Poland's successful transition

Economics Department

Poland is one of the most successful transitional economies in Europe. Can it keep up its good performance?  

Ten years after launching an ambitious programme of economic transformation, Poland has established itself as one of the most successful transition economies. Unlike other countries in central and eastern Europe, Poland did not encounter a mid-course depression, its currency has not been subject to speculative attacks, and the economy slowed down only moderately in the aftermath of the Russian crisis in August 1998. As a result, over the last four years output has expanded vigorously, inflation has declined and living standards have improved.

According to an economic survey published recently by the OECD, Poland’s robust economic growth reflects large inflows of foreign direct investment (FDI) and the dynamism of small private enterprises. In 1998 Poland attracted 40% of all FDI flows to central and eastern Europe and the Baltic States. Foreign investors initially focused on the domestic market, which after all is the largest in the region, although they are now showing interest in using Poland as a base for exporting goods to other western markets, including high-tech activities. In addition, with deregulation and small-scale privatisation, a vibrant sector of small and medium-sized enterprises has emerged. More than two million entrepreneurs now operate in retail trade, construction and light manufacturing industry. They make an important contribution to output growth and job creation, and form a new class of consumers.

Barring unexpected developments both at home and abroad, and despite some tightening of macroeconomic policies, output growth should gather new momentum and reach some 5–6% in the next two years.

Private consumption is projected to grow as Polish consumers enjoy strong increases in real disposable incomes in an environment of plentiful consumer goods and emerging new services. Business investment should remain strong, as Polish businesses continue to modernise and foreign investors bring in more capital. With the revival of activity in the European Union, exports should reach double-digit growth rates. The projected economic growth is expected to create more jobs, but registered unemployment – currently around 13% – may decline only gradually in the near future, as large groups of new school leavers join the work force and increase the number of job seekers.

Beating inflation

An encouraging performance, but to stay on track Poland will have to deal firmly with two macroeconomic challenges, the first of which is to keep inflation under control. Until recently, the monetary authorities had been successful in reducing inflation to a single digit level. They responded to an overheating economy with preemptive interest-rate hikes and then dealt successfully with the contagion effect of the Russian financial crisis by aggressively easing monetary policy. These timely actions gave the independent National Bank of Poland and its Monetary Policy Council (MPC) the credibility it needed in the eyes of the financial markets.

But inflation has revived in the last six months and climbed back above 10%. Such a level is not consistent with Poland’s desire to join the European Union and eventually replace its currency with the euro. To get there, the MPC has introduced a new approach of “inflation targeting”, a framework under which central banks announce their inflation targets to the public, and then adjust their stance whenever inflation is projected to slip off target. As a first step, the National Bank has announced that it intends to reach a medium-term target of below 4% by 2003. If accompanied with an appropriate monetary stance, this new framework should put Poland back on a path of gradually decelerating inflation.

The second challenge Poland faces is how to continue financing its large current account deficit, which now stands at some 7% of GDP. The deficit has widened in the last few years because of higher imports, a reflection of strong domestic demand. Exports have also been growing, but not fast enough to prevent the trade deficit from widening. While there is no specific level of the current account deficit which is unsustainable, a larger deficit would make Poland’s economy more vulnerable to unexpected external events, such as a new financial crisis in emerging economies. Financial markets do not feel comfortable about economies with large external deficits and they need to be reassured that the authorities are committed to the right macroeconomic and structural policies.

That includes maintaining a business-friendly environment that encourages further FDI. Sweeping structural reforms are under way, covering decentralisation, taxation, healthcare, pensions, privatisation, labour, and education, but not all of them have been successful. A recent proposal to reform the tax system has, for instance, met with stiff political opposition, and the authorities have been forced to drop some of their most innovative initiatives. And in healthcare, reform efforts have been lagging. Despite a new national insurance scheme and the fact that a comprehensive bill on healthcare is currently under consideration, much needs to be done to get the system right and win the public’s confidence.

High marks from Brussels

Though not yet a member, Poland already enjoys a high degree of integration with the EU. Two-thirds of its foreign trade is with the Union. In fact, Poland has a larger share of its trade with the EU than either Greece or Italy, and most of its direct investment flows come from west European countries. The European Commission regards Poland as a functioning market economy, able to cope with the competitive pressures and market forces which being a full Union member will undoubtedly bring.

So where are the weak points? Along with other EU countries, Poland needs to carry out a painful restructuring of industries that receive subsidies inconsistent with EU rules, such as coal mining and steel milling. Its environmental standards remain the legacy of a bygone era and could do with some improving, which would mean costly investments in air and water clean-up equipment. Finally, its small-scale farming sector will have to adapt to EU rules. The goal of EU membership has mobilised the entire country and has been the momentum behind the reform programme. But there are signs of “accession fatigue” setting in, and Poland is right to aim for a swift integration.

Sustained strong economic performance will be a boon to Poland’s ambitions. Of course, this presupposes that macroeconomic policy holds its steady course, and that measures are taken to weather the threats arising from both the widening current account deficit and the rise in inflation. Recent decisions by the Council of Ministers and the National Bank of Poland confirm that the authorities are taking these conditions seriously. Parliament has adopted a budget for 2000 that aims to cut the general government deficit and the government has adopted ambitious privatisation targets for the year which will provide the necessary financing of the budget deficit. And the Monetary Policy Council raised its interest rate three times since September 1999, proving its determination to keep the lid on inflation.

Who would doubt the Poles winning the battle? Arguably more than any other country, certainly among transition economies, Poland commands respect in the international arena and so far enjoys the confidence of the market. What remains to be seen is if Poland can sustain this remarkable performance over the long term.

Bibliography

Chlon, Agnieszka, Marek Góra, and Michal Rutkowski, Shaping Pension Reform in Poland: Security through Diversity, World Bank Social Protection Discussion Paper No. 9923, Washington DC, August, 1999.

Council of Ministers and Ministry of Finance, The Strategy of Public Finance and Economic Development – Poland 2000-2010, Council of Ministers and Ministry of Finance, Warsaw, June, 1999.

De Broek, Mark, and Vincent Koen, The ‘Soaring Eagle’: Anatomy of the Polish Take-Off in the 1990s, IMF Working Paper 00/6, Washington DC, January, 2000.

National Bank of Poland, Monetary Policy Council (1999), Inflation Report 1999, I-II Quarter, Warsaw, September, 1999.

©OECD Observer No 220, April 2000




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