Statement by OECD Secretary-General during a roundtable at the Czech National Bank

Introductory statement by Angel Gurría, OECD Secretary-General

Prague, 25 April 2008

Good afternoon Ladies and Gentlemen,
It is a great pleasure to be here at the Czech National Bank (CNB). As many of you know we came to Prague to present our 2008 Economic Survey to the government and the general public yesterday; I have also been discussing it with the political leadership. I am interested in hearing your views on its recommendations; hoping we can have a lively discussion on the short and long-term prospects of the Czech economy.

Let me touch briefly on some of the main findings of the Survey. 

Steady progress, but no space for complacency

With real GDP growth over 6% since 2005 and a manageable inflation risk, the Czech Republic is one of the economic bright-spots in the region, and indeed in the OECD area. Growth however will most probably slow this year to 4.5%; largely due to the squeeze on household incomes from a spike in inflation. We think quarterly growth on a year-on-year basis will touch bottom in the fourth quarter of 2008 and then pick up towards potential growth. By the fourth quarter of 2009 it should be close to a 5%. I understand this is roughly in line with projections by other organisations and think-tanks.

This is quite a bright outlook, especially if we consider that it will happen in a global context where near-term growth prospects have generally weakened. As I expressed last week in Washington, during the IMF/World Bank meetings, short-term forecasting models suggest that the US economy is now essentially moving sideways, if not contracting outright.

In the euro area, the deceleration is less abrupt though. Business confidence has held up better, as has export growth – despite euro appreciation. At the same time, unemployment has remained on a downward path. Even so, a spell of subpar growth lies ahead. Outside the euro area risks are apparent in those countries which combine high current account deficits, borrowing in foreign currencies and a generally weak macroeconomic policy framework. Fortunately, the Czech Republic does not fall into this category.

Regarding the current inflation spike, we consider that it will most likely not have significant lasting effects on expectations. We estimate an increase in the CPI of 6.5 to 7% this year. This is mainly due to one-offs, such as the increase in the lower rate of VAT, higher taxes on tobacco products and the health care fee. Furthermore we have some reason to assume that energy and food price increases will decelerate; especially if the world economy is slowing in the absence of growth in the US. We therefore project that inflation will fall to a little below 3% next year. By the fourth quarter of next year, it should be close to 2.5%, year on year, within the tolerance band of the new target. Again, this is roughly in line with others institutions’ forecasts. 

However, vigilance is necessary. The CNB has a lot at stake. Its credibility currently delivers low interest rates. But communication with the markets and the public is difficult; primarily because headline inflation is high, and will remain so in year-on-year figures for much of this year. These are challenging times for central banks. It may be of interest for you that I have just appointed Mr Klaus Schmitt-Hebbel, a German-Chilean economist who worked for the Central Bank of Chile for many years, as the new Chief Economist of the OECD. He is a leading expert on inflation targeting and I am confident that he will further strengthen our understanding of the best way to maintain price stability in turbulent times.

The Survey identifies two main issues and a number of further policy areas which are crucial to maintain the high pace of growth and convergence. The two main issues are: labour market bottlenecks and fiscal sustainability. Further major policy areas are education and the response to globalisation. Finally, a topic for the coming years to decide will be euro entry.

Labour market bottle-necks

One relatively easy-to-identify risk is that labour supply shortages may limit the pace of growth potential. The pool of unemployed is drying up and, according to demographic projections, the working-age population will begin shrinking soon. Our Survey identifies several policy areas where improvements can help: 

• There are avenues for improving general labour market conditions. The recent fiscal package has headed in the right direction by shifting the tax burden away from labour; thereby improving incentives to accept vacancies and expand hours worked. Also, the plans to strengthen activation in the social security system and to reform unemployment benefit are welcome.
• There is a need to press on with parametric change to the pension system; in particular regarding the age of retirement. This would help raise employment rates among older cohorts.
• We believe that family policy could do a better job of helping parents combine work and family. There are plans to facilitate more childcare services, but we think more should be done. Also, and more controversially, we think that the option of up to three years parental leave is too long. There is evidence that excessively long leave periods are damaging for parent careers and through this channel hamper child development.
• We understand that inflows of immigrant workers have already been filling in gaps in the Czech labour market and think that immigration policy should tap this opportunity more fully.
  The other big challenge for the Czech economy is to put fiscal balances on a sustainable path.

Ensuring fiscal sustainability

While currently debt and deficit figures look good, spending pressures are mounting. There is no room for fiscal complacency and we make a number of substantive recommendations in this area.

• A need for more ambitious general-government deficit targets. Given the better-than-expected deficit outcomes, the current targets are doing little work to motivate consolidation.
• Reforms to budgeting processes. Most important, we think there should be deeper scrutiny of spending plans in the preparation phase of the budget. In addition we suggest increasing the enforceability of the Medium-Term Expenditure Framework.
• A need to press on with pensions and healthcare reform. For pensions, further increases in the retirement age are crucial and the defined-contribution “carve out” currently under discussion can potentially mark an improvement on the current system. In healthcare the introduction of fees for some services has been a positive step. The second phase of reform is bold and needs careful design to deliver an improved system.  

Over the long haul, education policy matters tremendously. Our Survey suggests secondary education would be improved by less streaming of students and wider access to courses that provide options for tertiary education; the Czech Republic is one of the OECD countries with the lowest share of population with tertiary education.

Education is not only important from a humanistic point of view. It is important to increase competitiveness and productivity, to maintain employability throughout working lives and to facilitate innovation. Two weeks ago I was in Berlin to launch the Economic Survey for Germany and our education policy chapter served as a catalyst for debate, receiving most attention in the media.

Some other areas of structural policies can also help to sustain high growth. Ensuring good policy on transport infrastructure is, for instance, one of the few key factors in firms’ location decisions where policy plays a direct role. Also, innovation policy can help encourage high-value adding activity.

Euro entry

Euro entry would help the Czech economy to reap the full benefits of regional integration. The euro area is by far the main trading partner of the Czech Republic both in terms of imports and exports. The investment ties with these countries are also very strong. In fact, only two euro-zone countries ─Germany and The Netherlands─ account for about 60% of total FDI stocks.

Such a strong economic integration with the euro-zone will inevitably increase the ultimate benefits of a common currency. The commitment by the Czech Government to join the euro-zone at the right moment; is a clear signal to foreign investors and trade partners. The earliest possible entry year would be 2012 but there are risks.

The Czech Republic still is making good progress in meeting the Maastricht convergence criteria but nominal convergence will not be complete.

Joining a monetary union, like many important strategic decisions in economic policy, has costs and benefits. Entry to the euro-zone will probably make some Czech exports less expensive due to the absence of trend appreciation. But the loss of trend appreciation means inflation has to do all the work in achieving nominal convergence. And, of course loss of independent monetary policy limits the capacity to keep inflation under control.

But, on the positive side, many businesses will be relieved from exchange-rate uncertainty and associated hedging costs. Joining the euro area will facilitate price comparisons and, therefore, enhance competition. Furthermore, belonging to a larger currency area widens choices for investors and financing.

Let me just conclude by pointing to another potential risk for long-term growth in the Czech Republic: a possible gradual loss of international competitiveness. The rise of more and more competitive companies and investment platforms from emerging economies could drive firms (both domestic and foreign) to relocate production and services elsewhere. Such a process is perhaps inevitable in some activities. But there is a lot the Czech government can do to increase competitiveness and attract foreign investment. In the coming years, three elements will be crucial to improve competitiveness and productivity: increase tertiary education attainment; build a favourable environment for innovation to flourish; and the implementation of migration policy which is consistent with the ageing and educational challenges.

The OECD is already working hard with the Czech Government to help you consolidate and increase the competitiveness and productivity of your economy.

We are helping improving economic performance through our periodic Economic Surveys. We are also providing tools to improve the educational system with our Education at a Glance, the Tertiary Education Review and the triennial PISA studies. A balanced regional development is crucial to make the most of globalisation and our Territorial Review of the Czech Republic can help achieving this objective. We have also worked together in other specific country studies on key issues for the Czech economy, like ageing and employment, energy, social assistance and environmental performance.

And we can do more. In the coming months, our Innovation Strategy will grow increasingly sensitive to the Czech Republic’s concerns. The Competition Committee will be preparing for a peer review of the Czech Republic in June 2008. We are exploring the possibilities of doing the first Territorial Review of Prague. And we are looking at ways in which we can assist the Czech Republic throughout your presidency of the European Union starting January 2009.

I look forward to keep working with you to build the necessary frameworks and policies to consolidate economic growth, increase competitiveness and help the Czech people make the most of globalization.
Thank you very much.