Cablegate: Czech Republic: Skill Gaps in Labor Market

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FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 8250
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS SECTION 01 OF 03 PRAGUE 001414

SIPDIS

SIPDIS

STATE FOR EUR/NCE ERIC FICHTE, EUR/ERA
COMMERCE FOR ITA/MAC/EUR MIKE ROGERS
TREASURY FOR OASIA ANNE ALIKONIS

E.O. 12958: N/A
TAGS: ECON ELAB EINV ECIN SOCI SCUL EZ
SUBJECT: CZECH REPUBLIC: SKILL GAPS IN LABOR MARKET
THREATEN LONG-TERM COMPETITIVENESS AND FDI

REF: A. PRAGUE 607
B. PRAGUE 1239
C. PRAGUE 1173

1. Summary: The Czech Republic has been the darling of
foreign investors in Central Europe, and as a result FDI is
the number one engine of GDP growth. Foreign investors have
taken advantage of the low-cost, highly skilled workforce and
duty-free access to the EU to build mostly assembly plants,
warehouses, and factories. With Romania and Bulgaria set to
join the EU January 1, 2007, there are concerns regarding the
sustainability of high-levels of FDI in the medium to
long-term. The government investment promotion agency
CzechInvest in 2003 started to refocus investment incentives
to lure software and technology service companies, high
value-added investments, and businesses that are less likely
to move east in search of lower labor costs. However, labor
shortages in qualified engineers and managers have prevented
large-scale investment in these sectors thus far. This skills
gap threatens to persist and reflects serious structural
issues in education (post will report on Czech education
reform via septel). Reforms needed to fulfill the goals of
the Lisbon Agenda and to transform the country into a mature,
services-driven market economy have only been further
postponed by the current political stalemate (reftel A). End
Summary.

2. The Czech Republic,s economy has been booming in recent
years, thanks in large part to foreign direct investment
(FDI) (reftel B). Beginning in 2003 with the run-up to EU
accession, Czech GDP growth has been steadily climbing.
According to the Czech National Bank, the economy grew by
3.2% in 2003, 4.4% in 2004, and a whopping 6.0% in 2005.
Analysts are estimating GDP growth of 6.0% for 2006. FDI shot
up to a record USD 11 billion in 2005, from USD 4.9 billion
in 2004 and USD 2.1 billion in 2003, making it the largest
recipient of FDI in Central Europe and 20th largest in the
world. Former Deputy Vice Prime Minister for Economic Affairs
Radek Spicar notes that foreign companies were initially
attracted to the Czech Republic because of its macro and
micro-economic stability, along with its relatively cheap,
well-educated labor force and favorable location. This,
combined with a strong infrastructure, has led to rapid
development of assembly plants of various sorts, from cars to
laptop computers to plasma TVs, largely for export to Western
Europe.

Troubles Ahead: Will FDI Continue at Current Levels?
-----------------

3. Despite being one of the fastest growing economies in
Europe, there are legitimate concerns about medium to
long-term sustainability of FDI and, in turn, GDP growth in
the Czech Republic. Director of Investment Rene Samek from
the investment and business development agency CzechInvest is
worried about future growth, and with good reason. A recently
released (October 2006) Ernst & Young European Investment
Monitor Report shows a downward trend in the overall number
of investment projects in the Czech Republic and other
Central European countries, down from 19.8% in H1 2005 to
12.8% in H1 2006. Manufacturing projects are moving east, and
Sofia is now the fifth most popular destination for projects
across Europe. In a country where, according to the Ministry
of Industry and Trade Survey of the Czech Economy 2005, 73%
of all exports were machinery and transportation goods, the
loss of investment projects is a troubling sign that Czech
competitive advantage in wages and location may be eroding.
Czech wages are still much lower than in the west (3.42
Euros/hour in the CR versus 16.18 Euros/hour in Germany), but
are growing quickly: the 12.6% growth in wages since 2005 is
the fastest rate in the EU.

4. Since 2003, CzechInvest has refocused its investment
incentives to try to attract software and service-sector
investments, investments that have staying power. For
investing as little as CZK 15 million (USD 750,000) and
creating as few as 15 new jobs over a three-year period,
companies can earn corporate tax relief for up to 10 years,
financial support up to USD 8,900 per employee, and
reimbursement up to 35% of employee training and retraining
costs, according to CzechInvest. This policy has generated
some success, winning business deals from the likes of
Honeywell, IBM, and Accenture to build research and
development and service support centers, but is exposing some
weaknesses (i.e., low number of available skilled labor) of
the Czech labor force to compete in an information economy.

PRAGUE 00001414 002 OF 003

Samek said that if a company requested 500 R&D engineers, he
would recommend India.

5. Samek says that the skills gap is forcing some companies
to search for engineers from outside the country and work
with universities directly. Companies such as Honeywell are
actively recruiting engineers and other IT workers from
Russia and Ukraine. This is supported by the Ministry of
Labor and Social Affairs, which in 2004 launched a directed
migration program that puts work visas and residence permits
on a fast track for people with targeted skills. IBM has a
program with the Czech Technical University in Prague to
train faculty and students, offer internships linked to
studies and IBM projects, and fund and provide technical
expertise for thesis work. This gives IBM the advantage of
recruiting and hiring engineers before they finish their
studies.

6. The government has proposed new legislation that is
currently in Parliament, which will change tax incentives for
major investments in the manufacturing sector. Beginning in
2007, manufacturers would qualify for tax breaks for
machinery and technical investments that require highly
qualified technicians to operate rather than assemblers. If
approved, the proposed law would amend the landmark
investment incentive legislation first passed in 2000, which
has helped bring the bulk of foreign investment to the Czech
Republic.

Transforming the Workforce: Need for Education Reform
------------------

7. There is broad consensus that Czech long-term
competitiveness will hinge on human resources rather than on
wage or location advantages. To ensure continued economic
growth, the Czechs must be better skilled in the sciences and
in foreign languages, but there are institutional problems in
education that prevent this from happening. The Czech
Republic,s Lisbon Agenda National Reform Program points out
that secondary schools face a shortage of qualified teachers,
computers, and counseling services, and universities still
need to reform their curriculum to offer shorter, more
practically-oriented degree programs. Despite a soaring
economy, the amount of public funding devoted to education is
relatively low. Education spending in the 2007 proposed
budget amounts to 3.04%/GDP, down from 3.4%/GDP in 2006 and
up from 2.46%/GDP in 2005. Czech educational expenditures are
among the lowest in the EU, whose average is 4.9%/GDP.

8. The budgetary pinch has kept secondary teacher salaries
low and is having a big effect on recruitment, retention and
quality of teachers. According to a recent article in the
daily newspaper Pravo, Czech monthly salaries for all
secondary teachers are CZK 18,771 (USD 850), and for foreign
language teachers, CZK 16,000 (USD 720). These pay scales
represent an increase of 6.6% over 2005, but still fall short
of the national average salary of CZK 20,096 (USD 915).
Figures from the Czech Statistical Office support this. In a
pay survey covering 17 different professional fields,
educators came third from last, with only forestry workers
(hunters) and hotel and restaurant workers earning less.
Teachers are demanding a 25% pay increase, but the Education
Ministry has refused to consider it because of the
government,s current budget problems (reftel C).

9. Lower salaries have created staffing gaps at schools,
especially in foreign languages. According to an article in
the business daily Hospodarske Noviny, there are five times
more English philology students at the pedagogical faculty
than there were 10 years ago. But only a few will choose
teaching as a career when they can earn twice as much in the
private sector with their language skills alone. Schools are
lowering standards as a result of the shortage of teachers.
According to one report, only 29% of foreign language
teachers have a teaching credential.

10. Insufficient spending on education is delaying the
country,s transition to an &information economy.8 In 2002,
the Ministry of Education launched its Internet for Schools
program that aimed to provide all state schools with
computers and a connection to the Internet. This program
helped reduce the gap from 1 computer per 50 pupils to 1
computer per 14 pupils. However, according to a survey on the
use of Internet communication technology by households and
individuals in 2006, half of the Czech population has never
used a computer. Former Vice Prime Minister for Economic

PRAGUE 00001414 003 OF 003

Affairs Jiri Havel explains that the digital divide is a
socio-economic divide between wealthier families with
computers and Internet at home, and those who must rely on
the public schools for computer training.

11. Perhaps because of their lack of exposure to computers
and technology, Czech students have relatively little
interest in pursuing studies and jobs in the computer or
engineering fields. Ministry of Education Department of
European Integration Head Michal Kadera reports that the
acceptance rate for Czech Technical University in Prague
(CVUT) is 85%, whereas it is 43% for humanities-oriented
Charles University. Overall, Kadera says that two-thirds of
all Czech students are studying humanity-related subjects,
such as languages, economics, and law, though the jobs are
elsewhere. Today, Czech technical universities graduate 5,000
engineers a year, which is 55% of the EU-25 average.
According to the Czech Labor Office, more than 9,000
technical and IT jobs are going unfilled.

12. The Czech Republic has one of the lowest percentages of
university educated adults in the EU because of a high
student drop-out rate. Only 11% of the population has a
university degree, in comparison to 19% in the EU. Recent
statistics from the Ministry of Education show a 50% jump in
the student population from 2000 to 2005, but almost 30% will
withdraw before graduation. Spicar notes that even though
many universities have introduced shorter three-year bachelor
programs, most Czech university students prefer masters
degrees. Kadera also says that among public universities
master-degree programs dominate and lack any practical
orientation. Kadera again believes that a revamped curriculum
with shorter and more practically-oriented programs along
with career counseling is the solution.

13. Comment: The Czechs lag significantly behind the EU in
several important areas and need many structural reforms in
education to catch up. The percentage of the population with
university degrees is 60% of the EU average, and the
percentage of graduates with technical or science degrees is
55% of the EU average. No matter who forms the next
government, education reform needs to be addressed for the
long-term sustainability of a small, FDI-dependent open
economy like the Czech Republic. End Comment
GRABER

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