 period, Slovenian banks took on 10 billion of euros (30 % of GDP) of short-term loans abroad and lent it to the risky investors at home. Roughly one third of it was spent on acquisitions and management by-outs.
The plan, however, did not work out. When the crisis hit in, the firms and their new owners were left with big short-term debt that they were unable to refinance, while banks were left with worthless shares. Moreover, the highly indebted firms were extremely vulnerable and unable to respond to the suddenly dramatically decreased aggregate demand. Economy collapsed in 2009 with the GDP declined by 7.8 %. The rest of the story you can pick from the statistics.
So, where to go from here? I believe that bankruptcy and bail-out of the country is still avoidable. Slovenia needs to come up with a banking bail-out program that may cost up to 20 % of GDP. But can be done in a much cheaper and more efficient way by privatizing some of the troubled banks and leaving it to new owners to clean their balance sheets. It has to come up with a credible package of structural reforms to convince the financial markets to keep refinancing the budget deficit and for bailing out the banks. However, the major problem is that political parties keep being divided along the historical political divisions and are unlikely to reach a consensus on the reform package. And this makes me worry the most. It is not the state of the economy we are in, it is the state of the political class we have.
Though, by avoiding the bankruptcy the institutional system will most likely remain unaltered. This implies that Slovenia’s development will remain vulnerable in the long run. It will be left to the political elites to extract the rents whenever they get to grab the power. The key preconditions for a long-run stable development is to finish the privatization and to change the institutional system and the incentives. I don’t think our political class has a motive to do it. So the pressure has to come from abroad.
* Originally published in German in Die Presse.