Sustaining the impressive convergence gains allowed by the Czech automotive sector has become challenging due to its comparatively lower value added, lower investments in research and development, and lower skills in the labor market. Using a structural model of global value chains, the paper examines policies to smooth the transition to the production of electric vehicles in Czechia. The analysis explores the impacts of increasing labor productivity, boosting production capabilities, and moving up the global value chain. These policies were found to have a relatively lower impact when they shift specialization towards lower value-added stages of production.
Cross-Country Comparison of Productivity and R&D
2. The automotive sector is one of the largest sectors in Czechia in terms of output and employment. Czechia motor vehicle sector''s value added and employment shares, stood respectively at 4.9 and 3.2 percent as of 2014 (Figure 2). Furthermore, sectors adjacent to motor vehicles, such as trade of motor vehicles and repair of equipment, are also important sectors in Czechia economy, reflecting the positive spillovers of the auto industry to Czechia industry.3
Sectoral Share of Czechia Economy
Intermediate Suppliers and Consumers from Czechia Auto Sector
Electric Vehicle Production in Czechia
a. Value chains. The production side of the economy is composed of two value chains— corresponding to electric and combustion vehicles—and a numeraire good. The value chains consist of different stages of production, referred to as sectors and denoted by h. Each sector is composed of heterogeneous goods that differ in terms of their relative productivity and use both skilled and unskilled labor as inputs. The relative labor intensity of a sector is denoted by αh and the relative skill intensity by βh.
b. Trade of goods. Sector h goods produced in the domestic economy i can be traded to any foreign economy j by paying a variable trade cost and fixed trade cost . The fixed trade cost implies that in equilibrium only the most productive goods are sold in foreign market.
c. Entry of new goods. The final component of the economy determines the mass of goods produced in equilibrium. Firms in each sector pay a convex cost that allows them to produce new varieties of goods that differ in terms of productivity. Productivity is used in the creation of new goods and determines its relative profitability for the firm. The mass of goods determines the overall economic activity in a sector—for a given level of trade costs and cost of labor—and can be equivalently thought of as total factor productivity. Given this interpretation, the mass of goods is used interchangeable with a country''s sectoral capabilities.
Automotive Global Value Chain Structural Model Illustration
Illustration of the Automotive GVC
Czechia: Calibrated Parameters
Transition to Electric Vehicle Production
11. The model is used to simulate three broad policy schemes that could potentially aid the structural transition to electric vehicle production. As discussed below, these broad policy schemes are taken as stand-ins for groups of more specialized policies that could be implemented by the government.
a. Boosting labor productivity. The first group of policies is related to investments to increase or enhance the share of skilled labor, which is comparatively low in Czechia automotive sector, and more broadly at the aggregate level (Figure 4). This policy is implemented in the model by increasing Czechia labor productivity to match that of Germany, making skilled labor more abundant and cheaper. In practice, this group of policies captures any labor productivity enhancing policies, including investing in education, upskilling, re-skilling, and lifelong learning programs, as well as digitalization policies that could boost existing skills.
b. Support for horizontal production capabilities. The second set of policies considered relates to investments in the capabilities of the automotive sector where Czechia economy already performs well. This policy is implemented in the model by reducing the entry cost of Czechia for intermediate sectors in both the electric and combustion vehicle (CV stage 3 and EV stage 2) production by 20 percent. This policy scheme could alternatively be thought of as a reinforcement of the country''s current production capabilities and specializations. In practice, this policy includes improving the (global) competitiveness of the automotive sector as it is currently structured, including investing in infrastructure, subsidies to operations of current firms, or lowering trade costs.
c. Support for vertical production capabilities. While the second policy reinforces existing capabilities, the third policy scheme promotes moving up the global value chain through investments in capabilities that are not yet the comparative advantage of Czechia economy. This policy is implemented in the model by reducing the entry cost of the most downstream sectors for both electric and combustion vehicle production by around 20 percent, which facilitate the shift to higher value added and more skill-intensive sectors. In practice, this policy should be thought of as capturing any policy enhancing downstream activities, including research and development subsidies, lowering cost of new firm or product entry, or labor market policies that allow access to foreign experts.
12. Boosting labor productivity or supporting higher-value segments would yield a comparatively higher returns than horizontal policies. The outcome of the policy experiments mentioned above vary in terms of their impacts on output, the value-added share, employment, and the skill share (Figure 8). For comparability, the impacts are expressed as the change in the equilibrium outcomes under the policy scheme relative to the electric vehicle equilibrium (defined above).
13. Boosting labor productivity leads to an increase in output, employment, the skill intensity of the economy, and the value-added share. Higher labor productivity allows Czechia to move towards higher value-added sectors, and thus rebalances the productions of the intermediate EV sector and the final EV sector relative to the baseline. In particular, some of Czechia''s intermediate EV sector production would be produced in Germany, while part of the Germany''s final EV sector production would be produced in Czechia.
14. Policies to support horizontal production capabilities could paradoxically have negative effects on Czechia automotive sector across four dimensions. This effect could be attributed to the allocation of economic activity across sectors implied by horizontal policies. In Czechia, these policies are associated with a higher investment in the production of intermediate goods (e.g., EV car frames). While horizontal policies have a positive direct impact on the automotive sector in terms of increased production of intermediate goods (e.g., car frames), they also indirectly affect the final production goods (e.g., final assembly) through two channels in the model (section B).
a. Domestic competitiveness effect. In the short-term the final good becomes cheaper to produce, and more profitable, in both Czechia and abroad because due to cheaper Czechia intermediate inputs, which also has a positive impact on Czechia automotive sector.
b. Global competition effects. Second, all else equal, increased profitability of the final good production incentivizes investments that increase final good capabilities in both the domestic market and abroad. This results in increased global competition for Czechia final good producers, which over time negatively impact Czechia automotive sector, dominating other effects and leading to an overall negative impact on Czechia automotive sector. The negative impact dominates partly due to fact that horizontal policies lead to reallocation of activity from a relatively favorable stage of production (final good) to a relatively unfavorable stage of production (intermediate production).
This annex discusses in more details the model including the construction of the value chains, as well as the model parameters and their calibrations.
1. Countries and Household Preferences. The economy is populated by I countries, which we index by i and j. Each country i is populated by a mass Ui of unskilled workers and a mass Si of skilled workers that we assume are strictly greater than the labor employed in the automotive sector. Households have preferences over the consumption of a numeraire good C0 and an automotive good C given by
2. Production of the Numeraire Good. The numeraire good is freely traded and produced in each country by a representative firm that employs both unskilled and skilled labor. The production technology is given by
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