A Standard Computable General Equilibrium (CGE) Model of the Slovak Republic

Transcription

1 A Standard Computable General Equilibrium (CGE) Model of the Slovak Republi Stati and Dynami Appliations of EU Enlargement Poliies Karol Koronzi Researh Projet for Asian Industrialization Shool of Eonomis Nagoya University

2 Title: A Standard Computable General Equilibrium (CGE) Model of the Slovak Republi - Stati and Dynami Appliations of EU Enlargement Poliies Asian Industrialization Series, Volume V Name of Author: Karol Koronzi Editor: Johzen Takeuhi Publisher: Researh Projet for Asian Industrialization Nagoya University Furo-ho, Nagoya, Japan Tel/Fax: Date of Publiation: Marh 3rd, 2005 Copyright: Karol Koronzi Printed by Nippon Hi-Speed Print Co., Ltd.

3 Contents Contents... i Abstrat...iii 1. Introdution Review of related literature General literature on CGE Review of CGE models applied to various ountries EU integration of the Slovak Republi CGE models applied to the Slovak eonomy Eonomi impats of integration Model data estimation Construting the SAM from base data Desription of SAM aounts Adjusting the SAM to fit the model Additional data on employment and stoks of fixed assets Model desription Model struture Model equations System onstraints and model losures Eonomi poliy simulations Simulation harateristis Evaluation of results Trade liberalization Tax reform Foreign apital inflow Indiret poliy simulations and ombined simulations Overall assessment, onlusions and poliy impliations Referenes Appendix 1: Standard Dynami CGE Model of the Slovak Republi - System of Equations i

4 Appendix 2: Model output - seleted indiators of the 6-setor version Table A2-1: Seleted indiators of Short-term simulations (stati shok, 2000), 6-setor version, 100*mill. SKK Table A2-2: Seleted indiators of Short-term simulations (stati shok, 2000), 6-setor version, %-age hanges Table A2-3: Re-onstruted SAMs after Short-term simulations (stati shok, 2000), 6-setor version, %-age hanges Table A2-4: Seleted indiators of Long-term simulations (year 2010), 6-setor version, 100*mill. SKK Table A2-5: Seleted indiators of Long-term simulations (year 2010), 6-setor version, %-age hanges Table A2-6: Re-onstruted SAMs after Long-term simulations (year 2010), 6-setor version, %-age hanges Appendix 3: Model output - seleted indiators of the 57-setor version Table A3-1: Seleted indiators of Short-term simulations (stati shok, 2000), 57-setor version, 100*mill. SKK Table A3-2: Seleted indiators of Long-term simulations (year 2010), 57-setor version, 100*mill. SKK ii

5 Abstrat The objetive of this paper is to make an impat analysis by identifying the positive and negative impats of Slovak Republi's EU integration. Speifially, this researh is aimed to diretly evaluate the impats of EU aession based on a Standard Computable General Equilibrium Model, in the short- and long- run, and to onfirm (or rejet) a general opinion that integration should bring positive effets to the eonomy. Abolition of tariffs and nontariff barriers, tax reform, support of FDI inflow, and exhange rate are the main poliies under onsideration. By developing a standard CGE model appliable to the speifi onditions and struture of Slovak Republi's eonomy, this paper identifies problems and based on the outomes tries to make suggestions for poliy measures. The researh presented in this paper is new in several aspets. The main soure of data is a 2000 Soial Aounting Matrix, supplemented by Input-output and other data that is most reent and very detailed (57 by 57 industrial setors). Data is at the same time onstruted in a format ompatible with the System of National Aounts 1993 and the European System of Aounts The CGE model in this researh has been designed to make it possible to analyze any setor, or the whole eonomy. It is based on a Standard CGE model used by the World Bank, and allows to arry out stati and dynami simulations. Range for dynami simulations is for period of 11 years with year 2000 as benhmark. Model funtions are either of CES or CET type. Another strong feature of the model implemented in this researh is that foreign world is disaggregated, too. Speifially, this model implements three regions - domesti market of the Slovak eonomy, the 24 remaining states of the urrent EU, and rest of the world. iii

6 A Standard Computable General Equilibrium (CGE) Model of the Slovak Republi Stati and Dynami Appliations of EU Enlargement Poliies

7 To dad Aknowledgement: This researh paper ould not have been ompleted without the finanial support of the Ministry of Eduation, Culture, Sports and Tehnology (MEXT), and the Japan Soiety for the Promotion of Siene (JSPS), and without professor Johzen Takeuhi, Ph.D. of Graduate Shool of Eonomis, Nagoya University, who kindly offered help with its publishing. I would also like to express my deep gratitude for valuable omments to professor Mitsuo Ezaki, Ph.D. of Graduate Shool of International Development, Nagoya University, without the help of whom it would have never been possible to arry out this researh. Last, but not at least I would like to thank my mother and father for their onstant, espeially moral support during my studies in the field. 2

8 1. Introdution Slovak Republi has suessfully joined the European Union (EU) 1 on May 1st, 2004, reating a unique hane to overome its soial and eonomi lag with developed ountries 2. The integration itself is a multidimensional proess inluding omplex politial, eonomi, and soial fators, and invites a wide partiipation of the soiety, beginning with the government and its integration ativities, soial institutions, organizations, employee and employer assoiations, private businesses, up to individuals. And even if this proess in its early stage gives only a potential hane for development, it has no omparable alternative in the age of world globalization. Experiene of foreign ountries shows that in order to partiipate effiiently in building a new, enlarged EU, the Slovak Republi urgently needs to reate a mehanism that would allow to proess systematially analyses of poliy impats, programs, plans, and onepts. Unfortunately, suh a system is at the moment very disperse or in most areas ompletely absent. The main objetive of this paper is to make an impat analysis by identifying the positive and negative impats of Slovak Republi's EU integration. Speifially, our researh is aimed to diretly evaluate the impats of EU aession based on a Standard Computable General Equilibrium (CGE) Model, in the short- and long- run, and to onfirm (or rejet) a general opinion that integration should bring positive effets to the eonomy. Several works have been published about Slovak Republi's integration proess and its eonomi impats. However, most of the single-ountry analyses are based on qualitative or managerial methods, and there is a lak of quantitative analysis. Other works aomplished mainly in foreign institutions also inlude quantitative and/or CGE approah, however the Slovak Republi appears as part or a greater integration (e.g. the Central European region), or is negleted beause of data shortage. By developing a standard CGE model appliable to the speifi 1 EU was established on February 7th, 1992 by the signing of the Treaty on European Union in Maastriht, by a group of European ountries that have hosen to integrate many of their eonomi ativities, inluding forming a ustoms union and harmonizing many of their rules and regulations; it was preeded by European Eonomi Community (EEC) and European Community (EC). 2 Treaty of Nie, signed on February 14th, 2001, has the key importane for the Slovak Republi in the integration proess. By this already the fifth EU enlargement, Slovak Republi was offiially invited to join the union, after the treaty ratifiation by all 15 present member ountries, whih lasted for about two years (preisely, it beame to fore on February 1st, 2003). The atual enlargement took plae on May 1st, 2004, reating a new EU with 25 member ountries. 3

9 onditions and struture of Slovak Republi's eonomy, our paper identifies problems and based on the outomes tries to make suggestions for poliy measures. The researh presented in this paper is new in several aspets. The main soure of data is a 2000 Soial Aounting Matrix (SAM), supplemented by Input-output (I-O) and other data that are most reent (benhmark year 2000) and very detailed (57 by 57 industrial setors), and the data is ompatible with the System of National Aounts (SNA) 1993 and the European System of Aounts (ESA) The CGE model in this researh has been designed to make it possible to analyze any setor, or the whole eonomy. The CGE developed in our researh is based on a Standard CGE model used by the World Bank, and allows to arry out stati and dynami simulations. Range for dynami simulations is for period of 11 years with year 2000 as benhmark. The various kinds of funtions implemented are either of CES (Constant Elastiity of Substitution), or CET (Constant Elastiity of Transformation) type. Another strong feature of the model implemented in this researh is that foreign world is disaggregated, too. Speifially, this model implements three regions - domesti market of the Slovak eonomy, the 24 remaining states of the EU, and rest of the world. However, the model has not been designed as a typial "link" model where eah region has its own eonomy and is linked by an external element. This model is still a oneountry based model extended by disaggregated foreign world. This onept is further explained in the setion disussing soures of data. Depending on availability of data, it is possible further to disaggregate households (e.g. urban and rural) for inome distribution analysis, to disaggregate prodution fators (into e.g. skilled and unskilled labor, land, et.), to implement a range of various taxes (value added taxes, exise taxes, taxes on fators, import and export taxes, onsumption taxes, et.). In order to evaluate the impats of Slovak Republi's EU integration, modeled by related variables the following poliy simulations are arried out: 1. Trade liberalization and joining the ommon EU market - import tariffs (on goods) and non-tariff barriers (on goods and servies) from the other 24 EU ountries are abolished, and tariff rates applied to third ountries are adjusted to omply with EU's ommon external tariff sale; 2. Tax reform - poliy impats due to hanges in personal inome tax, value added tax (VAT) 3, sales tax, and orporate inome tax are simulated; 3 whih are onsidered as sales tax (or taxes on ommodities) aording to the system of Slovak National Aounts. 4

10 3. Foreign diret investment (FDI) inflow - hanges in investment due to the ommon EU market, Slovak open investment regime, and reforms in the publi administration imply inrease in inflow of foreign investment. Along with all the above "diret" poliies, a series of: 1) free movement of apital and persons within the EU, 2) inrease of nominal investment, and 3) real appreiation of the Slovak Crown (SKK) is inluded in the dynami simulations. The struture of this artile is as follows: Setion 2 overs review of literature related to the Slovak Republi and CGE modeling. In setion 3, a brief overview of the Slovak eonomy during the transition period desribed by general maroeonomi indiators, and eonomi impats of European integration proess is given. Disussion on data utilized for building the model, its onstrution and soures is in setion 4. Setion 5 explains the CGE model and its struture, inorporating an I-O and SAM approah. Setion 6 provides the eonomi analysis itself. Fousing on quantifiable measures, suh as tariffs, taxes, and investment, this setion evaluates the possible impats of European integration to the eonomy of the Slovak Republi, for the period from 2000 as benhmark year until An analysis of various eonomi poliy impats is provided, by setting up different patterns of strategies of maroeonomi development. GAMS ompiler is applied for model implementation. In setion 7, onlusions are drawn on the obtained results and suggestions for further poliy impliations made. 5

11 2. Review of related literature Before going on to the harateristis and results of the model developed in our researh, it is neessary to review works that have been done by other authors, although the range of works onduted on the Slovak eonomy by either CGE approah or other quantitative methods is generally very poor. We have reviewed four types of publiations before onduting this researh. 2.1 General literature on CGE First, general literature on CGE modeling, whih is very wide and reates the main soure of literature used for this researh. Wider appliation of this eonomi field to eonomi poliy started after the publishing of theoretial works of Arrow and Debreu in the 1950s. They expanded a ompetitive market equilibrium problem, whih was first formulated by Leon Walras (1874). It is a problem a lot more omplex than a partial analysis of individual markets, beause supply and demand at one market depend on both pries at own and pries at other markets. In this problem, every one in a population of n players has an initial endowment of a divisible good and a utility funtion for onsuming all goods - own and others. In the theoretial problem, every player sells the whole initial endowment and then uses the revenue to buy a bundle of goods suh that his utility funtion is maximized. Walras asked whether pries ould be set for everyone's good suh that this is possible. An answer was given by Arrow and Debreu (1954) who showed that suh equilibrium would exist under ertain onditions. They, however, did not give any algorithm to find suh equilibrium pries. Irving Fisher (1907, 1911, 1930) first ame with the idea to onsider algorithm to ompute equilibrium pries. He defined a model where players are divided into two ategories - produer and onsumer. Consumers have money to buy good and maximize their individual utility funtions; produers sell their goods for money. The equilibrium pries is an assignment of pries to goods so as when every onsumer buys an maximal bundle of goods then the market lears, meaning that all the money is spent and all goods are sold. At the age when there were no omputers, Fisher in 1891 onstruted a hydrauli apparatus, a mahine for alulating equilibrium pries and the resulting distribution of soiety's endowments among the agents in the eonomy. He presented a fully artiulated general equilibrium model 6

12 with broad sope and mathematial larity that is generally assoiated with Walras. However, as he says, his work has been onduted independently, without any knowledge of Walras' ahievement 4. Fisher's work has been explored in several onsequential works. In 1930s, the age when elementary omputers started to develop, Wassily Leontief turned his hand to a simplified version of Fisher's omputation. His ontribution is in developing the input-output method and for its appliation to important eonomi problems 5. Constrution of the first I-O tables for the United States for the years 1919 and 1929, whih were published in 1936 (UN 1999, p. 3), and further researh in the field lead him to be honored with a Nobel Prize in Eonomi Siene in There are several authors that ontributed to the tehnial part or solving a system of equations. Megiddo (1989), and majority of other authors utilize methods of linear programming for the system solution. Eisenberg and Gale (1959) give a onvex optimization setting to formulate Fisher's model. A reent work by Devanur et al. (2002) develops a ombinatorial algorithm for solving Fisher's model. Jain (2003) shows that Walras's model an be also formulated as a onvex optimization. Appliation of CGE models to development poliy has started by the work of Dervis, de Melo, and Robinson (1982). It is a World Bank study, and the researh presented in our paper also refers to the study as one of the main resoures. It is generally onsidered as the basi, or standard general equilibrium approah for development poliy in the world. The authors build on the work of Leontief (1986), Chenery (1954), or Arrow, Chenery, et. al. (1961), and they suggest a general equilibrium model supporting the formulation and ondut of eonomi poliy in developing ountries. Before going to the CGE, They disuss linear input-output models and their stati and dynami dimensions, going through linear programming models, models examining growth and strutural hange. A lose look is given to a CGE for a losed eonomy, whih is later extended by trade poliy and resoure alloation element. Speifi ountry appliation for Turkey is given. The authors also give very detailed methodologial notes of their approah. Work of Sadoulet, and de Janvry (1995) gives a omplex view on maroeonomi modeling applied to development poliy, starting with basi definitions of elements, solving partial equilibrium problems, and ending up in a omplex CGE model. Several other works on CGE have been published sine While Klein, Welfe, and Welfe (1999) disuss the priniples of maroeonomi modeling in general, Dinwiddi, and Teal (1988) give a simple and very detailed example of a two-setor general equilibrium model. De Melo (1988) makes trade poliy appliations on CGE. 4 for details, see Brainard and Sarf (2000). 5 for details, see e.g. Leontief (1986). 7

13 Multisetoral models are disussed by Robinson (1989), and by Robinson, Yúnez-Naude, Hinojosa-Ojeda, Lewis, and Devarajan (1999). General appliation of maroeonomi modeling is presented by Shoven, and Whalley (1992). Haque, Lahiri, and Montiel (1990) disuss basis of eonometri modeling, an area very losely related to CGE modeling. Devarajan, Lewis, and Robinson (1994) give a very lear overview of maroeonomi modeling and CGE, and give the general model a modern touh extending it by progressive funtional forms, speify the relations between model elements, and also provide methodology for model solution. A very reent work at the International Food Poliy Researh Institute (IFPRI) by Löfgren, Harris, and Robinson (2002) gives a detailed presentation of a one-ountry based, stati, standard CGE model. The work desribes in detail the system of equations, appliation and solution of the model by omputer, and also disusses the required database. This paper is one of the main resoures our work refers to. Our work extends the presented standard model by a multi-ountry, or multi-region formulation, and by developing a dynami dimension to the model. Variety of works on CGE by Slovak authors is very poor. As an example, a work of Chajdiak, and Ištvániková (2001) may be given, although only simple approahes suh as regression or eonometri analyses are disussed, and the work does not go into explanation of detailed equilibrium models. Works dealing with partial equilibrium are written by Kvetan (2000) on employment, wage, prie, and labor produtivity; Kvetan (2001) provides analysis on inflation. There are, of ourse, several other tehnial papers analyzing development issues by utilizing methodology related to CGE. Bulmer-Thomas (1982) suggests input-output for development analysis; West (1995) ompares with input-output with CGE models at a regional level; Dealuwé, and Martens (1998) provides an empirial analysis of developing eonomies by CGE Modeling; and Gunning, and Keyser (1993) utilize Applied General Equilibrium models for poliy analysis. Next, data neessary for the model, and its estimation is reviewed. Basially, data in a form of an I-O table, or SAM make the ore for CGE models, although the latter one is often utilized reently. Pyatt, and Round (1985) assemble works of various authors on SAM, presented at a World Bank onferene in Tehniques of SAM estimation are developed in the works of Robinson, and El-Said (1997, 2000), Robinson, Cattaneo, and El-Said (2000), et. Works on data estimation required for CGE analysis, speifi to the Slovak Republi are done by Cvengroš (1992) disussing methodology, and by Koronzi (2003, 2004a) on I-O tables, and by Koronzi (2004) on SAM providing the atual data. The I-O and of SAM 8

14 framework is followed by System of National Aounts developed by the international soiety, and is published in UN (1968, 1993), Eurostat (1996), and OECD (2000). Nowadays, progressive programming pakages suh as the GAMS, GTAP, GEMPACK, et. are used on powerful omputers and relative extensive models an be solved within minutes. An earlier, general work on omputer appliations is in Otto, and Johnson (1993). Theoretial review and disussion of eonomi links on CGE modeling in GAMS is given in GAMS (1998). The tehnial side of CGE modeling in GAMS is disussed by Brooke, et. al. (1998), and a very detailed speifiation is given by MCarl (2003). Besides the standard World Bank models or models developed by the International Monetary Fund there are several other types of general equilibrium models utilized throughout the world - OECD model, ORANI model (Australia), IMAGE model (Ireland), MSG model (Norway), or MIRAGE model (Frane) presented by Bhir, et. al. (2002). GTAP is an alternative model to CGE, is disussed by Hertel (1997). 2.2 Review of CGE models applied to various ountries The seond group of works on ountry- or region-speifi CGE models for ountries other than Slovak Republi is not diretly referened in this paper. However several ideas for building a new model for the Slovak Republi and a "lue" for starting it off are taken from these works. There is number of CGE models applied to strutural analysis of China, by Ezaki, and Itakura (1996), Xu (1996), Ezaki, and Lin (2000). Ezaki, and Son (1997) build a dynami CGE model for Vietnam. Various modifiations of a World Bank type CGE model are applied to developing ountries suh as Cameroon by Condon, Dahl, and Deverajan (1986); to Guatemala by Yúnez-Naude, Paredes (1999); to Honduras by Lizardo, Navarro, and Suazo (1999); or to the Dominian Republi by Aristy-Esuder (1999). Haan (1995) built a model for Hungary. Majority of these works is applied to strutural analysis. Ye (2004) disusses the way to the Arrow-Debreu equilibrium in detail. 9

15 2.3 EU integration of the Slovak Republi The third group of reviewed literature is general works published on Slovak Republi's EU integration. Majority of these works is onduted by methods of qualitative analysis, or by desriptive methods. Several analytial and prognosti works are published by international organizations. The World Bank in its series of ountry studies has a publiation on Slovak Republi's EU integration in its early stage, onentrating mostly espeially on issues related to growth (World Bank, 1998). Series of OECD eonomi surveys (OECD, 1991, 1994, 1996, 1999, 2002) follow the development of the Slovak eonomy in length, not only from the point of view of EU integration, but in general. The IMF also publishes oasional works: see Prust (1990), and Aghevli, Borensztein, and van der Willigen (1992). Trade poliy and the proess of its liberalization is reviewed by WTO (1995, 1996). Similar works on general eonomi development are also published by the National Bank of Slovakia (NBS, 1997 through 2004) disussing mainly monetary issues, and also by the Slovak government, that are unfortunately quite sattered. Analyses made by international organizations dealing espeially with European integration are made by the EU itself, in its regular strategy papers, and the assessment reports on preparedness for EU membership (see e.g. EU 1999, 2002, 2003a, 2003b). The strategy papers are quite lengthy and give suggestions for strategy of aession on a yearly basis. The assessment reports monitor the implementation of the Aquis 6. There are works dealing espeially with data by Eurostat (2003). The two douments published every year sine 1995 by the European Communities are (or were) to monitor the level of preparation for aession, and to suggest future strategies. These are 1) The regular report on Slovakia s progress towards aession, by the Commission of the European Communities, and 2) Strategy Paper and Report of the European Commission on the progress towards aession by eah of the andidate ountries. As year 2003 was the last 6 Aquis Communitaire, or Community Aquis, in full. It is the body of ommon rights and obligations, whih bind all the Member States together within the European Union. The Community Aquis omprises not only Community law in the strit sense, but also all ats adopted under the seond and third pillars of the European Union and the ommon objetives laid down in the Treaties (and also delarations and resolutions made by EU, issues regarding ommon foreign and seurity poliy, measures relating to justie and home affairs, international agreements made by the Community or EU states between themselves, setoral poliies, eonomi and fisal affairs, regional poliy, environment, external poliies, and finanial questions). Appliant ountries must aept the Community Aquis before they join the Union. Exeptions from the Aquis are granted only in exeptional irumstanes and are limited in sope. The members of the EU ooperate in three distint areas, often alled pillars. At the heart of this system is the European Community (EC) pillar with its supranational funtions and its governing institutions. The EC pillar is supported by two pillars based on intergovernmental ooperation: Common Foreign and Seurity Poliy (CFSP) and Justie and Home Affairs (JHA). These two pillars are a result of the Maastriht agreement to develop loser ooperation in these areas. 10

16 year suh doument was published before the aession, doument 1) is alled Comprehensive monitoring report of the European Commission on the state of preparedness for EU membership of the Czeh Republi, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Poland, Slovenia and Slovakia, and a speial one related to Slovakia only Comprehensive monitoring report on Slovakia s preparations for membership. There are no douments mentioned in point 2) published anymore. As a onlusion of the Commission in 2002, the Slovak Republi is a funtioning market eonomy (EU 2002, p. 127). The aession negotiations with Slovakia were suessfully onluded on Deember 13th, 2002, and the Treaty of Aession was signed on April 16th, 2003 (EU 2003b, p. 3). In a referendum held on May 16th and 17th, 2003, a majority of Slovaks expressed their support for membership of the European Union. Following ratifiation of the Treaty of Aession, Slovakia will join the EU on May 1st, A number of authors deal with EU enlargement, and its onsequenes either to the whole region, or speifi impats to the Slovak eonomy. Let's mention the works only of some. Impats of enlargement to the whole EU are being analyzed by Lejour, et. al. (2001), Breuss (2001), Brenton (2002), or by Banse (2003). Analyses of impats to eonomies of the new EU members (inluding Slovak Republi) are reviewed by Franois, and Rombout (2001) dealing trade poliy issues, Cohrane, and Seeley (2003) with agriultural problems, and Jensen, and Frandsen (2003) identifying overall impats. There are also several authors, mainly of Slovak nationality, dealing with enlargement issues speifi to the Slovak eonomy, e.g. Henning (1998), Marinšin, and Belavý (2000), Marinšin (2002), Bilčík, and Bunko (2001), Outrata (2002), Sirák, and Vagač (2003) or Alner (2003). Bruháčová, Hajnovič, Komínková, and Neme (2003) identify the integration onditions of Slovakia to the European Monetary Union. Complex, institution-based reports on the Slovak national level are arried out mostly by the Slovak Aademy of Sienes. Eonomi and soial onsequenes of the Slovak EU integration are summarized in SAV (2003), and in Šikula (2002). These douments are rather extensive, and our work refers to their findings espeially in the setion of this paper evaluating results and omparing outomes. Another work, onluded by the Conservative Institute of Milan Rastislav Štefánik (CIMRS, 2002) ompares the profits and osts, and opportunities and threats of EU integration, and potential impats to the Slovak eonomy. The governmental Institute of Statistis makes a tehnial, medium term prognosis on development of the Slovak eonomy from 2000 to 2005 (INFOSTAT, 2000). There are works of other authors, suh as Šíbl (1998) approahing the EU integration from an 11

17 institutional point of view, and works of Nováčková, et. al. (2000), and Kunová and Nováčková (2000) disussing legal issues. 2.4 CGE models applied to the Slovak eonomy The fourth group relates to ountry- or region-speifi works based on CGE approah related to Slovak Republi. While there are several works ranging from CGE models on individual entral European ountries, link models of entral European ountries, link models of EU ountries, up to World link models, majority of these either absolutely neglet, or, in the better ase inlude Slovak Republi in a wider aggregated region (e.g. Czehoslovakia, Central and Eastern European region, et.). The reason for this is most probably lak of onsistent data from offiial soures, and the relative insignifiane of Slovak Republi's eonomy within the region in omparison to the ost of data olletion. Let us mention some authors dealing with CGE modeling applied to this region. Petersen (1997) introdues a simple CGE with appliations to Eastern European ountries, Banse (1999) investigates the impats of EU aession in Central Europe. There are other CGErelated analyses arried out by Cohen (1999, 2000/2001) on Poland and Hungary; by Iwasaki, and Sato (2004) on Hungary; by Barry, Bradley, Kejak, and Vavra (2000) on the Czeh Republi; by Janovskij, and Rojíček (2004) on the Czeh Republi; by Stavrev (2000) on Czeh Republi and Hungary; Dziegielewska (2000) on Czeh Republi, Hungary, Poland and Slovenia; by Bhir, Fontagné, and Zanghieri (2003) on old member states; and applied to the whole European region by Antimiani, and Santuio (2004) ; and by Jean, and Laborde (2004). Literature utilizing CGE approah diretly to the Slovak eonomy is limited. A CGE model built by Sandizzo (2000) is applied to the Eastern European ountries, inluding the Slovak Republi. This model, however, utilizes SAM data from early stages of transformation when Slovakia was still part of Czehoslovak federation, and therefore it is questionable how truly the model reflets the urrent situation. In Sandizzo s work, the SAM itself had been estimated and foreasts based on Italian I-O data from Separate inorporation of agriulture and food setor into the CGE model of Slovak Republi (and also many other Eastern European ountries) was assisted by the Food and Agriulture 12

18 Organization of the United Nations (Poganietz, et. al., 2000). Benčík (2001) in ooperation with the National Bank of Slovakia builds a CGE model with speifi appliations to the Slovak eonomy. Benčík very learly defines the struture of the model and the relations between the individual elements, however its drawbaks are that the model itself is very simple (9 industrial setors, only one Cobb-Douglas prodution funtion, and one Cobb- Douglas utility funtion), utilizing older data (1996 I-O data), and gives only examples of its appliations, but almost no impliations of eonomi poliy. The author himself onludes that "further researh this field would be objetionable, beause it is neessary to extend the mathematial aspets of model onstrution, and to gather further onstrution know-how for omputably more stable systems." Páleník, and Kotov (2002) build a CGE model to quintify the osts and advantages of Slovak Republi's EU integration. Koronzi (2003b), and Koronzi (2004b) points the fous to maroeonomi issues, related mainly to Slovak foreign trade, and evaluates the impat of EU integration based on a self-built CGE model. Although the model is simple, the author learly speifies its struture and relations between agents, and also provides the full mathematial statement of the model. The author onludes that although small, the overall maroeonomi growth indued by integration is positive. However the results in a setoral view are variable, and as a solution investment (apital input) espeially in form of FDI is suggested. As result of trade liberalization, pressure on publi budget arises, and trade defiit is inreasing. Slowly but steadily, the Slovak Republi is piking up on CGE modeling praties, what an be onfirmed by the paper of Páleník, Kotov, and Bunta (2004). The authors evaluate impats of foreign trade liberalization (both import and export), issues related to tax reform (mainly value added tax), quantify the impat of inomes from EU funds, and also analyze environmental issues. The authors onlude that "the entry of the Slovak Republi into the EU will not bring an immediate boost of the eonomy and living standards, however, the total benefits of this proess will prevail its osts." Unfortunately, empirial and mathematial argumentation of the outomes is absent from their work. And in spite their paper is titled "Review of CGE appliations in the Slovak Republi", with one exeption, no referenes to similar works of other authors are presented. 13

19 3. Eonomi impats of integration As a onlusion of the EU Commission in 2002, the Slovak Republi is a funtioning market eonomy (EU 2002, p. 127). The Commission also onludes that ontinuation of its urrent reform path should enable the Slovak Republi to ope with ompetitive pressure and market fores within the Union. Improvements an be made to the maroeonomi situation, whih requires urgent measures to redue both the fisal and urrent aount defiits. Expenditure reforms, in partiular in the health and pension area and as regards subsidies and guarantees, are essential. The unemployment problem neessitates a whole range of strutural reforms, inluding the elimination of disinentive effets in the soial protetion system and a more flexible labor legislation. Supervision of the finanial setor an be further strengthened. The effetive implementation of the legal framework for a market eonomy needs to be further enhaned. Last developments show that Slovakia s maroeonomi performane has been improving onsiderably, although some imbalanes remain signifiant (EU 2003b, p. 5-8). Real GDP growth aelerated further to 4.4 % in 2002, and 4.2 % in 2003 as a drop in the growth ontribution of domesti demand was not fully ompensated by a strengthening of the external growth ontribution in the first two quarters, and with highest growth in the last quarter. The volume of GDP reated during 2003 was billion SKK (at urrent pries), whih was by 9.1 % more than a year earlier (NBS, 2004, p ). In a breakdown by use, GDP growth was stimulated exlusively by foreign demand, while domesti demand tended to redue its level due to hanges in inventories. Figures on unemployment vary most depending on the reporting ageny. Aording NBS (2004), unemployment dropped to 5.2 %. EU reports that unemployment is fell from its level of 18.6 % in 2002 to 17.7 % in the first half of Employment is growing from an employment rate of roughly 57.0 % in In 2003, the average monthly nominal wage reahed SKK, representing a year-on-year inrease of 6.3 %. Real wages fell by 2.0 %, after an inrease by 5.8 % in The urrent aount defiit again reahed more than 8.0 % of GDP in However, it was more than fully overed by FDI inflows, whih reahed almost 17.0 % of GDP in The urrent aount defiit dropped very signifiantly, to 0.9 % of GDP in This was primarily due to a favorable trend in the trade balane, espeially growth of export. Inrease in Slovak Republi's export performane is losely onneted with FDI in previous years, with the most dynami growth of export reorded in the automobile industry. Prie level in 2003 was 14

20 determined mostly by inrease in administered pries and higher indiret taxes, what led to an inrease of the inflation rate from 3.4 % in Deember 2002 to 9.3 % in Deember At the same time the ore inflation remains low. Approximating harmonized EU standards, the general government defiit reahed 7.2 % of GDP in the eletion year For 2003, the government targets a defiit of 5.0 % of GDP. General government debt dereased from 49.8 % of GDP in 2001 to 44.3 % of GDP in mainly refleting the use of part of the very high privatization reeipts to retire government debt. Table 1: Main eonomi indiators, Slovak Republi Soures: 1. Eurostat, 2. Statistial Offie of the Slovak Republi, 3. National Bank of Slovakia, 4. Author's alulations. Notes: 1. Several values are preliminary. 2. Data may be inonsistent due to variable soures. 15

21 Slovakia's progress on the reform path, also in the publi finane area, has reeived strong new impetus (EU 2003b, p. 5-8). Various measures have been deided on and some have already beome effetive. The government has deided to implement a far-reahing tax reform at the beginning of 2004, mainly onsisting of the introdution of a flat inome tax rate and a unified value added tax rate, both at 19.0 %. On the expenditure side, one of the main deisions so far relates to reforms of the pay-as-you-go pension system. A funded seond pension pillar has been introdued. In addition, further steps in a still long agenda for health are and soial benefits reform have been taken. The extension of guarantees has been further limited. Measures have also been taken to redue the strutural defiienies in labor market, in partiular by a revision of the labor legislation. In many strutural reform areas, the government benefits from strong tehnial support from international finanial institutions. The strong politial reform ommitment will need to be maintained for years to ome so that Slovakia ontinues its athing up with the most advaned aeding ountries. The government has been reversing the expansionary fisal poliy stane. Whereas Slovakia notified a general government defiit of 7.2 % of GDP for 2002 (ESA 95), the general government defiit target for 2003 was 5.0 % of GDP. The government has ommitted itself to a further defiit redution to 3.9 % of GDP in 2004 and to slightly below 3.0 % of GDP by The authorities have already reated to budget exeution risks in 2003, whih stem predominantly from lower than planned tax revenues, by advaning planned exise tax inreases. In 2004, fundamental and potentially growth enhaning tax reforms have been introdued, onsisting in partiular of the introdution of a flat personal and orporate inome tax rate and of a unified value added tax rate, all at 19.0 %. By their very nature, these hanges make any revenue foreast highly unertain and pose a high risk for budget exeution, thus neessitating a very onservative budgeting approah and undersoring the need for a swift ontinuation of strutural expenditure reforms. The restritive fisal poliy stane supports narrowing of Slovakia s high urrent aount defiit. The urrent aount defiit amounted to more than 8.0 % of GDP in both 2001 and The more stringent fisal poliy of the new government, together with the aelerated inrease in administered pries in 2003 and 2004, has a dampening effet on domesti demand. It also ontributes to a more balaned poliy mix and has allowed the National Bank of Slovakia to redue its key interest rate from 8.25 % in April 2002 to 6.00 % at the end of 2003, and to 4.5 % from July Together with market interventions, this has helped to mitigate the appreiation pressure on the Slovak rown and prevented an assoiated loss in 16

22 ompetitiveness. Altogether, the urrent aount defiit narrowed to mainly due to very strong export growth. The preparation of additional publi expenditure reforms, whih are neessary to underpin the envisaged fisal onsolidation, has gained very strong momentum. The government deided on further parametri hanges to the pay-as-you-go pension system for the beginning of The retirement age has been inreased to 62, and there is a plan to inrease it to 65 in the ourse of the next few years. Furthermore, the government introdued a funded pension pillar. Additional steps have been taken to improve the finanial situation of the health are system, by introduing o-payments for health are servies. Nevertheless, a long reform road still lies ahead in this area, and is just starting during these days by enforing laws in the parliament. The extension of guarantees has been limited. However, both guarantees and subsidies should be thoroughly sreened to implement additional redutions, also in onnetion with Slovak Railways and agriulture. The development of a detailed medium-term fisal framework, whih onsistently embeds and sequenes neessary expenditure redutions, is still lagging behind. The Slovak government has been moving more deisively to takle the deep-seated strutural unemployment problem. The ontinuation of reforms in the health and soial protetion systems are of the utmost importane and seem to be slowly reduing disinentives for employment reation and aeptane, partly by reviewing soial assistane benefits and lowering soial ontribution rates. Similar effets are likely to result from the tax reforms introdued in Furthermore, speifi measures and programs exist or are being onsidered to foster employment reation by Small and Medium Enterprises (SMEs), to strengthen regional mobility (partly by ameliorating the housing situation) and to redue skill mismathes (partly by ative labor market measures), although the effiieny of these programs need to be ontinuously reviewed. Progress has been made as regards finanial setor supervision but the authorities need to ontinue to safeguard the expanding finanial setor against stability risks. Both the legal framework and the implementation apaity in the supervisory area have been strengthened. Further measures to improve the legal framework for a market eonomy have been instituted. Its effetive implementation is also being enhaned. Examples of the further strengthening of the legal framework are the substantial aeleration in prie liberalizations in 2003 and 2004, the introdution of a highly regarded ollateral law, and improvements in the labor legislation. A anti-orruption at, and a new bankrupty at have been enfored. Slovak Republi has also embarked on an ambitious reform of the judiial setor. It is 17

23 gradually reduing the heavy workload of judges by reruiting Higher Court Offiials, applying ase management systems, reinforing training, also on managerial apaity, and at ombating orruption. The effetive implementation of the legal and administrative framework, however, still requires signifiant efforts. As a summary, several reforms by the Slovak government are taking plae reently. At the stage when reform of foreign trade has reahed the final stage by entering EU, reform of tax system by introduing a flat rate on orporate inome tax and VAT has been introdued at the beginning of In ombination with other reforms and aggressive support of foreign investors, the government poliy on FDI seems to be piking up on speed. Although the government's inentives in this field have to be admired, it is neessary also to say that reasons for inrease in FDI inflow is greatly influened also by omparative advantages of Slovakia with skilled but relatively heap labor in the EU, and also by privatizing the remaining state-owned enterprises with largest sale - steel, teleommuniations, railways, gas, eletriity, and water. Several other reforms run in parallel - reform of shool system (paid shooling has been introdued from September 2004), health system (free health servie is abolished starting from 2005), pension system (two-pillar pension system has been introdued from 2004, where one pillar is the traditional state-based pension, and the seond one is private where eah individual has the right to hose a private ompany for pension savings; age of retirement has been inreased to 62 and will be inreased again in the near future to 65), transportation (subsidizing of state-owned ompanies espeially bus transport, and prie regulation), publi administration (deentralization of government administration, fisal deentralization), support of employment programs. Impat analysis of all these aspets is dependent on data availability, however poliies quantifiable are arried out in our work. There are several positive fators of the reform and the eonomy in general is probably on the right trak, although it is hard to judge at this time yet. Market eonomy praties ome to the foreground, foreign investment (inluding speulative) flows into the eonomy, employment in seleted regions seem to inrease, slow inrease in real wages of some setors, et. By keeping the urrent trend in inviting foreign ar manufaturers, Slovak Republi will be world's number one in ar prodution per apita in The World Bank in its reent report (World Bank, 2004) is evaluating Slovak Republi as a top number 1 reformer from between all of the 148 ountries reviewed, with an overall rank 18 on the ease of doing business. Aording to the World Bank, Slovak Republi is leader in reduing the osts of starting a new business, lowest osts of employer dismissal, and there is a stable system of 18

24 lender guarantees. The suess due to these reforms should diretly bring an additional around 2.5 % of GDP inrease. However radial reforms are followed by a range of negative effets with deep soial impats. Espeially due to privatization of strategi setors, there is a huge onsistent pressure on prie inrease, and soial differenes are expeted to grow. Huge unemployment rates together with onstant inrease of pries and almost no inrease in wages, payments introdued for shooling, health, publi administration, inreased payments to the soial and pension system, radial inrease of indiret tax rates on basi food produts, mediine, and books, in the prodution setor priority given to foreign investors, all this indue a suspiion of strong soial impats. Redutions in publi administration ause diffiulty, inonsisteny and unavailability of standard maroeonomi data olletion, based on whih serious poliy analyses ould be built. Information exhange and ooperation between strategi organizations and government, or between departments of the government itself are absolutely without mutual oordination. Different institutions provide varying reports on idential indiators. Differenes are in Central Bank reports and reports of the Statistial Offie. As a speifi example, reporting of unemployment rates vary between the Ministry of Soial Affairs and the Statistial Offie by 25 %, in absolute values about 400 thousand people, whih is in omparison to the Slovak population well over the line of statistial errors. Budgets of researh institutes, majority of whih is state owned (or state managed) are drastially redued, ausing speialists to look for jobs in other setors or abroad. Very similar situation is in University researh with low motivating fators and poorly equipped researh failities, ausing young people to searh for aknowledgement abroad. And in spite of major uts in government expenditures, the absolute publi debt is further onstantly growing. As the author's future researh plan, integration impats in the soial sphere and inome distribution will be analyzed. This analysis at present is bloked espeially by lak of offiial data. 19

25 4. Model data estimation Integration into the European Union (EU) evokes the need to standardize the system of national aounts with those utilized in other EU ountries. For onstrution of this CGE, data arranged in form of SAM for the Slovak Republi in 2000 has been utilized. A SAM is an exellent desriptive tool, showing in detail the struture of an existing national eonomy. It provides important information on individual industrial setor size, behavior, and interation with the rest of the eonomy, and a link with the foreign world. At the same time, it is a neessary tool for CGE modeling. Data onstrution in this work generally follows the standard proedures suggested by the United Nations and Eurostat. The proess in partiular transforms Supply and Use tables into a symmetri I-O table, and one again, it is transformed into the symmetri SAM. This setion disusses the organization, methodology, arrangement and estimation of data and onstruts a detailed SAM, that are in the model extended by additional maroeonomi data, suh as labor supply or stoks of fixed apital. The SAM utilized for building our model has been proposed by Koronzi (2004), and the same data is utilized with only minor adjustments desribed in the following part. The SAM onsists of 135 by 135 aounts, of whih produtive sphere in the intermediate onsumption part is represented by 57 aounts of ommodities and 57 aounts of industries (or ativities). Classifiation of ommodities and ativities is based on the European System of Aounts (ESA) The fators are represented by 6 aounts, in whih the generation of inome within the eonomy and the rest of the world, respetively, are reorded: Net operating surplus, Net mixed inome, Gross wages, Soial ontributions, Other taxes on prodution, and Other subsidies on prodution. In the SAM, 4 domesti institutional setors that inome is alloated to are distinguished: Corporations (non-finanial and finanial), Government, Households (inluding selfemployed), and Non-profit institutions serving households. Taxes on produts onneted with intermediate onsumption (value added tax) and taxes onneted with final onsumption (exise tax, onsumption tax) are reorded in 5 separate aounts: Value added tax (VAT), Taxes on imports (onsumption), Taxes on imports (tariffs), and Consumption and other taxes, Subsidies on prodution. 20

26 Aounts of Gross fixed apital formation, and Changes in stoks represent possible eonomi funds reated by savings, by net apital transfers reeivable from abroad, and by lending/borrowing from abroad. The Rest of the world (ROW) aount reords transations of the rest of the world with the national eonomy. It aggregates goods and servie transations with ROW, and urrent and apital transfers with ROW. Imports inlude imports of goods and servies for intermediate onsumption and for final use. In this partiular ase, ROW aount has been divided into two aounts - 1) the remaining 24 states of the EU, and 2) the rest of ROW, in order to make it possible to model poliies related to EU integration. An aggregated 6 by 6 SAM is in Table 2. The final 135 by 135 SAM (inluding aounts for totals) of SR for 2000 is available upon request from the author. 4.1 Construting the SAM from base data For the onstrution of the Slovak SAM, data from Supply and Use tables has been transformed, following this proedure: 1. The intermediate part of the asymmetri Supply and Use tables is onverted into a square table that reates the intermediate part of a symmetri I-O table (Leontief type of I-O table). 2. The symmetri I-O table is ompleted by attahing two quadrants (value added quadrant and final onsumption quadrant (from information in the supply and use tables) - making the final table asymmetri. 3. The symmetri I-O table is onverted into the final SAM, preisely its intermediate part is used for estimation of the intermediate part of the SAM, and data from the remaining quadrants are used to finalize the SAM - reating a ompletely symmetri table. Or in other words, 1) Supply and Use tables are asymmetri, both their intermediate part and their transformation quadrants (the final onsumption quadrant of the Supply table, and the value added quadrant of the Use table). 2) The Leontief-type of I-O tables has a symmetri intermediate part, however the full table inluding the value added quadrant and the final onsumption quadrant is asymmetri. 3) The final SAM table is symmetri in both its intermediate part and its value added and final onsumption part. Therefore to onstrut a 21