The most immediate problem is the budget deficit. This has to be kept below 3% of GDP to satisfy the criteria for joining the Euro. It can be measured in various different ways. There is a central government budget, but also a more general budget for the government sector as a whole, balancing out across central and local government bodies and including funds that operate nominally outside the budget sphere.

All of these are included in figures produced by the Ministry of Finance using the methodology approved by the IMF. They should avoid fudges (such as masking a deficit by leaving it in a health insurance or pension fund that is nominally distinct from the state budget) and should allow for international comparisons.

The figures in Table 1 show revenue and expenditure in individual years for the government sector as a whole, converted to percentages of GDP. The difference gives the deficit which appears to have been growing steadily, accelerating after 1999.

Table No. 1: Balance of the Czech government sector, using IMF methodology

These figures exclude the category `net loans', the significance of which is taken up later. For now, it would appear that the change in comparison with the mid 1990s was not caused by changes on the revenue side. This fell in 1996, but only relative to GDP, which was still growing strongly. In subsequent years, the proportion of GDP coming as revenue to the state sector has been fairly constant. It is similar to the level in existing EU members and below quite a few.

The expenditure side shows larger fluctuations and a definite upward trend from 1996 onwards. This would appear to be the source of the growing deficit. A worsening in 1998 and 1999, with the economy depressed, could be expected, but continuation in the following years suggests a more serious problem. The usual culprits are seen as state sector pay, pensions, other state benefits and the `costs of transformation'. Each played a part in different years and can be followed from published figures.

Pensions have not been particularly important in the most recent period. The number of old-age pensions increased by less than 7% over the period from 1995 to 2001. Spending on all pensions as a proportion of GDP increased steadily up to 1997, rising from 7.5% of GDP in 1994 to reach 9% in the former year, but has not increased by much since then. Other state benefits have increased by more, roughly following the increase in unemployment. Taken together, these two elements can explain a growth in the deficit by the equivalent of about 2% of GDP since 1996.

The remaining difference is made up by the `costs of transformation'. These appear as the credits given by banks to big and small enterprises in the mid 1990s, most of which are unlikely ever to be repaid. To prevent the collapse of banks and enterprises alike, much of this bad debt was transferred to various institutions that the state created and the banks and enterprises, in many cases, were subsequently privatised, or reprivatised if they had had to be taken back under state control. Losses of those `transformation institutions' have been covered at various points by state subsidies which were equivalent to 2.4% and 2.8% of GDP in 2001 and 2002 respectively. When this element is excluded, it can be seen that there has still been a growth in the state sector's deficit, but it becomes less frightening.

There are two good reasons for considering the effect of its exclusion, or at least for balancing it against proceeds from privatisation. The first is that it represents a debt that should eventually be paid off: this will not be a permanent feature of the state budget in the way that pensions and health care for an aging population certainly will be. The second is that it can, at least in part, be balanced out by revenue from privatisation, another element that cannot be relied on forever. In fact, revenues from privatisation were in many cases only possible because the `transformation agencies' gave help by taking over bad debts.

Despite this, the figures usually used present these two elements in rather different ways. Revenue from privatisation is included within the `net loans' category. The logic of this is that it should not be seen as simple revenue. The state has gained nothing in net terms as it has lost the ability to earn from the assets sold. Revenue from privatisation therefore does not appear as an element reducing the deficit. This can make a significant difference. The government was exceptionally successful in 2001, and even more successful in 2002, in gaining revenue from this source. If this could be counted, then the budget deficit would practically disappear in 2002. This, however, would be false accounting, a method used by some EU members to gain admission to the Euro, only later to find that they could not keep within the required deficit level. However, it does seem reasonable to exclude the costs of transformation from consideration of long-term trends. This is therefore excluded in the calculation of a balance in the last column of Table 2.

Table No. 2: Balance of the Czech government sector as affected by costs of transformation and revenues from privatisation

Source: as Table 1.

It would seem that the three elements mentioned above have explained almost all of the growth in deficit. One major element, the costs of transformation, is predicted to fall in the coming years. If this were the full picture, then there would be a strong case for dismissing fears over the budget as grossly exaggerated. Unfortunately, a serious problem lies ahead.

Table 3 : Composition of Czech population by age group, 2001

Source: Statistical Yearbook of the Czech Republic, 2002, p.113.

Table 3 shows the breakdown of the Czech population by age group. There are two bulges, for people in their 20s and in their 50s. There are relatively small numbers in the 65-70 range. This explains why the number of pensioners has been increasing only slowly. The proportion of the population over 65 at the time of the 2001 census was 13.8%, little more than the figure for 1980. The birth rate was low in the 1930s, then increased rapidly in the next decade.

The large group in their 50s will be adding to the costs of pensions and the need for health care over the coming years. This will have to be financed by revenue raised from a declining proportion of the population in the working age groups. That decline will not be particularly sharp at first, thanks to the large group in their 20s, but will then accelerate due to the effects of a steadily declining birth rate since the early 1970s. As the table indicates, this fell still further in the early 1990s, leading to the small numbers under 10 years of age today and pointing to still smaller numbers of working age in the future.

The first real pinch should be felt in 2005. From then on it can be expected to become more serious. Life expectancy has been rising rapidly, increasing from 67.3 and 75.5 for men and women respectively in 1990 to 71.7 and 78.4 in 2000. These figures are lower than those of any current EU member. A further increase can be expected. This is very good news for those alive today, but will put more pressure on the state budget.

This `pension crisis' is a worldwide phenomenon, caused by the same trends towards longer life and less children. It creates problems for countries with state pension schemes, such as Italy, Germany and France. For them the problem is more serious, with pensions taking 16% of GDP in Italy, way above the level of the Czech Republic. Somewhere this growth has to be covered by higher revenues, or stopped. That means increasing contributions, although scope for that is limited, cutting pensions or increasing the pension age. None are popular. They all appear to break promises made in the past to a generation that paid contributions in good faith.

Private pension schemes, as once vigorously pressed by the World Bank, are no solution either. In the UK the standard state pension is low, taking only about 4% of GDP. Employees typically add to this with occupational or private schemes. These now face a crisis as, particularly with the recent fall in share prices, they are unable to honour commitments. In many cases employees have been told that they will not receive the pension they thought they had saved for. In effect, this is a chaotic and unregulated way of solving the crisis by reducing pensions to below the levels previously promised. Employees can try taking legal action for breach of contract but the outcome is unclear when the money may genuinely not be there.

There are various possible solutions, such as a state-guaranteed basic pension plus help in saving for an additional pension the value of which may not be fully guaranteed. Individuals will put money in over a working life, retire to some extent when they choose, and receive a pension in line with what they have put in. Its exact value cannot be guaranteed, as it will depend on the income of the pension fund at the time. The trouble is that a transition to a new system takes a long time.

Thus, although there is no immediate cause for panic, it seems sensible to seek solutions now to the problems of the state budget and the pension system. Both could be put off, but the aging population will make both more severe in a few years time and a more drastic solution might then be needed.