Short, sharp shock in the pipeline?

GDP is increasing at a rate of more than five percent, industrial production is expanding at a two-digit speed, exports almost doubled over the last four years and are still continuing to grow. The currency is stable and inflation is among Europe's lowest. The current-account deficit is small, and FDI is flowing in, as the return on capital is much higher than in Western Europe.

Despite the political turbulence, the economy seems to be immune to the problems: politics is decaying, while economics is flourishing. But can it continue forever? I am not sure that it is possible forever, but for a while, without a doubt.

Solid fundamentals

Poland's good economic performance is based on four solid fundamentals. The first is the process of productivity catch-up. The current real productivity of an average Polish worker equals about 50 percent of Germany's real productivity. However, the average labor cost in Poland is slightly more than 20 percent of German pay. That gives the country a huge comparative advantage as a place for production activities.

The favorable labor cost-productivity ratio is even more visible in the case of newly constructed factories and service centers. As a result, the average rate of return on capital invested in Poland is several times higher than in Western Europe. Capital is coming into the country and productivity is likely to be increasing at a fast rate for years, if not decades.

The second strong fundamental is the human capital of the country. The share of young people in Poland's population is significantly higher than in Western Europe. Moreover, Poland has a large pool of highly skilled workers and one of the highest rates of student involvement in tertiary education in Europe.

The third strong fundamental is the currency. After many years of painful stabilization by the independent central bank, the country now enjoys inflation of less than one percent. The złoty is stable and interest rates have converged to levels not much higher than in Western Europe.

Finally, the fourth fundamental is EU membership. The biggest benefit of EU entry is the abundance of business opportunities. The huge European market is fully open to Polish products, while investors are moving into the country. The upgrading of the legal and regulatory system, required for EU entry, helped to enhance the image of the country. Last but not least, the large EU development funds available for Poland under the seven-year EU financial plan will help solve the problem of the country's outdated infrastructure.

The weakest link

Obviously, the country has its weak points, and the weakest is arguably politics. The political scene is fragmented and unpredictable.

The unexpected electoral success of the traditionalist and conservative parties in the last election led to the virtual halt of the privatization process and a slowdown in many of the most-needed structural reforms. Without such reforms, it is not possible to put public finances in real order, avoid the further build-up of public debt and allow for the reduction of the tax burden. The lack of radical reforms also slows down improvements in the efficiency of governmental bureaucracy, leaving red tape intact.

Another victim of the shaky politics is the euro. The government was unable to set any date for entry into the eurozone. In the longer term, we may be threatened by monetary instability, raising the need for a significant tightening of central-bank policy, which could push rates up again.

A short, sharp shock

In the short term, growth prospects are bright. The rapid GDP increase combined with low inflation is likely to continue, leading to a fall in unemployment, a growth in income, a strong currency and excellent returns for investors. In the long term, the prospects are also looking good. The process of productivity catch-up is likely to continue for years, gradually bringing Poland closer to the Western European average GDP per capita.

The devil is in the medium term. However robust the development of the Polish economy and financial markets was over the last 16 years, the lack of a conclusion to structural reforms and missing the opportunity for a fast euro adoption could lead to serious problems in three to four years' time. The currency, lacking the anchor of the euro, may become unstable - forcing the central bank into high interest rates once again. Without budgetary reforms, the deficit and public debt are likely to increase sharply, once the economy slows down. The problems will probably be only temporary, but quite painful.

Witold M.Orłowski is the chief economic advisor at PricewaterhouseCoopers Poland