10 Case Studies of China and Poland
Language:
English
Print Publication Date:
15 Sep 1994
Keywords:
BOOK; government; country; FSU country; liberalization; market; management policy; discount window; demand management; price level; state enterprise sector; Budget planning and preparation; Public enterprises; Exchange rates; Social assistance spending; Eastern Europe
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Abstract

My remarks will concern economic reform efforts and macroeconomic stabilization in China. There are some remarkable differences between the effects of the Chinese reforms and the results to date of the reforms that have been undertaken in the countries of Eastern Europe and the former Soviet Union (FSU). While valuable conclusions can be drawn from both sets of experiences, China offers some unique lessons.

China

Yusuke Horiguchi

My remarks will concern economic reform efforts and macroeconomic stabilization in China. There are some remarkable differences between the effects of the Chinese reforms and the results to date of the reforms that have been undertaken in the countries of Eastern Europe and the former Soviet Union (FSU). While valuable conclusions can be drawn from both sets of experiences, China offers some unique lessons.

There are two important points I want to convey in my remarks. Let me state them briefly at the outset. First, China’s experience has made it clear that the maintenance of macroeconomic stability is essential to sustaining reform efforts. Second, to maintain macro-economic stability in a manner compatible with the transformation to a market-based system, it is necessary to make substantial progress in reform, particularly in the banking and state enterprise sectors and in the exchange and trade regime. Consequently, economic reforms and macroeconomic stability are closely connected parts of economic policy.

Economic Cycles in China

Let me move now to China’s macroeconomic experience since the country first embarked on reform in 1978 and examine what this experience might imply for economic reform and stabilization efforts more generally.

Since the reform efforts began, there have been three clearly discernible cycles, and at present the Chinese economy is in a fourth (Table 1). The first cyclical peak occurred in late 1979 and early 1980; real gross industrial output rose by 10 percent in that period. The second cycle peaked in mid-1984 or early 1985. In terms of real gross industrial output, the peak growth rate was 21.4 percent in 1985. The third cycle reached its peak in 1988; for that year, real gross industrial output rose by more than 20 percent. During 1992 (the current cycle), China recorded growth in industrial output of 22 percent, and I expect that either 1992 or 1993 will be seen as the peak year for this cycle.

Table 1.

China: Selected Macroeconomic Indicators, 1980–92

(Annual percentage change, unless otherwise specified)

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Sources: China Statistical Yearbook, 1992, and data provided by Chinese authorities.

In U.S. dollar terms.

Table 1 contains some spectacular numbers that illustrate the kinds of cyclical fluctuations the Chinese economy has undergone. There are huge fluctuations in a number of variables, such as fixed investment and merchandise imports. Real gross fixed investment, for example, declined by 12.5 percent in 1981—a major decline—followed in the next year by a positive growth of 28 percent. Similarly, in 1989 real gross fixed investment again declined by 15.5 percent, after registering very strong growth in the previous two years. In 1992 it rose again, this time by an amazing 28 percent. In another area, merchandise imports declined by 16.4 percent in 1982, when the economic cycle was approaching a low point. In 1983, there was a further decline of 10.9 percent, followed by positive growth of 27.6 percent in 1984 and 60 percent in 1985. But 1986 saw another decline. These kinds of numbers characterize China’s economic cycles. In my view, these wide fluctuations have something to do with the kind of policy framework the Chinese authorities have pursued.

As a first step toward explaining this link, I will discuss the common pattern across the three or four business cycles the Chinese economy has experienced since reform efforts were initiated in 1978. Typically, a cycle starts with government efforts to accelerate or reaccelerate reforms, followed immediately by a strong rise in investment that is underwritten by expansionary credit policies. This sequence leads to a “boom” situation that brings with it the threat of a sharp acceleration of inflation, followed by a “bust” or recessionary situation brought on by restrictive policies that rely on tighter administrative controls. The cycle thus comes to an end. And when a cycle ends with restrictive administrative controls, the reform process is put on hold or, in some cases, may even be reversed.

What lies behind this common pattern is the fact that state-owned enterprises, local governments, and many other economic entities see any call by the central authorities for faster reform as a signal to increase investment. For some reason, many Chinese economic agents see these two things as equivalent. Therefore, such a call typically results in a huge run-up in investment spending. This phenomenon is very common across cycles and explains why the Chinese economy is subject to such wide swings.

There are other reasons, which are more important from a policy perspective. Let me say first in this connection that “faster reform” in China means less central planning and thus a greater degree of decentralized decision making. In other words, economic agents are given more freedom to make their own decisions instead of being directed by the central planners. The increased decentralization of decision making has been a feature of all the reform efforts in China so far. Now, in that kind of setting, there is of course a need for effective aggregate demand management that relies less on administrative controls and other kinds of direct interventions. Simply put, what China needs are effective, market-based demand management policies.

In my view, the Chinese authorities have not yet been very successful in developing market-based macroeconomic management techniques. As I noted earlier, at the outset of a cycle, credit is typically allowed to expand very rapidly to accommodate the strong demand for investment. Only after excess demand conditions become a real threat—as they did in 1988, when inflation accelerated to around 50 percent—do the authorities make very strenuous efforts to reverse overheating. However, they do so by resorting to administrative controls, because other instruments are not fully developed. Stringent use of these controls clearly has been very effective in reversing overheated situations. Unfortunately, however, this approach runs totally counter to the Chinese authorities’ goal of transforming the economy into a market-based system and, as I have said, may lead directly to the suspension of reform efforts for a time.

Capacity to Implement Macroeconomic Policies

Looking at what the Chinese economy has experienced during its economic cycles, I would say that what is urgently needed is the capacity to implement a market-based aggregate demand management policy. Let me hasten to add that the problem is not that the Chinese authorities do not have at their disposal the basic elements of a market-based macroeconomic management system. In fact, many elements of a market-based macroeconomic management system already exist or are being developed.

On the monetary side, for example, the People’s Bank of China (the central bank) has at its disposal such market-based tools as reserve requirements and a lending facility for banks; for simplicity I will call the latter a “discount window,” although it actually differs somewhat from the discount facilities typically seen in industrialized countries. The People’s Bank therefore is much like any other central bank, with reserve requirements and a discount window at its disposal. In order to conduct open-market operations, it is planning to introduce short-term paper of its own soon.

On the fiscal side, tax reform is well under way, and once it is completed, the country’s macroeconomic management capacity will be greatly enhanced. China has a tax system, in the sense of having clearly articulated tax rates, tax bases, and the like, but this system is not used to its full extent. Instead, the authorities have relied on a method often referred to as the “contract responsibility system.” But the reform of the tax system that is now under way will improve the authorities’ ability to manage their public finances effectively.

Why have the Chinese authorities been unable to make good use of these basic tools? The first reason is lack of experience. Managing aggregate demand with market-based tools is not easy, even in industrial countries. In China, the process typically takes place by trial and error, particularly given the current lack of reliable monetary aggregates. The second reason the available tools are underutilized, particularly on the monetary side, is that many necessary structural reforms have not gone far enough in creating the infrastructure needed for the use of market-based policy tools. As I mentioned earlier, these reforms include those pertaining to the banking system, the financial markets, the state-owned enterprise sector, and the exchange and trade regime.

Why are these reforms important—that is, how can they help the Chinese authorities make better use of available market-based policy tools? First, a market-based monetary policy influences the real sector not by directly affecting the level and growth of demand components (e.g., consumption and investment). Instead, such policy indirectly affects the real sector through its influence on interest rates and the exchange rate. These key price variables are the cutting edge of a market-based monetary policy. Accordingly, in order for monetary policy to be effective in managing overall demand, these key price variables should be allowed to reflect underlying demand and supply conditions in the marketplace. But in China, interest and exchange rates are generally not allowed to function this way.

If a market-based macroeconomic policy—which works through interest rates and the exchange rate—is to be effective, markets for funds and foreign exchange must be free and competitive and, at the same time, economic agents must be subject to hard budget constraints. There are certain weaknesses in these areas of the Chinese economy at present. For example, the banking system is highly segmented, with specialized banks (for agriculture, commerce, construction, and so on) playing dominant roles. There is not enough competition, and the banks are required to provide what is called policy-based lending, including financing the losses of state-owned enterprises. The banking sector, therefore, can in no way be characterized as free and competitive.

Similar problems are evident in the exchange markets. Access to exchange markets, which in China are called “swap centers,” is restricted, despite the considerable liberalization that has taken place. Additionally, there is little arbitrage among the swap centers because of their segmentation, so quoted prices may differ across the country at the end of each day. The trade system also remains restricted in spite of recent liberalization efforts, further constraining the functioning of the foreign exchange markets.

Finally, let me turn to the state-owned enterprise sector, another area where reform is definitely needed if a macroeconomic policy reliant on market-based tools is to be effective. Currently, China’s state-owned enterprises are not subject to hard budget constraints. The demand for funds and foreign exchange from these enterprises is not price sensitive. In other words, the behavior of these enterprises (in terms of the level and composition of output and inputs) is not sensitive to such price variables as interest and exchange rates, which are central to a market-based monetary policy.

Substantial reforms are needed in the areas I have been discussing if a market-based macroeconomic policy is to operate effectively in China. Without such reforms, the Chinese authorities will continue to find themselves needing to resort to administrative controls in the conduct of macroeconomic policy. Although these controls can be effective, they run totally counter to the authorities’ goal of transforming the Chinese economy to one based on market mechanisms. It is heartening to see that the agenda for future reform now being worked out emphasizes areas that are of crucial importance to the development of the infrastructure necessary to a market-based macroeconomic policy.

Poland

Michael Deppler

Yusuke Horiguchi’s main point is that macroeconomic stability is as important to reform as reform is to macroeconomic stability. I draw the same lesson from the Polish experience of the last few years.

A Brief History of the Reforms

The history of Poland’s reforms can be divided into three basic periods: the “big bang” period of the first half of 1990; the period of shock and disarray that lasted from mid-1990 until the end of 1991 or middle of 1992; and the phase of renewed stabilization and recovery that has followed. January 1, 1990 saw the opening up of the economy and the introduction of the “big bang” approach to macroeconomic stabilization. This approach focused on a nominal exchange rate anchor, restrictive income policies, a tight fiscal position, and what would in retrospect be viewed as high real interest rates and fairly tight credit constraints. The program was spectacularly successful in some respects, but less so in others (Table 1).

Table 1.

Poland: Selected Economic Indicators, 1988–93

(Percentage change unless otherwise indicated)

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Sources: Central Statistical Office, Rocznik Statystyczny; Polish authorities; and staff estimates.

Private consumption only.

In the five main areas of the socialized sector through 1990; thereafter in the six main areas of the economy.

On a commitment basis, except external interest which is on a cash basis.

In relation to broad money at end of the previous year.

Excludes (i) increase in net credit to government due to valuation adjustment on domestic debt indexed to the dollar and (ii) increase in credit due to capitalized interest.

Balance of payments basis.

Including transactions with former Council for Mutual Economic Assistance (CMEA) area for 1991 and 1992.

Gross domestic product in zloty terms is converted into U.S. dollars at the commercial exchange rate.

Including arrears.

In percent of exports of goods and nonfactor services in convertible currencies.

For example, it was certainly successful in promoting the credibility of the exchange rate policy and in improving the overall balance of payments situation. The zloty exchange rate achieved credibility virtually overnight, and exports surged. While inflation did not improve as much as had been expected, it nonetheless declined sharply, helped in part by a much stronger fiscal position than anyone had anticipated. After the initial shock, the inflation rate dropped from over 600 percent in December 1989 to an underlying rate of around 70 percent in December 1990. Output, on the other hand, declined far more than had been anticipated. The level of industrial output, which had already fallen by some 20 percent in 1989, continued to drop sharply in the months after the reforms were introduced. Overall, then, the initial stages witnessed a more adverse split between prices and output than had been envisaged by either the authorities or IMF staff. On the other hand, some progress was made at this time toward meeting the basic objectives of opening up the economy and achieving a marked degree of price stability.

Progress over the next 18–24 months—the second stage—was harder to come by, owing to a mixture of exogenous and endogenous factors. Among the former, the most important was the collapse of trade with other countries in the Council for Mutual Economic Assistance (CMEA) and the associated fall in the terms of trade. These external events were beyond the control of the authorities and could only be accepted. However, this period was also marked by a series of internal shocks that were in part the result of domestic policies and in part the result of weaknesses arising from the transition process itself. Neither the authorities nor IMF staff were fully prepared for some of these.

The first element, a relaxation of policies in the second half of 1990, was occasioned by real wage and output levels that were markedly lower than had been expected in the circumstances, since both the fiscal and external positions were much stronger than expected. Thus, policies for 1991 were tailored to achieve a small increase in real wages. This relaxation of policies took place in a context that argued for a tightening—that is, the collapse of the CMEA.

The situation was greatly aggravated by two shocks to the budget. The first of these concerned state budget revenues, specifically the government’s tax receipts from primarily state-owned enterprises. These revenues had been surprisingly strong in 1990 because of increased profits on inventories—a consequence of price liberalization (Table 2). This increase led the Polish authorities and IMF staff to overestimate the underlying strength of fiscal revenues. In the event, with the ongoing deceleration of inflation in 1990–91, the fall in the terms of trade, and the emerging problem of budget constraints on enterprises, these revenues collapsed from 14 percent of GDP in 1990 to 6 percent in 1991 and to just 4.5 percent of GDP in 1992.

Table 2.

Poland: State Budget Revenue, 1989–93

(In percent of GDP)

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Source: Ministry of Finance.

Aside from the reversal of the inflation-induced valuation effects, this development reflected the presence of soft budget constraints on, and weak governance within, state enterprises. That is, these factors enabled enterprises to effectively shift the burden of adjustment to the state budget simply by reducing their tax liabilities as much as possible. The Worker’s Council dominated state enterprises, setting employment and wages at the highest level the cash flow permitted. As a result, profits plummeted, and so did the main source of government revenue—taxes on enterprise profits.

The same burden-shifting phenomenon showed up on the expenditure side of the budget as well (Table 3). Social expenditures rose from 11.6 percent of GDP in 1989 to 21.6 percent of GDP in 1992—an increase of 10 percent over three years. Essentially, the enterprises shifted older workers from the employment rolls to the pension or unemployment lists in order to maintain the real wages of existing workers. Here again, the burden of adjustment was once more being shifted from the enterprises to the state.

Table 3.

Poland: Revenues and Expenditures of the Social Safety Net, 1987–92

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Sources: Data provided by the Polish authorities; and staff estimates.

Data before 1990 refer to the State Fund for Occupational Activation only.

The lesson that can be drawn from this intermediate phase of Poland’s transition is that, in such circumstances, all of an economy’s structural weaknesses are likely to find their focus in the budget. These structural weaknesses then lead to macroeconomic weakness. This process needs to be avoided, as it can develop into a disastrous situation as far as macroeconomic stabilization is concerned. The IMF’s estimate of Poland’s fiscal deficit in late 1991 and early 1992, without correcting for these kinds of slippages, was some 15 percent of GDP. Left uncorrected, this deficit would have caused inflation to rise to three-digit levels in a matter of months. However, policies were tightened continuously to offset the slippages, so that the annual deficit was kept to some 7 percent of GDP, even at its 1992 peak.

Meanwhile, something quite unexpected was happening. Despite the economic gloom of the second stage, the economy was in fact turning around. Recovery had begun. A look at Chart 1 shows that the economy reached its nadir at the end of 1991 and began to improve thereafter. This recovery has continued ever since. The growth is admittedly not on a scale comparable with that cited by Yusuke Horiguchi for China. But in terms of the performance of the East European economies, the numbers are quite positive. Specifically, industrial output increased by some 27 percent between the trough in November 1991 and May 1993.

Chart 1.
Chart 1.

Poland: Industrial Production, 1988–93

(Average, 1990=100)

Sources: Polish Central Statistical Office, Statistical Bulletin (various issues); and IMF staff estimates.

A number of factors help explain this turnaround. The opening up of access to the European Community (EC) markets following finalization of the Association Agreement in December 1991 played a significant role, particularly in terms of boosting exports. Another was the rapid growth of the private sector. But the most interesting development was the supply response in unexpected sectors of the economy, notably in the medium-sized public enterprises. A survey sponsored by the World Bank of developments in these enterprises showed that once the enterprises ran out of money—in part because of the hard macroeconomic constraints that limited credit and subsidies—and the trade unions were faced with real budget constraints, the decision-making process changed.1 Responsibility was increasingly transferred to managers who began conducting business from a medium-term, profit-oriented perspective focused, in the first instance, on salvaging what could be saved of the enterprises. The surprising aspect of this development is that it occurred quasi-spontaneously, within a framework that provided managers with ill-defined and at best prospective incentives.

The Lessons of the Polish Reforms

The main lesson I draw from Poland’s experience concerns the importance of using macroeconomic and financial policies to drive and reinforce hard constraints at the microeconomic level. During the initial period after reforms are instituted, enterprises find many ways of avoiding adjustment: depreciation allowances, holiday funds, housing funds, social funds, and so on. But if the government maintains a firm overall constraint from the macroeconomic side on credit to enterprises, eventually firms will be forced to confront this constraint, despite their lack of clearly defined ownership and governance structures. And such a constraint will force real adjustment at the microeconomic level. In this sense, I view hard macroeconomic constraints as essential to structural reforms. This idea is the twin of the view expressed earlier that structural reforms are vital to macroeconomic stability.

What other lessons can be drawn from the initial stages of the stabilization program in Poland? Poland was the first East European transition economy with which the IMF was involved, and what was done in Poland became the model for most of the other reforming countries. A key feature of that model was the use of the exchange rate as a nominal anchor. The IMF’s analysis suggests that this anchor was extremely helpful in Poland. It certainly was a material factor in helping stabilize prices and in clarifying the structure of relative prices within the economy. Having said that, I would caution that care must be exercised in setting the level of a nominal anchor. Normally, prices rise steeply immediately after liberalization, as they did in Poland. The objective is to have the new exchange rate anchor the lower domestic price level that will eventually emerge. However, it is important not to set the new exchange rate too low; otherwise, the world price level is higher than the domestic level, and the anchor ends up pushing the domestic price level up rather than pulling it down. The anchor must be set at the right level.

Another lesson I would draw from the early stages of Poland’s stabilization-cum-liberalization is that the government must have a good understanding of the effects of rapid changes in inflation on tax receipts. In particular, the valuation effects stemming from these changes can easily mislead policymakers about the underlying strength of the fiscal position.

Third, what happened in Poland suggests that interest rates should be set with a realistic ex ante rather than an ex post view of inflation prospects. Most economists would agree that interest rates in Poland in the initial stabilization phase were set too high.

To conclude, let me mention that the European Department of the IMF periodically reviews its program experiences. The first review covered the 1990 programs for Poland, Yugoslavia, and Hungary. The main objective of that exercise was to draw on these experiences in setting up programs in Czechoslovakia, Bulgaria, and Romania. However, despite efforts to apply what had been learned to these other countries, the results in terms of output and unemployment did not show great improvement. The larger lesson may be that macroeconomic policies have only limited leverage in protecting reforming economies from the enormous output losses that appear to be inherent in the transition process.

Comments

Wang Xiaoyi

My talk will supplement some of the points Yusuke Horiguchi made about the general framework of structural reform in China. I also want to comment about the country’s present position in terms of reform.

According to figures for the first quarter of 1993, the main economic indicators in 1993 are rising faster than they did last year. Total industrial output is growing at an annual rate of 23 percent; investment in fixed assets at 68 percent; total retail sales at 17 percent; exports at 11 percent; and imports at 19 percent. The money supply increased by 41 percent (annualized quarterly growth rate) during the first quarter and by around 30 percent in the second quarter. But while the figures show that China is growing even faster than it did in 1992, some serious problems are also developing.

One of these problems is that investment in fixed assets has increased too rapidly and that the structure of that investment is not what was originally expected. In some places, recklessness was evident in the way the real estate industry established development zones, and the situation in the transportation industry, as well as in the supplies of energy and some raw and intermediate materials, was also unsatisfactory. Prices in the cities and the costs of some capital goods rose too quickly. In the large and medium-sized cities, the 12-month change in the retail price index had risen to 17 percent by the end of April 1993. There were ongoing difficulties with state finances and a too-rapid increase in the issuing of bank credit and currency that added to inflationary pressures.

What needs to be done to solve these problems? There are only two options. One is simply to choose a set of administrative measures that will adjust economic cycles. As Mr. Horiguchi said, administrative measures can be effective, but they may also intensify these cycles. The other approach is to work for economic stabilization by means of structural reforms. Obviously, the second option is the most viable, because a system of administrative controls will not correct the underlying problem.

Let me briefly discuss the framework of China’s structural reforms in 1993. Overall economic restructuring in 1993 has concentrated on several important areas. The first involves deepening the reform of state-owned enterprises by changing the ways in which they operate. Government administration needs to be separated from enterprise management, and enterprises need to become more market oriented. The authorities can facilitate the transition by turning state enterprises into legal entities responsible for making their own management decisions about operations, future expansion, and profits and losses. In this way, these enterprises will become major competitive agents in the market. The large and medium-sized state-owned enterprises that cannot be privatized must also be effectively managed. The system of selling shares should be expanded on an experimental basis, the management contract system improved, and the separation of taxes and profits encouraged. The government should promote the formation of associations and the merger of enterprises when conditions are right, as well as the establishment of interregional and even transnational enterprise groupings. Some small state-owned enterprises can be reorganized into enterprises with cooperative share-holding systems, and others may be leased or sold to collectives or individuals.

The second important area of reform concerns the speeding up of price reform and the active fostering of a market system. In 1993, controls on the prices of grain, cooking oil, and other major farm products should gradually be relaxed. More commodity markets can be developed on a trial basis, especially a capital goods market and wholesale markets for major farm products. Markets for such major commodities as crude steel, coal, nonferrous metals, grain, cooking oil, meat, and sugar also need attention. New ways of trading, such as transactions in the future markets, can be developed in accordance with each commodity’s individual characteristics. And China should more vigorously work to develop the market for the basic factors of production.

There is also a need to systematically build up financial markets for stocks, bonds, and other negotiable securities and to continue the experiment of the stock exchange. China also needs to develop markets for technology, labor services, information services, and real estate. Strengthening the systems of economic legislation and formulating or improving laws and regulations closely related to establishing a socialist market economy are also urgent steps.

The third important area comprises reforms to deepen the labor market, improve the wage system, and strengthen the social security system. In turn, these reforms should further strengthen the decision-making power of enterprises in terms of employment (in accordance with relevant governmental laws and regulations). Corresponding reforms in the macroeconomic management of labor and wages need to be carried out, in conjunction with reforms in the hiring and distribution systems of enterprises. These reforms should be guided by two principles: (i) that the overall rate of increase of the total payroll should be no higher than the overall rate of growth in the economy, and (ii) that the average rate of increase in wages should be lower than the growth rate of labor productivity. Different methods can be used to regulate enterprise payrolls.

The scope of China’s system of social insurance needs to be expanded, and implementation of the overall plan for providing pensions and insurance at the provincial level needs to be speeded up. Individuals will have to begin contributing to pension and insurance funds, while the management of these funds must be improved. The unemployment insurance system for state-owned enterprises can be incorporated gradually into a unified unemployment insurance system covering workers in state-owned, collective, and private enterprises, as well as the Chinese employees in foreign-funded enterprises. China should also promote the reform of the industrial accident and medical insurance systems.

Finally, China needs to strengthen its systems of macroeconomic control in order to establish a scientific system of economic management. The major task in the macroeconomic sphere is to achieve an overall economic balance, preserving the equilibrium between supply and demand. It is important to continue coordinating economic relationships and to maintain the social aspects of the economic environment, including, for example, ensuring an adequate supply of housing. Ways must be found to establish a new macroeconomic control system that is conducive to the development of a socialist market economy and to make better use of and coordinate the means of control.

China should also continue to deepen its reforms of the planning and investment systems. In 1993, the number of quotas covered by the “material plan” of the State Planning Commission will be cut by around 50 percent. Material planning for production and distribution should gradually be replaced by a system in which supply is calculated on the basis of demand instead of according to government orders. Planning departments should reconsider their functions and concentrate more on developing strategies, exercising macroeconomic control, balancing total supply and demand, making industrial policies, building markets, ensuring the construction of major projects, and coordinating their services. Planning mechanisms need to be revamped to include more indirect economic controls. The policies of state industries for the planning period will be examined as soon as possible so that planners will have a reliable basis for making future decisions on finance, banking, investment, and the utilization of foreign funds.

To invigorate the transportation and energy sectors, develop other key industries, and better guide and promote economic development, special programs will be formulated. The government should encourage more investment in fixed assets by issuing shares in selected areas and should expand reforms in the financial and taxation systems. A dual budget system will be developed to make the state budget more binding, and reforms of the banking system will continue. In 1993, the specialized banks should continue to play both a policy and a commercial role and work actively to create the necessary conditions for becoming fully commercial.

Economic reform in China is important, because people want to improve their living conditions. But I have to say that it is also difficult. For this reason, those charged with economic reform in China are always very pleased to have the chance to learn from other countries, including industrialized countries and the other former centrally planned economies. China needs to learn management techniques, especially marketing management techniques. I do not think that the final target for establishing a market economic system is the privatization of enterprises. Rather, the final target is improved living standards, more efficient enterprises, and higher levels of productivity.

Halina Wasilewska-Trenkner

My talk concerns events in the Polish economy between 1990 and 1993. Chart 1 shows the timing and extent of the decreases in Poland’s GDP. The letters on the horizontal axis indicate the approximate times when various new regulations, which I will discuss in my talk, were put in place. The sharp fall in GDP in late 1989 and early 1990 coincided closely with the Parliament’s adoption of new regulations aimed at liberalizing prices. In 1990, few new regulations were introduced, although a large number were adjusted, including some connected with the wage bill, wage increases, and interest rate policy.

Chart 1.
Chart 1.

Poland: Real Gross Domestic Product

(1989=100)

A: Price liberalization; new credit policy and new regulations on foreign trade, wages and the exchange rate; cuts in subsidies to state enterprises; state enterprise capital assets revalued at market prices.B: Price adjustments.C: Law on privatization.D: Changes in custom tariffs.E: Price adjustment and changes in regulations on unemployment benefits and pensions.F: Pact on privatization of state enterprises; talks opened on law concerning financial restructuring of enterprises and banks.G: Association with the European Union.×: Mass privatization program to begin.+: Value-added tax to be implemented.

The second round of major regulatory changes, which took place in 1991, began with price adjustments and the removal of many of the remaining price controls. The law on privatization was introduced in July 1991, followed by a new customs tariff in August. Other important new regulations were introduced in the fall of 1991, including the personal income tax that replaced existing payroll taxes. At the end of the year, there were further price adjustments and changes in the regulations governing unemployment benefits. In brief, the unemployment benefit system introduced in 1990 was found to be too generous; nearly everyone who turned up at the unemployment offices received assistance, and benefits were paid without restriction as long as recipients declared themselves unemployed. In contrast, the regulations introduced at the end of 1991 limited benefits to those who had been employed for at least six months in a one-year period and were offered for only one year.

Another important change that was made in 1991 involved pension schemes. Michael Deppler has already mentioned that Poland has many social problems and that the associated budget costs are substantial. This situation developed in part because of the political decision made in the 1980s, and followed until 1990, to protect pensions against fluctuations in general wage rates and prices. During 1990, when real wages fell and household incomes in general declined by an average of 4 percent, incomes received by pensioners’ households rose by some 17 percent in real terms. Pensioners were receiving too much protection. The government has tried to introduce reductions in pensions, but some of its actions have been deemed unconstitutional. The government must therefore pay considerable sums in back benefits to those affected. Since these sums could not be found in the budget, they will be reimbursed in the form of privatization vouchers from the mass privatization schemes.

The year 1992 saw fewer new regulations, but two developments were particularly important. The first was the new trade arrangement with the European Union (EU), which meant new and improved market access for Polish exports as well as some reductions in the tariffs on imports, especially on raw materials and investment goods. The second, known as the pact on the privatization of state-owned enterprises in the period of transformation, was the subject of talks begun in September 1992 between the government and the trade unions. It is broader than its name suggests, covering the choice of an appropriate route for privatization, the treatment of the social obligations that have long been the responsibility of state-owned enterprises, and the excess state tax (the tax surcharge levied on enterprises that breach regulations on wage increases).

In 1993, there have been three important developments. One is the mass privatization program itself, which was approved by the Parliament on May 31, 1993 and should start in September 1993.1 The second is the introduction of the new value-added tax (VAT), which goes into effect on July 5, 1994, along with the new custom tariffs. The third important development, which is being actively discussed in Poland, concerns the financial situation of state-owned enterprises, especially their financial arrears. Despite efforts to cut back on budgetary transfers, problems in this area remain. The government is trying to deal with these problems through the special law on the financial restructuring of enterprises and banks, which was approved in 1992 and came into force at the beginning of 1993. However, it has not yet had much impact, since the necessary financial support for the reconstruction effort is only now becoming available.

Table 1 shows the changes in the number and structure of Polish enterprises over the last three years. The number of communal enterprises is decreasing, while various types of commercial partnerships and joint stock companies are increasing. The most important enterprises at the moment are the state-owned enterprises, which are being transformed either into companies in which the Treasury holds shares or into joint stock companies that will be privatized in the future. The number of commercial law companies with foreign capital investment increased rapidly during 1992 and 1993.2 Joint ventures, usually small firms, are a traditional form of economic organization in Poland, and most of them are moving toward becoming share-based companies. And finally, there are now many individual Polish business establishments.

Table 1.

Poland: Economic Units, 1991–93

(End of period)

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Source: Polish authorities.

Turning to the reform process itself, I would like to consider a few of the main challenges Poland faces as a result of the transformation of its economy. Mr. Deppler has already mentioned one of the most important issues—namely, the use of the exchange rate as a nominal anchor. In 1990, the nominal exchange rate was set at a level that was 50 percent higher than it had been in December 1989. If you compare averages, the 1990 level was four times higher. Unfortunately, this high anchor did not produce the intended anti-inflationary effect; instead, it artificially pushed up both price increases and interest rates. What Mr. Deppler described as “the unexpected ability of enterprises to cope with the new situation” was due in part to the fact that, at the time, many state-owned enterprises held deposits in foreign currencies. For these firms, the newly depreciated exchange rate meant extra profits, and the managers found it quite easy to avoid the budget constraints of the transition period. Similarly, the situation offered households with deposits in foreign currencies the opportunity to become rich almost overnight.

When the new anchor was established, interest rates on savings in zlotys were set at the same high, positive level as interest rates on loans, while interest rates on savings in foreign currencies were set at LIBOR levels (minus some margin of profit for Polish banks), so that these rates were relatively low. The low rates resulted in a flow of corporate and household funds out of foreign currencies and into zlotys deposits, a trend that certainly helped the country’s liberalization efforts.

While some groups were experiencing large increases in income, others were seeing their incomes decline in real terms because of restraints on wage increases. This decline in incomes, combined with the price hikes that followed the freeing of prices (an important goal of the overall reform process), resulted in a significant increase in the number of people who found themselves much worse off in relative terms. The need to develop a social safety net intensified. The growing problem of open unemployment, exacerbated by the practice of transferring employees in state enterprises to pension schemes instead of laying them off, meant that the costs of such a net were potentially very large. It is worth noting that according to Polish law, a worker must be either 60 (for women) or 65 (for men) to receive a pension. In reality, however, the average age of our pensioners is around 58.

The various problems that have emerged have resulted in pressure from the trade unions for the government to change its course. Knowing the economic dangers involved, several earlier governments managed to avoid this challenge. But the current Government has no choice. In 1990, the government had good results with the state budget, because it was possible to cut subsidies. In 1991, it was still possible to cut back on some expenses. But that situation did not persist into 1992, and it has been very difficult to make major gains in 1993.

The problem now is to know how far to go in 1994, especially in light of the increasingly difficult problem of unemployment. The jobless rate for Poland is about 14.2 percent, but in some regions the figure is more than three times as high (Chart 2). Those regions with very high unemployment require special treatment. The government has already started to introduce special policies for these regions within the overall framework of the general stabilization program.

Chart 2.
Chart 2.

Poland: Unemployment Rates, March 1993

(By voivodship)

Source: Polish authorities.

Poland also has problems with certain economic sectors and with the different types of enterprises. One such sector, which includes industries like shipbuilding, is heavily influenced by the big trade unions and large commercial enterprises. These groups pose major challenges for the government, since they are not sensitive to any budgetary or other constraints. The medium-sized enterprises have already adjusted, or are in the process of adjusting, to the constraints and responsibilities of a market situation through changes in production techniques and management. Some smaller enterprises have effectively gone bankrupt, while others are being turned into private firms. In a few essential sectors of the economy, including coal mining, railways, and agriculture, the government is trying to introduce restructuring plans to ensure that the enterprises continue to operate effectively.

However, all these programs require capital, and the government is now working to establish a sound financial base for implementing them. This task involves not only raising the necessary capital, but also designing measures to limit the use of budgetary funds as the primary source of financial assistance for restructuring. It is important to establish budgetary arrangements that support the restructuring of state-owned enterprises.

Summary of Discussion

The discussion focused on three main aspects of the reform process: the “big bang” approach to reform used in Poland, fiscal and monetary policies in transition economies, and problems with the Chinese reforms. Initially, discussants questioned whether the East European countries—and Poland in particular—had been given any real choice about how quickly to implement their reform programs. It was suggested that a more gradual approach might have resulted in a smaller loss of real output and slowed the decline in living standards.

There were several responses to this theory. First, it was pointed out that there is no such thing as a “big bang” as far as structural reforms are concerned. Most reforms, including privatization and the restructuring of enterprises, take a considerable length of time both to prepare and to implement. The “big bang” concept relates more directly to the macroeconomic stabilization effort and price reforms that were undertaken early in the reform process in Poland and other East European countries. IMF speakers also argued that there is little evidence to show that a more gradual approach would have resulted in smaller output losses. Hungary was mentioned as a country that initiated reforms more gradually than Poland, yet Hungary’s output losses were greater. Romania is a more dramatic example. It has operated with accommodative credit policies and has been lax in its attitude toward enterprise arrears. Romania has suffered output losses equally as large as Poland’s, as well as inflation rates of over 200 percent—much higher than those in Poland.

The discussion of this issue ended with the observation that the large output losses Poland and other transition economies have sustained are not a consequence of the speed with which reforms are implemented. Rather, they are caused by the systemic changes associated with the dismantling of central planning. The demand management policies the IMF advocated during the initial reform effort would have had little effect on the size of these losses.

The second issue followed directly from the first. Some discussants suggested that Poland’s fiscal and monetary stance had been too tight, thereby contributing to the unfavorable split between prices and output. The response to this suggestion was similar to the response to the argument for gradualism. Some aspects of the reform—for example, higher indirect taxes—that push prices up are not easy to correct with demand management policies. IMF speakers agreed that, in retrospect, a somewhat smaller initial devaluation and lower interest rates might have benefited Poland. However, the speakers doubted whether these policies would have allowed countries such as Poland to strengthen their external accounts so significantly. Looser policies might have weakened the external accounts to the point where management demand policies, or something very similar, might have been required.

One discussant suggested that Poland’s adjustment process had involved “disorderly” elements, including sharp falls in both the GDP and living standards, in sharp contrast to the IMF mandate to achieve orderly adjustments to temporary balance of payments disturbances. IMF speakers strenuously rejected the idea that the process in Poland had been disorderly. They pointed to Poland’s good balance of payments performance and to the rapid increases in both its imports and exports, which resulted largely from increased freedom of trade.

The third issue—the Chinese reforms—opened with a reference to one important difference between the reforms in China and Poland. China maintained certain controls during the reform process. It was noted that, because of the political circumstances in Poland and other transition economies in Europe during the past few years, it would have been impossible to retain such controls. Discussants also questioned whether China can really deepen its reforms at a time when its economy is facing such serious overheating problems. One suggested response to this problem involved removing some of the more distortionary credit controls, such as the credit ceilings that apply to certain types of companies, projects, and locations. This approach would represent a sort of middle path between market-oriented, indirect monetary controls and the present administrative control system. Given the present seriousness of China’s overheating problem, however, it was generally agreed that it is unlikely stability can be restored while further radical reforms are being put in place.
1

See Brian Pinto and others, “Transforming State Enterprises in Poland: Evidence on Adjustment by Manufacturing Firms,” Brookings Papers on Economic Activity, Vol. 1 (1993).

1

The law took effect on June 15, 1993, hut decisions on which enterprises to privatize held up implementation of the program until 1994.

2

There are two kinds of joint ventures in Poland, governed by separate regulations. The first, which has existed since 1986, involves primarily investors of Polish origin and is known simply as a joint venture. The second involves foreign investors of any nationality and, because it is based on the principles of commercial law, is known as a commercial law company with foreign capital. (Other relatively new commercial law companies are funded with domestic capital.)

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Cover Coordinating Stabilization and Structural Reform
Coordinating Stabilization and Structural Reform
Proceedings of the Seminar Coordination of Structural Reform and Macroeconomic Stabilization, Washington, D.C., June 17-26, 1993
ISBN:
9781557754301
Publication Date:
15 Sep 1994
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557754301.071
Pages:
284
Chart 1.

Poland: Industrial Production, 1988–93

(Average, 1990=100)
Chart 1.

Poland: Real Gross Domestic Product

(1989=100)
Chart 2.

Poland: Unemployment Rates, March 1993

(By voivodship)