Polish lessons for Eastern Europe

In a time when the euro zone seems to be shaky, the growth prospects of Poland are substantial. At the end of the day, what are the reasons that made Poland a regional winner? Polish analyst Eva Blaszczynski shows what lessons other Central and Eastern European countries should learn from Poland’s latest economic performance.

Interview by Octavian Manea. March/April 2010 issue

FP Romania: Could we speak in terms of winners and losers when we assess the consequences of the global economic turmoil on Central and Eastern Europe? Are these outcomes related to specific economic legacies and policies embarked upon over time by some regional states?

Eva Blaszczynski: Yes, when the global financial crisis hit Central and Eastern Europe, many market analysts mistakenly painted the entire region with one very broad brush. In actuality, within the 10 new European Union (EU) member states, three very distinct economic profiles have emerged: based on development legacies, economic fundamentals and varying risk profiles. These profiles are linked to three types of economic transition models: the Baltic model, the embedded neoliberal model and the gradualist model. These differences not only reflected the severity of the crisis on each individual economy, but also the recovery options available to policymakers withinnational governments, international financial institutions and multilateral organizations.
As the dust begins to settle, winners and losers have clearly surfaced. Poland, the Czech Republic, Slovakia and Slovenia stand ahead of the pack, due impart to manageable current-account deficits, lower levels of indebtedness ( private and public), and in the case of Slovakia and Slovenia exchange rate stability due to recent euro adoption.
Romania’s and Bulgaria’s growth prospects, while facing stiff competition from healthier CE economies, will continue to be burdened by deep political and economic deficiencies. Unless major initiatives, both at the local and EU levels, take effect to reform chronic structural and institutional asymmetries (corruption and organized crime), the two Balkan countries are headed for stagnation.
Finally, the Baltic States and Hungary, saddled with debt and strict austerity programs, will have the toughest road and the least amount of flexibility regarding the speed and scale of their recovery programs. Despite their various predicaments, all of Central Europe has the opportunity to emerge stronger and more economically viable. The key for the region is to resist the burden of reform fatigue while continuing to converge with the EU-15. That responsibility, however, must not rest solely on Central Europe.
The EU, and its wealthier members, must also ensure that Central Europe continues to benefit and be deeply anchored in free-market principles and EU institutions. Most importantly, they must convince the region that they are not simply EU charity cases but critical players in Europe’s future economic prosperity.

Why Poland was better positioned to handle the crisis and to become a regional winner? Which are the weaknesses of the Polish economic model?

Much of the early praise focused on the current government’s ability to steer Poland through the worst economic storm in decades. However, much of Poland’s resilience can be attributed to twenty years of long and at times, difficult economic transformations (i.e. 1990s shock therapy).  Unlike other economies in Europe, Poland's exports didn't decline as dramatically, consumer credit growth was slower( with lower levels of foreign currency debt), internal consumption increased and GDP growth remained positive throughout all four quarters of 2009. Even the once-depreciating zloty has made a recovery and continues to gain strength. Many analysts expect the Polish economy to grow as much as three percent in 2010, a far better performance than anywhere else on the continent.
Although the Tusk government, in particular its Finance Minister Jacek Rostowski, should be applauded for promoting fiscal restraint and reassuring global investors against panic and a premature market sell-off, much of Poland's success rests on the strength of its internal consumer market. Specifically, when the zloty declined (and the euro became more expensive) Poles stayed and spent money in Poland. As the global economy recovers, Poland will have to do much more than rest on its laurels, especially as it seeks to attract future investment and capital, grow its economy and gain membership into the Eurozone.
As we head into the 2010 election season, a widening budget deficit, growing energy concerns and the lack of a concrete reform agenda highlight weaknesses in Poland’s economic model. Despite the government's laudable response to the financial crisis, it could have done more to improve Poland's business and investment climate – notably by enacting simpler business rules, easier tax-filing procedures, investments in e-government solutions and introducing radical steps to cut red tape. In a country where high unemployment and significant underemployment are all too familiar, the government should take notice and put structural economic reform high on their campaign agenda.

Although Poland and Hungary had some similar structural constraints (vast social spending, aging populations, falling birth rates, reduced contribution rates, big fiscal imbalances) why did Poland manage better the retirement problem than Hungary?

Although, Poland introduced unemployment benefits, minimum wage regulation and early-retirement schemes, Hungary’s social-welfare system was much more extensive (using both disability and early-retirement schemes) becoming the most generous in the region. Poland has by no means solved its pension dilemma, but it has pursued pension reform for well over a decade, diversified via private pension schemes and strengthened the link between entitlements and earnings.  While challenging, Poland has stronger macro fundamentals and therefore more diverse policy options than Hungary, which is confined to stricter policy prescriptions as a result of last year’s World Bank-IMF bailout.
Furthermore, the rationale behind Hungary’s pension program was driven by politics, not sound economics. Former-Prime Minister Gyurcsány was especially reluctant to reform the pension system given that older pensioners made up a substantial portion of the Socialist Party’s voter base.  
Hungary’s population, which numbers 10 million, has three million pensioners, many of whom took early retirement. Moreover, the average Hungarian retires at 58, and just 14 percent of citizens between the ages of 60 and 64 work, compared with more than 50 percent in the United States. Hungary has been running fiscal deficits for years, it’s annualcosts for pensions currently surpassing 10 percent of GDP.Though Poland spends a greater portion of its GDP on pensions, the government is working towards pulling the figure down sharply over the coming years. Meanwhile, the OECD estimates that Hungary’s pension outlays will be among Europe’s fastest growing in coming decades, thus putting additional pressure on an already strained economy.

It seems that Hungary is the main regional loser. What generated its economic decline well before the global crisis affected the region?

Over the last twenty years, Hungary has amassed large macroeconomic imbalances, while concurrently stalling large scale structural reforms. We have to remember that Hungarian debt (both public and private) was growing at a very fast rate. By the time the crisis hit Hungary had over 65 percent of its total outstanding loans denominated in foreign currency (euros or swiss francs). Only Estonia, Latvia and Bulgaria had higher shares of foreign currency debt. This factor as well as Hungary being outside the euro-zone made the economy especially vulnerable to swings in global currency markets.
Second, Hungary had built up one of the region’s largest government debt ratio’s (80% by 2009), while other Central European economies’ government debt ratio levels range between 15 to 60 % of GDP.  
Third, Hungary’s economy lacked diversification and was overly depended on an export-based development model. Over 90% of Hungary’s economy is based on exports, the highest among Central European EU member states. What exacerbated the problem was that its largest sector, automotive manufacturing, was one of the worst affected globally. When exports markets in the EU-15, Hungary’s largest market, took a nose dive, this had negative ripple effects throughout Hungary’s economy.
Fourth, incomplete structural reforms, exemplified by the maintenance of a vast and unsustainable social-welfare system have brought both the economy and the public sector on the verge of bankruptcy. At the same time an onerous tax burden, drove up labor costs for many of the country’s maturing small and medium enterprises (SMEs) with high income and payroll taxes. This tax wedge, the second highest in the OECD, undermines Hungary’s competitiveness and deters local business development.
By 2007, while the rest of Central Europe was growing between six and ten percent, Hungary was already experiencing a sharp drop in GDP (1.1 percent) and domestic incomes. When the global economy was strong these vulnerabilities were easily overlooked, but when external shock hit, it unmasked several lingering structural and economic deficiencies that, if ignored, could result in economic stagnation. In Hungary, those vulnerabilities became more acute due to historically weak post-transition governments, political infighting and lack of consensus over future reforms.

What are the lessons Romania and Hungary should learn from the Polish experience?

Two major lessons come to mind. First, that politics truly do matter. Specifically, strong government institutions, a well-functioning democracy, accountability and transparency play as integral a part in a country’s economic development as does sound economic policy. It strengthens confidence among a nation’s citizens. This was lacking in both Romania and Hungary during the peak of the crisis and eventually manifested itself on the streets of Budapest and Bucharest. Overall, Polish citizens had confidence in the way their government was handling the crisis. This was later reaffirmed with strong internal consumption and sustained activity among global investors.
Second, the ability to maintain relatively low-level macroeconomic imbalances enabled Poland to take advantage of preferential lending mechanisms and financial aid, such as accessing a $20.5 billion IMF flexible credit line (FCL), given to countries with stronger economic fundamentals. Not only did this help Poland avoid additional economic shocks, but it allowed for greater policy options and flexibility to be used in managing its recovery. In contrast, unsustainable deficits and high foreign debts forced both Hungary ($15.7 billion) and Romania ($17.1 billion) to seek IMF and World Bank bailouts, which tied them to strict and very specific austerity measures.
Both will have long-term repercussions on Hungary and Romania, including success of economic recovery, speed of euro adoption, and furthering EU convergence efforts.


Eva Blaszczynski is an independent analyst and writer. She has a weekly blog in the Warsaw Business Journal and acts as an ad hoc consultant for the Center for Social and Economic Research-CASE, Warsaw.

Excerpt from FP Romania nr 15 (March/April 2010)