Economic Policies
#22Key Findings
Returning to moderate growth in the wake of the pandemic’s worst months, Czechia falls into the middle ranks (rank 22) in terms of economic policies. Its score on this measure represents a gain of 0.4 points relative to 2014.
While slow to introduce a large COVID-19 response package, the Czech government ultimately devoted considerable resources to stabilization, leading to fiscal deficits well above 5% in 2020 and 2021. The country’s GDP declined by about 5.8% in 2020, and returned to growth of about 3% in 2021.
Thanks to a low employment share in the services sector, Czechia’s unemployment rate proved comparatively stable during the pandemic, rising from 2.0% to a short-lived peak of just 3.5% in 2021. The country had previously been experiencing a severe labor shortage. Average wages have risen steadily, with exceptional growth in the health and social care sectors.
Total state debt remains manageable, having risen from 30% of GDP to about 42% in 2021. Fiscal consolidation is now on the agenda. The government has been criticized for failing to develop an economic strategy that does not rely on production by multinational corporations using imported components. Domestic R&D spending has stagnated at about 2% of GDP.
While slow to introduce a large COVID-19 response package, the Czech government ultimately devoted considerable resources to stabilization, leading to fiscal deficits well above 5% in 2020 and 2021. The country’s GDP declined by about 5.8% in 2020, and returned to growth of about 3% in 2021.
Thanks to a low employment share in the services sector, Czechia’s unemployment rate proved comparatively stable during the pandemic, rising from 2.0% to a short-lived peak of just 3.5% in 2021. The country had previously been experiencing a severe labor shortage. Average wages have risen steadily, with exceptional growth in the health and social care sectors.
Total state debt remains manageable, having risen from 30% of GDP to about 42% in 2021. Fiscal consolidation is now on the agenda. The government has been criticized for failing to develop an economic strategy that does not rely on production by multinational corporations using imported components. Domestic R&D spending has stagnated at about 2% of GDP.
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How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?
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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.
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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.
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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.
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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.
The economic policies of successive Czech governments over the past 20 years have focused on achieving broad macroeconomic stability and attracting inward investment by multinational manufacturing companies drawn by wage levels about half the level of those in wealthier Western European neighbors. This strategy has ensured growth in most years. However, these growth rates have gradually slowed, as the inflow of foreign direct investment has declined markedly since 2008.
At the outset of the COVID-19 pandemic, the Czech government assumed that the pandemic would lead only to a “V-shape”’ recession, meaning a rapid drop followed by a rapid recovery that would return life to normal. Therefore, it focused on weathering the crisis in the short run and did not draw up an explicit economic recovery package. While the crisis has proved to be more protracted than originally thought, its measurable economic cost for Czechia was less than that recorded in many other European countries, with Czech GDP down by only 5.8% in 2020 before rebounding to around 3% growth in 2021. This was partly because of the country’s low share of vulnerable service sector activities and partly because of the strong showing of export-oriented manufacturing. One lasting cost of the COVID-19 pandemic will be higher public indebtedness. Gross public debt rose from about 30% of GDP in 2019 to 38% in 2020 to about 42% in 2021, following lower tax revenues during economic depression and higher spending to counter the effects of the pandemic. That should be a manageable level that poses no serious threat. Another change has been higher inflation, driven by oil, gas and raw material imports, reaching 6.6% in December 2021 over the previous year.
The biggest strategic issue remains the economy’s dependence on the export-oriented motor-vehicle sector. The Babiš government failed to develop a new strategy to reduce the economy’s dependence on multinational companies that consume a high proportion of imported components. Czechia’s National Recovery Program drawn up for the European Commission has been criticized by business organizations and environmental groups alike for its vagueness and its lack of ambition. The failure to develop a new strategy for economic development poses a danger to economic growth and the external balance at a time of transformation toward the production of electric vehicles, for which Czech industry is poorly prepared.
At the outset of the COVID-19 pandemic, the Czech government assumed that the pandemic would lead only to a “V-shape”’ recession, meaning a rapid drop followed by a rapid recovery that would return life to normal. Therefore, it focused on weathering the crisis in the short run and did not draw up an explicit economic recovery package. While the crisis has proved to be more protracted than originally thought, its measurable economic cost for Czechia was less than that recorded in many other European countries, with Czech GDP down by only 5.8% in 2020 before rebounding to around 3% growth in 2021. This was partly because of the country’s low share of vulnerable service sector activities and partly because of the strong showing of export-oriented manufacturing. One lasting cost of the COVID-19 pandemic will be higher public indebtedness. Gross public debt rose from about 30% of GDP in 2019 to 38% in 2020 to about 42% in 2021, following lower tax revenues during economic depression and higher spending to counter the effects of the pandemic. That should be a manageable level that poses no serious threat. Another change has been higher inflation, driven by oil, gas and raw material imports, reaching 6.6% in December 2021 over the previous year.
The biggest strategic issue remains the economy’s dependence on the export-oriented motor-vehicle sector. The Babiš government failed to develop a new strategy to reduce the economy’s dependence on multinational companies that consume a high proportion of imported components. Czechia’s National Recovery Program drawn up for the European Commission has been criticized by business organizations and environmental groups alike for its vagueness and its lack of ambition. The failure to develop a new strategy for economic development poses a danger to economic growth and the external balance at a time of transformation toward the production of electric vehicles, for which Czech industry is poorly prepared.
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How effectively does labor market policy address unemployment?
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Successful strategies ensure unemployment is not a serious threat.
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Labor market policies have been more or less successful.
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Strategies against unemployment have shown little or no significant success.
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Labor market policies have been unsuccessful and rather effected a rise in unemployment.
The labor market situation in Czechia is stable. Employment rates are high, and the unemployment rate has been the European Union’s lowest for some time. In the years before the COVID-19 pandemic, Czechia experienced a labor shortage that has been more severe than in any other European country, according to evidence from employer surveys. The lack of staff with the right skills is identified as a barrier to investment by employers. This situation partly reflects weaknesses in the education system and, in part, pay levels for highly skilled workers, which remain unattractive by international standards. An adequate active labor market policy plan to prepare the labor market for the economy’s necessary restructuring has not yet been developed.
As a result of the COVID-19 pandemic, the unemployment rate rose from an average of 2.0% in 2019 to an average of 2.6% in 2020 and to a peak level of 3.5% in March 2021, before falling to 2.3% in November 2021. Total employment has yet to return to pre-pandemic levels, but the shortage of labor experienced in previous years seems to have intensified. The number of employed persons increased across most sectors of the economy in the later months of 2021, while they remained below previous levels in service sectors that faced reduced demand due to lower levels of tourism. The number of self-employed also declined, owing to the large number of self-employed in hospitality and catering, which were hit hard during the pandemic. Labor shortages elsewhere have been partly covered by an increase in the employment of foreign workers, with 720,000 foreign workers or almost 18% of the labor force at the end of 2021, the highest level ever in Czechia. The labor shortage has also increased pressure for higher wages in some sectors. Average wages were up by 5.7%, with similar figures in manufacturing, and public and private services (third quarter of 2021 over the same period in 2020), albeit this equated to only a 1.5% increase in real wages owing to the higher price level. An exceptionally large increase was 8% in health and social care, while the minimum wage increased by only 4.1%, suggesting a possible loss in purchasing power for the lowest earners. Thus, the pandemic has not significantly changed existing trends, with labor shortages affecting all skill levels.
As a result of the COVID-19 pandemic, the unemployment rate rose from an average of 2.0% in 2019 to an average of 2.6% in 2020 and to a peak level of 3.5% in March 2021, before falling to 2.3% in November 2021. Total employment has yet to return to pre-pandemic levels, but the shortage of labor experienced in previous years seems to have intensified. The number of employed persons increased across most sectors of the economy in the later months of 2021, while they remained below previous levels in service sectors that faced reduced demand due to lower levels of tourism. The number of self-employed also declined, owing to the large number of self-employed in hospitality and catering, which were hit hard during the pandemic. Labor shortages elsewhere have been partly covered by an increase in the employment of foreign workers, with 720,000 foreign workers or almost 18% of the labor force at the end of 2021, the highest level ever in Czechia. The labor shortage has also increased pressure for higher wages in some sectors. Average wages were up by 5.7%, with similar figures in manufacturing, and public and private services (third quarter of 2021 over the same period in 2020), albeit this equated to only a 1.5% increase in real wages owing to the higher price level. An exceptionally large increase was 8% in health and social care, while the minimum wage increased by only 4.1%, suggesting a possible loss in purchasing power for the lowest earners. Thus, the pandemic has not significantly changed existing trends, with labor shortages affecting all skill levels.
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How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?
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Taxation policy fully achieves the objectives.
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Taxation policy largely achieves the objectives.
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Taxation policy partially achieves the objectives.
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Taxation policy does not achieve the objectives at all.
As the low fiscal deficits before the COVID-19 pandemic show, tax policy in Czech has traditionally ensured the availability of adequate financial resources for spending commitments. The progressiveness of the tax system has been limited by a flat income tax, a strong reliance on the value-added tax (VAT) and high social security contributions. While the statutory corporate income tax rate has been relatively low, enterprises have complained about cumbersome procedures. Businesses can apply tax deductions to research and development, but have not yet fully exploited this option, due to the ambiguous interpretation of the law by the tax authorities and the complex administrative process. Adaptations to the tax system to reduce environmental harm were required to join the European Union and were legislated in 2007.
The Babiš government proposed a major income tax reform in 2019. Initially postponed for fiscal reasons, the reform was eventually approved by the Chamber of Deputies at the end of November 2020, at a time of a growing budget deficit due to the pandemic measures. The most hotly debated novelty was a change in the method of calculating personal income tax, which abandoned the so-called super-gross wage (including social insurance contributions in the sum) introduced in 2008 by a government determined to appear to be cutting personal income tax rates to a flat rate of 15%. The abandonment of the super-gross wage has been associated with the transformation of the so-called solidarity surcharge, introduced in 2013, into an explicit second personal income tax rate of 23%. The government justified the reform both as a way of enshrining progressivity and as a measure to foster economic recovery. Critics, including the Fiscal Council (Národní Rozpočtová Rada, ÚNRR), have regarded the tax cuts mainly as a campaign goody ahead of the parliamentary elections in 2021 that will harm the sustainability of public finances. As a matter of fact, revenue from personal income taxes fell by 35.6% in 2021.
Save for the changes to the personal income tax, there were few tax changes in 2020 and 2021. The Babiš government did not adopt the announced changes to the tax code to support a new innovation strategy. Nor did it complete the preparation of a new tax on the use of coal and gas, promised to the European Commission in 2019.
The Babiš government proposed a major income tax reform in 2019. Initially postponed for fiscal reasons, the reform was eventually approved by the Chamber of Deputies at the end of November 2020, at a time of a growing budget deficit due to the pandemic measures. The most hotly debated novelty was a change in the method of calculating personal income tax, which abandoned the so-called super-gross wage (including social insurance contributions in the sum) introduced in 2008 by a government determined to appear to be cutting personal income tax rates to a flat rate of 15%. The abandonment of the super-gross wage has been associated with the transformation of the so-called solidarity surcharge, introduced in 2013, into an explicit second personal income tax rate of 23%. The government justified the reform both as a way of enshrining progressivity and as a measure to foster economic recovery. Critics, including the Fiscal Council (Národní Rozpočtová Rada, ÚNRR), have regarded the tax cuts mainly as a campaign goody ahead of the parliamentary elections in 2021 that will harm the sustainability of public finances. As a matter of fact, revenue from personal income taxes fell by 35.6% in 2021.
Save for the changes to the personal income tax, there were few tax changes in 2020 and 2021. The Babiš government did not adopt the announced changes to the tax code to support a new innovation strategy. Nor did it complete the preparation of a new tax on the use of coal and gas, promised to the European Commission in 2019.
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To what extent does budgetary policy realize the goal of fiscal sustainability?
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Budgetary policy is fiscally sustainable.
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Budgetary policy achieves most standards of fiscal sustainability.
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Budgetary policy achieves some standards of fiscal sustainability.
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Budgetary policy is fiscally unsustainable.
Before the COVID-19 pandemic, Czechia’s favorable economic performance allowed the government to retain its objective of reducing the general government fiscal deficit and stabilizing the public debt, while also allowing some expansion of domestic demand. While the central government posted small deficits, the general government budget produced a surplus between 2016 and 2019. Once the Czech government realized the seriousness of the COVID-19 pandemic, it responded in line with the advice of international agencies to do “whatever it takes” to protect public health, and to prevent damage being done to the economy and employment, thus leaving the resulting increase in public debt to be handled later. The result was a general government fiscal deficit of 5.8% in 2020, the highest since Czech independence, followed by a similarly high deficit in 2021. As a result, public debt rose from 30% of GDP in 2019 to 38% in 2020 and to 45% of GDP in 2021. While this is still a manageable level, the increase in debt means a narrowing of the government’s future fiscal space.
In order to allow for the increase in the fiscal deficit, the 2017 Fiscal Responsibility Act was amended in April 2020. The amendment approved a structural fiscal deficit of up to 4% of GDP in 2021 and called for annual reductions by at least half a percentage point until the medium-term budgetary objective is met again. Whether or not these targets will be met, strongly depends on the future performance of the Czech economy. In 2020 and 2021, the Babiš government refrained from tapping any potentials for savings on the expenditure side of the budget in 2020 and 2021. Moreover, its controversial 2020 personal income tax reform has caused substantial revenue losses. The incoming Fiala government has announced that it will speed up fiscal consolidation.
In order to allow for the increase in the fiscal deficit, the 2017 Fiscal Responsibility Act was amended in April 2020. The amendment approved a structural fiscal deficit of up to 4% of GDP in 2021 and called for annual reductions by at least half a percentage point until the medium-term budgetary objective is met again. Whether or not these targets will be met, strongly depends on the future performance of the Czech economy. In 2020 and 2021, the Babiš government refrained from tapping any potentials for savings on the expenditure side of the budget in 2020 and 2021. Moreover, its controversial 2020 personal income tax reform has caused substantial revenue losses. The incoming Fiala government has announced that it will speed up fiscal consolidation.
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To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?
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Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
The Babiš government continued the previous government’s verbal commitment to aim for the EU target of an R&D spending level equivalent to 2.5% of GDP. Despite the substantial EU co-financing, however, R&D spending has stagnated at about 2% of GDP and even slightly declined in 2020. Five foreign-owned companies and the automotive sector continue to account for 50% of total research in the business sector. Foreign and domestic businesses benefit from indirect subsidization, as 100% of R&D expenditure is exempt from taxation. However, many smaller enterprises complain that this exemption has not been honored in practice. Various reports have highlighted R&D weaknesses, suggesting a low effectiveness rate for much of what has been spent. Problems include the failure to attract and retain young, qualified researchers, who take advantage of the European Union’s free movement of people to find better-paid work in other countries; and the low employment level among women (who accounted for just 30% of researchers in 2020), which suggests that this population’s potential is not being fully utilized, and which may be a negative consequence of the lack of services supporting the work-life balance. Research groups often exhibit little change, with the same people staying together throughout their careers, and thus failing to benefit from experience acquired elsewhere. New research centers have frequently failed to make significant international contacts, and are often ignored by (largely foreign-owned) manufacturing companies.
The R&D sector, including universities and research institutes, reacted proactively to the pandemic after the government organized various forms of support. COVID-19 testing developed rapidly, but Czechia’s response to the pandemic has not helped the country move toward the forefront of international scientific development. The Czech government’s National Recovery Plan, as approved by the European Commission in July 2021, includes some measures to support quality research, especially in medical sciences, but does not address the structural problems of the Czech R&I sector.
The R&D sector, including universities and research institutes, reacted proactively to the pandemic after the government organized various forms of support. COVID-19 testing developed rapidly, but Czechia’s response to the pandemic has not helped the country move toward the forefront of international scientific development. The Czech government’s National Recovery Plan, as approved by the European Commission in July 2021, includes some measures to support quality research, especially in medical sciences, but does not address the structural problems of the Czech R&I sector.
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To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?
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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.
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The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
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The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
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The government does not contribute to improving the regulation and supervision of financial markets.
Czechia is not a significant player in international financial affairs. Its main banks are foreign-owned, and their independent international involvement is limited. The country has participated in some attempts to improve the regulation and supervision of financial markets, but has not shown much initiative. It has declined to introduce the euro, and has not sought to join the European banking union.