CZECH REPUBLIC 2006 - CERGE-EI · 2007. 3. 19. · CERGE-EI is an economics department jointly established by Charles University in Prague and the Academy of Sciences of the Czech

CZECH REPUBLIC 2006

A c c e l e r a t e d G r o w t h

Center for Economic Research and Graduate Education of Charles University& Economics Institute of the Academy of Sciences of the Czech Republic

An Economic SurveyProduced by

CERGE-EI is an economics department jointlyestablished by Charles University in Prague andthe Academy of Sciences of the Czech Republic.It provides an American-style Ph.D. program ineconomics and conducts state-of-the-art researchin theoretical and policy-related economics, witha particular emphasis on the transition to freemarkets and European integration. The Ph.D.degree from CERGE-EI is fully recognized both inthe Czech Republic and in the United States.

CERGE-EI’s mission started in 1991 with agoal to educate a new generation of economistsfrom postcommunist countries. Our graduatesare already filling posts in the IMF, World Bank,EBRD, OECD, regional central banks and minis-tries, universities, and private financial institutions.CERGE-EI plays a major role in preventing braindrain by keeping promising students in the regionand attracting scholars who have been trained inthe West. Over 70% of graduates remain in theregion or deal with the region in internationalorganizations, which contrasts sharply with the5% of Central and Eastern Europeans who returnafter receiving a Ph.D. in the USA. About onethird of the students are from the Czech Republic,the rest comes from essentially all postcommunistcountries. All courses are taught in English.

CERGE-EI maintains high academic standardsby employing professors and researchers trainedat top American and universities. Current faculty

members come from the Czech Republic, Russia,South Korea, Germany, USA, Turkey, Croatia, andSlovakia. They regularly publish in internationaljournals and present at conferences around theworld. CERGE-EI also runs the largest economicslibrary in the region.

CERGE-EI is institutionalized as a joint work-place of two separate entities: Center for EconomicResearch and Graduate Education of Charles Uni-versity in Prague and the Economics Institute ofthe Academy of Sciences of the Czech Republic.The co-operation agreement between these twoentities enables the efficient pooling of human,technical and financial resources of both institu-tions. Both the Academy and the University playan invaluable role in making CERGE-EI’s uniqueacademic and research program possible.

CERGE-EI is financed by the Czech government,grants from international institutions, and privatedonations. Contributions from foundations andcorporate donors have been essential in attractinginternational faculty and students. A substantialincrease in CERGE-EI’s endowment is requiredin order to extend its service to the least devel-oped parts of the former communist bloc andto enhance CERGE-EI’s high academic standards,its international character, and its position asthe leading center of research and education ineconomics in Central and Eastern Europe.

Said about CERGE-EI: “I was impressed by the quality of the program at CERGE-EI when I visited there. It is a leaderin economic education and research in the region.”Gary Becker, Professor, University of Chicago, and 1992 Nobel Laureate in Economics

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About CERGE-EI

CZECH REPUBLIC 2006

A c c e l e r a t e d G r o w t h

Charles University in PragueCenter for Economic Research and Graduate Education

Economics InstituteAcademy of Sciences of the Czech Republic

P r a g u e

D e c e m b e r 2 0 0 6

Editors:Petr Zemčík and Krešimir Žigić

Authors:

Editorial assistant:Silan Teymurtas

English editing:Robin-Eliece Mercury

The opinions expressed in this booklet are those of the author(s) and do not necessarily reflect the officialposition of CERGE-EI, Charles University, or the Academy of Sciences of the Czech Republic.

This publication has been approved by the External Publications Review Committee of CERGE-EI.

© CERGE UK, 2006

ISBN 80-7343-110-6 (Univerzita Karlova. Centrum pro ekonomický výzkum a doktorské studium) ISBN 80-7344-099-7 (Akademie věd České republiky. Národohospodářský ústav)

Ilkin Aliyev (III)Oxana Babetskaia-Kukharchuk (III)Ian Babetskii (VIII)Jan Bena (IV)František Brázdík (III)Petra Brhlíková (IV)Martin Čihák (IV)Martin Fukač (III)Zuzana Fungáčová (IV)Martin Gregor (II)Dana Hájková (VIII)Jan Hanousek (IV)Martina Horníková (VIII)Štepán Jurajda (V)Michal Kejak (III)Ondřej Knot (IV)David Kocourek (I)

Evžen Kočenda (III, IV)Lubomír Lízal(I)Vyacheslav Mikhed (VI)Daniel Münich (V)Andreas Ortmann (IV)Yuliya Rychalovská (III)Vilém Semerák (VIII)Ondřej Schneider (VI)Katarína Svítková (IV)Eva Tošovská (VII)Peter Tóth (III)Juraj Valachy (III)Ondřej Vychodil (IV)Bruno Wertlen (IV)Petr Zemčík (III)Alena Zemplinerová (III, VI)Jozef Zubrický (VI)

I. General Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5I.1 The Czech Republic – Economic Summary of 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5I.2 History and Geography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6I.3 Population . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Living standards during transition: GDP versus consumer durables . . . . . . . . . . . . . . . . 9II.2 Electoral System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

II. Political and Institutional Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11II.1 Constitutional System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11II.3 Electoral History of the Czech Republic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Current Major Political Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14II.4 Elections of 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15II.5 Regional Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

III. Macroeconomy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18III.1 Gross Domestic Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18III.2 Public Budget Deficits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19III.3 Monetary policy in 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Exchange rate pass-through into Czech inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23III.4 Exchange Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24III.5 Foreign Trade and Balance of Payments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25III.6 Foreign Direct Investment (FDI) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

The Attractiveness of Czech Firms to Foreign Investors in the Post 1995 Period . . . . . 29

IV Financial and Business Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31IV.1 Financial Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Interdependence of Central and Eastern European Stock Markets . . . . . . . . . . . . . . . 33IV.2 Czech Capital Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

Protection of Minority Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35IV.3 Legal Framework and Bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37IV.4 Developments in the Telecommunications’ Industry. . . . . . . . . . . . . . . . . . . . . . . . . . . 39IV.5 Corruption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40IV.6 Nonprofit Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

V. Labor market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45V.1 Human Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

Admission to Selective Schools, Alphabetically . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46V.2 Employment, Unemployment, and Wages. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Wages of Czech Female Managers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50V.3 Labor Market Institutions and Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Admission of Students to Secondary Schools: Crazy Matching . . . . . . . . . . . . . . . . . . 52

CONTENTS

VI. Public Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53VI.1 Pensions in Central Europe: Threat or Opportunity . . . . . . . . . . . . . . . . . . . . . . . . . . . 53VI.2 Tax-Benefit system in the Czech Republic. How Does It Influence

Incentives to Supply Labor?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56VI.3 Rent Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58VI.4 State Aid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

VII. Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62VII.1 The Environmental Success of Transition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

ECO-Industry in Czech Republic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

VIII. The Czech Republic and the European Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67VIII.1 The Czech Republic – two years in the EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67VIII.2 The Role of International Trade in Reaping the Benefits of EU Membership . . . . . . . . . 75

Wage Flexibility in the Enlarged EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

IX. Comparative Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

X. List of CERGE-EI Working Papers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

The year 2005 was the first one duringwhich the country was for the whole year anEU member, so it provides the first results ofthe effect of the enlargement that is not con-taminated with out-of-EU data. The CzechRepublic has experienced one of its highesteconomic growth years. The EU, and mem-bership turned out to be an additional push.GDP growth was at 6.1% and 2006 shouldnot be any different. This is better than anyneighboring country (having a tie with Slova-kia), but Latvia and Estonia were even ableto reap the benefits of double digit growth.

Other figures do not show that muchimprovement, if any. Again, better than ourneighbors, but we are not a leader of thenew member state pack. Despite this strongeconomic growth, the unemployment ratehas not sufficiently declined even though it isamong the lower ones. The Czech Republicwitnessed 8.9% unemployment at the endof 2005, which is about 0.6% lower than ofa year before when growth was only 4.2%.

The Czech economy is still ranked high interms of FDI attractiveness (number 1 accord-ing to the WCY 2006). The FDI fluctuatessubstantially, from 4.9 bln. USD in 2004 itpeaked to 11 bln. in 2005, but 2006 is ex-pected to be similar to 2004. To completethe picture, inflation slowed down to 1.9%in 2005 and accelerated in 2006.

Unfortunately, rapid growth and lowinflation are coming hand in hand withexpansionist governmental fiscal policy. Thelooming elections of 2006 put both thegovernment and the opposition in the par-liament on a spending spree, and the year2005 has witnessed a deficit of public ex-penditure at an alarming magnitude of 3.6%with no signs of improvement for the future.All reforms were shelved and literally rathernew ways of how to increase public spend-ing are being engineered.

The promised prepared moderate fiscalreforms have been forgotten. Taking intoaccount the fact that the Czech governmentwas not able to fulfill its reform plans neitherin the last year nor in 2003, the fulfillmentof the fiscal criterion in 2004 seems morelike happenstance. In fact, according to the(shelved) fiscal reform, the 3% criterion isexpected to be exceeded in future years.

To sum up, EU entry was a success andno catastrophic scenario materialized. Yet,we can see the negative impact in shelvingalmost all reforms and self appreciation ofthe achieved goal. The Euro area entry is notinteresting enough to foster a continuation ofreforms that are vital, namely pension reformand public finances together with labormarket functioning.

www.cerge-ei.cz C Z E C H R E P U B L I C 2 0 0 6 I 5

Chapter I. I GENERAL INFORMATION

I. GENERAL INFORMATION

I.1 The Czech Republic – Economic Summary of 2005

The first signs of people living in whatis today the Czech Republic are as old as1.6–1.7 million years and were found nearBeroun in Central Bohemia. The first Slavonicpeople came in the 5th and 6th centuries. Thefirst written references to the Czechs, Prague,and regions of Bohemia appeared in the8th and 9th centuries. In about the year 870,the Czech prince Bořivoj was mentioned forthe first time. He came from Prague andbelonged to the house of Přemysl, whichlater became the royal dynasty of Bohemia.This dynasty governed the Czech kingdomuntil 1306. During the reign of the Houseof Luxembourg (1310–1436), Bohemia wasthe center of the known Holy West RomanEmpire of German People, and Praguebecame one of the cultural centers of Europe.A short period of elected kings ended in

1526 when the Czech Kingdom (Bohemia,Moravia, and Silesia) became a part of Aus-tria, later the Austro-Hungarian Monarchy.

In 1918, after World War I, Czechoslova-kia emerged from the ruins of the Austro-Hungarian Monarchy as a modern democraticstate. Czechoslovakia, consisted of Bohemiaand Moravia, Slovakia and Carpatho-Russia(today a part of Ukraine). In 1939, Slovakiaseparated from Czechoslovakia and the Czechpart of the country was occupied by theGerman army and incorporated as a specialautonomous state into the German Empire.In 1945, Czechoslovakia was liberated by theSoviet and American armies. The Czecho-slovak state was restored without Carpatho-Russia, which joined the Soviet Union.

In February 1948, the Communist partygained power (in a formal constitutional way),

6 I C Z E C H R E P U B L I C 2 0 0 6 www.cerge-ei.cz


I.2 History and Geography

U. K.

BELGIUM

LUXEMBOURG

THENETHERLANDS

SWITZERLAND

SLOVENIACROATIA

BOSNIA SERBIA &MONTENEGRO

LITHUANIARUSSIA

GERMANY

DENMARK

FRANCE

POLAND

AUSTRIAHUNGARY

ITALY

ROMANIA

BELARUS

UKRAINE

BULGARIA

CZECHREPUBLIC

SLOVAKIA

and Czechoslovakia was under the Sovietsphere of influence until 1989. After the“Velvet Revolution” in 1989, the democraticregime was restored.

In response to the Slovak desire for greaterself-determination, a federal constitution wasintroduced in 1968. Completely controlledby the Communist Party, the CzechoslovakFederation had not satisfied the legitimateaspirations of the Slovak people. From 1990on, Czech and Slovak political leaders nego-tiated the future form of the federation. After

two years of unsuccessful negotiation andfollowing the 1992 parliament elections, thecountry was peacefully divided into the CzechRepublic and Slovak Republic on January 1,1993. In 1999, the Czech Republic joinedNATO; it became an EU member in May2004.

In terms of its area (76,867 square kilo-meters), the Czech Republic ranks amongthe smaller European countries. The CzechRepublic shares borders with Germany,Austria, the Slovak Republic and Poland.



Milestones of the Czech Lands in the 20th Century

1918 After the collapse of the Austro-Hungarian Monarchy, the First Czechoslovak Republicas a common state of Czechs and Slovaks was established.

1920 A democratic constitution was adopted.

1938 The Munich Agreement, occupation of part of Czechoslovakia by Germany andHungary; the Second Republic, Czecho-Slovakia, was established with extendedSlovak autonomy.

1939 The rest of the Czech territory was occupied by Germany, an independent Slovak statewas established.

1945 Liberation, the Czechoslovak Republic was restored.

1948 Communists took over the country, marking the beginning of a 40-year totalitarianregime.

1968 Prague Spring, the invasion of Warsaw Pact armies, a federal constitution adopted.

1989 The Velvet Revolution, end of the totalitarian regime.

1990 The first democratic parliamentary election in 42 years.

1991 Last Soviet military troops left the country.

1992 The separation of Czechoslovakia, establishment of the Czech and Slovak Republicsin 1993.

1999 On March 12, the Czech Republic officially joined NATO.

2004 In May 2004, the Czech Republic joined the EU.

With a population of 10.289 million (2001census), the Czech Republic is similar in sizeto Austria, Belgium or Hungary. Its popula-tion is ethnically homogeneous with an over-whelming majority of Czechs (94.8%), aSlovak minority (3.1%) and small Polish(0.6%) and German (0.5%) minorities (seeTable I.3.1 for absolute numbers). However,there is also a large and socially segregatedethnic minority of Romanies. The total size ofthis minority is hard to estimate. The Czech



I.3 Population

Table I.3.2 Age Structure of Population (in %)

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

0–14 20.0 19.5 18.8 18.3 17.9 17.7 17.0 16.2 15.9 15.6 15.2 14.9

15–64 67.1 67.6 68.0 68.4 68.7 69.0 69.3 69.0 70.3 70.5 70.8 71.0

65+ 12.9 13.0 13.1 13.3 13.4 13.6 13.7 13.9 13.8 13.9 13.9 14.0

Average Age 36.6 36.8 37.0 37.3 37.6 37.9 38.3 38.8 39.0

Median Age 35.9 36.0 36.2 36.4 36.6 36.8 37.0 37.6 n.a.

Index of Aging* 64.3 66.8 69.6 72.3 75.3 78.1 80.5 85.5 87.0 89.0 92.0 94.0

Sources: CSO Statistical Yearbook of the Czech Republic 2000, http://popin.natur.cuni.cz, CSO

* Index of aging – number of persons aged 65 or over for 100 children aged 0–14

Table I.3.1 Ethnic Minorities in theCzech Republic

1991 2001census % census %

Slovak 314,877 3.1 193,190 1.8

Polish 59,383 0.6 51,968 0.5

German 48,556 0.5 39,106 0.5

Ukrainian 8,220 0.1 22,112 0.2

Total 488,933 4.7 807,456 7.9

Source: CSO

15

20

25

30

35

40

Ratio of Population 65+ over Population 15–64

2030201020102000199519911980

Figure I.3.1 Old Age Dependency Ratio Development Projection

Year

Perc

enta

ge

Source: Czech Republic Population Development (CSO, 2001),Projection: Statistical Yearbook 2000, CSO

language is a part of the family of westSlavic languages (together with Polish andSlovak). The working age population (15–64years) accounted for 69% of the total popu-lation as of 2000 (see Table I.3.2). The oldage dependency ratio (the ratio of populationolder than 65 years to the working agepopulation) is on a trend to reach almost onequarter by 2030, putting the current pay-as-you go system in danger of insolvency (seeFigure I.3.2). The prognoses of demographicdevelopment suggest a slow decrease in thepopulation (see Table I.3.3). The decline hastemporarily slowed down due to immigration

and a recent increase in the number of births.As the generation of children born in agovernment generated baby-boom of the1970’s (known as ‘Husák’s children’) reachestheir early 30’s, they have started their fami-lies only now with a delay caused by a shiftin public preferences and a greater stress oncareer prospects for women. The populationnow slowly ages as life expectancy, which isstill far behind that in West European coun-tries, increases. However, infant mortality,while not high by any standards, in 1993, fellto a level which is one of the lowest in theworld.

Living standards during transition: GDP versus consumer durables

Gross domestic product of the Czech Republic in 1991 was by 12% lower than in 1990 andduring nineties stayed below the level of the GDP in 1990. The dramatic fall of the real grossdomestic product was caused by the transformation process of the Czechoslovak economyand later the Czech economy, respectively. A decrease of the real GDP was not surprising forthe situation of the Czech economy during the early stage of its transition. The majority of thetransition countries went through a recession in the beginning of the transformation processfrom a centrally planned economy to a market economy. Since1992, GDP has risen steadilywith the exception of the year1998, but it was still below the level of 1990 during the wholedecade (see Figure I.3.2).

The economy after the Velvet Revolution underwent an enormous structural change towhich individuals, firms, and a newly established government had to get used to. It was to beexpected that this accommodation process was accompanied by a decrease in the standard ofliving of the population. However, one can argue that this was a statistical illusion, in part dueto the fact that a portion of production was never sold and that statistics were manipulated



Table I.3.3 Descriptive Statistics of Population

Year of Census 1961 1970 1980 1991 2001

Number of Municipalities 8,726 7,511 4,778 5,768 6,258

Total Population 9,571,531 9,807,697 10,291,927 10,302,215 10,292,933

Population – Men 4,640,631 4,749,511 4,988,095 4,999,935 5,019,381

Population – Women total 4,930,900 5,058,186 5,303,832 5,302,280 5,273,552

in % 51.5 51.6 51.5 51.5 51.2

Source: CSO

in the communist era in attemptsto fulfill the infamous five-yearplans. A different prospective isgiven if one investigates data onconsumer durables, which tell asomewhat different story. Owner-ship of consumer durables rep-resents an important componentof the living standards of house-holds. The ownership of durablesfollowed a dramatically differenttrend than the GDP during theearly 1990s.

Number of reported consumerdurables per 100 households increased steadily from 1989 (see Figure I.3.3). The number ofconsumer durables didn’t just increase, but there is a significant change in quality of theseconsumer durables. The most illustrative case is television. The number of color TVs in Czechhouseholds has risen, and the structure has moved towards color TVs. In 1989, only 42% ofTVs were color; nowadays, 90% of TVs have a color screen, and the TVs with black and whitescreens have almost disappeared. This process is apparent for washing machines as well. Oldmechanical washing machines were substituted by modern, fully automatic ones.

The number of video recorders and PCs per 100 households is now 20 times bigger thanin 1989. It has increased from 2.7 to 47.0 in the case of video recorders and from 1.8 to 21.4in the case of PCs. Formerly rarely used consumer durables such as microwave ovens, whichhad almost not been used in the Czech Republic in 1989, are nowadays common. Interestingly,the number of cars has not been rising steadily since 1989. The number of cars actuallyslightly decreased in the early nineties, but we observe a steady upward trend since 1995. Theinitial level of 1989 was reached in 1997, and in 2003 one hundred Czech households owned68.3 cars, which is by 10 cars more than in 1989.

These figures suggest that inspite of the decrease of the realGDP during the transformationperiod, the living standard of Czechhouseholds was not affected ifmeasured by the number of con-sumer durables. The number ofconsumer durables didn’t justincrease by a significant amount;the structure in consumer durablesalso shifted towards higher qualityand up-to-date goods.



80

90

100

110

120

130

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

Figure I.3.2. Real GDP Index (1990 = 100)

Year

Perc

enta

ge

Source: computations based on OECD statistics database

0

20

40

60

80

100

120

2000199519921989

Figure I.3.3. Consumer Durables in 1989–2000(per 100 households)

YearSource: Czech Statistical Office

Microwave owen Colour TVVideo recorder

TV with B&W screenPC Fixed line Car

The constitutional system of the CzechRepublic consists of the Parliament andthe President. The Parliament of the CzechRepublic has two chambers: the Lower House(Poslanecká sněmovna) and the Upper House(Senát). The president is elected by bothHouses of Parliament for five-year termsand has limited and mostly representativeresponsibilities. He appoints the Prime Minis-ter and the members of the government, thegovernor of the Central Bank, ambassadorsand the Chief of Staff of the army and signslaws. He can return laws to the Lower House,but his veto can be overridden by an absolutemajority of all the members of the LowerHouse. The current president, Václav Klaus,was elected in February 2003. He replacedVáclav Havel, the leader of the Velvet Revolu-tion, who served as the Czechoslovak presi-dent from 1989 till 1992 and then as theCzech president from 1993 till 2003.

The Lower House is the most importantlegislative body. It has the power to pass

laws by a simple majority of the memberspresent during any given session (providingthe quorum is met), to cast a no-confidencevote against the government, and to overridea veto of the President and of the UpperHouse.

According to stipulations in the constitu-tion, the Upper House has limited legislativeaction and is only authorized to act uponLower House legislation. The Upper Househas three options when faced with billsapproved by the Lower House and must actwithin 30 days: accept by default (take noaction); reject with a suspending veto; orsuggest amendments (in both cases by asimple majority). In the latter two instances,the Lower House can vote either to accept orreject the Upper House action by an absolutemajority of all members of the Lower House.The Upper House can also initiate legislation.If the Lower House is dissolved, the UpperHouse assumes its functions until new elec-tions are held.

The Lower House of Parliament has 200members elected for four-year terms. Aproportional electoral system is used for theLower House which discriminates againstsmall parties: to enter the parliament a partyhas to attain at least 5% of the total numberof valid votes cast nationally. The country isdivided into 8 voting districts and each party

nominates an ordered list of candidates forthe Lower House in each voting district.

In contrast, the Upper House of Parliamentuses the majority system (plurality run-off)to elect its 81 members with one representa-tive for each constituency. The Upper Housemembers are elected for six years with aperiodic replacement schedule in which 27


Chapter II. I POLITICAL AND INSTITUTIONAL DEVELOPMENT

II. POLITICAL AND INSTITUTIONAL DEVELOPMENT

II.1 Constitutional System

II.2 Electoral System

members are elected every two years. Eachpolitical party can nominate one candidatein each of the 81 constituencies. Also, inde-pendent candidates can participate providingthey submit a statement of support signed byat least 1,000 eligible voters from the relevantelectoral constituency. A candidate is elected

on the first ballot if he/she receives a simplemajority of valid votes (at least 50% plus onevote). If no candidate receives a majority onthe first ballot, then the two candidates whoreceive the most votes from the first ballotrerun on the second ballot, and the majoritywinner on the second ballot is elected.

Given the proportional system used forthe Lower House (or, Chamber of Deputies),Czech governments are either coalition orminority governments or both. The partysystem features the extreme-left CommunistParty which typically controls third-highestnumber of seats in the House. Executivecooperation with the Communist is a politi-cal no-no among the democratic parties, socoalition building in the Czech Republic isnotoriously hard. Even Social Democrats stillobey their 1995 commitment not to createan executive coalition with the unreformed

Communists. The last four Lower Houseelections (1996, 1998, 2002, and 2006) thushave led to fragile cabinets, and producedan ongoing series of political stalemates.

Between 1992–1996, the Czech govern-ment was composed of a majority coalitionof the right-centrist parties: the Civic Demo-cratic Party (ODS), the Christian DemocraticParty (KDS), the Christian-Democratic Union(KDU-ČSL) and the Civic Democratic Alliance(ODA). In the 1996 election, the formerly safemajority coalition gained only 99 MPs inthe 200-seat House. In a historic concession,



II.3 Electoral History of the Czech Republic

Table II.3.1. Composition of the Chamber of Deputies

Election Year 2002 2006Party Votes % Seats % Votes % Seats %

ODS 1,166,975 24.5 58 29.0 1,892,475 35.4 81 40.5

ČSSD 1,440,279 30.2 70 35.0 1,728,827 32.3 74 37.0

KSČM 882,653 18.5 41 20.5 685,328 12.8 26 13.0

Coalition KDU-ČSL 680,671 14.3 31 15.5and US-DEU

KDU-ČSL 386,706 7.2 13 6.5

SZ 112,929 2.4 336,487 6.3 6 3.0

Others 484,499 10.2 319,153

Total of Valid Votes 4,768,006 5,348,976

Eligible Voters 8,264,484 8,333,305

Participation 4,789,145 58.0 5,372,449 64.5

Not Valid Votes 21,139 23,473

Source: CSO

Social Democrats (ČSSD) tolerated the coali-tion in exchange for the controlling seats inthe Lower House.

After the preliminary 1998 elections, the“winners’ without a majority curse” fell uponthe Social Democrats, who were unable toestablish a coalition government with just32% of popular votes. The resolution at thattime was almost a reverse of the 1998compromise: The ODS committed itself totolerating a minority one-party governmentof the ČSSD in exchange for a dominatingrole in the Lower and Upper Houses andparticipation in preliminary consultations onimportant issues between the ČSSD andODS. In particular, the two major partiesproposed changes of the electoral system,which nonetheless ended in vein due to therefusal of the Constitutional Court.

In the successive 2002 election, SocialDemocrats won with 30.2% of the vote. Awarning sign was the rising number of votes

for the Communists: They gained 18.5%percentage points, their best result since1989, while all democratic parties lost theirshare of votes. This was in part due to the low-est turnout (58%) in post-communist history.

The ČSSD, KDU-ČSL, and Freedom Union(US) managed to form a government, withthe weakest possible majority of 1 vote (101against 99). The weak government wentthrough several crises: In June 2004, afterthe Social Democrat’s crushing defeat in theEuropean Parliament elections, PM VladimírŠpidla was forced to resign from his positionas party leader and prime minister and insteadbecame the European Commissioner. Hewas replaced by 34-year-old Stanislav Gross,one of the most influential and ambitiousleaders of the ČSSD. His cabinet soon brokedown after a scandal involving the primeminister’s family finances. The coalition founda way out of the crisis by appointing JiříParoubek (ČSSD) as the new prime minister.



Table II.3.2. Composition of the Upper House

1998 2000 2002 2004Party Seats % Seats % Seats % Seats %

KSČM 4 4.9 3 3.7 3 3.7 2 2.5

ČSSD 23 28.4 14 17.3 9 11.1 6 7.4

KDU-ČSL 17 21.0 18 22.2 13 16.0 11 13.6

ODS 26 32.1 21 25.9 25 30.9 35 43.2

ODA (+US) 11 13.6 12 14.8 1 1.2 1 1.2

US-DEU 6 7.4 4 4.9

Independent n.a. n.a. 13 16.0 22 27.2 19 23.5

Others 2 2.5 3 3.7

Total 81 100.0 81 100 81 100.0 81 100.0

Source: CSO

Current Major Political Parties

The most important political parties currently are listed below and ordered according totheir positions on the traditional “left-right” ideological spectrum.

Czech and Moravian Communist Party (Komunistická strana Čech a Moravy, KSČM) – anextreme leftist unreformed communist party; opposes Czech membership in NATO andopenly advocates the return of the pre-1989 regime; successor to the former Communist Partyof Czechoslovakia, which was founded in 1921; has had stable representation since 1989.Chairman: Vojtěch Filip.

Czech Social Democratic Party (Česká strana sociálně demokratická, ČSSD) – a leftcentrist party of traditional European social-democratic orientation; supports membership ofthe Czech Republic in NATO; strongly advocates the Czech entry into the EU; successor to theformer Czechoslovak Social Democratic Party, which was founded in 1878 and forced tomerge with the Communist Party in 1948; established the minority government in 1998 anda coalition government in 2002. Chairman: Jiří Paroubek.

Green Party (Strana zelených, SZ) – a centrist party; albeit established in 1989, a newcomerto the Parliament in 2006 (aside from Latvia, the only Green Party in a Parliament in a post-communist country); advocates environmental tax reform, energy reform, health and socialsecurity reforms; aims at deeper European integration and stands against US dominance inNATO. Chairman: Martin Bursík.

Christian and Democratic Union – Czechoslovak People’s Party (Křesťanská a demo-kratická unie-Československá strana lidová, KDU-ČSL) – a centrist party of Christian-democraticorientation represented in the government in periods 1990–1998 and 2002–2006; fiscallyconservative advocate of a “social market economy;” opposes the recently adopted same-sexunion bill; strongly supports Czech membership in NATO and in the EU. Chairman: Jan Kasal.

Civic Democratic Party (Občanská demokratická strana, ODS) – a right-wing conservativeparty; a dominating member of government coalitions between 1992–1997; under the leader-ship of Václav Klaus in the 1990s, the driving force of economic and political transition;nowadays advocates flat tax, healthcare reform, tuition at universities, and consolidation ofgovernment deficits; strongly supports Czech membership in NATO; holds a “Euro-skeptic”attitude toward the EU and opposes the European Constitution. Chairman: Mirek Topolánek.



The Lower House. In the pre-electionyear, Jiří Paroubek (ČSSD) increased pressureupon the coalition partners and began ex-plicit cooperation with the Communists inthe Parliament. On May 24th, they jointlyoverturned two presidential vetoes andpassed the new Labor Code as well as a billfor nonprofit hospitals. Both KDU-ČSL and USmaintained their coalition, yet openly signaledwillingness to join a right-centrist coalitionafter the elections.

The ČSSD-led cabinet under Jiří Paroubekraised tensions: on the one hand, the econo-my was boosted; on the other hand, deepcontroversies arose in healthcare, corruptionscandals flourished, large procurements weredebatable, an immense structural budgetarydeficit emerged, and new social legislationimposed a strategic debt on the cominggovernments.

This contributed to a long, stressful, andexpensive electoral campaign. The intensivecampaign involved personal insults, verbalattacks, allegations of shady dealings, andclassified material from the police. Varyingopinion polls indicated a close and fierce duelof two major parties (ODS and ČSSD). Thevote reduced to either of two likely options:an ODS-led, center-right coalition, or a minor-ity government of ČSSD, explicitly backedby Communists.

The binary choice, scare tactics as wellas campaign intensity raised the electoralturnout by 6.5%. The ODS won electionswith a record-high 35.4%, and the ČSSDfollowed second with 32.3%. Surprisingly,however, neither of the two options cametrue, as the electoral result ended in a genu-ine deadlock: the right-of-center block of

ODS, KDU-ČSL and Green Party (SZ) gainedin total exactly 100 seats, which is exactlythe representation of Social Democrats plusCommunists.

In principle, the following options turn outto be the most likely: (a) a 100-seat coalitionof ODS, KDU-ČSL, and SZ, tolerated by ČSSD;(b) a minority government of ODS, toleratedby ČSSD; (c) a grand coalition of the ODS andČSSD; (d) a minority government of ČSSD,tolerated by ODS; (e) a provisional govern-ment appointed by the ODS and ČSSD; (f) a“rainbow coalition” (all democratic partieswithout Communists); (g) preliminary elec-tions. Negotiations are driven by the follow-ing long-term considerations: (i) The ODS andČSSD seek to reshape the electoral system,yet only success at the autumn Upper Houseelection may grant them the qualified ma-jority in both chambers which is requiredfor constitutional amendments; (ii) PresidentVáclav Klaus favors a Parliament that wouldensure his re-election in 2008; (iii) the ČSSDaims to eliminate the bargaining power ofminor parties, especially of Greens tend tosteal their votes.

The ODS was given a first try and launchedcoalition negotiations. On June 26th, the ODS,KDU-ČSL, and SZ signed a coalition agree-ment, splitting the posts 9:3:3. This is not yetthe end as the Social Democrats so far havemade no concession. Six weeks after theelection, as this brochure goes to press, nofurther progress in deal-making is visible. Inspite of that, stock markets, money markets,and foreign investors remain calm, as zerodifference in key policies is expected in eitherof the outcomes.



II.4 Elections of 2006

The local government in the Czech Repub-lic has two layers: 6,234 municipalities and 14regions (NUTS 3). These are self-administeredunits; people elect their representatives formunicipal and regional councils. The munici-palities are responsible for the usual kinds oflocal public services (elementary schools, locallibraries, street cleaning, etc). In addition tothat, 205 bigger towns have a special statusof “municipalities with extended jurisdiction.”These also carry out some administrativeagendas of the central government (ID cardsand passports, social security allowances,special child care, legal protection, drivinglicenses, etc.) not only for their own residentsbut also for the residents of nearby smallermunicipalities. This arrangement was adoptedin 2003, when the 76 county offices ofthe central government were abolished andtheir competences transferred either down-

stream to the “municipalities with extendedjurisdiction” or upstream to the regional gov-ernments.

While the division of administrative respon-sibilities between the regional governmentsand the central government is clear, the twogroups continue to clash over the division offunds, which are still largely controlled by thecenter. The regional offices took over someadministrative duties, and, more importantly,hundreds of health, social, and cultural insti-tutions formerly administered by the countyoffices. These institutions are still financed bygrants from the central budget, leaving littlefreedom for financial management decisionsby regional offices. Hospitals in particularwere transferred to the regional govern-ments, many in bad financial shape and withlarge debts, which the regional authoritiesare unable to cover from their own revenues.



II.5 Regional Administration

Table II.5.1. Regions

Number of regions 13a)

Minimum size (km2) 3,163 Minimum population 304,343Minimum number

132of municipalities

Maximum size (km2) 10,057 Maximum population 1,269,467Maximum number

1,048of municipalities

Average size (km2) 5,943 Average population 689,166Average number


Municipalities with extended jurisdiction

Number of municipalities with extended jurisdiction 205

Minimum size (km2) 48 Minimum population 9,500Minimum number

1of municipalities

Maximum size (km2) 1,242 Maximum population 376,172Maximum number


Average size (km2) 382 Average population 44,200Average number

31of municipalities

Note: a) Data for capital Prague are excluded from the tables since Prague has a specific status

Source: CSO

Secondary education had already comeunder the supervision of regional offices in2002, but the funds still flow directly fromthe Ministry of Education. Although theregional offices have been operating for fiveyears, their budgets are still prepared in anad-hoc manner. Legislation that would set upstable rules for the division of tax revenues

between the central government and theregions has been under preparation for years.So far, the regions have very limited sourcesof revenue that they directly control. As muchas 86% of their revenue (101.5 billion CZK in2004) comes as subsidies from the centralgovernment, most of which is again tied tospecific purposes.



Středočeský kraj

Hlavní město Praha

Jihočeský kraj

Plzeňský kraj

Karlovarský kraj

Ústecký kraj

Ústí nad LabemLiberecký kraj

Královéhradeckýkraj

Pardubický kraj

Vysočina

Jihomoravskýkraj

Olomouckýkraj

Zlínský kraj

Moravskoslezskýkraj

Karlovy Vary

Plzeň

České Budějovice

Jihlava

Pardubice

Liberec

HradecKrálové

BrnoZlín

Ostrava

Olomouc

The growth rate of the Czech economyhas accelerated in 2005 compared to previ-ous years. A record high rate of increase inthe gross value added has been registeredin the 4th quarter at the level of almost7%. The major factor contributing to sucha favorable economic development was an

expansion in the manufacturing sector. Theimprovements in industrial production, whichaccounted for more than 50% of the totalGDP growth, resulted from a sharp increasein productivity as well as important structuralchanges. The latter occurred due to the sig-nificant inflow of foreign direct investments,


Chapter III. I MACROECONOMY

III. MACROECONOMY

III.1 Gross Domestic Product

Figure III.1.1. GDP Growth Decomposition

Import Export Investment Government consumption Private consumption GDP Growth

-5%

0%

5%

10%

15%

20%

25%

30%

Q4

2005

Q3

2005

Q2

2005

Q1

2005

Q4

2004

Q3

2004

Q2

2004

Q1

2004

Q4

2003

Q3

2003

Q2

2003

Q1

2003

Q4

2002

Q3

2002

Q2

2002

Q1

2002

Q4

2001

Q3

2001

Q2

2001

Q1

2001

Q4

2000

Q3

2000

Q2

2000

Q1

2000

Table III.1.1. GDP growth rates, %

2006* 2007*

2004 2005 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

with adjustments 4.7 6.0 6.38 5.88 5.87 5.2 5.25 5.39 5.71 5.78to other forecasts**

without adjustments4.7 6.0 6.35 5.71 5.78 4.9 4.88 5.01 5.39 5.42to other forecasts

* predictions are done by CERGE-EI using time-series models** after taking into account EIU and OECD predictions; it is assumed that these institutions’ predictions depict systematic bias or deviation

from actual figures.

Source: CSO

favorable developments in demand, andstrengthening the competitiveness of domes-tic goods on the market. Overall, most sectorsincluding trade, financial intermediation, andenergy added to the economic growth. Themajor demand-driven factor of GDP growthwas a positive trend in net exports. Its nega-tive value decreased in 2005 in comparison to2004 and 2003 due mainly to the improve-ments in the trade balance. The developmentin final consumption expenditure throughthe year 2005 showed a volatile pattern withan increase in the rate of growth to 3.4% in

the 3rd quarter followed by a decline to 1.6%in the 4th quarter. A slowdown in householdconsumption and government consumptionwere the most significant factors behind suchdynamics.

In accordance with the CNB forecast, GDPis expected to grow further in the near futuredue to both net exports and investments.But, the forecasts done at CERGE-EI showthat despite growth rates remaining high, amild slow down in growth rates are expectedfor the 2006–2007 period.

In the first half of the 1990s, due to thebalanced and seemingly healthy public finan-ces the Czech Republic won an image of aprosperous and stable transition country.However, political and economic crises in1997 shattered this position and since thenthe public sector started to generate largedeficits. These deficits will be even larger

once the liabilities of the Czech ConsolidationAgency are fully accounted for. In such acase, the debt to GDP ratio can reach 48%in 2006.

Over the year 2005, state debt rose by98.3 billion of CZK, from 592.9 to 691.2billion of CZK (see Figure III.2.1). This increasewas driven by the deficits financed from



III.2 Public Budget Deficits

% o

f G

DP

Source: ESA 95, CSO, Eurostat

Figure III.2.1. Public Deficit and Debt

YearGovernment debtGovernment budget deficit

-10

0

10

20

30

40

200820072006200520042003200220012000199919981997

domestic medium and long term state bonds(an increase from 397.0 bln CZK in 2004to 487.5 bln CZK in 2005) that were usedto cover 70% of public debt in 2005. Since2004, Euro denominated bonds have beenused to finance deficits (an increase from48.8 bln CZK in 2004 to 78.9 bln in 2005)and now they are used to finance almost11% of state debt (8% in 2004). It is ex-pected that financing via Euro denominatedbonds will continue as a part of strategy todecrease the amount of short term debt from68.7% of total debt in 2000 to 25.0% in2004 and planned to 20% in 2006) and tofinance deficits via medium and long termbonds.

As a result of this strategy, the modifiedduration of state debt increased from 2.8years at the end of 2002 to 3.8 years by theend of 2005, and it reached a maximum of4.2 in the second quarter of 2005. Regardlessof the decrease in 2005, the state debt dura-tion is in the band set by the Ministry ofFinance.

Interest costs of short term liabilitiesshowed a decreasing trend over the first half

of 2005, but this trend reversed by end ofthe year (in January 2.70% p.a., in June1.68% p.a., and in September 1.83% p.a.for liabilities with a maturity of 52 weeks).

Interest costs of debt service show anincreasing trend but not as dynamic as thetotal amount of public debt. The increasein interest costs of foreign debt is driven bynewly issued government bonds denominat-ed in Euro (30.1 CZK billon) and the CzechRepublic maintains stable levels of ratings onits debt denominated in foreign currencies(Standard & Poor’s, A-, stable; Moody’s, A1,stable; Fitch IBCA, A-, stable).

In the beginning of the year 2006, the statebudget was changed to increase spendingby 5 billion of CZK to cover the costs of thespring flood which results in larger deficitsthan expected or forecasted.

Currently, mandatory expenditures consti-tute more than 80% of the state budgetexpenditures, and only 5 to 10% of total ex-penditures can be changed at the time ofbudget creation. This state of affairs doesnot allow the Czech Republic to fulfill theMaastricht criterion on public deficits. A



Bill

ion

s o

f C

ZK

Source : Ministry of Finance Czech Republic

Figure III.2.2. Public Deficit Composition

YearLocal governmentsCentral government

-120

-100

-80

-60

-40

-20

0

20

20042003200220012000199919981997

proposal from the Convergence Programfor the years 2006–2008 indicate that lowdeficits in 2004 and 2005 are not sustainabledue to the consolidation of state agencies,such as the National Property Fund and theCzech Consolidation Agency, and even in ano-fiscal consolidation scenario, the deficitwill reach 6.3% of GDP in 2006.

Therefore, it is expected that the fractionof the state deficit on public deficit willcontinue to increase due to expected deficitsof the state budget (see Figure III.2.2). TheConvergence Program aims to reduce thedeficit, but it remains to be seen whether thisobjective will be achieved, especially con-sidering the results of the 2006 elections.



Meeting the targetIn 2005 the Czech National Bank (CNB)

successfully kept the headline inflation with-in the target band of 1–3 percent, in spite ofthe lower core inflation (see Figure III.3.1,with the headline inflation adjusted for pricederegulations). The CNB’s original predictionsoscillated around the lower target band. How-ever, the headline inflation stayed within thetarget band particularly due to substantialprice deregulations which were larger thanthe CNB expected. Without this exogenousfactor, inflation would have moved belowthe target.

Over the year 2005, the CNB changed itskey policy rates four times and this includeda trend reversal. Until October, the rates wereon their decline to their historical minimum –the discount rate decreased from 1.25 to0.75 percent – when the CNB suddenlyannounced an increase to 1 percent. Thissudden move was accompanied by an an-nouncement that the monetary policy wouldstart a period of increasing discount rates.This was not expected by financial marketsand was immediately reflected in exchangerates. It also eliminated the negative interestrate differential against the main European

III.3 Monetary policy in 2005

Figure III.3.1. Inflation Targeting

Source: CNB, CSO

-1

0

1

2

3

4

5

Y-to-Y core inflationInflation target Y-to-Y CPI inflation

2005

Q4

2001

Q4

2002

Q1

2002

Q2

2002

Q3

2002

Q4

2003

Q1

2003

Q2

2003

Q3

2003

Q4

2004

Q1

2004

Q2

2004

Q3

2004

Q4

2005

Q1

2005

Q2

2005

Q3

Discount rate

Central Bank rate. There were two majorfactors affecting monetary policy in 2005:(i) persistent nominal appreciation of theCzech crown, and (ii) uncertainty about thedevelopment in the Euro area. While currencyappreciation stood behind the argumentsfor the rates decline, an expected increasein the Euro area rates acted in the oppositedirection, which apparently motivated theactions of the CNB.

Future challengesThe number one challenge for the mone-

tary policy in the future remains an accessionto the monetary union and adoption of theEuro in 2010. The CNB will be responsible formeeting the Maastricht criteria in terms of

inflation and later in fixing the nominalexchange rate. In this regard, a questionremains of when the CNB announces thebeginning of focusing on the EuropeanUnion target. This target is currently by onepercentage point lower than in the CzechRepublic, and it will be of great interest whatthe parity will be at which the nominalexchange rate will be fixed. The maneuveringspace for monetary policy is not large, sinceinflation forecasts remain high (due to oilprice shocks, and prepared price deregula-tions), and the currency permanently appre-ciates. There is a possibility that the CNB willattempt to cool down the economic perfor-mance to meet the Maastricht convergencecriteria by 2010.



Table III.3.1. CPI Forecasts

Annual inflation 2006* 2007*

rate, % 2004 2005 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

with adjustments average*** 2.80 1.90 2.04 2.33 2.54 2.59 2.51 2.42 2.36 2.44to other forecasts**

end of3.06 2.38 2.42 2.72 2.63 2.61 2.07 2.38 2.36 2.95period

without adjustmentsaverage*** 2.80 1.90 2.05 2.38 2.63 2.71 2.63 2.55 2.48 2.59to other forecasts

end of3.06 2.38 2.47 2.88 2.78 2.72 2.15 2.55 2.51 3.17period

* CERGE-EI forecasts** after taking into account EIU and OECD predictions; it is assumed that these institutions’ predictions depict systematic bias or deviation

from actual figures.*** Presented average inflation rate characterizes the percentage change of average price level of latest four quarters against the average

price level of previous four quarters.

Source: CERGE-EI Forecasting Model

Exchange rate pass-through into Czech inflation

The new member-countries of the European Union who join the ERM-II might be viewed asbalancing their monetary policy between low inflation, requested by the Maastricht Criteria,and a stable exchange rate vis-à-vis the euro imposed by the ERM-II. In this context, a linkbetween the exchange rate and inflation or, more precisely, the pass-through effect of avariation in the nominal exchange rate on domestic inflation receives particular attention.Traditionally, exchange rate pass-through (ERPT) is defined as the percentage change in thelocal currency price of an imported good resulting from a 1 percent change in the nominalexchange rate between the exporting and importing countries. Recently, the definition ofexchange rate pass-through was enlarged by encompassing consumer and producer prices.The estimation of exchange rate pass-through along the pricing chain allows the measuringof the relative pass-through, which means an assessment of the exchange rate pass-throughto, for example, import prices compared to the pass-through to another price category, e.g.consumer prices.

Estimating the pass-through effects for the Czech Republic along the pricing chain, we findthat the exchange rate pass-through to consumer prices does not typically exceed 25%. Thehighest pass-through is found for export and import prices, and a much lower pass-throughis observed for producer and consumer prices, showing that the exchange rate pass-throughdecreases on its way from one stage of production to another. This can be one of the expla-nations why despite a high degree of openness, the exchange rate pass-through in the CzechRepublic is far from complete. At the same time, the speed of the pass-through is relativelyhigh, as expected for a small open economy. For the Czech Republic, the exchange rateshock disappears after approximately six months. In other words, the effect from exchangerate shock to other variables (price indices) attains its maximum roughly after 6 months, andat least a half of this effect occurs during the first 3 months. Thus, the speed of the exchangerate shock transmission to all prices is quite high, which could be in the case of a small openeconomy. However, in absolute terms, the magnitude of pass-through to domestic prices is onaverage about 20% of the exchange rate shock. One possible explanation is that increases inprices induced by the catching-up process dominate downward price pressures stemming fromthe exchange rate appreciation. Furthermore, the magnitude of exchange rate pass-throughdecreases by moving from the initial stage of production to final goods.



At the beginning of the economic transi-tion in the Czech Republic, the exchange ratewas used as a nominal anchor of monetarypolicy. It was tightly pegged to a currencybasket, and the level of the nominal peg setin 1991 had not changed until May 1997.The combination of stability with the presenceof an inflation differential led to fast realappreciation. The appreciation and the intro-duction of convertibility meant that thepegged exchange rate could no longer playits stabilization role, and after speculativeattacks the crown was allowed to float in1997. Along with this move, the CzechNational Bank adopted in 1998 inflation tar-geting as a key monetary instrument insteadof the preceding exchange rate anchor.

The (lightly) managed floating regime hasremained unchanged until now, althoughchanges must be expected as the Czech Re-public is going to join the European MonetaryUnion (EMU) in the future. However, giventhe large budget deficits, the crown is un-likely to join the EMU before 2010–11. This

forecast is also in line with the position of theCzech National Bank that does not want toenter the European Exchange Rate Mecha-nism (ERM) II regime too soon and not forlonger than necessary (the exchange ratewould be pegged to the Euro for at leasttwo years).

As far as bilateral exchange rates areconsidered, the exchange rate of the Czechcrown to the U.S. dollar has traditionallybeen less stable than the CZK/DEM andlater CZK/EUR exchange rate: This may beattributed to close trade and investment tiesbetween the Czech Republic and the euroarea. During the transition period, the ex-change rate of the Czech crown to the Euroevolved in a relatively stable manner. Differ-ences between points of temporal apprecia-tion and depreciation did not exceed 14%in extreme cases. The largest depreciationoccurred during the period following the cur-rency crisis in May 1997, but even the changein the exchange rate during the currency



III.4 Exchange Rate

Figure III.4.1. Exchange Rates

YearSource: CNB CZK/USDCZK/EUR

25

30

35

40

200420032002200120001999199819971996199519941993

crisis was not as dramatic as those sufferedby Asian countries during the same period.

Since 2000, the crown has been steadilyappreciating (see Figure III.4.1). The appreci-ation against the USD became extremelydramatic in the last quarter of 2004 becauseof the evolution of the exchange rate betweenthe Euro and the dollar.The CZK remainedat this level against the USD also during thefirst quarter of 2005, but later went back tothe level of approximately 25 CZK/USD. Thecrown has experienced flat development inthe first half of 2005 while hovering around30.1. In the second half of 2005, the crowngained strength and went gradually to28.97 CZK/EUR, observed in December 2005.With respect to the USD, the Czech crownfluctuated in the first four months around23 CZK. In May, after an appreciation of the

USD against the EUR, the exchange rateCZK/USD went back to the level of the Octo-ber 2004 and remained untill the end ofthe year. The CZK/USD was quoted at 24.4 inDecember 2005.

The long-term trend of gradual real appre-ciation of the crown, driven by convergenceof productivity and institutional characteristicsof the economy to the EU level, is likely tocontinue but at a slower pace than in previ-ous years. In the near future, the behavior ofthe CZK nominal exchange rate with respectto the Euro will depend on the inflationand interest differential – if the inflation rateremains low, the CZK may even experiencemild nominal appreciation. The developmentof the CZK/USD exchange rate in 2006 willbe determined by the development of theEUR/USD exchange rate.



The Czech Republic can serve as a text-book example of a small open economy, inwhich international trade is an importantcomponent of its GDP (See III.5.1). The pro-portions of exports and imports of goodsand services to the country’s GDP in 2005amounted to 72% and 70%, respectively(merchandise exports amounted to 63%).The past trend in openness has been almostinvariably that of the increasing importanceof international trade for the Czech economy.Exports of goods grew faster than GDP whileimports did not – merchandise exports in-creased by 8.8% and imports by 4.9% in2005 (in CZK and current prices) after astrong increase in 2004 where exports andimports saw a 25.7% and 21.4% growthrates. A trade deficit has turned into a surplusof 40 billion CZK (1.3% of GDP) for the

first time since 1993. We expect a similardevelopment in 2006. The overall trade de-velopment is understandably similar to thatof trade in goods and services combined. Thistrend is likely to continue, and the tradebalance is likely to remain in positive territoryin the near future.

Until 2000, the current account deficitused to be lower than the trade balancedeficit because of the positive balance on theservices account. While the balance in ser-vices remains positive (0.6% of GDP in 2005),this positive effect is now dwarfed by awidening deficit in the income balance of thecurrent account. Moreover, this developmentof the income balance is likely to continuebecause of the huge inflow of direct invest-ment in recent years (see the next chapter)and consequent increases in profit repatria-

III.5 Foreign Trade and Balance of Payments

tion by the side of foreign multinationals (seesection below). Unlike in previous years, it istherefore the current account deficit thatshould be watched closely, primarily becauseof increasing income outflows. However, if weconsider the complete balance of payments,there does not seem to be any acute danger.The inflow of capital and the present ex-change rate regime (managed floating) meanthat any repetition of balance of paymentsproblems similar to May 1997 is unlikely.

The EU remains the main trading partnerof the Czech economy (see Figure III.5.2); itsshare of total trade turnover reached 78% in2005 (EU25). This share increased in 2005because several other European transitioneconomies (Visegrad countries) that used tobe important trade partners of the CR alsojoined the EU; the share of trade with theoriginal EU15 slightly decreased to 66.3%. Iftrade with individual countries is considered,then international trade with Germany standsout clearly since it constitutes close to twothirds of the country’s trade with the EU and33% of the overall exports.

The composition of Czech foreign tradehas changed dramatically during the tran-sition. Specifically, the share in exports ofmachinery and transport equipment (SITC 7)has doubled since 1993, while raw materialsand semi-finished products have shrunk insimilar proportions. This trend continues, andit was the increase in exports of machineryand transport equipment (the opening of theTCP car factory) that helped to bring tradebalance into the black in 2005. For more



Source: CSO ImportExport DeficitYear

Exp

ort

an

d Im

po

rt

Trad

e B

alan

ce

Figure III.5.1. Foreign Trade, Goods and Services (% of GDP)

40

45

50

55

60

65

70

75

80

20052004200320022001200019991998199719961995-6

-5

-4

-3

-2

-1

0

1

2

Figure III.5.2.Structure of Exports by Destination

Source: CSO

Others33%

Italy4%

France5% Austria

6%

U.K.5%

Poland6%

Slovakia9%

Germany32%

details on the commodity structure of Czechexports see Figure III.5.3.

The accession to the EU in 2004 did notbring any major shift in aggregate trade pat-terns since the association agreements hadalready created a free trade area betweenthe CR and the rest of the EU. Nevertheless,further increases in foreign trade were evi-dent. However, the accession also means thatthe CR will have to accept the common tradepolicy with respect to third countries. Thischange of trade regime has substantially influ-enced trade, e.g., trade with China (CzechRepublic’s fourth biggest trade partner with5.2% share of Czech imports) as the CzechRepublic has together with other EU countriesliberalized trade in textiles with China.



Figure III.5.3.Commodity Structure

Source: Eurostat

Chemicals6%

Other10%

Machineryspecialized

for particularindustries

11%

Machinery andtransport equipment

51%

Manufacturedgoods

classifiedchiefly bymaterial

22%

FDI started to accelerate dramatically afterthe financial crises of 1997, mainly thanksto the privatization of three big banks andTransgas during 1998–2002 (see FigureIII.6.1). However, years 2003 and 2004 saw

no major one large-scale investment projectand the increase in FDI have been significant-ly lower and spread across a number ofeconomic activities. According to the CzechNational Bank, the amount of FDI in the

III.6 Foreign Direct Investment (FDI)

Figure III.6.1. Total Inward FDI in to the Czech Republic, 1993–2005

YearSource: CNB, Balance of payments statisticsNote: Until 1997 data included FDI in equity capital, starting from 1998 data on reinvested earnings and other capital have beenincluded in FDI flows, year 2005 – preliminary data

0

50,000

100,000

150,000

200,000

250,000

300,000

2005200420032002200120001999199819971996199519941993

mill

ion

s o

f C

ZK

Czech Republic at the end of 2004 reached57.3 billion USD.

In 2005, the Czech government finally soldits 51% stake in the major telecommunica-tion company to Spain’s Telefonica. The dealwith the price of 3.5 billion US dollars wasone of the largest privatizations of the post-communist era. In 2005, another big, contro-versial government privatization project is thesale of oil and gas giant Unipetrol. This wasfinally resolved with the majority stake of63% acquired by Poland-based PKN Orlen. Apart of the agreement was a three-year re-structuring program. Due to these large deals,FDI inflow was close to 11 bn USD in 2005.

There still remains a large state share inthe electricity monopoly CEZ, which shouldbe privatized in the future. Meanwhile, CEZcontributes to the FDI outflows with its in-vestment into a Bulgarian distribution com-pany. By the end of 2005, Czech investmentabroad reached about 4.6 bn USD. This is stillrather low, but it can be expected that therecent surge in inward FDI will be followedwith a certain lag by growth of outwardFDI in the future. While most of the outward

investment is directed to other Central andEastern European or to Asian countries, about80% of inward FDI comes from old EU mem-bers (see Figure III.6.2).

The role of foreign capital in manufactur-ing has been steadily growing, and recently,foreign owned manufacturing firms wereestimated to produce 65% of total sales, to



Figure III.6.2.FDI to the CR by Geographical Zones

in 2005 (% of Total FDI)

Source: CNB, Balance of payments statistics

Other 55%

Japan 1%United States 1%Switzerland 2%Sweden 3%Austria 4%

Netherlands 18%

United Kingdom 2%Germany 10%France 2%Belgium 2%

Figure III.6.3. Share of Foreign Firms in Manufacturing

Source: CSO, enterprises with 25 and more employees

Year

Perc

enta

ge

Sales ExportNumber of Employees

0

10

20

30

40

50

60

70

80

200420032002200120001999199819971996199519941993

provide 45% of employment and to produce80% of total exports (see Figure III.6.3).Foreign direct investment is an importantcomponent of transformation in Czech

manufacturing and helps to facilitate a rapidchange. Moreover, in many companies, im-provements in performance are the key tocompetitiveness in global markets.



The Attractiveness of Czech Firms to Foreign Investors in the Post1995 Period(Based on: Tóth P., and P. Zemčík (2006) “What Makes Firms in Emerging Markets Attractive to Foreign Investors?Micro-Evidence from the Czech Republic”, Working Paper 294, CERGE-EI, Prague.)

Looking at patterns in FDI flows from developed countries to the Czech Republic during thepost 1995 period (see Figure III.6.1), we see an upward trend in the last three years. There aretwo potential explanations for this trend, relatively low employee compensation and CorporateIncome Tax. Comparing the average employee compensation across Visegrad countries (seeTable III.6.1), the Czech Republic had a slight but gradually fading comparative advantage overHungary during the late 1990s. However, Slovak employers paid out on average only 70% ofthe amount their Czech counterparts paid to their workers during the whole post 1995 period.Despite low labor costs, Slovakia struggled with a bad international renomé due to political and

Table III.6.1. Employee compensation rate (foreign country/Czech Republic)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Austria 6.02 5.13 5.04 5.28 4.70 4.68 4.40 4.01 3.77 3.60

Belgium 7.17 6.14 6.02 6.25 5.69 5.62 5.29 4.88 4.59 4.43

Denmark 6.76 6.14 5.84 6.10 5.55 5.62 5.32 4.83 4.60 4.40

Finland 5.78 4.99 4.87 5.27 4.73 4.77 4.57 4.12 3.90 3.77

France 6.49 5.57 5.40 5.59 5.00 4.94 4.63 4.21 3.96 3.81

Germany 6.23 5.32 5.11 5.31 4.70 4.66 4.31 3.89 3.63 3.43

Greece 2.28 2.14 2.27 2.45 2.30 2.35 2.25 2.14 2.04 2.02

Hungary 1.48 1.14 1.13 1.19 0.94 1.08 1.08 1.14 1.18 1.09

Ireland 4.71 4.05 4.10 4.36 4.05 4.13 3.96 3.64 3.41 3.36

Italy 5.12 4.53 4.46 4.55 4.09 4.08 3.82 3.49 3.31 3.18

Luxembourg 7.20 6.14 5.97 6.28 5.76 5.88 5.55 5.10 4.74 4.56

Netherlands 5.00 4.29 4.18 4.47 4.05 4.10 3.90 3.67 3.48 3.32

Poland 0.88 0.91 0.93 1.01 0.96 1.00 1.11 1.09 0.86 0.71

Portugal 2.38 2.19 2.17 2.33 2.13 2.21 2.11 1.95 1.85 1.78

Slovak Republic 0.71 0.63 0.67 0.79 0.67 0.76 0.70 0.69 0.67 0.70

Spain 4.17 3.72 3.67 3.87 3.48 3.50 3.32 3.09 2.97 2.91

Sweden 6.33 6.06 6.05 6.32 5.14 5.93 5.45 4.67 4.45 4.36

Switzerland 7.69 7.06 6.13 6.58 5.86 5.87 5.82 5.37 5.05 4.45

United Kingdom 5.11 4.17 4.67 5.59 4.87 5.66 5.42 5.10 4.56 4.15

United States 6.07 5.02 5.14 6.27 5.41 6.54 6.60 6.37 5.10 4.13

Source: OECD

economic instability through the late 1990s. As for CIT-s (see Table III.6.2), Hungary was anabsolute leader in the region with a stable rate of 19.6%. The remaining three of the Visegrad-4 (V-4) started with a rate of about 40%. Even though Poland and Slovakia gradually reached20% by 2004, the Czech Republic did not go below 28% by the same year.

The story is markedly different once contrasting the above indicators between WesternEurope and the group of V-4. German employers, for example, paid out on average sixtimes higher compensations to their employees than Czech workers earned in 1995 (seeTable III.6.1). Though the German-Czech, Austrian-Czech, and Dutch-Czech compensationratios settled at an approximate ratio of 3 by 2004. CIT-s were also substantially higher inthe three main Western European FDI source countries (see Table III.6.2). German CIT toppedthe list with 56.8% in 1995 while dropping to 38.3% by 2004. The latter number isroughly comparable to the S-CIT-s in Austria and the Netherlands of the same year. To sumup, the main foreign investors in the Czech Republic on average benefited from more thanthree times lower labor costs and about 10 percentage points lower corporate income taxrates compared to their home countries.



Table III.6.2. Country Corporate Income Taxes (CIT) rates

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Difference2004–1995

Austria 34.0 34.0 34.0 34.0 34.0 34.0 34.0 34.0 34.0 34.0 0.0

Belgium 40.2 40.2 40.2 40.2 40.2 40.2 40.2 40.2 34.0 34.0 -6.2

Denmark 34.0 34.0 34.0 34.0 32.0 32.0 30.0 30.0 30.0 30.0 -4.0

Finland 25.0 28.0 28.0 28.0 28.0 29.0 29.0 29.0 29.0 29.0 4.0

France 36.7 36.7 36.7 41.7 40.0 36.7 36.4 35.4 35.4 35.4 -1.2

Germany 56.8 56.7 56.7 56.0 51.6 51.6 38.3 38.3 39.6 38.3 -18.5

Greece 40.0 40.0 40.0 40.0 40.0 40.0 37.5 35.0 35.0 35.0 -5.0

Ireland 40.0 38.0 36.0 32.0 28.0 24.0 20.0 16.0 12.5 12.5 -27.5

Italy 52.2 53.2 53.2 41.3 41.3 41.3 40.3 40.3 38.3 37.3 -15.0

Luxembourg 40.9 40.9 39.3 37.5 37.5 37.5 37.5 30.4 30.4 30.4 -10.5

Netherlands 35.0 35.0 35.0 35.0 35.0 35.0 35.0 34.5 34.5 34.5 -0.5

Portugal 39.6 39.6 39.6 37.4 37.4 35.2 35.2 33.0 33.0 27.5 -12.1

Spain 35.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0 0.0

Sweden 28.0 28.0 28.0 28.0 28.0 28.0 28.0 28.0 28.0 28.0 0.0

UK 33.0 33.0 31.0 31.0 30.0 30.0 30.0 30.0 30.0 30.0 -3.0

Cyprus 25.0 25.0 25.0 25.0 25.0 29.0 28.0 28.0 15.0 15.0 -10.0

Czech Republic 41.0 39.0 39.0 35.0 35.0 31.0 31.0 31.0 31.0 28.0 -13.0

Estonia 26.0 26.0 26.0 26.0 26.0 26.0 26.0 26.0 26.0 26.0 0.0

Hungary 19.6 19.6 19.6 19.6 19.6 19.6 19.6 19.6 19.6 17.7 -2.0

Latvia 25.0 25.0 25.0 25.0 25.0 25.0 25.0 22.0 19.0 15.0 -10.0

Lithuania 29.0 29.0 29.0 29.0 29.0 24.0 24.0 15.0 15.0 15.0 -14.0

Malta 35.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0 0.0

Poland 40.0 40.0 38.0 36.0 34.0 30.0 28.0 28.0 27.0 19.0 -21.0

Slovakia 40.0 40.0 40.0 40.0 40.0 29.0 29.0 25.0 25.0 19.0 -21.0

Slovenia 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 0.0

Source: European Commission

The Czech Republic has a relatively largefinancial sector for a middle-income country,with total assets equivalent to 136 percentof GDP as of end 2005. This reflects in goodpart the smaller inflationary erosion of banks’balance sheets in the early transition years,compared to other new EU countries. TheCzech financial sector still has a substantialscope in which to grow: the ratio of totalfinancial sector assets to GDP in the EuroArea, for example, is about 2.5 times higherthan in the Czech Republic.

The banking sector still dominates thefinancial sector (see IV.1.1), even thoughits share in total financial sector assetshas declined from about 90 percent in themid-1990s to 74 percent as of the end of2005. This decline reflected the removal ofpoor-quality assets from banks’ balance sheets(which contributed to a relatively slower

pace of growth of banking assets in absoluteterms) and a rapid growth in non-bank finan-cial institutions, such as insurance companies,pension funds, and leasing companies. Thepresent share of banks in the financial sectoris close to the Euro Area average.

As in other emerging markets in Centraland Eastern Europe, the Czech financial sec-tor is dominated by foreign-owned financialinstitutions. In the banking sector, for example,institutions with majority foreign ownershipaccounted for 96 percent of total assets asof the end of 2005. This is a result of a pri-vatization of the four large state banks be-tween 1997 and 2001, entry by foreign banks,and an impressive process of consolidation,reflecting improvements in prudential regu-lations and the elimination of weak financialinstitutions through withdrawal of licenses,liquidations, and mergers (for example, thenumber of licensed banks was reduced from55 in the mid-1990s to 36 in 2005, and thenumber of licensed non-bank institutionshas also declined, by more than 50 percent inmost sectors except insurance).

The financial sector has been highly prof-itable and generally sound in the last fouryears. The position of the sector strengthenedfurther in 2005, aided by the growth of thedomestic economy. The average return onequity (ROE) was 25 percent in banks and52 percent in insurance companies in 2005.These values are comparable with otheremerging markets, and substantially abovethose in advanced countries (ROEs forAustrian and Belgian banks were about 15


Chapter IV. I FINANCIAL AND BUSINESS ENVIRONMENT

IV. FINANCIAL AND BUSINESS ENVIRONMENT

IV.1 Financial Sector

Banks 73.8%

Investment companies,investment and mutualfunds 3.7%Leasing companies5.5%

Other non-bankfinancial institutions5.9%

Pension funds 3.1%

Insurance companies8.0%

Credit unions 0.1%

Figure IV.1.1.Structure of the Czech Finacial Sector

Source:

percent in the same period, for example). Thequality of lending, which was very weak inthe 1990s, triggering several bank failuresand major bail-outs, has improved through-out the first half of the first decade of the 21st

century. This trend continued in 2005, withthe share of non-performing loans in totalnon-bank client credit reaching 4.1 percentat the end of 2005. Stress tests, performedby the central bank, suggest that the bank-ing system is resilient to moderate externalshocks.1

One of the most pronounced bankingsector developments has been a rapid growthin household lending. Household credit hasbeen growing at an average annual rate of25 percent since 2002, outpacing credit toenterprises by a wide margin. Overall, privatesector credit growth in the Czech Republichas been relatively modest in comparisonwith other new member states, but higherthan in advanced economies. Like in otheremerging market economies, rapid creditgrowth in the Czech Republic largely reflectsfinancial deepening. The initial level of creditto the private sector in the Czech Republichas been significantly below what would bejustified by the country’s level of economicdevelopment, and most empirical analysesproject that the level of financial intermedi-ation will continue to increase. Privatizationand the increase in foreign ownership facili-tated financial deepening. Disinflation andthe associated trend decline in policy ratesalso supported credit growth. Governmentpolicies and regulations (such as generoussubsidies for construction saving, a favorabletax treatment of housing loans, and, morerecently, a relaxation of rules on the use ofmortgage loans) provided a boost to growth

in household credit, and in particular tomortgages, which currently account for abouttwo thirds of loans to households.

The financial sector has become moreinterconnected with the external environ-ment, which has many positive aspects forthe domestic market. In particular, the domi-nance of foreign-owned institutions in themarket has led to improvements in profita-bility, risk management, governance, as wellas range, quality, and availability of financialservices. Also, cross-border competition hasstrengthened with a number of financialentities that are currently operating underthe single European license system. Hundredsof other banks, insurance companies, andinvestment firms have made notificationsand can offer their services in the CzechRepublic under the principle of free cross-border provision of services. Banks fromoutside Europe are also considering estab-lishing branches in the Czech Republic.

The increased interconnectedness alsobrings about some challenges. In particu-lar, the growing internationalization of thefinancial market creates challenges foreffective supervision of the financial sector,and increases the need for good cross-border supervisory co-operation. For exam-ple, the dominance of foreign ownership,while yielding substantial benefits for Czechcustomers also brings new potential risksin particular by creating new channels oftransmission of foreign shocks. Also, theCzech koruna has been recently used as acheap financing currency for investment inother currencies, which increases the risk thatglobal or regional turbulences spill over tothe Czech financial market and into financialstability.



1 See Czech National Bank, Financial Stability Report 2005, available at www.cnb.cz.

An important feature of the financial sec-tor is substantial ownership and functionallinks between institutions in its individualsegments. At the end of 2005, there werenine banking regulated consolidated groupsand a significant insurance company financialgroup. The presence of conglomerates cre-ates the need for effective financial sector

supervision across the segments of the finan-cial sector. Responding to these challenges,the Czech authorities have established anintegrated agency for financial sector super-vision within the central bank (CNB), by merg-ing CNB’s banking supervision with insuranceand securities supervision. The new integratedsupervision started operating in April 2006.



Interdependence of Central and Eastern European Stock Markets(Based on: Egert, B., Kočenda, E., 2005. Contagion Across and Integration of Central and Eastern European StockMarkets: Evidence from Intraday Data. William Davidson Institute Working Paper, No. 798, University of MichiganBusiness School.)

Stock markets in Central and Eastern Europe (CEE), especially those in Budapest, Prague,and Warsaw, underwent some remarkable developments both in terms of market capitali-sation and daily trade volumes from the very beginning of the economic transformation.Although the financial system of these countries largely remains bank dominated, the stockexchanges appear to be well integrated with world financial markets following the lifting ofrestrictions on portfolio capital movements. However, given that these markets are smallcompared to the stock exchanges of the largest OECD countries, they are sensitive to shifts inregional and world-wide portfolio adjustments of large investment funds and other marketparticipants, even though the amount of capital involved in such moves are by no means verylarge by global standards. This underpins the popular wisdom according to which thesemarkets are more volatile than well-established stock markets.

Recent studies focus on the intra-day data, which were not previously available. Potentiallinks and spillover effects for stock returns and stock volatilities among markets in Budapest,Prague, and Warsaw are investigated. Also studied are their interactions with selected majormarkets in the EU on the basis of intraday data recorded in five-minute intervals for theperiod from mid-2003 to early 2005. Given that this period does not cover any major crisis, thefocus is on interdependence rather than on contagion. While there does not seem to be anylong-term relationship for any of the stock index pairs, short-term spillover effects are identi-fied both in terms of stock returns and stock price volatility. In general, spillover effects arestronger from volatility to volatility as compared to spillover effects from a return to returnseries.

Development of the Czech capital markethas been rather non-standard due to the wayprivatization was conducted at the beginningof the 1990s. Mass privatization created about1,700 companies that were directly placed inthe newly established Prague Stock Exchange(PSE). Unfortunately, the market could notcope with such a huge number of illiquidshares, and the expectations of establishinga strong market within a short period of timedid not materialize. Instead, insider trading,price manipulation, fraud in the investmentfunds industry, and abuses of minority share-holder rights prevailed in the mid-1990s. Asmall office in the Ministry of Finance whichwas supposed to regulate the market didnot manage it, and even the creation of theCzech Securities Commission in 1998 did notsignificantly improve the situation due tothe weak enforcement of the new rules. Themarket was not transparent because mosttransactions were not carried out on thecentralized, price-setting market, but either

outside the PSE or at the PSE but as so-called“block or direct trades” that do not performa price discovery function. Such a situationdid not lead to investors’ confidence, andmarket liquidity as well as the developmentof the whole market suffered.

There were numerous attempts to improvethe conditions on the market, especially bythe PSE. They included a division of the mar-ket into several tiers with different capitali-zation and information obligations, delistingof the illiquid share issues, introducing a newtrading system (System for support of shareand bond market – SPAD) for blue chips,and prohibiting its members to trade thesetitles outside of the PSE. Despite the reformsand the adoption of the EU legislation, thesituation in the capital market has been im-proving only gradually, and the market stilldoes not serve as a source of capital forenterprises.

Nevertheless, the development of the totalvalue of trades as well as the PX index is



IV.2 Czech Capital Markets

Figure IV.2.1. Development of Prague Stock Exchange (1993–2005)

Year

Trad

ing

of

shar

es in

bil.

CZK

PX In

dex

PX IndexTrading of shares

2005200420032002200120001999199819971996199519941993

0

200

400

600

1,200

1,000

1,400

800

1,600

Source: International Monetary Fund

0

600

450

300

150

750

900

1,200

1,050

positive2 (see Figure IV.2.1). The growth fromthe previous years continued also in 2005.Total volume of trade has risen by approxi-mately 25% and according to the statistics ofthe Federation of European Stock Exchanges(FESE) based on its trading results PSE tookfirst place in the Central European region.Increase in trade value was driven by a surgein trading with shares on the main market,which accounts for more than 95% of thetotal trading with shares. Unfortunately thislively trading on the main market is onlyrepresented by several blue chips that arepart of the SPAD system.

This development also points out that theold problems are still present. The number ofliquid shares is very low, and new issues arenot coming. The only good news was the IPOof Zentiva (a pharmaceutical firm) that tookplace in June 2004. Zentiva is traded in SPAD;it also became part of the PX index. Never-theless, there was no IPO on the PSE in 2005if we do not take into account the dual list-ings of the ORCO and CME shares3. Eventhough thanks to the high prices and theenthusiasm of investors, the situation for IPOs

is in fact very favorable, but companies seemnot to be willing to open up to the public.Another problem is the fact that the primaryemission of the shares can be profitable onlyif it is large enough4. Despite the fact thatsome firms consider an IPO, the market isstill only waiting for new companies to enter.Moreover, 18 companies decided to leave themarket in 2005, and thus, there are only 39share issues traded on the PSE.

In 2006, there are new investment oppor-tunities coming to the PSE. These include thetrading of futures that started in October andthe possibility to trade investment certificates.Moreover, based on the demand for a marketsegment without strict information duties, theunregulated free market has been set up onthe PSE. The application for trading on thismarket can be submitted either by the issueror by a different party, and securities are ad-mitted to trade based on the decision of thePSE general manager. The unregulated freemarket is thus similar to the free market thatwas launched by the RM-system last year. If thestock exchange succeeds in attracting newcompanies this way remains a question of time.



Protection of Minority Shareholders(Based on Jan Bena and Jan Hanousek (2006):”Rent Extraction by Large Shareholders: Evidence Using Dividend Policyin the Czech Republic,” CERGE-EI working paper no. 291)

Failures in corporate governance have recently attracted wide attention around theworld. In the US, where most corporations have dispersed ownership, corporate governanceresearchers and practitioners concentrate predominantly on how to align incentives ofmanagement with those of atomistic shareholders. In contrast, the predominant form of

2 From March 2006 the PX index has replaced PX-50 and PX-D. PX index will be the continuation of the PX-50index and includes the most liquid share issues included in the SPAD system.

3 In comparison to this, there were 35 IPOs last year in Poland.4 The experts estimate that its size needs to be at least 1 billion CZK.

ownership in Europe and East Asia is control by a large shareholder, which often supplies topmanagement. Reflecting such very different ownership structure, the attention of corporategovernance is shifted from solving management-shareholder conflict to solving the oneamongst shareholders themselves. The key agency costs in firms with concentrated ownershiparise because a dominant shareholder has incentive to consume private benefits and extractrents at the expense of minority shareholders. The question of interest is whether rent extrac-tion takes place, how significant is it, and whether minority shareholders are able to monitorlarge shareholders in order to preclude it in the Czech Republic. The decisions taken by largeshareholders about how corporate profits are distributed can be documented by analyzing thedividend policy of more than 1,500 large Czech firms in the period 1993–2003. This analysisis the first comprehensive empirical study of dividends from a transition country in Centraland Eastern Europe.

Legally, all shareholders have the same cash flow rights in the Czech Republic. Payingdividends follows this principle as distributed cash reaches all shareholders proportionally, buta dominant shareholder exerting effort to seek private benefits associated with ownershipdoes not. The finding is that corporate dividend policy in the Czech Republic depends onconcentration and domicile of ownership. Firms with a dominant majority owner pay dividendsless often and their target payout ratio is small. In contrast, firms with a majority owner andat least one strong minority owner (monitored majority) pay dividends more often and thetarget payout ratio is large. The probability that a firm with a dominant Czech majority ownerpays a dividend is 0.09. If the Czech majority owner is accompanied by a significant minorityshareholder (Czech monitored majority) the probability increases to 0.16. The same patternholds for foreigners. The probability that a firm with a dominant foreign majority owner paysa dividend of 0.26 is a lot lower than the same probability if the majority owner is accompa-nied by a significant minority shareholder 0.58 (foreign monitored majority). The associatedtarget payout ratios for these ownership structures are as follows: positive but very close tozero for the dominant Czech majority ownership structure; 0.82 for the Czech monitoredmajority ownership structure; 0.61 for the dominant foreign majority ownership structure;and 0.86 for the foreign monitored majority ownership structure.

The above set of results for ownership concentration supports our hypothesis that, first,dominant shareholders extract rents from firms and do enjoy private benefits of control and,second, significant minority shareholders limit rent extraction by increasing the probability thata dividend is paid and increasing the target payout ratio. The presence of strong minoritiesshifts the dividend policy in the same direction both for Czech as well as for foreign largestowners and we highlight those minority shareholders plays a key role in determining dividendpolicy in the Czech Republic. Such results indicate that rent extraction and dilution of minorityshareholders seems to be associated predominantly with Czech owners as foreigners payhigher dividends relative to Czechs in all cases.

Expropriation by corporate insiders is not simply a matter of redistribution amongst share-holders only. It is damaging more generally as corporate insiders might choose to invest inprojects with low or negative returns just because they create opportunities for expropriation.Investment decisions are hence distorted and corporate growth is slower than it could be. Such



inefficient investment behavior, if undertaken by a large number of firms, has adverse effectson the whole economy. This is of an exceptional interest in countries like the Czech Republicwhich struggle to catch up with developed economies of Western Europe. Each dollaravailable for investing should be allocated to growth opportunities with the highest returns,and the investment decision should not be based on what projects make expropriationeasy. To address these problems regulators should, first, strengthen the rights of minorityshareholders to enable them to limit expropriation. Second, and more importantly, regulatorsshould support the development of sound and transparent financial markets prevalent inWestern Europe as they seem, based on extensive both anecdotal and research evidence, topolice dominant owners more effectively, comparatively better than countries like theCzech Republic.



Corporate bankruptcy is an importantinstitution of a market economy. Its functionis to free scarce resources from unproductiveuses and put them into the most productiveones, respecting to a maximum extentthe pre-bankruptcy arrangements betweenthe debtor and his creditors. In the CzechRepublic, resolution of corporate insolvencyrepresents a weak link in the legal and insti-tutional framework. Czech bankruptcy pro-cedures have long been egregious for theirlengthiness, low returns to creditors, liqui-dation bias, and, sometimes, questionablecompetency and integrity of bankruptcy trus-tees and judges.

The situation should change with theintroduction of the new insolvency law (the“Law”) that ended its path through thelegislative process, after some five years ofdebates and preparations, on April 14th, 2006when it was signed into law by the president.The Law will become effective on January 1st,2007. The new Law will completely replacethe current Law on Bankruptcy and Com-position which was introduced in 1991 andhas been amended twenty times since then.

The new Law differs from the previous one inmany respects of which we shall focus on themost important ones here. Conceptually, theLaw represents a more modern and market-compatible regulation. It treats the resolutionof insolvency not only as a procedural prob-lem but also as a problem of corporate gov-ernance of an insolvent firm, and it is builton the assumption that creditors are residualclaimants, giving them the right to makecrucial business decisions facing the bankruptfirm.

As for the individual features, the mostimportant are the introduction of the reor-ganization chapter, giving secured creditorsfull priority, giving creditors the right tochoose a bankruptcy trustee, and introducingdisincentives for various disruptive actions.We now describe the individual features.

The reorganization chapter is inspiredmainly by Chapter 11 of the U.S. BankruptcyCode but is modified to account for certaindifferences of the Czech legal and institu-tional environment. Its purpose is to adjustthe capital structure of an insolvent firm,reorganizing the claims on the firm’s value,

IV.3 Legal Framework and Bankruptcy

and let the firm continue under the samelegal entity (and, possibly, management). Thisprocedure should help save value when thereis significant asset specificity or when theindustry or the whole economy is in recessionand a market sale would not yield themaximum value for creditors. The problemis, however, how to prevent debtors (and/ortheir managers) from abusing the reorgani-zation chapter to maintain control over thebusiness even when this harms the creditors.Incidence of this perverse behavior has beenindicated even in the U.S., thus – given theinfamous track record of the Czech bank-ruptcy profession – it could be much more ofan issue in the Czech Republic. As a result,the major difference between the Czechreorganization chapter and the U.S. Chapter11 is the right of the creditors to decidewhether reorganization should be used ornot. This should ensure that reorganizationwill only be used when it makes sense andthat it will not represent a way for the debtorto escape creditors, which would have unde-sirable ex-ante effects on the credit market inthe form of a higher interest rate and creditrationing.

Under the current legislation, securedcreditors are entitled to receive in bankruptcyonly up to 70% of the value of their collat-eral, whereas out of bankruptcy they areentitled to full value of the collateral. Thissituation leads to various disruptive typesof behavior. First, banks, as the major se-cured creditors, are ex-ante motivated toover-securitize their claims so that the 70%of the collateral value is enough to cover thewhole claim. This behavior in turn reducesthe debt capacity of firms. Should one acceptthe arguments made by various bankruptcyscholars (e.g. Lucian Bebchuck or AlanSchwartz) for less-than-full priority of the

secured debt, one would rather have toformulate the rule in such a way that thesecured creditor would be entitled to receive70% of the minimum of the collateral valueand the value of his claim. Second, knowingthat he is entitled to obtain only 70% of thecollateral value in bankruptcy (given this valueis not high enough), the secured creditorprefers to avoid bankruptcy, which reducesthe credibility of a bankruptcy threat and,potentially, gives the debtor a means how tohold the secured creditors up (by threateningto declare bankruptcy on himself). Giving se-cured creditors full priority in bankruptcy, thenew Law attempts to avoid these problems.

The current bankruptcy law does notgive creditors a right to choose their ownbankruptcy trustee. This crucial person inthe bankruptcy procedure is selected by thejudge, and the creditors can only file a motionto dismiss him which the judge, however,does not need to follow. Such regulationcreates space for cronyism and corruption, asdocumented by several uncovered corruptionscandals. The new Law will enable the cred-itors to choose their own trustee, but theywill not be able to dismiss him at their will,only with the approval of the judge and fol-lowing some misbehavior. The reason for thecreditors’ limited discretion over the trusteeis to provide him with a reasonable degreeof independence and to guarantee the con-tinuity of the procedure.

The new Law also tries to tackle the prob-lem of various disruptive actions by both thedebtors and the creditors. On the side ofthe debtor, a common problem is delayingthe bankruptcy filing as much as possiblebecause this leads to the loss of control overthe firm. Between the moment a bankruptcyfiling should be made and the moment itactually is made, the firm value may fall sig-



nificantly and the creditors may suffer a lossas a result. To induce the debtor to file in timeshe is made personally liable for the differ-ence between a creditor’s actual compensa-tion and the face value of his claim, provideda willful delaying of the filing may be shown.

There is also a liability of a creditor for dam-age caused by a fraudulent bankruptcy filing.Also important are sanctions for creditorswho submit an obviously overvalued claim inorder to assure themselves control over thebankruptcy procedure.



The year 2005 can be characterized asthe year of Czech telecoms consolidation andglobalization. Furthermore, the regulatory andlegislative environment in the sector of tele-coms, newly named the sector of electroniccommunications together with digital TVbroadcasting, had to adopt fully the set of EUDirectives, known as the “New RegulatoryFramework”, in 2005.

In the fixed line telecoms, a massive con-solidation took place. The major consolidatingoperator on the “alternative operator scene”was GTS Czech that acquired in the end of2004 a similarly sized operator Aliatel. Byformalizing this acquisition in February 2005,a clear No.2 fixed line operator with the nameGTS Novera was formed. In July, the mainacquisition of the decade – the sale of 50.1%majority stake of the incumbent operatorČeský Telecom to the Spanish incumbentTelefonica – was finally completed. Togetherwith Český Telecom, Telefonica also gained100% control of the mobile operator Eurotelthat was fully acquired by Český Telecom in2004. Apparently, a dominant position ofČeský Telecom in both fixed and mobile tele-coms has been one of the main motives ofTelefonica for their first acquisition in theCentral European region. Later in the autumn2005, the consolidation in the fixed linesector continued with GTS Novera acquiringContactel, Nextra, and Telenor Networks that

strengthened GTS Novera positions mainlyin the segment of small offices and homeoffices and small and medium enterprises seg-ment. This, in turn, has enabled GTS Noverato compete with Telefonica / Český Telecomacross all business segments. In the resi-dential segment, the dominant position ofTelefonica / Český Telecom has remained un-challenged with several smaller competitors,e.g. Czech On Line, Radiokomunikace, Tele2playing a marginal role.

In mobile telecoms, the Czech marketbecame from 2005 a battlefield of globalplayers – Telefonica O2 controlling Eurotel,Vodafone acquiring Oskar in spring 2005and, finally, T-Mobile. T-Mobile claimed in2005 surpassing its rival Eurotel and gainingthe market leader position in the number ofSIM cards. In 2005, also preparations forconverged fixed and mobile services startedin Telefonica’s Český Telecom/Eurotel and thatwere sped up by Telefonica’s pan-Europeanacquisition of the mobile operator O2.

In terms of market value, the Czech tele-coms market reached a total revenue value ofaround 120 billion CZK in 2005 with mobileservices creating almost two-thirds of thetotal value.

From a customer perspective, the year2005 does not present a significant milestonefor a completely new end-user service; how-ever, several new services started in a trial or

IV.4 Developments in the Telecommunications’ Industry

pilot regime and are expected to be launchedfully in 2006. Among others, Eurotel launchedvideo calls based on high-speed Internetservice known as “third generation” (3G)and Český Telecom started a pilot projecton IP TV using ADSL lines. A common trendin telecoms is bundling traditional telecom-munication services, mainly connection toInternet, with Internet and TV content – IP TVon fixed ADSL lines or TV in mobile handsetsusing DVB-H standard.

In the regulatory area, the new Act onelectronic communications came into effectfrom May 2005, which has implied duties onthe regulator regarding the implementationof a new regulatory regime and telecomsmarket analysis. By February 2006, the regu-lator should have finished the analysis of themain telecoms markets (17 relevant markets)that included fixed and mobile telephony,data services, and broadcasting. In the mar-kets, where distortions to free competition(mainly due to a dominant position) were

identified, the regulator was obliged to im-pose remedies by May 2006 and decide onkeeping, increasing or canceling regulatoryobligations on dominant players imposed bythe previous “ex-post” regulation. There havebeen delays in completing the analysis ofmost relevant markets, which induced criti-cism from the European Commission and alsosome personnel changes in the regulatoryauthority later in 2006.

Overall, the year 2005 significantly changedthe competitive structure and the regulatoryenvironment of the Czech telecommunica-tions industry. It was also the year of majorinvestments in new technologies and networkcoverage for new services both in the fixedand mobile sectors. In 2006, it should becomeclear whether these structural changes andnew investments will materialize in morebeneficial services to customers and contrib-ute to the growth not only in telecom sector,but to the growth of the Czech economy.



In early 2005, the Czech daily MladáFronta Dnes reported that 67 percent of theCzech population believed that corruption isan alarming problem in need of a solution. Inlate 2005, the Prague Post reported aboutanother poll according to which nearly 70percent thought that corruption increasedin 2005, while only 3 percent thought thatcorruption was in retreat. A recent survey ofthe SC&C agency for Mladá Fronta Dnes[24.4.2006] found that 36 percent of theCzech population admitted having paid abribe and 21 percent claimed that they wereoffered a bribe.

While Tranparency International’s latestnumbers did not bear out this increasinglydark picture of the state of corruption – theCzech Republic roughly maintained its pitifulTI ranking and score from the previous year(see Figure IV.5.1), beating out only Latviaand Poland among the EU countries – therewere plenty of reports of corruption activities,and demonstrations of a lack of will toaddress the corruption problem, that left thepublic with little hope that corruption is aproblem that will go away any time soon.

Throughout 2006, for example, the inves-tigation into the largest corruption scandal

IV.5 Corruption

in Czech soccer history continued. Elevensoccer referees, club representatives, andofficials received suspended sentences andfinancial penalties (30–900 thousand CZK),all of them have appealed [MFD, July 13,2006] – none of the cases have been decidedyet. In addition, the Soccer Association ofthe Czech Republic (ČMFS) punished 16referees, club representatives, and officials bysuspension from function for 2 years and/orfinancial penalty (50 thousand CZK for thevast majority).

Almost predictably, the closure of two (outof five in 2005) major privatization deals – thesale of petrochemical company Unipetrol andof steel company Vítkovice Steel – were con-nected with (allegations of) major corruptionscandals. The allegations swirling around theUnipetrol deal inolved Poland’s PKN Orlenwhich bought the Czech government’s sharein the company for 14.7 billion CZK (609.7million USD) during the summer months.Apparently, the deal required PKN Orlento sell some subsidiaries to Czech company

Agrofert for 3 billion CZK. Curiously, thesesubsidiaries were worth 5.3 billion CZK onthe books, so new management at PKNOrlen refused to sell them. Which ledAgrofert to initiate several suits (and a PolishState prosecutor and a Polish parliamentarycommittee to investigate whether the saleof Agrovert was meant to be a payback).Specifically, it was alleged that Agrovert headAndrej Babis – known to be a close friendof former prime minister Gross [The PraguePost, September 7, 2005; February 08, 2006;July 12, 2006] (who himself was forced toresign over questions how he and his wifecould afford a couple of luxury apartmentswell beyond their means) – influenced theoutcome of the original deal. None of thesesuits has been decided yet. The privatizationtender for Vítkovice steel was won by Russ-ian company Evraz although their bid of 7.1billion CZK was not nearly the highest. CzechPenta Investments which offered 9 billion CZKfiled a complaint with the European Commis-sion. This complaint has not been decided yet.



Czech Republic PolandSlovakia Hungary

Figure IV.5.1. Corruption Perception Index

Source: Transparency International Czech Republic

Year

CPI

3.0

3.5

4.0

4.5

5.0

5.5

6.0

20052004200320022001200019991998

Not surprisingly, the usual accusationswere made about police officers (e.g. twomillionaire foreign police officers accusedand convicted in Karlovy Vary in spring 2005);customs officers (19 customs officers fromBřeclav accused yet in 2004 from extractingrents from truck drivers); taxi drivers (alto-gether 50 people accused from corruption andfalsification of documents regarding licenseissue in Prague); and city mayors (manipula-tions regarding donations, public tenders orallocation of municipal apartments).

The disputed circumstances of the firingof Supreme State Attorney Marie Benešová –who had held the post since 1999 – also keptthe public entertained for awhile. She wasdismissed – under an obvious pretext – aftershe dared to publicly criticise Justice MinisterPavel Němec – well known for having spenthis honeymoon in Qatar – for his handlingof the extradition of a Qatari prince who hadbeen convicted of, and sentenced for, childmolestation. She also had demanded thather budget be no longer under the control ofthe Ministry of Justice. As a parting shot,Benešová suggested that the true reason fordismissing her was Němec’s concerns aboutthe outcomes of various investigations ofhis ministry that Benešová had launched. Thepress seemed unanimous in its judgementthat Benešová had been too outspoken forher own good.

Police Chief Jiří Kolář also, finally, was letgo after billionaire Radovan Krejčíř, suspectedof plotting fraud and murder, among othercriminal acts, managed to escape during an

anticorruption police search of his house. Afew months before he had to resign becauseof this snafu, Kolář – in an interview withThe Prague Post (January 6, 2005) identifiedcorruption as the biggest problem that hisforce faced.

The last-minute, highly unusual cancella-tion in November of a long-planned visit ofa group of OECD anticorruption inspectors,raised eye-brows nationally and with theOECD which did not mince words in express-ing its irritation. The Justice Ministry explainedthat the visit was postponed due to logisticalreasons.

A new, and overdue, conflict-of-interestlaw approved in March 2006 was quicklycriticized for its shortcomings (the requirementto disclose financial statements, for example,does not apply to spouses of politicians) andthen in June 2006 overturned by the Consti-tutional Court due to procedural mistakesduring the approval process. A code of ethicsproposed more than a year ago was notimplemented, as politicians argued that newlegislation would not stop corruption. Anda law regulating lobbying activities, clearlymuch needed, is also not likely to materializeany time soon.

According to a poll conducted by SC&Cagency in fall 2005, 81.5% of the Czechpopulation doubts that the governmentcan solve the problem of corruption (MFD,November 23, 2005). In light of the eventsof the past year, it is easy to understandsuch sentiments. The question is: If not thegovernment, then who?



In the Czech Republic, the private non-profit sector that started to emerge only inthe 1990’s after the fall of the communistregime continues in steady growth. Takinginto account the four major nonprofit legalforms (civic organizations, foundations, foun-dation funds, and religious organizations),the number of nonprofit organizations hasincreased from 60,000 in 2004 to 64,000in June 2006. The major increase has beenexperienced by civic organizations – the mostpopular legal form. In addition, there are othertypes of nonprofit entities such as organiza-tional units of civic organizations that increasethe total number of nonprofit organizationseven further. According to estimates of theCzech Statistical Office (CZSO) there wereabout 75,000 active entities in 2004 sug-gesting that the increase in the period2004–2006 raises the number of active unitstoward 80,000. Most recent data on employ-ment and volunteer input (CZSO) indicatethat in the period 2002–2004, the number offull time employees remained about 32,000,the number of persons working under con-tracts other than contracts of employmentdecreased from 147,000 to 106,000, whilethe number of volunteers decreased from530,000 to 490,000.

The structure of the private nonprofit sec-tor continues to preserve the focus on cultureand sport, while the traditional nonprofitfields of education, health and social care playa minor role. As estimated by Czech NonprofitSector Research (CVNS), about one-tenth ofgalleries, museums, and memorials, one-fifthof galleries with expositions, and 40 percentof music ensembles are nonprofit. However,only 1 percent of all health organizations,2 percent of pre-school and 3 percent of

primary education facilities are nonprofit. Insecondary and tertiary education, the role ofnonprofit organizations is more significant.More than one-fifth (quarter) of secondaryschools (universities) are nonprofit. These in-stitutions are typically smaller than publicschools and their share of the student bodyis significantly smaller. In social services, thefraction of nonprofit entities exceeds one-quarter. However, in the case of activities tar-geted to specific groups, the fraction is muchhigher, e.g. facilities for foster care (100%);homes for mothers with children (70%); orfacilities for handicapped youth (51%).

Nonprofit entities in the Czech Republichave three main sources of income: fees andcharges (47%); public funding (39%); andphilanthropy (14%), as reported by USAIDfor the year 2002. The income structure,however, depends on the type of servicesprovided by particular organizations. For in-stance, public benefit organizations providinghealth care live on fees and charges, withless than 10% income coming from othersources. In contrast, schools and entities pro-viding social care receive respectively morethan one-half and one-third of income fromthe state (CVNS).

The nonprofit sector, mostly under theauspices of Donors Forum, the Czech basedumbrella organization for foundation-likeorganizations and corporate philanthropy,responded to a 25% decrease in foreignfinancial support in 1997–2002 (USAID) byseveral initiatives mobilizing domestic giving.To support individual giving, donation textmessages (DMS) were introduced in 2004.The project, which significantly simplifiessmall giving, has been very successful. In thefirst two years, about 4.3 mil. DMS was sent,



IV.6 Nonprofit Sector

representing more than 116 mil. CZK. Suc-cessful was also an initiative to exempt DMSfrom VAT. For several years, Donors Forumin cooperation with other organizations pro-posed tax assignation that would allow eachtaxpayer to assign 1 percent of her tax liabil-ity to a nonprofit organization of her choice.Although the initiative has citizens’ support,the legislation was not yet approved.

After the first 15 years of existence, theCzech nonprofit sector seems to be support-ed by a basic working framework. Currentactivities focus on legislative amendments,professionalization, and transparency of non-profit entities. The legislative framework stilllacks a definition of terms such as “nonprofitorganization” and “publicly beneficial activ-ity,” making the interpretation of acts relat-ed to nonprofit entities problematic. Anotherre-occurring topic is the adjustment of theincome tax law that currently forces nonprofitentities to do separate book-keeping formain and business activities, thus restrictingcross-subsidization of their publicly beneficialactivities.

The need for professionalization of theCzech nonprofit sector is strongly empha-sized in the report by USAID. Nonprofitorganizations are still run more often byenthusiastic people, who are devoted to thecause, but have neither education nor expe-rience necessary to do the job. Thus, mostof the organizations lack experts for strategicplanning, financial management, humanresource management, and marketing. Oneof the consequences is, for example, insuffi-cient development of fundraising amongnon-anonymous individuals, or work withvolunteers. Lack of professionalism and expe-rience is present also among board members,who do not meet requirements of the job as

those in the nonprofits in Western countries.One important example is that they do notbring in funds; their role in fundraising isminor if any – usually this task is delegatedto executives. Nonprofits understand the needto change the present situation (several orga-nizations exist that offer courses developingmanagement skills for managers in non-profits). The major problem until recently werethe costs of this training, which were toohigh for the majority of organizations. Thisis possibly changing after the accession to theEuropean Union, which requires a profes-sional approach and is willing to support itsdevelopment.

The recurring topic of the sector is trans-parency and accountability. Initially it has beenmotivated by several scandals in the sector(e.g., cooperation between foundationsand casinos; abuse of the foundation status)which had a negative impact on the publicimage of the sector. In May 2006, the Czechbranch of Transparency International in coop-eration with CERGE-EI organized a workshopsuggesting certification by an independentagency as a possible solution to the problem.The idea was coldly received. At this pointa certification system for nonprofits seemsfar away.

Nonprofits, though, realize the importanceof transparency and accountability, but theyprefer to improve it via increased self-reportingand self-regulation. This issue is pushed for-ward also by a new project initiated by fourlocal nonprofits at the beginning of 2006.The focus of the project is on the processesin the organizations and provision of infor-mation above the extent required by law.The project has started with an evaluation ofthe situation, and an on-line discussion of thetopic (www.vitaova.cz/transparentnost).



The Czech Republic boasts one of thehighest upper secondary school completionrates in the OECD and in this respect alreadyachieved one of ambitious Lisbon agendagoals. In 2002, 88 percent of the Czechpopulation aged 25 to 64 had completedat least upper secondary school. In contrast,only a very small proportion of the Czechpopulation has completed university: Only12 percent of the population aged 25 to 64has a university degree, compared to anOECD average of 23 percent.

The structure of the Czech educationaland training systems parallels those of otherEuropean countries. However, a very highpercentage of secondary school studentswere and still are traditionally enrolled invocational programs. For example, in 1995,only 16 percent of Czech secondary schoolstudents were in an academic secondary pro-gram, compared with 47 percent in a typicalOECD country. While the size of the generalsecondary programs has been on the wholealmost fixed and a substantial supply gaphas persisted over the last years, the rapidlydeclining size of the youth cohorts hasallowed an increasing fraction of each cohortto enrol in a general secondary educationprogram and to subsequently enter a univer-sity or a lower-tertiary-education program.

While private secondary schools, estab-lished only in the early 1990s, now provideabout one-fifth of the total of secondaryeducation in the country and are allowed tocharge tuition on top of their public subsidy,public universities and colleges, which are


Chapter V. I LABOR MARKET

V. LABOR MARKET

V.1 Human Capital

Table V.1.1 Fraction of population thathas attained at least upper secondaryor tertiary education (2002)

Type of education Upper Secondary TertiaryAge group 25–64 25–34 25–64 25–34

Australia 61 73 31 36

Austria 78 85 14 15

Belgium 61 77 28 38

Canada 83 89 43 51

Czech Republic 88 94 12 12

Denmark 80 85 28 29

Finland 75 88 33 39

France 65 79 24 36

Germany 83 85 23 22

Greece 50 72 18 24

Hungary 71 82 14 15

Iceland 59 64 26 29

Ireland 60 77 25 36

Italy 44 60 10 12

Japan 84 94 36 50

Korea 71 95 26 41

Luxembourg 57 64 19 23

Mexico 13 21 6 11

Netherlands 66 76 24 28

New Zealand 76 82 30 29

Norway 86 95 31 40

Poland 47 53 12 16

Portugal 20 35 9 15

Slovak Republic 86 93 11 12

Spain 41 58 24 37

Sweden 82 91 33 39

Switzerland 82 88 25 26

Turkey 25 31 9 11

United Kingdom 64 70 27 31

United States 87 87 38 39

Country mean 65 75 23 28

Source: OECD (2004) Education at Glance

tuition-free by law, continue to dominatethe production of tertiary education andcontinue to be highly oversubscribed. Privatecollege students, in contrast, do not get any

public support. Over the last decade, approxi-mately one-half of the applicants to thepublic tertiary system has been rejectedeach year.



Admission to Selective Schools, Alphabetically(Based on Stepan Jurajda and Daniel Münich: Admission to Selective Schools, Alphabetically. CERGE-EI Working PaperNo. 282, 2006.)

Sorting based on ‘alphabetical order’ is a fact of everyday life. Yet, so far there is littleevidence on the potential real effects of such sorting, thanks in large part to lack of data withindividual names or initials. The question of non-discriminatory sorting is particularly importantwhen distributing a rationed good or oversubscribed public service, even when the allocationmechanism is based on applicants’ characteristics. In this study, motivated by the continuedrationing of college applicants in the Czech Republic, we ask whether students with lastnames sorted high in the alphabet enjoy higher chances of being admitted to selective schools.Such an effect may exist when applications are evaluated based on multiple criteria in absenceof a clear summarizing measure, and when marginal cases at the top of the list obtain a morefavorable treatment compared to marginal applicants toward the bottom of the list, whereconstraints on total number of possible admissions become more binding.

We find empirical support for this hypothesis using data on student applications to Czechuniversities in 1999 and also confirm the existence of a specific name initials-ability sorting thatone would predict if schools did indeed use alphabetical sorting. In particular, the presence ofalphabet-affected admission practices implies that among students admitted to selectiveschools, those with last names in the bottom part of the alphabet have on average a higherability. Throughout our analysis we also test for the importance of the alphabetical position ofthe first-name initial, thus providing a natural check on our main results. It is reassuring thatwe do not find the first-name-initial position in the alphabet to play any important role.

Should our interpretation of the empirical findings be correct, there would be a non-negligible negative effect of apparently discriminatory practices for individuals with last namestowards the bottom of the alphabet. Rationing of public services based on a lottery is optimal,but the use of a fixed “lottery ticket” (one’s last name initial) throughout many lotteries(many schooling levels) is not fair. A simple remedy is to assign each application a numericalcode at random and base sorting on this alternative lottery, as many schools already do. Webelieve that our results motivate future research into the use of alphabetical listings in publicdecision making.

The Czech labor market traditionally boastsa high employment rate (i.e. the fraction ofpopulation employed) in comparison to bothEU-8 and EU-15 countries, as witnessedby the graph, which also shows the Lisbontarget employment rate (in red). Even thoughsome EU-8 economies, e.g. Hungary, havelower unemployment rates (the fraction oflabor force without work and searching forwork), these occur with the background of a

much lower labor market participation. TheCzech employment rate was traditionally highin comparison to EU-15 mainly because ofthe high employment rate of Czech womenaged 25–54 with less than tertiary leveleducation. Another unusual feature of Czechemployment with respect to that of the EU-15economies are the very high share of manu-facturing on total Czech employment and anextraordinary low incidence of part-time work.



V.2 Employment, Unemployment, and Wages

Figure V.2.1. Employment (%)

Source: Eurostat 20052000

Country

40

50

60

70

80

Uni

ted

Stat

es

Rom

ania

Cro

atia

Bulg

aria

Uni

ted

Kin

gdom

Slov

akia

Slov

enia

Port

ugal

Pola

nd

Hun

gary

Lith

uani

a

Latv

ia

Esto

nia

EU(1

5 co

untr

ies)

Cze

chRe

publ

ic

Figure V.2.2. Unemployment (%)

Source: Eurostat 20052000

Country

0

5

10

15

20

Uni

ted

Stat

es

Rom

ania

Bulg

aria

Uni

ted

Kin

gdom

Slov

akia

Slov

enia

Port

ugal

Pola

nd

Hun

gary

Lith

uani

a

Latv

ia

Esto

nia

EU(1

5 co

untr

ies)

Cze

chRe

publ

ic

There has been some decline in Czechaggregate employment rates between 2000and 2004. The most important factor behindthis drop are declining employment rates forthose aged 16–24 with less than tertiary leveleducation, which is related to their longer par-ticipation in education. However, during 2005,sustained economic growth finally started toshow on the labour market. The 2005 Czechemployment-rate growth of 0.4 of a percent-age point recovered losses from the previoustwo years and the (ILO) unemployment ratealso returned to its 2003 level of just below8 percent. These changes correspond to a total2005 employment growth of 1.2 percent.

This recent improvement in employmentand unemployment indicators occurred, notsurprisingly, while wage growth has beenslow. The 2005 all-year Czech wage growthwas 5.5 and 3.5 percent in nominal andreal terms, respectively – the lowest annualwage growth in over a decade. Importantly,anecdotal evidence suggests that collectivewage bargaining, which covers over 80 per-cent of enterprises with over 250 employees,is flexible and reflects industry and firm-specific product demand trends.

The sectors contributing the most to grow-ing employment were manufacturing, privateservices, and the public sector. Contrary toa new former (recurring) plans to make thepublic sector more efficient, its total employ-ment grew in the last two years. While a partof the rise in the number of state bureaucratscorresponds to new EU-related agenda at thecentral level, much is apparently due to thepartial transfer of the administrative agendato the regional governments, where theestablishment of new offices at the regionallevel was not accompanied by a correspond-ing slashing of central-level administrationstaffing. Finally, we would also blame theemployment hikes in the public sector on thelittle effective pressure it faces to improveits productivity.

The high employment rates, in comparisonto most other EU-8 economies, is in large partlikely related to the low level of Czech laborcosts, relative to productivity, even though thisadvantage has been shrinking in recent yearsdue to the crown’s continuous appreciation.Czech total labor costs (measured in Euro usingexchange rates) are only somewhat higherthan those of most EU-8 economies and con-



Unemployment rateEmployment rate Activity rate

Figure V.2.3. Key Labour Market Indicators for the Czech Republic

Source: CSO, Labour Force Survey data

Year

rate

s (%

)

200620052004200320022001200019991998199719961995199419930

20

10

30

40

50

60

70

tinue to be far below the labor costs typicalof EU-15. At the same time, a Czech worker’stotal output (measured by GDP per worker inpurchasing power standard) is, thanks to thelower Czech price level, closer to the EU-15average than the Czech labor cost. However,according to the OECD’s Taxing Wages, thestructure of labor costs in Czech lands is verysimilar to that of most developed economiesand is characterized by high contribution ratesand a high total tax wedge. The Czech taxwedge (defined as the ratio of income tax and

social security contributions of both employerand employee to total labor costs) is particu-larly high in international comparison whencalculated not for the average productionworker, but for a worker making only two-thirds of the average wage. Given the limiteddownward wage flexibility among low-earners,this tax burden may be work-discouragingfor low-education low-earners. Finally, laborcosts in Euro grew not only because of theCrown appreciation but also because of thesteady growth of real Czech crown wages.



Figure V.2.4. Wage and Employment Annual Growth Rates (%)

Source: CSU Real wage growthEmployment growth rate

Year

-4

-2

0

2

4

6

8

10

200420032002200120001999199819971996

Table V.2.1. Aggregate Productivity, Labor Costs and their Structure

Czech SlovakPoland Hungary Germany PortugalRep. Rep.

Labor Costs

Total hourly labor costs in EUR 5.4 3.6 5.3 4.5 26.9 9.0

Productivity

GDP per hour worked (EU-15=100%, PPS) a) 45 50 38 103 59

GDP per worker (EU-15=100%, PPS) 57 55 47 62 94 64

Structure of Labor Costs

Total social security contribution rate, 2003 b) 47.5 50.8 45.4 49.6 42.0 34.8

Total tax wedge = contribution rates59.1 57.1 51.6 62.6 62.9 40.4+ income tax rate c)

Sources: Eurostat, OECD (Taxing Wages)

Notes: a) Values as of 2002, b) Summation of pension, employment policy, health insurance and other contribution ratesc) Last two rows relate to an average-wage non-married childless production worker

Wages of Czech Female Managers(Based on Stepan Jurajda and Teodora Paligorova: Female Managers and Their Wages in Central Europe.CERGE-EI Working Paper No. 296, 2006.)

There is growing international evidence that women face a ‘glass ceiling’ – a barrierto career prospects, which precludes them from holding high-paying positions. Of particulargeneral public as well as academic interest is the representation of women among top-levelmanagers and their relative wage position. There is so far no evidence on this issue fromthe post-communist economies of Central Europe, even though the relative pay position ofwomen among the employee workforce has been extensively studied there.

We therefore analyze the representation of women and their relative pay in a large sampleof Czech top- and lower-level managerial employees from 2000–2004. Our managerialgender wage gap decompositions appear to be the first available outside of the mostdeveloped economies. Furthermore, unlike the existing literature on gender pay differencesamong executives, they recognize the adverse consequences of the low and uneven repre-sentation of female managers for the standard parametric Oaxaca-Blinder decompositiontechnique. Parametric assumptions lead to an over-estimation of the ‘unexplained’ componentof the gap, i.e. the part of the gap attributable to differences in rewards to individual charac-teristics and often interpreted as an upper bound to the extent of gender discrimination.We therefore employ a nonparametric matching wage gap decomposition approach.

We find that at 7% women are severely under-represented in top managerial positionsin the Czech Republic, and that there is a clear gender divide between lower and top-levelmanagerial ranks, given that the raw average pay gap between men and women increaseswith firm hierarchy level. However, our wage-gap decomposition analysis suggests that the sizeof the wage gap that cannot be linked to observable differences between men and womenis quite similar across hierarchies. In other words, after comparing the wage rates of womenand men who are comparable in terms of basic demographic characteristics, employertype and within-firm hierarchical position, there remains a gender wage gap of about 20percent. The key reason for why the relative wage position of Czech female top managersis worse compared to lower-ranking female employees is that they tend not to be presentat the top of the highest-paying companies. The policy implication of these findings is thatequality-enhancing policies aimed at the highly visible group of executives are more likely tobe effective in equalizing wages of male and female top managers if they focus on promotionpolicies in the most prestigious companies.



Internationally comparable indices of flexi-bility traditionally suggested that the Czechlabor market remains to be somewhat moreflexible than those of most EU countries andmany transition economies. However, thiscomparison has become less favorable sinceneighboring Slovakia introduced a numberof flexibility-promoting policies (pro-workstructure of support, flexible Labor Code),while there has been little improvement inthe Czech labor market. First, there were toofew pro-flexibility changes in the new CzechLabor Code to be put into effect in 2007,championed by the trade unions and theirpolitical representatives in the government.For example, laying off a single worker dueto inadequate effort remains very costly anddifficult.

Second, there has been arguably littleprogress in diminishing the disincentive effectsof the Czech welfare system. The extensiveCzech system of social assistance successfullyalleviates poverty, but makes the comparisonof market wages with the total level of avail-able social benefits work-discouraging espe-cially for families with children (details wereprovided in previous versions of this survey).Recently, a set of legislation that aims toreduce the inactivity traps has been passedin parliament, although the legislators haveintroduced a number of generous spendingincreases. The main disadvantage of the pro-posed new system is that is will remain verycomplicated; it is supposed to correct someof the labour-supply disincentives faced bylarger families and to shift some of thebudgetary and ‘activation’ responsibility fromthe central administration to municipalities.

Another key area of labor market policyis immigration. Given low fertility, the highCzech employment rate, and the particularlylow tertiary education attainment rate of theCzech labour force, (skill-based) immigrationis one of the key possible channels of increas-ing aggregate labour supply. As of the end of2005, there were about 280,000 officiallyregistered foreigners (about 2.7 percent ofthe total population), of which about 110,000had permanent residency. The largest twonationality groups are Slovaks and Ukrainians.Ukrainians now hold the majority of all work-ing permits. Unfortunately, the administrationof working permits is corruption-prone andexceedingly hostile, and there are no plansfor major changes proposed to the workingpermit system. The only legislative improve-ment in the immigration area is a new bill,recently approved by the Senate, which allowsforeigners living and working in the CzechRepublic the possibility of being granted per-manent residence after five years, as opposedto the currently used minimum of ten years.The bill could affect about 38,000 foreignersliving in the country. Meanwhile, the maingovernment programme aimed at supporting(skill-biased) migration has finished its pilotyears, during which it failed to attract asignificant number of workers. Starting in2006, it now covers not only a few smallcountries, but also Ukraine. However, untilJune 2006, the programme could accom-modate a maximum of 300 Ukrainians, anegligible fraction of the dozens of thousandsof Ukrainian immigrants, both legal andillegal.



V.3 Labor Market Institutions and Policy

Admission of Students to Secondary Schools: Crazy Matching(Based on forthcoming CERGE-EI Working Paper by Daniel Münich and Ondrej Knot. Partly based on D. Münich andJ. Myslivecek “Transition of pupils to high-schools: demand-supply discrepancies and consequences,” in Mateju, P.and J. Strakova (eds.), in (Ne)rovne sance na vzdelani: Vzdelanostni nerovnosti v Ceske republice [(Un)equal StudyOpportunities: Educational Inequalities in the Czech Republic], Academia, 2006].

In 2005, a nationwide dispute broke out over modifications of the admission procedure intosecondary schools. The modification to an already flawed admission procedure emphasizedexisting deficiencies. Public outcry also led to constitutional complaint which has not beenconcluded yet.

Under both the old and the modified rules, a 15-year-old pupil chooses a single school inthe first round of the admission procedure. Schools then select among applicants based onability – on entrance examinations and/or marks in the elementary school. This ability basedselection contrasts with ability blind mechanisms employed in the US and in a number ofother countries. Pupils not admitted in the first round compete for the remaining seats inthe following rounds.

The major problem of the mechanism is that good pupils who overestimate their admissionchances or ad hoc fail in the 1st round of admission cannot choose their 2nd best schoolbut only from schools with remaining slots. As a result, the process of school choice andadmission requires a lot of strategizing on the side of parents and pupils, is psychicallyburdensome, and outcomes are unfair to many. There is also empirical evidence that thescheme discriminates against especially promising applicants who have a weaker socialbackground because many of them are not able to strategize properly.

The aforementioned setbacks of the admission scheme have also efficiency implications.Strategic behavior of applicants biases observable information on demand for various schoolsand school types. In particular, the demand observed misleadingly indicates demand-supplybalance while it is not so. Hidden discrepancies benefit underperforming schools and old-fashioned school types, and it contributes to the rigidity of the whole schooling system.

The modifications introduced in 2005 were minor: one positive the other negative. Theformer implies that second round school applications are no longer submitted before the 1st

round but after it, when information on still available school slots is already available. Thischange should facilitate choice because when students decide about the school for thesecond round, they already know how many free seats each of the schools have. The latterone implies that applications and admission to non-state schools are to be newly governed bythe existing rules too. This reduces choice and increases the anxiety of students about theadmission procedure and decreases the interactivity of private schools.



IntroductionPublic pension systems represent the

largest expenditure item in almost all devel-oped countries. The European Union spendsa whopping 10.6% of its GDP on publicpensions. Indeed, Austria and Italy manage tospend as much as 13–14% of their respectiveGDPs on public pension schemes. The new EUmembers – namely the eight post-communistcountries in Central Europe – struggle withpension systems beset by a combination ofa socialist legacy, which shows a high popu-lation reliance on public pensions and nearnon-existent, long-term private savings; and

with fast approaching of low fertility ratesprevalent in west European countries thattranslates into rapid aging. This combinationburdens central European governments’budgets as witnessed by Table VI.1.1. If therewere no reform in Hungary, it could spendas much as 20% of its GDP on old-age pen-sions in 2050. Slovenia would come second,with 17.5% of GDP spent on pensions, andseveral other countries (including the CzechRepublic) do not lag far behind.

Central European countries have reactedvery differently to the pension challenge.Some enacted bold reforms, earlier seen only


Chapter VI. I PUBLIC SECTOR

VI. PUBLIC SECTOR

VI.1 Pensions in Central Europe: Threat or Opportunity

Table VI.1.1. Public pension expenditures in CEE countries

Old age Public pensionReplacement rateCountry dependency ratio* expenditures (% of GDP)

2004 2050 2004 2050 Total in 2004** 2nd pillar in 2050#

Czech Republic 19.7 54.8 8.5 14.0 61% 0%

Estonia 23.8 43.1 6.7 6.6 33% 21%

Hungary 22.6 48.3 10.4 20.3 66% 19%

Poland 18.6 51.0 13.9 9.3 63% n.a.

Latvia 23.6 44.1 6.8 8.3 61% 19%

Lithuania 22.3 44.9 6.7 10.4 40% 0%

Slovakia 16.3 50.6 7.2 11.2 49% n.a.

Slovenia 21.4 55.6 11.0 17.5 64% 0%

Germany 26.8 51.7 11.4 13.1 43% 15%

France 25.2 45.4 12.8 14.8 65% 0%

Ireland 16.4 45.2 4.5 11.1 67% 33%

Italy 28.9 62.2 14.2 14.7 79% 15%

Netherlands 20.5 40.6 7.7 11.2 71% 39%

Sweden 26.4 40.9 10.5 11.2 68% 15%

Austria 22.8 52.4 13.4 12.2 64% 0%

Source: OECD, European Commission (2006)* Number of people aged 65 and over as a percentage of people aged 15–64.** Theoretical replacement rate of a male worker with 40 years full-time work at average earnings, retiring at the age of 65

in 2005.# Expected pension paid from the 2nd pillar in 2050.

in Latin America; some pretended thateverything was OK. The Czech Republic wasactually a frontrunner when it launched(voluntary) private pension funds in 1994and reformed its pension system in 1996(retirement age was increased, pensionswere linked to life-time labor income). Butin late the 1990s, Hungary and then Polandreformed their respective pension systemsin a more comprehensive way. Followingthe relative success of these two reformers,other countries followed suit and in 2006,eight post-communist countries (five of themalready EU members) have implementedpension reform based on partial privatization.The region thus has become the other hot-bed of so-called “structural” pension reforms(Latin America being the first one).This briefsurvey looks at central European pensionsystems’ main characteristics and their devel-opments and also analyze possible remediesand actual policy actions of governments.Furthermore, it is discussed how the pensionsystems have reacted to recent reforms inseveral central Europeans countries, and wesketch challenges for future.

Pension landscapeCentral European countries inherited pen-

sion systems firmly rooted in their communistpast. The main role of pension systems wasthe prevention of poverty, the increasingdependence on government, and the manip-ulation of the labor force. These politicalobjectives resulted in pension systems with alow retirement age, little variation in pensionbenefits, and no private pension savings.

In the 1990s, most Central European coun-tries modernized their pension systems,separated them from the central governmentbudget, increased the retirement age andmade pension benefits more dependent on

pension contributions. The Czech Republicimplemented such a reform in 1994, com-plemented by a creation of voluntary privatepension funds.

However, these “first-wave” pension re-forms proved very quickly to be insufficientas Central European societies experiencedthe ageing phenomena whereby mortalitydropped due to better health care andimproved eating (and drinking) habits. Atthe same time, the fertility rate collapsed aswomen faced both increased opportunitiesin labor markets but also higher uncertainty.The fertility rate fell as low as to 1.17 childrenborn per woman in the Czech Republic. Atsuch a rate, the population of the countrywould shrink by 30% in a generation, ademographic equivalent of a nuclear attack.

Due to fast aging, most pension systems inCentral Europe dived into deficits in the mid1990’s. This pressure led to the first attemptto change the pension system structurally,i.e. to introduce private pension savings. Hun-gary adopted such a “three-pillar” pensionsystem actively supported by the World Bankin 1998. Poland followed (with even a morecomprehensive reform) in 1999, Latvia in2001 and so on. At the same time, pensionsystems were reformed in some other post-communist countries that were not the EUmembers (Kazakhstan, Croatia, Russia) – seetable VI.1.2.

Pension challengesThe different approach to pension reform

has transformed into different outcomes. Thevigorous reformers – namely Poland, Estoniaand, since 2005, Slovakia – witnessed muchmore benign developments in their currentpension spending and, more importantly,they may avoid stark increases in pensionexpenditures that are projected for more



apathetic countries as the Czech Republic andSlovenia. For example, public pension expen-ditures are set to remain stable in Estonia atabout 7% of GDP. The expenditures will fallin Poland from 14% of GDP in 2004 to some9% in 2050. On the other hand, pensionexpenditures will explode to 17% of GDP inSlovenia and to 15% in the Czech Republic.Hungary then demonstrates that an im-perfect pension reform complemented bygovernment inconsistency and politicalmaneuvering may even exacerbate the long-term outlook – see Table VI.1.1 – Pensionsystems do not, however, interact with thefiscal system only. Their impact is felt through-out the economy, most profoundly in laborand capital markets. Table VI.1.2 shows thetotal contributions to the pension systemsin respective countries. Beyond any doubt,contribution rates around 30% of the wagebill render labor less competitive in thesecountries and increases unemployment. Thecountries that have implemented pensionreforms have channeled a part of this burdento private savings, i.e. eliminated a part of

the deadweight loss associated with theapparent tax nature of pension contributions.Also, pension reformers tend to have a largerstock of assets accumulated in pension funds,albeit the depth of assets is still minuscule.This building up of savings makes domesticcapital markets more efficient and helpscountries to limit current account deficitsassociated with large capital inflows.

A pension crisis, as it is often described,neatly illustrates that challenges may beturned into opportunities if governmentstake early and well designed action. Agingis not something we should try to prevent,but it is a wonderful triumph of humankind.What turns aging into a threat is an ancient,ineffective and perverse-incentive pensionsystem created by a series of governmentsin the past. If the system is modernized, itsincentives are set straight to stimulate labormarket participation and not to encourageinactivity; aging will lose most of its negativeconnotations. The ways to do so are knownand tried; it is up to governments to takethem.



Table VI.1.2. Pension reforms in CEE countries

CountryReform Total pension contribution Contribution to the Pension fund assetsstarted (% of wages) funded pillar (% of wages) (% of GDP in 2004)

Czech Republic ? 28 0 3.6

Estonia 2002 22 6 2.8

Latvia2001, FF increasing

25.51 2–10% 0.3until 2010

Lithuania 26 0 0.3

Hungary 1998 26.5 8 4.0

Poland 1999 32.52 7.3 7.1

Slovenia 24.35 0 1.4

Slovakia 2005 24 9 n.a.

Kazakhstan 1998 0 10 n.a.

Russia 2002 22 6 n.a.

Croatia 2002 14.5 5 n.a.

Italy 32.7 0 2.6

Source: OECD Global Pension Statistics, European Commission (2006)

The Tax-Benefit system in the Czech Repub-lic hasn’t been considerably changed since1995 when the law on State Social Supporthad been novelized dramatically. In 2006,however, there have been changes to thesystem by a relatively high degree. These newchanges should yield changes to the incen-tives of agents to supply labour. This canbe measured by calculating a so-called NetReplacement Rates (NRR). NRR is a ratio ofnet income a person receives when she isunemployed and net income the same agentreceives when working for a particular wage.The higher the NRR the lower are the incen-tives of households to look for a job and viceversa.

Before 2006, the taxation side of thesystem could be described as follows:� Direct Taxes

� Income Tax� Real Estate Tax

� Indirect Taxes� Value Added Tax� Excise Taxes� Road Tax� Estate tax, benefaction tax and tax

on transfer of real estate� Social contributions

� Contributions for social insuranceand state policy of employment

� Contributions for public healthinsurance

Also before the changes to the systemin 2006, social benefits may be describedusing the following scheme:� Social insurance benefits

� Unemployment benefits� Sickness benefits� Pensions

� State social support� Means-tested: child allowance, social

allowance, housing benefit� Non-tested: parental allowance, foster

care benefit, funeral grant, birth grant� Social assistance

� Social necessity benefits� Social care benefits

The system is organized around a keyparameter – known as the minimum livingstandard (MLS). Before 2006, this amountwas calculated at the personal and householdlevel and is intended to reflect the cost ofliving. Most types of benefits are then definedas given fractions of the family-level MLS.

In 2006, there has been the followingchanges to the system:

1. The household’s part in MLS has beenabolished. The personal part of MLS was, onthe other hand, increased proportionally. TheExistential Minimum (EM) was introduced.Depending on cooperation with social officersregarding re-qualification or other attemptsto join the labour force. The base for calcula-tion social benefits is now EM, MLS, or somefraction between the two.

2. The Housing Benefit of State SocialSupport changed considerably. There is nowa called Socially Respectable Cost of Living,and a Normative Cost of Living dependent onthe region where the household lives and thenumber of persons living in the householdand defined by law.

3. Social Necessity Benefits are replaced bytwo types of benefits: namely the LivelihoodBenefit and the Housing Supplement. TheLivelihood Benefit should serve as a sourceof last resort. However, it now depends on



VI.2 Tax-Benefit system in the Czech Republic.How Does It Influence Incentives to Supply Labor?

participation of agents on re-qualification etcas the base for calculation can now be EM orMLS depending on the decision of social offi-cer. The Housing Supplement is now definedas a function of Socially Respectable Costof Living, and a Normative Cost of Living.Before, as a part of Social Assistance, it wasfully a decision of the social officer.

4. Income Tax changed in a way that mar-ginal tax rates for the two lowest taxationbrackets decreased. Also Tax Exemption pertaxpayer and spouse are now replaced byTax Allowance. Tax Allowance means that ataxpayer deducts a fixed amount not fromher Tax Base, but from the calculated Tax. TheTax Allowance and Tax Bonus per child are leftunchanged. Tax Bonus is paid to Taxpayerswith children who after deducting tax allow-ance for children, have a negative tax duty.

5. For the most types of social benefits, thetested income for eligibility decreased, sincenow only 80% of wage income and 80%of Unemployment Benefits is considered asincome, when testing eligibility for socialbenefits.

6. The maximum amount of the Unem-ployment Benefit has been increased from2,5 MLS to 69% of the Average Wage.

Net Replacement Rates have been calcu-lated since 1995. There are two types of NRR.Namely a called short-term NRR, where it isassumed that the agent looking for a jobreceives unemployment benefits, and a long-term NRR, where the underlying assumptionis that the agent doesn’t receive unemploy-ment benefits and receives only social bene-fits. Also, the NRR for Average ProductionWage are calculated, meaning that an agentis able to find a job with a wage as high asthe Average Production Wage, and NRR for66% of Average Production Wage. It is alsoassumed that in a household with two ormore members, there is only one memberwho is looking for a job while the other islong-term unemployed and not eligible forunemployment benefits. These assumptionsare made according to the OECD methodol-ogy of calculating Net Replacement Rates.Table VI.2.1 and Table VI.2.2 show the results.



Table VI.2.1. Long-Term Net Replacement Rates Average Production Wage: 66% of Average Production Wage:

Single Couple Couple Single Couple Couple(2 children) (2 children)

1995 38 66 80 55 90 80

1996 37 63 76 53 85 78

1997 36 63 77 53 85 79

1998 37 63 77 55 86 80

1999 38 63 78 55 85 82

2000 36 60 78 52 81 79

2001 36 59 78 52 80 78

2002 34 55 74 49 78 75

2003 32 52 71 46 74 77

2004 30 49 70 43 69 74

2005 34 48 70 42 69 83

2006 43 56 65 56 69 71

The results show that the system intro-duced in 2006 is more generous (i.e. giveshigher benefits) to single-person familiesbut substantially less generous to largerfamilies.

Further, the new system is more generousto short term unemployed than the oldsystem, but is less generous to long-termunemployed. Overall, the spread of NRR’sacross family types and income levels de-creases with the introduction of the newsystem, and we can also notice a generaltendency towards lower NRR levels, espe-cially for families with a higher number ofchildren.

Also, in the old system, especially forfamilies with a higher number of members,there is little difference between short-runand long-run NRRs. This agent is indifferentbetween receiving Unemployment Benefitsand being unemployed for more than 6months (where she receives only social bene-fits) because in the end she receives the sametotal amount of benefits. The new system dif-ferentiates the benefits between short-termand long-term unemployment. This is dueto the fact that only 80% of unemploymentbenefits are considered as income for thepurpose of calculating of the most types ofsocial benefits.



Table VI.2.2. Short-Term Net Replacement Rates Average Production Wage: 66% of Average Production Wage:

Single Couple Couple Single Couple Couple(2 children) (2 children)

1995 55 66 80 60 90 100

1996 55 65 76 60 85 99

1997 55 64 77 60 85 100

1998 55 63 77 55 86 98

1999 46 63 78 55 85 95

2000 46 60 78 52 81 91

2001 46 59 78 52 80 90

2002 46 57 74 50 78 87

2003 46 57 71 50 74 83

2004 46 54 70 50 69 85

2005 46 58 70 50 75 83

2006 61 69 78 66 84 82

The shape of the housing rent controlsystem in the Czech Republic started to beformed by the policy of the communistregime, which was targeted at the liquidationof private ownership of rental dwellings. Inaddition, this policy strictly regulated rentlevels by the law (e.g. Civil Code No. 40/1964

Coll.), and it enforced the complete allocationof all vacant rental dwellings. After the fall ofcommunism, a part of state-owned rentalunits were returned to former owners or theirsuccessors. This gave rise to the private regu-lated rental housing market in the country.In addition, in 1992 a Civil Code amendment

VI.3 Rent Control

excused all new leasing contracts from rentregulation, which started to create theunregulated market. However, the Decree ofthe Ministry of Finance (No. 176/1993 Coll.)determined further regulation of rents forleasing contracts signed prior to the enact-ment of 1992 amendment to the Civil Code.Furthermore, the regulated leasing contractswere made inheritable by tenant successorsif they were registered as living in a renteddwelling.

While in theory rent control may be justi-fied by a possibility to maintain affordablerents for people who need social protection,a need to give more bargaining power totenants if the rental market is highly monopo-lized, or by the goal to decrease rents andstimulate labor market mobility, these reasonsare probably not applicable for current rentcontrol in the Czech Republic. First of all,Czech rent control is not well-targeted atpeople with low incomes, old people, orother categories, who need social protectionbecause inheritable leasing contracts haveled to the devolution of rental dwellings totenants who are not necessarily sociallydisadvantaged. Moreover, the problem ofthe lack of targeting is strengthened by thefact that 40 percent of regulated dwellings(around 300,000 out of total 750,000 regu-lated rental units6) are owned by privateproprietors. Thus, the state is using rent con-trol to pass a part of its social protectionobligations in the housing sector onto privatelandlords.

It is difficult to argue whether there is aneed to increase bargaining power of tenantsin the Czech Republic, but even in case ofsuch need, the rent received as a result of abargaining mechanism should at least cover

the maintenance costs of landlords. However,according to estimates of the Association ofBuilding Owners, in many cities, regulatedrent is lower than the maintenance costs ofrental units. In addition, the current design ofrent control diminishes labor mobility ratherthan increase it. This occurs because tenantsin the regulated sector are not willing toterminate leasing contracts even if they arenot living in a dwelling, which leads to adecrease in the supply of rental units. Thisin turn results in an increase in unregulatedrent, which reduces labor mobility due to thehigher costs of working in a region otherthan the region of permanent residence.

The situation in reforming rent control isfurther worsened by the political deadlock tothis question. The existing rent control regu-lation was found as violated principles of theBill of Rights by the Constitutional Court ofthe Czech Republic, and several attempts toconduct minor changes in this system did notalter this decision. Moreover, the Associationof Building Owners and several membersof the Senate of the Czech Republic havesent an application to the European Court ofHuman Rights protesting against regulatedrents which do not cover maintenance costsand shift social protection costs from the gov-ernment to private house owners. While atthe moment the decision on this case is pend-ing, there is a very high probability that thisdecision will be positive for house owners dueto a precedent set with the positive resolutionin a very similar case with Polish landlords.

There are several possible ways of solvingthe rent control problem in the Czech Re-public. The first possibility is the completeelimination of rent control without payingcompensation to any tenants in the regulated



6 According to the information of the Ministry of Finance of the Czech Republic.

sector. While this plan may solve all problems,it might not receive much support becauseof its “unsocial” nature. Thus, the secondoption could be the elimination of rent con-trol with payment of direct housing subsidiesfor people who need social protection. Theonly drawback of this option is that it wouldrequire government to pay for social protec-tion from the budget rather than shiftingthese costs onto house owners. The third

alternative is a major reform of rent controlwith making it applicable only to low-incometenants, negotiating rents between landlordsand tenants which would make these rentsat least higher than maintenance costs,and eliminating the inheritability of leasingcontracts. Although this last alternative maywork in theory, it is difficult to judge whetherit would solve the practical problems of thecurrent rent control mechanism.



Principle of the state support of firms is anessential part to building a market economy.Government subsidies to enterprises distortthe strategic environment as they distortthe signal generated by the market in termsof competitor decisions and therefore, theyhave long lasting economic consequences andeffects. The negative effects can be expectedin markets where dynamic effects are im-portant because of technical infrastructurerequirements or customer loyalty.

Defining what constitutes state aid is notalways clear therefore, any quantification ofstate aid is relative. In addition, informationon the amounts approved by governmentfor a company or sector is often not public.No systematic evidence exists on state aidprovided up to 1997 in the Czech Republic.Beside direct state aid through the statebudget, quasi-fiscal operation through trans-formation institutions has been frequentlyused. During 1997–2003, officially registered

VI.4 State Aid

Figure VI.4.1. Share of Subsidies to Enterprises on GDP 2002

Country

Source: europa.eu.int/comm/competition/state_aid/scoreboard, CR – ÚOHS, CSO

%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

CZUKSFINPANLLIIRLFEELDDKBEU

State aid without agriculture, transport and fishing

state aid reached 362 bn. CZK, of which morethan 90 percent went in the form of rewardfor the rescue and restructuring of enterprisepurposes. It can be roughly estimated thatduring 1997–2000, state aid was twice ashigh as officially registered. In the Czech Re-public, subsidies to enterprises during thetransformation were not only non-transparentbut also well above the European Unionaverage. The negative effects on public bud-gets are obvious. From the point of view ofopportunity costs, state aid to rescue andrestructure caused a limitation in education,R&D, and culture, that are fields where onecan expect more positive externalities fromstate aid than in commercial enterprises.

Since 1998, a special investment incentivescheme has existed in the Czech Republic.Such a scheme is in its nature nothing elsebut a state subsidy scheme. The actual effectsof such a state subsidy or investment incen-tives on a particular enterprise that receivesthe subsidy can be positive as well as negative.Expected positive effects are the support ofan incumbent in a high technology industry;the restructure of an enterprise, and jobcreation. At the same time any state subsidy

to an enterprise will be necessarily accom-panied by negative effects on its competitorsand negative spillovers to other industries;hence, a distortion of market signals and in-dustrial structures in the long term. Providinga subsidy should be therefore fully transparentand accompanied by a careful analysis of anex ante evaluation of positive and negativeexternalities and effects and then comparethem to the extent of market failure thatshould be corrected by the respective subsidy.

Such an approach would limit the proba-bility that a company will receive state subsidysince, as the evidence shows, many of thesefirms that used to receive state aid went bustand were shut down eventually. In addition,the logical consequence of state subsidies toenterprises is the increase of the tax burdenand thus a decrease of investment incentives.It is therefore rather counter productive toconstruct incentive schemes for investors thatwill be selected by a state bureaucrat andthat might cause distortions of trade and faircompetition, while at the same time decreasethe incentive for other successful investorsselected by the market.



Significant improvements in environmentalprotection took place during the pro-marketreforms. Between 1989–1992 new regulationswere passed quickly and new institutionsto support environmental protection wereestablished. The economic transformationconnected with cuts or shutdowns in someenergy-intensive and polluting productions,resulted in lower emissions released into theair and water, especially from point sources.The amount of emissions reflected moreand less the lower economic performanceexpressed as the GDP. In this period approxi-mately 8,000 insecure landfills were closeddown and new landfills were built, complyingwith the relevant environmental safety para-meters and European regulations.

In the period 1993–1998 the effects of newlegislation became visible and the countryexperienced so-called decoupling (separationof GDP which was growing again and pollu-tion, which was decreasing or in other wordsthe level of pollution does not follow GDPgrowth any more). This period finished withthe improvement of the basic environmentalindicators which did not show any substan-tial differences from the EU 15 or OECD aver-ages. Between 1993 and 1998, the decreasein air pollution was achieved via emissionreduction measures. The emission reductionof dust and sulphur dioxide can be viewedas an extraordinary success since the emissionof dust into the air was reduced by an orderof magnitude. The change in nitrogen oxidesemission was less pronounced: the positiveinfluence of measures striving for emission

reduction in stationary sources was partiallycompensated with a transport increase. In1997, a second generation of legal wasteregulations was approved, which broughta certain liberalization of waste movements(colored lists of waste according to their risklevel). Over the whole period 1993–1998,the total environmental expenditures were2% of GDP. The number of adopted changesslowed down in the period 1999–2003, andthe environment situation was not improvingas fast as a consequence. The only exceptionwas a 50% drop in lead emissions caused bythe prohibition of leaded petrol distributioneffective from January 2001.

The current state of the environment of theCzech Republic is still not completely satis-factory. Target limit values for the protectionof human health and vegetation regardingtropospheric ozone are exceeded in the CR (aswell as in many European countries), and theCzech Republic also faces a high percentageof soil endangered by erosion, forest degra-dation, and a high number of endangeredspecies. Noise from transportation is alsoan area where future improvements arenecessary. In Prague, almost 40% of thepopulation is exposed to noise levels greaterthan 65dB during the daytime, in otherareas, between 10–30% of the populationare exposed to such noise levels.

The conceptual framework of the Czechenvironmental protection policy over the lastsixteen years has been gradually formulatedby the Czech government in 1990, 1995,1999, 2001, and 2004. As the environmen-


Chapter VII. I ENVIRONMENT

VII. ENVIRONMENT

VII.1 The Environmental Success of Transition

tal situation was improving, the emphasiswas shifted from the protection of humanhealth to nature conservation and biologicaldiversity. The currently adopted policy basi-cally reflects the 6th EU Action Program of theEnvironment.

The first part of the legislation frameworkregarding the protection of environment inthe Czech Republic was established after1989. During a relatively short period of time,not only were laws issued in areas that wereformerly not regulated, but most of theformer, obsolete regulations were replaced.In recent years, environmental legislation hasbeen significantly affected by the process ofharmonizing Czech law with the legislationof the European Communities. One negativeconsequence of rapid legislation develop-ments is the lack of interconnection amongthe legislation in the individual areas ofenvironmental protection. The principles ofenvironmental protection, the institutionsof the legislation, procedures, etc. are notdealt with in a uniform manner. The useful-ness and potential for further codificationof environmental law is currently under dis-cussion.

The improvement in the quality of theenvironment in the Czech Republic has beenbrought about not only by the promotion ofmandatory measures prescribed by law, butalso by voluntary activities of industry andpublic administration. The voluntary instru-ments of environmental policy comprise:� Ecolabelling (in mid-2005, more than 300products of 75 producers have been labeledas environmentally friendly products accord-ing the National Program for Labeling Envi-ronmentally Friendly Products in 41 productcategories);� Responsible Care (in the Czech Republic,this instrument was named “A ResponsibleEnterprise in Chemistry”, 29 companies ofthe chemical industry are entitled to use theResponsible Care trade mark);� Cleaner Production (during the 12-yearhistory of Cleaner Production in the CR, 118projects were implemented in business fromthe different fields, 32% of these projectsresulted in financial savings);� National Environmental Management andAudit Program – 1,332 firms have been cer-tified by ISO 14001, and 18 companies haveimplemented the Environmental Management



Figure VII.1.1. Investment in Environmental Protection

Sources: CSO, MZPCR, 2001 preliminary data

19.9

14.9 19

.4

6.0 9.

4 17.0 19

.9

28.3 32

.3 37.0 40

.5

35.2

29.0

21.4

1.0

1.2

2.0 2.01.8

1.4

1.00.9

0.60.8

2.4 2.22.2

2.3

0

5

10

15

20

25

30

35

40

45

Bln

. CZK

0

0.5

1.0

1.5

2.0

2.5

3.0

Perc

enta

ge

of

GD

P

Year

20032002200120001999199819971996199519941993199219911990

and Audit Scheme – EMAS, among theseenterprises manufacturing enterprises prevail;and� Additional voluntary agreements.

The quality of the environment could nothave been improved without a significantincrease in the funds spent on its protection– see Figure VII.1.1 and Table VII.1.1. Thebasis for the significant growth of investmentin the environment was laid down by newlegislation created after 1989. Not only de-manding goals (e.g. the amount of emis-sions), but also deadlines for the achievementof these goals were determined. In the 1990s,the amount of investment in air protectionwas given priority. Since 1998, the focus wason the investment in water protection ensur-ing pollution decrease. The largest amount ofinvestment in environmental protection wasreached between 1995 and 1997 (over CZK40 billion in 1997) due to events aimed at

air pollution reduction (esp. desulphurization).After 1998, the amount of funds spent onenvironmental protection was reduced, asthe most important environmental problemsof the 1990s had been solved.

For the time being, the environmentalprotection became an inseparable componentof international relations in the political andeconomical sphere. The development of thestate of the environment in past years hasbeen positively influenced by the EU acces-sion process of the Czech Republic and bythe development of multilateral cooperationwithin international organizations, especiallythe UN Economic Commission for Europe; theUN Environmental Program (UNEP); UNESCO;and the OECD. The Czech Republic becamea contracting party of most of the importantglobal and regional environmental multilat-eral agreements and established an effectivesystem of bilateral cooperation with Europeanas well as developing countries.



Table VII.1.1. Environment Protection Expenditures from National Sources a)

(Current Prices, bln. of CZK)

National State National TotalEnvironmental Fund Budget Property Fund

1998 2.3 4.7 2.2 9.2

1999 2.6 5.5 1.8 9.9

2000 2.9 5.0 2.1 10.0

2001 3.8 4.3 2.7 10.8

2002 4.1 5.0 3.2 12.3

2003 4.6 6.0 2.6 13.2

2004 4.6 6.6 3.5 14.4

Sources: SFŽP, MF ČR, FNM

Note: a) Excluding expenditures on drinking water since 1998

ECO-Industry in Czech Republic

At present, the European Union and its policy makers have expressed strong interest ina new sector of the economy consisting of enterprises specialising in producing environ-mental goods and services and clearing-up environmental pollution (to be known as the„Eco-industry“). This is widely seen as a rapidly growing sector, generating wealth, creatingnew jobs, as well as playing a major role in the transition of economies towards a sustainabledevelopment.

The analysis of the development of eco-industry in the Czech Republic is based on the defi-nition in „The Environment Industry Manual“, OECD/Eurostat, November 1998. The analysisdoes not work with a broad view of eco-industry but concentrates on these NACE groups,which are eco industries entirely („core industries“). This narrow definition encompasses thefollowing NACE groups:„Core industries“: Retreading and rebuilding of rubber tyres (25.12);Recycling of secondary raw materials (37.00); Collection, purification and distribution ofwater (41.00); Wholesale of waste and scrap (51.57); and Sewage and refuse disposal,sanitation and similar activities (90.00).

The total number of firms in NACE groups which create the “core” of the eco-industryincreased rapidly from 1990 to 2004 (see Table VII.1.2). During the last three years, thenumber of economic subjects in the eco-industry as a whole has relatively stabilized. Thedevelopment in the Czech Republic has followed a similar trend noted in advanced Europeancountries.

A recent statistical survey of the Register of economic subjects studied all enterpriseswith more than 100 employees and some selected companies with 29–99 employees. Theenterprises included in the statistical survey employed approximately 48,000 employees, fromwhich Sewage and refuse disposal, sanitation and similar activities (NACE 90) was 44% andCollection, purification and distribution of water (NACE) 41.00 42%, respectively. Whencomparing the current situation (2004) with that of 1999, we can see two major tendencies:(i) a drop in employment in Water collection, treatment and distribution, which is connectedwith the privatization of these enterprises by foreign firms, which improved their management



Table VII.1.2. Number of Firms in Eco-industries

NACE 1990 1999 2000 2001 2002 2003 2004

Retreading and rebuilding of rubber tyres 53 313 319 313 307 303 295

Recycling of secondary raw materials 246 1,303 1,393 1,483 1,551 1,607 1,648

Collection, purification and distribution165 405 414 416 417 412 420of water

Wholesale of waste and scrap 26 367 396 398 401 402 399

Sewage and refuse disposal, sanitation894 3,903 4,096 4,282 4,574 4,812 5,018and similar activities

Total 1,384 6,291 6,618 6,892 7,250 7,536 7,780

Source: Register of economic subjects (RES)

systems, and helped to make their production more efficient, and (ii) a growth of employmentin Wastewater and waste material disposal, and city cleaning, which is connected with newmunicipal wastewater treatment plants and an enhanced effort to keep cities clean. This issimilar to development in Western countries.

The average wage in the eco-industry is lower than the nationwide average: by 5.7%. Thehighest average wages are in NACE 41 (water collection, treatment and distribution) with18,235 CZK/month in 2004, and the lowest average wage in NACE 90.00 (wastewater andwaste material disposal, city cleaning) with 15,576 CZK/month. The evaluated firms in theeco-industries also show an upward trend in revenues from sales of own products and servicesto external customers especially in Collection, purification and distribution of water (NACE41.00) and in Sewage and refuse disposal, sanitation and similar activities (NACE 90.00).(See the Table VII.1.3).



Table VII.1.3. Revenues in Eco-industry (CZK million, VAT free)

NACE 1999 2000 2001 2002 2003 2004

Retreading and rebuilding of rubber tyres 241.8 355.0 453.7 245.8 302.2 805.9

Recycling of secondary raw materials 1,692.9 2,216.7 2,400.3 2,261.7 2,612.1 4,147.6

Collection, purification and distribution5,077.7 5,407.0 5,504.9 5,943.1 6,352.0 6,548.2of water

Wholesale of waste and scrap 2,110.8 2,588.2 1,266.4 1,119.0 1,651.6 2,806.5

Sewage and refuse disposal, sanitation3,992.2 3,452.2 3,981.1 4,232.5 5,171.0 6,338.7and similar activities

Total 13,115.4 14,019.1 13,606.4 13,802.1 16,088.9 20,646.9

Source: Register of economic subjects (RES)

Czech Economy – From theCMEA to EU

The Czech Republic was created in 1993when Czechoslovakia split into two parts; itshistory is much longer. Its economic historyhas been no less complicated than its politicalhistory. Having been the industrial center ofthe Austrian-Hungarian Empire before 1918,it was severely hit by the Depression in 1930sand became an economic colony of Germanyduring WWII. After WWII, it became a part ofthe Soviet block and started experimentingwith central planning. It ended up with oneof the most rigid and centralized systemsof central planning in Central and EasternEurope, but thanks to its industrial traditionsand good initial position, it still managed tomaintain standards of living at a higher levelthan in other CEE countries.

In its more recent economic history, it hasexperienced ebbs and flows as well. After the1989 “Velvet Revolution” and the beginningof reforms in 1990, it suddenly changed froma faithful member of Council of Mutual Eco-nomic Assistance (CMEA) and a centrally-planned economy into one of the most liberalcountries in the world – at least at the verballevel. Its government introduced ambitiouseconomic reform and a program of massprivatization (“voucher privatization”, it tookplace in several waves during 1992–94) thatalmost overnight turned a large part of state-owned companies into stock companies withprivate owners, and the majority of popu-lation into stockholders (there were morethan 6 million participants in a nation of 10

million). F. A. von Hayek and the liberal Aus-trian Economic School were declared officialinspiration for the government’s policies; boththe country and the architects of the reformwere widely praised for their achievements,and their experience was recommendedby international financial institutions as aninspiration for reformers in other countries.While the real economic development was notbad (the economy experienced substantialstructural changes and foreign trade reorien-tation without any dramatic welfare impacts),many reforms were not completed at all,and the performance of the economy couldnot live up to inflated expectations. The breakpoint came in 1997. The Czech Republic strug-gled with a high balance of trade deficitand a banking crisis; it finally had to give updefending the pegging of its currency, andto introduce restrictive policies that togetherwith the effects of incomplete reforms drewthe country into recession. The opinions onthe country’s previous policies took a turnfor worse too – instead of being an officialsuccess story it became a cautionary taleabout the importance of development ofproper economic institutions.

Alongside the process of economic transi-tion the country has decided to return “backto Europe” and renew its traditional eco-nomic and political ties with other Europeancountries. The Czech Republic signed anassociation agreement with the EU in 1993(the most important economic parts of theagreement had been put into effect in 1992as an Interim agreement) and it declared


Chapter VIII. I THE CZECH REPUBLIC AND THE EUROPEAN UNION

VIII. THE CZECH REPUBLIC AND THE EUROPEAN UNION

VIII.1 The Czech Republic – two years in the EU

membership in the EU as its main long-termpolitical aim. The official application to theEU was submitted in 1996, and after pro-longed negotiations, gradual adaptation oflaws and institutions, and the liberalization ofmutual trade, it joined the EU in May 2004together with 9 other new entrants.

Two Years in the EU – What Next?Two years have passed since the official

accession of the Czech Republic to the EU(May 1st, 2004). The accession was also ingeneral viewed as a symbolic end of thetransition phase; this has been emphasizedby the country’s graduation from recipientto provider status in the World Bank (April2005). The membership led to no suddeneconomic shock thanks to the long pre-accession period and the gradual adaptationof institutional and legal systems, but ithas contributed to the relative high economicgrowth that the Czech Republic has beenexperiencing during the last three years (seethe next section).

When the celebrations of the accessionwere over, Czech citizens woke up as mem-

bers of the EU and started asking andcomparing the effects of the membershipwith their daily life. While the overall macro-economic numbers (see the next section)are with the exception of public finance veryfavorable, the public seems to view the situ-ation through different eyes. The campaignfor the EU membership had in some caseslead to exaggerated expectations of rapidchanges in the standards of living; the con-frontation with reality had a sobering effect(see Figure VIII.1.1). The pendulum of thepublic opinion has even swung in the otherdirection to some extent, to a belief that EUaccession achieved relatively very little andthat the Czech Republic (and other Centraland Eastern European new members) havegot a very similar position as before, i.e.a poorer CEE country not treated as com-pletely equal by its EU partners. Currentpublic opinion is therefore rather lukewarm;most Czechs claim to be neither satisfiednor dissatisfied with membership (see FigureVIII.1.2).

The attainment of EU membership alsoinfluenced the political scene. The accession



Figure VIII.1.1.April 2006: Has EU Membership

Improved your Standards of Living?

Source: CVVM

Doesn’t know5%

Made worse19%

No change70%

Improved6%

Figure VIII.1.2.April 2006: Czech Satisfactionwith Membership in the EU

Source: IVVM

Doesn’tknow4%

Verydissatisfied

5%

Ratherdissatisfied

15%

Neither satisfied, nor dissatisfied40%

Rathersatisfied

29%

Verysatisfied7%

had been the main official aim for more than8 years (the official application was submit-ted in 1996), and it had been the aim onwhich main political parties and elites couldagree. There seems to be no such unifyingaim for the near future – neither the intro-duction of the Euro, nor the coming Czechpresidency of the EU (in 2009), nor the neces-sary reforms of the social security system,nor the threat of international terrorism seemto be able to generate some consensus onthe Czech political scene, which is assumedto remain fragmented.

Czech politics has been shattered by theresults of the June 2006 election. The Houseof Deputies of the Czech Republic (the LowerHouse of Parliament) uses the proportionalrepresentation system of election. This resultsinto the fact that several (typically about 5)parties are usually represented in the LowerHouse and any government that is to have asufficient majority in the 200 member Houseis almost necessarily a coalition. The results ofthe 2006 election resulted into a stalemate –the only coalition that includes the “winning”party (ODS, Civic Democratic Party), and doesnot contradict the fierce pre-election rhetoric,and does not strictly violate promises madeto the voters has only 100 votes out of 200.This is neither sufficient for succeeding in aconfidence vote nor for passing a bill in theLower House. Complicated negotiations onthe next government are still underway at thetime of writing, but it seems to be clear thatthe next government is likely to be weak andunstable, and the Czech Republic will expe-rience an early election. However, given thedistribution of political preferences, even anearly election may not be a solution, and achange of election system that could bringabout a change requires a consensus of themain political parties.

As far as EU membership per se is con-cerned, further program remains relativelyclear. The Czech Republic will be preparingfor its EU Presidency in 2009, and it is alsopreparing for the future adoption of thecommon currency: the Euro. Although theincumbent as well as the previous govern-ment have declared the preparation for theadoption of Euro as one of their priorities,the Czech Republic is still struggling withpreparation for meeting the Maastricht con-vergence criteria. It is the fiscal issues (deficitof the state budget) that cause the problemsand given the expected weakness of the nextgovernment, there is a danger that the CzechRepublic will adopt the Euro later than othernew members. The Czech Republic has beenalso trying to normalize its position in theEU and get more equal status for its citizens– especially with respect to the mobility oflabor, services, and the membership in theSchengen Agreement that introduces a singlevisa and a removal of border controls for itsfull members. Progress in these issues is likelyto remain slow; it was planned the CzechRepublic will become a full member of theSchengen zone in 2007, but full membershipis likely to be postponed to 2008, and it iseven possible that unlike other countries, itwill not lead to a complete removal of bordercontrols.

Recent Economic DevelopmentThe Czech economy has been growing

incessantly since 1999. After overcoming aminor slowdown to 1.9% in 2002, the rateof growth of its GDP increased up to 6.1% in2005. Similar rates of growth are expectedin 2006 (the estimates of GDP real growthrates for the first two quarters were 7.1%and 6.2% respectively) and in 2007 if thedevelopment of world economy remains



favorable. While the current GDP growth iscomparable with other new member coun-tries, it is substantially higher than in theold member countries (see Figure VIII.1.3).This difference in growth rates together withgradual appreciation of the Czech currencyalso means gradual convergence of the CzechGDP per capita (and standards of living) tothe levels typical for the original EU members.

The high growth seemed to be pulled byincreasing exports, and it can be at leastpartially attributed to the positive effects offoreign direct investment (FDI) and the EUaccession that has increased the motivationfor the inflow of FDI. For more details on the

development of foreign trade see the nextsection.

The inflow of FDI and increasing exportshave also changed the shape of the currentaccount. Although the Czech Republic hadbeen struggling with a high balance of tradedeficits in the past, it is now for the first timein its independent history experiencing abalance of trade surplus (+41.9 billion CZKin 2005). However, the inflow of FDI alsoleads to increasing pressure on the incomeaccount. The current account balance asa whole therefore remains in red numbers.Although the current balance improved toonly 2.1% of GDP in 2006, it is likely to



Table VIII.1.1. Main Economic Indicators

Year 1998 1999 2000 2001 2002 2003 2004 2005

GDP

GDP Growth -0.8 1.3 3.6 2.5 1.9 3.6 4.2 6.1

Foreign Trade

Exports, real y/y % 10.4 5.4 16.5 11.2 2.1 7.2 21.1 10.6

Imports, real y/y % 8.3 4.9 16.3 12.8 5.0 8.0 18.2 4.9

Trade Deficit as % of GDP -4.2 -3.2 -5.5 -5.0 -2.9 -2.7 -1.0 1.4

Balance of Payments as % of GDP and Its Main Components

Current Account -2.0 -2.4 -4.8 -5.3 -5.5 -6.2 -6.0 -2.1

Inflow of FDI 6.0 10.5 8.8 9.1 11.3 2.3 4.6 8.8

Inflow of FDI (bln. of USD) 3.7 6.3 5.0 5.6 8.5 2.0 5.0 11.0

Inflation and Interest Rates

CPI, y/y % *) 6.8 2.5 4.0 4.1 0.6 1.0 2.8 2.2

PRIBOR 2T 14.2 6.8 5.3 5.2 3.6 2.3 2.2 2.0

Labor Market

ILO Unemployment, % 6.5 8.7 8.8 8.1 7.3 7.8 8.3 7.9

Employment, y/y % -1.4 -2.4 1.3 0.6 0.0 -0.4 -0.4 0.7

Real Wages, y/y % -1.4 6.2 2.4 3.8 5.4 6.5 3.7 3.4

Public Finance

General Government Balance as % of GDP -1.5 -1.4 -2.1 -2.9 -1.9 -4.2 -3.4 -1.9

Exchange Rates

CZK per USD 32.3 34.6 38.6 38.0 32.7 28.2 25.7 23.9

CZK per EUR **) 36.2 36.9 35.6 34.1 30.8 31.8 31.9 29.8

Sources: CSU (Czech Statistical Office) – Macroeconomic indicators, http://www2.czso.cz/csu/redakce.nsf/i/cr:_makroekonomicke_udajeCNB – data on FDI, PRIBOR rates, exchange rates, http://www.cnb.czMFCR (Ministry of Finance of the Czech Republic (Macroeconomic Prediction)Trade deficit as % of GDP calculated from CNB (deficit) and CSU (GDP) data

*) As in the previous editions, December/December index**) ECU rate for 1998

remain in deficit, and the deficit is likely toreturn to values typical for years before 2006.The inflow of FDI was again at record levelsin 2005 (11 billion USD), though more thanhalf of the total FDI came from reinvestedearnings of companies that are already activein the Czech market (see the Section 3, Macro-economics for more on FDI). The balance onportfolio investment and other capital wasnegative, but the financial account as awhole remains in surplus caused by the highinflow of foreign direct investment.

In spite of the relatively high growth andthe development of oil prices, inflation hasremained low, thanks to the developmentof prices of food and agriculture produceand thanks to the gradual strengthening ofthe Czech currency. During the last five yearsinflation has been at comparable and evenlower levels as in the EMU countries. In spiteof possible effects of hikes in oil prices andexpansionary pressures of the deficit budget,it seems that the Czech Central Bank willbe able to meet its inflation target, i.e. 3%growth in consumer price index (±1%) inthe near future, although this may requiregradual upward adjustments of the bank’s

rates. The Czech Central Bank claims that itwill use the same inflation target until themoment of the adoption of the Euro. Inflationis unlikely to become a real economic prob-lem in the near future but it is not likely to bea major obstacle to the adoption of the Euro.

Unfortunately, the same cannot be saidabout the fiscal issues. Although the Czecheconomy has been in an expansionary phaseof the cycle since 1999 and a reform of publicfinance officially started in 2004, there hasbeen a central government’s budget deficitduring the whole period. Moreover, the struc-ture of expenditures and revenues is unbal-anced. (see Section 3, Macroeconomics formore on the fiscal stance). On the expenditureside, the budget is burdened by a high regu-lar mandatory social expenditures, while thegovernment has been trying to improve therevenue side by one-off gains from priva-tization. The deficit decreased to 1.9% ofGDP in 2005, the original projection was 4%of GDP. The decrease was caused by higherthan expected revenues (especially corporatetaxes and consumption taxes); the limit setby the Convergence Program for 2006 is3.8% GDP (ESA 95). The program aims to



Figure VIII.1.3. Real GDP Growth Rates in 2005

Source: Eurostat, Czech Statistical Office y/y growth, %

0 2 4 6 8 10 12

Latvia

Estonia

Lithuania

Czech Republic

Slovakia

Hungary

Slovenia

Poland

EU 15 average

decrease deficits gradually with complianceto the Maastricht convergence criteria beingthe final target.

In spite of the high growth predicted for2007, a deficit (CZK 88 billion) has also beenproposed for 2007 as well. While the totalpublic debt is so far well below the limitsset by the Maastricht criteria and it evenslightly decreased in relative terms in 2005(it amounted to 23.2%), without structuralreforms it could easily get out of control incase of an unexpected slowdown and sub-sequent recession.

Economic Effects of EU MembershipDirect effects of EU membership are not

easy to estimate and enumerate. The acces-sion to the EU was not a one-off shock; it waspreceded by a long pre-accession period anda gradual adaptation of policies and institu-tions. Besides the complex time dimensionthere are other important aspects that wereinfluencing economic development duringthis period, such as economic reforms per se(e.g. processes of privatization) and changesin the world economy.

The economic effects of accession workedvia several channels:

Liberalization of access to the EUgoods markets. In spite of generally sharedopinion, the EU accession did not meanoverall shock liberalization for foreign trade,because the Czech Republic already had afree trade agreement with the EU. From thepoint of view of trade policy the accessionwas a change from a free trade area to cus-toms union. What could play a more impor-tant role in the decision-making of investorsis the fact that accession makes this liberali-zation irrevocable by removing the threat ofintroduction of additional protective measuresor antidumping duties.

Partial liberalization of the movementof labor. Again this did not come as a suddenshock as the barriers were not excessivelyhigh for selected professions before the acces-sion (e.g. in the IT industry), and the barrierswere not removed completely (only selectedcountries – UK, Ireland, Sweden) allowedthe inflow of labor from CEE new membercountries initially. Additional countries joinedthe club in 2006 (Finland, Portugal, Greeceand Spain). Moreover, substantial real barriersto mobility (language barriers, low willingnessto move) persist.

Partial liberalization of the movementof services. Full liberalization in the servicesector remain a sensitive topic – on the onehand it is crucial for entrepreneurs from newmember countries, without it they will nowhave a level playing field; on the other hand,old member countries consider it as a poten-tial loophole that could be used to circum-vent restrictions on the mobility of labor.

Irrevocable adoption of acquis com-munautaire and the precedence of EUnorms. Again, although prospective mem-bers had been adapting their laws and normsgradually before entry, the accession changesthe situation by making it irrevocable andstable.

Adoption of common commercialpolicy of the EU that has changed tradepolicy with respect to third countries, espe-cially China and USA.

Reputation effect. The accession was un-derstood as a final signal that the situationin the CEE countries is really standard andstable.

Access to EU funds. The Czech Republiccould use up to 2.6 billion EUR in 2004–2006,and up to 26.7 billion EUR should be avail-able during 2007–2013. The real use of thefunds, however, depends on the ability to pre-



pare adequate projects and meet stringentadministrative criteria.

When we consider the experience of allnew CEE EU members, it seems that it wasthe combination of the effects, namely of thereputation effect, lower production costs andirrevocability of market access liberalizationand norm harmonization that mattered. Thenew members have experienced high inflowof FDI before and at the time of accession –both from the old member countries andfrom non-members. They play a double role:(1) For producers from third countries thatare a lower cost entry point to the commonmarket, entry point that shares basic tech-nical, health and safety norms with the EU;(2) for producers from “old” member coun-tries the new members represent an oppor-tunity to enjoy the combination of lowerproduction costs (though not at the level com-parable with the rest of Eastern Europe orChina) with more or less standard Europeanpolitical, legal, and economic environments.

The immediate effects of membershiphave therefore been positive – the high inflowof FDI has stimulated growth of GDP; de-creased in unemployment (see Table VIII.1.1and Figure VIII.1.3); and increased in theparticipation rate. The impact of improvedaccess to EU funding does not seem to havea pronounced effect so far – new membersare struggling with meeting all the adminis-trative criteria for really getting access to thefunds and a relatively high share of the fundshas not been used at all.

EU Membership in Near FutureThe Czech Republic as well as other CEE

new members are still adjusting to the acces-sion and they are trying to find their rolein the EU. The new members are at presentfocusing on equalizing their position with the

position of the “old” members, especially inthe fields of the mobility of labor, services, theaccess to funds, and influencing of the EUpolicy. The EU will have to solve the conun-drum of the reform of its decision-makingwhich was paralyzed when the proposedEU Constitution was refused in the 2005referenda in the Netherlands and France. Theinefficiency of the current arrangement isobvious, but any attempts at streamliningwill necessarily further restrict national sov-ereignty of the individual members. This, to-gether with perceived inequality of positionof “old” and “new” members can lead to afurther increase in Euroskeptic tendencies inthe Czech political system.

The Czech Republic is preparing for twoimportant events directly related to EUmembership:

Czech presidency of the EU, which willstart in January 2009 and the necessarypreparations have already started. A success-ful presidency can help improve the positionof the country in EU structures and alsocomfort the public opinion.

Adoption of the Euro. The Czech Repub-lic (and other new members) agreed to jointhe Euro when they are ready, and no opt-outclause applies to them. However, the countriesstill have to meet the convergence criteria,and they are able to influence the time whenthey will meet the convergence criteria.

The Czech Republic has had a Strategy ofAccession to Eurozone since 2003, but theEuro and its early or late adoption have notso far sparked any more important politicaldebates. It seems that main political partiesand the public on the one hand do not havea major objection against the common cur-rency, but on the other hand, they do notconsider the issue as too topical (adoptionof the Euro before 2009 is unlikely). This may



change when the first new members adoptthe common currency earlier than the CzechRepublic (e.g. Slovenia intends to switch tothe Euro in January 2007). From an economicpoint of view, the adoption of the Euro meanstwo basic problems: (1) the need to consoli-date the government’s budget so that thefiscal criteria are met; and (2) the needto enter the ERMII first, i.e. the danger ofreintroducing a soft peg to the Euro.

The Need for Further Reformsversus Political Stalemate

Even though the Czech economy startedits economic reforms in 1990, and it is nowoften described as a post-transition economy,there are several important interconnectedproblems that need to be tackled and thatwill require substantial changes in laws andgovernment policies:

Czech economic and political life seem tobe plagued with corruption; even possiblelinks between political elites and organizedcrime have been implied recently. Althoughthe position of the Czech Republic accordingto the corruption perception index publishedby Transparency International may not look sodramatic (in 2005 the Czech Republic ranked47th, on par with Slovakia and better thanLatvia or Poland), it is still worse than theposition of stable, developed democracies,and it is most probably contributing to theproblems of public finance and slower con-vergence.

Deep changes in fiscal policy are need-ed. The fiscal policy is getting into increasingproblems and deficits caused by mandatorysocial expenditures. These changes thereforecannot be accomplished without concurrentreforms of the social security (and healthcare)and the pension system.

Social security system is getting in-creasingly expensive to run, and it does notachieve many of its aims. While the incum-bent government has substantially increasedminimum wages, hoping that they will makeemployment a more attractive option thanunemployment, it has also substantially in-creased social security payments that havenullified the effect.

The Czech pension system is of thePay-As-You-Go type. While the revenues areat present sufficient to cover the expendi-tures, the changing demographic structure(ageing of the population) means that thesystem can get into serious troubles in future.

The Czech healthcare system based onpublic insurance is constantly struggling withthe need to finance care corresponding toEuropean standards from resources that aresubstantially lower. Indebtedness, paymentarrears, differences in salaries between theCzech market and other EU countries and theresulting threat of a future lack of qualifiedpersonnel in the future lead to constant strug-gles among the government, health-insurancecompanies, and providers of healthcare.

The situation is far from being really criti-cal at the moment, and this will not changein the immediate future as long as the rela-tively high economic growth persists. Never-theless, it would be prudent to start with thereforms as soon as possible.

Yet, any far-reaching reforms are highlyunlikely to materialize in the near future,although some reform steps (tax reform) havebeen suggested by the political party (ODS)that got the highest share of votes in theJune 2006 parliamentary election. The elec-tion ended in a political stalemate in whichno realistically conceivable coalition seemsto be able to form a stable majority in the



House of Deputies (the Lower House of theCzech Parliament). This situation is unlikely tochange in the near future; even if the politi-cal parties can agree on the creation of somecompromise coalition, the resulting govern-

ment will be fairly weak, and it will be inconstant expectations of a very probable earlyelection. Populistic decisions that will furtherworsen the state of public finance are thusmore probable than any structural reforms.



The Czech Republic has the characteristicsof a small and open economy, and its inte-gration into international trade has fairly in-tensified since the beginning of its economictransition. During the period 1995–2005, theshare of foreign trade in GDP increased fromaround 50% to approximately 70%. The yearsof growing openness of the economy weremarked by a parallel upsurge in imports andexports, a growing importance of highly com-petitive western European markets, as wellas changes in the commodity structure oftrade. The share of EU15 in foreign trade grewmost intensively in the first years of transition;

the growth continued up to 1999, and theshare has been more or less stable since then.Currently, about 70% of exports and 60% ofimports are executed with the EU15 markets.The share of trade with EU25 markets, closeto 80%, has been relatively stable since 1993when the former Czechoslovakia split.

As a consequence of the gradual liber-alization of mutual trade based on the EUAssociation Agreement, the trade in goodsbetween the Czech Republic and the EU15states was mostly free of barriers in 2004, theyear of accession for the Czech Republic tothe European Union. Upon EU accession, the

VIII.2 The Role of International Trade in Reapingthe Benefits of EU Membership

Figure VIII.2.1. Openness of the Czech Republic

Source: International Monetary Fund, Czech Statistical Office, Czech National Bank

Note: Data for 1989–1992 cover the territory of former Czechoslovakia, i.e.,include also exports of Slovak companies. Since 1993, Slovakia is included as a trading partner of the Czech Republic.

Year

Perc

enta

ge

0

10

20

30

40

50

60

70

80

90

20052004200320022001200019991998199719961995199419931992199119901989

Share of EU25 in total goods trade

Share of EU15 in total goods trade

Share of total imports in GDP

Share of total exports in GDP

Czechoslovakia Czech Republic

remaining barriers were eliminated, and theCzech Republic became a part of the Euro-pean single market; at the same time, tradeand investment relations with other accessioncountries were also liberalized. The year2004 thus saw an extraordinary foreign tradeperformance (certain methodological changesconnected with EU accession, however, part-ly obscure the developments). Also in 2005,Czech exports grew by double-digit rates, butcompared to 2004, the growth rates clearlycame closer to the pre-accession ones. Thelevel shift of exports thus was evident, butit is too early to conclude about any changein the trend.

Alongside the expansion of export acti-vity and a growing share of exports to thewestern European markets, there were alsoimportant developments in the commoditystructure of trade. In particular, the exportof machines and transport equipment havebeen accounting for a growing part of totalexport, with its share increasing from 30%in 1993 to 50% in 2005. This increase tookplace mostly to the detriment of all othercommodity groups. In relation to the EU15markets, Czech exports have developed evenmore specialized in machinery and transportequipment, whose share accounts currentlyfor 55%. This development has been a reflec-tion of the inflow of foreign direct investmentand building capacities in these industries.

Looking to the future, the characteristicsand intensity of international trade are crucialdeterminants to the benefits the Czech Re-public can reap when joining the Europeansingle currency area.7 Possible gains fromthe common currency include, above all,the elimination of the exchange rate risk in

economic relations (even though, this riskcan be to a certain extent eliminated alsovia financial markets), and if the exchangerate is more a shock creator than a shockabsorber, it will also mean the eliminationof one source of economic instability. Theintroduction of the common currency, hence,reduces the transaction costs of foreign tradeand foreign investment, brings positive mar-ket effects via increasing the comparabilityof prices and competition, and can leadto further economic integration. It can behence assumed that higher openness andtrade integration would be associated withgreater economic benefits of a commoncurrency since the efficiency gains from acommon currency will tend to grow with theintensity of mutual trade and investment. Inaddition, a large external sector may moder-ate the effects of the loss of independent



7 The cost of adopting the Euro include, abstracting from the one-off cost incurred upon the adoption, mostimportantly, the loss of the independent exchange rate and an interest rate policy in a phase of ongoing realconvergence of the Czech economy.

Figure VIII.2.2 Development of theCommodity Structure of Czech Exports

Source: Czech National Bank, Eurostat

0%

25%

50%

75%

100%

Misc.manufactured goods

Machines, transportequipment

Basic manufactures

Chemicals

SITC 0-4 and 9

EU15total2005

EU15total2000

total1993

monetary policy that is inevitably linked to acommon currency area entry since a highproportion of tradable goods within a con-sumption basket may decrease the effective-ness of a monetary policy.

For the Czech Republic, the high degreeof openness thus creates a certain potentialof economic gains related to entering entryto the euro area. Furthermore, according toa known “endogeneity hypothesis” (Frankeland Rose, 1997), a high intensity of economiclinks can be conducive to similarity of thebusiness cycles of trade partners. By this argu-ment, getting rid of frictions in internationaltrade and ensuing further intensification oftrade can also allow the countries to becomecloser in terms of possible introduction of acommon currency. On the other hand, the“specialisation hypothesis” (Krugman, 1993)states that greater openness of the economycan result in greater specialisation, which willincrease structural differences and increasethe likelihood of asymmetric shocks.

To gauge which phenomenon is moreimportant for an Czech economy, one can

look at the structure of trade. Trade amongthe same industries of different countries, orindustries that are influenced by the samedemand developments (possibly reflectingsome close vertical and horizontal links amongsuppliers), in general, provides for similarcyclical fluctuations of the economy. Differentspecialisation of the economies, reflected inmore trade among different industries, will,on the other hand, fuel different economiccycles.

The intensity of intra-industry trade (i.e.,trade between the same industries) betweentwo countries can be evaluated by quanti-fying its share in total foreign trade turnover.This can be measured, for instance, by theGrubel-Lloyd index, which is the complementof the ratio of a sum of net exports in allindustries over the sum of trade turnoversin each industry. The index takes valuesbetween zero and one; high values reflect ahigh share of intra-industry trade, which willindicate that supply and demand shocksaffecting particular industries will affect theeconomies in a symmetric way.



Figure VIII.2.3. The Grubel-Lloyd Index of Intra-industry Trade

Source: Eurostat, own computation

Year

0.60

0.70

0.80

0.90

Slovakia

Portugal

HungaryCzech Rep.

Austria

2005200420032002200120001999

The Grubel-Lloyd index is expressed as theintensity of the intra-industry trade with threecore euro-area economies (Germany, France,and Italy). The share of intra-industry tradebetween the Czech Republic and the threeeconomies is very high; a comparison withselected Euro-area economies and new EUmember states shows that the index is onthe upper boundary of the distribution. Thiscan signal that international trade can poten-tially contribute to a growing similarity ofeconomic cycles with the core Euro area coun-tries since the economic shocks affecting theCzech industries will probably be the same orsimilar as in the economies that account foralmost 70% of the Euro area GDP.

The openness and international trade argu-ments would thus speak in favour of relativelyearly adoption of the Euro. One has to keepin mind, however, that the adoption of asingle currency embodies also cost for theeconomy, represented, in particular, by theloss of an independent monetary policy,which can be amplified if the economy does

not have effective alternative adjustmentmechanisms available. This can potentiallyoff-set the gains from international trade.

International trade goes often hand inhand with some degree of currency substi-tution, which makes it useful to elaboratealso to some extent on the role of foreigncurrencies in domestic financial transactions.To improve trading relations and to reachsmoother and better trading conditions, asmaller country is often willing to accept thecurrency of its bigger trading partner.

Evidently, the main substituting currenciesare generally the Euro and the US dollar. Theexternal trade of the Czech Republic, as wellas that of the other new EU member states,is very much oriented on trade with the Euroarea, and therefore, the degree of substi-tution with the Euro (euroisation) in thesecountries is in focus. Substituting the domes-tic currency with the Euro, followed by areduction of transaction costs and exchangerate risks might help to increase competitive-ness of domestic companies on the European



Figure VIII.2.4. Currency Structure of Deposits Held by Residents (in % of Total MFIDeposits Held by Residents; End-2004)

Source: Eurostat, National Central BanksNote: Data on euro-denominated deposits are availableonly for the Czech Republic, Hungary, Malta and Slovakia

Country

Perc

enta

ge

0

20

40

60

80

100

Domestic Foreign total Euro

SISKPLMTLVLTHUEECZCY

markets. On the other hand, this would cutdown the potential gains of introducing theEuro.

The euroisation is perceived here as anunofficial (i.e. spontaneous) process, whenincreasing use of the Euro is evoked by mar-ket forces, as a result of business concernsand not of a purposeful government policyof unilateral adoption of the Euro. In thisrespect, a higher degree of euroisation mightpositively affect the integration of financialmarkets, due to cost reduction of interna-tional financial transactions, lowering marketrisks and diversifying asset portfolios. More-over, euroisation in the new EU memberstates may itself be facilitated by the progressin financial markets integration, the harmoni-zation of legislation, as well as the increasingfreedom of the movement of capital andlabour. When economic conditions are stable,euroisation may be interpreted as a ratherpositive process, reflecting integration ofmarkets and supporting faster convergenceof the countries toward the Euro area.

The degree of currency substitution ismeasured by a share of foreign-currencydenominated assets of residents in the totalamount of their asset holdings. The degreeof euroisation is expressed by the share ofthe Euro denominated assets of residents intotal assets held by residents and is present-ed for the Czech Republic and other newEU member states, for which the data areavailable.

Based on the share of foreign-currencydenominated deposits of all deposits held byresidents, the analysed countries can be di-vided into two groups –those with the shareless than 20% and the rest. The same divisioncan be used also in the case of the share offoreign-currency denominated loans in totalloans of residents. In both cases, the CzechRepublic is reaching the lowest shares of lessthan 10%. Similar results can be found alsofor Cyprus. Likewise, the rest of the new EUmember states, except for Latvia, Sloveniaand Estonia, are within the interval of up to20%. For the Baltic countries and Slovenia (as



Figure VIII.2.5. Currency Structure of Loans to Residents

Source: Eurostat, National Central BanksNote: Data for Malta are not available. Data on euro-denominatedloans are available only for the Czech Republic, Estonia, Hungary and Slovakia.

Country

Perc

enta

ge

Domestic Foreign total Euro

0

20

40

60

80

100

SISKPLMTLVLTHUEECZCY

well as Hungary, in the case of loans), foreigncurrency plays, in general, a more importantrole. In Estonia, for instance, bank lendingsince 1990s has predominantly (up to 80%)been either denominated in foreign currencyor linked to foreign currency (the Germanmark until 1999 and the Euro thereafter).Due to a country specific risk, the interestrates on the Euro-denominated loans havealways been considerably lower than onthe domestic-currency denominated loans. Asimilar situation can be observed also inLatvia, Lithuania, and Slovenia. Looking atthe development in Estonia, Lithuania, and

Slovenia over time, no substantial changeas a response to the ERMII accession inlate-June 2004 was realized.

To sum up, according to the findings pre-sented above, neither in the Czech Republicnor in the rest of the new EU member statesdoing the international trade within the Euroarea invoked an overall high intensity ofcurrency substitution. Arguably, foreign cur-rency denomination is more pronounced inthe countries with a history of fixed exchangerate regimes and past experience with thesubstitution of domestic currency with aforeign one during the pre-transition times.



Wage Flexibility in the Enlarged EU(Based on Babetskii, I. (2006): “Aggregate Wage Flexibility in Selected New EU Member States.” Czech National BankWorking Paper, No. 1/2006.)

After the enlargement of the European Union (EU) in May 2004, joining the EuropeanMonetary Union (EMU) is the next challenging step on the agenda of the ten new memberstates (NMS). Six of them – Cyprus, Estonia, Latvia, Lithuania, Malta, and Slovenia – havealready been participating in the Exchange Rate Mechanism (ERM) II for more than a yearand have ambitions to adopt the euro by 2007. The remaining four new EU members – theCzech Republic, Hungary, Poland, and Slovakia which recently entered the ERM II – plan tobe ready to join the euro area by 2009–2010.

Various studies suggest that there is a need for higher labor market flexibility in the contextof the EMU, of a currency board arrangement, or of a less rigid exchange rate peg such as theERM. Since the independent exchange rate policy is no longer available under fixed exchangerate arrangements, adjustment through the labor market should be of a higher magnitude incountries with fixed exchange rates than with flexible ones.

Due to limited and even declining mobility of workers within the new member states, andgiven the formal restrictions on the free movement of labor for new EU members, it is unlikelythat migration can be considered an efficient tool for coping with adverse shocks. Therefore,we focus on aggregate wage adjustment.

The macroeconomic data over the past decade do not seem to support the argument thatthe degree of wage adjustment is significantly higher for countries which already participatein the ERM-II. In addition, a complementary comparison of wage flexibility across countriesis done based on institutional characteristics of labor markets. The pattern of rigidities at

the micro level does not differ much from the estimated macroeconomic indicators of wageflexibility.

Several policy implications follow from the analysis. First, an increase in unemployment isone possible outcome of wage rigidities. A lack of wage flexibility is then considered to be oneof the costs of euro adoption. Second, results of our study suggest that joining the euro areais not likely to lead automatically to higher wage flexibility. Rather, the opposite effect couldoccur. Therefore, there is a call for adopting more flexible labor market policies in the monetaryunion in order to be better able to address asymmetric shocks. Third, in a low-inflationenvironment, real wage flexibility becomes almost synonymous with nominal wage flexibility,and both terms characterize the cost of disinflation. However, if nominal wages are rigid,especially downward, then the adjustment to shocks would go more quickly via real wages athigher inflation rates. Consequently, a decline in inflation in the new member states over thepast decade may have naturally contributed to the observed decrease in real wage flexibility,or the absence of such. Therefore, if the central bank sets its inflation target at too low a level,there might not be enough room for real wage adjustments. When the ability of wages toadjust is limited, the productivity channel may be viewed as an alternative shock absorber. Inparticular, if productivity grows faster than real wages, this creates some margin for copingwith shocks.



General Characteristics

CZ HU PL RO SK SL

Surface 78,886 93,030 312,685 238,391 49,034 20,273

Population (in thousands) 5,267 4,183 17,161 9,119 2,644 985

Urban share (%, 2004) 75 65 63 55 58 49

Economically active (%, 2003) 51 41 45 42a) 49 49a)

Note: a) Forecast

Level of Development in 2005

CZ HU PL RO SK SL

GDP total (current 99,733 88,800 243,398 79,314 38,113 27,634prices, mln of EUR)

GDP per capita (EUR) 9,700 8,800 6,400 3,700 7,100 13,800

GDP per capita (EU25=100) 42 38 27 16 30 59

GDP per capita in PPSb)74 61 50 35 55 81

(EU25=100)

Note: b) Purchasing power standard

Real Growth Rates in 2005

CZ HU PL RO SK SL

GDP 6.1 4.2 3.2 4.1 6.0 4.0

Gross fixed capital formation 1.3 5.6 6.2 13.0 13.8 1.5

Industrial production 6.7 7.3 4.6 2.1 3.9 4.0(NACE classification)

Construction 2.5 16.1 9.1 8.6 14.7 3.0


Chapter IX. I COMPARATIVE STATISTICS

IX. COMPARATIVE STATISTICS

Comparison of Selected Economic Indicators for CEFTA Countries*

* CZ – Czech Republic, HU – Hungary, PL – Poland, RO – Romania, SK - Slovakia, SL – Slovenia

Unemployment, Wages and Prices

CZ HU PL RO SK SL

Unemployment rate (2005) 7.9 7.2 17.7 7.7 16.3 6.5

Average gross monthly 524 567 515 206 395 1,118wage EUR (2004)

Real growth rate of wages (2004) 6.0 7.5 4.1 16.1 12.0 6.8

Consumer Price Index (2005) 1.6 3.5 2.2 9.1 2.8 2.5

Producer Price Index (2004) 5.7 8.4 7.6 18.5 3.4 4.3

Government Deficit, Current Account and Debt in 2005

CZ HU PL RO SK SL

Deficit as % of GDP -3.6 -6.5 -2.5 -0.4 -3.1 -1.4

Gross government debt as% of GDP 30.4 57.7 42.0 15.2 34.5 28.0

Current account (2003) as % of GDP -2.1 -6.8 -1.7 -8.7 -5.4 -2.0

Exports and Imports in 2005

CZ HU PL RO SK SL

Imports (mln of EUR) 69,630 60,198 90,897 34,430 31,388 18,000

Growth rate of imports 4.8 6.8 3.4 17.2 16.6 7.0

Exports (mln of EUR) 71,541 58,965 90,139 26,203 29,453 17,849

Growth rate of exports 10.4 11.6 7.1 7.6 13.8 10.5

Trade balance (mln of EUR) -4,247 77 3,333 -12,352 -448 -252

Source: Eurostat


Chapter IX. I COMPARATIVE STATISTICS

262. Teodora PaligorovaCzech Managerial Compensations:Why Does It Pay Off to Climb theCorporate Ladder?J U N E 2 0 0 5

263. Lubomira Anastassova, Teodora PaligorovaWhy Immigrants Manage to GrabMore SocialBenefits? EmpiricalCross-Country AnalysisJ U N E 2 0 0 5

264. Ondrej RydvalCapital and Labor Effects in a RecallTask: More Evidence in Support ofCamerer and Hogarth (1999)J U N E 2 0 0 5

265. Anu Kovarikova ArroGlobalization, Increasing Returnsin Component Production, andthe Pattern of TradeJ U N E 2 0 0 5

266. Eugen KovacTying and entry deterrence invertically differentiated marketsA U G U S T 2 0 0 5

267. Ian Babetskii, Balazs EgertEquilibrium Exchange Rate in theCzech Republic: How Good is theCzech BEER?J U N E 2 0 0 5

268. Galina VereshchaginaBetween-Firm Redistribution of Profitin Competitive Industries: Why LaborMarket Policies May Not WorkJ U N E 2 0 0 5

269. Yan Chen, Peter Katuscak,Emre OzdenorenSealed Bid Auctions with Ambiguity:An Experimental StudyA U G U S T 2 0 0 5

271. Frantisek BrazdikOriented stochastic dataenvelopment models: Rankingcomparison to stochastic frontierapproachA U G U S T 2 0 0 5

272. Radim Bohacek, Michal KejakOptimal Government Policies inModels with Heterogeneous AgentsS E P T E M B E R 2 0 0 5

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274. Jakub SteinerCoordination CyclesS E P T E M B E R 2 0 0 5

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276. Eugen KovacSpeculation and Survivalin Financial MarketsS E P T E M B E R 2 0 0 5

277. Martin FukacShould Private ExpectationsConcern Central Bankers?O C T O B E R 2 0 0 5


Chapter X. I LIST OF CERGE-EI WORKING PAPERS

X. LIST OF CERGE-EI WORKING PAPERSAll working papers are available at http://www.cerge-ei.cz/publications/

278. Andrew Austin, Tatyana Kosyaeva,Nathaniel WilcoxBelieve but Verify? RussianViews and the MarketN O V E M B E R 2 0 0 5

279. Evzen Kocenda, Ali M. Kutan,Taner M. YigitPilgrims to the Eurozone:How Far, How Fast?N O V E M B E R 2 0 0 5

280. Jose Noguera, Rowena A. PeccheninoCan a Cartel Fuel the Engine ofEconomic Development? OPECand the macroeconomics of oilA U G U S T 2 0 0 5

281. Andrew AustinProvincial Interests and PoliticalIntegration: Voting in the FrenchMaastricht ReferendumN O V E M B E R 2 0 0 5

282. Stepan Jurajda, Daniel MunichAdmission to Selective Schools,AlphabeticallyD E C E M B E R 2 0 0 5

283. Karin JoeveerWhat Do We Know about theCapital Structure of Small Firms?D E C E M B E R 2 0 0 5

284. Sergey SlobodyanIndeterminacy and Stabilityin a Modified Romer Model:A General CaseJ A N U A R Y 2 0 0 6

285. Dmitri Kolyuzhnov, Anna Bogomolova,Sergey SlobodyanEscape Dynamics: A Continuous-TimeApproximationJ A N U A R Y 2 0 0 6

286. Frantisek BrazdikNon-Parametric Analysis of TechnicalEfficiency: Factors Affecting Efficiencyof West Java Rice FarmsJ A N U A R Y 2 0 0 6

287. Byeongju JeongProprietary Policy and ProductionJ A N U A R Y 2 0 0 6

288. Katarina Svitkova, Andreas OrtmannCertification as a Viable QualityAssurance Mechanism: Theoryand Suggestive EvidenceF E B R U A R Y 2 0 0 6

289. Lubomira AnastassovaProductivity Differences andAgglomeration Across Districtsof Great BritainF E B R U A R Y 2 0 0 6

290. Ondrej Knot, Ondrej VychodilBankruptcy Regimes andGambling on ResurrectionF E B R U A R Y 2 0 0 6

291. Jan Bena, Jan HanousekRent Extraction by LargeShareholders: Evidence UsingDividend Policy in the CzechRepublicF E B R U A R Y 2 0 0 6

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297. Tigran Poghosyan, Evzen KocendaForeign Exchange Risk PremiumDeterminants: Case of ArmeniaM A Y 2 0 0 6

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299. Petra Brhlikova, Andreas OrtmannThe Impact of the Non-distributionConstraint and Its Enforcement onEntrepreneurial Choice, Price, andQualityJ U L Y 2 0 0 6

300. Daniel MunichMeasuring Economics Research inthe Czech Republic: A CommentJ U L Y 2 0 0 6

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308. Lubos BriatkaHow Big is Big Enough? JustifyingResults of the iid Test Based onthe Correlation Integral in theNon-Normal WorldS E P T E M B E R 2 0 0 6

309. Sergey Slobodyan, Anna Bogomolova,Dmitri KolyuzhnovStochastic Gradient versusRecursive Least Squares LearningO C T O B E R 2 0 0 6

310. Petra BrhlikovaMixed Competition and Welfareunder Various Nonprofit ObjectivesMixed Competition under VariousCost ConfigurationsO C T O B E R 2 0 0 6



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Telephone: +420 224 005 143+420 224 005 164

Fax: +420 224 005 185E-mail: [email protected]: www.cerge-ei.cz/nadace

The Foundation’s Mission is toprovide support and encouragethe further development ofeconomic education and research.

CZECH REPUBLIC 2006Accelerated Growth

Editors: Petr Zemčík and Krešimir Žigić

Authors: Ilkin Aliyev, Oxana Babetskaia-Kukharchuk,Ian Babetskii, Jan Bena, František Brázdík,Petra Brhlíková, Martin Čihák, Martin Fukač,Zuzana Fungáčová, Martin Gregor, Dana Hájková,Jan Hanousek, Martina Horníková, Štepán Jurajda,Michal Kejak, Ondřej Knot, David Kocourek,Evžen Kočenda, Lubomír Lízal, Vyacheslav Mikhed,Daniel Münich, Andreas Ortmann, Yuliya Rychalovská,Vilém Semerák, Ondřej Schneider, Katarína Svítková,Eva Tošovská, Peter Tóth, Juraj Valachy,Ondřej Vychodil, Bruno Wertlen, Petr Zemčík,Alena Zemplinerová, Jozef Zubrický

Editorial assistants: Silan Teymurtas

English editing: Robin-Eliece Mercury

Published by: Charles University in Prague – CERGEThe Economics Institute of the Academy of Sciencesof the Czech RepublicPolitických vězňů 7, 111 21 Prague 1

Prague 2006

ISBN 80-7343-110-6 (Univerzita Karlova. Centrum pro ekonomický výzkum a doktorské studium) ISBN 80-7344-099-7 (Akademie věd České republiky. Národohospodářský ústav)

Contact information:

CERGE-EI

Student Affairs Office

P.O.Box 882

Politických vězňů 7

111 21 Prague 1

Czech Republic

tel.: (+420) 224 005 161

fax: (+420) 224 005 247

e-mail: [email protected]

Ph.D. in Economics at CERGE-EILocated in PragueAccredited in the United States

CERGE-EI, a joint workplace of Charles University in Prague and the

Academy of Sciences of the Czech Republic, invites motivated students

seeking a Ph.D. in Economics to apply for admission.

■ A world-class education in Economics fully accredited in the Czech

Republic and the U.S.A.,

■ A multinational community – faculty and students from about 30 countries,

■ All instruction is in English,

■ The program is open to students from any field, although previous

experience in Economics and Mathematics or related field is beneficial,

■ Most students are granted tuition waivers and stipends,

■ Most CERGE-EI students spend part of their studies at universities

abroad,

■ Our graduates are regularly offered positions of importance at western

universities, international organizations, central banks, regional think

tanks and multi-national consulting firms.

Further information and application forms can be found at www.cerge-ei.cz.

UPCESUndergraduate Program in Central European Studies

C H A R L E S U N I V E R S I T Y, P R A G U E , C Z E C H R E P U B L I C

Academic ExcellenceUPCES was launched in 2001 with the intentionof being the most distinguished undergraduateacademic program of its kind in Central Europe.It is located at CERGE-EI in Prague, a renownedcenter for economic graduate education with anacademic reputation unparalleled in Central andEastern Europe.

CERGE-EI offers fully accredited degrees underthe authority of the New York State Board ofRegents and the Ministry of Education of the CzechRepublic. In addition, the Faculty of Humanitiesof Charles University, a partner with the UPCESprogram, is accredited by the Ministry of Educationof the Czech Republic.

UPCES students have a unique opportunity tointeract with other students since UPCES coursesare cross-listed through the School of Humanities.This creates classes that are a mix of Europeanand North American students.

Students from a wide variety of majors andinterests benefit from what UPCES has to offer.The undergraduate program is offered as a one-semester option or as a two- semester (year-long)option. There are two day-trips within the CzechRepublic as well as a long weekend trip abroad sostudents can explore and learn about life beyondPrague. Students have access to the extensiveCERGE-EI Library which has served since 1994 asthe depository for the World Bank and since 2002as the depository Library of the United NationsConference on Trade and Development (UNCTAD).The UPCES teaching faculty is comprised ofthe top figures in higher education in the Czech

Republic and all courses are taught in English.Detailed information on the program, coursesand professors can be found on the websitewww.cerge-ei.cz/abroad, including a download-able brochure and application form.

Eligible students must have proven academicabilities and a demonstrated interest in the socialsciences. Generally, the admissions committeeexpects a GPA level of 3.0. Students must havecompleted at least four semesters of university-level work. Students who apply before their junioryear should provide clear and compelling reasonsfor early application. Students from Central andEastern European countries are potentially eligiblefor tuition waivers and financial support thatcover both tuition and living expenses. It ismandatory that all CEE students have excellentproficiency of the English language, both writtenand verbal.

UPCES Contact information:

Office of International Academic ProgramsCERGE-EI, Politických vězňů 7111 21 Prague 1, Czech RepublicPhone: +420 224 005 201E-mail: [email protected]

ISBN 80-7344-099-7ISBN 80-7343-110-6

Documents

CZECH REPUBLIC 2006 - CERGE-EI · 2007. 3. 19. · CERGE-EI is an economics department jointly established by Charles University in Prague and the Academy of Sciences of the Czech