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14 May, 2015

How Poland Made It. Notes of a Businessman

If you want to save the country from the economic collapse, make protection of SMEs a national idea

I go to Poland on a working visit every year. And every time I see a sharp contrast with Ukraine. Our western neighbor today is different from what it was only two or three years ago, at least for an observant business traveler. The progress is manifest almost everywhere: in transport communications, financial services, investment opportunities, real sector, and small businesses.

It fills me with contradictory emotions. No, it's not because a Ukrainian, as the saying goes, would envy that his neighbor's cow is alive when his cow dies. It's just that our state, compared to Poland, seems to be a land of missed opportunities, even though we started on the path of capitalism from approximately the same starting point.

So, I decided to investigate in more detail the nature of the "Polish miracle." Why did Poland succeed, while we are still lagging behind not only the European countries, but also the post-Soviet states? And what experience of economic and administrative reforms would be beneficial to Ukraine in its strive to overcome the crisis and become a truly independent, business-oriented and prosperous nation?

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Denationalization

Probably the most important thing is that the Poles under Balcerowicz and Mazowiecki, at a stroke of the pen, eliminated everything that is still a stumbling block for Ukraine. Firstly, they let the unprofitable state-owned companies that had no market-oriented production policy to go bankrupt. Secondly, they mandatorily passed the management of the entire state-run utility sector to the homeowners. Thirdly, they eliminated the state banking system.

According to Polish reformers, the state cannot be the subject of commercial relations, either in the housing and utility or in the monetary and financial area. Can a transparent market exist alongside government monopolies or banks that enjoy preferences of the Ministry of Finance? The Polish answer was a conclusive "no," so all state-owned financial institutions were turned into private ones. Fifteen years later, Georgians did the same. But not Ukrainians.

Ukraine has, as we know, a huge subsidized state-run segment of the real economy. Infrastructure management has been monopolized by all kinds of state agencies and other bottomless sources of budget siphoning. Moreover, there are three state-owned banks, which last year showed astronomical loss figures of over UAH 20bn, according to official statements. They are recapitalized using treasury funds, that is, at the account of the tax payments.
In Poland, however, during just two years of reforms, the state was completely taken out of the real economy in 50% of industrial facilities. Privatization took place at public auctions, with cash payments instead of voucher schemes that were used in Ukraine.

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By the way, despite a galloping inflation, the government of Balcerowicz–Mazowiecki did not let the exchange rate to float freely, the move that the National Bank of Ukraine proudly announced a few months ago. On the contrary, the Poles resorted to strict monetary regulation, introducing a fixed and unified exchange rate of the zloty against the dollar.

These and a number of other measures served as an anti-inflation anchor for the country, minimizing the imbalance of the economy and providing the basis for establishing an effective money market.

Already a few years later, in early 2000s, Poland turned from an eternal debtor into a respectable player on the global investment market, with 2.4–2.9% inflation and over USD 80bn of own foreign exchange reserves. After just one year of shock therapy (I want to stress it: one year!), the government achieved GDP growth that has been stable ever since. In 1992, it was at 2.6%, and in 1995 it was already 7%.

Why? I would identify several reasons that are directly related to the Ukrainian format of transformation and, in my opinion, were quite unjustly neglected by the "post-Maidan" Cabinet during its first year.

SMEs rule

The Polish reformers realized that they had to make the most of whatever their compatriots' cultural code had preserved: entrepreneurship and natural respect for private property. So, SMEs became the locomotives of the government's anti-crisis campaign and minimized the social implications of the mass scale liquidation of the state-owned sector of the economy.

Creating an enabling business environment became one of the embodiments of the Polish national idea and took place under the national revival slogan.

By the end of the 1990s, Poland had about 3.5 million SMEs, that is, one business per 10 citizens, including minors. Proportionally, it is more than in the home countries of modern entrepreneurship: Switzerland and the Netherlands.

The contribution of small and medium-sized enterprises to Poland's economic recovery really cannot be overemphasized. Today, they account for about half of the national GDP, that is, more than USD 200bn.

By comparison, before the last year's crisis, their share in the Ukrainian economy never exceeded 10% of GDP, amounting to only USD 14bn. That is despite the fact that the economic potential of the Ukrainian SSR in late 1980s was twice higher than that of the socialist Poland. The older generation of Poles still remembers going to Ukraine to buy consumer goods, tea and fertilizers, similar to today's Ukrainian shuttle traders going to Polish wholesale markets to buy a whole variety of products.

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As long as our country holds the "honorary" 96th place in the World Bank's Doing Business index, with the 150th position in Trading Across Borders category and the fourth from the bottom (among 189 participants) in some other categories, such as, for instance, Getting Electricity, the problems with the national currency exchange rate and capital outflow are not surprising.

Today, foreign business has no motivation to come to Ukraine and to invest money in its economy. Domestic metallurgy and chemistry keep losing global export markets, and the supply of foreign currency is increasingly dependent on migrant workers alone.

The Polish experience in this sense is like an icon for us: if you want to save the country from the economic collapse, make the protection of small and medium enterprises a national idea.

Open marketplace

Balcerowicz's anti-crisis government saw the task of opening the domestic market to foreign capital as one of its highest priorities. Foreign Investment Law was one of the first government decrees. It completely abolished any restrictions on the share of equity capital owned by foreigners and established tax incentives for foreign investors.
In provinces where due to real sector privatization, labor market suffered the worst collapse, these benefits included tax holidays for a period from several months to several years.

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Most import licenses were canceled. Obtaining the remaining ones was made as easy as possible. Likewise, with just one stroke, all export quotas without exception were eliminated. There are no restrictions on taking revenues out of the country and on investment volumes. Nothing like that exists in Ukraine.

As a result, already by 1997, foreign direct investment in Poland reached USD 20.6bn. Ten years later, this figure exceeded USD 160bn. This is almost five times more than in Ukraine during the same period.

Laffer curve

During the industrial crisis of the early 1980s, American economists identified a fatal pattern: tax increase at a certain point does not increase budget revenues, but reduces them instead, because fiscal pressure destroys business, which is the donor of the treasury.

The Ukrainian government, despite the collapse of the economy and finance, failed to drastically reduce the tax burden on the corporate sector over the last year. In Poland, such reform also was not carried out immediately, but only in the early 2000s. However, its results could be for us a vital lesson in efficient economy.

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Following the reduction of the income tax for businesses from 27% to 19% during the very first year after the adoption of the new budget code, Poland's budget received more than USD 1bn of additional tax revenues. Using the Laffer curve principle gave the economy a chance to flourish, despite a significant reduction in the tax rate.

Today, the median income of an average Pole is much higher than USD 1,000 per month. Poland is one of the six largest economies in the European Union. The EU keeps investing in it. Why? Because the money is used to enrich the country, not to increase the wealth of the individuals close to the channels of foreign aid reception and distribution, as it is in Greece.

Pain shock

The rapid deregulation of the economy was a difficult social challenge and a pain shock. Hundreds of thousands of workers of different skill levels found themselves in the labor market. Unemployment that affected one in five economically active Polish citizens had the potential of splitting the country and stirring up a wave of leftist protests.

However, the Poles persevered. They had been waiting too long for liberalization, both political and economic, and were not ready to give up their freedom for the sake of the socialist welfare myths.

Polish reformers realized that the radical transformation was an extremely painful process. They had to launch the reforms flywheel immediately, while the nation still lived in the atmosphere of a patriotic enthusiasm in the years following the elimination of Soviet dictatorship.

History has shown that the government was right. Already in three or four years, the country's economy started generating far more jobs than were lost after the elimination of the subsidized public sector.

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About a third of migrant workers returned to the country, including former employees of the liquidated public sector companies. It was not because the crisis was raging in Europe in the late 1990s, and not because working in Germany became unprofitable, but because German production began to move to Poland en masse. In Poland, a business environment was created that was more favorable in terms of corporate taxation, proximity to commodity and sales markets, as well as with respect to state regulation.

The reformers made full use of the Polish sense of national dignity while the nation was highly euphoric. This helped suppress social pain, minimize protest aftermaths, and leave leftist populists without their grateful audience, with the exception of obvious outsiders.

What about Ukraine? Our reformers apparently slept through this "heroic" period. Over the year, when the enthusiasm ignited by the Euromaidan events naturally increased the society's ability to endure sacrifice, there has been almost no radical change in judicial, fiscal or administrative area. The faces and party banners have changed, but the methods of managing the wheels of state have remained the same.

At least, business felt no significant liberalization. As a consequence, the results of the last year for Ukraine were the drop in GDP by 35%, 70% devaluation, and 50% investment outflow from the real economy. Taking into account the exchange rate fluctuations, we lost investments of non-residents amounting to about USD 13.6bn. The effect was exactly the opposite of what was observed in Poland already in the first year of reforms.

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This means that the shock therapy was without doubt the right step made by the government of Mazowiecki and Balcerowicz. The gradual and prudent approach in this case would have obviously exhausted the impatient (in a good sense) Polish society, reviving the leftist and conservative moods.

It's like removing a court plaster from the body: you can do it slowly and carefully, overcoming pain and discomfort, or you can do it in one lightening-speed operation, requiring considerable willpower. In Poland, everything happened in the most resolute manner.
Poles did not say: "Give us money, for we are poor." They said: "Give us money, because we are implementing reforms and changing the system from within." Europeans know that providing funds does not mean solving systemic problems, let alone starting the flywheel of transformation. Today's Greece is a striking example.

Which scenario Ukraine will follow, Polish or Greek, will be clear in the coming months. If the government opts for the default, there will be no chance to go ahead on the Polish path.

BIO
Volodymyr Popereshnyuk was born in 1975. He graduated from the Zhukovsky Kharkiv Aviation Institute and earned his MBA from the International Institute of Business in Kyiv. He is Operations Director and co-founder of the Nova Poshta courier service group

 


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