Czechia

   

Economic Policies

#19
Key Findings
With a strong but slowing economy, Czechia falls into the middle ranks (rank 19) in terms of economic policies. Its score on this measure represents a gain of 1.0 point relative to 2014.

Previously high growth rates have moderated, but remain strong. Consumer spending has continued to increase, driven by strong wage increases across the economy, including a substantial hike in the minimum wage and large public-sector pay increases.

Unemployment rates were the lowest in the EU in 2018. Labor shortages, especially in skilled categories, are increasing problem, helping to drive the rising wage levels. Direct taxes, including the flat personal income tax, are low. A major income-tax reform passed in 2018 has been delayed until 2021 due to revenue-reduction fears.

Public debt is very moderate by EU standards, with recent fiscal surpluses helping to push it further downward. R&D spending is rising, approaching the EU average. The government has taken plans to join the euro zone off the agenda.

Economy

#16

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
7
The Czech economy has been among the fastest growing in Europe, with real GDP up by more than 4.3% in 2017 relative to 2016. However, growth slowed to about 2.9% in 2018. Stagnating motor vehicle exports, previously the main driver of growth, account in large part for the slower export growth. There may have been an effect from a higher exchange rate, following the decision in 2017 to abandon the commitment to a lower rate, but this remains to be proven. Consumer spending has continued to increase, thanks to pay increases across the economy, partly stimulated by an 11% increase in the minimum wage in January 2018, higher public sector pay, especially in education and public administration, and effectively zero interest rates on consumer credit. These pay increases marked a continuation of the previous Social Democratic government’s support for higher wages government and led to a return to slight budget deficit in the first half of 2018.
The competitiveness of the Czech economy is based on low wages, and the country acts more as a subcontractor than end-producer. This means economic stakeholders in the Czech economy lose out on the added-value of sales to the end customer and the profits associated with spare parts supply, service, training and future innovations. More than 60% of Czech exports belong to foreign companies; as a supplier of manufacturing services, the country is poorly connected to the world of innovation. The Czech Chamber of Commerce emphasizes the need introduce an appropriate tax policy that would compel foreign-owned companies to reinvest their profits in the country and thereby strengthen the competitiveness of Czech products. The Sobotka government sought to increase investment in education, R&D and the development of an environment for innovative activities within the domestic economy. In practice, however, improvements in these areas remain inadequate and have depended on EU funding.

Labor Markets

#17

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
7
The labor market situation in Czechia has improved considerably since 2014, but broadly stabilized after 2017 and has seen little change in 2018. The unemployment rate was the lowest in the EU in 2018 and the lowest in Czechia since 1998. However, the government has done little to address the substantial differences in unemployment with regard to regions and qualifications and the growing labor shortages reported across the economy. In 2018, the number of vacancies reached almost three times the number of active job seekers. The shortage of skilled labor is a major constraint on the manufacturing industry, discouraging inward investors from moving more demanding activities into Czechia. Complex regulations complicate the employment of foreigners from outside the EU, the European Economic Area and Switzerland.

The growing labor shortages, along with more aggressive bargaining practices from trade unions, has helped drive wage increases to a level only slightly below that of 2017, reaching 8.5% in nominal terms for the first three quarters of 2018. However, the biggest stimulus for higher wages has been government decisions over minimum wages and public sector pay, with the biggest increase being 13.2% in education, billed as indicating a recognition of the importance of that sector for economic performance.

Taxes

#10

To what extent does taxation policy realize goals of equity, competitiveness and the generation of sufficient public revenues?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
7
Compared with other OECD countries, the Czech tax-to-GDP ratio is low. While revenues have been sufficient to generate a small fiscal surplus ever since 2016, it will be challenging to ensure sustained financial support for areas such as education, R&D, and environmental protection after 2020, when EU structural funding terminates. The Czech tax system broadly ensures horizontal equity. One exception is the blanket tax allowance given to the self-employed to cover operating expenditure with no checks on what is actually spent. This leads to a lower tax rate on the self-employed rather than employed and an incentive to convert employment contracts into contracts for individual services. While revenues from direct taxes are low and there is nominally a flat personal income tax, a degree of vertical equity is achieved by a tax allowance on personal income taxes, a solidarity surcharge on higher incomes and some differences in VAT rates. Tax rates for enterprises are modest, but tax compliance costs relatively high. The Babiš government proposed a major reform of the income tax in 2018, but eventually postponed it until 2021 because of the resulting reduction in tax revenues.

Budgets

#11

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
7
Improved economic performance enabled the Czech government to retain its objective of broadly balanced budgets and reduced public debt while allowing some expansion of domestic demand. For the first time since 1994, and despite original plans for a deficit, Czechia ran a fiscal surplus in 2016. Largely due to the strong showing of tax revenues, the general government fiscal surplus further increased in 2017 and was stabilized at about 1.5% of GDP in 2018. Public debt has fallen from 44.9% of GDP in 2013 to 34.7% in 2017 and continued to decline in 2018, remaining among the lowest in the EU and well below the debt limits of 55% and 60% of GDP as defined in the 2017 fiscal responsibility law.

After years of controversy, the government won approval for the Act on Fiscal Responsibility in January 2017. This act sets debt limits for all tiers of government, introduces a central government expenditure ceiling and created an independent Fiscal Council (Národní Rozpočtová Rada, ÚNRR) However, the appointment of the latter’s members progressed slowly, so that it started its work only in 2018. The Council has criticized the small central government deficit envisaged in the 2019 budget for being pro-cyclical and has called for leveraging the current economic prosperity to create fiscal leeway for hard times.

Research, Innovation and Infrastructure

#28

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
5
In its last year in office, the Sobotka government committed to expanding government spending on R&D, aiming to reach the EU target for total R&D spending of 2.5% of GDP in 2020. The Babiš government has continued the verbal commitment to R&D. However, past high levels of total spending were heavily dependent on support from EU funds, raising the total to 1.9% of GDP for the 2013-15 period, with a strong emphasis on investment in new facilities that were yet to show benefits in actual research output. There was a small revival in government spending in 2017, bringing total R&D spending back to 1.8% of GDP, which is still below the EU average of 2.0%. The revival in the total reflects a shift in structure with business enterprises increasing their contribution to 57% of the total (against 49% in 2010). Five foreign-owned companies and the automotive sector (which includes vehicle production businesses) accounted for 50% of total research in the business sector. Foreign and domestic businesses alike benefit from indirect subsidization, as 100% of R&D expenditure should be exempt from taxation. Many smaller enterprises complain that this has not happened in practice.

Weaknesses in the R&D area include a perceived lack of government strategy, a failure to attract and retain young, qualified researchers – who benefit from the free movement of people within the EU to find better-paid work in other countries – and a low level of employment for women (23% of researchers in 2017) which suggests a loss of potential and could be a negative effect of poor services to support a work-life balance. Research groups often show little mobility, with the same people staying together throughout their careers and not bringing benefits from experience elsewhere. As a result of these problems, the capacity to take advantage of increased funding opportunities has been limited. Several new programs established by the Technological Agency (TA ČR) – new competence centers aimed at fostering both research excellence and the application of research results - were unable to redistribute all funds. Similarly, the Grant Agency of Czechia was unable to successfully distribute a significant part of the increased funding.

Global Financial System

#28

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial System
5
Czechia is not a significant player in international financial affairs. Its main banks are foreign-owned, and their independent international involvement is very limited. The country also did not participate in reforming the international financial system, preferring to see itself as a follower of initiatives developed elsewhere. While the Sobotka government made a turn from the euroskeptic policy of previous governments toward a more mainstream view of EU economic policy, neither the Ministry of Finance nor the Czech National Bank have come out in favor of accession to the EU Banking Union. The Babiš government has removed joining the euro zone from the agenda.
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