Avoiding the Middle Income Trap in Poland

August 19, 2014

Ismail Radwan Rzeczpospolita

Poland’s recent growth has been impressive

Poland’s economy has grown quickly in recent years, outpacing the most dynamic countries in Europe, over the past two decades and taking it from a moribund socialist system to a well-integrated upper income country and increasingly strong member in the EU and on the global stage. The country has taken good advantage of the opportunities offered by EU membership: utilizing EU funds to upgrade its infrastructure and integrating into Western supply chains particularly in the automotive sector. Not only is Poland now one of the richest of the new member states but it is also approaching the income levels of Europe’s so-called Southern cone.

Over the last decade, Poles have seen their income levels rise from 50% to 75% of the EU average. The growth continued throughout the crisis while all other European nations dipped into recession.  Moreover Poland’s growth has been equally distributed with the poor growing faster than the rich and a confident middle-class emerging.

But what next? Is such a growth rate inevitable? Some economists have argued that there is a middle income trap as several countries have managed to catch-up rapidly but then wavered when the conditions that made for their previous economic success no longer held. To continue to grow Poland will need to become more competitive, more innovative and take a more prominent role on the European and global stages.

Competitiveness is the key to future growth

Poland has grown rapidly largely due to cheaper factors of production, unleashed local demand and improved factor productivity. As income levels converge with the EU, Poland will no longer be able to ride forward under the “China of Europe” mantel.  Traditional factors of growth, especially total factor productivity are slowing down. A new growth model based on innovation that will turn Poland into a post-industrial economy is required.  This is no small challenge since the country’s demographics and tight fiscal situation limit the options for policy-makers.

Creating an innovative economy

There are five priorities in the quest for innovation:  (i) Improving the education system, (ii) Improving access to finance, (iii) Streamlining the business environment, (iv) Becoming technology ready, and (v) Establishing the supporting infrastructure for innovation.

Many industrial economies are struggling to meet the demand for “new economy skills”.  The global market for engineers and computer scientists is supply constrained and Poland is no exception. But there are signs that Poland’s policy-makers are attuned to these new realities. Poland’s youngsters score highly on standardized tests such as the PISA rankings where recent improvements have catapulted Poland above the OECD average. The creativity and drive of Poland’s youth was recently on display at the Youth Reforming Poland conference at the Warsaw School of Economics where a dynamic group of young Poles were actively engaging policy-makers on the important structural reform topics of the day.

The challenges for the education system are to reduce the disparities between rich and poor students, to ensure that all Poles are able to take part in the new economy. Offering second chance programs for older poles whose problem solving skills lag the rest of Europe will also help to keep them in the workforce for longer a key to combat Poland’s aging and shrinking population.

Although Poland has one of the most stable and efficient financial systems in the region, the sector is dominated by banks whose lending remains skewed towards mortgages and consumption credit with lending to businesses among the lowest in Europe. Despite progress on the Warsaw stock exchange, venture capital and the angel investor network remain in the nascent stages.

Supporting Poland’s entrepreneurs through a streamlined business environment is also a priority.  Poland currently ranks 45th among 183 countries in the World Bank’s Doing Business rankings. This is a respectable position for EU new member states. The authorities have focused on this agenda in recent years with Poland taking the title of top reformer in the 2013 rankings. This effort should be sustained going forward with a focus on making it easier to start a new business (where Poland ranks at 116th) and getting electricity (137th).  Policy-makers can usefully review the intellectual property rights framework including the rule of law, granting of patents and payment of royalties. 

In all the above areas, Poland has the advantage of being able to use EU grant resources to create a supporting infrastructure for innovation. A recent World Bank review of Poland’s innovation support programs noted that much has been done to establish a a monitoring and evaluation system and now the focus should be on maximizing the impact of the Euro 10 billion of EU funds that is earmarked for these programs over the next six years. The review highlighted the fragmentation of the delivery system with more than 24 organizations involved in doling out EU resources, the low level of R&D spending (less than 0.75% of GDP compared to an EU target of 3%) and the risk-averse nature of public programs that favor larger firms and concentrate on purchasing machinery rather than supporting the business plans of dynamic smaller firms.