SHOCK THERAPY: WHAT WE CAN LEARN FROM POLAND

By Taylor Marvin
Staff Writer
Poland’s transition to the market economy after its political liberalization in 1989 is generally regarded as one of the most successful transitions of all post-Soviet economies. Today the success of this transition is evident—Poland is a middle income nation that enjoys a stable democracy and close integration into European state organizations. This success is commonly attributed to “shock therapy,” a drastic neoliberal package of liberalizing economic reforms that Poland quickly adopted as it emerged from Soviet domination. While shock therapy was an effective response to communist Poland’s economic deadlock, it did come a high short term costs that could have been avoided. Despite its unnecessarily rushed introduction, shock therapy was successful because it was the right policy set at the right time for Poland. However, observers should be wary of drawing the wrong lessons from Poland’s experience—while neoliberal economic policies are generally helpful in aiding transitional economies, Poland is not a typical case. Despite decades of stagnation and communist mismanagement, Poland already possessed the public institutions, infrastructure, high human development levels and proximity to world markets that were necessary to succeed in the world economy. These pre-existing conditions made Poland’s economic success possible—a success that shock therapy enabled but did not directly cause.

Introduction

The Polish post-communist experience is unique. Despite facing formidable economic, political and social challenges upon democratization, today Poland is a developed nation that enjoys high levels of economic development and European integration, especially compared to its fellow Eastern European states. The credit for Poland’s success rests partly on its quick adoption of liberal free market policies in the immediate aftermath of revolution termed “shock therapy”, which included market liberalization and the end of Soviet-era social controls. However, this policy came at a cost. The economic revolution sparked a deep and unanticipated recession that the architects of shock therapy were not prepared to address. However, Poland’s experience is not an accurate model for the developing world. While shock therapy and its prescribed polices were an important part of Poland’s revival, other preexisting and non-replicable factors were just as vital. Shock therapy was not directly responsible for Poland’s resuscitation; rather, it removed the social and economic handicaps that had been holding it back.

The pre-1989 Economy

Upon revolution in 1989, Poland’s new Solidarity leadership faced a drastic economic situation.
Poland’s socialist economic system was fundamentally unsustainable. This structure rested on two central pillars: the dominance of state-owned industrial enterprises and the absolute centralization of economic control. Under Poland’s Marxian economy, central state economic bureaus managed production and fiscal conditions by decree. State planners decided what goods and services would be produced in what quantities and set official prices for both raw materials and consumer goods (Kondratowicz 1993, 9). In accordance with Marxist philosophy, the political and economic establishment placed a premium on manufactured goods—in 1975, heavy industry accounted for 45 percent of GDP, while services accounted for less than 15 percent (Kondratowicz 1993, 7). Additionally, state planners directly controlled the output of the industrial sector, preferring capital goods manufacturing over consumer goods (Kondratowicz 1993, 7), a preference that led to the widespread shortages that were characteristic of Polish society (Sacks 2005, 111). While shortages and consumer good scarcity were common in communist nations, they were much more severe in Poland (Adam 1999, 22). Consumers responded to chronic shortages by establishing an extensive black market economy that ignored official price controls and regulation.

Poland’s economic model was designed to provide universal employment and social services, prevent economic instability, transfer economic risks from state enterprises to the central government and secure prosperity for Polish workers. While the Soviet structure was initially successful, by the late 1960’s the fundamental deficiencies of a planned economy had begun to destroy Polish society. This unraveling was multifaceted. In an attempt to ensure low food prices for urban workers, the government elite maintained artificially low official prices for farm products. This preference was rooted in both ideology and politics; Leninist political philosophy focused on industrial laborers and Polish communist leaders saw urban unrest as a greater threat than rural discontent. While this policy did ensure low food prices, it discouraged agricultural production and led to further shortages. As a result, Polish leaders were forced to resort to wide publicly-funded subsidies that inflated the deficit (Kondratowicz 1993, 9). Confounding this problem was the lack of private entrepreneurship and capital necessary to modernize Polish economic production, and efficiency fell farther and farther behind Western levels throughout the 1970’s and 1980’s (Kondratowicz 1993, 10). By 1979, Polish national income began to fall as borrowing increased. The nation’s centralized economic structure left it completely incapable of adapting to these challenges. A lack of private investment or enterprise prevented gains in international competitiveness; fixed prices removed incentives for efficiency gains and any attempt by the government to reduce services or raise artificially low prices were met by public riots (Kondratowicz 1993, 10). This situation could not last. When policy makers were forced to relax the rigid controls over food prices in 1989, the excess demand, stifled by restricted production, sent food prices skyrocketing and inflation immediately jumped by over 250 percent (Kondratowicz 1993, 11). The Polish economic system had reached its breaking point.

This economy emergency coincided with looming political change. After the Soviet conquest of Eastern Europe, Poland existed in a strange political limbo, nominally independent but firmly controlled by Moscow. However, by the late 1980’s this political situation began to unravel. Spurred by growing economic stagnation, mounting inflation and the increasingly obvious ineffectiveness of the Communist leadership, democratic agitators, primarily trade unionists, became more and more militant in their demands for political revolution. In 1989 the choice became clear to Polish Communists and their Soviet patrons: either crush the growing ranks of protesters with military force or acquiesce to their demands for democratic reform. On June 4, 1989, democratic elections brought the reforming Solidarity union movement to power (Sachs 2005, 111). The electoral mandate was clear—Poland’s economic troubles would not be solved by reforming the system, but by revolutionizing it.

Shock Therapy

Newly democratic Poland was forced to deal with the obstacles it had inherited from five decades of communist rule. By the 1980s, Poland’s debt had ballooned to US $50 billion, or nearly two thirds of its GDP (Jackson 2005, 21). Inflation, unleashed by the relaxation of decades of artificial price controls, had reached 250 percent in 1989 (Slay 1994, 80). Inescapable hyperinflation seemed poised to devastate the economy (Sachs 2005, 115) and national income and productivity were declining (Jackson 2005, 21). Chronic shortages deprived consumers of basic necessities (Kondratowicz 1993, 15) and the goods that were available became extraordinarily expensive. Furthermore, because Poland’s currency was non-convertible and officially overvalued, smuggling and tax evasion had replaced formal international trade (Sachs 2005, 115). Poland’s democratic leaders faced a dilemma: how could Poland respond to these challenges and regain the social order and prosperity necessary for the survival of its democracy? Their response was simple: Poland would rejoin the European social model that its half-century detour of Soviet domination had led it away from. By adopting the privatized market economies and multiparty democratic government of its Western European neighbors, Poland hoped that it could quickly attain social and economic success.

Shock therapy, formally titled the Balcerowicz Plan after its primary architect Leszek Balcerowicz, was intended to rapidly reform the Polish economic structure from a centrally planned economy into a privatized market-based one. While economic liberalization was the eventual goal, Polish policy makers first focused t on preventing the emerging menace of hyperinflation (Poznanski 1993, 17). The Balcerowicz Plan was a complicated blueprint for economic reform, but held five core macroeconomic and social changes (Jackson 2005, 25):
• Monetary contraction polices (Poznanski 1996, 174) designed to restrict the supply of money and raising interest rates above the inflation level. Additionally, the government would no longer be able to finance budget deficits by printing money and raising the interest rate (Swoada 1995, 36).
• Austerity measures to reduce the Polish government deficit, mostly through cutting subsidies and eliminating tax exemptions (Belka 1995, 15). Additionally, the government committed to combating rampant tax evasion (Poznanski 1996, 174).
• Eliminating price controls. 90 percent of Polish price controls were immediately eliminated, while the official prices on key goods like rent levels and fuel were raised closer to their natural level (Belka 1995, 15).
• Liberalizing foreign trade. This was done by reducing barriers to international trade, encouraging foreign investment and moving to establish the Polish currency, the zloty, as a convertible currency whose value changed in accordance with the world market (Belka 1995, 15).
• Ending state control over income levels and reducing the role of state industries, which allowed the Polish private sector to grow and wages to be determined by market conditions.
In addition to these strategies, shock therapy also included recommendations to privatize state-owned industries through auctions and direct sales, continuing social safety nets, ensuring continued employment for state-sector workers and adopting the social and governmental standards necessary for entry into the European community (Sachs 2005, 115). The Balcerowicz Plan was passed into law December 1989, marking Poland’s final irrevocable break with its communist past.

Immediate Effects

Shock therapy’s wide package of social and economic reform came at a considerable short-term cost. A deep recession that far surpassed the economic disruption expected by surprised state leaders almost immediately engulfed Poland. Income levels fell, unemployment rose, and national output and inflation levels all suffered. Fortunately, these adverse effects were not permanent, and by the early 1990’s, all Polish economic indicators had returned to growth.

Rising unemployment was one of the most obvious costs of Poland’s economic reforms, with unemployment reaching 11 percent in 1991 (Poznanski 1996, 180). This rise was due to a variety of factors. Producers fired workers as output levels fell, creating losses that the gains in the expanding private sector were not able to absorb (Poznanski 1996, 180). Additionally, many of the state-owned enterprises’ inefficiencies had been hidden by the central planning quotas that provided an artificial demand for their goods; liberalization removed this market and revealed their inability to compete in open economy (Sachs 2005, 124). These losses, combined with rising energy costs sparked by the end of Soviet energy subsidies, led to the failure of many obsolete state-owned enterprises. Those unemployed by these collapses created a new class of unemployed, mostly middle-aged workers without the skills necessary to compete in the changing economy (Sachs 2005, 124). However, while post-liberalization unemployment statistics were grim, the opening market was not solely to blame. Under communism’s promise of universal employment, many of the unemployed went unreported or worked in the informal sector, so accounting for them upon liberalization contributed to the precipitous fall in the official employment rate (Poznanski 1996, 180). Nevertheless shock therapy did result in a rapid growth in unemployment to an extent that was not anticipated by the architects of reform. Those unable to find jobs in the unfamiliar private sector faced falling living standards, forced retirements and reliance on state pensions. This rise in entitlement obligations increased the state’s financial commitment and challenged Poland’s attempt to eliminate state debt (Poznanski 1996, 181). Poland’s necessary fiscal contraction prompted reductions from the Soviet-era pension levels (Tymowska 1993, 225), a move that further lowered the standard of living of the unemployed.

In addition to rising unemployment, Poland’s levels of economic output fell sharply in the years immediately following economic reform. GDP had fallen a calamitous 11.6 percent in 1991; only by 1992 did output begin to grow again (Poznanski 1996, 194). Specific economic indicators followed the same pattern. Industrial and agricultural output and investment levels all declined in the first years of shock therapy, only to return to positive growth in 1992 and 1993 (Poznanski 1996, 195). Similarly, inflation reached a runaway 584 percent in the first year of shock therapy and but fell to 43 percent by 1992 (Poznanski 1996, 194).

Overall Results

Despite short-term costs, Poland’s economy was on the rise by 1992 (Belka 1995, 13), just two years into the Balcerowicz Plan, and had surpassed its communist era GDP by 1995 (Jackson 2005, 2). Poles were able to successfully lower inflation, adapt to a completely different economic structure and, most impressively, thrive in a global marketplace after over fifty years of communism. The entrepreneurship of ordinary Poles was astounding—breaking from the Soviet tradition of state-owned, centralized industries by the mid 1990’s, Poles had managed to establish thousands of successful private firms. These private businesses drove Poland’s economic recovery, providing jobs and strengthening commercial ties with the rest of Europe. This success in establishing economic growth was fundamental in ensuring the stability of Polish democracy; without growing prosperity, the stability of Poland’s multiparty democracy would have been uncertain.

Though Poland’s economic recovery was multifaceted, it ultimately rested on the successful introduction of a liberal market economy. Shock therapy’s introduction of a stable, convertible currency, control of inflation, encouragement of private industry and foreign investment and trade all contributed to increasing economic activity which in turn stimulated job creation and rising incomes. Former state-owned firms were generally unable to remain competitive in the liberal market, though their job losses were matched by post-restructuring job creation (Jackson 2005, 31).

Additionally, foreign investment in post-communist Poland played a major role in reinvigorating the economy. Six-thousand foreign firms were established in Poland after 1990, stimulating the economy and contributing to growing employment by increasing production and consumption (Jackson 2005, 30). The nation’s success in attracting foreign investment and trade rested on several factors. Firstly, Poland enjoyed a close proximity to European markets that guaranteed steady demand for Polish products and increased the supply of foreign direct investment in the country. Of all post-communist Eastern European nations, Poland was the closest to Western Europe and consequently enjoyed the highest foreign capital inflows (Sachs 2005, 125). Additionally despite decades of communist mismanagement, Poland possessed a skilled workforce and developed infrastructure. Unlike many developing nations, the Polish population was educated, literate and experienced in industrial work. Poland also possessed functional, if run-down, roads, factories, and power infrastructure. All of these factors allowed Poland to attract the foreign trade and investment that allowed it to enter the global economic system and bring prosperity.

Western Europe’s proximity to Poland provided an additional benefit. Polish leaders knew that if they could successfully guide their country through the chaos of democratization and the dismantling of the Soviet-style economy, they could also eventually gain membership in economic and political organizations dominated by wealthy Western European nations (Van Brabant 1993, 118). This provided a powerful incentive for measured, moderate political behavior over short-sighted populism and provided a model for the institutions of future Poland.

Lessons from Poland

One decade after liberalization, Poland has clearly revealed itself to be an economic success. It has enjoyed the highest growth rate of any post-communist European nation and by 2002—12 years after the Balcerowicz Plan was implemented—Poland had become 50 percent wealthier than it was under communism (Sachs 2005, 127). In 2004, Poland was admitted to the European Union and is an influential voice in European politics. Today Poles enjoy high life expectancy, moderate foreign debt, a high ranking on the UN’s Human Development Index, and a sustained, stable growth rate (Pocket World in Figures). Furthermore, Poland has fared remarkably well in the 2008-2009 global recession, maintaining a growth rate far above the depressed European average (CIA World Factbook).

While shock therapy did create a sickening short-term fall in output and Polish standard of living, Poland’s experience with liberalization was substantially better than many of its post-Soviet contemporaries. Poland’s fall in GDP was less than that of Hungary, Czechoslovakia, Romania, and Bulgaria (Poznanski 1996, 194) and Poland was the first Soviet successor state to return to its communist-era level of output (Jackson 2005, 2). Additionally, while Poland’s experience with hyperinflation was worse than its neighbors (Poznanski 1996, 194), its current inflation rate is unremarkable, especially by post-Soviet standards (CIA World Factbook). Poland was also spared the fall in public health levels other reforming nations suffered; unlike its post-Communist peers, Poland did not see the lowered life expectancies that plagued others after revolution (Jackson 2005, 3).

Was shock therapy successful? There can be no doubt that Poland greatly benefited from its transition to a market economy, but these overall gains did come at a cost. However, any drastic economic revolution will incur some expense and given the scale of the Polish transition, its downturn was remarkably mild. In 1989, Poland chose to break with not only its economic system but its political order as well; it is naïve to expect such an abrupt revolution to be completely smooth. Despite this, the Balcerowicz Plan did have faults that directly contributed to the extent of Poland’s recession. By attempting to rapidly replace a half-century of economic practice, it created instability and uncertainty that contributed to decreased economic output and increased unemployment. Rapid, sometimes chaotic privatization, lack of government insurance for state-owned banks, and the abrupt removal of import tariffs stressed producers that were already undergoing a painful transition. Despite these flaws, shock therapy was a fundamentally useful policy, albeit one that would have benefited from a more gradual introduction. By accepting the inevitability of some short term costs, Polish leaders were able to ensure that the benefits of a liberalized market economy would not be lost on future Poland.

Despite the successes of shock therapy, Poland’s experience is not a replicable model for the developing world. The Balcerowicz Plan achieved such long-term success because Poland was fundamentally a developed nation handicapped by mismanagement and oppression; shock therapy merely removed these obstructive economic and political structures. Prior to Soviet domination, Poland was a democratic, market orientated European nation. Despite Soviet repression, the Polish people still possessed the traditions of the political and economic institutions necessary for success in an open economy. Furthermore, despite communism’s failure, Poland did emerge from the shadow of the USSR with valuable assets: developed infrastructure, an educated and industrially skilled workforce and established, though largely inept, social and governmental institutions. The fact that Poland already possessed the basic capital needed to compete in a global economy eased its transition into the free market. Many developing nations, especially those without an industrial past or tradition of democracy, have none of these assets, particularly the human capital so necessary for success in an open economy. Additionally, Poland benefited from its geographic proximity to one of the world’s biggest markets and centers of economic activity, a location that guaranteed rapid flow of capital, investment, and trade. Unfortunately, most of the world’s poorest nations aren’t so lucky. While economic liberalization and democratization can be a pathway to development, Poland is not the standard by which developmental success should be judged, but should rather be viewed as an extraordinary exception. Ultimately, the liberal model prescribed by shock therapy is helpful, but meaningful long-term growth rests more on geographic and institutional factors than immediate macroeconomic policy.

References

Adam, Jan. 1999. Social Costs of Transformation to a Market Economy in Post-Soviet Countries. New York: St. Martin’s Press, Inc. Sachs, Jeffrey D. 2005. The End of Poverty. New York: Penguin Group.
Belka, Marek and Stefan Krajewski. 1995. “Polish Transformation After 5 Years- Some General Remarks.” In Economic Transformation in Poland: Reforms of Institutional Settings and Macroeconomic Performance, ed. Marek Belka and Hans-Georg Petersen. New York: Campus Verlag.
Jackson, John E., Jacek Klich and Krystyna Poznanska. 2005. The Political Economy of Poland’s Transition: New Firms and Reform Governments. New York: Cambridge University Press.
Kondratowicz, Andrzej and Marek Okolski. 1993. “The Polish Economy on the Eve of the Solidarity Takeover.” In Stabilization and Structural Adjustment in Poland, ed. Henryk Kierzkowski, Marek Okolski and Stanislaw Wellisz. London: Routledge.
Poznanski, Kazimierz Z. 1996. Poland’s Protracted Transition: Institutional Change and Economic Growth 1970-1994. Cambridge, UK: Cambridge University Press.
Slay, Ben. 1994. The Polish Economy: Crisis, Reform and Transformation. Princeton, NJ: Princeton University Press.
Sowada, Christoph. 1995. “The Polish Stabilization Program: ‘Balcerowicz-Plan.’” In Economic Transformation in Poland: Reforms of Institutional Settings and Macroeconomic Performance, ed. Marek Belka and Hans-Georg Petersen. New York: Campus Verlag.
Tymowska, Katarzyna and Marian Wisniewski. 1993. “Public Health and Social Security.” In Stabilization and Structural Adjustment in Poland, ed. Henryk Kierzkowski, Marek Okolski and Stanislaw Wellisz. London: Routledge.
Van Brabant, Jozef M. “The New East and Old Trade and Payment Problems.” 1993. In Stabilization and Privatization in Poland: An Economic Evaluation of the Shock Therapy Program, ed. Kazimierz Z. Poznanski. Norwell, Mass.: Kluwer Academic Publishers.
The Economist. “Pocket World in Figures.” London, Profile Books Ltd, 2007.
The Central Intelligence Agency. 2010. The CIA World Factbook. “Poland.” https://www.cia.gov/library/ publications/the-world-factbook/geos/pl.html (May 15, 2010).

Image of Market Square in Wrocław, Poland. Courtesy of Wikipedia Commons.

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3 responses to “SHOCK THERAPY: WHAT WE CAN LEARN FROM POLAND

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