Balcerowicz: We can avoid the slowdown

Professor Leszek Balcerowicz

CE Financial Observer: We will soon be celebrating the 25th anniversary of the June elections that where the beginning of our political transition. How do you assess the previous 25 years of economic policy?

Leszek Balcerowicz: In order to assess them we have to make meaningful comparisons. Some comparisons are meaningless. I know some people who resent the fact that Poland is not yet as rich as Switzerland. Assessments of our economic situation are often loaded with slogans and emotionally-charged terms, such as „social”. We have to compare ourselves with countries that had a similar starting point. We must look at how they departed from socialism and what the results were. Using this method we see that between 1990 and 2013 Poland’s GDP increased more that twofold, and that this was the fastest growth among the former Eastern Bloc countries of Central and Eastern Europe (apart from Albania).

No country achieved better results taking a different route to Poland – for instance by implementing reforms more slowly or in another order. On the contrary, those countries that deferred reforms found themselves in a difficult situation. The most stark example is Ukraine, where the standard of living in 1989 was very close to the level in Poland, but where now it is almost three times lower. Romania is a less drastic, but nonetheless unfortunate, example, where market reforms were delayed by a few years. Those who talk of the social costs of reforms omit the far higher social costs of failing to reform.

The example of Hungary is interesting, because it was in a much better situation to Poland in 1989.

It was also a much richer country than Poland, but its governments made many mistakes that caused Hungary’s economic growth to be slower. Primarily, their fiscal policy was even worse than ours. This does not mean that we didn’t make mistakes or that we used every opportunity.

The Czech Republic also had a significantly better starting position than Poland. But GDP there has increased by only 40 percent over the past 25 years and Poland’s by more than 100 percent. The Czech Republic is still richer than Poland but the effects are worse. Why?

That’s a good question. Even better: why has Slovakia developed faster than the Czech Republic over the last 25 years? This is something that I asked the former president and prime minister of the Czech Republic, Václav Klaus, at a conference in Budapest that brings together all the old reformers. Also on the panel was former Slovakian deputy prime minister and minister of finance, Ivan Mikloš. Klaus replied that the question was too complex to address it at a conference. Mikloš answered without hesitation that at some point the Slovaks started making more reforms.

Following eight years of Vladimír Mečiar’s populist government, the cabinet of Mikuláš Dzurinda and Mikloš came to power in 1998, and thanks to their rapid and radical reforms the economy achieved high growth. This confirms the idea that faster growth comes with reforms that depoliticize the economy. Growth collapsed in the Czech Republic in 1993. It turned out that their banks, despite their formal privatization, had not been detached from the political sphere. There had been little restructuring of the economy, because the state-controlled banks had purchased the privatization vouchers and privatization had thus proved to be sham.

East Germany is an interesting case. In the autumn of 1990, even before formal reunification, I was at a conference in Wolfsburg where German politicians presented plans for financial transfers to the former GDR. Poland could not then afford even a fraction of these amounts, but the effects of these transfers anyway proved to be in vein.

Germany was a special case, which I would describe as a peaceful bombing of the economy. Physical bombing destroys productive assets. The peaceful type causes productive assets to bring only losses. Perhaps that situation was politically inevitable. The east-west exchange rate of deutschmarks was set at 1:1. In effect the East German economy became completely uncompetitive from one day to the next and all companies there began to bear losses. Enormous financial transfers were a result of this decision, which was made by chancellor Helmut Kohl for political reasons. Kohl won the election in East Germany as well. The Bundesbank was opposed. If a more competitive exchange rate had been set for the East German mark then the economy of the former GDR might have grown and at a some point the levels of both parts of Germany would have become equal. Of course there existed a risk that more people would have migrated from east to west. The decision was then very difficult.

The situation in Korea might be even more dramatic, if one day the monstrous North Korean regime falls. For a long time afterwards the border between the north and south will have to be maintained.

You said that despite the successes in Poland, more could have been done.

There have not been sufficient reforms to the entire judicial apparatus: the police, prosecutors, courts. This remains a weak link, which manifests itself in sluggish proceedings, and sometimes in unjust accusations against businesses and people. Reform of the justice system is one of two priorities in my civic activism. The other being maintaining the growth and stability of the Polish economy. I support movements such as Niepokonani, of people who have been wronged by the justice system. Reforming the system was not the main goal of the government of Tadeusz Mazowiecki.  Firstly, that was a coalition government where ministries of state power were in the hands of the communist United Workers’ Party [PZPR] and the judiciary was under the United People’s Party [ZSL]. Secondly, there were so many tasks and problems that there was not enough time for everything. It is worse that successive governments have not been able to pass deep reforms of the courts and prosecutor’s office.

Contrary to the current myth of „painful transformation” the social policy of early governments was unusually generous. Millions of people received benefits and early retirements. Was this a conscious policy?

The economic team, which I headed, was lean and did not have sufficient capacity. At the time we did not see what the consequences of labor minister Jacek Kuroń’s proposals – regarding unemployment benefits and pensions – would be. Jacek Kuroń had his own team and made the proposals public. Obviously, he did this in good faith. After a time we understood what the fiscal implications of the Minister’s proposals would be. In effect we had a sharp rise in spending on pensions and unemployment benefits. The Czechs and Hungarians did not have similar problems because they were in significantly more stable situations at the outset than Poland, and they didn’t have to take decisions so urgently. At the time we had hyperinflation and all the resulting chaos.

An important part of the transformation was privatization. Today this is still not finished.

My intention was to privatize as quickly as possible. A distinction must be made between the privatization of previously state-owned enterprises and the privatization of the market, for instance, through the creation of new, private, companies. This latter process has been a success with positive consequences for entire economy. Thanks to the solid stabilization and wide liberalization we saw market competition, and the strengthening of budget restraints also on state-owned enterprises, which began to shed weight. The result was the transfer of assets to the private sector. I tried to strengthen this process: the only tax relief I offered was to new private companies. I also convinced the Polish-American Freedom Foundation to put emphasis on financing private enterprise.

The privatization of state-owned enterprises was slower than I would have liked. There was no chance of an act on privatization appearing in the first package of laws to reform the economy. The project was accepted by the government in February 1990 and a law was finally passed in July. I offered Jan Wejchert the role of minister of privatization, but he declined. Eventually Waldemar Kuczyński became the minister, and in the next government Janusz Lewandowski. The privatization law might have been the beginning of a rapid process of transferring ownership, but it was not. The presidential elections were approaching, with parliamentary elections a year later.

There was a growth in populist sentiment and the fight over privatization became a electoral springboard for populists. We were, however, able to privatize the foreign trade organizations and state-owned farms, thanks to Dariusz Ledworowski, the minister for foreign economic cooperation, and Adam Tański, the minister of agriculture, respectively. Janusz Lewandowski prepared the crucial National Investment Fund project. The rate of privatizations significantly increased in 1998–2000, thanks to the work of Emil Wąsacz and Alicja Kornasiewicz. This was the largest reform of the Jerzy Buzek government.

A majority of the banks have been privatized. During the global financial crisis some voices emerged in Poland arguing that it would be better if the state held more banks, since it could then conduct a „sovereign credit policy”.

If the banks had not been privatized under Jerzy Buzek subsequent governments would certainly not have done it. We would in effect have a system like Slovenia, where 70 percent of banks are in state hands, with obvious results. The banks would be politicized, and a „sovereign credit policy” would mean loans being granted via politician’s phone call. Slovenia is going through a very serious banking crisis, the worst in our part of Europe. The privatization of Polish banks is evidence of the fact that, despite the unwillingness of some, privatizations can still be completed if the government is sufficiently determined.

How in retrospect do you assess the monetary policy of the last 25 years? For a long time we were unable to reduce inflation below 10 percent.

This was the result of a conscious decision to introduce the „crawling peg” – the slow devaluation of the zloty.  The constant weakness of the zloty made the battle with inflation more difficult. This was a controversial decision, but not an absurd one. Inflation was reduced gradually until the inflation target strategy was introduced by the Monetary Policy Council, which was established in 1998. Then it was possible to lower inflation to a level closer to that seen in the European Union. I had the pleasure of guiding the deliberations of the council from 2001. Although low inflation was not a condition of Polish entry to the EU, high inflation would certainly have made our situation more difficult. When I took the position of President of the National Bank of Poland inflation stood at around 10 percent. Gradually, all the while cutting interest rates, we brought inflation down to 2 percent. There the transformation was completed.

Since the outbreak of the global financial crisis we have lost momentum. Although this has happened in all of Europe, and in comparison we are still ahead, there are some prognoses that suggest our rate of growth will be closer to that of Western Europe. What can be done to catch up with rich countries more quickly?  

Several wealthy countries have in recent years been growing at a rate much lower than ours, for instance Sweden and Switzerland. Both these countries have strong fiscal discipline. The three most important forces influencing momentum are employment, investment (private investment in particular), and an overall improvement in efficiency. It is certain that without a serious dose of reform our growth will be lastingly reduced. Employment will fall as a result of demographic trends; the level of private investment is low and may still decrease; and the strongest force thus far driving growth, improving efficiency, is weakening. Taken together we have the prospect of a lasting slowdown. Unfortunately, this is not a topic of public debate.

Economists are talking about the middle income trap. According to World Bank experts, of the 101 economies that in 1960 were at an average level of development, only 13 were by 2008 in the group of highest-income countries. Does this trap threaten us?

I do not like that term, because it implies that there exists some kind of hard regularity preventing countries moving from the medium to the higher level. Meanwhile, development depends mainly on the decisions that are taken within a country. If the rate of growth falls and we stop developing, emigration will increase, again worsening our possibilities for growth. You might say that the so-called „hot water out the tap” strategy guarantees us a bad scenario. One consequence for example is massive losses for the Kompania Węglowa [Coal Company], possibly rising energy prices and a further lessening of competitiveness. That is one scenario, but there might be another: an acceleration of reforms without waiting for the economy to stall. This scenario is only possible if pro-development forces become stronger in society.

What needs to be done is not a massive problem intellectually, but rather politically. Russia’s invasion of Ukraine shows that we are not living in such a safe world, as we might have thought. The more so important it is that we pursue policies that ensure strong growth. The invasion betrayed a fall in the value of Western security guarantees. It is vital therefore that we invest in our security. In a worse economic scenario there will not be enough money.

You said that the development of necessary reforms is not a large problem intellectually. Let us try to define a list of necessary reforms.

Firstly, the ageing population. This is evidence of success. It means that our average life expectancy is increasing. It also has its consequences, which can be foreseen. It is difficult to find a sensible plan to ensure that young people have more children. Pro-family policy is a humbug. A rational approach is to extend the age of retirement and I give the current government credit for doing this.

Secondly, you need to use existing reserves. The employment rate among the youngest and oldest is low and this has to change. There’s no need to raise the minimum wage. You need to look at why young people are not finding work. One reason is the mismatch of the education system to the needs of the economy. Low employment among older people, in turn, is the result of legislation protecting people of pre-retirement age from dismissal.

Low levels of investment are due to policy factors that mean it is not profitable to invest more. For example there is almost no private capital investment in building apartments to rent because of the absurd tenant protection act. This has to change. We also have to diagnose what should be done to avoid an overall lessening of efficiency. The Civil Development Forum has catalogued many things. For instance, it is necessary to reform public universities, where there is most socialism. We know from OECD data that many areas of the Polish economy need to be reregulated. Generally it is possible to prepare a list of reforms that would prevent a slowdown. And this has to be forced on politicians, because when they are free of civil oversight they propose remedies that are worse than the disease.

Interviewed by Witold Gadomski

Leszek Balcerowicz – Deputy Prime Minister and Minister of Finance in the governments of Tadeusz Mazowiecki, Jan Krzysztof Bielecki and Jerzy Buzek. From 2001–2007 President of the National Bank of Poland. Founded and directs the Civic Development Forum.

Professor Leszek Balcerowicz

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