How to achieve the take-off into sustained growth? A case study for Slovenia

In this paper, we show that a successful policy aiming at enhancing economic growth in the long run must be based on policies improving human capital and technological progress. This is done for a small open economy in the European Union (EU) and the euro area: Slovenia. In particular, we investigate how fiscal policies aiming at supporting economic growth without violating the EU Stability and Growth Pact should be designed. Slovenia’s present situation is characterized by high and rapidly increasing public debt and low growth. It is an interesting case because it is one of the few small open economies from Central and Eastern Europe that was already in the euro area before the “Great Recession”.

Using the Slovenian Economic Policy Model (SLOPOL) 10, an econometric model of the Slovenian economy, we analyze the effects of different fiscal policies in Slovenia over the next couple of years by means of simulations. The fiscal policy multipliers of the Slovenian economy are shown to be small and short-lived, which renders expansionary fiscal policies inappropriate as a means of achieving higher growth. As expected from economic theory, increasing government transfers, public consumption, or public investment result in hikes of real gross domestic product (GDP) but not in a sustained increase or even higher growth. However, if an increase in government expenditures directly related to technical progress (such as higher funding of tertiary education or subsidies to firms’ investment in research and development) is implemented, this triggers a path of output permanently higher than that of the baseline simulation. This result shows that the key to prosperity and sustained growth is investment in human capital and technology, including for a small open economy like Slovenia.