Croatia and Czech Republic, Why is Czech Republic So Advanced?

What did the Czech Republic do, that Croatia didn't?

As Ekonomski Lab writes on the 5th of June, 2018, Daniel Hinšt compares the development of Croatia and the Czech Republic over the past four centuries and identifies several key differences explaining the different development paths between the two countries: commitment to economic freedoms, early privatisation, the opening up and internationalisation in the Czech Republic that occurred long before entering the European Union back in 2004, the labour market, and numerous historical and cultural factors explain why the Czech Republic is so far ahead when compared to Croatia.

The Czech Republic has the lowest unemployment rate in the European Union - the Czech Republic in its entirely stands at 2.2%, while the capital of Prague stands at 1.7%. Such unemployment rates are below the so-called ''natural'' level. Just how did the Czech Republic achieve this enviable result, and why did it move so far ahead than Croatia did after the fall of the Berlin Wall?

A look into culture and geopolitics:

The latest Eurostat data has shown that the Czech-German belt is the absolute best in the EU with regard to unemployment. Prague is the city with the lowest unemployment rate of 1.7%, but unemployment in the wider area of ​​the cross-border belt between Bavaria and Bohemia (western part of the Czech Republic), is also low. Regardless of the administrative boundaries that exist, it has always been the contact space of two of essentially similar cultures with the highest concentration of industry since as far back as Austro-Hungarian times.

The Germans once called today's Czech Republic Sudetenland, and they represented a significant part of the population, as did Jews, which is very important for a deeper understanding of the prosperity of this area. Such a combination of somewhat different, and indeed mutually complementary cultures, was an important link to the productive development of the Czech Republic as a whole. After the end of the Second World War, the demographic and national structure naturally changed. Imposing totalitarianism brought about repression over an otherwise classically libertarian nation, but, despite this, its cultural legacy has been largely preserved.

In the book "The main causes of economic backwardness of the Slavic peoples", written by Mijo Mirkovic in the 1920s, the Czech people were placed into a group of Slavic peoples with what was referred to as a partial legacy of reformation. Namely, the Czech national hero Jan Hus was the initiator of the Reformation more than 100 years before the much more well-known Martin Luther was.

When Czechoslovakia became independent after the First World War (Washington Declaration, 1918), the sociologist and philosopher Tomas Masaryk was the leader with outstanding liberal ideas in then European and international levels.

Unlike the somewhat ailing Yugoslavia, liberal-democratic Czechoslovakia refused to close itself to the bonds of authoritarianism after acquiring independence, but was among the key creators of the transatlantic alliance and the most productive world economy. Czechoslovakia decided to become better than the former Austro-Hungarian Empire, while Yugoslavia, between the two wars, had been culturally and economically sinking deeper and deeper into its own mess and general disorder. It's important to note that in Czechoslovakia, both great totalitarianism movements of the 20th century were imposed externally, from outside forces, while in Yugoslavia, the totalitarian ideas and political systems were both internal and external, meaning they were, at least partly, independent of external influences.

Such a historical and geopolitical choice was sufficient enough of a sign that after the collapse of communism, Czechoslovakia would take a very different path than Yugoslavia. While communism in the Czech Republic was more ''full on'' than it was in Yugoslavia, Czechoslovakia, the very soon to be Czech Republic, took advantage of the great political, economic and social opportunities of opening up to the transatlantic world, following the fall of the Berlin Wall.

The process of comprehensive liberalisation was possible owing to the general character of the Czech people, whereas in stark contrast, the capacity for the same on the territory of Croatia (and especially all of the former Yugoslavia) was extremely limited, to say the least. This is exactly where numerous answers to what often seem to be eternal questions lie.

The Economic Freedom Index (according to the Heritage Foundation, 2018) says the Czech Republic stands at 74%, making the Czech Republic 24th in the world (Croatia ranked 92nd, with 61%).

The main advantages are a high level of protection of property rights, a flat tax of 15% (a higher rate of 22% applies only to very high incomes above 1.3 million koruna) while in Croatia, the rate(s) is 24% and 36%, the ratio of public debt to GDP is 37.7% (in Croatia it was 78% at the end of 2017). In the Czech Republic, business start-ups are catered to and are facilitated more easily, and there is a largely open market with a high investment level and financial freedom.

Workers' freedom in the Czech Republic is at 77%, and public spending in GDP of 41% could be slightly reduced, although it is now much smaller than in Croatia where it's about 46%.

Since the 1990s, the Czech Republic has maintained relatively high ambitions in terms of economic freedom, and its excellent starting position thanks to the liberalisation reforms after the fall of the Berlin Wall allowed for relatively few changes.

The difference between the Czech Republic and Croatia had been constructed since then, and Croatia has, in the meantime, only made slight positive moves in the fields of monetary and banking stability, fiscal consolidation, business freedom and integration with the EU market.

The biggest difference between the Czech Republic and Croatia lies in the (lack of) flexibility when it comes to labour legislation.

The high level of economic freedom doesn't prevent the Czech Republic from being called a social-market economy. The social market economy is Czech realism, despite the high level of economic freedom, because every developed market economy, like that of the Czech Republic has a number of social elements, and almost none of them fall into the category of the so-called laissez faire, conceived by ideologists as a free and unregulated market that actually doesn't exist anywhere in a radical form.

In the Czech Republic, there is generally less waiting for the registration of ownership, there are smaller numbers, dynamics and losses of time when paying tax, there is a relatively quicker bankruptcy procedure whereby a much larger part of the residual value is paid and there is no obligation to fund the founding of a d.o.o. On the other hand, the Czech Republic has more procedures and a longer wait for building permits and a somewhat longer implementation period than Croatia. There are no significant differences in other similar areas.

According to the OECD Product Market Regulation (PMR) methodology, between 1998-2003, the Czech Republic carried out a 47% market deregulation (a decline in total restriction from 2.65 to 1.41 points, or 15% below the EU average), while Croatia, in 2013, with almost 2.08 points in terms of market regulation restriction was about 30% above the EU average.

In the area of ​​professional services (accountants, auditors, architects, engineers and attorneys, etc) the Czech restriction ''score'' in 2013 was 2.4, and in Croatia it was a much higher 3.7. Therefore, one mutual Czech and Croatian challenge remains the stronger deregulation of professions (which is characteristic of the whole of Central Europe), as there is a general lack of opportunity in this area to achieve greater productivity.

The result is that the Czech Republic currently achieves real per capita income of 88% of the EU average, while Croatia stands at about 60% in regard to the same question. The European Commission's report for the Czech Republic (2018) foresees a mild slowdown in GDP growth to 3% in 2018-2019. However, the main factor of growth in income and productivity was direct foreign investment (FDI) that contributed to the transfer of technology, knowledge and skills.

The attractiveness of foreign investment was initially motivated by lower wages in industry when compared to the average in Western Europe, and the favourable circumstances was a good correlation with the most developed European markets (primarily with Germany, which generates about a third of exports, mostly generated through FDI). Aside from direct sales to strategic partners (the most famous example is VW-Škoda, there are many more, mainly with companies from Germany, the Netherlands and the USA. The private sector has therefore remained absolutely dominant in the enterprise sector in the Czech Republic for more than two decades now.

Additionally, the Czech Republic's employment rate reached an impressive 78.9% in the third quarter of 2017. Contribution to this result was also stimulated by self-employment due to lower tax burdens and reduced contribution fees/rates. Strong export orientation (internationalisation of the economy) contributes more than significantly to foreign companies - accounting for 13% of all businesses, creating over 25% of jobs, 42% of added value, 64% of R&D investment, and over 80% of exports.

However, it should be taken into account that in spite of this, the role of foreign-invested and internationalised economic growth in the Czech Republic was relatively low, only by doing things in such a way could the high level of employment and competitiveness of the industry be properly sustained, which was largely the result of a good incentive-based investment system.

The Czech Republic has also developed a system of retraining or recognition of non-formal education and developed vocational education which manages to justify the regulation of professions. There is also a large amount of foreign labour. Since communist times in the Czech Republic, there has been a large Vietnamese community that has recently increased and partially complements the shortcomings of the domestic labour market's offerings.

The poverty rate in the Czech Republic is the second lowest among the OECD countries (immediately after Denmark), which is related to having an income close to the EU average and excellent employment statistics. The message is clear: excellent social results are possible only in the capitalist framework of growing economies, and everything else, as Hayek once said, the path to slavery (both intellectually and practically).

Given all of the above, it isn't really a surprise that the Czech Republic became the first post-communist country to have a stable enough investment climate to be rewarded with an investment-worthy credit rating. The Czech Republic today boasts an AA rating. It's also worth recalling that Croatia had already earned its first investment rating back in 1997. Then, Croatia was not far from the Czech Republic in regard to this factor, but Croatia's investment rating stagnated for a very long time, only to be reduced later, when Croatia fell to the status of so-called ''garbage'' as recently as 2012.

Thus, joining the European Union back in 2004 only expanded the massive scope of the opportunity in and for the Czech Republic, the basis of which was set much, much earlier on.

By this comparison, there should be a few words to say about tourism in both nations. Revenues from foreign tourists account for about 20% of Croatia's GDP, while this ratio stands at less than 5% in the Czech Republic, mainly thanks to the beautiful capital of Prague, which is successfully attracting visitors from all over the world.

Maybe the Czechs have advanced much too far to be able to compare Croatia with their country, indeed, and both Romania and Poland act as a far more realistic framework for comparison by modern standards.

Cultural and geopolitical factors have played a significant role in Czech history and have been the basis for the understanding of the long-term, visible developmental achievements we can sit and admire. Even if we only look at the modern history of economic development after the fall of the Berlin Wall, the Czech Republic opened up for foreign investments with gusto, while here in Croatia, many are still very skeptical of such models of development.

The Czech Republic is deeply concerned with education, especially lifelong education, a concept far ahead of Croatia - where about 2.3% of the adult population is in some form of education, while in the Czech Republic this figure stands at about 10%. By this, the Czech Republic is much closer in its ''behaviour'' to Scandinavia than it is to South-eastern Europe. The facts are really stubborn things, as John Adams and Ronald Reagan once said.


Click here for the original article by Daniel Hinst for Ekonomski Lab

*Daniel Hinst is a political scientist, a specialist in European studies, and conducts the Centre for Public Policy and Economic Analysis and writes in his own name