Bank urges increased regulation

An annual report by the European Bank for Reconstruction and Development (EBRD) finds the Czech Republic in better long-term economic condition than many of its post-communist neighbors, but also urges leaders in Central and Eastern Europe (CEE) to reassert the state's role in the economy.

"This is more about the policy message and recognizing that a strong state sector or a better state is what helps private enterprise thrive," said EBRD Chief Economist Erik Berglof at the launch of the report earlier this month.

The EBRD is a London-based organization credited with aiding many CEE countries in transitioning from command to market economies, but its latest report has raised eyebrows with its call for a greater state role after years of advocating free-market reforms.

"The 'old' growth model is one of internationally integrated, private sector-driven economies supported by market-enabling government institutions," Berglof writes in the report. "It is clear that the transition region's growth model - or at least its implementation - suffered from significant flaws."

"Two decades of transition had taught us the importance of market-supporting institutions, but the weaknesses of financial regulation and supervision and the vulnerabilities of exports to the global crisis surprised us," he continues.

While many economists agree with the report's general conclusions, some find irony in the bank's recommendations as they come after, not before, major economic problems in Hungary, the Baltics and elsewhere.

"In Eastern Europe, [the EBRD] has for a long time advocated reducing the share of government involvement in the economy," said Cinzia Alcidi, an economist with the Brussels-based Centre for European Policy Studies. "Now, it seems to be the opposite recommendation."

But the EBRD defends its conclusions, arguing they are only a minor "evolution" of earlier recommendations and are by no means a call for a return to the large state-owned enterprises of the past. The report reopens the debate on "the role the state can play in institution building," said EBRD spokesman Anthony Williams.

The bank's annual "Transitions" report is a wide-ranging one and analyzes a diverse set of 29 countries, from Poland to Albania and Mongolia. The commonality is that the EBRD invests in all these states - almost exclusively in the private sector - and that most were part of the former Soviet bloc. As of 2007, the Czech Republic voluntarily ceased to be a destination for EBRD investment, the only former Eastern bloc country to do so.

While the Czech Republic does not receive a full examination like other CEE states, the report makes specific observations about the Czech economy in the context of its neighbors, as well as including it in many data sets and periodic recommendations for the region at large.

"Renewed capital inflows in some countries and preoccupation with short-term concerns in others tend to foster complacency about deep reform," the report says.

The primary driver of growth in the Czech Republic in the late 20th century, according to the report, was low labor costs. In 2001, low unit labor cost in the Czech Republic was about 35 percent of what it was in the United States. By 2008, much of that advantage had evaporated, with labor costs in the Czech Republic more than doubling.

The report adds that the biggest complaints from investors in the Czech Republic are about poor infrastructure and also concluded that perceptions of corruption in the country have actually grown steadily worse since 1999.

However, the country fares well in comparison with many in the CEE region. Hungary, for example, is criticized for its citizens holding significant debt in foreign currencies, whereas almost all Czech household debt is in crowns. Furthermore, Czechs save more than anyone in the region and enjoy the lowest loan-to-deposit ratio: 79 percent, nearly half of that in Hungary and more than a third less than in Poland.

The Czech Republic has also seen foreign direct investment rebound to near pre-crisis levels, the report says.

While the report does offer individual analyses of various countries, many of which have widely divergent economic prospects, its general recommendations find the shortage of effective regulatory regimes to be widespread in the CEE and other former communist states including controls on environmental impact, tariffs and public procurements.

"We saw that market failure exists. Moving toward a situation where you have only a market can lead to a deep crisis," Alcidi said.

"For more than 15 years, the main paradigm has been moving toward less and less regulation," she said. "Now, the paradigm is,

'Be careful.' "

Benjamin Cunningham can be reached at
bcunningham@praguepost.com