Czech Foreign Trade in Healthy Condition

The current orientation of Czech foreign trade has proved relatively effective in crisis. The question is whether a stronger orientation of the country’s economy towards countries outside Europe would be desirable or indeed, whether it should be actively encouraged.

The onset of the US financial crisis and the Eurozone crisis that followed once again brought to the table the recurrent question: is Czech foreign trade too focused on developed markets, particularly the Eurozone ones? Is it not too dependent on the crisis-prone automotive industry? At that point the answer was obvious. Yes, we do need to expand our exports to the fastgrowing new markets of China, Russia, India and Brasil. Yes, we do need to diversify our exports.

Five years after the fall of Lehman Brothers, however, quite a different analysis seems to be in order. Czech foreign trade, with its orientation towards European countries and the auto industry, has coped really well. Foreign trade proved to be one of the main assets of the Czech economy, making a positive contribution to the growth of GDP almost throughout this period. This is partly because the focus on Western Europe is not, in fact, as significant as the gross foreign trade figures suggest, since a growing proportion of Czech goods exported to Western Europe ends up in developing markets. The question is whether this process could be speeded up by government policies and if so, whether that would really be beneficial. The fact is that the emerging markets seem to be past their peak, their role changing from the workhorse of the global economy into its Achilles heel by 2014. The Russia-Ukraine crisis is another reminder that investors can often underestimate political and security risks in economies that appear to portend, at first sight, substantial and rapid revenues…

Czech Industry and Its Changing Orientation over Time

Over the past ten to fifteen years Czech foreign trade has come a long way. While in 2000 the Czech Republic’s trade in commodities recorded a 100 billion crown deficit, by 2013 this turned into a surplus of nearly 400 billion crowns. This was largely due to the accession to the European Union and continuous integration into the common European market. The country has enjoyed a huge influx of direct foreign investment, particularly from Germany. German multinational corporations used their investments in the Czech Republic and in Poland (as well as these countries’more liberal labor legislation) to expose the German workforce to more competition than that faced by employees in France or other West European countries. Central European economies have helped Germany to keep a tight rein on real wages and thus to maintain its share of global exports over the past ten years. By contrast, France’s share of global exports, and Italy’s, has declined considerably.

Germany’s export successes have been, to a large extent, propped up by Central European economies. As a result, the Czech Republic’s trade surplus with Germany grew significantly between 2000 and 2013—from 54 billion to nearly 300 billion Czech crowns. The trade surplus with Germany currently contributes over 70 percent of the country’s overall balance of trade (compared to roughly 50 percent in 2000). The exporters’ growing reliance on Germany has gone hand in hand with growing dependence of the importers on China and some Asian countries: South Korea and Thailand in particular. In 2013 the trade deficit with China was approximately the same as the country’s trade surplus with Germany. The trade surplus with Germany consists, to a large extent, of net exports of machinery and vehicles—the backbone of Czech industry. On the other hand, imports from China and Korea mostly comprise electronics, telecommunication devices and office equipment. By comparison, the Czech Republic’s long-term dependence on imports of oil and gas from Russia and Azerbaijan remains unchanged.

A Distorted Picture of Dependence on Germany and China

However, the picture presented above is distorted, as it artificially inflates both the dependence of Czech exporters on the German consumer market as well as that of Czech households on Chinese products. This is because a number of goods that feature in the gross import and export statistics are only semi-finished products destined for final consumption on other markets. For example, many Czech companies in the automobile industry supply components to German car manufacturers who, in turn, use them in manufacturing aimed at further exports. Czech factory production is thus less dependent on German demand than on the demand in a number of other countries with whom the Czech Republic—at least at first sight—has no substantial trade relations. Import figures are similarly distorted. The marked increase in the imports of office technology and electronics from China and Korea is not simply a function of Czech demand. Rather, it reflects the fact that the Czech Republic has become a factory or assembly shop, which companies such as Foxconn use to assemble imported Asian components, turning them into machines for the rest of Europe. An OECD project provides a useful key for decoding these relations. The project aims to map the global streams of added value that builds up as a product travels from one country to another before ending up in a consumer’s shopping basket. The reason is quite simple: gross statistics reflect value added to imports and exports of multiple countries. The OECD aims to discover the country where the value added really originates and the country in whose shopping basket it ends up. In other words, it aims to disclose real economic relations and dependencies between individual economies.

What the OECD analysis shows for the Czech Republic in 2009 is that the gross export and import figures tend to inflate the significance of foreign trade. While the gross share of exports and imports in GDP amounts to roughly 80 and roughly 70 per cent respectively, once you strip these figures of the added value of re-exports the results are considerably more modest. The value added produced in the Czech Republic that ends up in foreign shopping baskets contributes some 35% of the Czech GDP. At the same time, the value added produced abroad which ends up in the shopping baskets of Czech households, companies and government, amounts to around 30% of the GDP.

Another interesting revelation is that the gross figures overestimate our import dependency on Germany and China. Many imports from these countries are merely processed in the Czech Republic before being exported elsewhere in the world. Gross figures show the volume of imports from China to be three times bigger than that from the US. However, when only those imports that actually end up in Czech shopping baskets are considered, the share of imports from China and the US is almost equal.

Gross statistics thus inflate the significance of Germany as the main market for Czech producers. While gross figures indicate that German exports amount to some 30% of all Czech exports, in the stripped off version they only amount to around 20%. Slovakia is another similarly overrated export destination for Czech companies. The US and China, on the other hand, are underrated. Gross statistics rank the US and China respectively as the tenth and thirteenth most important destination for Czech products. Yet the picture is quite different in terms of demand at the point of sale: the US ranks in joint fourth place, while China ranks tenth. This is because many Czech products reach the US and China by a detour, for example, via Germany. Furthermore, China and Russia are among the destinations whose significance for Czech exporters has grown considerably over the past decade: OECD statistics show that the importance of these two countries has almost doubled since 2000 (albeit from a relatively low base). Concurrently, the importance of the French and Italian markets has also grown, approximately by a quarter. Relative to this, the importance of the German market has decreased, also roughly by a quarter. This would confirm the hypothesis that Germany is increasingly significant as an interchange for Czech products that end up primarily in Eurozone countries and subsequently in Asia’s big emerging markets—Russia and China.

Czech Foreign Trade Has Weathered the Crisis

Although the dependence on exports to Germany remains high, the trend is decreasing and the actual figures are lower than those reflected in the gross figures for foreign trade. Meanwhile, the relative importance of Germany as a stopover for Czech products on their way to other Eurozone countries and to Asia has risen.

During the crisis the Czech Republic did rather well with this territorial export structure. From mid-2009 to 2013 the balance of trade in the foreign commodities market has made an almost continually positive contribution to the GDP. In 2011 and 2012 it basically amounted to the only component of the GDP that was growing and helped to prop up the entire economy as far as was possible under the circumstances.

Czech exports to Europe have been significantly boosted by an increased share in key markets, particularly in the auto industry. The entire automobile market has declined significantly since 2007, with registrations of new cars remaining over 20% below the pre-crisis level. However, over the same period the Czech producers have increased their share in both Škoda Auto and Hyundai markets.

The Czech economy has received a timely boost from its increasing orientation towards the Asian market, which—especially in the immediate wake of the Lehman Brothers collapse—grew at a much brisker pace than many Western European markets. This, however, wouldn’t have been much use by itself without a marked downturn in domestic consumption and with investments reining in imports. Without lower imports the foreign trade results wouldn’t have been quite so impressive.

Should We Push for Structural Change?

As we have seen, the current orientation of Czech foreign trade has proved relatively effective in crisis. The question is whether a stronger orientation of the country’s economy towards countries outside Europe—particularly the emerging markets in Asia—would be desirable or indeed, whether it should be actively encouraged. The answer is most likely: no.

Since the early 2014, the heyday of the emerging markets has been slowly but surely coming to an end. In some countries, including China, there are indications that the domestic economy, particularly the financial sector, is not ready for any further growth of domestic demand. Moreover, the Russia-Ukraine crisis and the growing political tensions in Turkey are a reminder that during the US-European financial crisis investors were apparently quite oblivious of the security and political risks inherent in doing business with emerging economies. On the one hand, the growing orientation of European exporters towards Asian markets is, to a large extent, a natural process that cannot be prevented. On the other, trying to actively speed up this process at this point would not make much sense either. What is far more important now is for Czech exporters to strengthen their position in multinational chains of supply, i.e. they must demonstrate that they are capable of providing greater value added and that they are not easily replaceable. The best way to achieve this is by means of a highly qualified labor force. This is the only key to a long-term prosperity of the Czech economy, regardless of whether most of our products are exported to Western Europe or to Asia.

Jan Bureš

Chief Economist at Poštovní Spořitelna (Postal Savings Bank).

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