The economy of the Second Polish Republic collapsed because of dogmatic policies

The reign of the Sanation camp (Polish political movement) is usually associated with large investments, but these only really began in 1935, after the death of Józef Piłsudski (a Polish statesman, the Chief of State (1918–22), the First Marshal of Poland and a leader (1926–35) of the Second Polish Republic), when Eugeniusz Kwiatkowski became the deputy prime minister responsible for the economy. While Kwiatkowski had previously served as the minister of industry and trade in the years 1926-1930, because of his political views he became marginalized in the years 1931-1935 (he was demoted to a relatively low-ranking position of the director of the State Nitrogen Compounds Factory in Chorzów and Mościce near Tarnów) (read more).

The gold standard

Until 1935, Poland’s economic policy mainly consisted in artificially maintaining a high (pre-crisis level) exchange rate of the Polish zloty (read more). In the opinion of economists, this was reducing the competitiveness of Polish products abroad. The money supply decreased along with the decline in GDP, which aggravated the deflationary tendencies. The decline in demand accompanying the deflation deepened the crisis (during deflation, consumers expect further price reductions, so they abstain from purchases, thus causing a further reduction in supply and GDP, as well as higher unemployment).

The pre-war economist Adam Heydel wrote that Poland had chosen a very orthodox method of combating the crisis after 1929. Poland’s politicians believed that during a crisis it is essential to maintain the gold parity and to strive for the price equilibrium to establish itself. This ideology was advocated by the countries of the Gold bloc, i.e. the so-called gold standard club.

At that time, there was no International Monetary Fund, World Bank or European Central Bank, which are frequently criticized for their mandate to influence the economic policies of many countries. Before the war, the Gold Standard was managed by the heads of four central banks — the American Federal Reserve System, the Bank of England, the French central bank and the German Reichsbank.

Poland joined the Gold Standard system in 1927, against the recommendations of the creators of the Polish currency, and especially its reformer Jerzy Zdziechowski, who had carried out a devaluation of the Polish zloty in 1925. In October 1927, the President of the Republic of Poland Ignacy Mościcki issued a decree in which it was declared that Poland would follow the rules of the gold standard club. The Polish authorities hoped that thanks to membership in this club the Second Polish Republic, which was still a relatively poor country, would be able to obtain the badly needed loans, but also foreign investments.

Poland was like Greece

Until 1929, the Polish economy was expanding and the trade was growing. The situation was so good that in 1929 GDP per capita in Poland reached 122 per cent of the value recorded in 1913, i.e. before the First World War. However, the following years were marked by a recession. In 1930, the GDP per capita was already at 115 per cent of the pre-war level. In 1931 it fell to 105 per cent, and in 1932 reached 95 per cent of the pre-war level. However, this was not the end of the declines, as in 1933 Polish GDP per capita reached the level of 91 per cent of the value recorded before the First World War. This ratio only started to increase again in 1936. In 1937, GDP per capita already amounted to 110 per cent of the pre-war value, and reached 125 per cent of the pre-war level in 1938, which means that at that point Polish people were the most affluent in the entire post-war period.

Looking at other countries in that time, it is difficult to find another place where the Great Depression had equally dramatic consequences (except for Germany). The economies of all the countries started to recover faster, among other things, due to the fact that they broke with the gold standard and carried out a devaluation of their currency. In some ways Poland was in a situation similar to that of Greece after 2008. The Greeks could not devalue their currency, because then they would have had to leave the Eurozone. However, in reality the Second Polish Republic could have easily abandoned the gold standard, because even the bloc’s founding countries did so. The Czech crown was devalued in mid-1930s. Thanks to this move, the Czechoslovak economy, which was based on exports, quickly dealt with the consequences of the crisis.

Devaluation

The American economist Irving Fisher believed that the gold currency should be appropriately manipulated. If the prices of goods are falling, the American dollar gains in purchasing power. Fisher explained that countries should always strive to achieve such a value of money at which the level of prices would always be equal. Therefore, if the price of goods decreases, the amount of metallic ore contained in the money should be reduced in order to offset the drop in prices. When the opposite situation occurs, the amount of gold should be increased, in order to increase its purchasing power. This theory was supported by some Polish policymakers, such as the aforementioned Jerzy Zdziechowski and Feliks Młynarski. It was also criticized by others, such as Ignacy Matuszewski, who served as the Minister of the State Treasury from 1929 and pursued a policy of austerity. During that time, Poland’s neighbors, i.e. Germany and the Soviet Union, pursued an extremely statist policy that increased the level of their national income.

A sharp devaluation of the pound sterling took place in 1931 and the British government authorized the governor of the Bank of England to abandon the gold coverage of the British currency. The United Kingdom’s decision was followed by all the Scandinavian countries, all the British dominions, Japan, Egypt and several South American countries. Later, the same decision was made by the United States (in 1933).

At that time Poland was defending the parity of the zloty at the level of almost 9 zloty per American dollar, but reduced it to just over 5 zloty in 1933. This means that unlike other countries, after the crisis Poland was trying to strengthen its currency, which meant that it could import a lot. Poland did not have the required capital and the structure of the country’s consumption did not allow for that. In 1933, Polish GDP per capita reached 44 per cent of the GDP per capita in Germany, which was at that point in the grip of chaos, 68 per cent of the GDP per capita in the fast-growing Soviet Union, which would soon go through the period of the Great Famine in Ukraine and Kazakhstan, as well as 28 per cent of the GDP per capita in the United States, which was about to start the implementation of F.D. Roosevelt’s New Deal.

When Poland came to the brink of bankruptcy in 1936, instead of devaluing the currency once again, Eugeniusz Kwiatkowski introduced restrictions in the issuance of foreign currency. Poland received a loan from France for armaments and launched an extensive expansion of the Central Industrial District. The Polish government only chose to devalue the currency in 1939, but due to the outbreak of the war there are no estimates of Poland’s GDP for that year.

With both hands tied

The lack of a decision to devalue the currency was a mistake which meant that Poland was unable to develop like the neighboring countries. There were at least two points in time when that should have been done: either in 1931 (when everyone did it or when the dollar devalued), or in 1936 (when France did it and when a new team assumed control of Poland’s economic policy).

The conviction that it was necessary to defend the gold standard stemmed from the desire to confirm Poland’s membership in the club of Western countries, and also from the desire to be appreciated by foreign capital. This did not happen, however, because all the countries had to cope with the Great Depression, and Poland additionally tied its hands by sticking to the gold parity dogma, even though no one really expected that from the Polish authorities. Because of that decision, the depth but also the length of the crisis in Poland was much greater than in other countries.

Shortly after the 100^th anniversary of regaining independence by Poland, the country should keep in mind that it is not worth holding on to economic dogmas at any price. Economic policy is supposed to serve the public. As a result of the dogmatic belief in the gold standard Poland became economically weakened and, consequently, also militarily weakened on the eve of the Second World War.

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