Eastern Europe and the Former Soviet Union: Class 3

Poland pre-transition More than 8,000 state-owned enterprises >90% of output and 80% of empl. industry accounted for 58% of GDP in 1988. (OECD countries 24%--41%) almost half of exports and imports with CMEA countries products of inferior quality aged capital stock; tech. backward

1990- Balcerowicz Plan Shock therapy Price liberalization trade liberalization legal reforms end restrictions on private ownership tight credit policy to lower inflation and force out loss-making enterprises restrictive wage policy ambitious fiscal policy

Criticism Too much; too quickly Excessive pain on large state enterprises, their employees and local communities

Counter-arguments Necessary conditions for privatization, enterprise restructuring and development of an institutional system compatible with a market economy

Pre-Big Bang obstacles faced by private entrepreneurs Hard to locate space Difficult to raise capital capricious tax authorities Bureaucratic snags Problem of obtaining materials

Immediate results--disappointing

Longer term results By 1994 Poland became the first country to see recorded GDP exceed 1989 level. Since 1994 continued GDP growth (6.2% per year 1994-97) investment growth export growth declining inflation

Pre-1994 growth was driven mainly by exports (9% per year) since 1995 domestic demand, led by investment, took over as the driving force growth in domestic demand has led to increase in imports and a trade deficit but largely offset by healthy FDI ($5 B in 1998)

Unemployment---still a problem 10-11% 1998-99 pockets of very high unemployment in regions where agricultural and industrial restructuring is difficult and incomplete

What explains Poland’s economic turnaround??? One perspective focuses on the achievement of macroeconomic stability Alternative. Look at categories of Polish enterprises (micro level) state enterprises privatized state enterprises new private sector firms

Contribution of Privatized SOEs Very little privatization in early 1990s took 3 years to work out a Mass Privatization Program August 1994: only 121 firms actually privatized

Exception---Prochnik Manufacturer of men’s overcoats privatized in April 1991. Seemed to have unusually good prospects quickly lost its traditional export markets collapse of Soviet market recession in Western markets competition from East and SE Asia lost old export subsidies currency problems cause supply problems

Need to devise new strategy Concentrate on domestic market (and high quality end) had to create a marketing division had to create a distribution network developed broader product line to gain image of garment manufacturer downsized to reduce production costs subcontracted out sewing jobs to idle state-owned plants sold off unproductive assets

State Enterprises Modest contribution: few successful examples. WHY??? Not much pressure to improve performance. Allowed to default on tax payments to avoid bankruptcy. “Managerial purgatory”

Example of Gdansk Shipyard Eastern bloc countries were major customers clients located by central government Polish government provided all financing built various classes of boats to maintain full employment most contracts are unprofitable. Depend on subsidies (no specialization) Managers focus on getting concessions from government.

With collapse of USSR lost major client refused to reduce size of operation or variety of products find it difficult to think in terms of profits tried to increase employment insisted on continued government support. “We are generating jobs for suppliers.”

Exception--Szczecin shipyards USA Today article. November 9, 1999. On brink of bankruptcy in 1991 $600 M of revenue in 1998. (9 times 1991 figure) new managing director negotiates write-off of 1/3 of $180 M debt and 5 year extension for the rest (buys time)

Focuses on mid-sized container ships Downsizes. Reduces total employment from 13,000 to 5,000 implements a performance-based compensation plan for workers reduced ship production time from 36 to 11 months. Sheds non-productive assets like workers’ apartment and vacation facilities

New private sector firms 35% of industrial employment

Limited access to capital BUT… Lacked inherited organizational structures had low fixed costs had motivation to exit unpromising markets and pursue more attractive ones

Source of entrepreneurial skills of managers Polish cooperatives. A transitional unit of organization Example of Gdansk cooperative maintenance services for state-owned enterprises got into high altitude repair of smokestacks, towers, industrial cranes etc. that had been allowed to deteriorate accumulated capital and reinvested in specialized equipment

Entry point to manufacturing Move into manufacturing from trading goods

Remaining constraints Raising capital. State banks were slow to change due to their links to state firms New private banks reluctant to lend to new private businesses without credit histories or reputations. High interest rates lead to dependence on retained earnings which slows expansion.