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Sunday, November 4, 2007

Employment and Unemployment in the Czech Republic

The Czech jobless rate fell to what for the Czech Republic in recent times was the unprecedently low level of 6.2% in September (or around 5% if we use the ILO rather than the Czech MLSA methodology). This was the lowest recorded level for the Czech Republic since the new data series was introduced in January 2004, and was the result of the rapid rate of job creation which has accompanied the third consecutive year of substantial economic growth. But the rapid rate of economic growth and job creation which has been taking place in the Czech Republic is at the same time starting to give rise to fears about ensuing labour shortages and a concern that these may lead to the sort of wage-increase driven inflation we are currently seeing in some other parts of the EU10. Indeed Czech Central Bank Governor Zdenek Tuma recently explicitly warned that a shortage of available labor may fuel wage growth, and that this in turn would fuel inflation.

In an attempt to maintain inflation under some sort of control the central bank has already raised interest rates three times so far this year, and only really decided to leave it's two-week repo rate unchanged at 3.25% at the October meeting because it took the view that the administrative fiscal-tightening measures the Czech government has now started to introduce following the fiscal expansionary measures of 2006 - and which will themselves not be bereft of some inflationary consequences, since they involve raising taxes and untility prices - were likely to have an overall restraining effect on demand such that it would be both unnecessary and undesireable to further tighten monetary policy at this point in time. This, and of course the increased external risk which follows from the financial market turmoil of last August.

Despite this consideration, several members of the monetary policy committe did voice their concerns that while demand side inflationary pressures seemed reasonably benign, labor market tightening may become a major factor in the Czech situation, and the non-inflationary effect of real wage increases that the comittee in fact took was conditional on fairly optimistic assumptions regarding labour productivity growth. All-in-all there was an expectation that inflation maywell be driven up towards the upper end of the 4 percent target range sometime early next year.
"The tension on the labor market is relatively significant....pressures on wage growth can be expected...If inflation is low, relatively significant pressures on the labor market can be expected."
Zdenek Tuma, Governor of the Czech National Bank speaking in Prague last month

Increases in regulated prices have pushed headline inflation closer to the 3 percent target in 2006, but the underlying inflationary pressures have remained subdued. Lingering slack in the labor market and inflows of migrant workers kept wage inflation moderate, which, coupled with strong productivity gains, helped contain labor costs. There are no apparent signs of the second-round effects from increases in energy and other regulated prices, which, together with well anchored expectations, underscores the strong credibility of the Czech National Bank (CNB).
IMF, Executive Board Concludes 2006 Article IV Consultation with the Czech Republic, February 28 2007

Czech GDP growth - which has hovered around the 6% mark - has certainly been strong, but not excessively so, in recent years, and the problems which currently exist in the Czech republic are certainly a far cry from the overheating issues which are arising elsewhere in the EU10, and in particular in the Baltics and Bulgaria.

The Czech economy grew at exactly an annual 6 % rate in Q2/07, with this growth being principally pulled by increases in domestic demand. Household demand is estimated to be likely to grow at around 6% this year, and investment at around 19%, while government demand is only forcast to grow at around a 1% annual rate. According to central bank estimates GDP is currently growing at roughly 1 % above its noninflationary potential, while overall monetary conditions remain broadly neutral. What all this means is that the Czech economy is now moving into tricky territory, with what is known as the output gap - which is really a rule of thumb measure of how fast an economy can grow without producing inflation, since the "gap" in question is a general measure of spare capacity - having turned negative around the end of 2005, as can be seen in the chart below which was prepared by a staff economist at the Czech National Bank. So basically the Czech economy is now dependent on flows of funds, and in particular on FDI (to pay for the current account deficit) and on inward migration of workers to meet all the labour supply needs.

Nominal wage growth has accelerated up towards 8 % mark in recent months while nominal uniit labour costs are now growing at around 3 %. This - if you like - is the "productivity gap". What it means is that real wages are no longer in "anti-inflationary" mode, since the ongoing decline in unemployment (which is now evidently below the level which any reasonable estimate of NAIRU ought to give us) means that supply side pressures emmanating from the real economy have become pro-inflationary.

I have commented separately on the fiscal situation in this note, but it is evident that structural reforms in government spending are essential if Czech finances are to achieve longer term sustainability. Even making full allowance for the impact of the new fiscal reform introduced this year, the government deficit is likely to be around 2.5 % of GDP in 2008, which is a strange posture to find in an economy running a negative output gap, ie in an economy which is already expanding at a rate which on many estimates would seem to be above its real capacity. However, it should be stressed that such measures of capacity are only that, estimates. Given the ease and facility of capital and migrant labour flows in todays global economy, a judicious leveraging of such a position can allow an economy to grow at well beyond what might seem to be the normal capacity rate. But this possibility is conditional on simply this, a judicious leveraging of the available resources.

One part of the current fiscal adjustment measures are, however, only temporary in nature, since further tax cuts are already envisioned for 2009. So without further measures, the government deficit will start to increase again in 2009. The previous government record here does not inspire excessive confidence, since fiscal gains which were achieved in 2005 were then relinquished in 2006, when fiscal policy turned expansionary, with the general government deficit having risen to something like 3.75 percent of GDP, reflecting pre-election tax cuts and increases in social transfers for pensions and health care. A large social spending package in the budget for 2007 is expected to raise mandatory spending in the coming years.

The procyclical fiscal stimulus which was implemented in 2006, at a time when the economy was set to register another year of robust growth, was untimely to say the least. In particular, the decision to increase mandatory social spending in the 2007 budget worsened the longer term fiscal position, and an opportunity was lost to consolidate fiscal gains in what were effectively the good times. The authorities have declared, however, an intention to achieve an annual reduction in the structural deficit by 0.25 percent of GDP per annum in their forthcoming Convergence Program.

Nevertheless, weaknesses have emerged in the process of implementing the medium term budgetary framework. The upward revision of the spending limits in the medium term budget during the 2006 and 2007 budget process and the abandonment of the 2005 Convergence Program targets suggests that the fiscal framework needs to be strengthened to increase fiscal discipline in good times. Given the current environment of political uncertainty, the fiscal framework takes on added importance as a disciplining device.
IMF Selected Issues, February, 2007

Certainly the current rate of growth in the Czech Republic - as elsewhere in the EU10 - is creating jobs and reducing unemployment at an unprecedented rate. In Q3 2007, total employment in the Czech Republic grew by 102,800 year-on-year and reached the highest level of employment achieved at any time over the last ten years, according to data from the Czech Statistics Office released at the end of last week. The number of employees rose by 87.3 thousand, and the number of self-employed by 17.5 thousand. The number of unemployed according to ILO methodology was down by 98.3 thousand year-on-year, the number of long-term unemployed dropped by 62.3 thousand. The general unemployment rate fell by 1.9 percentage points to the lowest level since the end of 1997 (5.2%).

The employment rate (the proportion of first (main) jobholders in the number of persons aged 15-64) reached 66.3% and was 0.9 percentage points up year-on-year. The male employment rate grew by 1.3 percentage points to 75.2%, while the employment rate of women grew by 0.5 points to 57.3%.

The seasonally adjusted average number of employed persons increased by 25.5 thousand (+0.5%) quarter-on-quarter.

The average number of unemployed according to the ILO methodology decreased by 17,900 quarter-on-quarter (seasonally adjusted). The number of unemployed fell to only 266,700 (of which 146.900 were women), and this is the lowest level of unemployed which has been registered since the end of 1997. In comparison with Q3 2006, the total number of unemployed decreased by 98,300 and has dropped by more than a quarter year-on-year (26.9%). Generally, unemployment dropped faster among persons in the young and middle productive age. Unemployment dropped more among the female population (by 53,600), especially in the five-year age group 20-24 (by 13,700). The total number of unemployed men fell by 44,700 year-on-year, most of this in the 20-24 age group (by 14,100). A majority of the unemployed (71.1%) are persons either with secondary education without GCSE (the leaving certificate) or with only basic education.

According to the Labour Force Survey results, the general unemployment rate according to the ILO methodology (derived for the 15-64 age group) reached a ten-year minimum of 5.2% in Q3 2007. Compared to Q3 2006 it decreased by 1.9 percentage points.

The different methodology use in the Labour Force Survey is what gives rise to the difference between the general unemployment rate using ILO criteria and the registered unemployment rate by provided by the Ministry of Labour and Social Affairs of the CR (MLSA CR), but it is important to note that the development trend is the same whichever rate you use. The registered unemployment rate by the MLSA CR reached 6.3% in Q3 2007 and decreased by 1.6 percentage points year-on-year.

The regional unemployment rate ranged from 2.3% in the Hl.m.Praha Region and 3.2% in the Jihočeský region to 7.9% in the Karlovarský Region and 9.0% in the Ústecký Region. The drop of unemployment showed itself in all of the regions of the CR, with the greatest declines being registered in areas with high or above average unemployment rates i.e. in the Moravskolslezský, Karlovarský and Ústecký Regions.

Much lower unemploy­ment rates are being recorded for university graduates (2.1%) and persons having full secondary education with GCSE (3.1%). A high unemployment rate continues to be observed among persons with basic education (18.8%) and an above-the-average unemployment rate (5.6%) is still in the large group of persons with secondary education without GCSE including those with vocational education.

Czech inflation accelerated to the fastest in 13 months in September, closing in on the central bank's target and suggesting interest rates may rise again as early as this month. Consumer prices rose an annual 2.8 percent, up from a 2.4 percent in August, according to the Czech statistics office.

Obviously a number of factors are at work in the way the Czech economy is assimilating this drop in numbers of unemployed without stoking inflation, but could one of the important details which "mark the difference" between the Czech Republic and some of its neighbours could be the fact that the Czech Republic far from losing workers on a net-basis through out-migration, has actually been acting as a magnet which attracts inward migrants in significant numbers.

The number of foreigners legally working in the Czech Republic grew by 38,000 at the end of September 2007 in comparison with December 2006, with the total rising to 223,000, and most of the newcomers arriving from either Slovakia (100,000), Ukraine (57,000) or Poland (22,000), according to statistics issued by the Labour and Social Affairs Ministry. Tens of thousands of non-Czech nationals also work in the country illegally, according to numerous estimates.

Lingering slack in the labor market has helped contain wage inflation. Despite strengthening demand for labor, suggested by rising vacancies, wage pressures have remained subdued, as rising inflows of immigrant workers have helped offset the impact of population aging on labor supply. Recent employment gains have been concentrated in industry and private services, including real estate, and do not yet appear broad-based. Unemployment has fallen, but remains around 7 percent, as continued geographical and skill mismatches have kept structural unemployment high.
IMF Selected Issues, February, 2007

Many Czech companies would be unable to operate without the foreign labour force according to HVB Bank analyst Pavel Sobisek. The share of foreign workers in the total labour force already exceeds four percent. The share of value added created by them is around 3 percent, according to Sobisek, while in some sectors, like construction and retail, the share is much higher.

So while some Czechs have left their country to work elsewhere since the turn of the century, the Czech Republic has been more than able to compensate for this by attracting workers from elsewhere. Obviously all of this is not completely problem free, in that wage pressures are nonetheless building up. But the situation is certainly strikingly better than in many other EU 10 countries. So, is there a lesson here for anyone?