Online Extra: The Two Faces of the Czech Republic

Prosperous Prague is ready for the EU, but in the poor north and east, exposure to real competition will inflict deep pain

If you're looking for evidence that Czechs are joining the European mainstream, look no farther than the sushi bars. Prague -- the capital of a landlocked country where the national dish is pork and dumplings washed down with pints of beer -- has at least 10 sushi restaurants these days. Just a few years back, you couldn't find sushi within 200 miles of Prague.

Take a stroll through Prague's Old Town now, and you might think you're in any European city. Nestled along the cobblestone streets are hundreds of trendy cafes, expensive boutiques selling fashionable clothing and shoes, and travel agencies offering trips to exotic destinations such as Thailand, Switzerland, and Disneyland. While the city has a patina that tells you many of its buildings date from the Middle Ages, the gray and grimy shops of the communist era have now been largely consigned to the scrap heap of history.

Czech-built Skoda cars still dominate the streets, but they're no longer the tinny little rattletraps of yore. Since Volkswagen took over Skoda a decade ago, quality has improved so much that its cars are considered as well built as nearly any European car. In short, Prague has lost much of its otherness.


  But that's not the Czech Republic's only face. Much of the country has seen far less progress in the 13 years since a million Czechs packed Wenceslas Square and shook their key chains -- setting off tremors that quickly toppled Czechoslovakia's Communist Party government. In the coal and steel towns of the country's north and east -- cities such as Ostrava, Karvina, and Usti nad Labem -- the old gray of the 1970s and '80s is far more visible.

The trendy cafes and boutiques seem far away indeed, and the prosperity of Prague's tourist-packed city center has been slow to spread. In parts of these nether regions, unemployment tops 18% -- more than five times the capital's rate.

So which is the real Czech Republic? And is the country ready to join the European Union? The answer is, sort of. From an economic standpoint, the Czech Republic is as prepared as any country in the region. Inflation, forecast at just 2.1% this year, is under control. And despite relatively anemic growth -- expected to come in for 2.2% in 2002 -- industrial output is seen climbing at a respectable 4% this year and 5% in 2003.


  Most of the vestiges of the old communist era have disappeared along with the tinny cars and the gray shops. Thousands of small companies have sprung up to compete with formerly state-owned enterprises, the private sector now accounts for 80% of gross domestic product, and per-capita foreign investment is the highest in central Europe as multinationals such as Philips, Matsushita, Peugeot, and VW build plants in the country.

Even the banks, which continued to finance moribund, state-owned giants throughout the 1990s -- and nearly collapsed under the weight of their bad loans -- have been largely reformed and sold to foreigners. Nonperforming loans today stand at less than 11% of total bank lending, down from 20% two years ago. "In some respects, it looks like the Czech Republic has been a member of the EU for years," says Pavel Sobisek, chief economist at HVB Bank in Prague. "Many companies are owned by partners from the EU. Most foreign trade goes to the EU. And there are no barriers to trade in most sectors."

Still, while much of the economy surges ahead, some sectors have been left behind. The steel mills in the north are among the least productive in Europe. Although foreign outfits are busy building new plants in the western half of the country, near the German border, the Czech Republic still doesn't have a real housing market, so workers have difficulty moving to where the jobs are.


  And businesses in sectors such as food processing and agriculture, where little foreign investment has forced the locals to boost their efficiency, remain at great risk when EU membership introduces far more vigorous competition. "Labor in the Czech Republic is six times cheaper than it is in Western Europe, but the productivity level is sometimes six times lower than in other countries," says Vladimir Jaros, director of corporate finance at the Prague brokerage Wood & Co.

Then there's the problem of political culture. Through the late 1990s, power in Prague was divided between the left-of-center Social Democrats and the right-of-center Civic Democrats. The two parties formed an alliance of convenience -- but not of cooperation. So they weren't able to actually accomplish much, which pushed the economy into a three-year recession starting in 1997. In June, though, Czech voters gave a coalition led by the Social Democrats -- under a new leader, Vladimir Spidla -- a tiny majority.

That has given Czechs new hope that their politicians are finally ready to set aside their petty quibbling and join the broader European political mainstream. "After several years of a funk, I think people are quite happy with the government," says Jiri Pehe, a former adviser to President Vaclav Havel and now director of New York University's center in Prague. "I wouldn't say the Czech Republic is a 100% democracy, but we're on the right path. The main ingredients are here."


  On balance, even though progress is needed in many areas, there's no doubt that the Czech Republic belongs in the EU, and most Czechs want to join. The move will surely expose the Czech economy to winds of change even stronger than those that have buffeted it over the last decade. But ultimately, EU membership should pay off in higher productivity, increased wages, better living standards, and faster economic growth.

And that will mean the prosperity now seen in Prague and the west will spread to the rest of the country, along with the cars, cafes, travel agencies -- and maybe even sushi.

By David Rocks

    Before it's here, it's on the Bloomberg Terminal.