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Thursday, April 24, 2008

OECD Warn The Czech Republic on the Economic Impact of Ageing

The Czech Republic must cut public spending, boost the retirement age and raise health-care co-payments to preserve economic growth, the Organization for Economic Cooperation and Development said in its most recent country survey out today.

The Czech Republic needs to be more ambitious in setting deficit targets while economic growth is at its current high levels, the OECD said in its 2008 country survey. It advised the Cabinet to support health-care and pension overhauls as the country's ageing population may start straining state resources as early as 2012.

The Civic Democrat-led three-party coalition this year introduced a flat income tax and medical fees and limited some social transfers to keep the public-spending shortfall below the European Union's threshold of 3 percent of gross domestic product. It also has plans to revamp the health-care and retirement system, though these may be jeopardized by the coalition's thin majority in Parliament, the OECD warned.

``To maintain these high growth rates, further reforms are necessary,'' OECD Secretary General Angel Gurria said today at a Prague press conference. ``If policy is not changed, spending will increase considerably'' amid a ``rapid pace of aging.''

The OECD urged Czech authorities to consider a ``full liberalization'' of rents, take steps to dscourage early retirements and reduce the length of parental leave to boost workforce supply (really I am not in agreement at all with this latter point, but I will need to find time for a longer post to explain why). It reiterated that tuition for university students is necessary to extend the number of people with higher education.

``Most important is a need to ensure fiscal sustainability through public-finance reform to put the economy in a better shape to cope with population aging,'' the OECD said. ``The current government made a positive start'' with ``a fiscal package that includes wide-ranging tax and spending reforms, many of which are aimed as first steps in more ambitious reform.''

``The recent global financial turmoil has so far not affected the economy, although weaker growth elsewhere may have some impact,'' it said. ``There is little sign of overheating so far; underlying inflation has remained moderate.''

The government earlier this month approved the outlines of an overhaul of the health-care system that includes allowing health insurers to make a profit. The Health Ministry's plan to sell all but one state-financed health insurer is opposed by two smaller coalition parties, however.

``The impact of the second phase of reform could be significant in strengthening competition on the quality and cost of services,'' the OECD said. ``Putting legislation through parliament is an uphill struggle because the coalition itself has a thin majority'' and ``as a result, many of these further reforms are uncertain.''

Concerning a change of the current pay-as-you-go pension system, the OECD recommends that ``mandatory'' transfer of social security payments to private pension funds be adopted rather than implementing the current proposal that would employees to choose between the two systems.

``Providing a permanent choice risks additional public expense because net contributors are likely to switch while net beneficiaries will stay with the full PAYG pension,'' the organization said.

The Czech Republic has dropped the 2010 entry date as a target for euro-adoption and has not set a new date. The government's strategy is to carry out long-term structural changes and allow the economy to close the distance with the richer euro-sharing nations to try and avoid an outcome whereby letting go of the possibility of an appreciating koruna doesn't trigger additional price growth (a problem that may arise in neighbouring Slovakia if the current entry bid is accepted). This government concern is shared by the OECD.

``A consequence of entering the euro area is that, with the loss of the exchange-rate channel, inflation has to do all the work in nominal convergence,'' the OECD said. However, ``delaying entry implies accumulating opportunity costs because it postpones the gains from adopting the euro.''

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