Might Slovenia or Slovakia be the Next Cyprus?

Two Cypriots: "Have you withdrawn your money from your bank?" "Why panic? Tommorrow is another crisis day..."


Now that Cyprus has joined the PIIGS countries as the latest victim of the euro crisis, many people are asking whether Slovenia or Slovakia could be the next? Another way of formulating the question: if it is true that Greece and Cyprus went under not so much due to their own fault, but because of the low interest rates of the eurozone, why did this not happen to the Eastern European euro members? Or did it?


Well, in the case of Slovenia, it did. The tollar was fixed at a low inflation rate in the ERM antechamber of the euro right after the 2004 accession of the country. Centralised wage negotiations, previously characteristic of Slovenia, were abolished in 2006, and the wage repression of the preaccesson period turned to its opposite. Increasing inflation and low nomina euro interest rates lead to low, sometimes negative real interest rates. This lead to an artifical boom much like in the case of Greece or IReland. The current account deficit was not counterbalanced by foreign direct investment (FDI), since Slovenia is not an FDI based economy, like the former Soviet Bloc, but a German/Austrian type Rheinland Model economy, privatised to domestic owners, still holding on to considerable state ownership. A successful corporative economy. As I have elaborated elsewhere, it is the only former Socialist country that has absolved transition successfully.

The situation in Estonia was similar. They introduced the euro years later, but having operated a currency board, the fixed euro echange rate essentially imported all the problems of the Eurozone. Real interest rates turned negative, a bubble was formed, followed by horrible collapse.

Interestingly enough it was only Slovakia that managed to sail the stormy eurozone waters without collapse. But why and how? Partly because Slovakia introduced the euro relatively late, and her autonomous monetary policy gave her room to manouver. When they finaly did introduce it, Slovak wages were kept at an astonishingly low level. Of all the countries in the EU, Slovakia has the wages that are the furthest away from what productivity would warrant. In fact they could have double the wages they actually do. To put it crudely: Slovakia managed to avoid the negative side effects of the Eurozone by staying poor. They avoided inflation, thereby low real interest rates and the bubble. In addition, they joined the euro in the midde of the global downturn, with relatively high unemployment rates, and therefore there was no pressure on wages to rise.

They deserve a wage rise badly. HOwever, they will need to deliver it gradually if the want to avoid being the last one to fall.