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The following OECD assessment and recommendations summarise Chapter 1 of the Economic Survey of the Czech Republic 2006 published on 8 June 2006.
Contents
Growth has strengthened
Between 2002 and 2005, annual growth in GDP per capita has risen from a little under 2% to 6%, and shifted above the average for other east-European OECD countries. Past reforms and accession to the European Union are contributing to further expansion of export-driven manufacturing, backed by foreign-direct investment. Indeed, the trade balance has become positive. Nevertheless, catch-up with more advanced economies is some way off and maintaining this performance will require continued reform. Entry to the euro area is aimed for in 2010 and this may provide an additional fillip to growth. In addition, the current government has published a blueprint for reform, the Economic Growth Strategy. It contains a large number of detailed proposals, many of which echo past and present OECD recommendations, and should be used as a catalyst for change. The most important measures have to be taken in fiscal policy; it is very important that the next government faces up to the considerable challenge of putting deficits on a sustainable track through public-spending reform. Policy will also have to push ahead in making improvements to the labour market, including the skills base, and with measures to enhance the business environment.
GDP, exports and the current account balance
1. Projections for 2006 will be added following the OECD's spring forecasting round. Growth in Hungary, Poland and Slovakia is a simple average.
Source: Czech National Bank; OECD, Annual & Quarterly National Accounts Databases; Secretariat projections.
Inflation and interest rates remain low and a commendable annual
assessment process is in place to guide the timing of euro entry
Real convergence in GDP per capita has been accompanied for several years by low and stable inflation. In the early 2000s growth in the consumer-price index actually undershot the target band of the Central Bank’s inflation targeting regime. However, inflation has since recovered and, as of early 2006, was well within the 3 +/- 1% target band. Interest rates are correspondingly low and similar to those in the euro area.
Despite these favourable conditions, there are risks in reaching the inflation and exchange rate criteria for euro entry. To reduce these, and other risks of euro entry, a special annual assessment process on the preparedness of the economy for euro adoption has been set up. The assessments look not only at conditions in relation to the Maastricht criteria but also at the alignment of the economy with the euro area and the flexibility of domestic markets. This process and the inflation-targeting regime are providing a good framework for euro entry and neither warrants major reform.
Maintaining progress toward achieving fiscal sustainability through
public spending reform remains the main policy challenge
The general-government deficit for 2005 is currently estimated at 2.6% of GDP on an accrual basis following 2.9% in 2004. These outcomes are a marked improvement on preceding years, even taking into account special factors in the accrual accounts. However, the outcomes partly reflect continued strong growth in revenues. In addition, spending was lower than budgeted because of the transfer of spending allocations into reserve funds. Nevertheless, there is no sign of a permanent downward shift in public spending when expressed as a percentage of GDP. Furthermore, the 2006 budget has seen relaxation in spending discipline on several fronts. In particular, the ceilings of the Medium Term Expenditure Framework have been raised, reflecting the expectation of structural revenue increases. There is some concern about the justification of these ceiling increases. Indeed, additional rules are needed in the Framework to deal with revenue and expenditure windfalls. Within the next few years, fiscal challenges lie in creating budgetary room for co-financing the much larger project funds that will become available in the EU’s 2007-13 budget, many of which are important for infrastructure development. The co-financing needed to make full use of EU funds will rise from about a ¼ of a per cent of GDP currently to about ¾ of a per cent of GDP. Generating room for these and other necessary infrastructure investment makes all the stronger the case for tighter spending controls elsewhere, so as not to put at risk a steady approach of the budget toward a balanced position, which is necessary to prepare for spending pressures due to population ageing that are set to accelerate. In sum, improving on the deficit outcomes in the lead-up to euro entry, and beyond, will be impossible without permanent savings through public-spending reform and would be helped by better budgeting processes.
Progress in other elements of public-sector reform has been uneven
Though plans for major healthcare reform have been drawn up by successive ministers, none have been implemented. As a result, little progress along the lines suggested in past OECD Surveys has been made. General economies in public spending have also been limited, notably a drive for staff cuts in government ministries has stalled.
Some progress has been made in improving the budgeting system. Various measures to tighten accountability are underway and cuts in the number of off-budget accounts have been made. New rules allowing ministries more freedom to carry over spending have reduced wasteful expenditure but are proving problematic in terms of overall spending control. An adjustment to the rules should be sought that preserves the advantages of this provision, especially for capital spending and EU programmes, while allowing the Finance Ministry to retain control over spending. One avenue that should be exploited is to link carry-over spending with progress in output performance budgeting. Use of public-private partnerships to help public finances remains limited, though legislation currently in the parliamentary process aims at paving the way to much greater use in the future. Such partnerships can help financing but need expertise and careful structuring to avoid undesirable long-term liabilities.
A second broad policy challenge is improving labour-market efficiency
and the skills base
While the most powerful long-term driver of catching-up has to be rising productivity, catch-up in GDP-per-capita can also be fostered through greater use of labour resources. Recent labour-market outcomes have been encouraging but fundamental problems remain, notably long-term unemployment. About half of the unemployed have been out of work for at least a year and they are strongly concentrated in certain regions of the country. Employment creation – in particular for groups with a low labour market attachment – is hampered by the high tax wedge and strict employment protection legislation on regular employment. As regards future productivity growth, the skills base is of crucial importance. Though the education system is performing reasonably well on some fronts, further reforms are needed to cater to the rapidly expanding demand for tertiary-level education. Secondary-school attainment has traditionally been high, but in the working-population as a whole the Czech Republic has one of the lowest shares of degree-level attainment in the OECD. However, change is underway due to a rapid rise in the tertiary enrolment rate among school leavers. This is only partially offset by population decline in young cohorts and overall demand for tertiary education courses is expected to continue growing for some time.
Some positive steps have been made in welfare reform and labour legislation
Stepping up labour utilisation requires a range of measures raising both the supply and demand for labour aimed at improving incentives and encouraging greater flexibility in the labour market.
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A number of measures have been taken to make the welfare system more work-oriented. In particular, as of January 2007, a new job-search bonus will be introduced, in-work benefits strengthened and sick pay arrangements improved. In addition, agreement has finally been reached on a schedule for removing rent control in housing, which should help labour mobility. Some progress towards more flexible labour legislation and wage setting has been made. The new labour code, if approved, will bring wider contractual freedom through modernisation of the legislation. Among the specific provisions in the code, legislation on working time accounts in particular should help flexibility. However, further lightening of rules on dismissal for those on permanent contracts is still required.
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In wage setting, large increases in the minimum wage have been granted in the first half of this year, continuing an upward trend seen since the late 1990s that has already been detrimental to international competitiveness and job creation.
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Reduction in the large tax wedge on labour needs to remain a broad policy priority as this is damping employment throughout the labour market. The resources for doing this are, however, limited by the need for fiscal consolidation and by competing priorities on spending and revenue reduction. Cuts in the wedge may therefore have to focus on reducing non-wage labour costs at the low end of the labour market.
A third broad challenge is improving business conditions
The business sector has to play a key role in closing the gap in GDP per capita with other OECD countries. As discussed above, the financial environment for business is quite good with low inflation and borrowing costs. However, the slow progress in reforms to labour regulation is damping business development. On other policy fronts, challenges remain in improving administrative process, overcoming weakness in specific areas of business legislation and in dealing with corruption. In addition, there are challenges in ensuring that taxation and business support achieve policy objectives efficiently, particularly in the area of innovation policy.
New bankruptcy legislation has been introduced
Bankruptcy legislation has long been criticised as hampering the efficient use of capital in the Czech Republic. Following several previous attempts, new bankruptcy legislation passed in early 2006 aims to strengthen the position of creditors in various ways, including the introduction of a “re organisation” option. Also welcome are legal changes that aim to reduce the administrative tasks of judges, lighten checking procedures in legal processes and shorten the maximum time allowed for registration of a file with the courts. Business registration forms have also been standardised. However, both the new bankruptcy legislation and the steps to cut red tape are likely to need some follow-up action; hence careful monitoring of the impact of these new systems is required. The reduced administrative burden for businesses should also discourage corruption arising from attempts to short-cut processes. The campaign against corruption is also being helped by an increasingly open recognition of the problem and by on-going efforts to introduce new measures to increase accountability, such as the recent proposed legislation that would increase financial disclosure requirements for politicians and public administrators. However, the fight against corruption is by no means over and pressure through new measures to enhance accountability has to be maintained, along with further reductions in the opportunities for corruption through simpler administrative processes.
How to obtain this publication
The Policy Brief (pdf format) in English and Czech can be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.
The complete edition of the Economic Survey of the Czech Republic 2006 is available from:
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SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts (suscribe)
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Additional information
For further information please contact the Czech Republic Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by Philip Hemmings and Alessandro Goglio under the supervision of Andreas Wörgötter. The drafting team was assisted by Lubomir Chaloupka (on secondment from the Czech Ministry of Finance) and Edward Whitehouse (OECD pensions specialist).
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