Investment – Will It Kickstart the Economy?

Dr Zdenek Drabek

The Czech economy has been stagnating for nearly five years. It’s becoming clear that a time will soon come when the persistent demands for higher wages, support for social programs, pensions, and defense and security funding can no longer be met. Likewise, the expectation of ever-increasing revenues will become impossible to fulfill. To break free from this quagmire, the Czech economy must grow.

Economic growth is generally generated from three sources: consumption, investment, and the net contribution of foreign operations (exports minus imports). While increased household consumption in the Czech Republic may help, it cannot generate the levels of growth required to match the standard of living of our neighbors. The Czech market is small, and foreign demand—along with exports—is struggling. Foreign direct investment in the Czech Republic is also declining, as the country becomes a “costly” destination for foreign investors in traditional industries.

The only viable way to accelerate Czech economic growth is through increased investment, particularly public investment, which has been highlighted as a growth driver by figures like Mario Draghi and the European Commission.

Challenges in Public Investment

Public investment plans seem impressive on paper, particularly when looking at the 2025 budget allocations. Similarly, the opposition, including the ANO party, has presented public investment programs extending to 2030. Both government and opposition programs focus on transport infrastructure, such as motorways and high-speed rail.

However, the bottleneck in completing motorways is not funding but other issues: the influence of environmental activists, objections from local municipalities and preservationists, private interests, and inefficiencies within construction firms. These factors lead to (1) unfinished motorways, (2) an increase in such unfinished projects over time, and (3) the paradoxical situation where increased motorway spending does not necessarily improve traffic flow. In essence, the challenges of public investment today resemble those of the central planning era.

A key element of any investment project is its design and administration. Here, the Czech Republic clearly has room for improvement. The poorly executed 2019 agreement with banks to co-finance public projects serves as a stark reminder. Under Prime Minister Babiš, the government created the National Development Fund, which was supposed to enable investments worth tens of billions of crowns. However, due to a lack of prepared projects, the fund was quietly dissolved.

Breaking the Impasse

The path forward is far from simple, but solutions do exist. For example, if motorway construction is to proceed, conflicts between various private interests must be resolved. This persistent failure has been noted by both Czech and foreign managers and is reflected in the World Bank’s Doing Business rankings, which evaluate the ease of doing business globally. These rankings place the Czech Republic among the least efficient developed countries.

Private Investment and Innovation

Current efforts include co-financing projects directly with private investors. This is economically sensible because private investors are compelled to conduct rigorous risk and financial return analyses—something state institutions often fail to do. However, these projects still face the aforementioned systemic issues.

Government programs also emphasize investing in innovation, but these investments must target areas that enhance productivity and lead to successful innovations. Success in these projects hinges on the depth of the financial sector, which remains underdeveloped in the Czech Republic. For instance, India’s capital markets, despite representing only 3% of global GDP, financed a third of all IPOs this year, accounting for 10% of global IPO funding.

In contrast, Czech startups face a rocky path to growth. Currently, the country has just three officially recognized unicorns (startups valued at over $1 billion). This pales in comparison to the 739 unicorns in the US, 53 in the UK, 30 in Germany, and 26 in France. Israel, a country comparable in size to the Czech Republic, boasts 25 unicorns.

Monetary Policy and Interest Rates

Could lower interest rates spur private investment? This seems unlikely. Inflation remains uncontained, according to the Czech National Bank (CNB). The recent election of Donald Trump as US president has further complicated the picture, with the Czech koruna (CZK) weakening by 2% against major currencies the day after the election.

The vulnerability of the CZK has been exacerbated by the European Central Bank’s recent interest rate cuts, which risk fueling inflationary pressures in the Czech economy. A tight labor market, full employment, and a shortage of skilled workers add to these pressures, as does the public sector’s commitment to wage increases. Imported inflation in energy and food continues unabated.

Conclusion

In response to the original question—can investment kickstart the Czech economy?—the answer is one of skepticism. Not unless the government takes steps to ensure more effective use of public funds for investment purposes, alongside safeguarding strategic and state interests. Bank loans may sustain the status quo but will do little to drive additional growth.

This brings us to the perennial question: should the Czech Republic finally adopt the euro? The insistence on maintaining an independent currency does not equate to true monetary independence, nor does it reduce investment risks or enhance the business environment.


Zdeněk Drábek
24 November 2024