Exports: Mainstay and Showcase of the Czech Economy—Threats and Opportunities

The old materialistic belief that whatever you cannot physically touch does not really exist is still deeply rooted in Czech thinking. Over the past years, as the world has become more “virtualized,” competitiveness in intangible activities has grown in importance in international trade too.

Since the Czech Republic joined the EU in 2004, there have been only two occasions when foreign trade stopped being the mainstay of the country‘s economy, making a negative contribution to the country’s economic performance: this occurred in 2007 and 2014. However, even in 2009, at the time of the deepest economic crisis in recent history when external demand dropped considerably (as did domestic demand for imports), the resulting contribution was positive. Apart from that, foreign trade has always been an area (sometimes the only one) that made a positive contribution to economic growth. The Czech Republic has thus been rightly described as largely export-oriented.

The Foreign Trade Fills the Gap Left by a Shortage of Investments

The recently published statistical data for 2016 confirm the position of foreign trade as something of a mainstay. Even though its performance was not exactly stellar, married to strong local consumer demand it was able to fill the gap left by a shortage in investment and helped to keep the dynamic of the Czech economic performance above European average.

Foreign trade and, within that context, a powerful export performance (which, in absolute terms, is around eight times higher than that of Greece, a country of similar size and, until recently, at roughly the same level of development) has been a mainstay of the Czech economy ever since the country’s EU accession. The overlap in the timing between the role of a mainstay and the length of EU membership is no mere coincidence.

For one thing, this was the time when the first phase of post-revolutionary restructuring was slowly reaching its completion, and the country’s modernized industry, with an injection of new capital, was able to throw off the constraints of the local market by expanding abroad. In doing so, Czech industry exploited the gradual relaxation of trade barriers and competitive prices, seizing the opportunity to assert itself in the EU market.

The actual date of EU accession and the opening up of opportunities offered by the single internal market were an incentive not only for domestic firms to mobilize their capital and develop new capacities but also proved attractive to foreign investors (whether from the EU, particularly its western part, or from outside the continent, especially from Japan and later also South Korea).

New Trend for the Predominance of Exports Over Imports

By that time Czech foreign trade had already undergone a fundamental transformation. A high degree of openness to the outside world has, in fact, been characteristic of the Czech economy throughout its modern history. However, during the 40 years of totalitarian rule this openness had become politically distorted, as some 80 percent of exports were directed to Comecon countries (it was demanded by the planned economies of the time). A kind of miracle occurred as early as the mid-1990s, as the qualitative character of Czech exports (further aided by the low exchange rate of the Czech crown) facilitated an almost full 180 degree turn in the orientation of our exports from East to West.

Foreign trade and, within that context, a powerful export performance has been a mainstay of the Czech economy ever since the country’s EU accession.

The early years of real economic restructuring were characterized by high demand especially for importing investments (which the domestic industry was not yet able to meet), but soon after 2000 the new trend for the long-term predominance of exports over imports of goods manifested itself.

It might thus seem that everything is exactly as it should be and that all one has to wish for is that the era of abundant exports continues unchanged. That, however, is not the case: foreign trade opens a window onto the Czech economic living room that provides an accurate mirror image of its structure. Even in a country generating a trade surplus of around 5% of GDP there is always room for structural improvement.

The External Balance Consists of More than One Single Item

The old materialistic belief that whatever you cannot physically touch does not really exist is still deeply rooted in Czech thinking. Over the past ten to fifteen years, as the world has become more and more “virtualized,” competitiveness in intangible activities has grown in importance in international trade too.

The Czech Republic is, indeed, not at all bad in terms of exporting goods. Yet we seem to forget that the external balance sheet consists of more than one single item – for instance, performance indicators also include services, sales of licenses, patents, technologies, and smart solutions. The current account also includes balance of revenues, which is much less flattering (more about that later). In addition, apart from the current account there is also the capital account, whose evolution may be even more crucial in the long term. It is the entire balance of payments that should be sustainable.

We are justifiably proud of one of its components. Nevertheless, at a time when services comprise 60 to 70 percent of developed economies and when their international marketability is also growing despite every obstacle, this is something we definitely ought to focus on, making sure that we are using all available market-conform tools to be internationally competitive in this area too.

Exports No Longer Rely Just on Underselling

Let us dwell a while longer on exports of goods or trade in goods. Its quality has increased to an extraordinary extent. Our exports no longer rely just on underselling but we are increasingly set on higher quality (even though, over the past three years, we have been cushioned by the Czech National Bank’s commitment to a fixed exchange rate).

However, it is concerning that 80 percent of our exports are driven by companies in foreign hands. A significant part of these exports is comprised of end-products manufactured by daughter companies of foreign corporations, with the rest consisting of spare parts, components, semi-finished products manufactured by home-grown smaller and medium-sized companies – all supplied to foreign customers mostly in Germany and, until recently, also to a large extent in Great Britain. Only there they are turned into final products and sold to the end-users.

The early years of real economic restructuring were characterized by high demand especially for importing investments but soon after 2000 the new trend for the long-term predominance of exports over imports of goods manifested itself.

This should not be construed as criticism of the presence of foreign capital in this country. On the contrary: especially in the 1990s, foreign capital played a pivotal role. Without it, our economy, depleted in terms of capital, know-how, and experience, could not even have dreamt of returning to Europe. Twenty-eight years later, however, one might expect that its vital presence would be, at least partly, balanced by corporations with domestic owners.

The Consequences of a Strong Foreign Presence in the Retail

In this respect we seem to be stuck in a rut, largely preserving, or only slightly tampering with, the conditions that arose in the 1990s, a period that did not play by the standard book. Admittedly, the government is not really making a big effort to help major domestic capitalists assert themselves in foreign markets. That is why many of them, even if their core added value remains in the Czech Republic, have for a variety of reasons decided to locate their company headquarters abroad, where the tax and administrative atmosphere seems to be more conducive to business.

One might speculate to what extent the strong foreign presence in retail chain stores and related corporations, especially in the grocery industry, is to blame for the fact that large quantities of goods that could be produced domestically to comparable standards (and more cheaply) are being imported at irrationally low prices, considering production costs in the country of origin (although I believe that this is so at least to a certain extent).

The government is not really making a big effort to help major domestic capitalists assert themselves in foreign markets.

This has two detrimental effects – for one, it places a burden on our imports (especially in the case of foodstuffs, agricultural commodities, or smaller handicrafts), while at the same time stifling local producers in what is hardly fair competition, often in regions and localities where this is almost the only economic activity possible.

Economic Policy Should Help Medium-Sized Companies

Nor has the process known as import substitution been particularly boosted by the Czech National Bank’s policy of exchange rate commitment, even though it was supposed to be precisely one of the intended side effects. In this situation, economic policy should strive to help the emancipation especially of medium-sized companies to end up at the furthermost end of the value chain, closest to the end-customer. If a critical mass of domestic businesses were able to reach the end-customer, they would be able to shape the market conditions and that, in turn, would help unleash complementary synergies in related services and benefit from them. This could potentially widen the range of activities considerably.

The commodity structure of our exports is also worth noting. Even though it remains rather wide-ranging and we have manifested real excellence in many activities, the number of Czech export mainstays has gradually been narrowing (it is to be hoped that the absence of the chemical industry is only temporary; more recently, the energy industry has not been doing too well not just in terms of the volume of electricity but especially in terms of our ability to produce and export power plant machinery).

The Digital Future is Knocking on the Door

Regardless of who owns key export companies, at least two threats to our splendid Czech export performance are emerging at this time. The first has already begun to materialize: a shortfall in the labor force in the domestic labor market is hindering new export orders because there is no one to meet them. This market failure is evidence of the inflexibility of the EU labor market, given that several countries are currently facing the opposite problem of high unemployment (especially among the young), yet there is no sign of flexible transfers that would correspond to the number of workers within the supposedly-single market.

The other problem relates to the future, which, as those in the know believe, is already knocking on the door or even loitering in the entrance hall. What I have in mind is the digital future, which many regard as the fourth industrial revolution. Our key export-oriented industries still rely heavily on a human labor force. But what if some 10 or 20 years from now these industries cease to exist? From our present-day perspective it may seem like science fiction but some predict that ten to fifteen years from now the demand for, say, products of the automobile industry in Europe will be reduced to a mere 10 percent of current demand.

The Reallocation of Capacities Invested in Transport Engineering

Due not just to the technological but also the social revolution: instead of vehicle ownership our mobility needs will be met by sharing, or maybe even some completely new modes of transport (such as teleportation). The question is whether the capacities that are currently heavily invested in transport engineering can be flexibly reallocated to new activities.

And, last but not least, given that foreign trade represents only one—albeit vitally important—item in our balance of payments, it is worth asking whether some other activities and their targeted development might yield promising new revenue streams. What comes to mind in this context is rational exploitation of foreign capital expansion of domestic businesses.

The automobile, as well as some other industries (food, furniture, shoes, clothes, sports equipment, and many others) are based not solely on the concept of exports but also on manufacturing in, or close to, the countries of their final destination. In terms of direct capital investment the Czech Republic is a key importer but only a minor exporter. The robust presence of direct foreign investment is resulting in an annual outflow of some 400 billion Czech crowns’ worth of exports.

The Centrifugal Forces Within the EU as a Serious External Threat

In the long term, natural support through domestic capital expansion could at least partly make up for this imbalance and be the first step in striving to achieve a greater equilibrium in the balance of payments of the capital account and, as a result, a balance of revenues in the current account, as well as striving for a friendly takeover of at least one part of the ownership structure of key export companies, transferring it to domestic ownership (the route recently taken by Poland).

Foreign trade is a mainstay of the Czech economy, and is set to remain so at least in the medium term. We should start doing everything that we can to turn it into a permanent mainstay by addressing the structural challenges listed above in a satisfactory and productive way.

The other problem is the digital future, which many regard as the fourth industrial revolution.

The centrifugal forces currently at work within the EU represent a serious external threat, especially in case of a hard Brexit. On the other hand, Britain’s small share of processing industries in the overall GDP is to our advantage as it makes the UK fundamentally dependent on importing a whole range of industrial goods from abroad, mostly from Europe. These links could continue, albeit under different conditions. And even if Britain should leave the Customs Union, the UK’s trade with any particular EU country will continue on equal terms in line with the common EU Trade Policies.

Regardless of who owns key export companies, at least two threats to our splendid Czech export performance are emerging at this time. The first has already begun to materialize: a shortfall in the labor force in the domestic labor market is hindering new export orders because there is no one to meet them.

More serious problems might occur if other EU countries decided to follow the British path, with others opting for passive resistance. In that case we might see a de facto collapse of the free market within the EU and a direct reduction of outside demand from the point of view of domestic exporters. Furthermore, a collapsing common market would also mean the loss of incentives for many foreign investors currently active in the Czech Republic. Since their capacities could not be exploited in the new circumstances, they would have to be considerably reduced, which would have a negative impact on export performance, GDP growth, as well as employment.

Petr Zahradník

Petr Zahradník (1965) is an economist specializing in EU economic policy, a member of the European Economic and Social Committee in Brussels, adviser to the Česká spořitelna Bank, and to the Czech Republic’s Chamber of Commerce. From 2009 to 2014 he was a member of the Czech government’s National Economic Council, and since 2006 he has been a member of EuroTeam, an advisory group under the Directorate General for Economic and Financial Affairs.

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