Comité économique et social européen – CESE

Commission consultative des mutations industrielles – CCMI

Economic and Social Council of Slovenia

Slovenia, Romania and the Czech Republic – Comparison of industrial transition models

N O T E S

INDUSTRIAL TRANSITION MODELS – AN ACADEMIC POINT OF VIEW

MR. JOZE MENCINGER – Economic transformation process in Slovenia

Professor at the University of Ljubljana, former deputy prime minister and minister for economic affairs in the Republic of Slovenia

BACKGROUND

Slovenia had a much better starting position at the beginning of the transition period, compared to other Eastern European countries.It did not have a hardcore communism. The borders opened as early as the 60s, central planning was already abolished in the 50s, companies were more or less independent. Slovenia was that part of Yugoslavia that specialized in exports to Western Europe. The main characteristic of this country is therefore its relative openness. However, 58 % of "foreign" trade was still done with Yugoslavia, and these trade relations ended abruptly.

The beginning of the 90s was determined by two transition factors: by economic transition on one side, and by the fight for independence/separation from Yugoslavia on the other side. It's hard to separate the effects of these two factors, they both account for the transition depression.

The main heritage of the old system was: the tradition of self-management within the companies, social property and survival of the old economic/political elite.

PRIVATISATION

-specific model of decentralized, distributional privatization,

-gradual transformation of social property;

The essential tool of industrial policy was privatization which was done in a decentralized manner (enabled also by the tradition of self-management), but at the same time it was also a distributional privatization. As a result of two-year long debates, the social property was subject of a gradual transformation. Privatization was done with the help of a so called privatization equation:

By November 1997 privatization was accomplished. According to Mr Mencinger, the privatization was done in the best possible manner, very well managed.

MACROECONOMIC STABILIZATION

-ignoring the Washingtonagreement with assumption S>D

-gradualism versus shock therapy,

-floatingexchange rate;

As for macroeconomic stabilization, Slovenia refused to apply the so called Washington consensus (agreed by the IMF, the World Bank and the US government as to how to manage the stabilization of Eastern European economies). This consensus was based on the assumption of the existence of a shortage economy, where supply equals to demand. But this was not the case in Slovenia: restrictions on the supply side were more important, so the Slovenian economy was a Say-type economy. In Mr Mencinger's view the Washington consensus increased the economic depression in Eastern European countries. Slovenia was against shock therapy. The country introduced the system of floating exchange rates immediately.

Concerning monetary policy, money creation was very smooth, substantial foreign exchange inflows were sterilized by issuing bonds (this is also an indicator of the gradualist approach of the economic policy). The Slovenian central bank played a crucial role in shaping the country's economic policy.

The development of some important economic indicators can be seen on the following chart:

MICROECONOMIC RESTRUCTURING

-gradualism versus shocktherapy,

-slow decentralized restructuring,

-retiring rather than firing,

-cautious approach to FDI

Restructuring of companies was essentially done (in addition to privatization) through "firing and retiring". Retiring employees was the socially more acceptable manner (especially in the case of surviving companies).

Restructuring was decentralized; it was basically the responsibility of the companies. In some rare cases, the government also helped with subsidies.

Restructuring was done without foreign direct investments (FDI). FDI is in theory beneficial, because:

  • FDI transfers technology and know-how;
  • FDI contributes to enterprise development and restructuring;
  • FDI contributes to international trade integration;
  • FDI bolsters competition;
  • FDI supports human capital formation.

In practice however, the following tendencies could/can be observed in Slovenia:

  • FDIs were acquisitions rather than greenfield investments, thus not investments in the macroeconomic sense;
  • FDIs concentrated on the finance, trade and communications sectors (so there was not much technology transfer);
  • FDIs increased imports more than exports;
  • FDIs increased specialization within a multinational, thus cutting links with the rest of the economy;
  • FDI brought strong monopolies(especially in the case of banks and retailers) forcing small emerging domestic firms out of business;
  • FDI creates addiction, income account deficit, and gap between GDP and GNP (for example, this gap is 80% in the case of Ireland, so there's a huge outflow).

The rate of return for foreign direct investors is around 10%, twice as high as in Western Europe. This makes it clear that it's better to keep these companies in Slovenian hands and try to manage it independently from foreign investors.

FDI in itself is not negative or positive; it always has to be examined case by case. But for example, banks in Western Europe are normally not in foreign hands, while banks in Eastern Europe were taken over through FDIs. Most FDIs in Slovenia are acquisitions, and in the long run this results in the outflow of the GDP (huge gap arises between the GDP and the GNP, outflow is > total current account balance). Slovenia is the only country where the banks have been retained in domestic hands. The profit of foreign direct investors in Eastern European banks is around 10%, so it's clear why Slovenia did not let their banks be taken over. Slovenia exports more capital than what flows into the country in the form of FDIs.

At the same time FDIs also played an important role in Slovenia, in the survival of certain regions – as was pointed out during the debate by Mr Mencinger's Slovenian colleague, Mr Samo Hribar Milic

In Mr Mencinger's view industrial policy is not necessary, restructuring, transformation should be managed in a decentralised manner, by managers.

Slovenia is a net contributor to the EU.(On the revenue side, Slovenia receives the highest amounts in the framework of the common agricultural policy, and only limited resources through social/cohesion funds.)

M. GHEORGHE ZAMAN – Economic transformation process in Romania

Professor (dean) at the Faculty of Financial Management and Accountancy, SpiruHaretUniversityBucharest

GENERAL ECONOMIC SITUATION

Transition in Romania was essentially shaped by the processes: transition toa market economy, preparation of EU-accession.

The transition is a complex, long-term process requiring a certain “gestation” (preparation) whichimplies the effective mixture between shock and gradual therapy approaches, excluding unilateralsolutions.

As for the economic transition in Romania, gradualist therapy was applied in the case of complicated economic/social structures; shock therapy was used in cases such as corruption or in cases where it promised to be effective.

But on the whole, the Romanian policy approach was gradualist.

One of the initial mistakes was that several politicians did not consider the industrial sector important for economic transformation, for creating market mechanisms. This was an error. Today even Germany realizes the importance of the industrial sector. The notions of deindustrialization and knowledge based society don't mean that the industrial sector should be neglected. These notions mean the modernization of industrial sectors. Industry, and even agricultural play a crucial role for the sustainability of a country's economy. The knowledge based society cannot entirely rely on the tertiary sector, the development of the industry is complementary to the development pf the knowledge based society. Relations, cooperation between universities and industrial sectors are very important. As Mr Fornea pointed out later on the example of the Romanian mining industry, it's very important that the government recognizes the significance of a certain industrial sector. If the government doesn't apply an appropriate administrative policy to keep the workforce in the mining industry, specialized know-how will be lost. And the policies should concentrate on technological investments and transfers, investments in human resources, and not on providing aid.

The industrial sector is an important engine of sustainable economicdevelopment inRomania, because it contributes to the following:

  • Productivity increase, enhanced skills and management capacity, improved production
  • Dynamic entrepreneurial business base
  • Value added products and services
  • Boosting the efficiency of RDI sector
  • Sustainable development and social inclusion
  • Effective public and private governance
  • Improving regional economies
  • Fostering competitiveness and quality of economy and human resources
  • “Post industrial development” or “deindustrialization”, knowledge-based society, information society – all these notions do not imply a diminishing role of the industrial sectorin quantitative and qualitative terms

Most industrial branches have been privatized in Romania, so the prerequisites for the functioning of a market economy are established. Now the most important thing is to create a favourable business environment and the appropriate legal and institutional framework.

Privatization was the main economy transformator. It was a very difficult, long lasting process.

GDP and the private sector developed in the following way in Romania:

The primary sources of the GDP increase were:

  • Foreign direct investments
  • Trade deficit
  • Substantial current account deficit (presently 14% of GDP)

The high current account deficit – which will most probably increase even more in the future – is a problem from the point of view of sustainability.

In the period 1999-2000, the economic policy is characterized by the following successes and failures:

Successes

  • Setting up of legal and institutionalframework of the transition to marketeconomy and privatization(privatization law no.58 (1991); acceleration of privatization (mass privatization) 1995; Europe Agreement of Association (1995); Approval of Strategy for preparing integration into EU; strategy for preparing EU accession 1995; FDI law; competition law; World Bank, IMF, EU, EBRDarrangements and programs)

Failures

  • Insufficient administrative capacity
  • Government on the basis of emergencyordinance with the power of law
  • Non effective technological and financialrestructuring of state owned enterprises (SOEs): for instance, subsidies were used to pay salaries and not for modernization of technology
  • Hesitant and slow pace of privatization ofSOEs
  • Subsidies for loss making SOEs
  • High inflation rates (three and two digits)
  • Legislative instability and low predictability(large number of new norms, frequentmodifications of laws)
  • Weak performance of judicial system
  • Unemployment increase (younger,women, and person over 45 years old)
  • Social polarization increase of personsliving under the poverty line

In the period 2000-2007, the economic policy is characterized by the following successes and failures:

Successes

  • Privatizing large SOEs with foreign strategicinvestors (chemistry, petrochemistry, oil, naturalgas machinery, metal industry, utilities, electricitydistribution, banking sector)
  • Sustained GDP growth for eight years
  • Relatively low rate of unemployment
  • Curbing inflation
  • Low budget deficit share in GDP
  • National plans and programmes agreed andarticulated with EU programs for 2007-2013(National Development Plan, National Strategy forRDI, Strategic National Reference Framework)
  • Higher education enrolment increase
  • Increase of women participation rate ineducation
  • Awareness concerning:– growth of jobs– adaptability of workers and companies– investment in human capital– employment and innovation pacts andpartnerships

Failures

  • Weak law enforcement, transparency andaccountability
  • Low economic competitiveness of industrialgoods and services (reduced competitivenessindex)
  • Unsatisfactory R&D scientific performance andlow demand of private sector for R&D activity
  • Brain drain
  • Labour migration abroad
  • Shortage of labour force on domestic labourmarket
  • Unemployment higher rate of for young peopleand persons over 45 years of age
  • Persisting corruption, bribery and incompliancewith the laws
  • Slow pace of social reforms (private pensionfunds, health care, education, special policies forpersons on risk)
  • Sharp dynamic increase of trade balance andcurrent account deficits, of public medium andlong term external debt

INDUSTRIAL RESTRUCTURING

There were four main periods:

Some industrial branches disappeared completely. These were normally uncompetitive, overstaffed companies.

One special problem is that branches with low R&D intensity grow faster than those that are highly R&D intensive.

The positive development in the IV period is also due to the effects of the structural funds of the EU. However, Romania needs to improve its absorbing capacities.

In Romania laws and regulations are in place to provide facilities to innovative SMEs, to promote their development. The key word here is innovative for lots of SMEs don't belong to the innovative category, only 5-6% of them can be called as such.

Industrial policy measures are really necessary for promoting innovation by SMEs.

A good example for industrial policies in Romania is the following. Upon privatization the new owner was often forced to maintain the number of employees and to keep the profile of the company unchanged.

FOREIGN DIRECT INVESTMENT

In the beginning foreign direct investments were NOT Greenfield investments, they were rather a factor of job reduction, especially at overstaffed SOEs.

Now the Greenfield investments are predominant, they provide for employment growth.

FDIs had overall a positive effect in Romania, due to the technology transfer.

Attractiveness (comparative advantages)

  • Low wages (285 euros average gross monthly salary), high profitability rate
  • Attractive market size
  • Location and EU membership
  • Substantial increase in the last 3 years about € 20 billion
  • 9.3% share of FDI in GDP by 2006 much higher than in the new member countries of EU.

Weaknesses

  • Poor accessibility to and from the rest of Europe
  • Poor quality of the country’s internal transportation and communication network
  • Perception of widespread corruption and difficult business environment
  • Multinationals in Romania do not generally sub-contract with local companies because of deficiencies of management, skills, quality of products and technology
  • Many multinational prefer to import most of their components using only in small proportions the national supplies
  • Bank do not provide sufficient business development support to their industrial client, their exposure to risk is very low
  • Hard access to capital, guarantees requires exceed the means of entrepreneurs
  • There are few other source of finance and shortage of early stage venture capital.

PROFESSOR MILAN ŽÁK, PHD – Economic transformation process in the Czech Republic

Rector of the University of Economics and Management in Prague

According to Professor Zak, there's only one truly successful industrial policy: privatization. The process of privatization is over in the Czech Republic, it happened in two major waves

The privatization program allowed various privatization techniques:

  • Tenders
  • Direct sales
  • Public auctions
  • Transfer to municipalities
  • Transformation into join-stock companies
  • Voucher privatization

The privatization was mainly done by vouchers. 90% of the economy is already privatized.

In the transformation process, the quality of institutions is crucial. Institutional quality can be measured in 3 ways:

  • Quality of governance
  • Condition for doing business
  • The degree of economic freedom

The quality of governance in the EU:

The conditions for doing businessinclude the following:

Dealing with licenses

Employing workers

Starting business

Registering property

Getting Credit

Protecting Investors

Paying Taxes

Trading across Borders

Enforcing Contracts

Closing a Business

Slovenia, Poland and Romania have the best/worst rankings in the following domains:

Best ranking:

CZ - Protecting Investors

RO - Protecting Investors

SLO - Paying Taxes

Worse ranking:

CZ - Trading across Borders

RO - Registering property

SLO - Registering property

The degree of economic freedom:

It is very important to study institutional quality as there is a clear positive correlation between the GDP and the quality of the institutional framework:

The institutional quality is also important in combating corruption, it's also important for the cooperation of politicians and pressure groups, and for the development of the civil society.

In the debate after Mr Zak's presentation, Mr Zboril added (upon the question of Mr Brewer) that life expectancy has risen by 10-12 years after the transition process, and now it's close to the EU average.

INDUSTRIAL TRANSITION MODELS – A PRACTICAL POINT OF VIEW

In the following we do not reproduce the entire presentations, as they deal with the chemical sector and they are supposed to demonstrate the policy context on the example of this specific sector. We only reproduce those parts that complement the presentations on the policy environment. For more information please consult directly the power point presentations.

MR. JOSEF ZBORIL – Restructuring in the chemical sector in the Czech Republic

Member of the European Economic and Social Committee's Consultative Commission on Industrial Change

The fast privatization process enabled the acquiring of management skills; it was an intensive learning process. FDIs are neither "saints" nor "evils". They always have to be examined on a case by case basis. In the CzechRepublic, mainly in the automobile sector, FDIs had a beneficial effect. But in general, for the whole of the economy, FDIs enabled outsourcing of policies (such maintenance of the employment level), they helped a lot the undercapitalized economy through fresh money shots, they brought know-how, human resource management, managerial skills).

Mr Zboril also added that in the Czech Republic no industrial policy was pursued, the privatization itself was the restructuring process. A few investors were only interested in buying and selling, which was not beneficial for the companies in question. A dedicated, strategic investor is always better.

According to Mr Zaman, FDIs have to be viewed in the context of globalization. Just like the globalization, FDIs are an objective tendency.

MR. SAMO HRIBAR MILIČ – Restructuring in the Slovenian industrial sectors

General Manager of the Chamber of Commerce and Industry of Slovenia

Slovenia is the perfect example of a win-win situation. Privatization was gradual; it has been the slowest among new EU members. The role of social dialogue was extremely strong, all changes happened as a result of consensus of the social partners; several collective agreements were signed during the process.