The Czech economy was hit through the external trade channel during the recent crisis, but it had no significant domestic imbalances, so macroeconomic policies had room for supporting activity and the recession was relatively short. Nevertheless, the recovery is less dynamic than in other economies in the region and further risks are arising from the international slowdown and sovereign debt crises. The government should therefore continue a broad based reform programme to enhance economic growth and make it more robust to economic shocks. It should build on past recommendations to improve the business environment, strengthen the education system, promote innovation and increase labour market flexibility. This Survey focuses on challenges in the following areas..

The Czech Republic is the most successful central and eastern European economy, measured in GDP per capita in Purchasing Power Parities and Prague is among the richest capitals in Europe. However, the country is still far behind where it was relative to the region1 in earlier times and convergence with the top OECD countries has stalled recently (Figure 1). Available estimates of potential growth rates suggest a rather sluggish medium-term real convergence of about 1 percentage point per year, down from about 1½ percentage points before the crisis. This deceleration is attributable to the slowing of trend labour productivity growth in the Czech Republic while there is acceleration in the OECD. The growth bonus linked to the post-communist transition, external opening and EU accession has been largely used up, the population is ageing fast, and increasing international energy and raw material prices will pose a further burden on growth. The economy is already well integrated in regional supply chains, the capital stock seems to be on a par with other EU countries and the FDI stock is above the EU average. Consequently, the share of Czech exports in the EU manufacturing good markets may have effectively peaked (IMF, 2011). Further convergence is therefore dependent on the transition to a more innovative, skill-based and more energy efficient economy producing higher value added goods and services.

The Czech fiscal position is generally sound and policy making is prudent. However, the fiscal framework was not strong enough to contain spending in the upturn and it would benefit from independent budget oversight. An anchor for the fiscal policy would be helpful, in the form of an explicit debt target coupled with corresponding spending ceilings and deficit targets. The ongoing fiscal consolidation, spending pressures and an already relatively high average tax burden necessitate public sector efficiency improvements. There is scope for improvement in the management of government spending, mainly by enhancing transparency, introducing performance-oriented budget indicators at both central and local levels, improving the management of state-owned enterprises and developing the procurement practices of the public sector. Legislated increases in the retirement age will improve pension system sustainability. A new defined contribution tier is being introduced which should help to diversify future retirement income. At the same time, there is uncertainty about the number of participants who will decide to divert their contribution to the new tier and hence about the implications for revenues in the existing defined benefit pension tier. Also, attention should be taken regarding administrative costs of the new tier, since these can have a significant impact on future replacement rates and therefore public support for it. With more emphasis on private savings, the financial literacy of the population also needs to be stepped up. In healthcare the authorities plan to continue improving the multi-insurer model through incremental reforms such as limiting pharmaceutical costs and improving provider-payment system. The potential for efficiency improvement in healthcare network planning and better care management should be explored, while ensuring that insurers and health providers are given the correct incentives.

A carbon-intensive energy system in the Czech Republic contributes to one of the highest ratios of greenhouse gas (GHG) emissions in the OECD. While EU emission reduction commitments provide the most visible and binding motivation for changing the way in which the country produces and uses energy, action is also required to improve energy security and public health and to avoid an adverse impact of emission reduction on economic growth and living standards. Energy system transformation requires ensuring a comprehensive, consistent and stable policy framework with stronger ex ante and ex post evaluation. A single carbon price should be achieved through the Emission Trading System (ETS) and carbon taxation. Excise tax rates on all fossil energy sources and products should be realigned, based on their carbon content and other environmental externalities, notably by increasing the relative taxation of diesel. The authorities should support implementation of carbon taxation at the EU level. Sectoral policies that complement carbon pricing in promoting greener energy sources, energy efficiency and less fuelintensive transport need to be strengthened. The most important measures include rebalancing support for renewable energy, streamlining energy efficiency support programmes, upgrading the transport infrastructure, increasing the attractiveness of public transport and stimulating the renewal of the road fleet.