One of the world biggest car manufacturers – Volkswagen- has recently decided to halt its planned investment in the construction of a giant battery factory in Líně near Pilsen after a year and a half of negotiations. The company was expected to employ around 4,000 workers. The report went through the Czech press as if it were a weather forecast – without much notice. Afterall, weather changes daily, and such news cannot compare with the interests of Czech voters who worry about their wallets, mortgages, savings, support for single mothers, pensions or salaries of doctors and teachers, not to mention the state’s commitments to NATO or Ukraine. Petr Fiala’s government expressed regret and even allegedly offered additional subsidies, but even those subsidies were not enough to change the VW Group’s mind. Almost in the same breath, the government expressed optimism that there would certainly be an alternative bidder for the project. All of this leads to a fundamental question: Shouldn’t the government ask whether VW’s refusal to invest in the Czech Republic is not linked to deeper problems in the Czech economy?
My answer to my own question is- yes, VW’s response is related to several fundamental problems of the Czech economy, which weaken the interest of foreign investors in investing in the Czech Republic. We are, of course, talking about strategic direct investment, not about short-term capital movements.
First, the Czech Republic has become a country with relatively high production costs. Country, which has been sought after not only for its “genius” work talent, as we often refer to ourselves, but mainly for the low price of the labor force, has suddenly found itself in a situation where the price of labor, the price of distribution services (for example, the margins of oligopolistic large chains), the price of energy – all this leading to such a burst of inflation that it has been already one of the highest rates of inflation in Europe in the recent years. Foreign investors invest in the Czech Republic not to satisfy Czech demand, but to be able to compete on foreign markets. This means that the price of Czech labor cannot be determined by the price at which the company sells its product or service on the small Czech market, but it must be its competitiveness in the foreign market. If exporters have problems competing in the open market, then Czech wages cannot grow adequately either. The Czech wages have increased by 30% since 2020, while in manufacturing, which is the driving force of exports, the wage growth was “only” 25%, and this explains where the problem lies.
Secondly, as is well known, the Czech labor market does not operate well. The number of vacancies is high, even though the economy has been hovering between stagnation and recession for some time. While unemployment is low, which is welcomed by trade unions, employers’ thirsty demand for labor simply does not match the limited supply of workers. Economists may call it the “problem of skill match.” But there are other serious problems, which are under the control of the government and its policies such as the government support for the unemployed, which is often too generous and unconditional to motivate an unemployed person to find a job for herself in the market. It is also related to the bloated state sector, which offers its employees the security of permanent employment, a benefit with which the private sector cannot compete. Moreover, given the size of the public sector, the government policies on salaries of firemen, policemen, teachers, doctors and other public sector employees is a key determinant of wage settlements in the economy as a whole.
Third, the Czech koruna is overvalued. Compared to March 2017, when the CNB’s exchange rate commitment ended, the Czech koruna has strengthened nominally from CZK 27 to the current CZK 24.50, i.e. by about 10%. What is important, however, is the relative change of producer prices at home and abroad. Czech domestic producer prices have increased by almost 50% since 2020, driven by prices of energy, chemicals, building materials and metals, which are important inputs, as well as by strong inflationary expectations. All of this has led to the rise of domestic costs that is higher than the rise of costs in the competitors’ markets. In other words, the real effective exchange rate, which is determined by the asymmetry in the movements of price levels at home and abroad, appreciated significantly. It is estimated that the industrial producer price inflation abroad was only between one half and two-thirds of the rise in the Czech producer prices. . The existing data show that the real the real appreciation of the koruna exchange rate over the past four years has been roughly in the range of 20 to 30%! Given the stagnant or declining production and an essentially stable level of employment, it is almost impossible for this appreciation to have been neutralized by a 20 to 30 percent increase in productivity!! Exporters, therefore, first losing out on the strengthening of the nominal exchange rate, and simultaneously facing the rise in the real effective exchange rate, lost competitiveness. This dramatic appreciation of the real exchange rate and thus the loss of competitiveness of Czech exports is one of the reasons why it was important to reduce inflationary pressures as soon as possible.
Fourth, the existing foreign projects of foreign investors in the Czech Republic are still undoubtedly profitable, helped by the inflationary situation in the market, by the ability of large firms to borrow at lower Euro interest rates and thus bypass the Czech credit market, and by having strong or dominant positions in the market. However, for new projects, foreign investors need conditions that are “investor-friendly”, which they can only wish for in the Czech Republic. Using the ranking of world economies from Doing Business created every year by the World Bank, the Czech Republic is in a disrespectful 41st position (2020). In areas that are key for a greenfield investors, such as “starting business” or “dealing with construction permits”, the Czech Republic is in the catastrophic 134th and 157th position! It couldn’t be worse.
Fifth, the attractiveness of Czechia as a market for greenfield projects or startups with high added value is very limited, especially by shortages of labor, human capital and inflation of material inputs. Unlike, for example, Israel, where foreign investment was oriented towards high-tech sectors, most foreign investment in the Czech Republic went into the companies that needed massive restructuring and streamlining of production. Exceptions, such as Avast have been and still are few in the Czech Republic. This means that the Czech Republic must compete in this time with other countries on “price” and not with the brains of Czech minds. We need time for the latter.
And a personal note at the end. 30 years ago, I was in contact with VW management during their purchase of Škoda in Mladá Boleslav (does anyone still remember the FAZI I led at that time?). VW’s eager interest in Škoda (Auto) at that time was completely different from the current lukewarm behavior of VW’s management in the negotiations on the construction of a gigafactory in Líně near Plzeň. This captures well the completely different prospects of profitability of doing business in the Czech Republic by foreign investors such as VW 30 years ago and today.
Zdeněk Drábek
Prague, 7 November 2023 ( For Hospodarske noviny)