OECD Economic Surveys: Czech Republic 2018

Executive summary

Abstract

Economic prospects are good.

• The economy is thriving.

• Strong demand and exports are driving growth.

• •  Economic growth will slow due to labour shortages but remain above its potential.

• •  Poverty and inequality wellbeing indicators are good.

Low productivity is limiting convergence towards OECD living standards.

• GDP per capita has been increasing but convergence towards OECD living standards is slow.

Better skilling, R&D and innovation are needed for the upgrading of the economy.

• Better skilling is necessary to increase labour productivity and innovation to maintain the price competitiveness and to favour upgrading in value chains.

• •  Increasing labour force participation of women with young children would reduce labour shortages.

• •  An acceleration of immigration procedures and facilitation of immigrants’ integration could reduce labour shortages.

The Czech Republic has to address the challenges of an ageing society.

• Ageing will weigh on public finances.

• •  Retirement age should be tightly linked to life expectancy.

• •  Financing of health and long-term care can be expanded making all types of income contributing.

There is room to improve the delivery of health care.

• The Czech health care system performs well along several dimensions but can be improved.

• •  Indicators for the quality of care and outcome performance are missing in the management and regulation of the health care system.

• •  The delivery of health care could be improved through better management of hospitals; and putting more incentives in the remuneration scheme of health providers.

• •  The efficiency of the delivery of primary care is suffering from lack of co-ordination.

Short-term economic prospects are good…

The economy is thriving. The growth acceleration in 2017 to 4.6% is more balanced than in previous years. Internal demand is led by strong household consumption, supported by income growth, and private investment. Exports also sustained their expansion in 2017 thanks to boosted activity of trading partners. The unemployment rate has continued decreasing throughout 2017 and at below 3% is among the lowest in the OECD. Inflation picked up strongly in 2017 reaching an annual average of 2.5%. This increase in inflation – from around 0.5% during the last three years – was partly driven by an acceleration of wage growth. Exchange rate appreciation will dampen inflation.

Table A. The economy is projected to grow at above 3% per year in 2018 and 2019

	2017	2018	2019
Gross domestic product	4.6	3.8	3.2
Private consumption	4.0	3.8	3.5
Gross fixed capital formation	5.9	5.2	4.3
Exports	6.9	5.3	5.4
Imports	6.2	6.1	5.7
Unemployment rate	2.9	2.4	2.3
Consumer price index	2.5	2.0	2.1
Current account (% of GDP)	1.1	0.5	0.3

Source: OECD (2018), OECD Economic Outlook 103 (database).

Output growth will slow down on account of labour supply constraints, but will remain above the Czech Republic’s 3% potential growth rate in 2018 and 2019. Increasing wages and employment will keep household consumption and internal demand high. Private investment will remain strong thanks to favourable credit conditions. Exports will stay high. Growing wages and strong household consumption are expected to keep annual inflation slightly above the 2% Central Bank’s target in 2018 (Figure A). The Czech National Bank (CNB) has started raising its policy interest rate in August 2017 to stabilise inflation at its target level over a medium-term horizon.

Figure A. Inflation will remain around the target

Source: Calculations based on OECD (2018), OECD Economic outlook (database) and Thomson Reuters Datastream (database).

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… but the Czech Republic faces risks, including high housing prices.

Risks stem equally from internal and external factors. Labour shortages could hamper growth. At around 2.4%, the unemployment rate is hitting a floor. Also, there are signs of overheating as the economy is growing above potential, therefore the rise in inflation and wages may lead to a normalisation of interest rates more rapidly than anticipated. This may create a gap with the rates in the euro area, and therefore further appreciations of the exchange rate. On the external side, the Czech economy is particularly exposed to trade disruptions. Exports in terms of value added contribute to around 45% of GDP. Housing market developments are of rising concern. The loans for house purchase have accelerated in the last two years and are reaching high levels. Price growth in the housing sector was the highest among EU countries in 2017. Therefore, household indebtedness is increasing and banks are exposed to a reversal in household income growth.

The low level of wages is limiting convergence towards OECD living standard standards…

The Czech Republic’s growth model of low wage and high reliance on FDI has been successful in increasing GDP per capita but convergence towards OECD living standards is slow (Figure B). Even though wages have accelerated recently, their level remains low in international comparison. Low labour shares are influenced by the gap between GDP per capita and gross national income, which is among the highest in OECD countries (Figure C). Foreign direct investments have benefited the economy through its increasing participation in global value chains. However, there is room to better share the benefits of growth to support inclusive development.

Figure B. Czech wage level is converging slowly

Thousand USD, in 2017 constant prices and constant PPPs

Source: OECD (2018), OECD Labour Force Statistics (database).

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Figure C. The gap between GDP and gross national income is high

Thousand USD PPP per capita, at current prices, 2016

Source: OECD, National Accounts (database).

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… and better skilling, R&D and innovation are needed for the upgrading of the economy.

Better skilling is necessary to increase labour productivity and innovation to maintain the price competitiveness and to favour upgrading in value chains. The Czech labour market is shifting towards higher-skilled employment. Since the 1990s, the service sector has expanded and manufacturing has become tightly integrated into global value chains; employment shifted from medium-skilled towards high-skilled jobs (Figure D). Sectors such as manufacturing, IT and business services are expected to continue expanding. Providing workers with the right skill set and training to adapt to a changing environment will increase the resilience towards automation. For instance, the demand for a highly skilled labour force, especially the technically educated one, will increase.

Figure D. Employment is shifting towards high skilled jobs

Change in percentage point in share of total employment, 2015 to 2025

Source: European Centre for the Development of Vocational Training (Cedefop) (2017), Forecasting skill demand and supply.

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Preparing the labour market for technological change is high on the political agenda. Policy actions that foster productivity and innovation as highlighted in the last survey (OECD, 2016[1]) should be accelerated.

The skill mismatch is still important. Graduates are lacking in the fields of mathematics, science, statistics, and health and welfare studies. Current developments suggest that the stock of skills in the labour force may not suffice to address emerging shortages in certain sectors, such as health and IT. Providing effective, up-to-date and tailored information, advice and guidance are crucial to address emerging skills gaps. Vocational education should be further developed to play a significant role in overcoming skill mismatch through the involvement of employers in the design of curricula and in developing internships.

Increasing labour force participation of women with young children would limit labour shortages.

Available skills of women are not fully utilised in the labour market. Female graduates form the majority in mathematics and natural sciences (59.6%) and health and welfare studies (83.5%). These skills are often not available to the labour market as one out of three women aged 25 to 34 that graduated in a STEM (Science, Technology, Engineering, and Mathematics) field with a tertiary degree reported being inactive in 2016. Despite recent efforts, female labour force participation tends to fall with childbirth, contributing to gender inequality.

The long break in young mothers’ employment is partly due to long parental leave rules. Spending on maternity and parental leave is the highest among OECD countries, reflecting a preference for home care over formal childcare. Conditional on the expansion of affordable and quality childcare, the maximum duration of parental leave should be reduced. Child care facilities should be further developed by redirecting funds from cash transfers and parental leave. Increasing the flexibility of jobs by better enforcement of rights for part-time work, flexible teleworking arrangements and shared jobs can support the re-entering of female labour into the market.

The Czech Republic faces challenges of an ageing society.

Ageing will weigh on public finances. The Czech population is ageing more rapidly than in most European countries; the dependency ratio will rise from 28.1% in 2016 to 49.7% in 2070 with a peak at 56.1% in 2058.

Pension spending as share of GDP should be stable up to 2030, but will then rise steeply by more than 2.5 percentage points of GDP over 20 years. In 2017, the Czech government withdrew the perpetual increasing of the statutory retirement age and instead put a ceiling at the age of 65. However, the retirement age ceiling is worsening the effect of pension spending on public finances (Table B).

Also, the recent changes in the pension indexation rule are pushing up pension spending by approximately 0.3 percentage points over the projection horizon.

Health care and long-term care expenditures are also projected to rise in the upcoming decades. In comparison with other countries, the Czech Republic is going to face one of the biggest spending increases as share of GDP.

Financing of pensions, health care and long-term care currently requires more than 43% of the government budget. Assuming that the size of the budget in relation to GDP remains constant (at around 35%), the projected social expenditures in 2060 would take more than 75% of the budget (Table B). As in many OECD countries, the Czech Republic could consider linking retirement age tightly with life expectancy. Improving the efficiency of health care delivery could help cushion the impact of ageing on health spending.

Table B. Impact of ageing on public finance

Pension expenditure projections, % of GDP

	2016	2030	2040	2050	2060	Peak year
Total public pensions	8.2	8.2	9.2	10.8	11.6	2059
linked to life expectancy		8	8.5	9.7	10.2	2059
Expenditure projections as shares of the government budget
			% of GDP		% of govt. budget
			2017	2060	2017	2060
Pensions			8.2	11.6	32.4	45.7
Old age pensions			6.8	10.2	26.8	40.2
Health care			6.2	9.6
financed by social security contributions			4.1	3.3
financed by the government budget			2.1	6.3	8.4	24.7
Social long-term care			0.7	1.4	2.8	5.5

Source: EC (2018), Ageing Report: Economic and budgetary projections for the 28 Member States (2016-2070), OECD projections of health spending.

Improving the health care system

The Czech health care system performs well along several dimensions but can be improved. Life expectancy rose by 2.6 years to 78.7 years between 2005 and 2015, just below the average of 80.6 years in the OECD. Spending on health care at 7.2% of GDP in 2016 is relatively low compared with OECD peers. However use of health services is among the highest in the OECD (Figure E).

Figure E. Number of physician consultations

Per inhabitant, 2015 or nearest year

Source: OECD (2017) Health Statistics (database).

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Indicators for the quality of care and outcome performance are missing in the management and regulation of the health care system. Moreover, the health system is heavily regulated by the government through the Reimbursement Decree which sets most prices and volume limitations of activities of health providers. Having a genuine negotiation process between health care providers and insurance funds would help reduce some of the inefficiencies in service delivery.

Overall, there is a need to rebalance the system towards more competition between health providers and insurance funds and private funding to improve quality, efficiency and reduce the reliance on public funding.

The delivery of health care could be improved through better management of hospitals; and putting more incentives in the remuneration scheme of health providers. In hospitals, optimising outpatient care and day surgery should reduce the length of stay and lower spending. The new diagnostic related group (DRG) system should be used for setting the prices of health services but also to incentivise or reform underperforming hospitals. The DRG system should be based on a group of best-performing hospitals.

The efficiency of the delivery of primary care is suffering from lack of co-ordination. Patients’ ability to access specialist care without a prior general practitioner (GP) consultation, poorly defined mutual responsibilities of outpatient specialists and GPs and current payment systems mean that primary care’s potential to lead for instance chronic disease management is not being fulfilled. GPs should be entrusted with a greater gate-keeping and co-ordination role to ensure that patients are better directed to the most appropriate place for their treatments, which also allows diminishing the overuse of hospital facilities.

Ageing will account for roughly half of the future rise in health-care spending and pushes for broadening the financing of the health system. While total health spending is low, the share of public spending in total spending at 82.4% is among the highest in the OECD. The heavy reliance on public financing is a weakness in the context of an ageing society. Over the last 15 years, voluntary and out-of-pocket payments increased, reaching 17.6% of health care expenditure in 2016, remaining below the OECD average of about 20%. The main sources of revenue for the health insurance system are compulsory contributions that are levied primarily on wages. To increase revenues and allow more spending on health care in the future, the tax base needs to be broadened. Within the current scheme, contributions by the self-employed could be increased gradually. More generally, all kinds of income sources could be taxed to contribute to social security financing. Moreover, introducing smart cost sharing can steer patients’ behaviour and promote cost-efficient consumption of health care.

 

MAIN FINDINGS	KEY RECOMMENDATIONS
Macroeconomic and financial policies
Average annual inflation at 2.5% in 2017 was above the target. There are signs of overheating in the economy that could affect the inflation.	Gradually raise the policy interest rate and stand ready to fasten the pace if needed.
Banks are exposed to increasing loans for house purchase following rising house prices.	Allow the CNB to set binding prudential rules applicable to individual loans.
The fiscal position is strong.	Keep some fiscal space to cope with future ageing-related spending.
Tackling long run challenges, including the impacts of ageing
The structure of government revenues relies heavily on social security contributions. The tax wedge is the 6th highest across the OECD.	Rebalance tax revenues by reducing social security contributions and raising indirect taxes (VAT compliance and environmental taxes).
The population is ageing rapidly. The financing of ageing-related spending count already for more than 43% of the government budget.	Link tightly retirement age to life expectancy. Broaden the financing of health care and long-term care by expanding the base of contributions to all types of income.
Need for stronger price incentives to green the economy.	Introduce a carbon component in energy taxation for carbon emissions outside the EU system.
Addressing labour shortages
Labour shortages are the main bottleneck to economic growth, as the 15-64 year old population declines. Many are inactive because they have poor skills or their skills are mismatched to job vacancies.	Increase resources to education, skilling, reskilling and upskilling. Accelerate immigration procedures and facilitate immigrants integration, including language classes.
Female labour force participation tends to fall with childbirth, contributing to gender inequality.	Keep expanding the supply of affordable childcare facilities. Reduce the maximum duration of parental leave as planned and incentivise fathers to take some of the parental leave. Increase the flexibility of jobs by better enforcement of rights for part-time work, flexible teleworking and shared jobs.
Improving the health care system
A harmonised monitoring system to evaluate health services is lacking. The decree that sets prices for health care services (Reimbursement decree) undermines the negotiations between health care providers and insurance funds.	Gradually introduce a pay-for-performance scheme for hospitals and doctors based on a broad set of performance indicators. Reduce the scope of the reimbursement decree by limiting its coverage and leave room for negotiations between insurance funds and health providers.
The number of hospital beds is still above the OECD average. The remuneration for GPs is dominated by capitation fees and less by fee-for-service rendering it less profitable than for specialists.	Continue reducing hospital beds by encouraging regions and municipalities to restructure capacities of health services and facilities. Strengthen the role of primary care through gate-keeping and further shift towards a better mix of capitation fees and fee-for-service for GPs.
The average age of doctors is high and may limit health access in the future. Nursing graduates are too few. Adverse lifestyle factors such as smoking, alcohol consumption and the prevalence of obesity are close or above the OECD average.	Increase the capacity of medical faculties and the number of students through scholarships and ensure the sustainable financing of universities. Increase taxes on tobacco, alcohol and consider introducing taxes on unhealthy food and beverages. Promote a healthier lifestyle and further develop education, disease prevention and screening programmes.
Differences in the funding of health care provided in hospitals and long-term care facilities create perverse incentives to use hospitals.	Align payment schemes for long-term care in health and social care setting by co-ordinating the use of user fees.