Making Poland Great Again?

After eight years of so-called “hot water in the tap” economic policies, new Development Minister Mateusz Morawiecki has presented an ambitious, complex and somewhat overwhelming plan to modernize the Polish economy, with the state playing an important role as a guide through the transformation process By Wojciech Rylukowski Drones instead of furniture, cyber security and data centers instead of international helpdesks and innovation instead of imitation. This is the future vision of Polish specializations in the economic development plan unveiled by the ruling conservative Law and Justice (PiS) party in February. The goals of the program are very ambitious, with the aim of transforming Poland into an innovation-based, high-income country. To achieve this goal the country will have to make a considerable effort and overcome several structural obstacles. [caption id="attachment_94394" align="alignleft" width="300"] Image: Shutterstock[/caption] Diagnosis The author of the concept, Development Minister Mateusz Morawiecki (hence “the Morawiecki plan”), has identified five challenges that Poland is currently facing. These are: the middle-income trap, the lack of balance between Polish and foreign capital, the lack of innovative products, the demographic trap, and the weak institutions trap. Morawiecki’s diagnosis of the current situation starts with the assertion that the resources that have enabled Poland to grow rapidly over the past years, such as cheap labor, are running out. Poland needs to find new “locomotives” of growth to avoid becoming trapped in a middle-income status. The competitiveness of many Polish companies is based on the production of unsophisticated, cheap products. Only a few small and medium-sized companies are able to introduce innovation. Furthermore, the country’s development has been dependent on Foreign Direct Investments, which was beneficial to some extent as Poland received capital and technology, but the growth of domestic companies was inhibited. The ministerial plan states that foreign investors are still welcome and needed, but “healthy” economic growth requires a balance between foreign and domestic capital. Another hindrance to Poland’s growth is its ageing society. Estimates show that the working population will systematically dwindle. By 2050, as many as five million fewer Poles will be of working age. This “trap” has serious consequences, as it may lead to the insolvency of the social pension scheme, increased debt and diminished investment outlays. The program also states that Poles don’t earn enough, and GDP growth has to be matched with salary increases. At present, half of the population earn less than PLN 2,500 net, which accounts for 80 percent of the average salary. The document points to the fact that differences between regions are widening, with underdeveloped areas of eastern Poland missing out on investment opportunities. Last, but not least, Morwiecki’s diagnosis says that public finances are in bad shape, making it a drag on the country’s development. [negative]Poland wants to attract foreign investors by offering tax exemptions and investment or employment grants if they locate their R&D centers in Poland and create high quality workplaces. [/negative] Poland’s chronic budget deficit leads to increased public debt, of which half is in the hands of foreign investors, constituting a significant risk to economic stability. Theoretical underpinnings In order to overcome these traps, the state, according to the minister, has to be more active than it has been until now. In an interview with Polish daily Polska The Times, Morawiecki admitted that one of his inspirations is the theory of new structural economics coined by Chinese economist Justin Yifu Lin. The concept constitutes an endeavor to marry two development economic paradigms: the structuralism, which focuses on market failures and promotes import substitution policies, and the neoclassical, which centers on state failures and pushes for “neoliberal,” market-oriented reforms. In line with the theory, the state plays an important role in moving a country from one stage of the development into the next. This advancement is possible through industrial and technological upgrades, which require simultaneous improvements in education, financial and legal institutions, and infrastructure. Since private firms are not able to internalize the costs of such changes, it is the government that is [caption id="attachment_94396" align="alignright" width="300"] Image: shutterstock[/caption] responsible for doing so. In this concept, the state has a facilitating role and provides the necessary coordination to remove the barriers to the emergence of firms and their related industries, but also lets them grow and develop organically. Under the new structural economics, the market is seen as a basic mechanism for effective resource allocation, but the state needs to intervene by providing information about new industries, subsidizing activities in the process of industrial upgrades and catalyzing the development of new industries. In practice, Lin advises looking for industries and sectors in which a country can specialize and which can bring high added value. Subsequently, the state has to identify strong and weak points of domestic companies operating in these sectors and their legal, infrastructural or institutional environment. The next step would be to provide support by creating a scientific or infrastructural base, building clusters and transferring resources there. In sectors with high potential, where there aren’t any domestic firms, Lin advises attracting foreign capital and technology – it will bring added value to the economy and domestic companies would learn through spillovers. The plan “The state cannot be reduced to the role of a night watchman. It should be a partner and a guide” – this statement, made by Minister Morawiecki, reflects the substance of the program. It is based on five pillars: reindustrialization, the development of innovative companies, foreign expansion, sustainable social and regional development, and increased savings. One of the key ideas of the plan is the establishment of the Polish Development Fund, which will come from merging existing institutions, including the Export Credit Insurance Corporation (KUKE), development bank BGK, the Polish Agency for Enterprise Development (PARP), the Polish Information and Foreign Investment Agency (PAIiIZ), the Industrial Development Agency (ARP) and Polish Investments for Development (PIR). The Fund will integrate and organize the tools offered by those institutions and will propose new solutions, resulting in increased efficiency. [caption id="attachment_94392" align="aligncenter" width="1024"] Image: Development Ministry[/caption] The support will cover numerous areas – small and medium-sized enterprises, investments, infrastructure, export, promotion and innovation. The fund will obtain capital for investment on preferential terms offered by international financial institutions. In line with the theory by Justin Lin, the government has singled out strategic sectors of the economy, the so-called domestic areas of intelligent specialization, which will receive the support of the state. Presenting his plan, Morawiecki gave examples of industries which are already operating in Poland and which, with a little help and guidance, could become powerhouses of the economy, creating high added value workplaces. According to the minister, Poland could specialize in such businesses as: drone manufacturing, the shipyard industry centered on the production of passenger ferries, the IT sector (cyber security and data centers) or rail vehicle manufacturing. Companies from these sectors (and others including chemical, food, transport or armaments) would get a helping hand through special development programs. Poland also wants to launch the StartInPoland project, aimed at the commercialization of innovative solutions created by start-ups. A new bill on innovation is also planned. On top of that, the share of R&D expenditures in GDP is to be increased from 0.8 percent at present to 2 percent in 2020. The ministry is also preparing a set of tools for entrepreneurs, which includes: a new coherent legal act called the Business Constitution, less burdensome tax audits, the abolition of useless licenses, simplified taxes, more friendly public administration and so on. Poland wants to attract foreign investors by offering tax exemptions and investment or employment grants if they locate their R&D centers in Poland and create high quality workplaces. In addition, the government wants to support Polish exporters and Polish products, as well as foreign expansion of companies through a special division of the Polish Development Fund. The program will also introduce new procurement policies which abandon the lowest price criterion, provide concessions for small and medium-sized enterprises, and include points for innovation and social clauses promoting stable jobs. Under the plan, PLN 1 trillion will be spent on investments within the coming years. Half of the sum is to come from European funds, another PLN 230 billion could be sourced from Polish companies’ savings, with the potential of state-owned companies estimated at PLN 150 billion. Up to PLN 80 billion will be delivered in development programs carried out in cooperation with international institutions, such as the European Bank for Development and Reconstruction, and the World Bank. The plan sets ambitious aims. It envisages that by 2020, Poland’s GDP will stand at 79 percent of the EU average, the level of investment will reach 25 percent of GDP, the number of small and medium-sized companies will grow to 22,000 and Poland’s outward FDIs will increase by 70 percent. The devil is in the detail? The plan has attracted considerable interest, with only a handful of the most liberal economists ridiculing it through comparisons to centrally planned economies and the communist-era specific five-year development plans. But this interest doesn’t equal endorsement and appraisal. The biggest concerns raised are in relation to the generality of the plan, and also its complexity as it embraces so many economic, institutional and political dimensions that it is on the verge of being implausible. Doubts pile up as we take a look at the details. The plan states that 99.8 percent of Polish companies are small and medium-sized and because of their size, they are not capable of competing in terms of innovation. However, one of the main points of the plan is state support for small and medium-sized companies and the goal is to increase their number. Another apparent contradiction is the assertion that dependency on foreign capital may shake the stability of the economy and is generally costly, while at the same time the plan stipulates attracting Foreign Direct Investments. Unlike recently, foreign investments are supposed to generate high quality jobs and Poland is to become the promised land for R&D centers. It is nonetheless, difficult to say why that would be the case, as the FDI policies are almost exactly the same as they were before (tax exemptions, investment grants, special economic zones etc.). Even though Poland has thousands of bright engineers, the main factor attracting foreign investors is still cheap labor. [negative]The biggest obstacle in executing the plan might be Morawiecki’s power base. Law and Justice (PiS) began its time in office in conflict with Poland’s top constitutional court, which resulted in the launch of the procedure of the rule of law by the European Union. [/negative] The composition of the PLN 1 trillion investment budget provokes some questions. As much as PLN 200 billion is to come from the savings of Polish companies, but there is no guarantee that they will invest the money, as such decisions are contingent on numerous factors. “There are not many interesting investment opportunities in Poland. Poland is generally poor with the exception of Warsaw and some bigger cities. Companies’ money lays idle in bank accounts. Morawiecki’s challenge is to entice them to invest,” said professor Witold Modzelewski, a tax advisor, and one of the authors of the tax system in Poland. Additionally, Andrzej Rzońca, an economist from the liberal think-tank FOR (Forum for Civic Development), points to the interesting fact that many of the goals of the plan have already been reached. For example, for 15 out of last 20 years, industrial production has exceeded GDP growth. According to the IMF, the value of investments in Poland will reach more than PLN 2 trillion by 2020, a figure twice as large as the one set in the plan. Morawiecki wants to reindustrialize Poland, but 25 percent of the country’s GDP comes from manufacturing, compared to the 19 percent EU average. Direction to follow “Economic plans are usually divided into three stages, the first one is the ideological-axiological, the creation of a certain intellectual model, and we are at this point,” Modzelewski reassured. Once the plan gets to the second stage, when the concept is turned into legal acts, a much clearer vision will emerge. “At this point it is difficult to discuss the plan, assumptions are correct,” Modzelewski said, adding “the program is original.” In the last eight years, the economic policy of the previous ruling PO-PSL coalition was described as the policy of “hot water in the tap.” “The central tenet was the lack of great ideological plans, no big visions of modernization, with the role of the state reduced to guarding against possible shocks. Morawiecki’s plan comes as an interesting and necessary turnaround if Poland wants to escape its status as a semi-peripheral European economy. It is unlikely that every point of the program will be fulfilled, but the document indicates the direction to follow. Morawiecki’s success will be establishing a dialogue with businesses and convincing them to trust him,” Modzelewski said. “Polish commercial courts are in really bad shape. The state must have an efficient justice system and regain the trust of businesses and citizens,” he added. Even if the only positive outcome of the plan is increased efficiency of state institutions, it is worth giving it a go. Paradoxically, the biggest obstacle in executing the plan might be Morawiecki’s power base. Law and Justice (PiS) began its time in office in conflict with Poland’s top constitutional court, which resulted in the launch of the procedure of the rule of law by the European Union amid concerns of the party breaching the constitution. Recently, PiS refused to publish the verdict of the Constitutional Tribunal, preventing it from coming into force. Analysts warn that the situation may lead to the emergence of two separate legal orders: the first, based on governmental acts and the second, based on the constitutional court’s rulings. On top of that, in January, rating agency Standard and Poor’s lowered Poland’s credit rating for the first time in its history, saying that the system of checks and balances has been eroded. The move raised the costs of lending and undermined foreign investors’ confidence in Poland. The negative atmosphere surrounding the government may discourage highly competent professionals from joining Morawiecki’s team, and only the best bureaucrats can guarantee the success of such complex undertaking. Additionally, foreign investors may turn away from Poland and, in the longer perspective, EU funding might be at risk. This grim vision is still distant, but it would be the greatest failure of the ruling party, if its reckless policies bury the chance of a much-needed upgrade to the Polish economy.