The decision caused disappointment in the Czech Republic – but it fit the picture. Last week, the Volkswagen Group rejected plans for a new battery factory near Pilsen (Plzeň), Czech Republic.

Despite long negotiations with the Czech government, the Gigafactory for electric car batteries will not be built in the Czech Republic. It is a defeat for the Czech government: the factory was one of the government’s central economic policy projects.

Although the investment decision only affects a single project, it is symptomatic of the state of the Czech economy and its future prospects. After almost two decades of catching up, the economy has barely grown for many years and economists warn that without fundamental changes the economy will lose touch with other European countries.

POLAND

Europe’s true growth star

In fact, the Czech Republic is the real sick man of Europe at the moment. The most impressive evidence: The Czech economy is the only one of the 27 EU economies that has still not fully recovered from the slump caused by the Corona crisis.

While other Central and Eastern European countries such as Hungary, Romania and Slovakia have long since made up for the pandemic losses and are leading economic growth in Europe, the Czech Republic has lost half a decade economically.

Currently, Czech economic output is still one percentage point below the level at the end of 2019, and economists at the International Monetary Fund (IMF) do not expect the gap to close by the end of the year. Experts also expect weak growth for the coming year. “The Czech economy is struggling with a significant period of weakness,” says Tomas Dvorak, senior economist at analysis house Oxford Economics.

The Czech Republic’s economy has been struggling with weak growth for years

The lack of recovery since the pandemic can be explained by a whole host of factors: Czech companies do not produce particularly energy-efficiently and have therefore suffered greatly from the energy crisis following the Russian invasion of Ukraine.

The Czech central bank – the country is not in the euro – raised interest rates very early on, deliberately strangling the economy in order to combat inflation, which is exceptionally high compared to Europe. And unlike in other European countries, including in Central and Eastern Europe, the government was very cautious when it came to Corona and energy aid.

These are all just temporary factors. But you are encountering an economy that has been struggling with weak growth for years. However, the disappointing development of the last few years has only brought it into the focus of many observers.

POLAND

Strange friend

In August, an investigation by the Czech Chamber of Commerce shocked the public with pithy words. The Czech Republic is at risk of falling into the so-called middle-income trap, the business lobbyists warned: The economy is at risk of being squeezed between competition from poorer, low-wage countries and rich, high-tech countries such as neighboring Germany.

“The Czech Republic is at the greatest turning point in its modern history,” says an economic analysis commissioned by the chamber. “It has exhausted all previous growth factors, lost its competitive advantages and fallen into the so-called middle-income trap.”

The warning about the growth trap initially sounds like attention-seeking drama: China, Brazil and Albania are middle-income economies. The Czech Republic, on the other hand, plays in a different league. By global standards, it is a highly developed, wealthy industrial country with a per capita income that is at least 87 percent of the EU average.

“The Czech Republic needs a new economic model”

Economists still believe the warning is justified. “The image is helpful when it comes to diagnosing the long-term problems of the Czech economy,” says Krystof Krulis, a researcher at the Association for International Affairs (AMO) in Prague. He warned in an analysis a few years ago that the Czech Republic could fall into a growth trap. “After all, we are talking about the long-term restructuring of the Czech economy.”

His diagnosis of the Czech economy: Too expensive to compete with cheaper, low-wage countries, but not yet technically sophisticated enough to keep up with high-tech countries like neighboring Germany. “The Czech Republic needs a new economic model,” says Oxford economist Dvorak.

A well-trained workforce with technical expertise and low labor costs have long ensured growth. But at some point this model reaches its limits: as soon as prosperity and wages reach the same level as in Western Europe, an important competitive advantage will disappear. The Czech economy has not yet managed to switch to production with higher added value.

Looking back now shows that the Czech Republic’s growth engines ran out of steam a long time ago. The fortunes of the Czech economy have been decoupled from the development of neighboring economies since 2009: while Germany rushed from record to record economically in the golden decade before the pandemicPoland expanded its economic power, the Czech Republic lost ground in the economic race to catch up.

The result: Prosperity is stagnating and the goal of catching up with the level of prosperity in Western Europe is becoming more distant. Poland, for example, has reduced its gap to the EU’s per capita income by a fifth since 2009. The Czech Republic, on the other hand, only increased by four percent in the same period.

The conclusion of the Chamber of Commerce economists: “If current trends continue, Poland can overtake the Czech Republic in the coming years.” Such a development was unthinkable ten years ago.

BUSINESS MANNERS GRIMM

“The situation is much more unpleasant than previously thought”

It is also a warning to Germany. Because the problems in this country are very similar. The five economists have just warned that German economic growth will hardly be sufficient to maintain prosperity in the future if business and politics do not initiate new structural change and stop supporting industries that have long-term prospects in this countrynot survivableare.

The recipes are the same in Germany as in the Czech Republic: more money in education, research and development. Less bureaucracy. Investments in machines, robots and software to replace missing workers. And more high-quality production that is so internationally superior that high wage and location costs are irrelevant.

However: “That is easier said than done,” says Oxford economist Dvorak. “Something like this is difficult for politicians to control. Even if you know where you want to go, it’s not easy to make it happen, otherwise everyone would do it.”

Nevertheless, he also sees many options for the Czech Republic, such as a well-trained workforce, technological know-how and geopolitical tailwind: more and more companies are relocating production from China closer to their home markets or to friendly countries. A huge opportunity for the Czech Republic and other countries in Central and Eastern Europe.