Financial Policy in Polandís Transitional Economy
The first effect of the fall of Communism in Poland was the expression of a great enthusiasm amongst people throughout the region as they celebrated their new-found freedom. The second was economic chaos. The sudden halt and collapse of the centralized command economy and the simultaneous thrust into the turbulent world market left Poland in a limbo that could only be transcended by coherent and effective economic policy. In formerly communist countries, formulating the financial aspects of this policy can often present some of the greatest challenges for national leaders. In the case of Poland, the development of sound financial policy was a significant factor in its relatively fast recovery and transition to a market economy.
The main dilemma in developing financial policy in Poland, or in any former communist power, arises from the simple fact that finances in general had been vastly ignored for more than a generation. It is true that the command economy in Poland did operate with a currency and made some attempts at rudimentary accounting. Even still, the attention of an enterprise was always highly and unevenly centered on output. Production, not profits, were what mattered. This was so much the case in Poland that individual enterprises often did not even perform their own financial accounting, leaving the duty to another state organ (Montias, 81). In fact, it was to the state, not the market, that the enterprise owed its existence. It was from the state that the enterprise procured all of its inputs, as well as all of the investment goods it needed to expand or to replace depreciated capital. When enterprises operated at a loss, it was the state that kept it functioning with government subsidies. Most times, money for transactions such as these did not even change hands, and it could have been considered fortunate if some accurate record had been kept. Instead, materials were delivered directly and bad business carried on as usual.
In 1989, the rules for businesses and for the economy drastically changed in every possible way. Money went from playing a subordinate role in the command economy to playing a dominant role in the market economy virtually overnight. From then on, the focus would be on profits, not production. All of the state enterprises that comprised Polandís economy, having been accustomed to state subsidies, inefficient operation, and often operation at net losses, found themselves in a crisis Blanchard et al, 117). In order to survive in the market, they would need massive, comprehensive, restructuring. If they failed to do this, they would become bankrupt and Polandís economy would grind to a halt.
The problem that arose here is that in order to restructure, especially on such a scale, great sums of money would be needed, and this could no longer come from the state. However, Poland lacked the elaborate system of financial institutions that seemed necessary to provide credit for the badly needed changes. In addition, its lack of financial traditions or aggregated expertise in this area gave little guarantee that the credit, even if it became available, would be allotted wisely. It was from this tenuous position that Polandís leaders were charged with formulating a new financial policy that could successfully navigate the Polish economy towards recovery. With hardly any foundation to start from, the odds were definitely stacked against them.
To the credit of the Polish government, they moved quickly and made very sound decisions, despite some political wrangling. Prior to 1989, the only tangible bank that existed was the Central Bank of Poland. One of the first measures the new government took was to decentralize the banking system and to open it up freely to competition. In 1991, after only two years, private banks made up roughly thirteen percent of deposits (Jeffries, 489). Foreign banks were also allowed to do business in Poland, but when their numbers exceeded ten percent of banks in the country, the government ceased issuing them licenses. They were still allowed to hold majority stakes in Polish banks, but could no longer set up completely independent subsidiaries.
In addition to allowing private banks to exist, they were given a relatively broad arena in which to operate. Not only could they make loans to companies, but they could take out equity in a firm as well. This was an option that banks in the United States were not able to exercise until the recent repealing of the Glass Steagal act. However, while the banks were given many liberties, the government, at the same time, wisely designated specific boundaries beyond which the banks could not act independently. For instance, while the banks were able to take out equity in a firm, approval from the central bank was needed in order to take over more than twenty five percent of a firm (Jeffries, 489). In addition, while banks were free to lend to whatever firm they wished, they required central bank approval if their loans to any one particular firm were to exceed fifteen percent of the bankís assets (Jeffries, 489).
In order to make sure that the fledgling new banks could survive the bumps in the road that were sure to come, the government also set up laws to protect them from some failing firms, should they suddenly default on their debt. One law stipulated that banks that had financed a minimum of thirty percent of a companyís bad debt could apply for a debt\equity swap (Jeffries 489). Also Government bonds became available to banks in order to minimize significant losses incurred due to bad debt.
When summed up, it appears that the Polish government took a moderate approach when designing its financial policy. For every law that propelled an economic component into the turbulent market, there was a parallel measure taken to shield it against its greatest perils, and, most importantly, leave room for error. While firms now had to look to private banks who demanded performance for funds, the move to restrict foreign banks insulated firms from the most merciless demands for high interest and immediate repayment. The freedom of banks to loan and take equity was necessary to quickly distribute funds to the hungry firms.
But the adjoining need for approval for particularly high percentages of debt or equity would held prevent two things. First, it became less likely that massive failures of banks and firms would happen together in a sudden fashion. Second, it protected against hard losses from the lingering habit of firms to take massive subsidies at once and then continue to operate at a loss for long periods of time. Finally, while banks were expected to use their funds wisely, it was understood that many enterprises would not survive and that bad debt would plague the transition years. Government support of banks through debt/equity swaps and through government bonds, while it would not be enough to save banks that had truly invested miserably, would aid talented bankers that suffered moderate misfortunes. This would keep the banking system afloat throughout the transition.
The most significant effect that Polandís financial policy had on the economyís transition is that it allowed it to be as gradual as possible within the market framework. The market framework consists mainly of the changes that came immediately and abruptly, like floating prices determined by individual firms, and survival based on profit. The very nature of that framework demands that its institution in a formerly communist country must be abrupt (Blanchard et al, 110).
While the Polish government may not have been able to slow that particular aspect of transition, they did create conditions that were able to slow the pace of privatization (Blanchard et al, 119). It was their financial policy that created this gradualist effect. First, the freedom of the banks to lend and take equity, combined with the safety nets for bad debt, helped to make firms more confident that they would be able to obtain the funds necessary to restructure and continue to operate. This, in turn, avoided hasty liquidations of potentially valuable firms by the state or their new private owners. It became easier to find private buyers who would leave the firms in tact because they knew they could find the financing to restructure the firms into profitable enterprises.
In some cases, firms even had time to restructure while still under state ownership, making them more attractive to potential buyers as the risk of early losses was reduced. Jeffries, while quoting from a study done by the World Bank, points out that while privatization was clearly the ultimate goal, ĎPolandís experience also shows that rapid changes in ownership may be unnecessary, and that restructuring before privatization may be desirableí (Jeffries, 490). It was fairly clear that some firms that had operated in the command economy were simply too inefficient and would have to shut down entirely. The Ďenterprise pactí, which set a late deadline of March 31, 1994 for privatization ensured that these would eventually be weeded out. But with gradual privatization, the weeding out process was allowed to be much more selective. As a result, the surviving firms were often able to adjust well (Jeffries, 490).
As Polandís new economy continued to develop, more and more evidence mounted that the governmentís financial policy was aiding in the transition. Firms were adapting relatively quickly to their new environment and were creating a firmer foundation for the economy. In 1992, Poland became the first Eastern European nation to show an renewed increase in GDP after the initial drop (Jeffries, 501). The economy as a whole was beginning to recover earlier than in many other countries where the pace of reform had simply been too rapid. Polandís financial policy, and its overall transition, can be seen as a strong case for policies of moderation and gradualism.
Blanchard, Boycko, Dabrowski, Dornbusch, Layard, and Shleifer. Post Communist Reform. Cambridge, Massachusetts: The MIT Press, 1993.
Jeffries, Ian. A Guide to Economies in Transition. New York: Routledge Publishing Company, 1996.
Longworth, Phillip. The Making of Eastern Europe: From Prehistory to Post Communism. New York: St. Martinís Press, 1997.
Montias, Michael. Central Planning in Poland. London: Yale University Press, 1962.