What went wrong in Slovenia and how to get out of the mess?

08  October 2012    5:00 pm

Joze P. Damijan, Institute for Economic Research, Ljubljana




The decline in Slovenia could hardly be more dramatic: From 7 % economic growth in 2007 to a 7.8 % decline in 2009 and 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. One can blame it on the stock and real estate prices that more than tripled in the booming years, whereby the bubbles were fuelled by 10 billion euro of short-term foreign debt channelled through the banking sector. The burst of these bubbles contributed to a vast amount of bad loans in the banking sector in the amount of 20 % of the GDP. One can also blame it on the previous government that managed the crisis miserably by increasing wages in the public sector by 10 % and a minimum wage by 25% just when the crisis hit in in 2009. Budget deficit surged and competitiveness fell enormously. The crisis government ended its three-year term in 2011 with fresh public debt in the amount of 20% of GDP without even tackling the problem of troubled banks or stimulating the economy. However, “greedy managers and irresponsible politicians” can explain only “how”, but not “why” Slovenia has fallen into a catastrophe. The fundamentals of the crisis-to-come were built into the system long ago. One has to stick to the institutional analysis to understand the roots of the crisis. The key is to understand how and why, in the framework of only partly changed old institutional system coupled with a flood of cheap money, the political change in 2004 triggered the disaster. Hence, an effective bank bail-out program and a credible package of structural reforms are crucial to resolve the current crisis. But “repairing” the institutional system is a key to secure a long-term stable development and to prevent similar systemic crises.