The result of the three decades of the transformation of Slovakia’s economy has been substantial catching-up with the developed West. In 2019, the income per capita in Slovakia in comparable prices reached 72% of EU-28 even surpassing Greece and nearing the level of Portugal. One particular calculation suggests that Slovakia’s nominal GDP in EUR terms increased about tenfold since the birth of the country in 1993.(1) Sectorally, the structure of the economic activity has reached the Western model and technologically we saw enormous progress (2). While the first decade post 1989 Revolution was characterized by basic economic reforms and thorny path to democracy, the second one was by the admission to the EU and, structurally, the enormous expansion of the automotive and electronics sectors. Unfortunately, the last decade saw a decline of FDI inflow, policy dormancy on certain fronts, and stagnation of the overall economic convergence.
At the start of another decade, the natural question arises: Which is the next big thing for the Slovak economy in the 2020s? Since a future vibrancy of the automotive and electronics sectors is at the question, what will be a future source of Slovak economy dynamism? In this blog, it is argued that domestically owned advanced exportable and quasi exportable services merit substantial policy focus as they could significantly help the growth of the Slovak economy. Things like IT services, advanced professional and consulting services, and high-end tourism are examples of such services. Other examples could include international trade companies, commercial fairs organizers, top-end marketing or interior design studios, or even as specializes services as tennis academies or local showbiz (popular in Czechia) – all with significant international activities. Since start-ups are an important source of the economy’s vibrancy, let us ponder – what are the advantages of advanced services start-ups vis-a-vis the ones in manufacturing?
First, the advanced services firms are easier to establish logistically – compare what it takes to construct and start running a production factory vis-a-vis to, say, establishing a consulting firm. No doubt, for most manufacturing projects the startup process is a very complex and demanding undertaking with substantial operational risks relative to advanced service sector startups.
Second, advanced sophisticated services usually feature very high added value produced per capita – higher than the value added created in most sectors of manufacturing. Hence, from the point of view of the nation-wide allocation of resources and the resulting recording of created value added in national accounting, it should be advantageous if resources flow to the sector of advanced services. This is also an environmentally friendly allocation of human resources.
Third, it can be argued that, in most cases, it is easier to reach the knowledge/technology frontier in case of advanced services than it is in the case of advanced manufacturing production. R&D in manufacturing is a complex, difficult, and costly undertaking and it is a question of how advanced Slovakia’s R&D base compares to the developed West. For illustration, just compare what is easier – to be on the knowledge frontier for creating, for instance, a corporate identity package by a Slovak marketing studio for a foreign client or to be on the technology frontier for producing a branded Swiss-like watch to export?
Fourth, clearly, most manufacturing start-ups require a lot more capital than start-ups in services do. Furthermore, a start-upper/entrepreneur in some manufacturing sector has much more to lose financially if his project fails. Hence many relatively risky projects might never be implemented in manufacturing while comparable start-up projects in the advanced services sector may still be undertaken. Ceteris paribus, this can lead to more entrepreneurial activity in a country where policy focus pushes resources to flow to a less capital intensive advanced services sector.
Last but not least, advanced services firms typically feature a much higher labor share on a produced value than does a typical manufacturing firm. With the AI revolution expected to dramatically drive the labor share down in the economy and thus magnifying distributional issues, the proliferation of advanced services firms can counter such trends.
Manufacturing and the automotive/engineering cluster within it have an enormous tradition in Slovakia. The sector has been a driver of economic growth to date in Slovakia and, no doubt, efforts should be made to develop the cluster further. However, the AI revolution and ensuing robotization will reduce the importance of labor costs advantage across sectors including in the automotive. For at least that reason, attempts to attract additional FDI in the sector might be an uphill battle in the future. Given that the manufacturing start-ups are not an easy undertaking in their own right, we should not forget that the development of a vibrant sector of advanced services represents probably an easier route to higher income per capita levels. A policy focus should not overlook that.
Vladimir Zlacky
LookingEast.eu
(1) Vladimir Zlacky, Slovak Economy: What next, Slovak Spectator, July 2020
(2) Vladimir Zlacky, Lubos Korsnak: A brief note on sector productivity in CEE 1995-2009,2012, UniCredit research note, published on LookingEast.eu