Back in the mid-1990s, the mood in Warsaw was buoyant. The favourite metaphor for the Polish economy of the then minister of finance was that of “the soaring eagle of Europe”.
Today, two and half years after EU accession, growth is running strong enough to again warrant flattering metaphors. In the meantime, however, Poland’s growth performance has been somewhat disappointing. Now that activity is soaring anew, the challenge is to ensure that the upswing turns into a sustained catch-up. This requires a number of reforms, many of which are spelled out in the most recent OECD Economic Survey of Poland, released a few months ago.
Since Poland joined the OECD, real GDP growth has on average exceeded 4% per annum, as against 2.75% OECD-wide, 3.75% for the other new EU member states and barely over 2% for the EU15. As a result, income per capita, valued at purchasing power parity, rose from below 40% of the OECD average in the mid-1990s to almost 50% today.
While the income gap has narrowed, it remains wide. Upon OECD accession, Poland was the third poorest OECD member, ahead of Mexico and Turkey and, today, this ranking is unchanged. In fact, while Poland did catch up during the 1990s, it subsequently lost momentum, especially when compared with some of the other, smaller new EU countries, where convergence has been making faster headway.
However, since mid-2005 or so, the Polish economy has been expanding at its potential rate or even a bit faster and this newfound dynamism is not expected to falter over the near term. Encouragingly, investment is booming, following a protracted spell of much-deplored under-investment.
Equally spectacular and at least as welcome is the stunningly rapid decline in unemployment over the past few quarters. Indeed, after hovering for five years between 18 and 20%, the unemployment rate has plummeted since late 2005. Its level remains the highest among OECD countries but it is projected to decline further. Granted, emigration, early retirements and a growing number of full-time students are helping. But the improvement also reflects a strong pick-up in employment, which is now expanding faster than ever since Poland joined the OECD.
Even though apparent labour market slack is rapidly diminishing, inflation has stayed very subdued, well below the mid-point of the National Bank of Poland’s 1.5-3.5% target range. In fact it is low–if somewhat volatile–by OECD standards and especially in comparison with other catch-up economies.
Another pleasant surprise this year has been the faster-than-expected decline in the fiscal deficit. Like in many other OECD countries, revenues have come in more abundantly than foreseen. While this constitutes an improvement, it is partly cyclical, and it is not sufficient.
With a gross public debt ratio that is far below the OECD average, with a major pension reform successfully implemented back in 1999, and given the government’s intention to bring down the deficit below the Maastricht threshold by 2009, some question the need for more rapid fiscal adjustment.
Yet, on current policies, even with growth of around 5% per annum, the public debt ratio is set to rise, because of the spending pressures.
To achieve lasting and better fiscal consolidation, the Zł30 billion (less than €8 billion) nominal state budget deficit ceiling used as an anchor by the government should be complemented by a multi-year framework spelling out expenditure priorities, with limits on overall public spending.
Specifically, spending on social transfers ought to be reduced so as to make room for other priorities, notably health and long-term care, child care, education and active labour market measures. Mainstreaming the social security regime for farmers is one of the main recommendations, and should be easier now that the rural sector receives substantially more income from the EU Common Agricultural Policy.
There is also a need to simplify the tax system and to reduce administration costs. As part of the streamlining, the tax base should be broadened as much as possible, by curtailing special provisions and exemptions.
Furthermore, it is important to bring down the very high tax wedge (that is, the gap between wage costs to employers and wages paid to workers), especially for low income earners, so as to reduce the disincentives to take up a job. The government package involving a cut in payroll taxes sent to Parliament a few months ago was a step in this direction.
Another important avenue to raise labour utilisation is to promote internal geographical mobility–international mobility is already remarkably high. This can be achieved by continuing to upgrade transport and communications, and by improving the national integration of the public employment service. A more fluid housing market would also help.
Turning to human capital, a number of education reforms were introduced during the 1990s. Partly as a result, the quality of compulsory education has improved, but from comparatively modest levels. One way to make further progress would be to encourage the pre-schooling of children under six.
Tertiary education has expanded tremendously over the past 15 years, from 400,000 students, all in the public sector, to 2 million, with many in private institutions. This surely helps lift productivity, but problems of co-ordination and mismatch of resources endure, both between public and private institutions and among students.
A state body has been created to monitor the quality of higher education institutions. This makes for more transparency and better quality. However, quality control and information dissemination need to be reinforced. Equity and efficiency would both benefit if tuition fees for full-time students in public highereducation institutions were introduced, alongside improved systems of means-tested grants and student loans with income-contingent repayments.
Adult training is key in a rapidly changing economy, but Polish firms are less active in that respect than in most other OECD countries, and a large share of the training is financed by the employees themselves. Moreover, training is in practice mostly benefiting younger and more educated persons.
Productivity can also be boosted through better product market regulation and intensified competition. One dimension of the problem is corruption. The efforts underway to eradicate it are important, since it holds back potential investment, both domestic and foreign.
Last but not least, productivity could be raised by reducing public ownership further. It remains very high compared with the other OECD countries, at the expense of investment in R&D and physical capital. The OECD’s advice is therefore to step up privatisation and to step back from the temptation of “economic patriotism”, which tends to dress up what are in effect incumbent producers’ private interests as public or security concerns.
To sum up, Poland’s convergence may have been slower than in some of the other catch-up countries so far, but it has certainly been very real. The current auspicious economic environment and comfortable external position of the Polish economy make it the best of times to push through the more ambitious reforms. ~
N.B. This article is based on a speech delivered by Vincent Koen, Counsellor in the Economics Department, at a conference celebrating Poland’s first decade as an OECD member in Warsaw on 23 November 2006. For the full 2,800 word version, click here or contact email@example.com
- Cotis, J.-P. and V. Koen (2005), “The political economy of strong fiscal adjustments in aspiring euro area countries”, presented at a National Bank of Poland and Magyar Nemzeti Bank conference, Warsaw, 30 June–1 July.
- de Broeck, M. and V. Koen, “The ‘Soaring Eagle’: Anatomy of the Polish Take-Off in the 1990s”, IMF Working Paper No. 00/6, January 2000.
- OECD (2006) Economic Survey of Poland, June.
- OECD, Going for Growth (2005, 2006). The third in this series is to be published in February 2007.
- Growth and Competitiveness in the Polish Economy: The Road to Real Convergence, European Economy, Occasional Paper No. 27, November 2006.
©OECD Observer No 258/259, December 2006