Monday, February 16, 2009


Bloomberg has published an article about the recessionary expectations in Slovenia (link). The article outlined concerns over a potential cooling of export demand and a decline in aggregate investment that could trigger a consecutive output decline or the rise in the rate of unemployment. Earlier, Slovenian Statistical Office reported a 17,5 percent decline in industrial output, 5,5 percentage points more than in earlier quarter. The greatest fear facing the Slovenian economy is an exogenous recessionary shock which is basically a decline in export demand as the Euroarea economy turmoiled a recessionary output decline (link). Germany, which remains Slovenia's largest trade partner, has already encountered the fastest GDP shrink since the last recession in 2001.

Although 93 percent of economists believe that tariffs and import quotas reduce general economic welfare (link), ideas to propel protectionism to cure the current economic downturn have recently been proposed. Slovenia is a small and open economy. The gains from free trade with the EU27, European Economic Area and European Free Trade Area have been huge as well as benefits from membership in the European Monetary Union. Following the accession of EU in 2004, robust output expansion was encountered and quarterly output growth rates varied from 3,3 percent in Q3 (2005) to 7,6 percent in Q1 (2007) although some economists noted that the economy will encounter a significant rise in unemployment after the EU accession due to the loss of exchange rate. Tolar/euro exchange rate parity has been problematic mostly because the Bank of Slovenia propelled currency depreciation as an attempt to cure the export industry from a declining competitiveness in regional and global markets. As the basics of monetary economics teach, the main effect of a discretionary currency depreciation is an increase in the rate of inflation which follows the rise in aggregate demand in the absence of productivity shocks that could ease the inflationary impact of currency depreciation. Openness and international trade is one of the main engines of economic growth. It is empirically evident that countries with free trade experience higher economic growth and greater welfare respectively.

The reason for a particularly mild extent of recessionary impact in Slovenia is the fact that there has not been a high-mark decline in consumption expenditure which could deteriorate the stability of output growth. However, the fears of ongoing recession have been highlighted by Gorenje, one of Slovenia's major export companies, which reports a 25 percent slump in demand in Eastern Europe. The company immediately demanded government aid (link).

As every student of introductory macroeconomics can tell, recessions are unavoidable while government interference can only extend the length and pain of the recession as it during the Great Depression of 1930s together with president Hoover's infamous increase of top marginal tax rates and disastrous Smooth-Hawley tariff raise. This year's economic downturn will hopefully crunch the old belief that Slovenian economy is immune to recessions. As I wroted in earlier posts, Slovenia's main ongoing macroeconomic challenge is to sustain stability and set the course of pro-growth policies to pursue stable and sustainable economic growth in the long-term perspective as well as to tackle the issue of aging population caused by PAYG pension system. Probably one of the best possible cures for the recession are productivity shocks. These shocks, such as R&D and innovation, increase the potential output and ease the impact of a rise in aggregate demand on possible inflation during output expansion or recession similar to oil shocks of 1970s. In the last two consecutive periods, Slovenian economy faced deflation.

The Slovenian government recently endorsed subsidies for companies to retain employees and avoid the possible layoff scenario. As an economist I have serious doubts whether the decision to launch subsidies is based on cost-benefit analysis. What subsidies of this kind create is a deadweight loss and diminishing productivity due to the problem of adverse selection caused by collective bargaining and a strong political power of unions. As the history of macroeconomic and financial crises teaches us, follow-up recessions are unavoidable while any kind of distortions levied on the economic activity only prolong the recession and decrease growth prospects in the future. Real convergence, sustainable long-run growth and catching-up to EU15 income per capita is the medium-term objective which could deteriorate if rigid regulation and government spending in the share of GDP increased.

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