Monday, July 01

The shocking truth about the Czech economy


"Market is collapsing, cuts and cuts everywhere...this year is ... tough" - these are the words of a network agency boss to me in a recent e-mail, but I have heard similar sentiments from many people. I can hardly think of an agency or client company of significant size which tells us it is doing well.

But this is just the global/European crisis, right?


Consider the latest quarterly report from Tesco plc. There you can see that the Czech Republic is the second worst performing of 11 countries in which Tesco is active. To quote the report: "Our performance in the Czech Republic reflects a step-up in competitive intensity in the market, combined with the ongoing impacts of declining economic growth and increasing unemployment."

You may also note from the Tesco report, that its performance in Slovakia is significantly better than in the Czech Republic. I am not surprised. For several years now I have been warning anyone who listens that the Slovak economy seems to be performing significantly better than the Czech economy. This week for the first time I found a reliable and straightforward summary of the GDP performance of the two countries.

The figures are a devastating inditement, both of the mis-management of the Czech economy during Miroslav Kalousek's reign as Finance Minister, and of the complacent, provincial thinking of the entire political class. This criticism extends to the wider group of economic "experts", including the CNB,  and the journalists who report their 'analysis' and pronouncements - since none of them to my knowledge have ever made this simple comparison.

Slovakia - outperforming the Czech Republic for the last ten years

There are few countries in Europe which have such a close relationship with each other as the Czech and Slovak Republics do. Many Slovak businesses are controlled or heavily influenced from Prague. The structure of the economies, with their heavy dependence on car manufacturing and assembly, is similar. Yet the Czech economy appears to have important advantages over the Slovak economy; car manufacture is not as dominant as in Slovakia; it is physically, logistically and operationally closer to the healthy German economy; it has a bigger and traditionally wealthier population. You might expect the economies to be similar, but with the Czech economy performing better thanks to these inbuilt advantages.

Yet despite all these advantages, Slovak GDP has consistently grown twice as fast as Czech GDP both since the crisis, and before it. That is an incontrovertible fact. When I first pointed this out to a friend of mine, one of the original partners of Patria Finance, 3 years ago, he commented that of course Slovakia was starting from a much lower base. In the 90's of course, Slovakia was grievously mis-managed. Unfortunately that is no longer an explanation. By my crude calculation based on the figures since 2008, Slovakia GDP/head will overtake the Czech figure during 2015.

Let me make that absolutely clear for you: by 2015, Slovakia will be a richer country than the Czech Republic!

In order to anticipate some expected comments, let's concentrate on Slovakia for a moment. My friend Erik Best said of the figures: "before drawing any conclusion, I would like to see comparable figures for government borrowing and spending (which is of course a big factor in GDP)". This release from Eurostat suggests that Slovakia has marginally higher government debt than the Czech Republic but well below that of many EU countries including the UK. It does have a significant long-term problem with unemployment; we might speculate that the government has failed to enable the benefits of economic growth to spread beyond "Greater Bratislava".

But Slovakia's growth is hardly a mystery. In 2004 it made sweeping changes to its fiscal policy, so sweeping that the World Bank named Slovakia as "the world's leading economic reformer". Most readers will know of the 19% flat rate income taxes, but perhaps less well known is that, according to the regional director of a network agency, "you can set up a new company in Slovakia in two days" (whereas here, two months might be a reasonable target). Of course the current Fico government has started to undo some of these reforms but that is for the future.

And of course, there is one other key difference. In 2009, Slovakia joined the Eurozone.

Czechs are in denial.

If you want an example of the provincial complacency I referred to earlier, this interview in Tyden in late 2010 with ex CNB member Robert Holman is hard to beat. Read just the second paragraph in which he claims that compared to the Slovaks - in the eurozone-, the Czechs were able to respond to the crisis 'more flexibly'. If you then return to the GDP figures, can you discern the "advantages" of having your own currency, which Holman proclaims in the article? And while Holman has thankfully departed the CNB, it is clear that Miroslav Singer thinks the same way as he does.

This is no academic discussion. It is directly related to the business situation of the companies we work with. Marketing activity succeeds when economies are growing, when people feel confident enough to spend. In a recession, marketing budgets are cut, and the jobs are cut soon afterwards. That is why good people have been out of work for a year, why good agencies are screaming about how bad business is, why Tesco is 9% down...

You would think that by now, people with intelligence and information would have started to try and hold Kalousek and Singer to account. But there is not much sign of that. In Hospodarske noviny (26 June, not on the web), Renata Mrazova, who has succeeded our new, unelected prime minister as Chairman of ING PS pension company, told the rest of us that "we should stop complaining and look for a positive way out of the 'lousy mood' in the country." So that's alright then. Your company may be 9% down on last year. Your agency may be about to go bankrupt. Your pension may be at risk because of the performance of ING pension funds. But it's all our fault, for being in a lousy mood. And HN describes Ms Mrazova as a "leader".

As I have written before, if the Czech Republic were a brand, Kalousek would have been sacked ages ago - simply on the basis of the results, before we even start to consider his drinking on the job. On the other hand, among the established political class, I don't see anyone who would be an obvious improvement.

How do we fix this mess?

In his excellent book, "How do we fix this mess?", Robert Peston of the BBC explains that globalisation forces nations to identify their comparative advantage in order to maintain a healthy economy. He uses as an example the Korean concentration on high-tech consumer products. Samsung is a fine example of the success of this, but it also means State investment, such as in the LTE 4G network which has connected Seoul for four years now, while both here and in the UK, it is barely beyond the test phase. It is the task of politicians to identify that comparative advantage and build their economic and monetary policies around that advantage. An example of this would be the UK's decision to concentrate on making the City of London a global financial centre. I never liked this strategy, and I think it has failed - but at least it was a strategy. A far better one is that of Germany. Design and produce things the world wants to buy; things that are produced to a higher quality, at a higher price; and produced not just by big companies, but by many small companies, who provide people in small towns with employment. Slovakia too, demonstrated in 2004, that it had come up with a strategy; to combine low cost of labour with a business-friendly environment, which attracts foreign investment.

Have you ever heard any Czech politician clearly explain what the Czech comparative advantage is, and how the government will make it a success?

What could that comparative advantage be? I would suggest that it would be "Germany, but at a lower cost". That has already been successfully followed in the case of Skoda Auto. Czechs have a modern tradition of technical skills, and share some German instincts for efficiency. Czechs are showing strength in the new IT skills. Some people have talked of Brno becoming a "mini Silicon Valley" based largely on the success of anti-virus software companies AVG and Avast. But what has the government done to encourage this? As far as I can tell, absolutely nothing. How do you connect from Brno to the rest of the world, either physically or over the internet? With some difficulty, is the answer.

It is clear what would need to be done, to implement such a strategy. Taxes need to be lowered, and bureaucracy slashed, in order to have an advantage over Germany; but also, don't forget, not to have a disadvantage versus Slovakia. Investment in infrastructure is urgently needed to encourage high tech companies to locate in Brno rather than in Leipzig or Bratislava. Investment in education is needed to make the most of golden Czech hands and quick Czech brains of the next generation. Ah, people may say, but where will the money come from? Am I advocating a big increase in government debt? No, there is no need for that. The answer is to stop the stealing. Most commentators believe that around 15% of state budgets are lost to corruption. I cannot think of a better way to get rid of the "lousy mood" among honest businesspeople than to implement a serious war on corruption. And of course, were it to succeed, that could even give us a comparative advantage over Slovakia!

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