Without industry Poland won’t be wealthy

Gdansk Shipyard, Gdansk, Poland (Gary Denham, CC BY-SA)

CE Financial Observer talks with Maciej Bukowski, the President of Warsaw Institute for Economic Studies (WISE).

Nowhere in the world has wealth been achieved without producing a large amount of goods. At least 15 years will pass before Polish companies become innovative, and another 15 before they gather the capital necessary to compete in the most profitable branches of industry.

CE Financial Observer: In your opinion should Poland become more industrialized? Isn’t it too late for that? In developed economies, including Poland, factories are being turned into lofts. 

Maciej Bukowski: Indeed, it is so, however, it doesn’t mean that industry has disappeared from those countries entirely. In the US, industry accounts only for 10 per cent of the GDP, but this is because it is extremely efficient – it employs few people, and cheaply manufactures a lot of goods. It was somewhere in the 1960s, 1970s, when industry in the developed countries entered the path which had been followed by agriculture a hundred years earlier – its share in the GDP and employment began to decline consistently until it fell from a few dozen to just several per cent.

In 20 years’ time, in the US or the UK, industry will account for no more than 5 per cent of the value added, and yet its output will still be significant. Thus, the legend about the alleged industrialization of the USA and deindustrialization of Western Europe told in Poland is not true. Within the entire OECD we can observe the same process, according to which the wealthier a country is, the smaller and more efficient its industry.

Can Poland jump into that post-industrial period right away?

It can’t, I’m afraid. Nowhere in the world has wealth been achieved without producing a large amount of goods; maybe with the exception of a few resource-rich countries and tax havens. If Poland wants to be wealthy, it has to industrialize. And if Poles were even more ambitious and wanted to join the world top of the tops, even mere industrialization would not be enough. The development of industry must be accompanied by a similar improvement in the quality and value of private and public services. Progress in this domain, however, proves to be much more elusive. Services of top value and efficiency require a much better institutional and regulatory environment than industry, as well as deep structural changes within the society itself. In my opinion, these changes – to become sound and deep-rooted – require not several dozen but a hundred years of transformation.

The Polish industry accounts for an 18 per cent share in the GDP, whereas the European average is 15 per cent. Do we need an industrial revolution or just evolution?

Perforce, Poland has a larger share of industry in the economy because it is much less efficient than in the West. Furthermore, due to relatively low efficiency of the Polish industry and agriculture, its service sector is underdeveloped – because Poland has to engage much more people in the production of necessity goods. At the moment, in the processing industry Polish output per capita is only 40 per cent of what Americans produce, so Poland can potentially be twice or even three times more efficient than now. Still, the progress as compared to the times of communist Poland is considerable. At the end of the planned economy period, our output per capita was only 10 per cent of the US indicator.

So, what is the sequence of events needed to happen? First, establishing modern factories, then opening R&D departments, and finally specialists working there and creating innovations which over time may move us into the post-industrial era, is that right?

To put it simply – yes, it is. To use the analogy with agriculture once more, in the 18th and 19th centuries, it saw a great technological revolution, which allowed to release human resources and create the factory industry based on them. Today, only 0.5 per cent of the population in the developed countries produces food for the remaining 99.5 per cent. The industry works similarly. Until 1960s-1970s the share of industry in employment in the majority of Western countries grew. Since that moment it has declined because human labor is driven out by organizational changes and machines.

The industrial revolution allows easy production of everything we need and at the same time it releases human resources for work in services. The more advanced that process in a given country, the more developed in terms of organization, the better mechanized and the more efficient its industry, and at the same time – which is a paradox, really – the less that industry matters in the entire economy.

However, to enter that path, we have to become industrialized. In the study entitled Work in the Times of Innovation you wrote about the South Korea and Taiwan. Those countries saw a move from agriculture to industry, investments in infrastructure and education, development of light industry, then heavy industry, and ultimately a switch into exports. At which stage is Poland now?

It’s not only the examples of Korea and Taiwan, but nearly all countries which were late for the first wave of industrialization in the 19th century and had to catch up with Western Europe or the US. A relatively poorer country, which at the same time has labor force that is well prepared for work in industry, has to look for its opportunities in labor-intensive branches, as its advantage lies in competitive wages, and not in capital that is insufficient.

Poland, which currently produces furniture and buses, and mounts trains or delivery trucks from imported parts, fits into that picture. However, as the investment in production grows, the wages will rise, and the competition for qualified workers will intensify. This will encourage companies to boost the mechanization of production processes and to restructure production towards less labor-intensive specializations providing for larger margins at the same time.

How long will it take?

I think it must take at least 15 years for Poland to reach the point when Polish companies in general begin to see their competitive advantage in improving their innovativeness. The rate of ROI in R&D will exceed the return from the purchase of foreign technologies only when not just the best Polish industrial companies but also the average ones are closer in terms of technology to their Western competition and equally market-savvy. Then, another 15 years will pass for a sufficient number of Polish companies to accumulate the necessary capital and competence to count in the branches in which the technological progress is the fastest, i.e. electronics, biotechnology, advanced industrial chemistry, medicine production, or automotive industry.

Can the state advance that process?

No-one in the world has managed to do that. Be it Poland and the entire Eastern Europe, be it Latin America or South Asia, history knows no example in which the state chose perfectly the proper industry branches or the ‘national champions’ without overinvestment, underinvestment, or a whole range of other problems. Contrary to what some columnists say, the market may not be replaced in that area.

What should be the role of the state then?

Good legal regulations guaranteeing economic freedom and the security of savings and investment are of key importance to economic success. Another factor is to create a business climate encouraging entrepreneurs to engage in possibly riskier ventures which improve the technological advancement and complexity of industrial production from the macroeconomic point of view. Finally, what counts is the quality of people active in the labor market – their knowledge and cognitive capabilities.

The state may stimulate all those areas, e.g. by taking care of the quality of the law, transparency of public elections, or efficiency of services such as health care or education. By the way, as regards the latter, Poland has succeeded on a global scale in the last decade – despite some widespread opinions. Poland should continue those reforms. Higher education is of great importance too – only good universities will be capable of educating competent employees for the future research and development centers.

Does it mean that there is no space for active industrial policy in Poland?

There is, but industrial policy doesn’t equal to steering the economy manually, it means smart regulations. In the Polish conditions I would begin with privatization. Not many people realize how much overstaffed state-owned companies are, and at the same time how little – as compared to similar private or foreign enterprises – innovative and dynamic in the market they are.

Secondly, I would support urbanization because modern industry and advanced services are better developed in large metropolises. When institutional solutions fail to promote migration from the countryside to large cities, industrialization meets natural barriers, and economic development slows down long before drawing level with the developed West.

Thirdly, what is necessary is the cooperation of private companies with one another; that’s why the state should as a minimum support the establishment of technological clusters. And last but not least – which is the easiest step, really – some tax changes in favor of investment and innovation would be helpful.

Can Polish needs for the development of industry be combined with the EU policy of reducing carbon emission?

Of course, it can. The picture of industry consisting of smoking chimneys and sidings full of railway wagons with coal is a cliché left from communist times. Contemporary industry is totally different. A facility producing goods worth billions of euros a year may be a corrugated-iron hall without chimneys, warehouses, with no army of workers knocking at the gates every morning. A passerby may confuse such a hall with a supermarket. Such industry is not only inconspicuous but also much less energy-intensive than in times of communist Poland.

In a typical industrial company energy costs don’t exceed 2-3 per cent of all production costs; by comparison, remuneration costs amount to 30-40 per cent, and the costs of materials to 50 per cent of total costs. Even an absolutely improbable doubling of energy bills could still be balanced e.g. with a slight decline of employment and by introducing better organization of production and greater mechanization. A slightly different scenario may play out in energy-intensive branches. Nevertheless, the energy-intensive industry accounts for merely 5 per cent of total output, and that share is dropping every year. Finally, the EU climate policy provides for special protective measures.

So, I wouldn’t believe the stories that the energy and climate package will kill Polish industrialization.

But energy prices will grow?

Yes, they will. Poland has to remember, though, that investment in conventional energy, mainly coal, also has its cost. Either the taxpayer or the consumer will foot the bill, there is no other way. And few people realize that the difference between the total costs of energy generation from coal, uranium, or wind is not that big. Soon that list will be expanded by photovoltaic, whose prices are dropping unbelievably fast. The temporary slight cost advantage of coal is to a large extent the result of the fact that the price of coal does not reflect all the environmental and health costs of coal burning. If we took those costs into consideration, which by the way the European Union, and from 2017 also China, is trying to do in the emission trading system, then coal-oriented energy industry wouldn’t be so investment attractive any more.

Should we get more involved in the RES?

I don’t know the future, but many analysts expect Western Europe, the US, Japan, South Korea and China to agree sooner or later to leave the majority of fossil fuels – coal, oil, and in the end gas as well – under the ground. This has already being discounted by the biggest investors, e.g. in the evaluations of the world mining companies. The global warming problem is indeed a very serious one. Many countries invest substantially in technological solutions alternative to coal, and declare a serious decline of coal position in their energy balances in their strategies with a 2050 horizon. Not many people know that e.g. the pace of wind investment in the US is similar as in Germany.

The investment boom in the wind, nuclear, and PV industry is observable in China too. All these countries have decided to support the RES in terms of legal regulations, also to provide a guarantee to their industrial companies that the expenditures incurred for the development of these technologies will pay off in the future. Poland can’t pretend that it doesn’t see that.

Should Polish companies enter the RES market?

Yes, they should. It is much easier for our industrial companies to enter a new market than to look for room in an old one with deep-rooted manufacturers. Besides, our attachment to coal is based on the mining sector perspective rather than motivated by industrial considerations. In fact, we import key elements of conventional power stations from the West, and in terms of technology wind turbines, the PV, or biogas plants are much simpler than e.g. nuclear reactors, so they present lower entry barriers to Polish producers. What’s more, Poland is already producing components for wind power plants and photovoltaic panels.

Is this the hope for Polish industry?

This would be too strong a statement. Energy industry accounts for only 2-3 per cent of the GDP, so the demand for industrial goods generated thereby is not considerable. It is, however, a significant niche for the machinery industry, thus the technological transformation in the energy sector will definitely have an impact on industrial companies.

If the raw materials may never be extracted, and the traditional energy industry is becoming less and less profitable, we know why WIG20, the most important index of the Polish stock exchange, is dropping.

Polish problem, unfortunately, is that private industrial companies are concentrated in labor-intensive branches, whereas the capital-intensive industry is dominated by inefficient publicly owned companies – like the mining industry which is bringing enormous losses, or the energy sector which is supposed to save the mines but will go under itself any time now. Plus fuel and chemistry companies which occupy the traditional technological niches and which product profiles require no research and development in a manner comparable to Western business groups operating in the same branches. As a consequence, the scale of operations, efficiency, and margin of those enterprises are considerably lower than for the private European or American competition.

I’m afraid that if those companies are not privatized entirely, most of them are going to face failure in several years due to the political steering. Let’s hope that by that time private companies gather proper capital resources and experience to be ready to move towards more advanced industry branches.

To sum up: what kind of industry does Poland have, and what kind should it have?

Poland manufactures goods of low or medium technological complexity: machines, electric devices, transport vehicles, metal and agricultural products, rubber goods. On the other hand, it lacks a strong position in branches in which technological progress is the fastest, such as the production of pharmaceuticals, advanced chemistry, or electronics. This is, however, true as of end of 2015. We have to keep our eyes open because in 25-30 years, when Polish companies gather sufficient capital for investment, the most profitable branches may be totally different.

Maciej Bukowski PhD – the President of the Warsaw Institute for Economic Studies (WISE), academic researcher at the Warsaw University. He is a co-author of many publications dealing with economic development, including several Polish strategic documents (among others the Hausner Plan, Poland 2030 – Development Challenges). Recently WISE has drafted a report entitled ‘Work in the Times of Innovation’, which is the tenth position of the Employment in Poland 2014 series.

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