The Czech Republic Toward EU Accession

A summary of the World Bank Report, September 1999.

One of the latest in the series of World Bank Country Studies is a report on the state of affairs regarding the EU accession process of the Czech Republic. It provides a good insight on the subject matter and is devoid from the mere criticism that characterises the recent EU Commission's report. Instead of that, the study outlines desirable policy action in three fields. The first part focuses on macroeconomic policies in the pre-accession period which serve to pave the way to accession. Second, necessary reforms to maximise the benefits from joining the EU single market. And third, minimising the costs of adopting the Acquis Communautaire.
In the following summary an overview will be given of the most important findings of the World Bank study, which should give you more insight into the core of the issue.

Macroeconomic Policies in the Pre-Accession Period.
The Czech Republic's goal is to join the European Union (EU) in the shortest period of time. In order to arrive at this goal, it is necessary to implement a strategy based on macroeconomic policies that realign key economic fundamentals and that generate sustainable growth. In addition to that, structural reforms are needed to enhance the prospect for EU accession.
  • Promoting Economic Recovery and Sustainable Growth

  • The recession that started in 1998 intensified in the first quarter of 1999. Real output is falling, unemployment has doubled (now 8.3 percent) and domestic demand declined. The decline of GDP for the first half of 1999 was at an annualised rate of 4.5 percent. Signs of recovery come from the external sector, since foreign demand started to grow. The Czech Republic has potential for relatively high rates of growth over the medium-term (4-5 per cent of GDP), driven by productive investment, deep structural reform and improved export performance. At the heart of the recovery of the Czech economy lies the privatisation of remaining stakes in large state-controlled banks, and the severance of the unhealthy relationship between those banks and large industrial conglomerates. Strategic foreign investors are needed to bring a sound banking culture. Further on, structural reform is needed in the enterprise sector. A Revitalisation Agency was established to take over the debts of the banks' portfolios and restructure selected enterprises. Credit availability should increase, especially to give the small and medium firms access to loans. Although many reforms are necessary it is important to acknowledge the achievements of the Czech economy. Enormous effort has been put forward to transform the planned economy to a market economy and the Czech economy is now one of the most open economies in the region. Import tariffs are low, a limited amount of non-tariff barriers, an open capital account and sizeable trade flows with the EU. Besides that, educational levels are comparable to those in the EU.
  • Fiscal Sustainability and the Challenges of Fiscal Decentralisation

  • Although the Czech government maintained a fiscal policy aimed to achieve a nearly balanced budget, many budgetary operations have carried out outside the budget. This causes the implicit fiscal deficit in the Czech Republic to be significantly higher than the deficit calculated through conventional methods. The banks are (again) a major source of constraint on the budget. Many of them need state support to survive. Besides fiscal discipline, decentralisation is another important area of reform. An intermediate level of government should be created. Experience elsewhere shows that issues as environmental protection, unemployment and privatisation are better handled within a regional context. Government reforms on the level of municipalities, transparency of state-allocated loans and the role of the private sector in the provision of public goods are other main areas of reform.
  • Foreign Trade Policy and Foreign Direct Investment

  • Although growth rates remained respectable, from 1996 on exports to the EU slowed down. Since regional competition for a larger trade share in the EU has sharpened, the Czech Republic has lost some momentum in its export penetration in the EU. Foreign trade in Central Europe is closely linked with forms of foreign direct investment (FDI) and the Czech Republic has a lot to catch up in comparison with Poland and Hungary in this respect. The increase of the contestability of its domestic markets is necessary for increasing the competitiveness of Czech firms and creating a business friendly environment, which will also serve to attract more FDI. Measures to increase the contestability of domestic markets are (1) the improvement of the competition policy framework; (2) the improvement of the current framework of state aids; (3) to open government procurement to foreign contractors, i.e. eliminating the preferences offered to resident firms; and (4) to align Most Favourable Nation (MFN) tariff rates on industrial products with those levied by the EU.
  • The Challenges in Social Sectors: Social Security, Health and Education Reform

  • The Czech Republic's social sector policy has been aimed to arrive at a system that meets the needs of a market economy. The three main components of social protection consists of (a) the pension system, (b) social assistance and support, and (c) the unemployment compensation scheme. Given the demographic structure of the country, the pension system will need to be reformed. Life expectancy is increasing and pension expenditures relative to GDP have been growing by 12 percent between 1995 and 1998. Considerable effort has already been made to bring the social protection system in line with EU countries. The recent growth in unemployment necessitates a reconsideration of the employment compensation scheme. Unemployment hits the hardest on the population of 300,000 Gypsies or Roma, who are often not educated and suffer from widespread discrimination. The government has recently taken steps to address the situation.
    Although there is little demand from the transposition of the Acquis Communautaire on the health sector, concern has already been expressed by the EU regarding the health financing system and its viability over the longer term. As the process of accession to the EU advances, an affordable and efficient health care system that does not compromise the government's expenditure envelope and the quality of services provided is necessary. The prospect of EU accession has significant implications for the Czech educational system as well. EU membership will place the Czech Republic in a very competitive economic environment. There is a need to modernise the education system, in particular at the secondary and post-secondary levels.
Maximising the Benefits from joining the EU Single Market
To be able to benefit from the EU single market, the Czech economy has to be restructured and its capacity enhanced. It is therefore important to improve the environment under which the financial and enterprise sectors operate and to develop a strategy to reform key components of the economic infrastructure.
  • Reforming the Financial and Enterprise Sectors

  • The 1998-99 recession has served to highlight the deficiencies in the structural front, particularly those related to microeconomic foundations of the banking and enterprise sectors. The financial conditions of the banks remain weak, the sources of which are: (a) poor corporate governance; (b) significant non-performing loans; (c) poor ability to assess risk; and (d) the belief that the Czech authorities would not let banks fail. To enhance financial discipline privatisation of banks is necessary. To facilitate this privatisation process, three recommendations are given that also serve to minimise the costs to the State. (1) Acceleration of legal reforms. Especially the alteration of the legal conditions surrounding the seizure and the sale of collateral and the bankruptcy process. (2) Administration of the privatisation process. An outside advisor is needed to strengthen the steering committee that administrates the privatisation process. (3) Pre-privatisation governance of the State banks. Before the privatisation process begins, the governance structure of banks should be improved to ensure effective privatisation. In addition to banking reform measures, a set of reforms related to the future performance in the enterprise sector is necessary. Four areas deserve attention: (1) complete privatisation of the remaining state assets in the enterprise sector by sales to strategic investors; (2) recovery of assets of transformation institutions; (3) improvement of corporate governance; and (4) meeting EU quality, environmental and safety standards to prepare the real sector for the strong competition in the EU. Further reforms concern the capital market. The Czech Republic needs to arrive at effective and credible capital market institutions which channel savings into productive investments.
  • Facilitating Labour Market Adjustment

  • In comparison to other countries in transition, the Czech Republic was unique in coping with the reallocation effects on employment. For years it maintained very low levels of unemployment, but the 1997 currency crisis and the follow-up recession changed the face of the Czech labour market. In respect to EU accession, some EU regulations could increase labour costs and adversely affect labour demand and international competitiveness of enterprises. Moving quickly towards mutual recognition of educational and training systems and professional qualifications with the EU will help the Czech republic strengthen its human capital. Investments in education are therefore needed. Taxes on labour, such as social security contributions and employment insurance should be reduced in order to create jobs and discourage tax evasion.
  • Economic Challenges in the Infrastructure Sector

  • The Czech Republic needs to develop and implement appropriate microeconomic policies in the key infrastructure sectors. Efficient functioning of key infrastructure sectors of the economy is vital to both sustained economic growth and international competitiveness. The main challenges are: (1) designing and implementing post-privatisation market and governance structures that promote effective competition and credibly limit the powers of government to intervene in the operations and finances of privatised companies; (2) adopting (retail) pricing policies that are consistent with the dual objectives of economic efficiency and social equity; and (3) designing competitively neutral mechanisms to support universal service. Very important is the limitation of government influence over privatised companies.
Minimising the Costs of Adopting the Acquis Communautaire
Three sectors are likely to present the strongest challenges for the authorities in adopting the EU norms and directives, jointly known as the Acquis Communautaire. First, the investments needed to comply with the Acquis in the environment sector. Second, the agricultural sector and third, the challenges of reforming the public administration.
  • Coping with EU Environmental Directives

  • In recent years, the country has made much progress in harmonising its environmental laws and regulations with those of the EU, and is working hard to complete the process. The principle gaps relate to legislation on water, waste, integrated pollution prevention and control, and genetically modified organisms. Particular challenges of adopting the environmental acquis are: (1) the scale and scope of EU legislation concerning environment is broad, which requires substantial investment; (2) the costs will be immediate, while the benefits of such investments will be seen only in the long term; (3) the requirements of EU directives do not always correspond with the Czech Republic's immediate national priorities; and (4) the investment programmes required to upgrade infrastructure could exacerbate regional disparities in income and employment. The EU however, plans to make funds available to the accession countries to help financing the investments related to the environmental acquis. The backbone for successful implementation will be to strengthen institutional capacity. Many public agencies will have to be changed and some new bodies will possibly have to be created. The total investment requirements have been estimated at approximately EUR 6.6-9.0 billion (1998 prices). Total annual costs will be EUR 1.2-1.7 billion or 2.5-3.7 per cent of GDP.
  • Preparing the Agriculture and Rural Sectors for Competition in the EU

  • The share of agriculture in the economy contracted significantly during the transition, reaching about 4 percent in 1998. The relatively poor product differentiation developed by the food industry and the relatively poor performance of the agricultural marketing chain has limited the ability to export and even to compete with imported goods; the Czech Republic is a net importer of agricultural and food products. The major features of the farming structure are : (a) dominance of larger-sized firms (75 percent of the total agricultural land); (b) leasing of land as a major form of tenure; (c) low profitability; (d) significant indebtedness especially the co-operative farms; and (e) barely restructured collective farms still run as they were during the pre-transition period with limited motivation on the part of the members. In order to create a viable farming structure under EU conditions the authorities need to further transform collective farms: settle farm debts, sell the remaining state-owned land, and open agricultural land for new investors. Rural development, particularly in less-favoured regions of the Czech Republic (mainly mountains), faces several challenges. First, a decentralised and multi-sectoral approach. Second, an emphasis on the development of small and medium sized projects. Third, a fair treatment of communities not based on political favouritism. And fourth, increased collaboration with the private sector (enterprises, NGO's, etc.).
  • Improving Public Administration

  • An important aspect of the Czech Republic's candidacy for EU accession involves bringing its public administration and governance capacities in line with the EU member countries. This is a critical task, as joining the EU will impose severe pressures to the public administration both to transpose the acquis and to enforce it. One of the main shortcomings of the current system is the absence of an intermediate, i.e. regional, level of government. A new administrative division is being prepared, but it is still uncertain when it will be established. The public sector also suffered from "benign neglect", caused by its relatively well functioning in comparison to Poland and Hungary. Modernisation of this sector is needed to enhance transparency, reduce corruption and improve the general quality of public service. Another problem is the absence of a Civil Service Act and no official category of "civil servant". Like all other employed persons in the country, government workers are regulated by the Labour Code, and thus have a contractual relationship with the specific employing Ministry rather than the state as a whole. This is one of the more serious roadblocks to the Government efforts to meet EU accession norms in the area of public administration. Further on, a revision of the current cabinet structure, that is more supportive to the Prime Minister is necessary as well as the creation of a policy analysis unit within the office of the Prime Minister. Finally, the policy formulation capacities of Ministries need to be strengthened. All these reforms should serve to make Cabinet decision-making more effective.
Concluding Remarks
The Czech Republic's development strategy should consist of three different types of policies and/or reforms:
  1. "Win-win" policies and reforms where early implementation is desirable on its own right, regardless of its accession to the EU;
  2. Policies and reforms which are not a formal EU requirement but are nevertheless essential to the growth and stabilisation strategy - such as privatisation and pension reform; and
  3. Policies and reforms, required by the accession process, whose adoption will demand more time and careful sequencing of actions in order to maximise their benefits. Examples of the latter include the adoption of the Common Agricultural Policy (CAP) and the full set of EU environmental standards.
Membership of the EU is the most important development agenda for the Czech Republic. It is first and foremost an issue of creating the proper conditions under which the Czech Republic will be capable of reaping the benefits of integration. The adoption of the Acquis should be viewed as an instrument to speed up the necessary reforms. Joining the EU is an enormous task that requires the focus and full commitment of the government and society at large.