Cure for Poverty

23 July 2013, 19:00

Leszek Balcerowicz is well-known among professional economists and beyond that circle. As Poland’s Vice Prime Minister and Finance Minister in 1989-1991, he implemented a programme of economic reforms, so-called shock therapy, within a short stretch of time that transformed the country’s comand economy into the market economy and set up solid foundation for growth for many years to come. In 2001-2007, Balcerowicz chaired Poland’s National Bank and, again, confirmed his reputation of a brilliant economist as the National Bank’s monetary policy kept the country from the downfall of the 2008-2009 crisis. Given the lack of positive changes and economic growth in Ukraine, The Ukrainian Week asks Prof. Balcerowicz for his advice on reform.

UW: What keeps Ukraine from realizing its economic potential and spurring GDP growth?

LB: Bad private investment and business environment. If a country’s population is as educated as Ukraine’s yet its economy does not grow consistently, bad environment for economic activity is always the main reason. Ukraine’s problem despite its considerable progress has been its expansionary fiscal policy with excessive spending and huge subsidies which leads to high taxes, shadow economy and budget deficit. From time to time, it leads to crises.

This should be removed. In what way? That’s not philosophy. If spending is as high as it is in Ukraine, it should be reduced. Ukraine spends a huge amount of money to subsidize gas, heat and the like. This should have been stopped twenty years ago, like in Poland. Subsidies for cheap gas lead to two kinds of damages. One is fiscal pressure on the budget. The other is preserving Ukraine’s energy dependence on fuels imported from Russia. This is a bad economic policy by itself further aggravated by the politicians’ attempts to get concessions from Russia.

These subsidies make no economic or political sense.  A better option is to launch innovations when they help you save something even if you pay more for gas. Apart from subsidies, private business environment is heavily affected by corruption. With massive, uneven and unpredictable corruption, you can’t expect much honest investment. And without investment, the economy will not grow fast.  But corruption can shrink when the sources of it are removed. One source is excessive regulation which harms the business. So, massive deregulation and a switch to new regulations are needed.


UW: The advocates of unchanging gas prices and transfers for individual consumers claim that a higher gas price will drive the population into poverty. This can lead to a social collapse. How would you comment on this?

LB: The same was said in Poland, Czech Republic, Hungary, Latvia and Estonia twenty years ago, but we still did it and are now doing better than Ukraine. The advocates of fixed gas prices are rather afraid and pretending to care about the population. However, by preserving the situation as it is they are harming people, not helping them. If you look at the statistics, you will see a huge current account deficit. It is clear that this policy is not sustainable or consistent. On the one hand, the stable exchange rate of hryvnia to US dollar is very popular as far as I understand. But you can’t have this policy if you want to maintain the stable exchange rate. Sooner or later, it will lead to negative consequences.  

UW: How damaging are the instruments used to support fixed exchange rate?

LB: I want to say that I do not recommend it for Ukraine. I agree with the IMF that a transition to the floating exchange rate and inflation targeting like we did in Poland in 2000 would be better and safer for Ukraine. This means that the NBU has to promise to keep inflation at, say, 2-3% and try to keep it that way. But, if the fixed rate is popular for some reason and the government undertakes to maintain it, the current fiscal policy is undermining to this. Its negative effect is only a matter of time.

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UW: The great weight of the foreign sector, i.e. exports and imports, in Ukraine’s economy is one of the arguments in favour of the fixed exchange rate. Some worry that floating exchange rate will result in strong exchange rate fluctuations and all the negative consequences of this.

LB: In Poland, exports are diversified more, and it has floating exchange rate. There are financial instruments that help you cope with these fluctuations. What I’m saying is that fixed exchange rate is not really bad. A country may have it but it has to meet certain conditions to preserve it, and these are not met in Ukraine. Bulgaria, for instance, has a stronger peg to the euro supervised by the Currency Board. But when it faced the downfall after the lending boom, they cut government spending significantly to preserve stability, and they did. So, fixed exchange rate takes more fiscal discipline than the floating one, while Ukraine has weaker fiscal discipline. This is the problem.

First of all, Ukraine has huge government spending: it has one of the highest government spending to GDP ratios in Europe, the second highest after Belarus. It is prematurely high because Ukraine still has low per capita income. A country that is still poor but has high government spending cannot grow fast. With the policy Ukraine currently has, it risks facing regular crises and slow growth.

I was surprised to see that real wages grew 15% over the past year in the statistics on Ukraine. It was unbelievable! If you ask anybody, how to ruin economic growth, you will hear just that – increasing government spending and real wages, while destroying profits and undermining stability.

UW: There is a concept in Ukraine that economic development requires a strong middle class. Is it really necessary? What is Poland’s experience in establishing one?

LB: The middle class is a result of the growing private sector. When you destroy the private sector by crushing profits, you block the development of the middle class. The middle class are not people who are officials. They do not depend on the government and work in private organizations. And private organizations grow when there is private investment.

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UW: Ukrainian economy has not yet recovered from the 2008-2009 crisis downfall. Poland, on the contrary, had slower GDP growth but no recession. How did you manage to avoid one?

LB: Indeed, Ukraine had the second deepest GDP decline in 2009, following Latvia. This was largely caused by the previous credit and fiscal boom. When you spend too much, a collapse follows. That’s why I’m astonished when I look at figures here. We did not have the boom in Poland. I was the governor of the central bank at that point and we kept fairly high interest rates, so lending did not grow too fast there. That was the first reason. The second reason was that we have floating exchange rate. This means that zloty weakened and this helped support our exports.  

UW: Until 2008, metallurgy was the driver of economic growth in Ukraine. After the crisis, many efforts are directed towards the development of agriculture. Is this good policy or is it better to diversify sources of economic growth?

LB: This is not normal. It was the practice of command economy with the centre giving instructions on which sectors should be developed as a priority. It’s different in Poland. We made a free economy where there are people with different ideas. As a result, the sectors develop that the centre would never think of developing. A million private businessmen with strong incentives will invent much more than a hundred people at the top. This is the essence of free economy. Create a better environment for private businessmen, better incentives for activity – free and fair competition in the first place – and you will get a surprising result, not only in metallurgy or agriculture. 

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