Untitled Essay, Research Paper

A study of the market reforms in post-communist eastern Europe with a specific

case study of Poland

Introduction

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.

Communist Economics

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

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.

Poland

Brief History

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.

Inefficiency

Agriculture

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

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.

Foreign Debt

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).

Market imbalances

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.

Summary

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.

Stabilization

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.

Popular Attitudes

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).

Institutional Reform

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.

Supply Response

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.

World Environment

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.

Conclusion

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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