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Prejudice and Fact in Poland’s Industrial Transformation

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1993
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IAN M. HUME AND BRIAN PINTO

Three years into Poland’s “big bang” economic reforms, evidence shows state enterprises to have been more responsive to new economic realities than the prejudice of a passive, failing state sector would indicate. State-owned enterprise (SOE) behavior and reform remain vital for medium-run growth, not only in Poland but also in other reforming countries where the state manufacturing sector typically accounts for a high share of GDP, employment, taxes, and exports. While conditions are different in different post-communist countries, Poland’s experience as a front-runner offers some useful lessons.

Privatization of large, manufacturing companies is not an easy task, especially on the scale required in the former centrally planned economies of Eastern Europe. In 1990, many argued that state assets should be rapidly privatized. Any delay would mean wasted time and when privatization was finally implemented, there would be nothing left to privatize. This view was based on the popular image of SOEs as sluggish in adjusting to the new economic realities and resistant to restructuring.

A survey (see box) of 75 companies, all of which were SOEs at the start of the Polish reforms, was conducted in mid-1991. It was repeated a year later, with 64 returning the filled-in questionnaire that contained monthly information on all conceivable variables of interest, including sales, costs, profits, wages, bank borrowing and interfirm credit, tax arrears, excess wage tax penalties (paid on wages in excess of a legislated norm wage), and so on. These firms were from five manufacturing sectors—metallurgy, electromachin-ery, chemicals, light manufacturing (textiles, leather), and food processing. By mid-1992, of the 64 responding companies, 3 were privatized, 24 were commercialized (but 100 percent treasury-owned joint-stock companies, nevertheless) and 37 were still SOEs. Out of the group of 39 best performing companies, 2 were privatized, 14 were commercialized, and 23 were SOEs.

The survey data show firms to have been vigorous in their responses. The results indicate that some companies are capable of adjusting, restructuring, and expanding profitable sales prior to privatization. It would be wrong to conclude from this that privatization is either unnecessary or can be infinitely delayed. On the contrary, by taking the initiative, many companies have enhanced their viability and increased their value as privatizable assets, while some have not. In the case of Poland—where there are different privatization tracks for companies of different degrees of viability—this divergence of experience may make it easier to identify which track will suit which company.

Evidently, hard budgets and import competition—key ingredients of Poland’s reform program—can lead SOE managers to restructure companies even when privatization and better managerial incentives lag behind. Interviews with managers and other evidence suggest four factors are playing a crucial role in the transformation:

  • the government has held a consistent economic policy line (despite periodic political instability) right from the start of the reform on January 1, 1990. SOE managers became convinced by mid-1991 that the government had neither the intent nor the resources for bailing them out and that they must therefore make it on their own;

  • rapid trade liberalization and the elimination of subsidies quickly clarified price signals, forcing firms to focus on efficiency, marketing, and profits, in contrast to the obsession with the production target in the former centrally planned regime;

  • commercial bank behavior changed sharply following improved supervision and control, which was implemented in late 1991 (some 21 months after the big bang), diminishing the adverse selection of loans and directing resources to better firms; and

  • SOE managers became familiar with operating in a market environment and see their future and reputation as inextricably linked to the success of the firm, either when privatized or as is.

Enterprise behavior

Based on the data collected, the survey was able to establish a number of broad findings reflecting the dynamism of enterprises.

Sectoral differences. In 1991, the success of enterprises depended largely on their manufacturing sector. By 1992 it was common to find within each sector some enterprises doing well, others less well. This is a clear sign that the prereform allocation of resources is now bending to market forces. Initially, sectors were resilient to the reform shocks, depending upon various starting points, such as dollar accounts and inventories carried over; and favored access to the captive former Council of Mutual Economic Assistance (CMEA) market and cheap inputs and energy, which lasted until March 1991. Now factors within each enterprise (management actions, and others) rather than sectoral origin are becoming the main determinant of performance.

Enterprise performance. Data from the first six months of 1992 were used to classify the 64 enterprises into three groups: those that exhibited positive retained earnings after payment of all taxes and penalties (AAA—31 firms); those that showed positive pre-tax profit only (AA—8 firms); and those with negative pre-tax profit (A—25 firms). The chart shows the profit trends in these three groups of firms in the period from the end of 1989 to mid-1992 (the profit rate on the basic business of firms, abstracting from sales of assets and net extraordinary gains). Remarkably, the AAA firms have been able to maintain a steady rate of underlying profitability throughout. These firms also had the earliest recovery in sales, showed wage restraint, were conservative in borrowing from banks, and were the most likely to stress product mix changes as a factor stimulating sales.

Adjustment measures. All three groups of firms showed declining sales and rising finished goods inventories in 1990 and 1991, although AAA firms had a smaller adverse experience. Therefore, all firms were under pressure to react to the sharply changing conditions in the economy during this period. There were the shocks of the reform process—hard budgets, new relative prices in the goods market, free trade—and the shocks coming from the collapse of the CMEA—realistic input prices and collapsed markets.

The data from the survey show how these firms have responded to these shocks, as measured by a number of indicators.

Labor and unit cost management. All the firms surveyed had made significant adjustments in labor force and wage behavior, the sample as a whole having trimmed the labor force by 27 percent between September 1989 and June 1992. But neither labor shedding nor wage restraint alone explain the financial success of the best companies. The best, in fact, shed relatively fewer workers and paid the highest wages. However, since they were successful in securing an earlier recovery in sales their productivity was higher and their unit costs lower.

Materials and energy management. All firms managed to reduce the consumption of materials and energy per unit of sales. Comparing the first half of 1991 with the first half of 1992, the 31 best companies had reduced this consumption by some 22 percent, the remaining companies by some 17 percent.

Credit management and arrears. There is significant evidence to distinguish the behavior of successful from unsuccessful firms, based on their management of investment and operating credits. In the case of the least successful firms, again, a poor sales record was reflected in a high (and growing) level of inventories, which drove these firms to high levels of borrowing compared to sales. By June 1992 these firms had working capital loans of over 200 percent of the costs of sales, compared to less than 90 percent for the best firms. Since the least successful firms had also invested at about the same rate as the most successful, these firms were left with a huge interest burden, measured by interest payments as a share of profits before interest and taxes. Beyond mid-1991, the least successful (A) firms as a group were unable to meet their interest payments, while this burden never exceeded 50 percent for the best (AAA) firms. The most successful firms had much lower tax arrears (less than 4 percent of taxes due in mid-1992) compared with the least successful (close to 51 percent in arrears). The best firms were also net lenders to other enterprises, not borrowers (as were the least successful).

Company decapitalization. The notion that state-owned companies will tend to decapital-ize themselves by favoring excessive wage payments is not borne out by evidence in the companies surveyed. Investment exceeded depreciation in all but the least successful firms. Even in the latter, the shortfall can hardly be attributed to excess wages since the wage penalties (which were up to 500 percent of a given wage increase) were only a small fraction of resources available to pay the excess wage tax (“disposable cash”).

Export diversion. It was always assumed that firms with a long history of production for sales under contract to customers in the CMEA would find great difficulty in penetrating alternative export markets, following the CMEA collapse. Such difficulties are no doubt real for many firms, but the survey found that in two major export sectors (metallurgy and chemicals) fully 91 percent of hard currency exports of surveyed sample firms consisted of diverting the same products to western markets; 89 percent before the collapse of the CMEA in 1990/91. While this diversion is encouraging, as it meant a concerted marketing effort, the evidence questions the presumption that more exports means more adjustment. Metallurgy and chemical hard currency exports in 1990 were of standardized products underpinned by cheap inputs from the former Soviet Union under CMEA trade. Many of the adjusted firms in the sample were primarily selling on the domestic market under the competitive pressure of low import barriers.

These findings suggest that managers have shown considerable willingness to adjust. In fact, all firms have undertaken adjustments; firms at the bottom of the heap shed the most labor. These firms, however, are also beleaguered by the biggest debt overhang and highest excess employment. The extent to which adjustments have led to profitability has therefore varied. The single factor that seems to have separated the successful from the less successful firms is final sales performance. Unfortunately, we know too little from the survey about why some firms could sell and others not, although managers of AAA firms were the most likely to stress product mix changes as a factor stimulating sales.

All firms have been driven to respond with varying degrees of success to the tightening of budget constraints and the relative price shock that were key elements in the Polish reform package. Opinions were always divided on whether such stringency alone would be enough to bring a real restructuring of the enterprise sector or whether, as others believed, a specific micro-intervention was needed to change the governance of the enterprise by commercializing/privatizing it, as a pre-condition for its restructuring. The latter concern has been driven by the fears that firm-level incentives, in particular managerial compensation, are not consonant with the long-run health of the firm; that the limbo status of firms between announcements of government intentions to rapidly privatize and actual implementation would prompt decapitalization; and that in any event, managers lacked the expertise for restructuring. It is, therefore, intriguing that managers of AAA firms with no personal stake in the company akin to the incentives that would exist in a market economy comparator are performing well; and indeed that managers of SOEs in general are defying the stereotype of an inert sector.

Overall supply response

Of course, 64 firms is a small sample on which to base conclusions for the whole of Polish industry. However, other evidence tends to support the thesis that state sector companies have adjusted and are entering a recovery phase, which represents the “supply response” to the reform package imposed in early 1990. The Business Survey in Poland, which tracks anticipated industrial performance based on a poll mainly of SOEs, indicates growing optimism. Expectations of better performance indicated by the survey are corroborated by seasonally adjusted industrial output data, which indicate a systematic recovery starting in 1992.

Further, it is interesting to note a number of other features in the performance of this sample of 1,200-1,500 mainly state-owned companies polled by the Business Survey. First, in the period since the beginning of 1992 (i.e., the sharp recovery period), it has been the heavy industries and the larger firms that have been among the leaders in the process. The industries that have performed above the average of all branches have been: ferrous and nonfer-rous metals; transport equipment; textiles and clothing; glass and pottery; and the food industry. In addition, the data show that firms employing over 2,000 workers have shown significantly greater production growth than those employing smaller numbers. The firms with the lowest production growth were those employing less than 250 workers.

Moreover, supporting data in the survey show in various respects that the sampled companies are exhibiting aggressive market behavior. In 1992, orders for both domestic sales and exports grew by some 20 percent; the number of companies reporting increased difficulties selling their products fell by half; about the same was reported by companies selling in export markets. The number of companies reporting higher profits from exports increased by 6 percent; those reporting lower export profits declined by some 4 percent. These findings do not support the popular “albatross” conception of the large state-owned company in the heavy industry branches. Although there undoubtedly are many SOEs in difficulty, there is also an element of dynamism contributing vigorously to the supply response.

Interpreting the evidence

The data support the following broad conclusions:

  • Thanks to the maintenance of a disciplined macro framework, the Polish reforms are working, as evidenced by the systematic supply response based on increasingly competitive activities.

  • The state sector enterprises, many of them in heavy industry branches, are among those leading the recovery, giving added weight to the sustainability of reform.

  • Although SOEs have undertaken (spontaneous) restructuring of various kinds, it would be wrong to conclude that changes in the governance of such enterprises—by commercialization and privatization—are unnecessary or could be delayed. Instead, the survival and future health of these enterprises is now more assured because they have recognized and acted upon the need to take their future into their own hands; to this extent such companies are better placed to accelerate their commercialization and privatization through whatever means.

  • The fact that small companies have apparently fared less well than large companies gives cause for concern. Since most new private companies—whose growth is to be encouraged in the new Poland—are small, the question arises as to whether there are special barriers to such companies that need to be addressed.

For a detailed analysis see “Transforming State Enterprises in Poland: Microeconomic Evidence on Adjustment” by Brian Pinto, Marek Belka, and Stefan Krajewski, Policy Research Working Paper 1101, The World Bank, March 1993, and forthcoming in theBrookings Papers on Economic Activity. Information on the Business Survey Poland was obtained from Kuniunktura w Przemysle Polska; Instytut Rozwoju Gospodarczego, Szkola Glowna Handlowa, December 1992.

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