Czechia has experienced robust economic growth, benefiting from its strategic location, strong industrial base, and competitive labour costs, aiding its convergence towards OECD and EU average incomes. However, its labour productivity remains below these averages, highlighting potential structural issues that may hinder productivity-enhancing capital reallocation. Despite being services-oriented, the manufacturing sector, particularly in automotive and high-tech industries, is more prominent than in neighbouring economies, offering a comparative advantage in producing various low- and high-technology goods. The country shows technological prowess in nanotechnologies, pharmaceuticals, and environmental management technologies, which it can capitalize on to further develop key industries by attracting investment and bolstering domestic SMEs. Czechia's specialisation in assembling processed goods with imported intermediate inputs suggests, however, that foreign multinational enterprises (MNEs) based in Czechia limit procurement from local suppliers, impacting the potential for FDI spillovers on SMEs.

Over the past decade, FDI has shifted from traditional manufacturing to low-technology services such as finance and real estate. While the automotive industry's share of FDI has declined, non-automotive manufacturing industries have increased their share, suggesting potential development of diversified FDI-SME ecosystems that can benefit overall growth and productivity. Despite the COVID-19 pandemic and geopolitical tensions, FDI inflows have remained resilient, with only a moderate decline between 2019 and 2020, followed by a strong recovery. Sectors with high FDI stocks exhibit higher labour productivity, but they account for a small share of business R&D expenditure. Foreign-owned firms in Czechia are also twice as productive as domestic firms, particularly in low-technology services, highlighting the potential for FDI spillovers. However, in manufacturing, productivity differences between foreign and domestic firms are narrower, indicating potential parity in operations and opportunities for knowledge exchange.

Czechia’s economy is dominated by low productivity micro firms, which minimally contribute to value added and turnover relative to their share of employment. The lack of medium-sized enterprises points to significant challenges in scaling-up and difficulties in knowledge and technology transfers within key sectors that attract substantial FDI. SMEs in Czechia lag behind larger firms in terms of exporting, but have significantly improved their performance in introducing product, process and organisational innovations and in collaborating with other innovative firms over the past decade. They outperform their EU peers in the use of certain digital technologies (e.g. cloud services, e-commerce) and in providing training to their employees. Many Czech enterprises report, however, difficulties in recruiting employees with “above average” digital skills and accessing the necessary finance to scale up their operations.

Affiliates of foreign MNEs import about half of their intermediate inputs, while sourcing less locally compared to other OECD economies, limiting growth opportunities for domestic firms. They also export their outputs or sell to other foreign affiliates operating in the Czech market, reducing the potential for FDI-SME spillovers through buyer linkages. In contrast, strategic partnerships around joint R&D and innovation projects are common and create technology transfer opportunities. Cooperation with competitors on innovation is increasing among Czech SMEs, offering potential for wider economic spillovers through imitation or tacit learning. The potential for knowledge transfer through other channels such as the movement of skilled workers from foreign MNEs to local SMEs is limited. Job-to-job mobility, particularly in the science and technology related sectors, is much lower in Czechia than in many peer economies. Higher wages in foreign MNEs also further discourage labour mobility to domestic firms, limiting skills spillovers.

The Czech FDI-SME policy framework, although relatively integrated, involves multiple ministries and agencies, which may lead to fragmentation resulting in more bureaucracy and policy complexity. Policy coordination can also be a major challenge and cause delayed reforms. Inter-agency collaboration primarily relies on informal channels and highlights a potential area for a more structured and formalised coordination mechanism to take place. Streamlining FDI-SME governance and improving policy coordination is pivotal. Differences between the implementation of national policies at the local and national level suggest an opportunity for enhancing cooperation among ministries, national implementing agencies, regional branches, and regional innovation centres. This coordination could facilitate a closer alignment between national objectives and local actions. Although Czechia has adopted several strategic documents outlining SME and investment policy priorities, these require a comprehensive government approach for effective implementation. The number of different strategic documents may potentially complicate policy coordination, underscoring the need for a more integrated and streamlined approach.

Czech institutional framework balances comprehensive policy development with the specific needs of SMEs and FDI. The framework’s emphasis on coordination and comprehensive evaluation mechanisms allows for the creation of policies that are not developed in isolation but reflect the interconnected environment. Recent reforms were directed towards supporting domestic SMEs and strengthening the spillover channels through which FDI affects SMEs. The reforms encompass a comprehensive set of policies and programmes targeted at enhancing SME performance, attracting productivity enhancing FDI, and strengthening agglomeration economies. Whilst also promoting strategic partnerships between SMEs and FAs and fostering value chain linkages. Despite these efforts, there is still potential to further improve and strengthen support for business R&D through legislative strategies as well as place-based approaches. Czechia has made significant strides though they remain below the OECD and EU average.

The need for pursuing place-based efforts is exemplified by the cases of Ústí nad Labem and South Moravia. Both regions have distinct features that attract innovative FDI and SMEs. Ústí nad Labem is characterised by strong industrial sectors, particularly in mining and manufacturing, while South Moravia excels in its innovation ecosystem, IT, and services sectors. South Moravia primarily focuses on attracting FDI into high value-added activities, supported by its infrastructure and educational framework. Both regions could enhance their ability to attract FDI with strong spillover potential by improving digital and transport infrastructure and capitalising on their geographical locations and large stock of brownfields. There is further potential in enhancing cooperation across municipalities, which are currently fragmented, to improve public service delivery and coordinate development strategies, thereby increasing attractiveness for FDI and international talent. In Ústí nad Labem, there is scope to enhance regional branding by aligning local strengths to communicate the regional quality of life, such as lower cost of living or proximity to natural and urban settings and capitalise on regional competitive advantages to meet business demand from domestic and foreign enterprises. In South Moravia, there is room to further leverage its innovation-led business ecosystem to promote inclusive development. Additionally, it is crucial to maximise knowledge and technology diffusion through increased collaboration with academics, the public sector, and the private sector.