In the medium term, almost all economic government proposals will weaken rather than accelerate growth and at the same time reduce economic stability.
In 2015, Poland’s economy was the fastest- growing in Europe, at the rate of 3.6%. The government expects that this year’s growth will reach 3.8%, which perhaps is an overly optimistic assumption, but there is a consensus among economists that growth at the level of 3.4–3.6% is probable. It would again be one of the best results in Europe. Moreover, Polish economy is among the most stable in the European Union. In November 2014, the European Commission published a report assessing the equilibrium in the member-state economies. It took into account such factors as private and public debt, foreign trade balance, unemployment rate, credit flows in the private sector, and share in export markets. Along with nine other countries, Poland was included in the elite club of economies not threatened with imbalances.
Andy yet on January 15 this year, the Standard & Poor’s rating agency downgraded the long-term credit rating of Poland, denominated in foreign currencies, from A- to BBB+. It also changed the outlook from positive to negative, which means that there is a likelihood of a further downgrade in the next 24 months.
“Since winning the elections in October 2015, the new government in Poland has launched various legislative measures which we consider as weakening the independence and efficiency of key institutions, which is reflected in our assessment,” said S&P justifying its decision. This raised an uproar in Poland. Politicians from the ruling Law and Justice party, who claimed before the elections that Polish economy was in a bad state (its campaign slogan was “Poland is in ruin”), decided that the decision of the rating agency was political, and that Polish economy was in fact thriving. The opposition maintains that it indeed was thriving before the elections, but the policy of the current government would lead to a crisis.
Public Finances Far from Equilibrium
To accurately assess the condition of Polish economy, we must put aside the propaganda slogans both of the previous and the current government. Among the countries of the EU, Polish economy best absorbed the global financial crisis and now its GDP is 28% greater than in 2007. The government has in recent years reduced the deficit of the public sector and in June 2015 the European Union lifted the excessive deficit procedure against Poland. Polish exports are growing dynamically and last year there was a small surplus on the foreign trade sheet. A stable banking sector is a strong point of the Polish economy. In 2008 and 2009, Polish banks did not have to ask the government for bailouts—unlike American and European banks. But not everything looks as rosy as the previous government claimed.
In the last 25 years, Poland never managed to match government spending with revenues. Twenty years ago sovereign debt was (according to the EU methodology) at 164 billion złoty, and by 2014 it reached 867 billion złoty. In order to avoid an austerity program, the previous coalition government of the Civic Platform and the Polish Peasant Party took over the savings deposited in open pension funds managed by private companies. Compared with many European Union countries, public debt is not excessive— it amounts to just over 50% of the GDP, while in many EU countries it reaches 100%. But the debt is constantly rising and neither the previous nor the current government has any idea for stopping this process.
The public sector deficit slightly exceeds 3%, which would be acceptable if not for the fact that the economy is in a recovery phase. If it slows down, as it did in 2009 or 2012, spending and revenues will again go their separate ways and the debt will skyrocket.
Global economy is developing today in an environment of low interest rates, which we owe to unconventional policy of major central banks. Due to low interest rates, debt financing is cheap. But if interest rates go back to their long-term medium levels, the government will be forced to introduce austerity measures, which it strongly dislikes.
Ironically, problems of the Polish budget to some extent result from the inflow of structural funds. Poland is the greatest beneficiary of EU funds. But to make use of them, domestic institutions have to make their own financial contributions, which is a burden on state and local government budgets. The greatest absorption of funds is expected in 2017–2019. And the budget will be very strained in this period.
Middle Income Trap
A few years ago, the World Bank published a report showing that out of 101 countries which were in 1960 included in the group of middle income countries, only 13 advanced to the higher- income group by 2008. The rest was stuck in the “middle income trap.”
Most Polish economists agree with the prediction that Poland is threatened with the “middle income trap.” There are differences of opinion as to how to escape the “trap,” but everyone agrees that ill will not be easy.
The mechanism of the “trap” is known. It is easier to achieve increases of production when the starting point is low. Low-income countries compete on international markets with cheap labor and labor-intensive goods. They import technologies from better developed countries. They can achieve significant increases of productivity when there is a shift of employment from low productivity sectors—traditional agriculture, small trade, and crafts—to more efficient sectors such as manufacturing industry and modern services.
But as these countries grow, reserves of unqualified labor shrink and industrial workers demand higher wages, which undermines competitiveness if the economy is not producing goods with a higher added value.
Polish economy used to reach high dynamics, for it utilized simple reserves, foreign capital and technologies were flowing in, employment in non-efficient sectors—agriculture and mining— was decreasing while it was growing in services and manufacturing. However, these sources of growth are gradually drying up and hence the weakening development. In the 1990s (starting from 1992, when the recession resulting from the transition ended), Polish economy was growing at the average rate of 5.1%, in 2001–2010 the rate was 3.9%, and in 2011–2015 it was 3.0%. Forecasts made by both Polish and international institutions say that in the next decade the rate will go down to 2%, as that is the level at which rich countries are growing. But Poland will not be rich yet. It will stay in the “average” group.
One of the reasons for the waning growth of the Polish GDP is a low share of investment in national income and a low savings rate. All economists emphasize the necessity of raising the investment rate, which is slightly more than 18% of the GDP, while in Ireland in the rapid growth period of 1996–2005 it was about 25%, in Estonia before the crisis it was 30%, and in Germany in 1961–1973 it was 27.2%.
An even more important structural problem of the Polish economy is the low level of savings, which means that to finance its growth, Poland needs to borrow money abroad or rely on foreign direct investment.
In order to increase growth, we must stop subsidizing unprofitable coalmines, increase the mobility of the labor force so that employees can move from areas with high unemployment to places with a labor shortage, finish the privatization process, encourage women and older people to take up employment, even part-time, improve education and make it more attuned to the demands of the market, and remove barriers to entrepreneurship. Unfortunately, the government’s ideas for accelerating growth are completely different.
More Consumption, Pipedreams about Investment
PiS campaigned with the agenda of significant increase in social spending (500 PLN, or 115 EUR, monthly for every second and successive child in the family until they are 18), reducing income taxes, and lowering retirement age. These promises, the joint cost of which is estimated at several percent of the Polish GDP, were to be financed by special sectoral taxes—imposed on banks and insurance companies and on large retailers. But the total revenue from these two taxes can amount to no more than 0.5% of the GDP.
In fact, the main source of additional revenue is to be “sealing the leaks in the tax system.” In Poland, like in other EU countries, there is a lot of tax fraud, especially related to VAT. Businesses “optimize” the amount of tax they have to pay, sometimes by registering their companies abroad. Fighting against these practices, the government will perhaps increase its tax revenues without putting the rates up, but there is no guarantee that the boost will be significant.
During the election campaign PiS also announced a change in economic policy, aimed at raising investment rate and economic growth. The program of stimulating growth is prepared by the Deputy Prime Minister and Minister of Development Mateusz Morawiecki. He announces that the government will attempt to raise the investment rate through the activities of government institutions: the National Economy Bank and other banks controlled by the Treasury, the funds organized within the Polish Investments program, state-owned companies, and even the National Bank of Poland. These institutions are to provide the economy with cheap capital (at a lower interest rate than offered by the market, perhaps at 0% or even negative) targeted at areas preferred by the government, including the development of innovation.
It is an idea for stimulating public investment or investment of state-owned companies. The government’s share in the economy in Poland is much greater than the OECD average. The government sector employs 27% of all workers and produces 24% of the GDP, while absorbing 32% of investment. The government owns several banks, and controls industries it regards as strategic: energy, fuels, railways, seaports, gas and oil pipelines, mining and processing of copper, and the arms industry. But the efficiency of public investment or investment by state-owned companies is significantly lower than in the private sector.
At the same time, government policy does not favor private investment, which in the last two years was growing quite dynamically. Businesses fear tax increases, changes of regulations, and aggressive actions of tax services. And hence they tend to refrain from further investment. Negatively affecting growth are also announcements of some ministers, criticizing foreign capital coming to Poland.
Mateusz Morawiecki, until recently president of the third largest bank in Poland—BZWBK belonging to the Santander group, claims that escaping the middle income trap requires making Polish rather than foreign capital the foundation of growth. However, there is a contradiction between the government’s growth policy and its social spending agenda. The social spending program is supposed to increase consumption. This year the program of the 500 złoty hand-outs to families will be delayed by a few months, yet still it is going to cost 17 billion złoty, which is about 1% of the GDP. Such a demand stimulus will probably slightly boost the economy, but it will be a short-term effect. Growth of consumption, financed from such sources as bank profits, will further reduce the savings rate. This means that Poland will to an even larger extent have to rely on imported capital.
Lowering the retirement age will reduce not only savings (when we retire, we consume what we previously saved), but also the number of people willing to work. And in the coming years the baby boomers will reach retirement age, while the age groups entering the labor market will be less numerous.
New government spending will increase the deficit, which will have to be financed with new debt. Instead of offering loans for growth, banks will buy government bonds, especially now that the new tax is based on the volume of loans, while Treasury bonds are exempt from it.
In the medium term, almost all economic government proposals will weaken rather than accelerate growth and at the same time reduce economic stability. And this is what the analysts of Standard & Poor’s, who on January 15 announced the downgrading of the Polish credit rating, are worried about.
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