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Monday, October 22, 2007

Slovenia Is Different

by Edward Hugh: Barcelona

Well as the title of this post suggests, Slovenia - in the EU10 context - certainly is different. And it is different from its peers in a number of significant ways, some of which readers may find more surprising than others.

One of the most obvious ways in which Slovenia is different is to be found in the fact that Slovenia uses the euro. As is by now pretty well known, on January 1, 2007, Slovenia officially joined the Eurozone and adopted the euro as its new currency. At the same time, Slovenian euro coins, which had been available inside Slovenia as a "starter kit" from December 15, became legal tender across the whole Eurozone.

So much for stating the obvious. There is, however, another way in which Slovenia is - at least a little - different from the other EU 10 countries, and this difference is to be found in its demography. Slovenia is, in terms of its median population age, quite literally the oldest member of the EU10 group.

As can be seen, Slovenia's median age - which is now around 41 - has been rising quite rapidly in recent years, and as a consequence it has now the oldest member of the group, and is getting quite literally older by the day. As we will see below, this little detail is not exactly devoid of economic significance.

The principal reason why Slovenia is somewhat older than the rest of the EU 10 - and why it is ageing comparatively more rapidly - is the greater life expectancy that Slovenians enjoy. Below you can see male life expectancy at birth for all the EU10 countries. I have used male life expectancy here since the much higher male economic participation rates and levels of human capital formation among males in the over 50 group give male life expectancy a considerable importance, especially if your plan is - like that of the World Bank - to increase participation in the over 55 age group as a way of offsetting the impact of low fertility.

Of course this is not an "us against the rest" situation, and Slovenia is not alone in having rather longer life expectancy, the Czech Republic comes a close second, followed a little further back down the road by Poland and Slovakia. As we can see, even when we come to look at the male life expectancy at age 60 numbers, the Czech Republic and Slovenia stand out for being somewhat different from the rest of the group.

And there is another dimension on which the countries of EU 10 may be separated one from another. Immigration. Some of the group are net recipients of migrants, which others, as is by now pretty well known, have been large scale sources of outward migration.

What stands out here is the way some countries - in particular the Czech Republic, Hungary and Slovenia - have been receiving migrants while others have been losing them. And the data presented here (which is the official Eurostat data) substantially underestimates the losses in the out-migration countries). The data I present here for Romania is laughable, and by a large order of magnitude (as I explain here), and I haven't even bothered to present the data Bulgaria have submitted to Eurostat since it is an affront to our intelligence.

But the general lack of care and attention from which this data seems to suffer is an important deficiency for the countries concerned since it must convert the interest rate setting procedure for the central bank into a complete comedy. How exactly do you estimate the inflationary consequences of any given level of interest rates when you do not even know how to within a reasonable order of magnitude how many people you really have inside the country and available for work - your potential "capacity" that is. Still, since this issue - despite the recent increase in interest among central bankers in topics like inflation targeting and Taylor rules - seems to worry virtually noone, so we will not lose time unduly by taking the matter further here, except by noting that, of course, in Bulgaria, due to their hard-peg with the euro, they effectively have no autonomous interest rate setting ability anyway, and this could be one of the reasons why the authorities there seem to demonstrate so little interest in finding out how just many of their citizens are in fact working abroad. Evidently they are quite content to continue with the party, until of course it can go on no longer.

No Lynx, But A Solid Hare Perhaps?

As defined by Claus in this post, Slovenia is not really one of the lynx economies, given its more moderate sprint velocity, but growth has been steady and solid all the same.

This situation is not recent. Even though Slovenians comprised only about one-thirteenth of the total poulation of the ex-Yugoslavia, the republic was the most productive of those in the ex-Yugoslavia, accounting for one-fifth of its GDP and one-third of its exports. Thus on gaining independence in 1991, Slovenia already had relatively prosperous economy (in EU10 terms) and strong market ties to the West.

So even if, in recent years, Slovenia's growth has not been so spectacular as that of some of its peers, it has been steady and solid, and in this sense there is much less possibility of Slovenia finding itself in the grips of a "boom-bust" cycle.

Slovenia is in fact the most prosperous country in transition Europe and is well-poised to join the mainstream of modern developed economies. On many measures it has already advanced to the level of the other developed economies, and the expression emerging economy may already be something of a misnomer in the Slovenian case.

Slovenia als benefits from a well-educated and productive work force, and its political and economic institutions are vigorous and effective. Its per capita income is now 86% of the EU average, and although Slovenians have taken a cautious, deliberative approach to economic management and reform, with heavy emphasis on achieving consensus before proceeding, the overall record is undoubtedly one of success.

Despite the generally good productive record, there is some evidence that Slovenia has begun to lose competitiveness in recent years. If we look at the evolution of the Real Effective Exchange Rate, and make a comparison with Germany (where, of course, very large efficiency savings have been made there since the mid 1990s), we can see that while in the late 1990s and the early years of this century Slovenia steadily became more competitive, in recent years this steady process of improvement has been arrested and the situation has started to deteriorate.

And if we look at another measure of productivity - unit labour costs - we will see that the large improvements of yesteryear are now no longer being made (which is hardly surprising, since the more you close the gap, the more difficult it is to keep closing it). Nonetheless if Slovenia is the confront the challenges of the rapid ageing in the population which is about to occur, then this trend will need to be addressed and reversed.

Labour Shortages?

As has already been suggested, given the rather better initial position of Slovenia, and the rather more balanced pace of economic econvergence growth, Slovenia is at this point - and also helped by a steady instream of economic migrants - avoiding the worst excesses being produced by the growing labour scarcity phenomenon elsewhere. Unemployment is, nonetheless, coming down quite rapidly.

This decrease in umeployment is, naturally enough, in large part due to a steady increase in the numbers of those employed, or, if you prefer, to a successful policy of job creation.

But the end result, of course, is that the number of people available for work is declining steadily.

In part this is other face of the coin of slowing productivity growth accompanied by accelerating GDP growth, what you don't get out of efficiency improvement you have to get out of increased factor inputs, in this case of labour. And this situation isn't going to improve anytime soon, if we look at Slovenia's long term fertility performance.

As can be seen, Slovenia dropped below replacement fertility somewhat earlier than the other EU10 countries, probably around 1980. Alos the number of live births per annum peaked around the same time (ie with people who will now be nearly 30) at around 30,000 a year. By the mid 1990s this number was down to about 18,000, or under two thirds of the high point. This means that from now on the Slovenian labour market faces a diminishing number of potential entrants, and by a rather large percentage difference.

Wage Push?

If we now turn to wages, we can see that even though the levels of increase are in no way comparable to Baltic or Romanian ones, Slovenian wages are nevertheless rising steadily, and significantly beyond the level of productivity increase.

Similarly, if we come to look at inflation in Slovenia, we will find that it is not big beer at this point, but that, in line with the other indicators we have been looking at, it has started to tick upwards in a way which may indicate trouble to come down the line, especially if growth remains vigourous.

As could have been expected from looking at the real effective exchange rate data, the unit labour costs data, and the chart for wage and salary increases above, private consumption growth has been vigourous - though not exaggerated - in Slovenia in recent years, and has been a substantial driver of GDP growth.

Not unsurprisingly, this steady but slight attrition of Slovenia's competitiveness does find its expression, and it is in the trade balance, which has deteriorated, even if ever so slightly.

Slovenia, due in large measure to tourism, normally acheives a balance on services trade, which to some extent, but not completely serves to offset the significant deficit in goods. On the current account side the position is rather similar, that is it is midly preoccupying.

At the end of the day all of this needs some contextualising. Nothing we have seen above is dramatically worrying, not at all. But the slow and steady deterioration in some of the indicators needs to be set against the rapid ageing which is taking place in Slovenia. If Slovenia follows the profile of othermore elderly societies - Germany, Japan, Italy - then we can expect the private consumption element to steadily lose its capacity to drive GDP growth, and Slovenia will need to become more and more reliant on exports. But to be able to rely on exports for growth Slovenia will need to reverse the loss of competitivity trend, it will, to put matters starkly, need to become like Germany.

This situation becomes partricularly clear when we look at the chart for the 25 to 49 age group as a percentage of the total population.

As can be seen this group "peaked" as a part of the population in 2000.

The macroeconomics of why this age group is important, and why its peaking-out is a significant moment in economic terms is in fact rather straightforward. The moment of maximum 25-to-49 age group share could be thought of as the moment of maximum capacity and growth potential for any given economy. This is basically the case for two reasons. In the first place the 24 to 49 age group includes the crucial 25 to 49 household-former, first-time-homebuyer group. In terms of credit expansion, it is this group which drives a significant part of internal demand, since this is the group with the greatest propensity to borrow forward, and this is vital.

The 25 to 49 age group also includes another important group for economic analysis, the 35 to 50 one. It is this group which drives an economy in productive terms, since these are the prime age workers. If you think of a society as a 100 metres sprint athlete, then there is an age when this athlete is at the maximum of his or her running potential, an age after which, and with the passage of time, they can only run the 100 metres more and more slowly. Well a society is the same in terms of its collective economic potential, after the 25 to 49 age group peaks an economy can only move forward more slowly, and evidently, unless the situation is addressed via either increased fertility or greater immigration, the pace becomes progressively slower as the 25 to 49 age group declines inexorably as a % of the total population.

So, as I indicate above, Slovenia is at the crossroads. In some ways its most productive era is now coming to a close, and the hard part lies out in front: how to find the reources to pay for the pension and health systems which will be needed to sustain this ever more elderly population, and how to do it with an ever older, and ever smaller workforce. Is Slovenia to become more like Germany, or more like Italy. That is the question.