A study of the market reforms in post-communist eastern Europe with a specific case study of Poland
Poland, as well as it's fellow post-communist countries, face an arduous task in
re-inventing their economies to match the dominant Western style currently dominating the world. The difficulties lie in the areas of ideology, structural needs (massive changes required), world recession(current) and debt load.
Why did the economics of the communist bloc fail so miserably? Why has every single socialist, fascist, communist and other non-democratic country had to implement economic change in order to survive? This is due to some inherent problems in the command economy idea.
Monopolies (in a command economy) tend to produce inefficiency, low quality goods, lack of innovation and technological improvement.
Command economies tend to focus on growth rather than strength leading to larger production and an evan. worse use of available resources.
The 1980's marked a change in world markets meant that the communist economies were faced with four challenges that would, if met, have meant the continuation of the USSR.
Resource saving miniaturization requiring high technology and skill were demanded (command economies have neither), Flexible production to meet a variety of needs (command economies have large factories to keep production high - they, thus, did not have the funds or ability to affect the necessary changes to their means of production), the 'information age' meant that the communist bloc had to deny the new prevalent types of technology, which would spread Western ideas, and thus they fell behind), and 'software' became essential to the growth of industry (the 'hardware' focus of the East could not absorb this new approach.
As well, the changes are being attempted in a deep period of economic crisis that make an already difficult process even more difficult.
Changing the Economy
Systematic transformation requires institutional innovations, the internal liberalization of the economy, the external liberalization and the adjustment of the real economy as well as the monetary system.
Not only does there need to be a different institutional framework for a market economy but one has to remove most of the inherited structures and to change the typical behavioral patterns in industry, state and private households.
Privatization is a difficult task because of four main factors. Firm sizes in post-communist countries tend to be large. This means that their division or shrinkage poses difficulties for foreign investors, they are however, not worthwhile at current sizes and must be reshaped. Expectations are running high but attitudes ingrained in the workforce will need time to change. None of the structure exists to deal with private firms and must be created along with the labor needed to run it. There is very little knowledge and certainty about the property rights issue and until resolved investors will be wary of the situation.
However, not all countries have addressed the needed changes in the same fashion. Poland has been a leader in foreign investment and involvement when compared to it's post-comminist counterparts.
The name Poland is derived from that of the Polanie, a Slavic people that settled in the area, probably in the 5th century AD. Poland is a nation in east-central Europe. In the 18th century it was divided up by its neighbors and ceased to exist until resurrected in 1918. Again partitioned by Germany and the USSR at the beginning of World War II, it was reestablished as a Soviet satellite state in 1945, and remained a Communist-dominated 'people's republic' until 1989.
Mikhail Gorbachev's appointment as Kremlin leader in March 1985 was the signal that the Polish opposition had been waiting for. Exploiting the new liberalization in the region, Lech Walesa and Solidarity, Pope John Paul II and the church hierarchy, and ordinary citizens stung by the deepening economic recession combined to force the Communists to sit down at roundtable talks in 1989. They secured far-reaching political concessions and exploited the resulting opportunities for political competition to drive the Communists from power
The new non-Communist government sought to bring about economic reform through 'shock therapy' in a scheme devised by Finance Minister Leszek Balcerowicz. Introduction to Polish economic situation
Poland's fundamental economic problem is that production and living standards for it's 38 million people is considered to be inadequate. With a GDP about a third of the United States (on a per capita basis), Poland is considered to be a middle income country.
During the 1970's, the Gierek government tries to tackle the problem (of economic distress) through a policy of rapidly expanding consumption coupled with investment financed by foreign borrowing. For several years this economic policy generated growth of about ten percent per year (The USA's current growth (In GDP) is between 2-3% with 4% being the goal).
However, the policy was to eventually fail due to mismanagement, recession in Western export markets (i.e a lack of foreign investment), a bias towards products in weak demand but costly to produce (in terms of energy input and raw resources). These three factors produced an economic crisis that resulted in negative growth rates in 1979,80,81 and 82. It also produced the Solidarity movement in 1980 and the implementation of martial law the following year.
During the 1980's, Poland managed to regain earlier production levels, at the end of this period of economic development there was some restructuring of production, away from heavy industry towards lighter industry, food processing and services. As well there was slight movement towards the movement of business from state to private hands (with the goal of believed market mechanisms for efficiency). The private sector, in Poland, now accounts for one-third of the labor force (2/3 of that in agriculture).
However, former policies (as mentioned above) have created a basic economic situation in Poland that is marked by inefficiency, foreign debt and market imbalances.
Agriculture accounts for 13% of national income, 28% of employment and 12% of export earnings. It is predominantly a private industry sector (about 75%) but productivity is low and development is stagnant. In this area Poland has fallen progressively behind it's east European neighbors.
This lack of progress is due mainly to an inefficiently small size of farms (10 hectares or less), inefficient production methods, lack of investment incentives and limited access to inputs such as fertilizers and pesticides (which would increase productivity and reduce loss due to pests).
Industry (including energy and manufacturing) produces about half of GDP and employs 29% of the labor force. The sector is largely biased towards heavy industry and large state enterprises (classic approach of communist ethic). Over 90% of industrial output is produced by the 6000 (or so) state owned enterprises. This outmoded productive base needs to be restructured. Industry is largely over-manned and energy intensive. Energy consumption is 2-3 times higher per unit of production in Poland than in the average Western Industrialized country. There are significant energy reserves in Poland, in the form of coal, oil and gas (in eastern Poland), but these reserves need modern technology to be tapped. Poland is no longer a net energy producer and must import energy to maintain production.
Incentives for management and workers have been distorted (includes unrealistic prices-low energy and pollution costs, soft budget constraints and employment guarantees.
Largely created during the 1970's, this totaled more than 48 billion dollars (US) before the more than 50% reduction of official debt in March of 1991. The remaining 30 billion dollars is still a heavy burden on the economy. The debt service due (interest - simple maintaining of debt at present level) in 1991 amounted to 4 billion (40% of 1989 exports).
The government fell into arrears with many creditors (2/3 owed to foreign governments, 1/3 to foreign banks). The debt was being traded on the markets at 15 cents on the dollar down from 40 cents at the end of 1988 (meaning that the creditors were not secure in the belief that Poland was a good debtor and that their debts were unlikely to be paid in full - hence the drop in value of holding part of their debt).
Shortages and excess demand for consumer goods and factors of production were deeply ingrained in the system until the reform of January 1990. Subsidies accounted for 14% of GDP (down from 17% in 1983), and the budget was running a deficit of 8% of GDP in 1989.
Poland's economy was structured, in the same way systematic of communist countries, in an inefficient manner. Production was large, state owned and in usual monopoly, This meant that the economy was without the benefits of private market mechanisms for economic efficiency. In attempting to compete in an increasingly globalized world market Poland's economic situation became dire. This coupled with debt (and the needs of servicing it) meant that the economy was in need of change on a grand scale if Poland was to emerge as an economic force with reasonable success in comparison to her neighbors in Europe and the world .
The Reform Process
Against the background , the Mazowiecki government adopted a rapid and radical reform program for 1990. The aim, of this program, was to effect a transformation of the Polish economy from a command to market economy based on proven institutions with market determination of prices and convertible currency. The program included measures for stabilization, liberalization and restructuring.
A number of policy measures were directed primarily to stabilization objectives.
1) Budgetary balance: increasing taxes by 50%, reducing government investments, and reducing subsidies from 14% of GNP to 6% in 1990. (These measures were designed to increase revenue while decreasing expenditures making for a balanced budget and the ability to repay the national debt)
2) Tight monetary policy with positive real interest rates (interest minus inflation = real interest rate) to eliminate hidden subsidies from household savers to state enterprises via low interest rates in the banking sector that were estimated to total 10-15% of GNP in 1988 and 1989.
3) Eliminating controls on more than 90% of prices in the economy, with exceptions in energy, public transport and housing. (This was designed to eliminate state pricing that did not reflect accurate market pictures of cost and demand)
4) Wage restraint, providing only mild wage indexation (indexation = change of wages based on cost of living increases (i.e. inflation) - limited means that wages would remain largely unindexed and thus workers would not (unless given a raise) earn the same relative salary as years past and would experience a loss in buying power). Excess wage payments were taxed at a punitive 500% enterprise tax rate.
5) Foreign debt was rescheduled by an agreement with the Paris Club (Holder of 2/3 of national debt) in march 1990 and reduced by at least 50% in March 1991. A structural adjustment loan of 394 million was obtained by the World Bank in 1990, as well as an IMF (International Monetary Fund) stand-by of 569 million and commitments from the G-24 stabilization fund (of 1 billion) and EC (economic community) of financial aid.
Liberalization of Foreign Trade
This implies the lifting of most of the quantitative and licensing restrictions coupled with the lowering of tariffs to between 15 and 50% for most goods. Since 1982 an increasing number of enterprises have been granted authorizations to conduct foreign trade activities, in addition to the 60 (odd) specialized state enterprises (with the same privilege).
Export incentives include export related income tax reliefs, a foreign-exchange retention system introduced in 1982 (this granted export enterprises priority rights to buy foreign exchange for production related imports).
Restructuring of the Economic system
This was to mean measures of a more radical nature to be introduced in a gradual nature.
1) Deregulation of state enterprises and enforcement of strict payment procedures; new bankruptcy and anti-monopoly legislation intended to harden budget constraints and to reduce monopoly power. The system of ad hoc, ex post tax differentiation with respect to sectors, firms and factors of production will be replaced by a uniform system of taxation (enterprise tax, personal income tax). Abolishment of industrial associations, in order to, prevent informal co-ordination of their activities.
2) Well defined property rights. The new government inherited a system under which workers' councils were directly involved in enterprise decision making and the appointment of managers (the obvious lack of industry strength under this system is obvious). A Major difficulty is the reconciliation of workers' rights and the privatization law of adopted in July, 1990 (this law envisages far-reaching privatization).
State companies are being transformed into companies with shares owned by the state to be sold later to the public. At most, 20% can be sold to worker on preferential terms and 10% to foreign investors without certification. However, larger scale sales to foreign investors are possible subject to government approval (the process is expected to be mere formality).
The obvious gain of this is to increase government revenue (in the short term) and to create, through foreign investment, a vibrant economy providing jobs and revenue n the future.
3) A new monetary system based on a two-tier banking system. The monopoly bank was split in February 1989. Interest rates are to reflect market forces, government bond sales can be used to manage possible budgetary deficits, and commercial paper will be issued (which can cope with the problem of inter- enterprise arrears by turning them into tradeable securities to be discounted at commercial banks).
This was designed to create better adjusting 'natural' market forces and to enable industry to better cope with the economic changes.
The Results of Reform
The reform program led to initial results that were no less than remarkable. However these results have in most cases not been sustained over time.
Inflation, after an initial jump, fell to a much lower rate; but it did not fall as far as was hoped and the problem is not yet beaten (low inflation has become a dominant economic policy in the last two decades). In 1990 inflation was at 585%, in 1991 it was supposed to drop to 36% (according to IMF forecast) but only fell to 80%. (For perspective the 'normal' inflation rate in the Western world stands at between 1-3%).
Relative prices responded rapidly to the 1990 price liberalization and shortages largely disappeared. Strong positive real interest rates were established. The budget was initially in surplus (unheard of) but has since gone back into deficit.
The economy remains in a deep recession. GDP fell by 8-12% and output by 12-18% in 1991. The deepest output decreases have been in textiles, coal, metal and transport. Investment in 1991 was 15% below levels of 1990.
However, output in the private sector increased in 1990 by 17% (might be due to the simple increase in the size of the private sector). Agricultural output has not decreased, so far, despite a drop in fodder and fertilizer sales to one-third of former levels.
As well, bankruptcies have been rare, new firms have been established (net increase in firms in 1990 of 362,000). Enterprises have been cushioned, so far, by decreasing investment expenditure, sale of capital assets and stocks, and have used their resources to secure short-term survival and avoid lay-offs.
Unemployment is also low compared to the drop in production levels (May 1991 - 8% of labor force jobless).Real wages have fallen sharply (25% immediately after reforms in 1990) and continue a downward trend.
Problems of Reform
The ultimate aim of the reform process is to infuse a dynamic element into the economy by means of marketization (making economic agents responsive to real prices) of production and privatization of the means of production. The full range of the necessary conditions for growth is not clear (economists rarely agree) but it is clear that there exists a minimum requirement for successful reform. This includes political, cultural and economic sustainability.
Initially, both the government and the population were fully committed to the reform process. In the first months of 1990, the government could claim an unprecedented degree of legitimacy and support from the population. In the public opinion polls the proportion of people who felt that their economic situation was at least 'not bad' rose from 13% in autumn in 1989 to 20% in January 1990 and up to a high of 27% in March of that same year.
Since then, however, this spirit of success has become tarnished. Polls in mid 1991 showed that most people expected tensions to increase. In 1991 the CBOS polling firm recorded (in March) a 48% difference between optimist and pessimist (54% pessimist versus 6% optimist).
The likely reason for this is that expectations rose faster than the possible economic gains and the populations expectations were not (nor could not be met).
A huge amount of new economic legislation is required to establish a general rule of law and institutions appropriate to a market economy.
A crucial aim of reform is to improve incentives for private and state-owned enterprises. Property rights are to be clearly defined and contracts and payment procedures strictly enforced. Privatization has a high priority, however, there are still issues of timing, scale and foreign investment that need to be worked out.
The Polish people are eager for quick reforms and a fast rise in living standards. There are, however, risks to endeavors such as quick privatization. This type of project (mass privatization) is costly in terms of consultants, administration (to monitor the new owners rights) and is dangerous in terms of insider acquisitions.
Privatization policies are also difficult in an environment where the home populace is unable to afford a stake in the new firms. During the initial phase of reform individual Polish financial strength has diminished. This has meant that foreign investment was needed to buy the once state owned firms. This might create problems in the future with little or no control exercised by the Polish themselves in their own country.
Adequate labor market institutions are absent, worker still appeal (in general) to the state authorities rather than to enterprise management when claiming higher wages and other improvements. A system of collective bargaining is needed, and the private enterprise needs representative organizations.
Institutions that can transmit market signals to producers are lacking. Should the signals pass there is often structural rigidities that prevent the necessary changes needed to capitalize on consumer demand.
This is crucial to the success of reform in accelerating economic growth. Poland has had the misfortune of four recent blows to the economy. The reduction of the former GDR market after the German reunification (this has meant the loss of job for 35,000 Polish migrant workers), severe cuts in exports to other parts of the former CMEA (especially Russia) (Poland's exports for reasons of quality and price cannot compete with Western exports), increases in world oil prices (Poland imports energy) and finally the world recession of the past 4 years which has forced Western economic concentration on itself and thus world aid has been reduced.
Poland has been the unlucky recipient of economic and political freedom in terms of timing. The Western world is in a debt crisis and can no longer help as much as they once would. As well, the end of the Cold War has meant that Poland is no longer as important as it might have been as a lever for the democratic countries of the West. It's pursuit of democracy does not have the same impact as it would have had under Cold War circumstances.
From an economic point of view Poland, and every other East European country in this situation, is faced with a lumbering giant of an economy littered with inefficiency, waste, bad management and technology decades behind the countries they are now in competition with. This means that Poland will need to effect a complete reconstruction of it's economy in order to be able to, in the future, compete on an even level.
Poland has the ability to emerge from this economic recession and emerge as an solid economic power capable of providing good living standards for her people.
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