Baltic Countries

Poland – why it succeeded so far

January 13, 2016, by Hubert Fromlet, Kalmar

Newspapers and politicians all over the world currently show a high degree of disappointment about Poland’s political development after last year’s general elections. Fears of markedly reduced democracy are expressed quite loudly. Economists, however, are more silent. This fact may confirm once more that foreign analysts at financial institutions and elsewhere usually are not well informed about economies outside the traditional OECD area (though Poland nowadays is an OECD country). This is – by the way – also true of China for which herd analysis usually dominates even outside the country, particularly among most financial players.

In my view, recent developments in Poland should not be underestimated. Poland’s strong emerging role during the transition to a working market economy was indeed impressive. Poland was even the first country among the former planned economies in (South) Eastern Europe that reached pre-1989 GDP levels. I have seen Poland’s impressive development many times with my own eyes since its opening-up in 1990.

The secret behind Poland’s success story until recently was without doubt that Poland – more or less – never moved backward in its reform policy. Sometimes Poland moved somewhat more to left of the road, sometimes a little more to the right – and the pace of reforms was during certain periods quite slow and during other periods more accelerated.

But the direction was always forward – and never really backward! This is probably the most important explanation of Poland’s political and economic recovery in the past 25 years. My own research has also confirmed in a number of studies that reliable and steady – sometimes quite slow – moves forward usually mean more to sustained economic growth than a mixture of fast structural improvements and following setbacks.

So, why should Poland want to jeopardize its achieved, good international credibility position? Foreign companies have invested a lot in Poland and, thus, contributed strongly to Poland’s fairly good international competitiveness. In other words: it should not be ruled out that reality and memory can take this quite large European country back to frameworks that are in line with nowadays valid European standards. However, good psychological feeling should be applied – particularly by Poland’s partners in the EU and in NATO. Such a position seems to be more promising than threats – if I understand Polish mentality correctly.

Anyway, the analysis of Poland’s political and economic development should be intensified in many international institutes and commercial organizations. We should keep in mind that Poland is an important European country – though often underestimated.

 

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

 

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The Baltics in Search for Exports

June 3, 2015, by Mārtiņš Kazāks, Riga

In 2014, Estonia grew by 2.1%, Latvia by 2.4%, and Lithuania by 2.9%. Flash estimates for Q1 2015 report GDP growth dipping to 1.2% YoY in Estonia and Lithuania (contraction of 0.3% and 0.6% QoQ), and 2.0% in Latvia (still up 0.4% QoQ). Investment activity has been quite weak for a couple of years whereas consumption growth has remained by and large robust. Thus, the key reason for the dip in growth seems to be external, i.e.: (i) collapse in Russian demand, and (ii) subpar EU growth.

If subpar EU growth has tamed the upside for the Baltics (overall it still holds good growth prospects as the EU demand is still rising), Russian contraction and especially the rouble depreciation have an outright negative hit. The reason for Russia’s contraction is its chronic structural weaknesses (excessive dependence on oil, poor rule of law, weakness of market institutions) – reinforced by sanctions (impaired access to finance and technologies due to the sanctions from the West, but also Russia’s own imposed embargo on food imports) due to the Russia-Ukraine conflict.

Flash estimate for Q1 2015 reports Russian GDP to have shrunk by 1.9% YoY. Real household incomes are down about 10% YoY as are retail sales; investment activity seems to have fallen through the floor. It could have been worse… with oil prices gradually picking up, the rouble has stabilized at somewhat stronger levels than expected, which means that inflation, though still at about 16%, seems to have peaked and is likely to start retreating. Industrial output has reported small positive numbers. Still, Russia is set to shrink further this year and recession is likely to end only in 2016. Moreover, when recession will end, recovery will be bleak low single digits as its old oil-driven growth model has run out of steam and there is nothing broad and strong enough to substitute for it. So, there is not much hope for strong demand growth from Russia over the longer term either, even when ignoring the lagging rule of law, investor protection and geopolitical risks.

How does this Russia trouble affect the Baltic economies? It has cut sharply into the Baltic exports – in Q1 2015, goods exports to Russia fell by 29% for Latvia, 34% for Lithuania (-60% for Lithuanian origin goods) and 49% for Estonia from one year ago. More difficult to measure, but confidence must also have suffered, reducing investment activity. Yet, the overall impact is not that devastating at all. Despite the massive drop of exports to Russia, total exports have grown a tad for Latvia (up 0.4% YoY), and only marginally inched down for Estonia (-0.4%) and Lithuania (-3.8%; -4% for Lithuanian origin goods).  Thus, the good news is that the massive fall in the exports to Russia have been compensated with expansion in other (mainly EU) markets. So far we see only limited and contained impact – within certain sectors or companies – on corporate profitability and liquidity.

In short, the Baltics are coping quite well with this. One of the reasons is that it is not the first time the Baltics see something like that; during the 1998 Russian crisis, for example, dependence on trade with Russia was much larger than it was before the current watershed, so companies have been diversifying their markets for a long time. As to the sanctions – Russia has had a habit of introducing one off sanctions against specific goods already before and also quite regularly (e.g. there was a ban specifically on Lithuanian milk products in 2013). Companies know how to react in such instances. Yes, this is costly, but companies have seen it before and know what to do.

We expect the Baltic goods exports to Russia to fall by 30%-50% in 2015, and trade links with Russia to weaken substantially. Russia’s share in goods exports has been shrinking, e.g. for Latvia, from 9.4% in Q1 2013 to 6.8% in Q1 2015. To compensate for the shortfall in Russia, there has been a spectacular growth to many so far for quite exotic markets for the Baltic exporters such as Middle East, China or Japan. But the major volume growth has been already established to the core partners of the EU. The share of destination EU has risen, e.g. for Latvia from 70.9% in Q1 2013 to 75.4% in Q1 2015, and it is likely to continue going forward. If political alliances for the Baltics have clearly been with Europe, fast and lucrative export growth to Russia and its peripheral trade partners at times may have put politicians in a situation to weigh among political and economic alliances… now political and economic alliances are likely to become closer aligned, which will add to stability – and this is good.

We see the dip in early 2015 as temporary since a gradual pick up in EU growth (supported by ECB quantitative easing stimulus) must lift European demand and thus the Baltic exports and consumer spending. Overall, we expect the Baltics to grow by about 2% in 2015 and 3% in 2016. Slower than before, but not that bad either.

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Mārtiņš Kazāks
Swedbank Deputy Group Chief Economist and Chief Economist for Swedbank in Latvia

 

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25 years After the Fall of the Berlin Wall – Reflections on Developments in the Former Planned Economies

November 5, 2014, by Hubert Fromlet, Kalmar

1. On November 9 in 1989, a colleague of mine and I had some meetings in both West Berlin and East Berlin. In the morning, we had no idea about what a few hours later could be called an historical day. We saw the fall of the Berlin Wall with our own eyes. What an event!

This particular experience convinced me pretty soon that it would be worth-while dealing as early and as much as possible with the commenced /forthcoming political and economic revolution that was about to happen.

2. The first country I visited was Poland. This happened already in early 1990. After this trip, I continuously and repeatedly went to all the other countries that were transforming their planned economy into a market system. These early trips to Poland, Czechoslovakia, Hungary and also to the new Baltic states gave me a real feeling of how badly the old system of he planned economy had worked – but also about the enormous efforts that had to be made in order to establish a new, functioning economic and legal system. Somewhat later, Romania, Bulgaria, Slovakia and Croatia, for instance, became interesting places to look at as well.

3. The implementation of the new legal and institutional framework was particularly difficult in the European reforming countries. Reflect, for example, for a few moments how many new – democratic and market-oriented – laws had to formulated, approved by parliament, and finally be applied by the courts! Do not forget all the education of judges that was needed!

The marketization of the planned economies was certainly not easy – and all the administrative/institutional reforms not either. Marketization also included important elements like free competition (whenever appropriate), the establishment of a modern financial system, new monetary and exchange rate policies, the creation of new economic policy tools, privatization, new tax systems, the opening of trade borders, openness for FDI and the import of technology, the encouragement of SMEs, etc. There were indeed mountings of reform areas.

4. Reforming countries with EU-membership objectives proved – generally spoken – be more successful during this transition process than countries without this final goal. Reform pressure – both economically and politically – for joining the EU was sometimes quite tough and had to be managed smoothly.

5. However, despite all the progress in most former command economies: many reforms/structural improvements still have to come (like, by the way, in most of the traditional OECD countries)! All the former planned economies have become part of the global economy. In this context, I would like to quote the late Nobel Prize winner Paul Samuelson who said to me in the 1990s “that globalization means that there is no room anymore for comfortable ineffectiveness”. Certainly not for the previously planned economies either!

It should also be mentioned that most of the (formerly) reforming countries had their ups and downs during the transition process – a transition process that certainly is not yet concluded in all former planned economies in Northern, Eastern, Central, South Eastern European countries – and even less in the nowadays independent Asian countries that previously were parts of the Soviet Union.

6. We have seen during these 25 years how some reform-delayed countries could catch up quite nicely at a later stage – but also the opposite, i.e. how countries with relatively favorable starting positions violated quite a bit of their initially nice reputation. Russia, Belarus and – more recently – Hungary turned out to be the largest disappointments.

7. The Baltic countries had their ups and downs since the early 1990s. Marketization and most of the necessary institutional reforms went quite smoothly. For a while – in the middle of the past decade – Estonia, Latvia and Lithuania were even called “European tigers”.

Around 2004/2005, however, the Baltic countries became increasingly imbalanced, caused by rapidly growing deficits in the current account and an enormous credit boom which regrettably was backed up strongly by some in the Baltic financial markets dominating and irresponsible Swedish banks. Too passive domestic supervisory authorities and governments made the problem even worse – but also the unilateral strong links to the euro and as a result of this policy the loss of an independent monetary policy. Today, the Baltic countries have achieved a satisfactory macroeconomic balance again – but (potential) growth has come down and problems on the labor market remain in place.

8. Let’s finally come to the economically most successful (reforming) country in the past 25 years (not including the former East Germany in this analysis). In my opinion, the answer is obvious: Poland. I have been many times to Poland in the past two and a half decades and written lots of reports on the country; thus, I do not have any doubt about this conclusion.

9. So what did Poland better than the other reforming countries?

In my view, three special factors were decisive (more, could, of course be mentioned):
¤ the early privatization and the creation of a new financial market
¤ openness to foreign direct investment, and, thus to imports of technology
¤ confidence in Poland’s economy and economic policy – without notable interruption neither domestically nor from abroad. In my view, this confidence part plays an underestimated role in many evaluations of the Polish success story – and should be “administrated” well also by future Polish governments.

Despite this positive general judgment, it should be stressed that also Poland still has a lot of structural work to do: for instance what concerns certain institutions, government debt, the budget process, health care, other social services and future-oriented research. And we realize these days that not even Poland is immune against all kind of external distortion. Russia’s current problems and EU’s disappointing growth development will probably lead to a slowdown of Polish GDP growth pretty soon.

10. Altogether, many positive developments could be noted in the previously planned European economies. Unfortunately, positive trends are not a homogenous phenomenon in the reforming European/Asian countries as a whole. The achievable growth potential has not been met everywhere in the past in the past 25 years. There are obvious winners and losers. However, both the current winners and losers should remember three obvious conclusions:

– the wise words of Paul Samuelson about comfortable ineffectiveness (see above),
– economic heterogeneity between the countries has been increasing strongly since 1990 – and the winners of today are not necessarily the winner of tomorrow (and vice versa),
– speed is not all when it comes to economic reforms; it may be even more relevant to emphasize the importance of continuously moving forward – and not move backward as Russia currently is doing.

At the end of the day, economic growth and well-being is very much about confidence of the household and corporate sector – both in the short and in the longer run.

 

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

 

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