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Poland's Economic Model

Author: Christopher Alessi
November 20, 2012

Introduction

WARSAW - Poland has seemingly defied the odds in the face of an ever-consuming debt crisis roiling the continent. The sixth-largest European economy, it was the only country in the EU not to fall into recession at the height of the global financial crisis in 2009 and the only member to experience economic growth in 2010. But challenges loom on the horizon, including high unemployment, rising inflation, and growing fiscal deficits. In the near term, Poland risks losing subsidies if wealthier EU states prevail in freezing the bloc's long-term budget. It must also decide when to adopt the euro, even as the single currency union struggles to implement fiscal reforms.

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Significantly, Poland has started to leverage its growing economic clout to play a larger role in European politics. Polish Foreign Minister Radoslaw Sikorski has demonstrated "leadership that has been sorely lacking in the EU" while forcefully making the case for the country's growing role in a more united Europe, says CFR's Charles Kupchan. It is a country "heavily invested in the future of the EU," he says.

The Polish Economy Post-Communism

The collapse of Communism in Poland following the victory of the opposition Solidarity movement in free elections in 1989 paved the way for the rapid establishment of a free-market economy. Poland's transition to a capitalist system was spearheaded by then-finance minister Leszek Balcerowicz, with the assistance of U.S. economist Jeffrey Sachs. Balcerowicz and Sachs administered so-called "shock therapy" to the Polish economy by implementing a large-scale privatization program of state industry; creating a stock exchange, capital markets, and a convertible currency; eliminating price controls and slashing subsidies; and carrying out strict budget cuts. The goal of the program was to integrate Poland into the mainstream global economy by making it more like the states of Western Europe, which shared a "common core of capitalist institutions," Sachs explains in his 1993 book Poland's Jump to the Market Economy.

When Poland's new, democratically elected government--led by former prime minister Tadeusz Mazowiecki--came to power, it faced significant economic challenges, including an inconvertible currency that was not functional, an inefficient economy driven by heavy industry, and a monetary overhang resulting from a debt burden accumulated in the 1970s, explains the University of Michigan's Anna Grzymala-Busse. Shock therapy, Grzymala-Busse says, immediately freed up the currency and opened up the country's labor market, even as consumer goods flooded the market. Still, because Poland was willing to forcefully apply shock therapy, the Paris Group of international lenders forgave half of the country's debt. The approach "worked insofar as after the period of hyperinflation, it basically brought the economy into line," argues Grzymala-Busse. "There was not much of an alternative."

"[Shock therapy] worked insofar as after the period of hyperinflation, it basically brought the economy into line. There was not much of an alternative."—Anna Grzymala-Busse, University of Michigan

Similarly, Harvard University's Grzegorz Ekiert says that despite some initial doubts about the "big bang approach," shock therapy was ultimately successful in Poland. "Central and Eastern European countries that were moving faster [in implementing economic reforms] are in better shape today than countries that adopted more gradual policies," Ekiert says. In his revised 2005 book God's Playground: A History of Poland, Norman Davies writes that shock therapy in Poland "proved to be a great blessing" for, among other reasons, bringing hyperinflation under control quickly, increasing productivity, reducing the country's foreign debt, and paving the way for greater foreign investment. "In terms of economic recovery measured as GDP per capita, Poland by 1996 clearly led the field of all ex-Communist states," Davies says.

Still, shock therapy has its share of detractors, including Canadian journalist and activist Naomi Klein. In her 2007 book The Shock Doctrine: The Rise of Disaster Capitalism, Klein argues that economists like Sachs took advantage of post-Communist countries, including Poland, to implement radical free-market policies and advance a strict neo-liberalist ideology at the expense of democracy. In Poland, shock therapy caused a "full-blown depression," triggering a 30 percent reduction in industrial production and rising unemployment, she writes.

Sachs has forcefully refuted Klein's claims. In 2008, he told the Guardian, "Poland ended up the most successful recovery, with robust democratic institutions, and I couldn't be more thrilled."

Poland Joins the European Union

Poland acceded to the European Union in 2004 after a decade of preparation that included establishing a stock market and securities and exchange commission; strengthening its governing institutions; removing trade barriers to integrate its economy with that of Western Europe; and securing OECD and NATO memberships. "There was a consensus among elites and among the population that moving in the direction of a market economy and joining the EU was the end goal of [Poland's] transformation," says Ekiert. The country's efforts in the 1990s to meet EU membership criteria helped restructure the Polish state and economy, he adds.

Since joining the EU, Poland has benefited significantly from EU structural funds, allowing the government to invest steadily in infrastructural development. At the same time, Polish farmers have enjoyed an influx of subsidies from the EU, helping the agricultural sector to thrive. In the EU's 2007-2012 budget, Poland was allocated €67 billion in structural funds, according to the Financial Times. Equally significant, EU membership created labor mobility, explains Grzymala-Busse. In 2004, millions of Poles emigrated to England and Ireland, which helped to substantially reduce Poland's unemployment burden.

Moreover, growth accelerated starting in 2004, says the Warsaw School of Economics' Marzenna Weresa. "Starting from the point when we joined the EU, we managed to catch up by fifteen percentage points with the rest of Union in terms of GDP per-capita measured in purchasing power parity," Weresa explains. Indeed, Polish GDP growth rose above 6 percent in early 2008 (WSJ), and despite dropping in 2009, the country was the only EU member not to fall into recession in the wake of the global financial crisis.

Poland Weathers the Storm

Poland fared so well compared to its EU counterparts during the global financial crisis of 2007-2009 for multiple reasons, including a high level of internal demand, strict regulation of its financial sector, and a flexible currency that allowed for the depreciation of the Polish zloty that boosted the competitiveness of Polish exports, explains Weresa. Moreover, Poland was largely insulated from the worst of the crisis because it was not a member of the eurozone, argues Grzymala-Busse. But, perhaps most significantly, she explains, the Polish economy is "tied very heavily" to Germany, the largest economy in the EU and the eurozone country least affected by the downturn. Ekiert concurs: "Poland is linked to the German economy in a very profound way. Poland is doing well if Germany is doing well."

"Poland is linked to the German economy in a very profound way. Poland is doing well if Germany is doing well."—Grzegorz Ekiert, Harvard University

Ekiert also outlines three inflows of capital to Poland that helped sustain its economy during the crisis. These include foreign direct investment, EU structural funds (of which Poland has been the largest recipient over the last several years), and remittances from Poles abroad. At the same time, Poland was also shielded from the worst of the financial crisis because its financial institutions are "outdated," says Ekiert. Polish banks, he says, "could not participate in [the high risk] financial transactions that brought down many banks in the West. Being backwards in this situation was a big plus."

Still, Poland's economy has consistently matured over the past twenty years, as it has sought to integrate itself into the European and global economies by facilitating foreign investment ($14.2 billion in 2011, according to the Financial Times) and expanding trade ties. The country has harnessed its high productivity, low wages, and an educated labor force to market itself as an increasingly attractive outsourcing destination for financial services, clean energy and high-tech manufacturing, and, eventually, shale gas production. The Warsaw Stock Exchange is the largest bourse in Central-Eastern Europe, with a domestic market capitalization of €117 billion and equity session turnover of €30.3 billion, as of August 2012. It is also the fourth-largest European exchange behind Eurex, NYSE Euronext, and NASDAQ OMX.

At the same time, growth has slowed for Poland this year, highlighting some of its economic challenges. GDP growth is expected to drop to 2.5 percent for 2012 from 4.3 percent last year, while growth is projected at 2.2 percent for 2013. The ongoing eurozone sovereign debt crisis is beginning to have an impact on the Polish economy, as demand from Western Europe continues to drop. Consumer spending has also slowed, aided in part by rising unemployment, which hit 12.4 percent.

Poland and the Euro Question

As a non-eurozone EU member, Poland has enjoyed the perks of being in the EU without the acute pressures facing many of its European neighbors. "It has benefited from the single market, but hasn't suffered [directly] from the eurozone crisis," says CFR's Kupchan. While Poland's "ultimate goal is to become a major player in the EU, which means joining the eurozone," Kupchan says, "it's not likely to happen anytime soon." Poland is not eager to "be on the hook" for helping fund bailouts for indebted peripheral eurozone states, like Greece, says Grzymala-Busse. But, she acknowledges, "joining the euro would make all financial transactions and trade that much easier" for Poland.

"Maybe by 2020 it will start to prepare to join the eurozone."—Marzenna Weresa, Warsaw School of Economics

While Poland has committed—and is officially on track—to adopting the euro, government officials have indicated that they will delay joining the single currency union until its prospects are more stable. Even if Poland wanted to join immediately, it has not yet met the EU convergence criteria required to join the eurozone regarding, among other factors, its inflation and budget deficit levels. For example, Poland's budget deficit is currently 7 percent of GDP, well above the eurozone requirement of being at or below 3 percent. Moreover, all countries planning to join the eurozone must implement the Exchange Rate Mechanism II for at least two years before it can use the euro, a move Poland has not yet taken. As such, Weresa says, Poland is not going to adopt the euro in the short term. "Maybe by 2020 it will start to prepare to join the eurozone," she predicts.

However, there are concerns that the longer Poland holds off joining the eurozone--which is taking significant steps toward further fiscal and political integration as a result of the crisis--the more likely it will be relegated to the second rung of a so-called two-track EU. "Poles are very concerned not to become second-class citizens in the EU," says Ekiert. But the Poles "think they can still bargain their way into many institutions [such as the nascent eurozone banking union] without adopting the euro now," he adds. Weresa agrees: Poland, with a population of approximately 38 million people, is "too big a country to be marginalized in the EU," she says.

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