Experiences with the monetary transmission mechanism in Poland

1
Lessons of Post-communist Transition
Leszek Balcerowicz
Belgrade, 21 May 2005
2
I. Analitical scheme.
External developments (shocks)
(9)
(8)
(7)
(2)
Outcomes (performance)
Initial conditions
(10)
The institutional system
(6)
(3)
(4)
(1)
Other policies
Reforms
Policies
(5)
Socio-political developments
3

• II. Initial conditions in transition countries.
• Nature of the communist institutional system.

• A. The control exerted by the communist state
  was exceptionally extensive
• private entrepreneurship was banned, which,
  together with the initial nationalisations,
  resulted in a monopoly of the state sector
• state-owned enterprises were subject to central
  planning, which included output commands,
  rationing of input and foreign exchange, price
  controls, and directed foreign trade
• the range of financial assets available to
  enterprises and individuals was extremely
  limited, as a market-type financial system could
  not have co-existed with central planning
• the establishment and functioning of
  non-economic organisations were also heavily
  controlled, that is, civil society was suppressed
  and political opposition was banned
• foreign travel was restricted
• the media were subjected to formal censorship,
  direct party control and personnel policy the
  mass media were largely an instrument of
  communist state propaganda.

4

• B. These extensive restrictions co-existed with
  an overgrown communist welfare state, which
  included
• relatively large transfers in kind (education,
  health)
• social protection delivered via state-owned
  enterprises (SOEs)
• artificially low prices for foodstuffs, energy,
  and housing
• a social safety net, typical of some market
  economies, did not exist as the need for it was
  sharply limited through the curtailment of
  individuals opportunities and risks.

• C. The communist state was peculiar with respect
  to the provision of public goods.
• Defence spending was excessive and was shaped by
  the imperial aspirations of the ruling elites.
• Law and order was kept at a reasonable level,
  but at the cost of practices typical of a police
  state.
• The legal framework and the justice system
  criminalized private economic activity and
  independent political activity, and were ill
  suited to the market economy, the rule of law and
  a free society.

5

• Communist countries economies were different,
  but all of them were lagging behind market
  economies with a comparable GDP per capita level.

Data for post-communist countries refer to the
first year of their transition or the preceding
year, i.e. 1989 for Poland, Czech Republic,
Hungary, Slovakia and Bulgaria, 1990 for
Lithuania and Estonia, 1992 for Belarus,
Uzbekistan, Kazakhstan and Tajikistan. Data for
Euro zone, Mexico, Korea and Chile refer to the
year 1989.
Source EBRD Transition Reports, OECD Economic
Outlook 73.
6

• Countries under communism lost a lot of distance
  to Western
  European economies.

Per-capita GDP (in 1990 international dollars)
in 1950 and 1990 Poland vs. Spain,
Hungary vs.
Austria.
Source Maddison A., The World Economy A
Millennial Perspective, OECD, Paris 2001.
7
III. Dozen or so years after the collapse of
communism, the achievements of former Soviet bloc
countries differ greatly 1. Economic indicators

• economic growth,

Real GDP, 2003 (1989100)
Source EBRD Transition Report, 2004.
8

• labour productivity,

Change in labour productivity in industry, 1992 -
2003 (1992100).
Source EBRD Transition Report, 2004.
9

• reducing inflation,

Inflation, 2004 (annual average, ).
Source IMF, The World Economic Outlook Polish
Central Statistical Office.
10

• attracting Foreign Direct Investment,

Cumulative per-capita FDI inflow, 1989-2003,
(USD).
Cumulative FDI inflow, 1989-2003 (billion USD).
Source EBRD Transition Report, 2004 UNCTUD
11

• employment

Different employment/unemployment rates may be
misleading given the disguised unemployment in
some countries with a lower registered
unemployment rate.
Employment rate (employed aged 15-64 as a percent
of population aged 15-64 in 2003)
Unemployment rate as a percent of labour force in
2003
The reliability of data for Belarus is
qestionable.
Source Eurostat, National Statistical Offices
12

• Disguised unemployment can be easily seen when
  changes in real GDP and official unemployment are
  examined.
• Unemployment in Ukraine remained at an almost
  unchanged level in the first years of transition,
  whereas GDP fell much more than in Poland and
  Slovakia.

Real GDP (, 100 the year before transition
started - bars), unemployment (, end-year -
lines)
Poland
Slovakia
Ukraine
Source EBRD, Transition Report 1995-2005, Polish
Central Statistical Office.
13

• That is why only countries with a similar level
  of reforms can be compared
• Higher registered unemployment in Poland arises
  from the fact that some reforms were blocked e.g.
  in the tax and social security systems. Because
  of that high tax wedge discourages from working
  and increases the grey economy.

Tax wedge in 2004 (Income tax plus
employee and employer social security
contributions less cash benefits as a percentage
of labour costs)
Single parent with two children at 67 of the APW
One-earner married couple with two children at
100 of the APW
Source OECD, Taxing Wages 2004.
14

• High taxes and social security contributions are
  caused by excessive
  public expenditure.
• In countries where public spending was reduced,
  unemployment decreased.

Public expenditure ( of GDP - bars, left scale)
and unemployment rate ( - lines, right scale)
Latvia
Estonia
Lithuania
Poland
Source IMF, National Statistical Offices,
central banks.
15

• 2. Non-economic indicators
• improving health indicators,

Infant mortality per 1000 live births, 1990 and
2002.
Source World Bank, World Development Indicators,
2004.
16

• income distribution.

Gini Coefficient of Income Per Capita, 1987-90
and 2000-01 (in ).
Source World Bank, Transition The First Ten
Years, 2002 World Development Report 2005
UNICEF, 2003.
17

• environmental efficiency.

GDP unit of energy use, 1989 and 2001 (PPP USD
per kg of oil equivalent).
Source World Bank, World Development Indicators,
2004.
18

• IV. Explaining the differences in indicators.
• The principal factors explaining differences in
  growth rates are
• initial conditions,
• external developments (e.g. the Russian crisis)
  including
• - access to markets,
• location,
• extent of market reforms and the nature of
  macroeconomic policies.

19

• Countries which introduced reforms faster,
  achieved better
  economic results.

GDP level (1989100) and average value of EBRD
liberalisation index (1991 2003).
Countries excluded from the regression due to the
questionable quality of the statistical data.
The index level is the level of a composite index
calculated as an arithmetic average of the 8 EBRD
liberalisation indices published in the EBRD
Transition Reports (index of price
liberalisation, index of forex and trade
liberalization, index of small-scale
privatisation, index of large-scale
privatisation, index of enterprise reform, index
of competition policy, index of banking sector
reform, index of reform of non-banking financial
institutions). EBRD Index value 1 (minimum)
very little (or no) progress since the fall of
communism value 4.3 standards and performance
typical of advanced industrial economies
Source EBRD Transition Reports.
20

• These findings are strongly supported by
  substantial empirical literature reviewing the
  experience of countries in transition.

21
Why better economic results go hand in hand with
better non-economic
indicators (health, environment, etc.)?
Some crucial factors conducive to long-term
economic growth are also conducive to
environmental improvement and to favourable
health related developments, e.g.
less waste
less environmental degradation and less damage to
health

• economic reforms

healthier foodstuffs become more available and
relatively cheaper

• stronger rule of law

ecological regulations are more strictly observed

• privatisation (separation of companies from
  the state)

22

• Countries which liberalised their economies
  faster, experienced a smaller
  increase in the inequality of earnings.

GINI coefficient (2000-2001) and average value of
EBRD liberalization index (1991 2003).
Source World Development Report 2005 EBRD
Transition Reports UNICEF, 2003.
23

• For the past 5 years some former USSR countries
  have been developing faster than the Central
  European ones.

Real GDP in 2003 (1998100).
Source EBRD Transition Report, 2004.
24
Some early transition countries are catching up
quickly with the ones that are already advanced
in reforms.
Armenia a case study.

• During past few years Armenia achieved good
  economic results.

Real change in good and services exports (in ).
Real GDP growth (annual rates, in ).
Consumer price index (in ).
Source EBRD Transition Report, 2004.
25

• Armenia is an example of
  a
  post-communist country with a limited state.

Average general government expenditure(as of
GDP).
Tax revenues (as of GDP).
Average general government balance (as of GDP).
Source EBRD Transition Report 2004, IMF Country
Reports.
26

• Reforms in Armenia led to an extension of
  economic freedom.

Economic Freedom Index (The lower the value of
the index and rank, the greater the extent of
economic freedom).
The index level is based on a composite index
calculated as an arithmetic average of the 10
sub-indices concerning (1) Trade, (2) Fiscal
Burden, (3) Government Intervention, (4) Monetary
Policy, (5) Foreign Investment, (6) Banking
Finance, (7) Wages/Prices, (8) Property Rights,
(9) Regulation, (10) Informal Market. The ranking
included about 150 countries.
Source Heritage Foundation.
27
Lithuania a case study.

• During last few years Lithuania achieved very
  good economic results.

Real GDP growth (annual rates, in ).
Real change in exports of good and services (in
).
Consumer price index (in ).
Source EBRD Transition Report 2004.
28

• Lithuania managed to cut public expenditure and
  reduce fiscal deficit.

Tax revenues (as of GDP).
General government expenditure (as of GDP).
General government balance (as of GDP).
Source Eurostat The European Commission, AMECO.
29

• Reforms in Lithuania resulted in an increase in
  the extent of economic freedom.

Economic Freedom Index (The lower the value of
the index and rank, the wider the extent of
economic freedom).

• The index level is based on a composite index
  calculated as an arithmetic average of the 10
  subindices concerning (1) Trade, (2) Fiscal
  Burden, (3) Government Intervention, (4) Monetary
  Policy, (5) Foreign Investment, (6) Banking
  Finance, (7) Wages/Prices, (8) Property Rights,
  (9) Regulation, (10) Informal Market.
• The ranking included about 150 countries.

Source Heritage Foundation.
30
Slovakia a case study.

• During last few years Slovakia achieved very
  good economic results.

Real GDP growth (annual rates, in ).
Real change in exports of good and services (in
).
Consumer price index (in ).
Source EBRD Transition Report, 2004.
31

• Slovakia managed to limit the state.

General government expenditure (as of GDP)
Tax revenues (as of GDP).
General government balance (as of GDP).
Sources Eurostat The European Commission, AMECO.
32

• Reforms in Slovakia resulted in an increase in
  the extent of economic freedom.

Economic Freedom Index (The lower the value of
the index and rank, the wider the extent of
economic freedom).
The index level is based on a composite index
calculated as an arithmetic average of the 10
sub-indices concerning (1) Trade, (2) Fiscal
Burden, (3) Government Intervention, (4) Monetary
Policy, (5) Foreign Investment, (6) Banking
Finance, (7) Wages/Prices, (8) Property Rights,
(9) Regulation, (10) Informal Market. The ranking
included about 150 countries.
Source Heritage Foundation
33
V. Some other observations on economic
transition. 1. Economics of transition.

• Models of fiscal transition varied substantially
  from one country to
  another, ranging from the Irish model to the
  collapse-of-state model.

General government spending ( of GDP).
Source EBRD Transition Reports, OECD Economic
Outlook 73.
34
Privatisation a broad definition approach.

• Privatisation of economy includes 3 processes
• entry privatisation,
• assets privatisation,
• transformational privatisation.
• Entry privatisation and assets privatisation are
  very important in the post-communist economies
  but they cannot substitute the transformational
  privatisation.
• The longer the delay in the privatisation of
  SOEs
• the greater the probability of its bankruptcy or
  liquidation,
• the lower the price, if one manages to privatise
  at all.
• The performance of the privatised enterprises
  depends on the privatisation method.

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• Polish experience shows that enterprises
  privatised with the participation of foreign
  investors achieved the best results whereas
  employee partnerships achieved the worst results.

Productivity of privatised enterprises
(1993100).
Productivity is measured as revenues in real
terms to no. of employees. The survey is based on
the research of 837 enterprises (almost all
enterprises privatised till 1993 in each
category). Due to the cases of liquidations,
bankruptcies, acquisitions and so forth the
number varied in subsequent years and in 1999 it
declined to 807 companies. The number of
enterprises in the year 1993 (1999) in each
category group is as follows capital
privatisation 97 (95), capital privatisation
with foreign participation 67 (65), employees
partnerships 701 (675).
Source M. Baltowski (ed.), Przedsiebiorstwa
sprywatyzowane w gospodarce polskiej, PWN, Warsaw
2002.
36
Average revenues of privatised enterprises (in
real terms, 1993100).
Dynamics in the number of profitable enterprises
(1993100).
The survey is based on the research of 837
enterprises (almost all enterprises privatised
till 1993 in each category). Due to the cases of
liquidations, bankruptcies, acquisitions and so
forth the number varied in subsequent years and
in 1999 it declined to 807 companies. The number
of enterprises in the year 1993 (1999) in each
category group is as follows capital
privatisation 97 (95), capital privatisation
with foreign participation 67 (65), employees
partnerships 701 (675).
Source M. Baltowski (ed.), Przedsiebiorstwa
sprywatyzowane w gospodarce polskiej, PWN, Warsaw
2002.
37

• There are two models of banking sector reform in
  the post-communist world. One relies on the
  influx of foreign investment, which leads to
  quicker privatisation and quicker modernisation.
• Another model a blocked or delayed entry of
  foreign capital leads to large state-owned
  banks and rather small and often fragile domestic
  private banks.

Assets of foreign-owned and state-owned banks
relative to assets of all banks in 2002 ()
Data for 1998
Source Ulrich Voltz, "European Financial
Integration and the Financing of Local Businesses
in the New EU Member States, Working paper No.
89, EBRD, 2004 and "Great Potential But Not
Without Series Reform, Russia Equity Research
Banking Sector, NIKOIL URALSIB Financial
Corporation, 2004 .
38

• It is too simplistic to assume that financial
  crises in certain transition economies were
  caused by the liberalisation of capital flows.

• Such crises did not occur in countries with the
  lowest number of controls on capital
  transactions.

Index of capital transactions controls, 1996.
The value of the index is equal to the number
of areas of capital transactions controls
covering 10 selected areas (1) capital market
securities, (2) money market instruments, (3)
collective investment securities, (4) derivatives
and other instruments, (5) commercial credit, (6)
financial credit, (7) guarantees, sureties, and
financial backup facilities, (8) direct
investment, (9) liquidation of direct investment,
(10) real estate transactions.
Source IMF, Exchange Arrangements and Exchange
Restrictions, 1997, 2003.
39
2. Political economy of transition.

• Democratic countries liberalised their economies
  faster and to a larger extent.
• Non-democratic regimes have stuck to a
  non-market economic model.

Average EBRD liberalisation index value and
political and civil liberties rating (1991-2004).
Competitive democracies
Non-competitive political regimes
The index level is the level of a composite
index calculated as an arithmetic average of the
8 EBRD liberalisation indices published in the
EBRD Transition Reports.
Source Freedom House, EBRD Transition Reports.
40

• The economy benefits from an independent and
  efficient judiciary system.
• - The independence of judges should be combined
  with an efficient judiciary system, which
  requires organisational and procedural reforms.

- The efficiency of the legal system varies among
the post-communist countries.
Enforcing contracts in days as of January 2005
Source World Bank, Doing Business in 2005.
Removing Obstacles to Growth.
41

• Mass media.
• Public TV is susceptible to political control. It
  is, therefore, desirable to privatise public TV.
• Under a dictatorship, the news media do not
  criticize the system, because they cannot. When
  the media are set free they have a tendency to
  focus on what is negative.
• This is why professionalism and adequate training
  of journalists is fundamentally important.
• Conditions for reforms do not mature with time
  and for this reason they should be implemented as
  soon as possible.
• It is naive to think that the more we discuss,
  the more reforms we get.
• Without reforms a countrys economic situation
  cannot get better, and, given that, everybody
  will be dissatisfied.