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Poland: economy in transition.

After a review of the current position of the Polish economy and the basic reforms initiated by the Solidarity government, the author considers the policy issues involved and the steps to be taken for a transition from a socialist to a capitalist economy. Foreign private and public sector funds will be necessary for the transition to be successful.

THE SOLIDARITY-LED government, which came to power in September 1989, inherited from the Communists the stewardship of a planned economy in a state of collapse. The political and economic policies of the predecessor Jaruzelski-Rakowski regime stoked the fires of inflation, which hit over 50 percent on a monthly basis and which the Solidarity government had to stop immediately in order to prevent the complete implosion of the Polish economy.

The economy and industrial base inherited by the Solidarity government led by Tadeusz Mazowiecki was shot through with inefficiencies of all kinds. Prices of goods and services were unrelated to costs, requiring enormous state subsidies to enterprises while shortages were pervasive. The state-owned enterprises were organized in ways that made it "easier" for the planners to implement the directives of the central plan and made it easier for the managers to meet plan's targets in the "economy of scarcity." As a result, Polish manufacturing and service sectors are populated with enterprises that are highly integrated both horizontally and vertically. [1] The Polish economy thus lacks the Mittlestand (medium-sized) firms, which have been characterized as a foundation of West German economic growth and export trade. Fortunately, Poland's economy seems less concentrated than that of East German.

The managers of these enterprises had very little incentives to minimize costs, to meet consumers' needs, or to maintain any kind of financial discipline. Because prices did not reflect economic costs, subsidies both at the firm level and consumer level were pervasive. Worse, when bankruptcy threatened, the "soft budget constraint" was invariably relaxed and the government would bail out a firm.

Finally, the half-hearted attempts at reform by the Rakowski-Jaruzelski regime have handed workers' councils a substantial role in day-to-day management, thereby further hampering efficiency.

Surprisingly, perhaps, social infrastructure also has been devastated by years of Communist rule. One might have, incorrectly, expected that social services, such as housing, education or health care, and even environment, would not be denied the necessary resources in a socialist state. In fact, The opposite was the case. The Solidarity government has been confronted from its inception with a crumbling social infrastructure that ultimately will require huge sums to rebuild.

Agriculture also has suffered under communism. Because in Poland it remained largely uncollectivized, with 80 percent of land in private hands, it remained undercapitalized, underequipped, and short of credit. Unfortunately, privately held land was broken up into numerous small plots on which efficient cultivation was almost impossible. At the same time, legal restrictions on land purchases made it impossible to combine small holdings into more efficient private farms. [2]

This precis of the economic situation in Poland offers some indication of the enormity of the task that reforming, rebuilding, and restructuring of the Polish economy will have to entail.


The first task for the Solidarity government was to put the economic house in some semblance of order. The government had to decide quickly on an overall strategy and implement it, before the economy collapsed completely. As has been widely reported, the Polish road to a democratic, capitalist economy took a form of a "leap to the market." The strategy for reform fashioned by the Deputy Prime Minister and the Minister for Finance Leszek Balcerowicz eschewed the notion of partial reforms and rejected the idea of the "third way" between socialism and capitalism as a way out of the economic morass facing Poland. Instead, banking on the overwhelming support for the Solidarity-led government, the government took drastic steps towards economic reform. It quickly implemented its macroeconomic stabilization plan to control the budget and the money supply and embarked also on preliminary microeconomic reforms.

As a key part of its macroeconomic stabilization program, the government fixed the rate of exchange of a zloty to the dollar at 9,500 zl/dollar, close to the black market rate but much above the preexisting official rate, and it also ensured complete convertibility of the dollar in international trade transactions. This had two purposes. First, it provided a stable set of zloty prices for commodities that were traded internationally. The second purpose was to increase competitive pressures on Polish firms so as to put downward pressure on prices.

The government also implemented a policy of wage controls in state enterprises, in which wage discipline broke down completely in 1989. As a result, certain relative wage rigidity crept into the system.

To accompany these macroeconomic measures, the government also introduced the first set of microeconomic reforms. The government removed (almost) all subsidies to state-owned enterprises and largely decontrolled prices.

The aggregate effect of this package reforms on the Polish economy has been dramatic. (See accompanying charts.) After an additional burst in the early Winter of 1990, rate of inflation fell to a 5 percent per month rate. [4] This is still very high by Western standards, but much below the 50 percent plus rate before the macrostabilization plan was implemented. There is no doubt that the government will have to bring the inflation rate down even further if it wants to maintain a stable rate of exchange. It is impossible for Poland to experience an annual inflation rate that exceeds tenfold the OECD average while maintaining a convertible currency and a fixed exchange rate. Poland's reserves of foreign exchange are, after all, limited (although the stabilization fund has yet to be touched), and net capital inflows are not significant enough to permit a persistent divergence in core inflation rates. Nevertheless, there is now some danger that short-term capital inflows may increase dramatically. After all, measured in terms of Western currencies, short-term interest rates in Poland are very high.

Macroeconomic stabilization led to a substantial reduction in output. Some measures indicate that gross domestic product declined by about 30 percent since January 1990. This could be an overstatement. First, a common sight on the streets of Warsaw are hundreds of vendors who sell a multitude of products from the back of trucks and cars and from makeshift stalls. This is especially common for agricultural products, which are sold at lower prices than those charged in stores. [5] It is plausible that the official statistics underestimate the size of the informal sector. Second, there has been some shift of production to smaller private enterprises that likewise are underreported in the official statistics. Most importantly, there are no queues, a fact not reflected in standard GNP statistics.

The magnitude of the reduction in domestic output is, perhaps, not entirely surprising, given that state-owned enterprises are not flexible or well-prepared to adjust to economic shocks. [6] The adjustment problem was further compounded by the fact that enterprises faced totally undeveloped short-term and long-term credit markets in which to obtain financing that would tide them over the recession induced by macrostabilization. In any case, it would have been difficult for potential lenders to spot those enterprises that were creditworthy. In the absence of sound accounting rules, pervasive subsidies, and the like, sound lending practices were not likely to develop.

In spite of severe contraction, the Treasury has been able to maintain a budgetary surplus, thus putting a further damper on inflationary pressures. Moreover, throughout the period, Poland has been running a sizeable trade surplus, mostly due to an almost 30 percent reduction in imports during 1990. Exports increased also, but only by about 11 percent, indicating that in spite of low wages and low export prices, Polish firms are not yet seriously competitive in international markets.

Given the structural weaknesses of the Polish economy, the next round of reforms has to focus on building a market-oriented, profit-motivated, modern industrial sector. In a way, this is a much more complicated task than macroeconomic stabilization. A massive marketization of an economy has never been tried before and the technical problems are daunting. This is where Poland finds itself now.



The current policy tasks now are how to turn the socialist economy into a capitalist one. [7]

Poland lacks the most basic institutions of a modern market economy. [8] The prerequisite legal foundations are not yet in place: the property law is undeveloped; corporate and securities laws are only now being drafted; the commercial code is outdated. Similarly, there is no stock market; there are no private commercial banks, yet, and there are no private investment banks; there is no bond market. As a result, the process of constructing a market oriented economy, based on private property, i.e., the process of "marketization," must proceed on numerous fronts simultaneously.

Unavoidably, however, some steps must precede others. But what is the correct sequence? An example may clarify the problem: Should the state-owned enterprises be broken up horizontally and vertically prior to their privatization; or should restructuring be done afterwards?[9] On one hand, "sanitizing" firms prior to privatization will slow the process of property transfer. On the other hand, restructuring after privatization may be difficult, and may harm the financial interests of those who bought the shares.

Moreover, the issue of sequencing is central to the choice of a privatization strategy for Poland. As of this writing, Polish authorities must plan to privatize at least 5,000 enterprises. [10] There has never been a privatization program on such a scale anywhere in the world. Clearly, if standard privatization techniques (such as IPOs) were used in Poland, the privatization process would drag well into the next century. [11] This surely would undermine any efforts to create a market economy. Moreover, because there is a shortage of private savings, IPOs would have to be "underpriced" in order not to brake the overall savings constraint. Finally, the absence of developed capital markets greatly limits the feasibility of large-scale public offerings.

In light of institutional, macroeconomic, and political constraints, Polish authorities have been forced to look to less orthodox privatization programs. There has been no shortage of such proposals. In fact, excess supply has developed. So far, Sejm (the Parliament) has (almost unanimously) passed the enabling legislation that would permit the government to proceed with the disposal of state assets. The details of the privatization program are not yet settled. The enabling legislation sets some of the parameters that any plan will have to satisfy.

In the nutshell, the privatization process will be overseen by the newly established Ministry of Property Transformation (MPT). It will select enterprises for privatization after consultation with the management and workers' councils. This consultative process may slow privatization. For example, it is not clear whether the Ministry will be keen on privatizing enterprises whose management and workers oppose the property transformation.

Enterprises that are ready for privatization will be transformed into joint stock companies, with the state initially holding all the shares.

A privatization plan entails a choice of a mechanism (or mechanisms) for transferring ownership of state assets, after the enterprises have been transformed into joint stock companies. IPOs are probably not feasible, if only for technical reasons. It is not clear how the broad investing public may acquire sufficient information about them to make rational investment decisions, especially if 200 or more enterprises are privatized in a very short order. [12]

In my view, it is preferable to distribute shares to the public through some sort of financial intermediaries. Here several alternatives are possible. One that I find quite attractive, and feasible, is to create "mutual funds" into which the shares of the privatized enterprises will be distributed via some mechanism. Subsequent to that, mutual funds' shares would be distributed to the public equitably. [13]

It will have to be decided whether the mutual funds (the PrivInts) should receive the shares free or whether they should be required somehow to pay for them. If shares are distributed free there is no need to value the enterprises prior to privatization. This makes it possible to privatize many enterprises very quickly, perhaps as many as 2,000 in one year. Another possibility would be to "capitalize" the funds with vouchers" that could be used only for bidding on shares of privatized enterprises. [14] Then, bidding for those shares would establish market value of the enterprises, measured in vouchers. The shortcoming of this solution is that share values would be established in voucher units and not in zlotys, which are the important values.

In my view, some sort of valuation is necessary, even if only of a rudimentary kind in order to "anchor" the real prices of the enterprises. Otherwise speculative gyrations and bubbles can quickly destroy the nascent capital markets in Poland.

After the enterprises are privatized, their governance structure will change also. As a result of half-baked reforms, the enterprises have in effect been captured by directors (senior management) and workers' councils. This must be changed, if Poland is to become competitive in world markets. In privatized enterprises, managers will be subject to more stringent oversight, and workers' councils will loose their power (although workers will have representation on corporate boards, as they do in West Germany).

Rapid privatization is also important because directors have been taking advantage of poorly defined property rights and have been "privatizing" on their own. These private transactions - such as shady joint ventures, asset selloffs, and dubious contracts - benefit the management and harm the society. These spontaneous privatizations have decapitalized many state-owned enterprises and enriched the despised nomenklatura. Privatization should put a stop to the worse excesses of this kind.

Much hope is being placed on the ability of corporate boards to oversee managements. The idea is to have corporate boards modeled on German-type boards rather than American-type boards. [15] Boards will also have representation from the mutual funds, if these are established. [16] The funds' representatives will be representing the Polish shareholding public.

Two more features of the general privatization program merit mention. The first is the special provision for preferential treatment of workers in any share distributions. Workers will be entitled to buy up to 20 percent of shares issued at discount. (In the event of free distribution of shares, workers will be entitled to some share of the floatation.)

The second important provision is that foreigners are limited to no more than a 10 percent share in a privatized enterprise, unless the limit is waived. [17] There is a concern in Poland that foreigners will buy out Poland at discount prices. [18] Experience so far indicates that this apprehension is not warranted. There certainly has been no rush of foreign capital to Poland. Furthermore, there is no reason to assume that Polish assets will be underpriced on the average. In fact, various pressures may cause overpricing of assets, especially if the government has a hand valuing the assets of the privatized enterprises.


There is very little chance that Poland can implement its privatization program and accomplish the transition to a market economy without extensive foreign participation and assistance. In Poland, there is a shortage of physical, financial, and human capital needed for the immense and immediate tasks facing Poland. It has been estimated that modernization of the East German economy will cost between 500 billion DM to 1 trillion DM (giving the mid-point estimate of $450 billion). There is no reason to assume that it will cost less to bring the Polish economy up to Western standards. There is absolutely no chance that Poland can internally generate that kind of resources. To put this number in some kind of perspective, we may note that Poland's gross domestic product was about $65 billion by 1990. Yet, it also should be noted that some serious improvements can be accomplished relatively cheaply.

For instance, Polish managers have very little expertise in running profit driven enterprises. Polish managers will have to be taught the skills necessary for competing in the West. joint production and marketing ventures with foreign firms can thus be very effective in transferring the necessary managerial and marketing skills. Such agreements could have a very large marginal product and yet be very "inexpensive."

Polish firms also lack technology to produce goods that could compete with those of their foreign rivals. Again, joint ventures and "green field" direct foreign investments are the most effective route for transfer of technology and know-how. Even a small number of such arrangements could have substantial impact on the Polish economy. They could energize some firms and put competitive pressures on others. Unfortunately, thus far most of the joint venture agreements have been in the service sector and have not entailed any substantial technology transfer. In fact, the size of those ventures has been very small, often no larger than $100,000. Only a few large-scale ventures have been finalized thus far.

So far American firms have shown little enthusiasm for joint ventures in Poland or for direct investment. In Poland, like elsewhere in Eastern Europe, the U.S. lags significantly behind in the share of total foreign capital invested. According to a recent study prepared by a London-based consulting firm, Central European Investments, Germany accounts for 35 percent of total foreign capital, while the U.S. accounts for only 6.5 percent.

In many respects, Poland compares favorably with other Eastern European countries. At the current rate of exchange, an average Polish wage is about $1,000 per year. Polish wages, unlike East German, are not likely to rise to Western European levels any time soon. If the rate of exchange holds and there is no runaway inflation, Polish production should be competitive in the world markets, especially if joint ventures and direct foreign investment improve productivity. Poland also offers the largest domestic market in Eastern Europe - much larger than that of Czechoslovakia or Hungary - and is well located to serve the vast markets of the Soviet Union.

Admittedly, Poland has not yet made sufficient progress in putting in place many of the important institutional components of a market economy. The legal foundations are still not quite there; commercial banking is almost nonexistent; privatization policy, which will impact on incentives for direct foreign investment and joint ventures, is only now being formulated; and the inefficient bureaucracy has yet to be shaken fully from its traditional obstructionist ways. On top of this, telecommunications infrastructure is both antiquated and inadequate. Indeed, it is often difficult to imagine how Poland can attract significant foreign investments unless it greatly accelerates its modernization of the telecommunication sector.

In order to fill those requirements, public assistance from western governments is needed. After all, it is not likely that private firms will finance the enormous costs of the reforms. According to some estimates, it will cost Poland $100 million to implement its privatization program alone. [19] Yet the profit opportunities from the reform (marketization) process are limited: surely, Poland cannot afford the sort of fees that the Thatcher government paid to the investment banks, for example. While I anticipate that Poland ultimately will have to expend some of its scarce foreign exchange to finance the marketization and privatization process, a substantial portion of the cost will have to be defrayed through foreign assistance.

It is also important to note that the public sector in Poland - hospitals, schools, roads, the environment - has also been devastated by Communist rule. And, to top it all off, there is a $28 billion government-to-government debt owed by Poland. This debt, incurred by the Communist regime, is now restraining growth and is undermining recovery.

In sum, there is ample opportunity for Western governments to help Poland help itself. In deciding on the efficacy of aid to Poland, it must be borne in mind that the political and economic situation is unlike that in the Soviet Union. Poland is fully committed to the path of reform. Consequently, the policy arguments against extending aid to the Soviet Union cannot be applied to Poland.

Unfortunately, Western countries, including the U.S., have not been rushing to support the transition process. The issue of foreign debt is unresolved. The U.S. Congress seems incapable of approving the next round of Support for Eastern European Democracies (SEED) appropriations. And the Common Market's Agricultural Policy is blocking agricultural exports.

Poland is at the cross-roads. [20] The population is getting restless about the costs of transition to a market economy. There is still a strong consensus behind the reforms, but there is disagreement on policies. The political life also shows strains: the common enemy - the Communists - are gone and Solidarity is no longer an opposition movement.

In spite of all this, the prognosis for Poland is good, if not excellent. The government is committed to keeping inflation under control by keeping a lid, perhaps a bit too tight, on wages and refuses to bail out enterprises in trouble. It is also pushing hard towards privatization of state enterprises.

It is now up the world business community to express its confidence in Poland by committing some of its resources to rebuilding the Polish economy.

* Janusz A. Ordover is Professor of Economics, New York University, New Youk, NY; Director and Senior Advisor, Putnam, Hayes and Bartlett, Inc.; Advisor, Ministry of Finance, Poland.


[1] Polish chicken and egg monopoly, Poldrob, not only produced poultry and eggs but also produced its own feed, maintained an extensive transport base, truck repair facilities, and distribution networks.

[2] For more on this see "East European Farming," The Economist, July 21, 1990, 15-18.

[3] A more extensive review of the early reforms is in Jeffrey Sachs and David Lipton, Poland's Economic Reform, Foreign Affairs, Summer 1990, 47-66.

[4]There is some question as to the causes of that burst. One explanation is the removal of subsidies that resulting in an upward shock to costs. Possibly, the (monetary) savings overhang - savings that were accumulated by households because there was nothing to buy - was diverted to consumption, as shortages eased. Yet another possibility is that enterprises, which previously had very little incentive to maximize profits and optimize price levels, begun to exercise their latent market power. See R. Frydman, and S. Wellisz, and D. Lipton and J. Sachs, "Creating Market Economy in Eastern Europe: The Case of Poland," Brookings Papers on Economic Activity, 1990:1, for a discussion of these diverse explanations.

[5] Retail distribution is still very inefficient. Until recently it was monopolized by two or three cooperatives, which now are being slowly dismantled and restructured.

[6] At the same time as the government was stablizing the economy, trade with the Soviet Union fell as well. As a result, many enterprises lost their traditional markets, without gaining new ones.

[7] It must be noted that in the Polish aquarium," the prewar capitalist economy, the state owned a substantial portion of national economy and it exercised significant influence on the allocation of investments to sectors.

[8] Using Marxist economy, one could say that the "superstructure" is missing.

[9] Poland has recently passed a rather stringent antitrust statute. It is not likely that the authorities will be able to enforce all of their provisions. The antimonopoly office is understaffed and certainly lacks the necessary experience. Some of the provisions of the statute seem much too far reaching, e.g., the provision against excessive pricing, and hopefully will be enforced only in the most egregious cases.

[10] There are approximately 7,500 state-owned enterprises. However, some of them are likely to go bankrupt and thus will be liquidated, meaning that their assets will be turned over to the existing employees and management or they will be leased through a competitive auction.

[11] Traditional approach to privatization is to value the assets of the enterprise, set the initial offering price for the shares and then place the shares with the investing public and/or institutional investors.

[12] It will not be possible for the Ministry to conduct such extensive advertising campaigns as those that accompanied the British privatizations. And neither it is likely that the Polish public will be able to comprehend the financial statements that will have to be disseminated.

[13] I have termed those funds Privatization Intermediaries, or PrivInts, because they do not resemble American or European mutual funds.

[14] In fact, under this scheme households receive the vouchers. Then, the households invest in the mutual funds. It is not clear how households could make rational investment decisions when they will not be able to determine the value of the funds' assets in zlotys.

[15] This makes good economic sense since "markets for control" are not likely to exist for quite some time in Poland. Consequently, shareholders cannot rely on the securities market to "police" Polish managers.

[16] The contemplated mutual funds will differ from American-style financial intermediaries. Whether they can play the role of German-style banks remains to be seen.

[17] Upon request, the Ministry can raise the limit in special circumstances.

[18] Foreigners are not allowed to purchase state-owned land, for example.

[19] To see what is involved, consider the fact that Poland has only one insurance company. This insurance company has to be restructured; new insurance companies established; and appropriate regulatory apparatus put in place. All these tasks require financial and specialized human resources that are scarce in Poland. As of this writing, it appears that the Know-How Fund, financed by Britain, will cover the costs of reorganization of the insurance market. There are many more examples of this sort - one that readily comes to mind is the reorganization of the social security system.

[2O] See an excellent piece by Timothy Garton Ash, "Angry New Eastern Europe," The New York Review of Books, August 10, 1990, on the political situation in Eastern Europe.
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Title Annotation:International Perspective
Author:Ordover, Janusz A.
Publication:Business Economics
Date:Jan 1, 1991
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