MONETARY POLICY REPORT | AUTUMN 2023 (box 1)
(authors: Anna Drahozalová, Kamil Galuščák, Martin Kábrt)
The weak performance of German industry and the deteriorating growth outlooks for the largest European economy are an important signal for the Czech Republic. This is not just because Germany is the most important destination for Czech exports, but also due to other specifics in mutual economic relations. This box uses firm-level and macro data[1] to disentangle the Czech Republic’s foreign trade relations and shows not only Germany’s importance to our economy, but also the specific nature of Czech exports in general.
Czech goods exports are dominated by intermediate products such as metal products and machinery parts. By contrast, the share of goods for final consumption (15%) is one of the lowest in the EU. The upshot of this export structure is that Czech exports react faster (i.e. earlier) and more strongly to changes in global demand. While Czech exports of final goods depend on domestic demand in each destination country and move relatively independently across export territories (see Chart 1),[2] Czech exports of intermediate products to different destinations are more synchronised (see Chart 2). This is because demand for intermediate products reacts in advance to expected changes in global demand, as it very quickly reflects the sentiment and order books of final producers.[3] The current cooling of the global economy has thus been visible in exports of intermediate products already since the spring. Czech exports to Germany include a particularly high share of intermediate products, making them all the more sensitive to expected global economic developments.
Chart 1 – Czech exports of consumer goods differ markedly by destination country
Czech exports of consumer goods by destination country; y-o-y changes in %
Chart 2 – Czech exports of intermediate products are fairly synchronised across destinations
Czech exports of intermediate products by destination country; y-o-y changes in %
A related feature of Czech exports is a high share of specific intermediate products intended for, and useful to, specific customers only (see Chart 3),[4] such as automotive parts, computer processors and medicaments. Exporting such products does not give exporters much room to change their geographical focus or seek new opportunities when existing customers reduce their orders. This orientation towards specific products makes exporters more vulnerable and sensitive to macroeconomic developments. The firm-level data of Czech exporters allow us to determine the proportion of specific intermediate products for which there are no alternative export destinations. In the case of Czech exports to Germany, 15% of the total value of Czech firms’ specific intermediate products are products that are exported nowhere else. Higher shares are observed only for exports to Slovakia and the UK.
Chart 3 – Czech exports are characterised by a high share of products intended for specific customers only
share of generic and specific intermediate products in total exports of those intermediate products from EU countries in 2022; Eurostat; CNB calculations
The key role of established business relations is confirmed by the breakdown of export growth into intensive and extensive margins. This shows how much exports rise thanks to established business relations and how much thanks to new opportunities – due either to new firms becoming involved or to existing firms exporting new products or finding new markets for their goods. Established business relations have long been predominant in Czech exports. Exports therefore rise and fall due to rising and falling orders placed with the same exporters and to rising and falling demand for the same products and from the same countries (see Chart 4).[5]
Chart 4 – Established business relations largely determine the dynamics of Czech exports
annual growth rate of Czech exports and net contributions; CZSO firm-level data from residents on movements of goods; CNB calculations
Note: Weighted averages of year-on-year changes in exports at firm level, at product level under the six-digit classification of goods codes (Harmonized System) and at destination country level. Average exports in both periods are in the denominator.
Exports to Germany are extreme from this point of view as well. Unlike other destinations, only a negligible proportion of changes in exports to Germany stem from new products or new Czech exporters entering this market. More than 60% of all Czech exporters supply the German market, and over one-sixth of them supply no other market. From this perspective, the German market may be largely saturated with Czech products, so it may be difficult for other Czech exporters to find new opportunities there. Existing exporters are unable to make up for a decline in orders by switching to new customers. This again indicates the high sensitivity of Czech exports to the condition of the German economy.
What lies behind these unusually strong trade links between Czech and German firms? The size and geographical proximity of the German economy no doubt plays a key role. The close ownership links between Czech and German firms are also important. Foreign-owned companies account for almost 75% of Czech exports, with Germany being by far the largest direct investor in the Czech Republic.[6]
Although Germany plays a crucial role in Czech exports, two factors dampen the impact on the Czech economy. The first is that sectors with a lower share of domestic value added account for an above-average share of Czech exports to Germany. In manufacturing, for example, the share of domestic value added in exports is just 54% according to OECD estimates. This sector’s share in exports to Germany is meanwhile 4 pp higher than its share in total exports. Conversely, Germany’s share in services exports, where the Czech Republic adds over 80% of the value, is below average. The second dampening factor is the above-mentioned large-scale foreign ownership of Czech exporters. When exporters thrive, part of their profits leave the Czech economy via dividends. By contrast, when exports are sluggish, the outflow is less pronounced.
Overall, the dependence of Czech exports on demand from Germany is even stronger than would be consistent with the role of our Western neighbour as the largest customer of domestic firms. The high share of intermediate products in Czech exports further increases the sensitivity of the latter to global sentiment. Moreover, the importance of established business relations and the saturation of the German market with Czech products limit the room for finding new opportunities when existing customers reduce their orders. However, the ultimate impact of this asymmetric export orientation towards Germany on the Czech economy is partly cushioned by the below-average share of home value added in exports to Germany compared with exports to other countries and by the extensive foreign ownership of Czech exporters.
[1] The series International trade in goods and Cross-border movements of goods (CZSO), and International trade (Eurostat).
[2] The charts show the Czech Republic’s largest export destination countries.
[3] See the October 2023 cnBlog article Německo – opět nemocný muž Evropy? (Germany – the sick man of Europe again? available in Czech only).
[4] The distinction between generic and specific intermediate products is based on the BEC (Broad Economic Categories) product classification, Rev. 5.
[5] See Margins of trade: Czech firms before, during and after the crisis, Kamil Galuščák and Ivan Sutóris: CNB WP 12/2016. France is in a similar situation, with established business relations making the biggest contribution in the French firm-level data, although their role is not as important as in the Czech Republic (see From macro to micro: Large exporters coping with common shocks, Jean-Charles Bricongne, Juan Carluccio, Lionel Fontagné, Guillaume Gaulier and Sebastian Stumpner, Banque de France WP 881, July 2022).
[6] See the thematic article Disentangling financial globalisation: Who are the ultimate owners of foreign investment in the Czech Republic? in the June 2021 Balance of Payments Report.