Economic Trends - No. 54
CONTENTS
Czech Economy: Recent Macroeconomic Development 1
Milton Friedman: A Theory of the Consumption Function 7
FDI in the New EU Member States: Recent Trends 10
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Released for printing on October 19, 2007
Economic Trends reflect the view of the Chief Economist Team of Komerní
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Economic Trends 2
In the first half of 2007, the GDP
increased by 6.2 %, y/y. The domestic
demand kept the leading role, with only
marginal impact of external trade.
The Czech GDP growth continued to
be roughly double than the growth in
EU 27 (reported at 2.8 %, y/y) and the
outpace is even higher in comparison
with the eurozone (2.5 %, y/y). The
catching-up process to developed
market economies thus continues.
The shortage of skilled labour creates
pressure on wages: in the second
quarter of 2007, growth of real wages
in manufacturing (8.4 %, y/y) surpassed
the growth of productivity (7.0 %, y/y).
If this process should continue, it would
undercut the competitiveness of the
Czech manufacturing exports.
CZECH ECONOMY: RECENT MACROECONOMIC
DEVELOPMENT
Kamil Janáek, Eva Zamrazilová
1. ECONOMIC GROWTH
In the first half of 2007, the GDP increased
by 6.2 %, y/y, with growth slightly slowing
down in Q2, to 6.0 %, y/y, down from 6.4 %,
y/y, in Q1. As expected, the domestic demand
kept the leading role, with only marginal
impact of external trade. In Q2 2007,
consumer demand rose by 6.5 %, y/y, which
means a slight slowdown in comparison with
7.2 % in Q1, nevertheless still it represents the
second highest value in previous three years.
On the other hand, government expenditures
declined by 1.6 %, y/y. Fixed capital
investments increased by 4.2 %, y/y. This was
a notable deceleration in comparison with
the growth of 7.6 %, y/y, in 2006. In the area of
domestic demand, consumer and investment
demand were in a reasonable balance.
Exports of goods and services rose by 13.8 %,
imports by 13.9 %, y/y. Foreign trade thus
ceased to be the driver of GDP growth, but
due to statistical reasons: improving terms of
trade have perverse effect on national
accounts data on foreign trade: they are
underestimating the growth of exports, while
overestimating the data for imports.
Therefore, in current prices, the net exports
rose by CZK 16.2 bill., y/y.
The Czech GDP growth continued to be
roughly double than the growth in EU 27
(reported at 2.8 %, y/y) and the outpace is
even higher in comparison with the eurozone
(2.5 %, y/y). The catching-up process to
developed market economies thus continues.
The biggest contributor to GDP growth in
the Q2 was manufacturing (accounting for 28 %
of GDP) with growth of value added by almost
10 %, y/y. Industry reported very good results
for the eight months of 2007: the growth of
output reached 9.9 %, y/y, with the growth of
manufacturing amounting to 10.9 %, y/y.
Industry was driven predominantly by a good
result of the electronics with the growth of
18.9 %, y/y, solid growth of the automotive
industry (12.8 %, y/y) accompanied by rapid
growth in rubber and plastics (23.5 %, y/y)
and a very good result of general machinery
(20.4 %, y/y). On the other hand, output of
metal industry stagnated. Industry has been
pulled by both foreign and domestic demand.
Favourable foreign demand was behind
growth of the export sales (15.2 %, y/y),
which was strongly above total increase in
sales (11.1 %, y/y).
Industry continues to hire new employees January
to August, the employment rose by
2.3 %, y/y. In particular, electronics, rubber
and plastics are the main drivers of rising
employment. Nevertheless, further growth of
employment will probably encounter a barrier
of shortage of qualified labour force, as
indicated by signals from some regions and
big companies. The shortage of skilled labour
creates pressure on wages: in the second
quarter of 2007, growth of real wages in
manufacturing (8.4 %, y/y) surpassed the
growth of productivity (7.0 %, y/y). If
this process should continue, it would
undercut the competitiveness of the Czech
manufacturing exports.
For the first eight months, construction
output rose by 8.9 %, y/y, with notable
fluctuations in the course of that period.
Construction registered extremely high
growth at the beginning of 2007, with the
output increasing by 25 %, y/y, January to
April. However, this extremely strong
construction activity was driven by
favourable weather conditions and low bases
for comparison. In the forthcoming months a
strong slowdown appeared, caused partly by
the fact that the full-year space for
construction works is limited and abovestandard
part of this space was exhausted in
the course of first four months. In addition,
lack of capacities has emerged, both for
technical and personal reasons. Lack of
qualified workers pushes up the wages, with
wage inflationary pressures in construction
emerging, too. Prices of construction works
belong to the most rapidly growing prices in
the Czech economy, with year over year
increase amounting to 3.8 % in September.
The developments in building construction
and engineering strongly differed: building
rose by 17.3 %, y/y, January to August, while
engineering declined by 5.6 %, y/y. The
decline in engineering has been connected
with problems in preparing and financing of
engineering projects. In housing construction,
No. 54 3
Retail sales rose by 8.6 %, y/y, January
to August 2007. Rapid growth of
incomes, record-low unemployment,
still relatively low inflation, credit boom,
optimistic expectations of households
concentrated on housing market these
continue to be factors behind
strong figures on retail sales.
For the first eight months, the trade
surplus amounted to CZK 55.1 bill.,
which was roughly double than in the
same period last year. The improvement
in trade balance was exclusively
attributable to the favourable
developments in terms of trade, which
improved by 3.4 percentage points.
In the second and third quarter of
2007, the inflation in the Czech
economy started to grow, in the first
place due to strong consumer demand.
The year over inflation amounted to 2.8 %
in September. The year over year CPI
was driven in particular by food and
housing prices, which account for 41 %
of the consumer basket.
the growth of finished flats in Q2 was recordhigh,
exceeding 30 %, y/y. In the forthcoming
years, mid-term sustainable trajectory of
housing market is estimated around 5 %. The
development of mortgage market strongly
correlates with housing boom. The volume of
credits on housing amounted to CZK 550 bill.
at the end of August, rising by 35 %. y/y.
Consumer demand has accelerated as of the
beginning of the year, with no significant
fluctuations during the first eight months.
Retail sales rose by 8.6 %, y/y, January to
August 2007. Rapid growth of incomes,
record-low unemployment, still relatively low
inflation, credit boom, optimistic expectations
of households concentrated on housing
market ­ these continue to be factors behind
strong figures on retail sales.
Housing equipment (16.7, y/y), textiles and
footwear (16.4 %, y/y) and cars (13.1 %, y/y)
were the main drivers of retail sales.
Purchases of housing equipment have been
aligned with boom in housing (note that in
Q2 2007 the growth of finished flats was
record high). The increase in sales of housing
equipment accounted for more than one
quarter of total increase in retail sales (in
volume terms). In addition, the rapid growth
of housing out of centres of big cities has
been supporting the cars sales.
Strong investments in housing and other
consumer goods have had some adverse
effect on demand for foods: food sales rose
by 4.2 %, y/y, for the first eight months, i.e.
slightly below last year dynamics and notably
below overall growth of retail sales.
2. FOREIGN TRADE AND
EXCHANGE RATE
January to August 2007, the exports
increased by 16.6 %, y/y, the imports rose by
14.9 %, y/y. The favourable trend of higher
growth of exports in comparison with the
imports led to significant year over year
improvement of trade balance. The trade
surplus amounted to CZK 55.1 bill., which
was roughly double than in the same period
last year.
The key volume items continue to be
machinery on the "credit side" and fuel and
chemistry on the "debit" one. Machinery
exports rose by above average 18.6 %, y/y,
producing a surplus of CZK 186 bill., for the
first seven months. Similar to previous year,
cars accounted for approximately two thirds
of the machinery surplus (CZK 125 bill.), with
year on year increase of CZK 10 bill. Mild
winter and strong USD stood behind the
decline in deficit with fuel. The deficit with oil
declined to CZK 58 bill. (by CZK 3.5 bill. less,
y/y), deficit with gas fell to CZK 28 bill., down
from 37 bill., last year. On the other hand, the
deficit with chemistry increased by CZK 8.7
bill., y/y, to CZK 60 bill., and was thus higher
than the deficit with fuel.
The improvement in trade balance was
exclusively attributable to the favourable
developments in terms of trade, which
improved by 3.4 percentage points. The
export prices rose by 2.5 %, in the first seven
months, driven in particular by higher export
prices of semi-manufactured goods. Contrary
to export prices, the import prices decreased
by 0.9 %, y/y, due to cheaper fuel and
machinery.
In the third quarter of 2007, the Czech
currency started to appreciate again; both
towards EUR and USD. The Czech crown
appreciated from 28.3 CZK/EUR to 28.5 in
July 2007 to 27.6 CZK/EUR, in September
and from 20.6 CZK/USD to 19.9 CZK/USD at
the same time. This trend of appreciation of
the Czech currency has been continuing also
in the first half of October. Due to this
favourable development of the exchange rate
to USD, the import prices of fuels continued
to decline, y/y, even under record high oil and
gas prices.
3. INFLATION AND MONETARY
POLICY
In the second and third quarter of 2007, the
inflation in the Czech economy started to
grow, in the first place due to strong
consumer demand. The average inflation rate
was still at 2 %, in September. The year over
inflation amounted to 2.8 % in September,
with prices of goods rosing by 2.7 %, and
prices of services by 2.9 %. The year over year
CPI was driven in particular by food and
housing prices, which account for 41 % of the
consumer basket. Food prices rose by 3.2 %,
y/y, housing prices increased by 3.7 %, y/y.
After almost two years of decline of food
prices in 2005 and 2006, the food prices
started to grow, from the second quarter of
2007. This trend will continue not only in the
rest of 2007, but also in 2008, due to
situation on the world markets and due to
competition of food industry and chemical
Economic Trends 4
industry for some agricultural products (as a
consequence of emerging production of the
bio fuel in the Czech Republic).
As indicated above, the appreciated
exchange rate was able to attenuate (at least
partially) the inflationary pressures. It applies
at the first place for consumer prices of
electronics and for petrol prices. Therefore,
the prices of transport even declined, by 0.1 %,
y/y.
Producer prices continued to accelerate in
the course of 2007. The year on year PPI
amounted to 4.0 %, in September 2007.
Producer prices in manufacturing (3.3 %, y/y)
were below the overall growth. Metal
production continued to be the main factor
of overall PPI growth (5.7 %, y/y), driven by
expensive metals. The pass-through of
expensive metals is visible on increasing
import prices of semi-manufactured
production, which rose by 4.2 %, y/y, in
September. Producer prices of coke and
refined oil products increased by 6.8 %, year
over year. Prices of intermediate goods grew
by 4.2 %, y/y, and prices of energies by 7.8 %,
y/y. The year over year growth of PPI of final
production (investment goods, consumer
goods) was significantly lower: 1.9 % and
1.0 %, respectively.
Emerging demand inflationary pressures
forced the Czech National Bank to increase
basic interest rates three times during the
first three quarters of 2007. 2W repo rate
thus stood at 3.25 % at the end of September
2007, which was by 75 basis points higher
than it had been a year before. By these rate
increases, the CNB proved to be decided to
keep inflation at the targeted range.
According to the fresh Situation Report on
Economic and Monetary Developments, the
risks of headline inflation forecast are on the
upside; major risks and uncertainties
represent impact of excise duties and VAT
changes on inflation expectations, external
developments and stronger CZK exchange
rate.
Despite the rates increases, the basic
interest rates in the Czech Republic are the
lowest among all 27 EU countries: the
difference between repo-rate and refi-rate of
the ECB still at 75 basis points, the difference
between 3M Pribor and 3M Euribor is at 130-
140 basis points.
4. UNEMPLOYMENT
At the end of Q3 2007, the rate of
unemployment was at 6.2 %, by one and half
percentage point lower than a year before.
The number of unemployed declined to 365
thousand, which has been a record low figure
since November 1998. At the same time, the
offer of vacancies reached a new record-high
(137 thousand). As a consequence, the ratio
between unemployment and vacancies
declined to 2.7, a record-low level since June
1997.
Even under the unemployment rate above
6 %, there is a shortage of labour force in
some segments, which starts to represent a
barrier for future economic growth. At the
same time, figures on vacancies indicate that
it is relatively easy to find a job; however, it
Table 1: Main Macroeconomic Indicators
22000022 22000033 22000044 22000055 22000066 0066//0077 0077//0077 0088//0077 22000077FF
GDP %, y/y 11..99 33..66 44..66 66..55 66..44 ­­ ­­ ­­ 55..88
Inflation %, y/y 00..66 11..00 22..88 22..22 11..77 22..55 22..33 22..44 33..77
Inflation %, m/m ­­ ­­ ­­ ­­ ­­ 00..33 00..44 00..33 ­­
Industrial prices %, y/y --00..77 00..99 77..77 --00..33 22..66 44..66 44..11 33..77 55..00
Industrial prices %, m/m ­­ ­­ ­­ ­­ ­­ 00..77 00..22 --00..11 ­­
Unemployment rate* %, eop. 99..88 1100..33 99..55 88..99 77..77 66..33 66..44 66..44 66..11
Industrial production %, real 11..99 55..55 99..66 66..77 99..77 66..66 1111..55 55..55 1100..55
Construction output %, real 22..55 88..99 99..77 44..22 66..66 --44..55 --11..77 33..33 88..55
Retail sales %, real 33..00 44..99 22..55 44..00 66..44 77..66 88..99 88..00 77..55
State budget CZK bill. --4455..77 --110099..11 --9933..55 --5566..44 --9977..33 11..33 1199..77 2222..22 --8855
Trade balance CZK bill. --7700..88 --6699..88 --2266..44 3388..66 1122..66 33..00 66..99 7755
FOREX reserves USD bill. 2233..77 2277..00 2288..44 2299..55 3311..33 3311..22 3311..88 3322..22 3322..55
PRIBOR 3M % average 33..66 22..33 22..44 22..00 22..33 22..9933 33..0077 33..2288 33..00
CZK/EUR Average 3300..8811 3311..8844 3311..99 2299..7788 2288..3344 2288..5544 2288..3333 2277..8866 2277..99
CZK/USD Average 3322..7744 2266..3322 2255..77 2233..9955 2222..6611 2211..2277 2200..6644 2200..4455 2200..66
Source: Czech National Bank, Czech Statistical Office, forecasts by Komercni banka
*Note: As of July 2004, the unemployment rate is published according to the new methodology
Producer prices continued to accelerate in
the course of 2007. The year on year PPI
amounted to 4.0 %, in September 2007.
There is a shortage of labour force in
some segments, which starts to
represent a barrier for future economic
growth.
Emerging demand inflationary pressures
forced the Czech National Bank to
increase basic interest rates three times
during the first three quarters of 2007.
2W repo rate thus stood at 3.25 % at
the end of September 2007, which was
by 75 basis points higher than it had
been a year before.
Food prices rose by 3.2 %, y/y, housing
prices increased by 3.7 %, y/y. After
almost two years of decline of food
prices in 2005 and 2006, the food
prices started to grow, from the second
quarter of 2007. This trend will continue
not only in the rest of 2007, but also in
2008, due to situation on the world
markets and due to competition of food
industry and chemical industry for some
agricultural products.
No. 54 5
does not apply to all professions. The
vacancies are concentrated to some
professions (workers in construction,
mechanics, assembly workers), while demand
for some professions is very weak. Low
administration staff and shop assistants have
been in worst positions, with UV ratio
amounting to 6­8.
Moreover, in professions, where the demand
for labour is high, strong regional disparities
occur. E.g., the overall number of vacancies
and unemployed is roughly equal in the case
of construction workers. However, the
number of the respective vacancies strongly
exceeds the number of unemployed in Prague
and some other regions with strong
construction activity. On the other hand,
construction workers cannot find a job in
districts with high unemployment. The same
applies to non-qualified labour, with number
of vacancies being almost three times higher
than the number of unemployed, in Prague.
On the other hand, 70­80 non-qualified
workers fell upon one vacancy in districts
with high unemployment. All these facts
witness extremely low regional mobility in
the CR.
The regional differentiation of professional
and qualification mismatch on labour market
has been the reason for high long term
unemployment and represents an important
challenge for the government policy. Due to
rigidities of labour market and still generous
social system, there is a contrast between
more than 200 thousand of officially
employed foreigners and more than 150
thousand of long-term unemployed.
5. OUTLOOK
For the second half of 2007, we expect that
the rapid dynamics of the Czech economy will
continue. For 2007, the GDP growth will be
around 6 % and will continue to be driven by
strong consumer demand and fixed capital
investments. For 2008, we expect slight
deceleration of GDP, along with the slowdown
expected in eurozone (i.e. the biggest Czech
trade partners), to around 5 %, or even
slightly below.
As the developments of new orders indicate,
also in the forthcoming months the Czech
industry will be favourably influenced by still
solid foreign demand as well as by continuing
domestic demand. An adverse effect of strong
EUR on the developments of foreign orders is
not expected before the end of the year. For
2007, we continue to expect the growth of
industrial output between 10 and 11 %, i.e ,
slightly above the last year growth.
Fundamental factors behind growth in
construction are the same as in previous two
years: continuing projects in infrastructure,
activities of foreign investors, boom in
housing. For the rest of the year we expect
average growth path around 5­6 %. The fullyear
growth in construction is expected to
range from 8 to 9 %.
The main factors of growth in retail trade,
i.e. record low unemployment, rapid growth
of wages, boom in housing, high propensity
to spend, wide offer of credits will continue to
act. Therefore, we do not expect notable
weakening of consumer demand in the
forthcoming months. The boom in housing
will be peaking in the rest of the year pushing
up the sales of housing equipment. The fullyear
growth of retail sales will be close to 8 %.
At the same time, retail trade figures plus
acceleration of inflation indicates that
another raise of basic interest rates by 25
basis points until the end of 2007 is
probable. The tightening of monetary policy
will have some effect on consumer boom, but
not before the beginning of 2008.
The exports will continue in double-digit
growth, driven by the machinery exports, in
particular by the automotive industry,
electronics and general machinery. Fuel
imports are expected to decline, year on year,
due to weak USD, which more than
compensates high world prices of oil and gas.
The developments of the export and import
prices will thus be favourable until the end of
year, with terms of trade gradually improving.
Therefore, the trade balance will also
continue in year over year improvement; the
full-year trade balance surplus is expected
around CZK 75 bill.
The trade balance will have a favourable
effect to the current account; nevertheless,
the deterioration of the balance of incomes
will be more rapid than the improvement of
the trade balance. We expect the current
account deficit to be around CZK 100 bill., in
2007. This will mean that the deficit of the
current account will reach approximately 3 %
of GDP, which is in tolerable limits.
However, in the longer time horizon, some
risks for external balance persist. The growth
of the deficit on the balance of incomes has
been very rapid (expected at CZK 230 ­ 240
Due to rigidities of labour market and
still generous social system, there is
a contrast between more than 200
thousand of officially employed
foreigners and more than 150 thousand
of long-term unemployed.
An adverse effect of strong EUR on the
developments of foreign orders is not
expected before the end of the year. For
2007, we continue to expect the
growth of industrial output between 10
and 11 %, i.e , slightly above the last
year growth.
The tightening of monetary policy will
have some effect on consumer boom,
but not before the beginning of 2008.
The full-year trade balance surplus is
expected around CZK 75 bill. The trade
balance will have a favourable effect to
the current account; nevertheless,
the deterioration of the balance of
incomes will be more rapid than the
improvement of the trade balance.
Economic Trends 6
bill. in 2007), with the shift from
reinvestments to dividends. Further shift in
the distribution of profits of foreign
controlled companies to dividends payments
would not only increase the pressures on
financing the current account deficit, but
would also limit the coverage of the current
account deficit by non-debt financing. The
risks will be more serious in the period of
ERM II, with the monetary policy aimed to
keep the exchange rate in tolerable limits.
The inflation in the Czech economy will
accelerate in the last quarter of 2007, due to
strong consumer demand and declining
unemployment. We expect the year over year
CPI to be around at 3.7 %, at the end of 2007.
Average inflation will be around 2.5 %.
Changes in VAT and regulated prices (rents,
utilities) will push up the inflation up as from
the beginning 2008. The year over CPI is
expected to range from 4 to 5 % in the first
quarter of 2008, i.e. above the targeted
interval of the central bank. Even though the
inflation driven by the change in indirect
taxes and regulated prices is not the kind of
inflation that the CNB is expected to react;
the steps of CNB will depend on the scope
and speed of second-round effects.
As for PPI, two key factors will play major
role also in the rest of 2007: world prices of
oil and metals. The main driver of PPI ­ metal
prices ­ will remain expensive due to high
global demand driven in particular by strong
economic activity in South-East Asia. In
addition, some pass-through of expensive
utilities into manufacturing industries must
be expected, despite the attenuating effect of
appreciating Czech currency. At the end of
2007, the year over year growth of producer
prices will be at 5 %.
The newest data about inflation, wages
and retail sales are indicating that the Czech
National Bank will increase the basic
interest rate until the end of the year; most
probably by 25 basis points. This would
lessen the gap between 3M EURIBOR and
3M PRIBOR below 100 basis points. A slight
appreciation of the Czech currency is
expected to continue: the average 2007
exchange rate is expected at 27.9 CZK/EUR
and 20.6 CZK/USD.
Solid economic activity will continue to
affect the unemployment positively in the
autumn months, with the unemployment rate
expected to decline to 5.7 %, in November.
Regular autumn decline will be replaced by
seasonal December increase due to finishing
seasonal jobs and term contracts. At the end
of 2007, we expect the unemployment rate at
6.1 %. The decline of the unemployment is
expected to continue in 2008, however, there
is a risk that this decline will already
In the longer time horizon, some risks
for external balance persist. Further
shift in the distribution of profits of
foreign controlled companies to
dividends payments would not only
increase the pressures on financing the
current account deficit, but would also
limit the coverage of the current
account deficit by non-debt financing.
The newest data about inflation,
wages and retail sales are indicating
that the Czech National Bank will
increase the basic interest rate until the
end of the year; most probably by
25 basis points.
No. 54 7
Milton Friedman was awarded the Nobel
Prize in Economics in 1976, for his
contributions to the analysis of consumption,
to monetary history and theory, and for his
analysis of complexity of stabilization policy.
As Erik Lundberg stressed on that occasion,
from the scientific point of view, one of the
most important contributions of Milton
Friedman was his new concept of consumption,
based on the hypothesis of permanent
income, not current income, as the decisive
factor determining the final consumption.
Consumption Function is one of the
innovations brought to economic theory by
The General Theory of J. M. Keynes2.
Macroeconomic view of the relations between
the main national income aggregates,
introduced by Keynes, at the same time
means ­ in relation to consumption ­ that
the link between aggregate demand and
aggregate consumption occupies a key
position in his theory. In this respect, J.M.
Keynes talks about the "basic psychological
law" (1936, p. 96). His opinions can be
summarized as follows:
1. consumption expenditures are a constant
function of disposable income;
2. the marginal propensity to save is positive,
but lower than one;
3. marginal propensity to save is lower than
the average propensity (meaning that the
average propensity to save declines with
increasing income);
4. marginal propensity to save also declines
with increasing income.
Later, this Keynes's statement was called
the "hypothesis of absolute income", as
consumption is here determined by the
absolute income level. The consumption
function inspired many analytical and
statistical studies, as its concept offered itself
to econometric analysis. The numbers of
empirical works about the consumption
function grew almost geometrically in the
first decade after The General Theory was
published. They all were marked by a
relatively high coefficient of correlation, all
explained the changes in consumption by
variations of income. However, they were not
able to bring any substantial contribution to
the knowledge of facts about income and
consumption.
The first prediction of aggregate components
of the after-war U.S. national income showed
that the consumption function is not a
sufficient instrument for explaining and
predicting consumer behaviour, in the light of
new empirical data.
The work of Simon Kuznets (1946) about
U.S. Gross Domestic Product since 1869, and
that of R. Goldsmith (1955) about savings,
showed that in the U.S., the aggregate savings
rate was roughly stable since 1869, while the
real income grew four times. That cooled the
enthusiasm of Keynesians. On the other hand,
the family budget studies were showing that
the consumption/income ratio (C/Y) decreases
as income grows, as presupposed by Keynes.
Economic theory was striving to give
an answer to these inconsistencies, by
developing further the theory of consumption
function, and by revising the postulates of
consumer behaviour.
The first reaction to the inconsistencies in
consumer behaviour not explainable by the
consumption function was the so-called
relative income hypothesis. This theoretical
concept is connected with the names of D.
Brady and R. Friedman, F. Modigliani and J.
Duesenberry. The most complete and best
known explanation is by Duesenberry (1948),
(1949).
Duesenberry underlines two main aspects:
1. consumption behaviour of individuals is
mutually dependent, rather than
independent (psychological "demonstration
effect" and "imitation effect");
2. consumer behaviour is non-reversible in
time (so-called "ratchet effect").
So, people have a strong tendency to
imitate the consumption of their neighbours,
MILTON FRIEDMAN ­ A THEORY OF
THE CONSUMPTION FUNCTION1)
Kamil Janáek
1 Paper based on speech at colloqium "Friedman Semper
Vivus", held on October 4, 2007, and sponsored by
Komerní banka.
2 Keynes himself did not use the term "consumption
function" ­ that was introduced by Alvin Hansen.
Milton Friedman was awarded the
Nobel Prize in Economics in 1976, for
his contributions to the analysis of
consumption, to monetary history and
theory, and for his analysis of
complexity of stabilization policy.
Consumption Function is one of the
innovations brought to economic
theory by The General Theory of J. M.
Keynes.
Keynes's statement was called the
"hypothesis of absolute income", as
consumption is here determined by the
absolute income level.
The first reaction to the inconsistencies
in consumer behaviour not
explainable by the consumption
function was the so-called relative
income hypothesis.
Economic Trends 8
and at the same time they continuously strive
to reach higher living standards. If, at the top
of the cycle, they reach a certain level of
consumption, they will try to keep it even as
their income falls cyclically. In other words,
people strive to keep the highest consumption
level reached in their past.
Testing of the relative income hypothesis
brought relatively good results. Especially the
predictive results were good, achieved with
consumption functions based on this
hypothesis ­ compared with those based on
the hypothesis of absolute income.
However, even the relative income hypothesis
was unable to give a fully satisfactory
explanation of consumer behaviour. The
assumption that consumption and income
move in the same direction was in conflict
with the fact that sometimes, consumption
grows when disposable incomes fall. Also, the
assumption failed to be proved that the
increase of consumption is proportional to
the rise of incomes, no matter how big or
small the income rise is. On the contrary,
historical series of national accounts proved
that the average dispersion of consumption
in the course of the cycle is substantially
smaller than the dispersion of income.
Milton Friedman reacted to all the
inconsistencies of the relative income
hypothesis in his book "A Theory of The
Consumption Function" (1957), where he
formulated a new concept to the
consumption function, called the "permanent
income hypothesis".
Friedman strictly distinguishes between
measured income (income of the current
period) and the income which determinates
consumer behaviour, which he calls the
"permanent income". Consumers adapt their
spending to the average of past, present and
expected incomes ­ not to their actual
current income. Friedman (1957) writes that
permanent income is the amount which the
consumer unit could consume (or thinks to
be able to consume) without any decrease in
it wealth. People adapt their consumption
to their long-term expected (permanent)
income, paying little attention to transitory
fluctuations. (see table)
According to (1) permanent consumption is
proportional to permanent income; the
proportionality coefficient k depends on the
interest rate i, the ratio w of wealth to the
permanent income, and on other economic
and demographic factors u (age, consumer
preferences, etc.).
The equations (2) and (3) are definitions income
and consumption can be divided in
two components, permanent and transitory.
Permanent income in the given year is thus
the product of two factors: wealth of the
consumer unit, seen as the discounted
present values of the stream of future
expected incomes, and the rate r which
discounts the expected incomes. The
transitory and permanent parts of income
and consumption are uncorrelated with one
another (see 4).
An important, outstanding, and hard-tobeet
quality of Friedman's book lies in the
volume of empirical material gathered, and in
its use for testing the permanent income
hypothesis. Chapter Four is devoted to
analyses based on budget studies (i.e. to
cross-section data), Chapter Five to data from
the time series of national accounts. With the
same thoroughness, Friedman analyzes (in
Chapter Six) the relation between the relative
income hypotheses and the permanent
income hypothesis. The permanent income
hypothesis clearly explains why the
propensity to consume is substantially lower
in data from cross-section studies than in
analysis of aggregate time series. The same is
true for analysis of different consumer groups
(white and Afro-American families, farmers,
doctors and other professional groups, etc.).
Analysis of the family budgets has proved
that there have been no substantial
structural changes in the behaviour of
individual consumer units (i.e.households),
over 70 years. During that time, the k
coefficient (the ratio of permanent
consumption to permanent income) was
substantially higher (between 0.9 and 0.95)
Cp = k(i, w, u) Yp (1)
Y = Yp + Ytr Ytr = 0 (2)
C = Cp + Ctr Ctr = 0 (3)
(YtrYp) = (CtrCp) = (YtrCtr) = 0 (4)
However, even the relative income
hypothesis was unable to give a fully
satisfactory explanation of consumer
behaviour.
People adapt their consumption
to their long-term expected (permanent)
income, paying little attention to
transitory fluctuations.
Friedman strictly distinguishes between
measured income (income of the
current period) and the income which
determinates consumer behaviour,
which he calls the "permanent income".
Milton Friedman reacted to all the
inconsistencies of the relative income
hypothesis in his book "A Theory of The
Consumption Function" (1957), where
he formulated a new concept to the
consumption function, called the
"permanent income hypothesis".
No. 54 9
for wage-earners than for entrepreneurs: for
non-agricultural entrepreneurs, k was 0.8, for
agricultural entrepreneurs 0.9. It was thus
proved that uncertainty as to future incomes
forces entrepreneurs to create larger reserves
for unexpected crisis situations. It has also
been shown that (as could be expected) k is
higher in larger families, than in smaller ones.
At the aggregate level, the ratio of aggregate
consumption to aggregate income (k*)
remained more or less constant in the U.S.
over more than half a century, at the level of
0.88. The stability of k* means that, either,
the variables determining k, and the
distribution of consumer units in individual
groups were constant, or, their changes were
offsetting in their effects. Milton Friedman
mentions two contradictory trends:
1. the falling relative weight of farmer
households in the U.S. population, leading
to an increase of k*, and
2. the decreasing size of households, leading
to a decrease of k*.
The scientific value of the book (and, even
more, of the author) is accentuated by a
systematic endeavour, rarely seen elsewhere,
to look for data and analyses that could
discredit the permanent income hypothesis.
Very few economic theoreticians dare to
make such a hard test of validity of their own
theory.
"A Theory of the Consumption Function" is
innovative also in the methodology used.
Milton Friedman has made a substantial
contribution to economics as a positive
science ­ which characterized the Chicago
School immediately after the World War II.
In the essay "Methodology of Positive
Economics"3, Friedman opposed the
prevailing view (represented mainly by Lionel
Robbins), that the truth of a theory should
primarily be tested on the correspondence
between its aassssuummppttiioonnss and the ffaaccttss..
Friedman argues that even if one could get an
empirical correlation between theoretical
assumptions and facts4, it would be irrelevant
for the usefulness of the theory. Only the
correspondence of the pprreeddiiccttiioonnss and ffaaccttss
can show whether a theory should be
accepted or rejected. According to Friedman,
results, not assumptions, should be the main
focus of scientific activity in understanding
the real world.
"A Theory of the Consumption Function"
was a great contribution to economic theory;
Friedman has proved that economics is a
positive, empirical science. For all the abovementioned
reasons, one can say that this
book was the best work of Milton Friedman,
a work that has substantially influenced
economic thinking of the second half of the
20th century.
RReeffeerreenncceess
BRADY, D.S. ­ FRIEDMAN, R. D.: Savings and the
Income Distribution, Studies in Income and
Wealth, X, NBER, New York 1947
DUESENBERRY, J.: Income, Saving and the Theory
of Consumer Behavior, Cambridge, Mass. 1949
FRIEDMAN, M.: Essays in Positive Economics,
University of Chicago Press, Chicago 1953
FRIEDMAN, M.: A Theory of the Consumption
Function, Princeton 1957
GOLDSMITH, R.: A Study of Saving in the United
States, Princeton 1955
JANÁâEK, K.: Makroekonomické spotfiební
funkce, Academia, Praha 1976
KEYNESS, J.M.: The General Theory of
Employment, Interest and Money, Harcourt, Brace
and Co., New York and London, 1936, (esky:
Obecná teorie zamstnanosti, úroku a penz,
NâSAV, Praha 1963)
KUZNETS, S.: National Product since 1869, NBER,
New York 1946
3 See Essays in Positive Economics (1953).
4 That cannot be done in case of the so-called ideal
types, like the homo oeconomicus.
"A Theory of the Consumption
Function" was a great contribution to
economic theory; Friedman has proved
that economics is a positive, empirical
science.
Economic Trends 10
The inflow of FDI has been the key factor of
the transition and catching-up processes of
new EU member states. This brief survey is
aimed to give basic information about the
inflow of foreign direct investments to
Central and East European new EU member
states concerning the differencies in the
volume of investments and its structure. A
special attention is paid to the differences in
profitability of FDI among individual
countries and factors which contributed to
them. Moreover, the life cycle of FDI is
discussed as a major factor of development
of profitability as well as the changes in
distribution of profits to reinvestments and
dividends.
GENERAL TENDENCIES
The inflow of FDI into the new Central and
East EU member states accelerated in the
previous three years with total inflow
amounting to EUR 110 bill., in 2004­2006,
which was higher inflow than in preceding
five years. Regional distribution of the FDI
inflow has been strongly attributable both
to macroeconomic policies of individual
countries and to the timing of the EU
accession. FDI has been booming in Bulgaria
and Romania in recent two years, inflows
reaching their historical peaks in 2006 as
the EU membership was crucial anchor for
stability. Nevertheless, the new investment
opportunities in Bulgaria and Romania did
not have a strong adverse impact on the
investments to the eight countries that
joined the EU in 2004. In 2006, the FDI
declined only in three of eight countries
(Czech Republic, Hungary and Estonia),
where the peak in 2005 was to a large
extent driven by one-time privatisation
deals. Ups and downs in privatisationrelated
FDIs have been causing fluctuations
and differences between individual
countries and individual years.
As for the the stock per capita (see Figure 1),
it is obvious that at the end of 2006, the
leader was Estonia with FDI per capita
amounting to EUR 9.2 thousands, followed
by Hungary (EUR 6.2 thousands and the
Czech Republic (EUR 5.7 thousands). On the
other hand, Poland, Bulgaria and Romania
were the countries that lagged behind, with
final stock around EUR 2.0 thousands per
capita. Similar picture applies for
comparison based on stock of FDI in per cent
of GDP (Figure 2). In this comparison, there
is the only difference in position of Bulgaria
with strongly above average stock of FDI
reaching 62 % of GDP.
FDI IN THE NEW EU MEMBER STATES:
RECENT TRENDS
Eva Zamrazilová
Table 1: Inflow of FDI, EUR bill.
11999999 22000000 22000011 22000022 22000033 22000044 22000055 22000066
CCzzeecchh RReeppuubblliicc 55..99 55..44 66..33 99..00 11..99 44..00 99..44 44..88
HHuunnggaarryy 33..11 33..00 44..44 33..22 11..99 33..66 66..11 44..99
PPoollaanndd 66..88 1100..33 66..44 44..44 44..11 1100..33 77..77 1111..11
SSlloovvaakkiiaa 00..44 22..11 11..88 44..44 11..99 22..44 11..77 33..33
SSlloovveenniiaa 00..11 00..11 00..44 11..77 00..33 00..77 00..44 00..33
EEssttoonniiaa 00..33 00..44 00..66 00..33 00..88 00..88 22..33 11..33
LLaattvviiaa 00..33 00..44 00..11 00..33 00..33 00..55 00..66 11..33
LLiitthhuuaanniiaa 00..55 00..44 00..55 00..88 00..22 00..66 00..88 11..44
BBuullggaarriiaa 00..99 11..11 00..99 11..00 11..99 22..77 33..11 44..11
RRoommaanniiaa 11..00 11..11 11..33 11..22 11..99 55..22 55..22 99..11
EEUU 1100 1199..33 2244..55 2222..77 2266..22 1155..11 3300..99 3377..44 4411..55
Source: The Vienna Institute for International Economic Studies
The inflow of FDI into the new Central
and East EU member states
accelerated in the previous three years
with total inflow amounting to EUR
110 bill., in 2004 ­ 2006, which was
higher inflow than in preceding five
years. Regional distribution of the FDI
inflow has been strongly attributable
both to macroeconomic policies of
individual countries and to the timing
of the EU accession.
As for the the stock per capita, the
leader was Estonia with stock of FDI
per capita amounting to EUR 9.2
thousands at the end of 2006, followed
by Hungary (EUR 6.2 thousands and
the Czech Republic (EUR 5.7 thousands).
No. 54 11
Table 2: FDI Structure at the End of 2005, in %
CCRR HHuunn PPooll SSKK SSLL EEsstt LLaatt LLiitt BBuull RRoomm
AAggrriiccuullttuurree,, ffoorreessttrryy 00..22 00..44 00..55 00..44 00..00 00..55 11..55 00..77 00..66 00..55
MMiinniinngg,, qquuaarrrryyiinngg 00..44 00..11 00..11 00..66 00..00 00..44 00..55 00..77 00..99 77..33
MMaannuuffaaccttuurriinngg 3388..11 4411..44 3366..66 4400..55 4433..77 1133..33 1122..88 3399..66 1122..88 3377..33
EElleeccttrriicciittyy,, ggaass,, wwaatteerr 55..77 44..22 33..44 99..11 44..55 22..22 1111..11 1122..55 00..22 44..22
CCoonnssttrruuccttiioonn 11..22 00..99 11..88 00..88 00..33 11..22 11..66 11..22 2233..44 00..88
TTrraaddee aanndd rreeppaaiirrss 99..88 1111..77 1188..44 1122..22 1144..00 77..88 1133..99 1111..00 33..88 1155..00
HHootteellss,, rreessttaauurraannttss 00..77 00..88 00..55 00..66 00..44 00..33 00..99 00..99 1100..33 00..22
TTrraannssppoorrtt,, ccoommmmuunniiccaattiioonn 1122..11 1100..11 77..99 99..11 33..77 33..00 1111..66 1133..77 11..11 1122..33
FFiinnaanncciiaall iinntteerrmmeeddiiaattiioonn 1188..88 1100..33 2200..33 2211..88 1199..77 4455..77 2211..11 1122..33 3344..99 1144..55
RReeaall eessttaattee 1122..33 1177..99 1100..00 44..11 1122..99 1155..22 1177..44 66..44 99..66 77..77
OOtthheerr 00..99 22..44 00..55 00..88 00..77 1100..33 77..55 11..00 22..22 00..22
Source: The Vienna Institute for International Economic Studies
Figure 1: Stock of Inward FDI per capita, thousands EUR.
10 ­
9­
8­
7­
6­
5­
4­
3­
2­
1 ­
0Source:
The Vienna Institute for International Economic Studies
CR Hun Pol SK SL Est Lat Lit Bul Rom EU10
2000 2006
Figure 2: Stock of Inward FDI, in % of GDP
100 ­
90 ­
80 ­
70 ­
60 ­
50 ­
40 ­
30 ­
20 ­
10 ­
0 Source:
The Vienna Institute for International Economic Studies
CR Hun Pol SK SL Est Lat Lit Bul Rom EU10
2000 2006
Economic Trends 12
Basic information about the structure of FDI
in the new EU member states can be found in
Table 2. The new member states show similar
features, with most important share of
manufacturing, accounting for approximately
one third of FDI stock on average. Latvia,
Estonia and Bulgaria are rather exceptions
with shares of manufacturing slightly above
10 %, while the shares of manufacturing
amount to around 40 % in the rest of the
countries. The second position belongs to
financial intermediation with average share
about 20 % ­ the shares in Estonia and
Bulgaria are extremely high and in Hungaria
and Lithuania rather low. Trade, transport and
communication also concentrated an
important part of FDI inflows. In most
countries, the weight of manufacturing is
declining while activities such as financial
intermediation and real estate and other
business activities are on the rise. While FDI
in manufacturing may be labelled as the
efficiency-seeking investments, the FDI in
services are mostly local-market oriented.
PENETRATION OF FOREIGN
CONTROLLED COMPANIES
The importance of FDI in individual
economies can be measured by the
Table 3: Profitability of FDI, in % of FDI Stock
22000000 22000011 22000022 22000033 22000044 22000055 22000066
CCzzeecchh RReeppuubblliicc 66..33 77..77 99..11 1100..44 1111..77 1100..44 1100..88
HHuunnggaarryy 88..99 88..44 99..77 88..33 99..66 88..99 88..44
PPoollaanndd 22..11 11..77 11..77 44..00 1122..11 99..99 1100..00
SSlloovvaakkiiaa 00..99 11..66 22..11 1177..77 1188..00 1166..55 1144..00
SSlloovveenniiaa 33..11 --00..33 55..11 55..33 66..88 66..22 55..88
EEssttoonniiaa 77..99 99..77 1100..44 1100..00 99..33 88..00 88..66
LLaattvviiaa 44..44 44..22 44..22 77..11 1133..22 1122..11 1133..22
LLiitthhuuaanniiaa 55..33 55..33 33..44 99..00 1111..22 88..22 88..44
BBuullggaarriiaa 44..88 55..33 66..77 1100..00 99..00 66..88 44..99
RRoommaanniiaa 11..11 11..55 22..88 88..22 1133..99 1100..88 1100..99
Source: The Vienna Institute for International Economic Studies
1 World Investment Report 2007. United Nations
Conference on Trade and Development, United Nations,
New York and Geneva, 2007.
Figure 3: Transnacionality Index, 2004, in %
50­
45 ­
40 ­
35 ­
30 ­
25 ­
20 ­
15 ­
10 ­
5 ­
0 Source:
World Investment Report 2007, UNCTAD, 2007
Est SK Hun Bul CR Pol Rom Lat SL Lit
In most countries, the weight of
manufacturing is declining while
activities such as financial
intermediation and real estate and
other business activities are on the rise.
While FDI in manufacturing may be
labelled as the efficiency-seeking investments,
the FDI in services are mostly
local-market oriented.
No. 54 13
Transnacionality index, published by the
UNCTAD in regular World Investment
Reports1. The Transnacionality index is
constructed as the average of four shares:
FDI inflows as a percentage of gross fixed
capital investments (for the past three
years), FDI stocks as a percentage of GDP,
value added of foreign affiliates as a
percentage of GDP and employment of
foreign affiliates as a percentage of total
employment. The so far latest values of these
transnacionality indices are disposable for
2004 (in World Investment Report 2007).
As of the new CEE 10 member countries,
Estonian economy has been the one with
highest penetration of FDI, followed by
Slovakia, Hungary and Bulgaria, which
exceed the 30% bar. Czech Republic holds
the fifth position, slightly below 30 %. In
the broader framework of developed
economies, these five countries belong to
the first ten, out of 31 world's most
developed countries. The countries with
highest transnacionality index are Belgium
and Luxembourg with levels of index above
60 %. The third place belongs to Estonia
(47 %), followed by Ireland (46 %). In
majority of the rest of EU-27 countries, the
value of index ranges from 10­20 %.
PROFITABILITY
OF FDI
The whole amount of FDI-related income of
the foreign investor is booked as the outflow in
the current account (on the balance of
incomes). The relation of this income to the
FDI stock can be interpreted as the profitability
of foreign investments (see Table 3).
Slovakia has been the country with the
highest return on FDI stock, with
profitability of FDI between 14 and 18 % in
the course of previous four years, followed
by Latvia. The profitability around 10 % has
been achieved in the Czech Republic and
Poland, and the earnings slightly below 10 %
have been reported by Hungary, Estonia and
Lithuania. The lowest profitability seem to
show the FDI in Bulgaria and Slovenia. The
differences in profitability are partly
connected with timing and structure of FDI
inflow in individual countries. Nevertheless,
the most important factor standing behind
the differences in profitability has been most
probably ­ the differentiation in labour
costs.
Figure 4 shows comparison between the
profitability of FDI (average of 2004­2006)
and unit labour costs (in % of EU-25 average
in 2005) for eight countries. The two
countries with highest profitability of FDI
(Slovakia and Latvia) dispose with lowest
labour costs ­ which were at 39 % and 25 %
of EU-25 average in 2005. On the other hand,
Slovenia reported lowest profitability of FDI
as well as highest unit labour costs (77 % of
EU 25 average). In the Czech Republic and
Poland the profitability is above average and,
at the same time, labour costs are below
average of observed countries. The
exceptions are to some extent Estonia and
Lithuania, with rather low labour costs but
also with low profitability.
In Slovakia, which reported highest
profitability of FDI, two thirds of the FDI stock
has been made by manufacturing (41 %) and
financial activities (22 %). Out of Slovak
manufacturing, high share of metal industry
(25 %) contributed to high profitability. In
Table 4: Profitability of FDI and Unit Labour Costs
PPrrooffiittaabbiilliittyy ooff FFDDII ((iinn %%)) TToottaall uunniitt llaabboouurr ccoossttss
((22000044­­22000066 aavveerraaggee)) ((EEUU == 110000))
SSlloovvaakkiiaa 1166,,22 3388
LLaattvviiaa 1122,,88 3388
CCzzeecchh RReeppuubblliicc 1111,,00 4488
PPoollaanndd 1100,,77 4455
HHuunnggaarryy 99,,00 5522
EEssttoonniiaa 88,,66 4477
LLiitthhuuaanniiaa 77,,00 4400
SSlloovveenniiaa 66,,33 7777
Source: Eurostat, The Vienna Institute for International Economic Studies
As of the 10 new CEE member
countries, Estonian economy has
been the one with highest penetration
of FDI, followed by Slovakia,
Hungary and Bulgaria.
Slovakia has been the country with
the highest return on FDI stock, with
profitability of FDI between 14 and 18 %
in the course of previous four years,
followed by Latvia. The profitability
around 10 % has been achieved in the
Czech Republic and Poland, and the
earnings slightly below 10 % have been
reported by Hungary, Estonia and
Lithuania.
The differences in profitability are
partly connected with timing and
structure of FDI inflow in individual
countries. Nevertheless, the most
important factor standing behind the
differences in profitability has been
probably the differentiation in labour
costs.
Economic Trends 14
Estonia, the share of FDI stock in manufacturing
is very low, amounting to only 14 %,
which may contribute to generally low
profitability of FDI. In the case of Lithuania,
structure of FDI probably playes an important
role in low profitability, too: although manufacturing
accounts for 40 % of FDI stock, one
half of the FDI in manufacturing belongs to
coke and refined oil products. This is industry
with high volatility of input prices and thus of
profits. On the contrary, cars and electronics
account for only 1 % of overall Lithuanian FDI
stock.
THE DISTRIBUTION OF
PROFITS
The theory of life cycle2 of FDI indicates
that FDI goes through various life-cycle
phases, within which various factors
affecting both profit ratios and profit
allocation between reinvested earnings and
dividends paid abroad are at work. In the
first phase after a FDI is realized, the foreigncontrolled
corporation will post a loss (the
loss phase). In the second phase, the
company's performance improves, it
becomes competitive and its profits rise.
Nevertheless, the successful development of
the company is associated with further
investment, as in this phase earnings can be
fully reinvested. The length of the second
phase depends on the size of the domestic
market and the company's position on that
market, on the stability of export markets,
and on the possible alternatives of financing
the development of the company. The size of
reinvested earnings and the share of
dividends in direct investment income can
be strongly affected by the degree to which
the company is stabilised prior to
privatisation.
In the third phase, the company attains
"maturity" and its market share and
profitability stabilises. In this phase, the
parent company transfers most of the
accumulated earnings as dividends. It is
therefore reasonable to expect that
reinvested earnings will fall sharply ­ both
as a percentage of total earnings and in
absolute terms ­ in favour of transferred
dividends.
Longer time series on the developments and
structure of foreign direct investment income
indicate that, in the period 1990­2004, the
investors from developed countries (which
prevail in the new EU member states)
reinvested 45 % of profits on average, with
share oscillating between 40­50 % in
individual years (see UNCTAD 2006)3. In 10
new Central and East European EU countries,
on the whole, about 50 % of FDI-related
earnings were reinvested, however, significant
2 J. C. Brada, V. Tomík: Reinvested Earnings Bias, The "Five
Percent" Rule and Interpretation of the Balance of
Payments ­ With an Application to Transition
Economies. William Davidson WP 543, 2003.
3 World Investment Report 2006. United Nations
Conference on Trade and Development, United Nations,
New York and Geneva, 2006.
The two countries with highest
profitability of FDI (Slovakia and Latvia)
dispose with lowest labour costs.
Slovenia reported lowest profitability of
FDI as well as highest unit labour costs.
Longer time series on the developments
and structure of foreign direct
investment income indicate that, in the
period 1990­2004, the investors from
developed countries reinvested 45 % of
profits on average, with share
oscillating between 40­50 % in
individual years.
Figure 4: Profitability of FDI and Unit Labour Costs
17 ­
15 ­
13 ­
11 ­
9 ­
7 ­
5 ­
80
­ 70
­ 60
­ 50
­ 40
­ 30
Source: Eurostat, The Vienna Institute for International Economic Studies
SK
Total unit labour costs (EU = 100) ­ right axis
Profitability of FDI (in %) ­ left axis
Lat CR Pol Hun Est Lit SL
No. 54 15
differencies appear between the countries
(see Table 5).
General tendency from reinvestments to
dividends is obvious in majority of Central
European economies. 2006 was a year of
especially high shares of income repatriation
from Hungary, Slovakia and Slovenia. The
fifty-fifty-share between repatriation and
reinvestmnent was maintained in the Czech
Republic and Poland. In Baltic states and
South-East Europe, the repatriation rate is
usually lower than in Central Europe.
The recent trends and external experience
in distribution of profits of foreign
controlled companies are important for the
future of external balance in the Central and
East European economies. All these
countries register current account deficit
(Figure 5). There are visible differences in
balance of trade and services between
individual countries, which currently turned
to the surplus in the Czech Republic and
Hungary. However, these countries and also
Estonia have started to suffer from high
deficits on the balance of incomes, which is
expected to be on the rise also in other
countries.
The development will be strongly aligned
with the stock of FDI in the economy and
with the profitability of FDI. Further
developments of the current account deficit
Table 5: Share of Repatriated Profits, in % of FDI Income
22000000 22000011 22000022 22000033 22000044 22000055 22000066 AAvveerraaggee
22000000--22000066
CCzzeecchh RReeppuubblliicc 2299 2299 3388 4499 5522 5511 5544 4433
HHuunnggaarryy 4488 4433 4433 4444 5500 5599 8833 5533
PPoollaanndd nn..aa.. nn..aa.. nn..aa.. nn..aa.. 3344 6633 5500 4499
SSlloovvaakkiiaa 9999 9999 9933 2200 3366 5544 7733 6688
SSlloovveenniiaa 4466 nn..aa.. 3333 2266 2277 3366 110000 4455
EEssttoonniiaa 4488 2288 4499 2266 2266 2277 2211 3322
LLaattvviiaa 3366 6644 7722 5555 4411 4444 2266 4488
LLiitthhuuaanniiaa 2277 4411 4422 4455 3377 5577 2233 3399
BBuullggaarriiaa 4466 9966 6633 5555 2277 5544 5599 5577
RRoommaanniiaa nn..aa nn..aa.. nn..aa.. 2288 3300 5511 4422 3388
Source: The Vienna Institute for International Economic Studies
Figure 5: Current Account and Balance with Goods and Services in 2006 (in % of GDP)
5­
0­5
­
­10 ­15
­
­20 ­25
­
Source: ECFIN
CR Hun Pol SK SL Est Lat Lit Bul Rom
Current account (% of DGP)
Balance of goods and services (% of DGP)
In 10 new Central and East European
EU countries, on the whole, about 50 %
of FDI-related earnings were reinvested,
however, significant differencies appear
between the countries.
General tendency from reinvestments
to dividends is obvious in majority of
Central European economies.
In Baltic states and South-East
Europe, the repatriation rate is usually
lower than in Central Europe.
The recent trends and external
experience in distribution of profits of
foreign controlled companies are
important for the future of external
balance in the Central and East
European Economies.
Authors: Kamil Janáek +420-224 214 666
Chief Economist kamil_janacek@kb.cz
Eva Zamrazilová +420-222 436 633
Senior Analyst eva_zamrazilova@kb.cz
FAX +420-224 222 839
Assistance: Pavlína Souralová +420-222 436 632
Assistant pavlina_souralova@kb.cz
Economic Trends 16
will be strongly affected by the balance of
incomes. The pressures on external
financing of the current account deficit will
be dependent on the share of reinvestments
which represent neutral item for the whole
balance of payments. The future
development will be crucially dependent on
three major factors: developments of trade
with goods and services, share of
reinvestments and the inflow of FDI into
basic capital. Further shift to dividends
represent risky factor for the current
account deficit. The FDI into basic capital
are not expected to reach the levels of the
previous decade which will be further
emphasized by the move of the investors
from Central Europe further in the EastSouth
direction (Croatia, Russia, etc.).
Moreover, this territorial shift may be
another cause of further increase of
dividends payments to use them for
financing in other countries.
The future development will be
crucially dependent on three major
factors: developments of trade with
goods and services, share of
reinvestments and the inflow of FDI
into basic capital.