November 2022
Let’s start with what is very well known. Inflation in the CR has risen dramatically, and its origins are explained by factors such as higher energy and commodity prices on world markets and problems in supply chains. Inflation has negative effects in the form of a fall in real incomes, the value of household savings, the loss of competitiveness of Czech firms and distorted incentives in the labour, goods, services and capital markets. Inflation devalues credit and increases the risk of investment and economic recession.
Czech inflation, however, has another characteristic – it is twice as high as the average inflation in the EU, especially in Germany, the most important country for us economically, and it is also twice as high as inflation in the USA, which, in turn, affects the rise in commodity prices on world markets. Inflation in the Czech Republic is obviously specific to something.
The CNB has responded to rising inflation with rapidly rising interest rates. However, the CNB is too isolated in this policy, which means that the fight against inflation will be much harder and less predictable than it would like. After its pre-election promise to reduce the budget deficit, the government is now in a similar situation as the previous government and is programming a deficit that will grow to levels comparable to those of the Babiš government.
What is happening in our country? Why is the Fiala government finding itself in such a precarious and controversial situation? Why is it not doing a better job of explaining the real causes of our inflation, which are leading it to abandon some of its pre-election promises?
There are several reasons. Prime Minister Fiala is presenting the budget as a “war budget” – the need to replace Russian gas and other raw materials with alternative sources at a higher cost, funding immigrants and supporting Ukraine, and investing in national security and defence. These are certainly worthy goals.
However, one of the dominant reasons for the budget deficit is the social entitlement perception ingrained in the Czech society and the role of the state in the labour market. Budgetary expenditure is highly influenced by the so-called mandatory expenditures , such as old-age pensions or the salaries of groups of civil servants, and these essentially force the Minister of Finance to increase hose expenditures by the inflation factor automatically. Government policy plays a huge role in determining wage policy not only in the state sector but as a “wage setter” in the private sector. Government wage increases in the large public sector set the “bar” for wages throughout the economy.
Of course, the budget deficit is also influenced by a strongly ideological stance on not raising taxes. However, as I have already indicated, the dominant factor is the national culture of social entitlement and the dependence on the state by the Czech people, such as the support for self-employed mothers and the huge range of social programmes. We are not alone in this, of course; the social sentiments of the Germans, French and others lead to similar pressures. However, I dare say that we are real champions in this area and that the same extremes do not occur in those countries as in ours. These pressures on the government cause less attention and resources to go into better and more productive use of public resources. Reducing and streamlining social programs is not a priority, and these programs are typically the last to be considered when cutting budget expenditures.
CNB’s role in this situation is very difficult. High interest rates not only lead to higher interest rates on new mortgages but have a serious impact on small and medium-sized enterprises that depend on credit. High interest rates are anti-growth for large companies because, with full unemployment, these firms can only respond to rising nominal demand (stimulated by government spending) with higher wages and thus prices. Interest rates in the CR are higher, much higher than those of the ECB or the Fed, the US central bank. While this allows the CNB to maintain a stable exchange rate, which is positive for controlling inflationary pressures, it comes at the cost of worsening the competitiveness of Czech firms and their growth.
Government policy is problematic. Fighting inflation does not receive sufficient attention and does not seem to be a priority. In a situation in which the government is facing mandatory spending and social demands for various household support programmes, the government’s ideological “purity” in the form of maintaining tax neutrality and insisting on the fiscal responsibility of a good and responsible steward its resolve to limit the economic role of the state has somewhat fallen by the wayside and remained at this stage an empty election promise. Addressing inflationary pressures will require bold steps by the government, including legislative adjustments to mandated spending – in addition to more efficient operation of the EU energy market.
Wage policy in the public sector, which is entirely under government control, is also key to dampening inflationary pressures. For example, pay rises for secondary school teachers are sympathetic, but should they not also take into account the salaries of university teachers? Or those of primary school teachers or kindergarten teachers? None of these questions about education sector priorities were addressed in these details by the political parties. The result is a government policy response to the immediate mood and pressures of the electorate.
It is important for social programmes to support those in critical situations. These are primarily those who cannot help themselves in these difficult times. Government aid has been and is too focused on income support, and so it goes across the board to support everyone instead of those who need it most. But without a cushioning of political pressure on social support, it will be impossible for the government to resist calls to adjust the revenue side of the budget and raise taxes. In the meantime, however, inflation is approaching 20 per cent and some companies are already considering relocating abroad and others are talking about the inevitability of laying off their employees.
Dr. Zdenek Drabek, Charles University, former advisor to the World Trade Organization and the World Bank.