What can eastern European countries learn from the Slovak economy? A twin deficit growth approach

Abstract

This paper applies an extended growth model to the Slovak economy and explains the potential pitfalls that a transition economy faces on the way to converging with other advanced European countries. Our empirical analysis shows that Slovakia grew at a higher rate than that allowed by the balance-of-payments equilibrium rate and that this is consistent with the accumulation of trade deficits over time. A scenarios analysis shows that improving trade competitiveness, changing import and export shares toward a current account balance, and financing the economy at a lower cost will be the most successful ways to achieve higher growth.

Keywords:

• internal and external imbalances
• price and income elasticities of trade
• equilibrium growth rates
• 3SLS system regressions
• supply constraints

JEL Classifications:

• C32
• E12
• H6
• O4

Notes

1. For recent applications of Thirlwall’s Law, see Soukiazis and Antunes (2012) regarding Portugal and Soukiazis, Muchova, and Lisy (2013) regarding the Slovak Republic.

2. Financing the current account with capital inflows is not a sustainable solution in the long-run and does not have the same dynamic effects on growth as the export-led policy.

3. For a detailed discussion on the history and new developments of this Law, see Soukiazis and Cerqueira (2012).

4. The original Thirlwall’s Law assumes that relative prices remain constant in long-term analysis, but this assumption is debatable, used in some studies for the sake of simplification. Many studies have shown that relative prices are important for international trade and explain a substantial part of economic growth. As an example, Garcimartín, Rivas, and Martínez (2010–11) attributed the slowdown of economic growth in Portugal to the adoption of a strong currency (loss of price competitiveness) when this country joined the euro zone.

5. The time index t is not attached to the variables for the sake of simplification. Appendix 1 provides full information on the variables used in the system and the data source.

6. Exchange rate is defined as the domestic price of foreign currency. Therefore, an increase in e indicates depreciation of the domestic currency.

7. For more details on the original specification of the investment function see Goodwin (1951) and Chenery (1952).

8. Public debt is originated by issuing government bonds to finance budget deficit.

9. In order to avoid replications we do not present the full development of the extended model. More details for the derivations can be found in Soukiazis, Cerqueira, and Antunes (2012) (see Appendix 1, Equation A.5).

10. It was not possible to use a longer period due to lack of data, given that official series for Slovakia begin in 1993 (the year of the division of the former Czechoslovakia into the Czech Republic and the Slovak Republic). Therefore, the robustness of the estimation results must be interpreted with caution.

11. To compute Thirlwall’s Law given by , it is necessary to estimate the import demand function by 2SLS to obtain the aggregate income elasticity of the demand for imports, π = 2.598. The growth rates of consumption, investment, exports, and relative prices are used as instruments for , which is treated as endogenous in the import equation. The average growth rate of exports is 8.545 for the whole 1996–2015 period considered.