Boom and bust

series: Article of the week on PICC site
source: polishmarket.com.pl

     Poland is likely to end this year with positive growth, unlike most of its neighbours East and West. Professor Leszek Balcerowicz, former National Bank of Poland governor, explains why. The crisis began in the United States. It has its dynamics and when it seemed in August 2008 that it might peter out, it suddenly exploded much more fiercely instead. Discussions continue to this day on whether it was the failure to bail out Lehman Brothers that escalated the crisis or whether it was because other banks had been earlier bailed out. However, the only thing certain is that the crisis erupted in the United States and that it lasts to this very day. There are ever more indications that it is bottoming out. The most important thing, however, is how fast it rebounds.

     What determines the impact on other countries of what began in the United States? This impact is determined by two basic factors. First – the strength of commercial and financial links with the developed world. Countries that have been more strongly tied up with the United States and with the developed world, have suffered the most. Those, which have not, include North Korea. It is a country completely isolated from the outside world and represents a devastating example of civilization's failure. It should, however, be kept in mind that negative consequences of the current crisis ensue from a country’s opening itself up to the world even though in itself the opening represents a major driving force in its long-term development. South Korea, for example, has been hurt by the crisis. It is worth recalling that living standards in North as well as South Korea in 1960 were equally low. But by 2008, per capita GDP in North Korea stood at 7% of that registered in South Korea. That is a lesson that a distinction has to be made in the economy between short-term and long-term mechanisms. Another factor is the scale of earlier committed economic sins. The more sins there were, the deeper are the consequences of economic collapse. Sinning in the economy, speaking in a popular way, amounts to stimulating the economy through increasing demand on such a scale that the economy is eventually bound to collapse. Stimulating the economy is in fact tantamount to spurring the crisis. When expenditures rise faster than domestic production, a gap opens up causing an imbalance. Indebtedness – and that includes foreign debt - grows. In the end, everything breaks down.

     If we look at Poland from that angle, let us pass on to encouraging parts of this analysis. It is often said these days that Poland is an oasis in crisis. Indeed, Poland is one of the few countries in the world that have a serious chance of steering clear of recession. The other countries mentioned are China with a 6.8% growth forecast, though the figure is slightly inflated, similarly as in the case of India. Then come Pakistan and Indonesia, both with a 4 % growth rate forecast and Egypt with a 4.4% growth prospect. In that ranking, a 0.8% GDP growth is forecast for Poland. It can be assumed, however, that it will be higher. The data for the last quarter are indeed encouraging in the sense that Poland is the only country in Europe which has in Q2 recorded a positive growth after an earlier decline of 1.4%. Growth rate data for other countries in Europe are far from good, standing at -20% in Lithuania, -18% in Latvia, -16% in Estonia, more than -7% in Hungary, -6% in and Italy and nearly -6% in Germany.

     There are in my opinion six different factors, which taken together, differentiate Poland from other countries:

1. Contrary to other West European countries, Poland has not invested in sophisticated American securities. We have displayed sound backwardness. Sometimes excessive progressiveness is indeed outright harmful rather than sound. One land in Austria, for example, invested in toxic Mortage Base Securities. Several Norwegian city councils and many German, French and Spanish banks did the same. It was common for the banking sectors in central and eastern European countries that they refrained from investing in US securities and so were not hit by the consequences.

2. Being a relatively big country, Poland has been less tied up with the outside world because more of the demand in the country is satisfied by its own products. In 2008, the ratio of exports and imports to the GDP in Poland stood at 68%. This contrasts with 168% in Slovakia, 134% in the Czech Republic as well as in Hungary and 120% in Lithuania, Latvia and Estonia. The outside shock on Poland’s economy was consequently much weaker.

3. Poland’s exports and economy are not based on one dominant sector in which prices are subject to strong fluctuations. Poland is, admittedly, a raw-material producer but we should not be unhappy that it is not a Kuwait, whose position is now precarious. In a country like Kuwait, no reforms have to be made and foreigners can be brought in to do the work. I may also quote the example of Russia which experienced a bonanza when the price per one barrel of oil went up to $150, but things got sour when it dropped to $50. The mechanism is the same in Ukraine with metallurgy dominating its exports.

4. Poland has a floating currency exchange rate. When the economic situation outside the country changes, the exchange rate fluctuations serve as a cushion to ward off the consequences. The floating exchange rate by itself cannot substitute reforms but in the short term, and unlike in countries with a fixed exchange rate, it cushions the blow. The Baltic states have long tied their currencies to the euro. In that context one might ask about the wisdom of adopting euro. Since it is good not to have the euro, would it not be better to keep the cushion? However, this needs to be considered in the context of long-term calculations, rather than of only one year. Account should be taken of the benefits and possible costs in a long-term perspective. All studies I know of, indicate that in the long term Poland, which is strongly tied up with the euro zone economy, would do well to adopt the euro, provided it is well prepared to do so. This means that the economy needs to become more flexible. That applies in particular to the labour market to facilitate mobility. If we are to reap maximum benefits, we have to speed up reforms, render the economy more flexible in financial terms and prepare brakes in case credits rose excessively.

5. Poland’s policies in recent years have been far from ideal, but not extremely so. What does ”bad budget policy” mean? It means yielding in politics to pressure from Father Christmas figures who promise things but do not say where the money would come from to pay for them. During Poland’s accelerated growth in 2005-2007, expenditures grew faster than the GDP. Among others, free-for-all birth bonuses and additional family allowances were introduced to encourage families to have more babies. Fortunately, Poland’s budget policy was not nearly as extravagant as in Hungary. Promises were made there just before the general election to increase wages in the public sector by about 50%, and rose still, these promises were kept.

6. Excessive growth of credits is another factor, and a very significant one in some countries. What does “excessive” mean? In the Baltic states, Hungary and Bulgaria, consumer loans (and in particular mortgages denominated in foreign currencies such as the Swiss frank) rose by 50% each year. This led to a collapse, among others because interest rates were too low and because other brakes had not been put in. We tried to put these brakes in in Poland. The fiscal policy should still be conservative so that interest rates are not lowered too much. Inflation would then be lower, GDP growth slightly higher but prospects of growth in the future better.

     The above are in my opinion the six reasons which explain why Poland stands a real chance of evading recession. And it is evident that only some of these are associated with objective factors, and some with the economic policy pursued. Sometimes our solutions were not good but not as bad as in other countries.

     Finally, what is most interesting – the future in the short and long term. The short term means this year and the next. There is a chance that Poland’s growth rate this year will be slightly above zero. I think that growth estimates ranging between one and two percent next year are feasible. These forecasts are corroborated by stabilisation of the economic situation in the West. Germany has registered a slight growth and no decline has been noted in France with growth standing at zero. Of course, one needs to watch how fast these economies rebound. There are many indications that this may not come rapidly. Among others, because too-strong a campaign has been launched against the crisis and because budget expenditures were being increased for fear of a disaster. Such arguments are used in combating global warming for if there is to be a disaster, everything else is better than the disaster. That, however, has nothing to do with economic calculation. It is playing on emotions.
Growth in the world will probably be stormy but in the short term we stand a chance of enjoying positive growth.