Economist Tomáš Dvořák on why Czechia is “sick man of Europe” – and how to move forward

Tomáš Dvořák

A recent Die Welt article calling Czechia the “sick man of Europe” in economic terms received a great deal of attention in this country. The headline quote came from Tomáš Dvořák, a young Czech economist with the UK-based analytics firm Oxford Economics. So why is Czechia the only EU state not to have yet returned to pre-Covid GDP levels? And what can be done to improve its economic outlook? I discussed those questions, and more, with Dvořák at our Prague studio.

You have a strong British accent, Tomáš – how long have you been living in the UK?

“About 10 years, although this year, in 2023, I’ve actually moved back to the Czech Republic. Or I’m sort of living in between: I still work in the UK, I still work in London, but I also spend a lot of time in the Czech Republic as well.”

I can also hear a slight Scottish accent, and I know you studied in Glasgow. Why Glasgow?

“You know what? This might sound like a fairytale… I was very keen to study in the UK, that was always the goal and back then, before Brexit, in Scotland EU citizens didn’t have to pay tuition fees.

“So that made it much more attractive. That was the initial reason. I have to say, after living in Scotland for a few years, I love the country. It very deeply grew on me.

“So I feel a bit bad saying that I chose it because of the money initially [laughs]. But yes, a great place.”

What about Glasgow itself? I love Glasgow – I think it’s one of the greatest cities.

“Yes, it is. I absolutely agree with that. I would say it takes a bit of time to like Glasgow.

“I remember even when I arrived, I thought, This is going to be a rough four years. But it’s not a love at first sight. It takes a bit of time. It’s rough around the edges, but the people there are amazing, it’s a really vibrant city – great music scene.

“I recommend it very much. Tourists tend to skip Glasgow for other places, and I get why, because it’s not beautiful in the traditional sense. But it’s great.”

Recently you were quoted in an article that got a lot of attention here, in Die Welt, saying that Czechia is the “sick man of Europe”, economically. When and how did Czechia become the sick man of Europe, as you call it?

“Well, if you take it chronologically, then I think we did become the sick man of Europe during the pandemic, or right after it, when we never actually quite recovered from it – at least economically, that is.

“If we look at GDP, which is I suppose the main measure, we have never reached the pre-pandemic size of GDP since. So the pandemic was the start, but then there have been other things.

“I think it’s quite important to maintain the chronological order, so after the pandemic we had the energy crisis. That was something where we were hit perhaps more severely than other EU economies.

“And after that, basically here we are – we’re still struggling with the aftermath of that.”

Why was Czechia hit harder than other EU states by the energy crisis?

“If you look at how much energy we need to produce, we’re actually very inefficient.”

“For several reasons. We’re still a net importer of energy commodities, but at the time it was mainly from Russia. That made us quite vulnerable.

“Second of all, our economy is very energy… you can say intensive, or inefficient. Because if you look at how much energy we need to produce, we’re actually very inefficient; technically we’re the second worst in the EU, behind Bulgaria.

“So that was another issue that sort of made the energy shock reverberate quite hard.

“Also the economy itself is quite industry heavy, which in the past served us very well – that was the engine of growth. But in a crisis such as this, when electricity becomes very expensive, naturally an economy like ours is going to suffer. And it did.”

Are there any other reasons why Czechia is the only state in the EU whose GDP is lower than it was at the time Covid hit?

“So far we’ve only talked about the past – things that happened. I think we should also talk about the present and the near future, and in the present it’s not really the energy crisis or the inflation that’s really stifling the economy.

“I know it sounds weird, because prices are still high, but when you look at how they have developed over 2023, since January they’ve barely risen. So it sounds strange, but inflation is almost gone.

“And real incomes are growing at a very low pace, but in the last two quarters they have been growing. So this is clearly not the issue.

“I’d say at the moment the real issue is mainly the high interest rates that we have, the tight monetary policy from the Czech National Bank, which is feeding through the economy.

“And it’s important to understand this is what the Czech National Bank is trying to do. This is their way, this is their tool, of curbing high inflation – curbing the demand. And this is exactly what they have done, in several ways.

“At the moment the real issue is mainly the high interest rates that we have, the tight monetary policy from the Czech National Bank.”

“It has curbed investments by firms and it’s also made savings more attractive, because you earn a lot more interest on it, so households are not spending now, they’re saving.

“So that’s what’s happening right now. Then if you move on to the near future, just as it seems that the domestic economy might bounce off the bottom, we have different headwinds coming in.

“First of all, the Czech economy is not doing very well, but neither is the eurozone economy. That’s, I think, fair to say. The eurozone economy, Germany in particular, is very important for us, because we are very export-oriented.

“If there’s no demand in the eurozone, or weak demand in the eurozone, we’re going to suffer. And unfortunately that’s what seems to be happening right now.

“And I suppose the last elephant in the room to mention here is the fiscal side of things. The fiscal consolidation, which is going to progress in 2024, is also going to drag on growth.”

So essentially Czechs have stopped spending, that’s the issue?

“That’s the main… we like to call it ‘headwind’. Yes, that’s the main headwind.

“The fall in consumption has been massive. When we compare it to the drop in spending we saw during the great financial crisis of 2008, this has been about four or five times bigger.”

“I should also say here that the fall in consumption has been massive, dare I say unprecedented. Because when we compare it to the drop in spending we saw during the great financial crisis of 2008, this has been about four or five times bigger, peak to trough.

“These are huge numbers, never seen before.”

The Czech government is trying to ultimately balance the public finances through these austerity measures that you’ve referred to. But is it then the case that these policies are contributing to the country’s economic woes?

“In the near term, yes. And I don’t think even the government would dispute it. When you consolidate public finances – when you’re cutting expenditures and raising revenues – yes, that is going to drag on growth [laughs]. There’s no denying that.

“The government would say that it’s doing it with a good reason, it’s doing it with an eye to the future. I have to partially agree, in the sense that the government was faced with a very tricky situation, because it came into power in very difficult circumstances.

“It first had to really support the economy during Covid. And that was the right thing to do, by the way. Maybe all of the expenditures weren’t properly targeted, but certainly as a whole that was the right thing to do.

“The second huge shock came with the energy crisis. And again, I think very few people would argue that helping households and companies by capping the energy price was a bad idea.

Tomáš Dvořák | Photo: Ian Willoughby,  Radio Prague International

“But these two – even though they were technically one-off – were huge expenditures. But in addition to that, the previous government passed a tax cut. That’s not a one-off. That created a gap, what we call a structural deficit, that’s there every year. That means the debt was rising.

“Now I need to stress here that debt levels in the Czech Republic are quite low, compared to everywhere in the advanced world. But they were growing at a fairly large pace, so some sort of consolidation was clearly needed.

“I suppose the question is, if the economy is not doing too well at the moment, even without any consolidating, Would it be a good idea to maybe structure the consolidation package a bit differently? Would it be maybe a good idea to slow the pace? I think that is up for discussion.”

If we could speak more generally, Czechia has for several years has had one of the lowest, if not the lowest, rates of unemployment in the EU. But there are very low salaries here. Maybe the low unemployment rate kind of masks the issue of salaries, but that is a big factor in Czechia, it seems to me. Why is pay so low in this country?

“This is a very, very good question and I’m glad you asked it, but I’m also sad to say that I don’t have the full answer.

“On one hand, this is a long-standing issue in that we are what economists call the ‘middleman’ in the supply chain.

“Especially in industry, we tend to be the last step before the final product. Whether it’s a car, whether it’s a big machine, that usually tends to get made in Western Europe and we produce the intermediary goods, the inputs.

“Especially in industry, we tend to be the last step before the final product.”

“That is what we call low value added input. Over the long-term, over the medium-term, salaries kind of mirror the growth in value added, so that’s holding salary growth back a little bit.

“At the same, what I do find quite strange is… We talked about real wages, so wages adjusted for inflation, have fallen drastically during the energy crisis over the last couple of years – despite extremely low unemployment.

“Now, if you take textbook economics, that shouldn’t happen. If you have a very tight labour market, then nominal wage growth should be very strong.

“But it hasn’t been. And in fact the labour share of income has fallen over the last couple of years. This is something I struggle to explain, and I think it’s something that many economists would struggle to explain.

“But it maybe points to what I would call a non-standard working of the Czech labour market that is holding salaries down; perhaps one thing could be that Czechs value having a job, and being in employment and that sort of certainty, above stronger salary growth. But that’s just speculation.”

In the 1990s everything looked so bright, the future looked so bright. Now a lot of people are speaking very negatively about the Czech economy. Where did it all go wrong?

“I think we need to differentiate between what we call structural and cyclical weakness, at the moment.

“Cyclical weakness is something that’s tied to the business cycle, and that comes and goes. If I really simplify it, that’s something that will get better over time. And I think that there’s a big component of that as well, linked to high interest rates – that is a cyclical factor that is going to fade, next year.

“Real wages have fallen drastically – despite extremely low unemployment. If you take textbook economics, that shouldn’t happen.”

“But there are also structural issues. And I think we’ve really neglected certain trends and certain things that are going to be important for the future. We’ve ignored them.

“Here I’m mainly talking about the energy sector and the green transformation, perhaps growth in new technologies and perhaps trying to manage the manufacturing sector, which is still huge, in a way that sort of keeps moving up the value chain.”

You’re obviously not a policy-maker. But still what would you say if the government were somehow to ask you for advice, if they said, What should we do to try to cure the “sick man of Europe”?

“Well, first of all I hate to be the bearer of bad news… Actually, I’m going to offer two bits on the near term.

“In the very near term, there’s not much we can do. Helping the economy takes time. Even if the government were to change its course today, that would still take a few quarters to work in. The same for the central bank.

“At the same time, I think the worst is nearly over. I think growth will return, during next year. It might start slow, but it will build throughout the year.

“So that’s the cyclical side of things. If I were to try to advise government, first I’d say that we need a proper vision and strategy that’s going to remain beyond successive governments.

“We need to build political consensus on certain things, because if one government does one thing, then the next one comes along in four or five years time and reverses the course, that’s bad. And that’s actually what has been happening in the past.

“And then we really need to focus on, I’d say, two things in the medium term.

“The first one is the green transformation, which is even more important for us as an industrial country. If we want to keep our industry, like we did over a century, then that’s something we really need to focus on: decarbonise the energy sector. Our energy sector is obsolete – there’s no other way of saying it.

“The other one is, we’re facing a negative demographic trend. Our population is shrinking and this is going to be difficult for the pension system. It’s going to be difficult for the economy.

“We need to keep finding ways to fight that, whether that’s helping with childcare, so people on parental leave can work, whether it’s having more inward migration, whether it’s other ways: housing is very tightly linked to it.

“This is something that is already biting now, but it’s going to bite much more in 10 to 15 years.”

When you mention green policies, sometimes it seems to me that “green” is almost a dirty word for Czech politicians. Would you agree?

“Unfortunately, yes. Although one thing to maybe highlight here is that there’s been a change in rhetoric in recent months from the government, mainly from the prime minister, on sort of acknowledging the scale of the challenge in the energy sector.

“This is something I welcome. Of course, these are just words, we also need deeds. But this is a good first step – acknowledging the size of the issue is a welcome first step.

“But overall I agree. I think maybe public opinion isn’t quite as bad, but many politicians, you’re absolutely right, basically take ‘green’ as an insult.”