Republic of Poland: Selected Issues

This paper provides evidence that globalization has dampened inflation in Poland in the last ten years. A broad-based statistical and econometric analysis of financial and household balance sheet data implies that exchange rate-related credit risk and liquidity risk are currently contained. Rapid growth of foreign currency loans puts a premium on sound lending practices, risk management, and effective supervision. The many indicators examined in this paper suggest that there exists considerable room for enhancing the flexibility of the Polish economy.

Abstract

This paper provides evidence that globalization has dampened inflation in Poland in the last ten years. A broad-based statistical and econometric analysis of financial and household balance sheet data implies that exchange rate-related credit risk and liquidity risk are currently contained. Rapid growth of foreign currency loans puts a premium on sound lending practices, risk management, and effective supervision. The many indicators examined in this paper suggest that there exists considerable room for enhancing the flexibility of the Polish economy.

III. Assessing the Flexibility of the Polish Economy37

A. Introduction

68. A broad consensus has emerged among policy makers that flexibility is critical for good economic performance. In various speeches Allan Greenspan praises the “remarkable increase in economic flexibility” and argues that “[t]he impressive performance of the U.S. economy … offers the clearest evidence of the benefits of increased market flexibility.” (Greenspan, 2005) On the other side of the Atlantic, the “key word is flexibility” to Jean-Claude Trichet and the “lack of sufficient structural reform in Europe is … a major cause of the gap in economic growth between Europe and the US.” (Trichet 2006a and 2006b). Moreover, much of the EU’s Lisbon Agenda was, and is, geared toward making participating economies more flexible for the good of growth and employment.

69. Globalization, ICT advancements, and EMU have put economic flexibility center stage. Goods, services, and financial markets are rapidly integrating internationally, in the wake of liberalization and falling transportation and communication costs. This offers rich rewards for those that embrace the new opportunities quickly and adjust to the ever changing global environment nimbly. On the other hand, rigid economies risk falling behind, as their structures become less and less attuned to the demands of the global marketplace. EMU has likewise put a premium on flexibility. With monetary and exchange rate policies geared toward the needs of the Euro Area as a whole, adjustment to changing circumstances at the member country level must increasingly come from a flexible real sector.

70. This chapter tries to assess the flexibility of the Polish economy. With the transition experience under its belt, Poland is no stranger to large-scale economic change. But how does Poland fare when it comes to the ability to adjust smoothly to the new challenges of globalization and to exploit the opportunities afforded by it? The next section tries to define economic flexibility and how to measure it. Attempts to come up with a single quantitative indicator are constrained by the breadth of the concept of flexibility and by data limitations. The assessment therefore relies on a variety of different approaches and general lessons from the literature. Section C assesses flexibility using economic outcomes as a yardstick. Section D explores to what extent the elements that are typically seen as making up flexibility are in place in Poland. They include product markets, financial markets, labor markets, and the business environment. Section E concludes.

B. The Concept of Flexibility

71. In referring to flexibility policy makers typically have an economy in mind that has one or more of the following features:

  • Resilience in the face of shocks. Observers are astounded by how smoothly the US economy has absorbed major shocks in recent years—such as terrorist attacks, natural disasters, and the many-fold increase of oil prices—and attribute this to increased flexibility. In terms of macroeconomic outcomes, a flexible economy would hence be characterized by low output variability, as well as high average output growth as even large adverse shocks that would otherwise trigger a full-blown recession no longer do so. In terms of the underpinning economic structure, the idea is that the economy’s resilience is driven by a nimble supply side response, rather than skillful macroeconomic management.

  • Ability to embrace and create new opportunities. Rapid change in the global economic environment constantly creates new opportunities that firms in a flexible economy are better positioned to seize than firms operating in a rigid economy. Indeed, to a large extent it is the entrepreneurial and technological ingenuity of flexible firms that generates the dynamic change of the economic landscape endogenously. In terms of macroeconomic outcomes, a flexible economy would hence exhibit superior growth performance. At the disaggregated level one would expect to see a high degree of structural change as resources are rapidly reallocated across sectors, across firms, and within firms. The fast pace of structural change would be underpinned by strong entrepreneurial spirit and conducive business conditions.

  • Full resource utilization. In an economy with a nimble supply side, entrepreneurs operating under conducive business conditions are likely to find ways to tap resources fully. Hence, persistently high unemployment, idle capacity, and sluggish investment would be hard to square with a high degree of economic flexibility.

72. Measuring flexibility empirically is a complex task. The predicted macroeconomic implications—high growth, subdued output volatility, and a high degree of structural change—are very broad indicators that are also affected by many factors other than flexibility. For example, it is well known that growth performance also depends on the initial level of per capita GDP or trade openness. And observed cross country differences in output variability and structural change might reflect a higher or lower exposure to shocks rather than a higher or lower degree of economic flexibility. In the face of limited observations it is in practice not feasible to control for all these other influences. In addition, construction of empirical measures of structural change quickly run into constraints of data availability. Newer research suggests that it is often the intra-sectoral or even intra-firm reallocation of resources that is critical for flexibility. However, data on such a disaggregated level exists only for a very few countries.

73. Any outcome-based assessment must therefore be complemented by an analysis of microlevel indicators of flexibility. The literature suggests that it is above all a high degree of competition that makes for a nimble supply side. A high degree of competition is in turn fostered by deregulated product markets, trade openness, and private ownership of enterprises—all aspects on which indictors are available or can be constructed relatively easily. Other aspects that are typically seen as important for flexibility are deep and accessible financial markets to finance entrepreneurial endeavors and modern labor market institutions. Finally, measures of the business environment are good summary indicators of how conducive a country’s institutional setup is for entrepreneurial flexibility. Indicator-based measures of the business environment comprise many of the above mentioned elements but usually go further to also include aspects related to the functioning of the judicial system, the efficiency of public administration, corruption, etc. Survey-based measures of the business environment draw on the expert opinion of business leaders.

C. Outcome-Based Measures of Flexibility

74. Data for measuring the degree of structural change in Poland is scant. The most comprehensive and detailed database on sectoral output is compiled by the University of Groningen, using the OECD Structural Analysis Database as a point of departure. It contains the real value added of close to 60 sectors for the years 1994-2003 for most OECD countries. The sectoral composition of exports is available from UN Comtrade database for a wider set of countries, allowing comparison with emerging market economies, as well as OECD members. Microstudies on structural change seem unavailable for Poland, expect for one reference to firm turnover.

75. Structural change in Poland seems to have slowed, according to sectoral output data. The index constructed here measures the degree to which value added is reallocated between sectors during the full sample period 1994 to 2003, as well as in the first and second subperiod. No attempt is made to control for cross-country heterogeneity of shocks or initial structural misalignment. for the period as a whole, the Polish economy experienced a large degree of structural change, surpassed only by Ireland and Korea. This likely reflects a large need for restructuring when transitioning from decades of central planning and the reform push early in this process. This is confirmed when examining the subperiods 1994-98 and 1999-2003. Poland enjoys a high ranking in the first subperiod but then falls back to a median position amongst OECD and EU countries in the second subperiod. Lately Poland ranks behind Germany, Portugal, or Austria, all of which have been rather slow growing. This raises the question whether Poland’s pace of structural change is consistent with its income convergence aspirations.

Selected Countries: Index of Structural Change 1/

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Source: IMF staff calculations based on University of Groningen 60-industry database.

Weighted average of (absolute) growth rates of sectoral value added shares. Weights reflect the size of sectors.

76. To a lesser extent the slowing pace of structural change is also evident in Poland’s export pattern. The structural change index is constructed from export data for 64 types of goods. Again, Poland ranks toward the top of the OECD-EU league for the full sample period 1994-2004. And, as in the value-added based analysis above, the pace of structural change declines from the earlier to the later subperiod. Within the group of OECD and EU countries, the slowdown is, however, somewhat less pronounced and Poland retains an above-median position. This might reflect that exposure to stiff competition on world markets kept exporters more agile than firms serving primarily the domestic market, where competitive pressures might have been less intense.

Selected Countries: Index of Structural Change of Exports 1/

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Source: IMF staff calculations based on United Nations COMTRADE Database.

Weighted average of the (absolute) growth rates of sectoral export shares. Weights reflect the size of sectors.

77. Structural change of Poland’s export pattern was rather low by emerging-markets standards. While Poland has retained a rather favorable ranking among OECD and EU countries, it fares less well when compared with emerging markets. Most emerging-market economies exhibit a considerably faster pace of change in their export structure. Poland might want to benchmark itself against such countries in light of the disappointing growth performance of many EU countries and its hopes to converge rapidly to western European income levels.

Selected Emerging Market Countries: Index of Structural Change of Exports 1/

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Source: IMF staff calculations based on United Nations COMTRADE Database.

Weighted average of the (absolute) growth rates of sectoral export shares. Weights reflect the size of sectors.

78. Other indicators at the more disaggregated level confirm that structural change in Poland was not particularly rapid. The above sectoral analysis suffers from failing to capture structural change that takes place within sectors. Recent research suggests that it is precisely “creative destruction” at this microlevel that is critical for economic flexibility (Caballero, forthcoming, and Kolasa, 2005). Unfortunately, there are few microstudies carried out for Poland that would lend themselves to cross-country comparison. The one notable exception are Klapper, Laeven, and Rajan (2004) who study firm entry rates. Poland’s rate was 12 percent, comparable to western Europe, but trailing the 16 percent that was the average of transition economies’ entry rates. Moreover, the sample period is 1998/99, a time of relatively strong growth in Poland. The Baltic countries had higher entry rates, although they grew much more slowly at the time. One can conjecture that Poland’s entry rates have declined since 1998/99 as growth slowed in the first half of this decade. Indeed, Rogowski and Socha (2005) find that entry rates have declined considerably.

A03ufig12

Selected Countries: Firm Entry Rates and GDP Growth, 1998/99

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Sources: IMF staff calculations, IMF, World Economic Outlook, and Klapper and others (2004).

79. Structural change appears a strong driver of growth. Empirically, the value-added based and the export-based indices of structural change are strongly positively correlated with GDP and overall export growth, respectively. In the cross-country sample the correlation coefficients come out at 0.96 and 0.73, respectively. This suggests that structural change is primarily driven by firms taking advantage of new opportunities rather than restructuring needs arising from adverse shocks. It also underscores that there is little hope to achieve high rates of growth through an across-the-board expansion without the kind of structural change facilitated by flexibility.

80. The pattern of growth performance and output volatility is also consistent with the view that Poland has fallen back in terms of flexibility. Taking a longer term perspective and evaluating performance over the last ten years as a whole, Poland fared very similarly to regional peers. Output volatility was contained and only the Baltic countries grew significantly faster. However, when focusing on the last five years, Poland clearly trails its peers, both in terms of the level and stability of the growth rate. Considering the multitude of factors that potentially influence growth and its volatility, one can of course not be sure to what extent the drop of Poland’s performance really is attributable to insufficient flexibility. However, it is worth noting that the growth slowdown was driven by total factor productivity, an area likely to be most directly affected when efforts to make the economy more flexible slacken. Total factor productivity contributed 3.8 percentage points to growth during 1996-2000 but only 1.6 percentage points during 2001-05, thus accounting for almost 90 percent of the slowdown in overall GDP growth.

A03ufig13

Selected Countries: GDP Growth and Output Volatility

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Sources: IMF, World Economic Outlook; and IMF staff calculations.1/Measured as standard deviation of real per capita GDP growth rates.
A03ufig14

Poland and Country Groups: Growth Contributions in 5-Year Periods

(In percent per year)

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Source: IMF staff calculations.

81. Poland’s poor labor market performance is indicative of a lack of flexibility in large parts of the economy. The employment rate is notoriously low. Only 52 percent of the working-age population was employed in 2005, less than in any other EU country. At the same time, unemployment remains the highest in the EU. Over 18 percent of the labor force were unemployed in 2005, although the recent cyclical upswing of the economy together with the migration of larger numbers of Polish workers to other EU countries has brought some relief. Moreover, it is sometimes argued that Poland’s labor market statistics are biased by extensive unregistered economic activity. However, this is likely to also be the case in other countries and it remains unclear whether the presence of unregistered economic activity really much distorts countries’ relative labor market performance as reflected in official labor market statistics. In any event, there can be few doubts that economic institutions in Poland do a relatively poor job in utilizing labor resources, by either letting them lie idle or employing them unproductively in the informal sector. This waste of resources is inconsistent with the notion of a highly flexible economy where a conducive business environment would allow nimble firms to tap resources fully and efficiency with few intermittent disruptions.

A03ufig15

Central European Countries: Employment Rate and Real GDP Growth, 1998-2006

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Source: IMF World Economic Outlook, Eurostat, and IMF staff calculations.1/Data for 2006 refer to the first quarter.

D. Microlevel Indicators of Flexibility

82. Deregulated product markets, modern labor market institutions, and accessible financial markets are traditionally seen as the main underpinnings of overall economic flexibility. They are, for example, the main areas that HM Treasury examines in its periodic assessments of the UK’s readiness to join the Euro area (2003). That said, there are additional dimensions which importantly affect overall economic flexibility, such as entrepreneurial spirit, framework conditions for businesses, or a supportive educational system, to name a few. However, they are less tangible and difficult to measure. This section therefore focuses mainly on the traditional elements but also includes a discussion of business environment indicators.

83. An emerging literature offers some clues about the relative importance of the different elements of flexibility. Ideally, policy makers would like to know where flexibility matters most so that they are better able to focus their reform efforts in the most promising areas. Several papers and studies establish the link between the different elements of flexibility and macroeconomic performance: product market deregulation is found to increase investment (Alesina et al., 2005), labor demand (Griffith et al., 2004), and output growth (IMF, 2004). Similarly, labor market regulations such as employment protection laws are linked to higher unemployment (IMF, 2003) and lower output growth (Loayza et al., 20004). In addition, more recent research uncovers complementarities between labor and product market reforms (Blanchard and Giavazzi, 2003, and Berger and Danninger, 2005). Several papers establish a robust link between financial development and growth, but the direction of causation remains difficult to establish (see Levine, 2004, for a survey). Loayza and others (2005) find that the contribution of trade to growth increases with labor market and firm-entry flexibility. Regarding the most promising areas of reform, ensuring a high degree of competition appears to be the single most important framework condition (Jaumotte and Pain, 2005).

Product markets

84. Poland’s product markets appear to be the most regulated in the OECD. Conway and others (2005) comprehensively study product market regulations for the OECD. They cover all member countries and provide an assessment for the years 1998 and 2003. Although their summary index indicates a declining degree of rigidities, Poland ranks as the country with the most regulated product markets in both years. The poor rating permeates both subindices, the one on inward-oriented policies, measuring the degree of state control and barriers to entrepreneurship, and outward-oriented policies, measuring obstacles to trade and invest freely across borders.

85. Inward-oriented policies suffer from a relatively high administrative burden to market entry and relatively widespread state control of enterprises. As a result Poland fares poorly in the two subcategories of inward-oriented policies, “barriers to entry” and “state control.” Apart from the administrative burden for firms to enter the market, “barriers to entry” also consider legal restrictions on entry and antitrust exemptions, both areas in which Poland appears not to have a particular shortcoming. Poland’s “state control” rating is pulled down because the government retains ownership control over a sizable share of the economy in a variety of sectors. Other forms of state control, such as price controls or intrusive regulation are not found to be areas where Poland has particular deficits.

A03ufig16

Selected OECD Countries: Product Market Regulations, 1998-2003

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Source: Conway and others (2005).

86. Poland’s relative shortcomings are likely to have persisted. The OECD study is somewhat dated and reforms since 2003 might have changed the picture. Indeed, Poland has streamlined the registration process for firms newly entering the market in the context of the 2004 Enterprise Freedom Act. However, the more up-to-date “Doing Business” survey of the World Bank (2006) still ranks Poland only 92nd in a sample of 155 countries in this aspect, much behind the EU 15 (average rank of 45) and other central European countries (average rank of 54). Regarding state ownership, 25 percent of output still came from state-controlled enterprises in 2004 and government disengagement since then has been limited.

A03ufig17

Poland: Public Ownership in Selected Sectors

(In percent of total)

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Source: Central Statistical Office of Poland.

87. Turning to outward-oriented policies, the lack of openness of the Polish economy suggests scope for further liberalization. In the OECD study, Poland’s ratings are poor, because of relatively high tariffs and widespread barriers to foreign ownership of Polish assets, although administrative procedures or regulatory barriers that would discriminate against foreigners appear not be an issue. Again, it is not clear whether this unfavorable assessment still applies. The study reflects policies that were in place in 2003 and the alignment of Polish laws and regulations with the acquis communautaire in the runup to EU membership in 2004 have likely liberalized the foreign trade and investment regime since then. However, empirically Poland’s trade openness remains below what country characteristics would suggest (see Box). This indicates that there remains room for further liberalization also in the area of outward-oriented policies, be it in the legal framework or in its practical implementation.

Openness of the Polish Economy

Poland has the lowest ratio of trade to GDP among the central and eastern European countries, even though they share similar geographical locations and economic structures. Their trade policies have also converged in the wake of EU accession.

The larger size of Poland’s economy partly explains its low trade ratio. A cross-country regression for a sample of 130 countries seeks to control for size and other pertinent country characteristics. Indeed, regressing population, distance to trading partners, per capita GDP, an index of administrative barriers, and dummies for major world regions on trade ratios explains about 70 percent of their observed variation.

However, even after controlling for Poland’s larger size its trade ratio remains unduly low. The regression results confirm that given Poland’s characteristics, it would be expected to have a lower trade ratio than other central European countries. However, Poland’s actual trade ratio of 63 percent of GDP for the sample period 2003-05 falls substantially short the 87 percent that would be predicted on the basis of its economic characteristics.

Openness Regression Results

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Source: IMF staff calculations.

Number of days it takes to complete procedures to export and import a standard cargo of goods.

A03bxufig01

Actual and Predicted Trade Ratios

(In percent)

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Source: IMF, World Economic Outlook; and IMF staff calculations.

Labor markets

88. Labor laws and regulation appear not to unduly impede labor market flexibility in Poland. Employment protection legislation in Poland is less strict than in the OECD on average and or in regional peers, according to the index calculated by the OECD, echoing the findings in business environment surveys, as discussed below. Minimum wage is earned by 4 percent of full time employees, and stands at around 35 percent of average wages. while this is a rather moderate ratio by international standards, it might be binding in distressed regions or for inexperienced workers, possibly shutting them out of the labor market (Ministry of Economy and Labor, 2005). And legislation adopted last year that adjusts the minimum wage each year by wage growth plus a premium until it reaches 50 percent of the average wage could create problems over time.

OECD Countries: Strictness of Employment Protection Legislation, 2003 1/

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Source: OECD Employment Outlook 2004.

A higher value indicates stricter employment protection legislation.

89. However, labor is saddled with a large tax burden in Poland, hampering full utilization of labor resources. The tax wedge, measured as the difference between labor costs and take-home pay, is toward the high end of OECD countries’ range, though comparable with other central European countries. The bulk of the tax wedge reflects social security contributions, with income taxes playing a more moderate role. Indeed, in no other OECD country do social security contributions account for as large a share of public revenues as they do in Poland. The large difference between labor costs and take-home pay means that many employment contracts that would be mutually beneficial to employers and employees in the absence of the tax wedge are not concluded, driving down employment ratios. Moreover, labor taxation exhibits little progressively in Poland, thus exposing those at the lower end of the income distribution to hysteresis-type unemployment. During unemployment spells in the wake of adverse economy shocks their skills deteriorate thus damaging their employability permanently.

OECD Countries: Tax Wedge, 2005 1/

(percent)

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Source: OECD, Taxing Wages 2005.

Tax wedge is defined as income tax plus employee and employer contributions less cash benefits as a share of total wage cost. For a single worker with no children.

Percent increase in the tax wedge as the earning of the worker goes up from 67 to 100 percent of average earnings. Higher numbers indicate greater progressivity.

90. Easy access to out-of-work benefits is probably the single largest drawback of labor market institutions in Poland. The generosity of benefits is typically assessed by means of the net replacement ratio—the after-tax benefit as a percent of net income when working. Judging from replacement ratios alone, Poland’s system would appear to be somewhat less generous than that of the median OECD country. However, benefits seem easily accessible. Despite reform efforts, about 9 percent of the working age population remains on disability or early retirement pensions. This reduces incentives to take up work and lengthens unemployment spells, during which workers tend to deskill. Indeed, generous social transfers are identified as one of the main culprits for the steep increase of unemployment from the mid-1990s by Estevao (2003), along with skill mismatches.

OECD Countries: Net Replacement Ratios, 2004 1/

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Source: OECD.

For married couple with two children and on earner of 100 percent of the average production wage.

91. Evidence on wage flexibility is mixed. The flexibility of labor market institutions can also be judged indirectly by the extent of wage rigidity in the economy. if institutions are flexible, changes in the economic environment that affect labor productivity should lead to wage adjustments rather than employment fluctuations. Two recent studies try to establish whether there is evidence of downward rigidity of nominal wages in Poland. Yamaguchi (2005) finds downward rigidity in labor force survey data. But Brzoza-Brzezina and Socha (2006) argue that it is more appropriate to focus on data on total employee compensation at the firm level. This data exhibits no evidence of undue downward rigidities.

Financial markets

92. Accessing financing appears relatively difficult in Poland, potentially constraining a flexible supply-side response in a changing economic environment. Even the most efficient companies would find it hard to expand or restructure had they to rely solely on retained earnings. According to the Business Environment and Enterprise Performance Survey (BEEPS) of the EBRD and the World Bank, enterprises rate costs higher and access to financing harder in Poland than in any other central European economy. Polish enterprises pledge higher collaterals than elsewhere and make greater recourse to own-source funding. These difficulties of securing affordable financing are confirmed by other business environment surveys, which are discussed below.

93. Accordingly Poland’s capital markets are shallow compared to other OECD or EU countries. The principle domestic sources of outside financing are the banking system, equity markets, and bond markets. In Poland they account for a combined finance volume of less than 40 percent of GDP—much below ratios of over 150 percent of GDP typical in the OECD or the EU. A lack of financial depth is characteristic across central and eastern Europe, but in most other countries bank credit has been growing at high rates in recent years while Poland has experienced a much smaller, and more recent, pickup.

OECD and EU Countries: Financial Market Depth, 2004

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Sources: GFSR, BIS, World Federation of Exchanges, IFS, and national SE websites.

Business environment

94. A favorable business environment is critical for economic flexibility, as firms are well positioned to react fast and with minimal frictions to changing circumstances only in an economy where doing business is easy. Indicators that seek to measure the quality of the business environment therefore also speak to flexibility and merit careful attention in any assessment of an economy’s flexibility. Moreover, analysis of the many subcomponents that make up business environment indicators can offer some clues about areas of relative strength and weakness. Many subcomponents try to capture aspects that have already been discussed above, such as product and labor market regulation and availability of financing, providing reassurance that they are indeed instrumental for making doing-business easy and, by extension, the economy flexible. But business environment indicators also add several new dimensions: the quality of the judicial system, investor rights, the financial and administrative burden of taxation, the quality of infrastructure, perceived conflict risk, technological proficiency, the quality of public institutions, the level of corruption, etc.

95. Poland fares quite poorly in virtually all business environment surveys. The below table summarizes the country rankings according to the most commonly used indicators. The country coverage of the surveys is quite broad, ranging from 60 to 157. On average Poland ranks not even in the top-40 percentile. With the exception of the institutional quality index compiled by the International Country Risk Guide (ICRG), Poland ranks last or second to last relative to its peers in the region.

OECD and EU Countries: Country Ranking According to Business Environment Indicators 1/

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Sources: The World Bank, World Economic Forum (WEF), IMD, International Country Risk Guide (ICRG), and Heritage Foundation.

Data refers to 2006 or latest available observation.

96. Poland also seems to have made less progress than most of its peers in improving its business environment. Sufficiently long time series are available only for a few indicators. They seem to suggest that the business environment is generally on an improving trend in Poland. But elsewhere it is improving more rapidly, so that Poland’s relative position has been deteriorating. According to the Heritage Foundation’s index of economic freedom, in the late 1990s Poland’s business environment was roughly at par with that of the other EU-8 countries (Hungary, the Czech and Slovak Republics, the Baltic countries, and Slovenia). However, since then a gap has been opening to Poland’s disadvantage, which has only recently begun to shrink. The World Economic Forum’s competitiveness index confirms that Poland has not managed to pull ahead of other countries. Since 2001, the first survey that covers all EU-8 countries, Poland has retained its position as roughly the fortieth most competitive country. All other EU-8 countries have improved their ranking, except for Hungary which fell behind but retains a ranking substantially ahead of Poland.

Selected Countries: World Competitiveness Ranking

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Source: World Economic Forum.

Adjusted. Rank amongst the 75 countries included in the 2001 competitiveness ranking.

A03ufig18

Index of Economic Freedom 1996-2006

(As compiled by the Heritage Foundation; lower number indicates more freedom)

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

97. Cumbersome procedures, difficulties to enforce contracts, and problems to secure credit appear to be the main shortcomings of Poland’s business environment. The subcomponents of the World Bank’s Doing Business survey offer some insights into the relative strengths and weaknesses of Poland’s business environment. The interests of investors appear well protected and restrictions on the hiring and firing of labor seem less of an issue than in regional peers or the EU-15 countries. On the other hand, the survey suggests that the business environment is most severely hampered by excessive licensing requirements, difficulties to enforce contracts, and problems to obtaining credit. In measuring licensing requirements the survey focuses on the construction sector: it compares across countries how many licenses are needed, how much they cost, and how long it takes to obtain them for building a standardized warehouse. It finds that it takes 322 days to get the 25 licenses required at a cost of 83 percent of per capita GDP. The subcomponent on contract enforcement is designed to capture the efficiency of the judicial system. The specific standardized example considered is a debt contract between two non-financial entities with the debtor defaulting and the creditor filing a lawsuit. Poland’s court system appears to work extremely slowly with contract enforcement taking 980 days, compared to an average 375 and 262 days in the other EU-8 and the EU-15. According to the survey, access to credit is hampered mainly by weak legal rights of creditors, especially in the area of secured lending, but also by insufficient credit information through private credit bureaus or public registries.

Components of Business Environment Assessment

(Country Ranking according to Doing-Business Survey 1/)

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Source: World Bank, Doing Business in 2006.

Lower ranking indicates better performance.

Excludes Luxembourg.

98. Other studies confirm the findings of the business environment surveys while offering more concrete guidance for improvements. EBRD (2005) assesses Poland’s system for collateralized lending in detail and suggests considering registering pledges and mortgages through a simple administrative notice system rather than through bureaucratic court decisions, allowing the private sales of called-up collateral instead of relying on court-led auctions, and clarification of the mortgage law. All this would bring down lending cost, stimulate market entry, and strengthen competition. Balcerowicz (2006) studies administrative obstacles for businesses operating in Poland. While the 2004 Law on Economic Freedom and the introduction of binding ex-ante tax rulings in 2005 were important steps forward, room for further improvement remains: market entry could be stimulated by lowering still high costs of establishing limited liability companies and minimum capital requirements, scaling back self-regulation of professions, and making the complex licensing regime more transparent. As to the construction sector, it is well known that the lack of spatial development plans has hampered real estate development in many areas of the country.

99. Relatively favorable labor cost developments seem to have compensated for disadvantages in the business environment. Notwithstanding Poland’s poor business environment ratings, a couple of recent surveys by business consultancies suggest that Poland has become quite attractive for investors. In Ernst & Young’s European Attractiveness Survey, business leaders rank Poland the fourth most desirable destination for foreign investment. And according to A.T. Kearney’s Foreign Direct Investment Confidence Index Poland advanced to fifth position in 2005. The surveys also suggest that Poland’s attractiveness seems to be grounded predominantly in low labor costs rather than business-friendly regulation or good infrastructure. Indeed, data on employee compensation in Central Europe confirm that Poland’s wage cost advantage over Germany is unchanged from the beginning of the decade while it has shrunk in the case of Hungary, the Czech Republic, and the Slovak Republic.

A03ufig19

CE-4: Employee Compensation, 1995-2006

(Per business-sector employee, in percent of compensation in Germany)

Citation: IMF Staff Country Reports 2006, 392; 10.5089/9781451832006.002.A003

Sources: OECD Economic Outlook Database (June 2006); and IMF staff calculations.

E. Summary and Conclusions

100. The many indicators examined in this chapter suggest that there exists considerable room for enhancing the flexibility of the Polish economy. Given that there is no single indicator that adequately captures flexibility, the assessment in this chapter relies on a multitude of measures. In the period covering the last five years, outcome-based measures attest to a slowing pace of structural change, particularly in firms that are not exposed to the discipline of export markets, a disappointing growth performance, and underutilization of labor. Microlevel indicators point to a poor business environment, rather rigid product markets, and shallow financial markets. While efforts to make the Polish economy more flexible have generally never subsided, or gone in reverse, many other countries appear to have advanced faster. Unless this trend is reversed, Poland’s hopes to converge rapidly to EU income levels could become difficult to fulfill. Indeed, as a catch-up country Poland might want to take its cues from the most dynamic emerging market economies rather than the wealthy but slow-growing countries of western Europe.

101. Microlevel indicators and lessons from the literature offers some clues about priority areas for reform. The literature suggests that a high degree of competition is key to economic flexibility. In Poland, difficult entry conditions for firms appear to hinder more intense competition on domestic markets. The administrative burden appears high, capital requirements seem onerous, and licensing regulations are reportedly intransparent. At the same time, shortcomings in the judicial system, contract enforcement, and regulation of securitized lending complicate access to financing. Moreover, a sizable share of the economy remains in the hands of state-controlled enterprises, that are less subject to competitive pressures than their privately owned counterparts. The literature also stresses the importance of trade openness for economic growth. The analysis in this chapter suggests that the Polish economy is less open to trade than comparable countries—a finding that warrants further research, including into the underlying reasons.

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37

Prepared by Engin Dalg1ç and Christoph Klingen.