A conversation with Ondřej Lopušník, Macroeconomic Predictions Unit in the Ministry of Finance’s Financial Policy Department. A discussion about public finance, fiscal measures, and other problems stemming from the current economic crisis.
12/8/09
Introduction:
Basically what I am responsible for is to track the impact of the crisis and recession on the Czech economy. This is my temporary agenda. I’m interested in monetary policy and financial markets.
What were you most concerned about when it became clear that the crisis would affect the Czech Republic?
Well, definitely it was clear that something is wrong in the United States. We at first thought that this would lead to just some slowdown of the Czech economy. If I remember well, in the January forecast of 2009, we still projected some slow economic growth, and only in the April forecast did we project an economic downturn.
My personal concern was not about the financial sector because our financial sector is quite strong, but maybe about unemployment. Also recently I’ve started to be worried about the fiscal issue with the deficit and debt. But the unemployment, for me, is a big problem. On one hand, you have the total unemployment which is projected to peak next year and then gradually decline. The peak will be around 10% according to the method used by the Ministry of Labor and Social Affairs. But what you don’t see in this aggregate number is large regional differences. There are regions where now you have unemployment at 15%, and now the big problem with labor market is the number of unemployed people per one vacancy. Just today the Ministry of Labor issued statistics for November, and we’ve got some 509,000 unemployed people, but only 33,000 vacancies, so you get some 15 or 16 people for one vacancy, but this is just the average. There are regions where we have 40 or 50 people for just one vacancy.
Is there something the Ministry of Finance could do to address this issue, aside from maybe some tax reforms?
This is definitely a political issue. Politicians have to decide on the proper policies to deal with this problem. I personally liked those social security contributions reductions because I think this was aimed to keep people and jobs. Because if you reduce social security contributions paid by employers you reduce the cost of labor. But these were abolished because the concerns about the state of public finance grew quite large.
How do you think politicians can combat this difference between the effects in urban or rural areas?
Well, definitely what’s the problem is low regional and professional mobility of the labor force. People are reluctant to, let’s say, work some 50 or more km away from their homes. I think that there was a proposal to subsidize these distant travels to work. Also what could be helpful are some training courses, where people could change their qualifications or acquire some new skills. The combination of these two things would be helpful, but still I think it’s a long-term issue because people are not used to traveling large distances to work.
Are they interested in acquiring these new skills, or looking towards science as an employment option?
I don’t know to be honest. I think that if you are in a region where there is no demand for your skills, you have no other option than either to move somewhere else or to try to acquire new skills if you don’t want to stay unemployed. Actually, there is a program called ‘educate yourself’, which is one of the anti-crisis measures. Although, its scale is quite limited. Basically, firms that send their employees to those training courses to acquire some additional skills get some subsidies. It’s partially paid by the Czech state, but the majority is paid by the EU.
Returning back to duties of the Ministry, do you use other materials aside from your Macroeconomic Forecast (e.g. Czech National Bank forecasts) when you make these publications?
Every month we make our internal survey of forecasts of other institutions to get an idea of what they are thinking concerning future developments. We also, twice a year, make a similar survey, which is then published on the Web page of the Ministry of Finance. Maybe it might make some members of the Ministry change their thoughts, consider how other institutions differ in opinion. I think that mostly we make our own opinion based on the data we have.
Can you talk a bit about the forecasts for 2011 and 2012? There is a projected 2% GDP growth.
Well we have 2.8% for 2011 and 3.3% for 2012.
How can you account for the potential for a second dip, let’s say when Germany and other EU members introduce their austerity packages?
What is uncertain right now is what will happen when all of those fiscal stimulation measures will be phased out. What we believe in right now is that there will be no second dip in economies and markets. Although, I think that one cannot complete exclude this possibility. But, I think that when all of those fiscal stimulation measures will be gradually phased out, the economic situation will be strong enough that the recovery will be sustained.
How about exports and demand from other countries? Do you think this will fluctuate alongside the introduction of austerity packages in other countries?
Certainly, yes. Our export this year has extraordinarily good results. Because, all of those fiscal stability measures. For example, there is quite a big impact of the car scrapping scheme in Germany. Also, we’ve got lower prices of oil than we had in Europe before, so this helps our foreign trade balance as well. Definitely what we can expect is that when the situation abroad changes, then it will impact our foreign trade performance. But, well, with regards to our October forecast, in comparison with the previous July forecast, we somewhat improved the expectations regarding the development abroad. They compare the July and October forecast in the beginning of the publication. On the one side, you have improvement or better than expected development abroad, but on the other side you have the fiscal consolidation package effect in the Czech Republic. Basically these two effects offset each other. It’s interesting, because in the July and October forecasts, GDP growth is the same; this is just the key explanation.
What worries you most with these low expectations of GDP growth? Is the deficit of highest concern at this point?
The deficit and debt is of high concern because, I think that the Commission has already launched their excessive deficit procedure with the Czech Republic. What we are obliged to do is reduce the deficit below 3% of GDP by 2013. If we don’t succeed, there might be some negative consequences in terms of payments from EU funds. Also, if we don’t succeed, the markets might view this as a negatives sign, and we might have some other problems. For example, increased costs of financing the deficit. Definitely the state of public finance is a big concern.
What tradeoffs do you face when trying to tackle the issue of public finance?
One has to take into account the effects on the economy, but maybe if one decides to lower the deficit, then the tradeoff is how to do that – if you want to reduce expenditures or increase revenues, or a combination of these two. This is basically a political issue. Even if the political parties reach a consensus that the deficit has to be reduced (which I hope they will reach, because the EU will put us under pressure with this issue) then you have the Civic Democrats who want to reduce expenditures, and Social Democrats and Communists who want to increase revenues of the state budget. Reaching a consensus in this respect will be difficult. Personally I hope that we will make something of the deficit, and that something will really help our budget, even medium and longer-term, so that there won’t be some short-term measures.
What do you side with more, Civic or Social, as far as increasing revenues or decreasing expenditure?
Well, I think it should be a combination of both. The political structure may change somewhat. At one time the Social Democrats might be more powerful, and other times it might be another party. It is good that they reach a consensus. Even if there are some other elections in the future, power rebalanced, they will stick to their previous changes.
What programs do you think will suffer most as a result of consolidation?
I think that cutting expenditures and social spending will be particularly difficult given the high weight the Social Democrats and Communists put on this issue. Maybe wages in the public sector will be cut. For example, pensions might be increased less. Also, spending on infrastructure might be reduced. There might be some increase in taxes.
We will have elections in May or June of next year. Maybe what’s interesting is the new political partly, TOP09. They are more similar to the Civic Democrats than the Social Democrats. If they make some good results in the elections, there might be a shift in the balance of political power towards more cutting expenditure approach.
Are they garnering a lot of support?
The election surveys indicate that they might get something between 10 and 15%. They might even be the third largest party.
With regards to austerity measures, what do you want to see implemented for 2011, or is it too difficult to say at this point?
You just cannot keep cutting expenditures all the time. In my view, cutting expenditures and increasing revenues should be balanced.
What do you see as useful in NERV’s recent publication offering a vision for the Czech Republic?
To be honest, I did not read their final report. As far as I know, what you should take into account is informal institutions. You cannot take what they made in Finland and make an exact replica and apply it in the Czech Republic because the informal institutions are different. I even talked to one of the NERV members, and he basically said that the ‘copy paste’ approach is not feasible. Definitely what they did in Finland is make huge investments into education and research and development (R&D). I also support this. Interestingly enough, Finland is doing pretty poorly these days. I looked today at their recent GDP development, and I was quite shocked because in the third quarter of 2009, they declined by 9% almost on year on year basis. I really would be interested to know why this is so.
Do you think there are some improvements that can be made in the country’s fiscal framework? (This was one of NERV’s recommendations.)
What we should do in my view is change the structure of expenditures. You’ve got 80% mandatory expenditures. If you want to cut you have to change them all, which may be pretty difficult. Maybe changing the rules or lowering the share of mandatory expenditures would be helpful. Personally, I think that ensuring some medium and long-term sustainability of public finance is what we have to do very quickly.
Do you see that being possible, given that you have an interim government in place?
Well, it will be difficult. I think that the situation is no longer sustainable. You cannot run large deficits if you have quite nice economic growth, it’s not possible to do so in the long-run, so you have to make some changes.
Are politicians convinced of that?
I think some of them are, but not all maybe. I think that the pressure the EU puts on the Czech Republic with this respect might be quite helpful. You know, if we don’t put our public finance in good shape, then we might face some really ugly consequences. This definitely might make politicians take some more decisive action.
In the case that the Czech Republic reaches below 3% GDP goal by 2013, will they then look towards adopting the euro?
With regards to the euro adoption, you’ve got your Maastricht criteria, which is a necessary condition. What we also pay attention to is how our economy is really prepared for euro adoption – how much we can take advantage of the common currency. We of course also focus on how the business cycle in the EU or in the euro area and the Czech Republic differs. The Ministry of Finance and CNB published a joint report of these issues. I think that we won’t have the euro before 2015. I even read that Governor Tuma, in an interview, suggested that the koruna might have 100 years anniversary, which would mean that we wouldn’t have the euro in 2018.
Do you think the business cycle is coming in line with that of the EU?
I do not know much about this issue.
How can the Ministry of Finance help promote export demand, perhaps from Germany and other EU countries?
Our possibilities are quite limited. What the government can do, and what it did do, is to raise the funds that the Czech Export Bank, for example, has available. There are, I think, two specialized institutions; one is Czech Export Bank, and another is some kind of export insurance guarantee agency, which guarantees export loans that banks provide to exporters. The idea is that if you increase resources of these institutions, they might be able to support more export loans. Also if private banks have some guarantees, they are more willing to extend loans to our exporters. But you’ve got to have demand first. I think we have no way to make foreign firms purchase our products.
Is there any way to encourage foreign investment?
We’ve got an FDI subsidy scheme. Basically in the past, this was an important factor behind the strong inflow of FDIs, but these were mainly directed to what I would call assemblies. We just import some components, assemble them here and then export. I think there was a shift in the FDI subsidy scheme towards more high tech investment and R&D investment. Definitely this is a way to encourage this kind of investment. Maybe what would also be useful is to increase expenditures in education in the Czech Republic because you need to have a skilled labor force to attract those kinds of investments.
How about changes concerning the infrastructure of education? Is there optimism to be held in this regard?
As far as education is concerned, this has been recently a big issue in the Czech Republic because of the proposed changes in financing of the Academy of Science, which is an academic institution engaged in research in many fields. Education is chronically underfinanced in my view, so I think we should put more money into education. There is also a pressure to have more people with university degrees, but I am quite personally convinced that everyone is talking about quantity and nobody is interested in the quality of education. Maybe we should prefer that we have fewer people with university degrees, but better educated.
Do you think that, right now, there is enough support for high-tech investment among the population? (Enough potential employees to support this kind of growth)
I’m sure that we have enough highly skilled people, that we are attractive enough for FDIs into R&D and high technology.
How about distinguishing the Czech Republic among other CEE economies? Would potential FDI contributors from the West be able to distinguish between the Czech Republic and Hungary, for example?
As far as FDIs are concerned, I’m quite sure that investors who want to invest in the Central European region distinguish pretty well. Then you have, for example, short-term financial investments, like portfolio investment, etc. In this respect, I don’t think it’s even possible to make those people distinguish between, for example, the Czech Republic and Hungary. You’ve got an investor in Japan or the US, and he might not even know where our country is, and just to tell him that we’re in a better shape than Hungary…though with regards to FDIs I don’t think this is a problem. If you make a decision that you invest in Central Europe, then you come here and have a very close look at individual countries, then you make a decision.
Are there other sectors which are promising engines of long-term growth for the country?
I think that it might be some sectors of industry that make use of the output of R&D, for example. In my view, what is promising is information technology. What is also promising is green technology. Also, what might be good from the long-term view is the so-called nanotechnology.
With regards to industry, will they not move further East within the next ten years as their factories become outdated?
Maybe some companies will move further East, but I think that it won’t be a large-scale issue.
You mentioned green technology. How can the Czech Republic expect to get ahead in this sector when most countries are looking to specialize in this same area?
Definitely it’s hard to compete if you have many competitors. I hope that we are smart enough that we will get some part of that total pie that will be divided between countries, but I really don’t know how we should do that. We might support education and research in this area and hope that there will be some people with good entrepreneurial behavior and business ideas, and they would succeed. But I really don’t know how you would decide some specific measures to promote this kind of activity.
Are there any other policies that you’d like the country to implement to come out of the recession?
The data, or GDP, suggests that we have bottomed out and that some mild recovery might be on the way. To design policies to get us out of the recession, it’s maybe too late to do this. What we can do is have some policies that will promote further growth and that will make the economic growth sustainable in the long-term. In this regard, besides the good shape of public finance, what might be helpful are policies regarding the labor market and that will increase its flexibility.
How can you expect that the government will increase investment if they have to simultaneously cut expenditures?
What the government can do is to make more use of PPP projects. Anyway, I don’t think that any wise enough government would cut investment expenditures that support long-term growth.
Do investment measures fall in the category of the 80% expenditures that are bound by law?
Investments are in those remaining 20%. Those 80% are mainly pensions and social security expenditures. Of course you have wages of employees in the public sector.
When do you expect the Czech Republic will return to its former levels of growth?
Well, the pre-crisis period was an exceptional one. You know, the forecasts expect 3.3% growth in 2012. We might achieve somewhat better results in 2013 and onwards. 2011 is the year when we could have, again, some nice growth performance.
How do you think the country can tackle this issue of long-term vision, in the sense that the interim government’s capabilities are quite limited, and the next government will likely not maintain a long-term perspective by the end of their term…?
This is interesting, but not a question for me. It’s all dependant on the political situation and on the will of politicians to make the changes the country would need. What I personally hope for is that the next government, be it left or right wing, will have a position strong enough to really make the changes it wants to do. Because if you have a weak government, then you propose a change, then it is amended in Parliament, and you basically end up doing nothing. It’s much harder to achieve something if you have a weak position in the Parliament.
Is there anything else that worries you about the economy that we haven’t discussed?
Maybe another problem is that we should deal with is population aging. What we need to do is some reform of our pension system. We currently have a pay as you go system, and of course people might save in pension funds, but they are not obliged to do so. Maybe we should have a pension system with more pillars. Pay as you go system is one pillar, another pillar is obligatory savings, and of course a voluntary pillar. Again, this issue is extremely difficult from the political point of view. The views of politicians differ too much. Maybe they even don’t want to hear arguments of each other, just stick to their own view and don’t listen to the others’ view even of the others might be right. It is important for me because if we don’t do something about the pension system now, then we can have really big problems with public finance in the long-term.
