Poland: Low Labor Costs Will Not Generate Success

July 3, 2015

Rzeczpospolita daily

Poland must attract investments in the sectors with high value added - Theo Thomas, World Bank economist, explains to Grzegorz Siemionczyk.

Rz: Last year Hungary was the second fastest growing economy in the EU, right behind Ireland. According to EC projections, this year Hungary will perform just a bit worse. Is there any link between such dynamic growth of Hungarian economy and the reforms implemented by Orban’s government which – according to most commentators – were supposed to end in country economic disaster?

            Central and Eastern Europe economies resemble one another as far as growth drivers are concerned. Currently they are benefiting from strong integration with global supply chains, especially business links with Western Europe, where the economy is picking up. At the same time, consumer spending has been bolstered by a drop in oil prices. As far as specific reforms implemented by the current Hungarian government are concerned, the economy may have benefitted from the conversion of loans originally contracted in Swiss francs. In the long term, however, stable growth requires stepping up private investments, which in turn depends on the investment climate. Some government reforms have raised concerns precisely because they may have an adverse impact on investment climate over the longer-term.

In Poland during presidential election campaign we could hear voices urging us to copy some Hungarian solutions in Poland, for example, to impose taxes on banks, supermarket chains, etc. Would this be a good idea?

            Politicians get their inspiration from reforms carried out in other countries.  That is quite natural. Since some Hungarian developments, which had initially been approached by Europe with skepticism, did not bring about such negative effects as expected, politicians from other countries may now feel that they actually have more leeway than they thought. Nevertheless, this does not mean that Hungarian solutions will or should, for that matter, be copied elsewhere.

In the West, corporate capital expenditures are the missing link in economic recovery. Yet, they were the key driver for GDP growth over the last few quarters in Poland. How can this be explained?

            Last year Poland experienced a strong recovery of corporate capital expenditures; previously, they had been stalled due to unfavorable external environment, inter alia. As a result, the capacity utilization rate in Poland was quite high and companies could no longer keep investments on hold. This year the trend should continue.

In the longer timeframe, the situation will largely depend on whether Poland upholds the reforms aimed at improving the investment climate, initiated over the last few years, and makes good use of EU funds that will continue flowing for several more years. At the same time, the quality of investments will begin to gain more and more prominence, in contrast to mere investment value and growth dynamics.

Poland should increasingly attract investments in the sectors with high value added. It is true that they are not always labor-intensive, but they offer higher quality jobs.    

Traditional investments in Poland have been import-intensive. At present, however, quick investment growth goes hand in hand with foreign trade surplus. In that context it is sometimes claimed that the model of economic growth in Poland has become somewhat similar to the Asian model. Is this a legitimate conclusion?

            Even though in recent years Poland has reported a trade deficit more often than a surplus, net exports have been a significant driver of GDP growth for quite a time, accompanied by the inflow of Foreign Direct Investment (FDI). We expect this trend to continue; Poland will probably keep expanding its share in global goods and services markets at a faster pace than economic growth dynamics in the country. Having said that, Polish exports are still focused largely on other EU countries and its product mix remains quite stable. In other words, Polish exporters  - as it can be observed in other countries of the region – do not excel at entering new markets or bringing out new products in the old markets. If Poland really wants to sustain the Asian export-led growth model, it also needs to export innovative products and services with competitiveness based on something more than relatively low labor costs. In this area, however, some promising signs have begun to emerge.

Yet, you said that increase in exports was accompanied by FDI inflows in Poland. But FDI is now much smaller than it used to be prior to the crisis. Can this situation change?

            I do not anticipate that investment growth (FDI included) will recover to the levels observed before the crisis - in Poland or elsewhere in Central and Eastern Europe. Prior to the crisis, some investments were channeled towards overheated sectors of the economy such as the real estate sector, for example. While overall levels of FDI have fallen, there is better targeting of investments, largely focused on the sectors with products and services that are traded internationally. It means that countries may compete for those investments, which adds to the significance of structural reforms which make labor markets more efficient, facilitate doing business, streamline restructuring laws and so on, and so forth. All that makes the country more appealing to investors. On the other hand, we should understand that Poland does not need so much FDI as in 1990s, when Poland’s development was lagging further behind and domestic capital was scarce. Today, Polish companies can relatively easily borrow capital on domestic and foreign markets and invest it at home.

Removing barriers to trade is a reform direction recommended by the World Bank not only to the countries from our region, but to Europe in general. Does it mean that the single market in Europe is underperforming?

            Simply put, the European market is not a single market yet. Many changes must take place for that objective to be fully attained. There are still some serious legal differences between the countries regarding, for example, starting a business, getting construction permits, consumer protection, licensing for some types of activities, etc. Likewise, the flow of capital in the EU is not totally free yet. To illustrate my point that the single European market is yet to perform as it should, let me mention the recent dispute between Poland and Germany concerning the issue of whether the German minimum wage should apply to lorry drivers in transit through Germany. These differences can add to the costs and uncertainty of trade.

Does Europe need further tax harmonization, including uniform CIT rates?

            I do not believe so. Individual Member States vary in terms of their economic and spending structure and social protection systems, so it stands to reason that they can also have a different mix of budget revenues. Having said that, transparency in tax matters is crucial and mechanisms to ensure that EU countries do not compete with each other by means of obscure or what may be judged unfair measures applied selectively to some entities.