Commission Report (2002): Czech Republic

The capacity to cope with competitive pressure and market forces within the Union

The ability to fulfil this criterion depends on the existence of a market economy and a stable macroeconomic framework, allowing economic agents to make decisions in a climate of predictability. It also requires a sufficient amount of human and physical capital, including infrastructure. State enterprises need to be restructured and all enterprises need to invest to improve their efficiency. Furthermore, the more access enterprises have to outside finance and the more successful they are at restructuring and innovating, the greater will be their capacity to adapt. Overall, an economy will be better able to take on the obligations of membership the higher the degree of economic integration it achieves with the Union before accession. Both the volume and the range of products traded with EU Member States provide evidence of this.

Macroeconomic stability has been sustained over the last three years but the fiscal imbalance could put it at risk. Macroeconomic policy has been conducted with a sufficient degree of predictability to allow proper decision-making by economic agents. Market mechanisms work sufficiently well and allow an efficient allocation of resources. A successful economic policy-mix and macroeconomic stability have created a stable environment for economic activity.

The well-skilled labour force has been an asset for coping with economic restructuring and making the Czech economy more competitive. The high quality of professional education and the short time required to obtain qualifications together with relatively low wage costs have been an advantage in competition for foreign investments. While the majority of the labour force have completed secondary education (about 66%), the percentage of people with tertiary education has remained at a level of about 12%. Considering the trend towards increasingly advanced production technologies, a more sophisticated services sector and deeper integration into the world economy, education must be able and willing to meet higher demands. The education system faces the challenge of expanding tertiary education and providing the workforce with tools to adapt to life-long learning in order to continuously meet changing labour market requirements.

Employment policy is focused on fighting unemployment and on fostering flexibility. Progress in this policy area has been rather limited, though there seems to be a policy consensus on the most pressing deficiencies on the labour market: increasing regional disparities in unemployment, rising unemployment levels within what are considered high-risk groups and a declining employment rate in the older age groups. Labour force mobility will remain limited as long as adequate housing cannot be provided due to the highly regulated rent market. Active employment policy measures need to be focused on target groups with a clear linkage to market requirements.

High levels of gross fixed capital formation have significantly improved the supply side of the economy. Over the last five years, fixed investment has averaged 28.8% of GDP. Private investment has reached 23.8% of GDP on average, thus leaving about 5% for public investment which compares favourably to the EU average. This strong investment performance has helped to replace the old capital stock and has upgraded production capacities. As a result productivity increases of about 3.2% on average over the last three years have pushed up output growth and improved competitiveness. Physical infrastructure as a prerequisite for smooth economic development has got closer to international standards. The road and railway network is well-developed and offers adequate transport possibilities, even if additional investment is needed to develop Trans-European Networks. Existing bottlenecks have been targeted by investment programmes.

The Czech economy has emerged as an attractive market for foreign investment. From 1997 to 2001, inflows of foreign direct investment (FDI) reached an average of 7.8 % of GDP, peaking at 11.6 % in 1999 and then decreasing to 8.7 % in 2001. In the first quarter of 2002, FDI reached EUR 3.1 billion. FDI inflows originated mainly from the EU and other OECD countries and were concentrated in the machinery and equipment sector and in the financial services sector. Privatisation-related FDI has accounted for a large share of total FDI, but greenfield and brownfield investment has gained increasing importance. This development has been supported by offering attractive incentive packages to foreign investors. The Czech Investment Incentive Act provides a large number of investment incentives that can be combined. The Office for the Protection of Economic Competition ensures the compliance of the investment grants with the acquis.

Corporate restructuring has proceeded but a number of important enterprises have to catch up on this. Overall, restructuring of export-oriented firms in foreign ownership has been much deeper and faster than that of domestic firms. Since companies under foreign control generally benefit from more favourable financing conditions and work under better corporate governance, they tend to be more competitive on the markets. This has strengthened the financial performance of the corporate sector as a whole. However, a number of domestically owned enterprises have remained highly indebted and loss-making. In particular, some steel companies have yet to go through thorough restructuring processes before they can become competitive market players. The restructuring of major players in the gas market and the attempt to restructure electricity utilities is the result of considerable efforts by the Czech government to prepare the gas and electricity sectors for the internal energy market. The Czech Consolidation Agency has been successful in preparing two large enterprises for privatisation so far (Tatra Koprivnice and Zetor Brno) and is trying to achieve the same for other strategic companies. Remaining restructuring cases could benefit from a revival of sales of non-performing assets by the Czech Consolidation Agency.

The sectoral structure of the economy, which is characterised by a relatively large manufacturing sector, has altered only marginally. The share of the manufacturing sector in the economy has altered with the economic cycle. Its decline, both in terms of gross value added and of employment, came to a halt in 1999, and it has been rising again since then. In 2001, industry (without construction) produced 34% of gross value added, the same share as in 1997. The development of the services sector in terms of GDP shows just the reverse trend, though its share in total employment has been on the rise over the whole period. In particular, financial intermediation and the tourist sector posted gains. The gross value added of construction fell from 8% in 1997 to 7% in 2001 with a smaller drop in the share of total employment. The agricultural sector has never posed a severe challenge in terms of structural adjustment because of its small size; it decreased from a mere 4.4 % of gross value added in 1997 to 3.9 % in 2001.

The importance of small and medium-sized enterprises (SMEs) has been growing, but it has not been possible to exploit the full potential of the SME sector for economic growth. In 2001, SMEs produced 42% of GDP and employed about 60% of the workforce. As regards external trade, the SME sector has constantly increased its share in total exports. Expansion of the SME sector is one of the economic policy priorities. There has been a growing awareness that not only limited access to outside financing and to business advice but also skills gaps and lengthy administrative procedures are severely hampering the economic potential of this sector. The government has set up a series of support programmes aiming to reduce these shortcomings, though tackling the administrative burden on SMEs and start-ups could in itself significantly improve the situation. As regards access to financing, the introduction of a central register of credits should help overcome the reluctance of banks to lend money. Of particular importance is the absence of mechanisms addressing the setting-up of venture capital funds, seed capital schemes, equity, etc. Such forms of financing are particularly necessary to build up new technology-based SMEs.

Government policies have continued to interfere in the markets though to a decreasing extent. The biggest source of market distortion remains the presence of state aid in state-owned enterprises. Large state aid has been awarded to the steel sector and the banking sector. Hidden subsidies to the corporate sector take the form of tax and social security arrears. There is also a broad range of state support to the corporate sector comprising investment grants, tax holidays and employment and qualification measures. One set of these investment incentives is targeted in particular at large foreign investors in order to attract foreign capital and know-how and another one aims first of all at SMEs.

The Czech economy is very open and trade integration with the EU has reached high levels. While in 1997 exports and imports of goods and services amounted to 119% of GDP, this ratio rose to more than 145% in 2001. Exports to the EU also showed a clear upward trend, from roughly 60% of total exports in 1997 to about 69% in 2001. Imports from the EU as a percentage share of the total, by contrast, have hovered around the five-year average of 62%. In general, trade with developed market economies has intensified, but trade relations with other transition economies have been extended as well. External trade is concentrated to a very high degree on technology and capital-intensive manufactured goods, with an emphasis, on the export side, on road vehicles and electrical machinery.

The economy as a whole has achieved a satisfactory level of competitiveness. Unit labour costs have declined except for the year 1999. Continuously high inflows of FDI and gains in labour productivity over the last five years have enhanced the external competitiveness of the Czech economy. It has been possible to maintain this competitiveness despite the significant appreciation of the Czech crown against the currencies of its main trading partners. Only during 1997 did the Czech crown depreciate in real terms. Thereafter it resumed its appreciating trend. Between the beginning of 1997 and April 2002 its real effective appreciation, in terms of producer prices, vis-à-vis its partner countries amounted to a total of 16%, or an annual average rise of nearly 3%. However, during the first half of 2002, the appreciation was very steep, but it is not yet possible to judge to what extent this development has harmed the overall competitiveness of the external sector.

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