Government analysis seeks to pinpoint strategy for future economic growth

A strategic analysis of the Czech economy has unveiled a serious flaw: some of the biggest and most profitable sectors of the economy are in foreign hands and have an increasing trend of shipping their profits out of the country rather than re-investing them. And while the foreign investment has fueled much of Czech economic growth over the last 20 years or so, the volume of investments appears to now on the wane.

Aleš Chmelař, photo: archive of CEPSAleš Chmelař, photo: archive of CEPS We spoke to one of the authors of the analysis, Aleš Chmelař, and first of all focused on the overall figure often cited for the outflow of funds from foreign owned companeis in the Czech Republic.

“There’s a lot of attention from the media on this figure of 200 billlion to 300 billion crowns and last year it was roughly – if you take into account reinvestment as it is not part of the outflow –around 300 billion, 298 billion to be exact. This number does not say much actually, it is a lot of money, it is up to 8 percent of GDP, but it depends on the overall stock of investments in the Czech Republic and it also depends on the return on this investment. It also depends on the growth levels and a lot of other variables. What we did, and what was one of the aims of the analysis was as part of the tasks that the government as part of the action plan for growth and employment gave us, was to analyze whether this outflow is somehow proportional to the economic fundamentals of the Czech Republic. We did quite a simple regression analysis using a lot of variables that could explain the outflow and found at that looking at almost any measure you could take, the outflow is twice or three times what it should be. So somehow the structure of the economy does not correspond to the volume of the money leaving. Therefore we have a structural economic problem.”

Maybe it’s too simple to say, but when you look at the Czech economy nearly all the banks are in foreign hands, the biggest industrial producer, Škoda Auto, is in foreign hands, many other manufacturers, Škoda Transport, are the same. You look almost anywhere, most of the utilities, such as gas distribution, a fair bit of the electricity distribution and pipeline companies, are the same. Wherever you look, a lot is in private hands. That is the basic fact isn’t it?

“In the last 20 years you don’t register any growth in the domestically owned economy and all the growth in the Czech economy registered since 1995 was basically to Foreign Direct Investment (FDI).”

“Yes it is. But it should not be a problem if the rest of the economy thrives. And as part of the analysis we also looked at the added value directly linked to foreign investment and to domestic activities. And we found out quite a shocking conclusion that actually the added volume in added value in GDP of the domestically owned economy has not moved or grown at all, or almost at all, since 1995. So in the last 20 years you don’t register any growth in the domestically owned economy and all the growth in the Czech economy registered since 1995 was basically to Foreign Direct Investment (FDI). Therefore we see that, and it is visible from the numbers, the amount of foreign investment now decreases we are in serious trouble as regards future potential of economic growth because we have not succeeded in the last 20 years to mobilize internal engines of growth.”

The analysis is there, what do you expect the follow-up to be? In a sense this report starts a discussion – maybe it had started already – but where will it go from here because we are only a year away from elections and normally in a year in government you cannot do that much…

Photo: InIT Lemgo, CC BY-SA 3.0Photo: InIT Lemgo, CC BY-SA 3.0 “This should not be an electoral thing, it should be a long term consensual direction and maybe many stakeholders in the Czech Republic should look at it as a structural problem of the economy and somehow get consensual ways on how to tackle them. As you said, the debate has started but what we tried to do was put the debate on a more robust, both economically and analytically, level so that we can really go to the nitty gritty of the potential measures. In terms of its future what we expect is that we stop just discussing it in a vacuum and that we see that this is a problem that we have objectively shown that there is a structural problem and now we have to discuss the issues. Before it was all very much intuitive – 300 billion is a lot of money, we have to reduce it, some measures could reduce it or not, but there was no real need. Now we face actually in the very long term a need to actually tackle this problem. It will not be tackled in a year, it cannot probably be solved in terms of any concrete legislation or regulation in the next year. But it should, and that is why the Office of the Government as an institution that has a longer period of strategic thinking, follow after the elections and be independent of the electoral cycles.”

Reading some of the suggestions that are made, there are various ones such as more regulation of some of the network companies so that they don’t make so much profits or some of the profitability is clawed back; higher wages in foreign companies which have high earnings and high profits; a clampdown on foreign tax havens; maybe some new taxes. These are interesting suggestions but I wonder how you can have higher wages in some of the companies that have higher profits. Clamping down on tax havens, people talk about it a lot but it happens only bit and a lot of Czech companies as well as foreign ones use tax havens. Are there any options in the report that seem more promising or any models in other countries that could give a lead to the Czech Republic?

“The share of wages in GDP is roughly by around 10 percentage points lower in the Czech Republic than in Germany or any other Western European country.”

“First of all, it’s not about more regulation but better regulation. If you have a network producer or network service that generates a return on investment of 20 percent a year, there is basically a rent seeking problem and it is quite obvious. And if you have the infrastructure that is not commensurate to the infrastructure in Western Europe then you really have a problem. And it is not about too little regulation but about effective regulation. So, for sure there is reflection, or should be reflection, about more efficient regulation of network sectors. It does not concern specifically one of them, it is a problem of all with large infrastructure. And there is a debate and there are a lot of reforms on the table in terms of the regulatory environment for network sectors. That is the first thing.

“The second is in terms of solutions in the wage sector and the government, and this current government, has been implementing a lot of measures and motivating the trades unions to raise wages. From a macro-economic perspective these wages seem too low. In a different analysis that we did internally last year showed that the share of wages in GDP is roughly by around 10 percentage points lower in the Czech Republic than in Germany or any other Western European country, which shows that there is a macro-economic space of 20 percent above the normal increases every single year,. So basically the wages in the Czech Republic are basically 20 percent undervalued compared to what they could be. But there is a problem that many domestic companies cannot afford to allow themselves to raise wages because they actually face quite a competitive environment in terms of the sub-contracts they perform. It is a much more complex issue, I admit. But in terms of wages in some sectors, I think there is room for sectoral agreements in some areas and trade unions would probably welcome that. With employers there has not been a discussion about it. But there are ways of addressing wages, either by raising minimum wages or looking at sectoral wages or sectoral agreements and overall wages in the public sector that have a spillover effect on the private sector.

Photo: David KoubekPhoto: David Koubek “Something that I would like to underline is the first set of measures that we propose, I am well aware that this discussion is embedded in the discussion in other Central European countries but those discussions are misleading in a way as they try to find a different Central European model to tackle this. The Czech Republic is different, it is a high industrial country a highly export oriented country that needs to be integrated into the internal market and needs to have institutions that are long-term sustainable. Therefore, looking at the models that we could emulate and really apply in the Czech Republic we have to look mostly to Germany, if I oversimplify it, or to Austrian corporatist models where they have economic institutions that are coherent. They do not need high degrees of foreign investment because they can generate, for example on the financial side themselves. On the innovation side they can also generate themselves and they don’t need an inflow of know-how and innovations. And faced with the decreasing level of foreign investment in the Czech Republic we somehow have to copy those institutions already existing, perhaps not to the letter, in Germany or Austria. In the area of education, we somehow have to focus on sustainable ways of supply of students to the workforce and emulate the German and Austrian dual system of education.

“In terms of banking, we really have to look in terms of some public entity that would help as in the case of Germany in the case of the Kreditanstalt. And the third level is actually the innovation side. Innovation in Germany is led by small incremental improvements that is different from the disruptive ways that the British model relies on. And we need to have manageable institutions that communicate, mostly with SMEs, but with all companies on the transfer of innovations, which is the case for example with the Fraunhofer Institut which is both a public and private entity. These are the institutions that we need to sustain a sustainable development model that would not require forever a sustained inflow in foreign investment. Obviously, what we see from the numbers and from the structure of the world economy, those levels will not come at the rate we saw in the past and ensured quite high economic growth.”

I understand what you are saying, but what would be the outcome is a totally different Czech economy to what we have at the moment. From where we are to there is a massive step. A lot of those innovations in Germany come from small and medium-sized companies. The structure of the Czech economy is that there are a lot of GDP in large companies, many of them foreign-owned large companies. We are looking at a total shake-up in a sense...

“Somehow we need to get from the domestic or SME sector 2.0 percentage points of GDP.”

“Well, not really. The driving institutions including infrastructure, the skill structure, the sectoral structure of the economy, the overall orientation of the model, is quite coherent and quite close to the German one. Of course, the ownership division is somehow different but this should not disable the development of the SME sector, for example. It is quite a large sector actually. I simplify it that they are the subcontractors of the larger companies, but there is a huge scope for improvement and gradual improvement. It does not have to be an overhaul. The added value of foreign direct investment will still probably grow, the only thing is that its growth will not allow for long term sustainable levels of growth for the Czech Republic. The structural growth level potential of the Czech Republic now being estimated by the European Commission and other institutions, by the Czech National Bank, the Ministry of Finance is roughly 2.5 percent of GDP. We have had a significant growth from foreign direct investment to the tune of 4.0 percent of GDP in the past 10 years, or perhaps 20 years not looking at the recession periods. And somehow we need to get from the domestic or SME sector 2.0 percentage points of GDP so that it could go a bit beyond the forecast of 2.0 percent. It is not such a big deal and that has happened in other countries but we need small sectors of an economy, which is functioning quite well but has loopholes, mostly in the areas that I told you and on the financial side, the education side and the innovation side. If we concentrate on those loopholes, the rest of the economy is quite coherent and quite complimentary and looking quite well.”