As Covid-19 spreads, causing more countries to take counter-measures, Central and Southeast Europe is no exception. ING’s latest report said that collectively it is downgrading the 2020 GDP outlook on the back of virus fears.
Piotr Arak (PIE, Public domain)
CE Financial Observer: The Polish Economic Institute was established a little over half a year ago with a goal of reorganization of research on the Polish economy.
Piotr Arak: After the first half-year of operation we are already concluding the start-up phase and we are entering the stage of institutional development. Although we still have a lot of issues to sort out, we are building structures, we have already created a new brand, and at the same time we are constantly trying to provide new knowledge, new data resulting from our internal research, and to shed light on the areas that have not been explored yet. The statistical summary of what we have been doing in the past 8 months is as follows: 11 reports, five so-called policy-papers, and one awaiting publication, 16 weekly reviews prepared every week based on our research and reports, as well as 20 conferences that we have organized.
What do you mean when you speak of new, unexplored areas of research?
Firstly, as a public institution we have been the first to analyse an alternative indicator of economic development for most countries and territories of the world. We named it the Index of Responsible Development. We have described the problems that are associated with the measurement of socio-economic development in our times.
And isn’t GDP enough for that?
GDP serves important functions and it is a great indicator of economic development, or, to put it directly, of production growth. However, in today’s world, in the economic system of developed countries, economic growth alone will be playing less of a role than in the past. Because of that, we have to come up with measures that describe the standard of living, as well as others that reflect our environmental footprint — this includes the quality of the air. These are the elements that we have indicated in our study.
Will you be improving your index? Or do you see it as a finished measure, the usefulness of which can only be verified after several years?
In the long term we will certainly attempt to improve this tool. The HDI index, introduced by the United Nations in the early 1990s, has also undergone some changes. Therefore, we indeed have to focus on these discussions, which will certainly continue. We believe that in the 21st century it will be possible to create a measure accepted by most economists, which will provide an alternative to GDP. This means that it will be used alongside GDP and will be just as important as GDP. Will that be our indicator? That is rather unlikely, but we will surely want to participate in international discussions on what such an indicator should look like, and what measures it should contain.
But this is not the only issue that you’ve taken up.
A second important area of our activities thus far has been a study of the corporate income tax gap (CIT Gap), where we’ve attempted to show the scale of corporate income tax optimization carried out by legal entities. We are all well aware of the VAT gap, and the first report dedicated to this phenomenon was prepared in 2013. Back then no one knew what it was, and few people were initially interested in the matter. The issue only gained popularity later on. We are inspired by the success of that report, which triggered an avalanche of discussions, debates, and ultimately also legislative changes. That is why we are now raising the issue of the CIT gap. This topic is present in many discussions, for example, among entrepreneurs. They are discussing the options of so-called tax optimization, that is, the reduction of due taxes through the reduction of revenues or an increase in costs, as well as through the fraudulent transfer of revenues out of the Polish territory. In our opinion, the latter method is increasingly popular. It currently accounts for 40 per cent of the CIT gap and its share is growing. This is another important topic, which should be addressed by the Polish state. We have prepared a relatively broad estimate of the CIT gap. However, the subsequent studies will be better and more accurate, as has been the case with the VAT gap.
But while closing the VAT gap would be unequivocally beneficial, in the case of the CIT gap an approach that is too restrictive could discourage existing and potential investors, who could move to countries with more business-friendly and lenient legislation.
Poland will never have a zero-rate CIT like some member states of the European Union, such as Ireland. Therefore, it is not possible for Poland to compete with the tax havens or countries that are regarded as such by the European Parliament. On the other hand, just like the other larger countries that have a more diversified economy, Poland should be eliminating loopholes in the system, because it’s simply worth it. Meanwhile, the companies are not likely to leave such countries, because they not only want to be present in these markets, but in some cases they simply have to be present there. Let’s keep in mind that Poland has a 9 per cent CIT rate for small enterprises and a 19 per cent rate for large enterprises — this isn’t excessive. And for companies that make use of tax relief, in accordance with the intentions of the legislature, taxes can be very low. In our approach, the CIT gap covers activities that are illegal or are inconsistent with the intentions of the legislature. Some of these things haven’t been well studied thus far. Nowadays — as proven by the fight against the VAT gap — all that is needed is an effective technological interface and a bunch of experts. This really isn’t quantum physics! And it is not something that the United Kingdom, France, Germany and other developed countries haven’t been doing anyway. Therefore, in my opinion, we should be aware of the scale of the problem and we should adapt our tools appropriately.
So what is the main goal of the Polish Economic Institute?
We want our materials to be useful from the point of view of public debate. We should keep in mind that the role of think-tanks has changed drastically in the 21st century. This means that they’ve had to shift their emphasis away from quasi-academic studies, which they had been pursuing just 30-40 years ago. Instead they are now focusing on greater practicality and usefulness of their activities. While great effort still has to be devoted to research work, the results of these efforts have to be comprehensible and accessible to the decision-makers, who now have less time than in the past to get acquainted with such materials.
We have great people, like Professor Aleksander Welfe, who is working on a forecasting model for the Polish economy, which will be developed this year and will probably see the light of day next year.
What will this model cover? GDP forecasts?
Yes. Both short-term and medium-term forecasts. I can also add that in accordance with the assumptions of the project, our model is supposed to be even more complex than the one used by Poland’s central bank NBP.
What is the current condition of the Polish economy?
At the very beginning of the year we expected that the rate of GDP growth in Poland would slow down to approximately 4 per cent. A growth of 3.8 per cent was assumed in the budget for 2019, while NBP predicted an increase of 3.7 per cent at the end of last year. Other institutions have prepared various forecasts, ranging from 3.5 per cent to nearly 4.1 per cent. These forecasts had to be revised after the announcement of the stimulus package for the Polish economy, implemented in the second, third, and fourth quarter of 2019. We now expect a GDP growth of 4.3 per cent in 2019, while some commercial banks are even talking about growth as high as 4.5 per cent, depending on the strength of this stimulus package. If we can achieve the growth of 4.5 per cent in Poland while Germany grows by 0.5 per cent — according to the forecasts — this would mean that the Polish economy has undergone the most important structural change in several decades when it comes to our ability to create added value.
So the fiscal impulse will be relatively strong.
It seems so. This is what many financial institutions and banks are forecasting. We even assume a rate of growth somewhat more modest than the others. It also seems to me that economic slowdown is a psychological effect. Our internal factors of growth through private investment — which accounted for a significant part of economic growth last year, when we recorded a growth rate of 5.1 per cent, along with the boost from consumption will ensure that this year will also be good.
Is the continued development of the Polish economy threatened by the situation on the labor market? Has Poland been affected by a shortage of workers?
Yes, that is a significant challenge. When it comes to threats to growth, the problem of insufficient labor resources is certainly an important issue. However, this challenge could be easily resolved, as Poland still has a lower employment rate among people of working age (20-64 years old) than the average in Europe, and especially in the EU member states that are leading in this regard, such as Germany and the Czech Republic. There is a difference of approximately 8 percentage points between the employment rate in Poland, where it amounts to about 71 per cent, and in those countries, where it reaches approximately 80 per cent. These 8-9 percentage points constitute a reserve which can be used. This group includes, among others, people from the agricultural sector, which would have to be retrained, as well as people working in the shadow economy. Their transition to the services and manufacturing sectors — where, for example, the transport industry needs 100,000 new drivers — could increase the rate of employment, and therefore also the revenues of the public finance sector. For us, this is a challenge that we can deal with.
And what is the future of private investment? We know that consumption cannot sustain growth in the long run. Will private investment be big enough to sustain the high rate of growth in the long term?
The statistical data on Polish companies’ investments in R&D are improving. Between 2016 and 2017, the number of R&D employees in Poland increased by one-fourth. In the declarations of employers, their number increased from 110 to 144 thousand. And this is not because some people found work, because we didn’t suddenly employ so many researchers in business. Instead, it was because of the new classification that entered into force along with the reforms introducing tax relief for R&D. So businesses have started deducting their R&D spending. Before that, they were solely treating that as a cost, and they did not see this as an investment.
As a result, the statistical data in the coming years will show growing investment expenditures of Polish companies due to the fiscal incentives that have been created. Entrepreneurs will simply apply a different classification to what they previously classified as ordinary costs. Therefore, the information that productivity in Poland has risen by a quarter since 2015 means that there has been an increase in investment costs. This could not have been achieved otherwise. If this wasn’t previously visible in the statistical data, it’s because we didn’t measure the rate of investment carried out by private companies very well. We will probably have to organize a discussion concerning the quality of official statistics to ensure that these data are more visible. Perhaps further fiscal stimuli will also be necessary in order for the entrepreneurs to be able to deduct their actual capital expenditures more broadly.
Getting back to the forecasts: will Poland still enjoy such high growth rates after 2019?
It seems that in 2020 the previously mentioned factors of growth through consumption and investment will persist. But there is also the question of our immediate surroundings. The Germans are forecasting that the economic situation in the Eurozone will improve in 2020. So with an improving economic situation in the Eurozone, Poland will be able to maintain the very high rate of economic growth recorded in 2019 also in 2020. The discussion concerning the Polish statistical data on growth is amazing, and I say this as a person who travels a lot around the world to different conferences and debates. To our Western partners, Polish results are simply beyond belief. Poland is a beacon of stability, compared with the structural problems faced by Finland, Ireland, France and Italy, where they have a relatively high unemployment rate along with a low growth rate (or even a technical recession in Italy). If Poland maintains this level of convergence and if it continues to catch up with the countries of Western Europe, it could enter the group of the 20 most affluent countries in the world — in terms of the size of the economy — before 2030.
So it seems that we should be satisfied with these results.
That’s right. This year Poland will overtake Portugal in GDP per capita at purchasing power parity. Now, we should keep in mind that this is a former colonial empire with enormous wealth inherited through the generations. Poland has already overtaken Greece, and before that Hungary. It has the chance to also overtake other European countries, and Italy is already within its reach. Because of that I believe that due to the size of the economy, Poland should be taking up more challenges of a global, long-term nature. One example of such activities is the Three Seas’ Initiative and the economic projects that are implemented in connection with that initiative. This is currently the most interesting initiative – aside from Hansa 2.0 – devoted to the development of a forum for discussion and economic development in Europe. Several dozen projects are already being implemented, an investment fund is being established, there are many new ideas and private capital is also starting to become involved. Additionally, we will soon face a discussion on the opening of the European Union for the accession of subsequent Balkan countries.