Executive summary

There is untapped potential for productivity spillovers from international investment in the Slovak Republic. In the last decades, significant foreign direct investment (FDI) inflows in export-oriented manufacturing (particularly the automotive industry) have fuelled economic growth and supported convergence towards higher-income OECD economies. However, much of that investment has concentrated in labour-intensive, low-wage, low-value added industrial activities (e.g. car assembly), with limited knowledge spillovers to the wider economy. Despite, therefore, large stocks of FDI by international standards (amounting to 58% of GDP in 2019), important productivity gaps between foreign affiliates (FAs) and local businesses remain. The gap was on average 65% in 2018, compared to 20% in Estonia or Slovenia, and has declined only marginally in recent years.

One factor that explains this is the high proportion of low productivity micro firms in the Slovak business population. These micro enterprises – with less than 10 employees, which represent 97% of employer firms and account for over 40% of business sector employment – engage little in research and development (R&D) and innovation, are less digitalised than peers in EU countries and have typically lower capacity to establish linkages that could support knowledge transfer. They also have lower capacity to adopt more advanced foreign technology and adapt to the higher quality standards of FAs.

Consequently, FDI-SME linkages remain too loose to enable effective spillovers. FAs in the Slovak Republic source less extensively from domestic suppliers than in other OECD countries, limiting the scope of spillovers through value chains. Multinationals’ efficiency-seeking strategies target low-cost workforce for labour intensive activities, and proximity of European markets, rather than a strong supplier base. Moreover, huge wage differentials between FAs and SMEs tend to discourage labour mobility towards domestic firms, reducing spillovers and upskilling in strategic areas (e.g. digital skills), and exacerbating the limited training opportunities locally. Finally, Slovak SMEs perceive market competition as a barrier to innovation, which also reflects their scale up limitations. This points to competition by imitation as a poor FDI-SME diffusion channel.

There are however stronger channels that offer large potential of spillovers to the local economy. The small population of Slovak SMEs – with 10 or more employees – appear to be better integrated in innovation networks and more often involved in innovation co-operation within their supply chain than in other EU countries. The share of medium-sized and small innovative enterprises that co-operated with clients or customers on innovation (24% and 14% respectively in 2018) is higher than the EU average (16% and 12%). Local SMEs also show a high propensity to collaborate and exchange information with competitors in the same industry. Foreign employers often engage in local training initiatives, e.g. through dual education agreements with higher education institutions (HEIs) and vocational schools, which supports upskilling.

The Slovak FDI-SME policy system is fragmented. Many ministries and agencies are involved in FDI-SME policies, resulting in more bureaucracy and policy complexity. Policy coordination is a major challenge and a root cause of delayed reforms. Inter-agency collaboration is limited and takes place either informally or centrally through line ministries. Several high-level councils bring government actors together to identify priority areas where cross-ministerial planning is necessary, but their competences are not always aligned with their tasks, leading to bottlenecks in coordination, especially linked to smart specialisation.

Policy coordination and streamlining FDI-SME governance should be a high priority. Due consideration should be given to horizontal coordination and restructuring the governance framework, e.g. through the merger of implementing agencies and joint programming in areas that require complementary expertise. Vertical coordination and inter-regional collaboration should also be improved. Currently, subnational governments have substantial responsibilities in areas affecting enterprises, but they lack organisational capacities and thus ability to support local FDI-SME ecosystems. FDI-SME policies should be better articulated with local development strategies and action plans. Indeed, although the main national agencies have established offices in regions, those often remain disconnected from the policy priorities and actions of subnational governments.

Recent reforms were directed towards diversifying the economy and FDI beyond low value-added manufacturing and strengthening domestic innovation capacity. A comprehensive set of assistance services support the internationalisation of Slovak SMEs and help foreign investors identify local suppliers and partners. Investment promotion efforts focus on investments that use smart industry technologies with higher potential for technology diffusion. However, incentives for innovation and R&D partnerships do not always involve foreign investors and their volume is low compared to EU peers. More impact could be obtained with systematic support for FDI-SME ecosystems in knowledge-intensive value chains, and sectoral action plans for growing industry clusters.

In parallel, the provision of SME development services by multiple agencies has contributed to increase the administrative burden on SMEs. There is scope to simplify procedures and raise awareness about the availability of public support. For instance, the R&D tax incentive could be simplified to become more attractive and accessible to smaller businesses, and the EU Structural and Investment Funds could be leveraged to help SMEs scale up their productive capacities, especially in knowledge-intensive value chains. Boosting SME performance will also require addressing skill gaps, including in FDI-intensive sectors, and incentivising investments in on-the-job training and human capital.

The need for pursuing place-based efforts is exemplified with the cases of Banská Bystrica and Košice. Despite improvements, regions in Central and Eastern Slovakia continue to lag behind in attracting FDI and benefit less from investment promotion policies. Banská Bystrica accounts for only 2% of the national FDI stock, with investment concentrated in a narrow number of manufacturing industries. In Košice, the FDI stock is larger and more diversified, e.g. in information and communication technologies, energy and other services, but the region concentrates almost 80% of the FDI stock of Eastern Slovakia. The proportion of investment projects supported by the Slovak Agency for Investment and Trade (SARIO) in Central and Eastern Slovakia has increased in recent years, but efforts should be intensified. Also, adequate evaluation should assess policy effectiveness in supporting regional development and convergence.

More developed local networks and clusters could enhance SME performance and entrepreneurship. In Banská Bystrica and Košice, most economic sectors are dominated by micro firms, with limited absorptive capacity and very low survival rates, but the well-developed network of HEIs and R&D institutions can drive local entrepreneurship and innovation. Local associations could also play a stronger role, e.g. by providing business support and networking services. Promising industrial clusters are emerging – sometimes with the support of formal cluster organisations (e.g. the Košice IT Valley) – which could stimulate regional SME development and entrepreneurship, and enhance attractiveness to investors.