The reforms are possible but must be wanted

(Infographics: Darek Gąszczyk)

Experts preparing the ranking appreciated Poland’s progress in the areas such as registering property, paying taxes, enforcing contracts and resolving insolvency.

Poland’s progress is not an effect of a happy coincidence but an effect of steps taken by the Ministry of Justice. These were initiated by Minister Jarosław Gowin and former Director of the Department for Strategy and Deregulation, Jarosław Bełdowski; they set themselves a goal to move Poland up in the DB ranking.

Analysts preparing the ranking gave our country a higher score for expansion of an electronic system for filing land and mortgage registers, fast enforcement of contract claims owing to the first electronic court in Lublin (although the institution is also criticized in Poland), for streamlining procedures before economic courts and solving insolvency-recovery proceedings without winding up the company.

The liberalisation of access to professions is much more difficult. The Ministry of Justice had to withdraw from some proposals, and the very minister came under the fire of the media for tackling issues unrelated to the reform.

Where there’s a will there’s a way

Doing Business, as every such ranking is subjective, and the positions in the ranking are sometimes an effect of methodological errors or insufficient knowledge of the authors. But for foreign investors, this is an important indicator. Poland achieved some success which produced several, more general conclusions:

1. The reforms improving business conditions, and thus increasing the potential economic growth rate, are still possible and should be implemented. They call for effort on the part of decision-makers and carry a risk. Therefore, a determined group that has a proper power to make decisions is a must.

2. One of the conditions for a successful reform is a precise definition – a quantitative one would be the best – of the goal of the reforms. It is usually difficult to achieve a goal with one simple solution – e.g. introduction of one law – but with numerous coordinated moves. Reforms without goal definition are chaotic, and sometimes counterproductive. By defining the goal of the reforms, it is not only easier to monitor their course and make corrections, but also to explain the need for change to the public.

3. When introducing reforms, it must be realised whose interests would be damaged and try to neutralise the groups waiting for the fiasco. Mancur Olson, a prominent American economist and sociologist, who died in 1998, proved that long-lasting democracy strengthens the activities of groups that are against free competition. Such small groups are often well-organised, and most of all – aware of their goal. They can convince the public that their interest is everyone’s interest.

The liberalisation of access to professions should push down prices of many services, but the public (great majority) observes the process indifferently, while the opponents are very active.

For politicians, reforms entail a political “price” (having an adverse effect on the government’s reputation and the parties in power), which appears immediately. Possible benefits such as faster growth, unemployment reduction, larger investment, better education, etc. appear only after some time, sometimes when the reform makers are already removed from power. This is the main impediment to introduction of reforms in democracy. The reason for the present debt crisis suffered by many countries of the euro area is the many years of governments’ aversion to pay the political price of the reforms.

According to Doing Business 2013 ranking, Poland came 161th (out of 185) in “Dealing with Construction Permits”, 137th in “Getting Electricity”, 124th in “Starting a Business” and 114th in “Paying Taxes”. Improvement could be achieved through reforms involving changes in regulations. This should be a task of the entire government. The example of the Ministry of Justice demonstrates that this is not impossible.

OECD Recommendations

The OECD Economic Surveys Poland of March 2012 contains the following recommendations of structural reforms in Poland:

– Promote labour mobility by continuing to upgrade transport and communication infrastructure and reforming housing policies;

– Reduce the skills mismatch in the labour market by: improving the training system and developing a flexible lifelong learning system; promoting vocational education at the tertiary level and internships;

– Improve tertiary education by allowing public higher education institutions (HEIs) to introduce cost-related tuition fees for all students, developing student loans and reinforcing HEI quality assessment;

– Ease the administrative burden on businesses;

– Continue the privatisation of state-owned companies in the financial, mining, chemical and airport sectors, and network industries;

– Pursue gas and electricity market liberalisation by fully complying with EU regulations and possibly by implementing ownership unbundling (production and distribution) in those sectors.

The recommendations have not been discussed in Poland and did not inspire the government to take steps recommended by OECD experts. Some solutions of the Polish government – increasing the disability pension contribution, increasing state control over the power and chemical sectors – are simply heading into the direction which is opposite to the OECD recommendations.

The example of coordinated activities to achieve the set goal in the past 3 years was the policy of the Chinese government and the local governments of several major cities aimed at lowering housing prices. In 2007, the average price for a good dwelling in a large city was the equivalent of 21-year average wage in China. Such exorbitant price was partially a result of the expanding bubble in the property market, which was a concern for the government.

Still, the main motive for the action was to ease the potential tensions among a young, educated generation having no hope for own home. In consequence of increasing the borrower’s down payment in mortgage loans, introduction of lending restrictions on purchasing several dwellings and facilitation in housing construction, as well as faster provision of new construction sites – in 2012 the property price in relation to wages dropped to 16 years. This could be a good example for the Polish government, how to be effective.

The goals of the reforms – proposed changes

The general purpose of the reforms should be to boost long-term GDP growth rate to 5 per cent and reduce the natural unemployment rate to 5 per cent and at the same time increase the activity rate. It could be broken down as more detailed, quantitative goals.

My suggestions are given below. Some of the goals complement each other. Obviously, the values attributed to each task can be disputable.

Reducing the share of the State Treasury in Polish stock exchange capitalisation below 5 per cent. The present share is ca. 20 per cent.

The State controls several largest listed players. It also owns non-listed companies worth ca. PLN 100bn. The purpose of privatisation should be not only to reduce the public debt but most of all to improve management of companies and give access to capital, thus enabling investment. Poor efficiency of many state-controlled companies is one of the reasons for lowering long-term growth.

Privatisation of the entire Polish energy sector and demonopolisation of the gas market. No gas supplier can hold more than 50 per cent of the market share.

The regulations must be amended. The present energy law is so beaurocratic that it hinders market entry of medium-sized companies – e.g. sellers of energy and heat generated in smaller plants. The beaurocratic and unstable law is a key impediment to private investment in the Polish energy sector. The government tries to solve the problem by getting involved in the investment process (e.g. nuclear energy, shale gas exploration). This is rather ineffective and will consume modest state resources. The same goal – providing energy supply and lowering electric energy prices – can be attained through improvement of regulations.

Increasing the savings rate in the economy from the low level of ca. 17 per cent to 25 per cent. Our savings rate is clearly below the EU average, in which only several West European countries but also Estonia, Bulgaria and Latvia do not have the 25 per cent.

Without increasing the savings, a lasting increase in investment rate will be impossible, especially in private investment. To grow faster, the economy must reach for foreign capital, also financial capital, which exposes us to the volatility of foreign markets. The increase in savings in the upcoming decades will also be necessary in confrontation with the ageing of the population. Proposed steps:

a) adoption of tax solutions conducive to long-term saving;

b) change of the functioning rules of pension fund management companies, reducing costs and forcing greater competition;

c) introduction of a ban on funding the deficit from the Demographic Reserve Fund and increasing the contribution to this Fund from privatisation and taxes on raw materials;

d) radical narrowing of the general government deficit, and in the transitional period – maintenance of surplus (liquidation of negative savings).

Increasing investment from the current ca. 20 per cent to 25 per cent.

The government tries to maintain the shrinking investment through introducing Inwestycje Polskie (Poland’s state investment programme). This is, however, risky in many respects. If the management board of Polskie Inwestycje Rozwojowe SA, which will be the main vehicle of the government’s programme, chooses a conservative policy when funding the projects, the utilised resources will be small and insignificant in the scale of the economy. If, however, under political pressure, it will try to accelerate the projects, many of them will prove fruitless and the programme may generate substantial loss, and in consequence lower the long-term growth. Stimulation of private investment calls for:

a) reducing income taxes, both mid and top rate;

b) simplification of income taxes through a clear definition of the taxable base;

c) introduction of investment settlement that is favourable for entrepreneurs;

d) adoption of a new VAT Act – in Poland, the tax rate is relatively high while many VAT rates on goods and services are lowered, which not only complicates the system but also encourages fraud and should be changed;

e) introduction in the Tax Code of provisions stabilising the tax system for entrepreneurs until the return of investment expenditure (the same should apply to non-tax provisions, e.g. charges for CO2 emissions impacting the assessment of the yield on investments);

f) comprehensive review of provisions required for investment processes, especially construction – their simplification should cause a leap forward in DB “Dealing with Construction Permits” and “Getting Electricity” rankings.

1. Lowering the government debt to GDP (as defined in ESA 95) from the present 56 per cent to 40 per cent. The Ministry of Finance managed to contain public debt growth, which stands at 56-57 per cent. In a Multiannual Financial Plan of the State for 2012–2015, the Ministry of Finance provides for reducing the general government debt in 2015 to 47.2 per cent according to Polish methodology, and last year’s update of the Convergence Programme of the Ministry of Finance – to 49.7 per cent (as defined in ESA 95).

This is expected to turn out impossible due to economic slowdown. But assuming that the scenario would materialise, the public finance would still be exposed to exchange rate fluctuations. Zloty depreciation causes government debt to come close to the prudence threshold. This causes rigidity of the fiscal policy, discouraging the necessary tax reform. Significant reduction of debt requires public spending cuts to GDP from the current 44 per cent to less than 40 per cent. Deeper fiscal reforms than those undertaken by the present government are thus necessary. These should involve e.g.:

a) slowing down the indexation of disability pensions and old-age pensions granted according to the rules from before 1999, so that in 2025 the level of defined-contribution pension schemes is equal to the defined-benefit pension schemes, and the defined-benefit pension schemes would be self-financing by 2025; it is also necessary to further eliminate the industry privileges (miners’ and teachers’ pensions);

b) KRUS (Agricultural Social Insurance Fund) reform, eliminating fraud;

c) introduction of the obligation to maintain accounting books by farms using direct subsidies and covering them with taxes and contributions such as are paid by entrepreneurs;

d) adoption of an additional financial criterion for the assessment of the situation of people applying for social benefits;

e) abolition of the Teacher’s Charter;

f) introduction of fees for tuition in higher education institutions;

g) introduction of co-financing of medical services.

2. Increasing the level of innovation of Polish companies to the European average.

According to Eurostat, average 53 per cent of industrial and service enterprises in the EU introduced innovation in 2008-2010. This was reported by 79 per cent of German enterprises, 61 per cent Belgian enterprises and 60 per cent Swedish, Portuguese and Irish ones. Yet, only 28 per cent of Polish ones so reported. In this ranking, we ranked the last but one – before Bulgaria. Reforms conducive to innovation are not easy to implement. The following steps are necessary:

a) improvement of secondary and higher education institutions levels, with special emphasis on technical schools – one of the goals should be two Polish schools (incl. a technical one) ranking among the first 100 in the Shanghai ranking;

b) imposing an obligation on higher education institutions to maintain publicly accessible “career registers of graduates” – which would be a basis for the candidates to see the real value of the institution;

c) introduction of Poland-wide tests in higher education institutions (depending on a line of study: mathematics, economy, foreign languages, IT, accounting, etc.); schools whose students did not pass the tests at a certain level would lose the higher education institution status;

d) introduction in the tax system of incentives for innovative enterprises;

e) introduction of tax relief for venture capital firms – e.g. the possibility to settle losses and profits over a long-term.

3. Lowering the prices of housing vs. net wages from the present 1.5-month wage per square metre to 10-month wage per square metre. ‘Pro-supply’ mechanisms are necessary such as:

a) statutory introduction of the obligation of municipalities to have spatial development plans – after a year of vacatio legis the municipalities having no such plan would be put under court-appointed administration;

b) introduction of cadastral tax on property – this should be the main source of funding municipalities;

c) co-financing of municipal land development programmes by the central budget;

d) provision for construction of undeveloped land owned by state institutions (e.g. the army, Polish Rail);

e) simplification of regulations governing construction permits.

(Infographics: Darek Gąszczyk)

(Infographics: Darek Gąszczyk)

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(Infographics: Darek Gąszczyk)

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