POLAND: ECONOMIC STAGNATION AHEAD (DELETED) - JULY 1986

Created: 7/1/1986

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Poland:

Economic Stagnation AheadI

Scopeanalysis in this paper is based on an econometric model described in

DI Technical Intelligence Report6etailed Model of Polish GNP. POLGNP determines the resource costs and, thus, the feasibility of Polish economicespecially tbe ability of the economy to reduce its dependence on imports The model is designed to project the effects of technological adjustments and structural shifts in the economy on requirements for the factors oflabor, energy, and imports. The model can then measure the trade-offs between domestic production, soft currencyand hard currency imports. Tables in the appendix to this paper summarize POLGNP's projections for productivity and importunder alternative scenarios for consumption, investment, and exports in the

Judgments

infyrmai/qnltj in ihit rtpotl

recovery from its economic crisis of theas stalled, and prospects for sustained improvement over last year's disappointing performance appear slim for the rest of the decade.esult, Warsaw, Western creditors, and the USSR will find no escape from the dilemma posed by Poland's economic weaknesses:

to meet consumer demands with increased supplies will leave ihe Jaruzelski regime saddledullen and unproductive labor force. Although the regime's use of force and intimidation mayuperficial calm, continued economic problems will erode the more enduring political stability that the regime is seeking.

Even under optimistic assumptions about Poland's hard currency trade performance. Warsaw will make little progress in meeting its financial obligations. Western creditors face more years of debt reschedulings, missed payments, and pleas for new credits from the Poles.

- The USSR will have to continue providing substantial assistance if it wants io stave off economic decline in Poland. fl

To sustain economic recovery, in our view, Warsaw must do three things:

Increase consumption to provide incentives for improved workerand to ease social tensions.

Increase investment lo expand productive capacity and to lessenon hard currency imports.

Improve hard currency export performance to restore some semblance ofj

The dilemma facing Poland, however, is that an attempt to meet any one of the requirements conflicts fundamentally with the other objectives.Moscow's demand for elimination of Poland's trade deficit with the USSR may limit the resources available to increase consumption, invest* ment. and hard currency exports!

Poland has given Western creditor governments its blueprint for dealing with these problems in its "'Program for Improving the Slate of Poland'she program projects annual increases in GNP ofercent during the. It emphasizes growth in investment and exports but allowsodest increase in per capita consumption as well. The key provisions of thisgrowth rates scaledbeen incorporated intoconomic pbn.ffl

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Our analysis using the POtGNP econometric model indicates lhat Poland cannot meet the Recovery Program targets for both economic growth and foreign trade balances. In our view, Polish planners have underestimated popular pressures for large increases in consumption, the amount of investment needed to modernize the capital stock, and the economy's need for energy and high-quality materials. Poland must overcome all these constraints to achieve the program's targets, but our mode! indicatesoulduch higher level of imports than the program projects. Whereas the Recovery Program calls for hard currency imports to growercent and for soft currency imports to increaseercent annually, we project these requirementsercent, respectively. Unless imports growore rapid rate than Warsaw projects. Poland will be unable to achieve simultaneously its basicof moderately rapid economic growth, restoration of at least minimum creditworthiness with the West, and balanced trade with the USSR. Under the Recovery Program's growth targets, our model projects that:

The hard currency trade surplus would increase fromillion5 to8 billionhort of the Poles'goal7 billion surplus.

Poland's soft currency deficit would rise fromillion rubles5illion rubleshis would run counter to the goal of balanced soft currency trade8urplus0 that was set in the Polish-Soviet trade protocolj|

Thus, we do not sec the Recovery Programorkable approach to Poland's major economic problems. The Poles will not be able to meet their growth targets unless Western creditors and the Soviets temper their demands for net resource flows from Poland. The unwillingness of the West and the USSR toarge net flow of imports for Warsaw will hold Polish economic growth well below the program's goal. Yet foreign creditors alsoimit on the amount of resources that can be squeezed out of the Polish economy.J |

Our model's analysis indicates that economic growth will probablyercent annually between nowhis wouldeterioration in the Polish standard of living, but it would not provide the gains in consumption desired by the Polish people. At this rate of economic growth, the hard currency surplus could increase5 billion bysufficient to halt the growth of the debt by covering interest payments but not enough for debt repayments. This seems the maximum amount of debt service payments Western creditors can expect. Efforts to extract more would slow GNP growthercent but would add little to the trade surplus because savings on imports would diminish. If creditors are willing to accept less, Polish growth could riseercent. The hardsurplus would contract rapidly, however, because import needs would rise much faster than GNP.fl

In contrast io ffc Wcsi, the USSR cannotlessnet flow of resources to Poland without risking serious damage to the Polish economy. Furthermore, slow growth could even widen Warsaw's deficit with the USSR by limiting Poland's capacity to expand soft currency exports while soft currency import needs would continue to rise. Cutting back deliveries to Poland would not benefit the USSR because il would depress Polish export capacity and could well risk economic,collapse. Even if Moscow can force the Poles to redirect some exports from'thc West to the USSR, the Soviets probably will continue putting more into Poland than they will get back.fl

Contents

Scope

Key

Economic

Consumption and Livlnt

The Hard Currency Trade

Tbe Soft Currency Trade

The Polish Recovery

Obsolete Cawul

Labor S

Energy

Import

Recovery Prog um

Qui

Appendix

Economic Stagnation Ahead I

Poland has experienced wide swings in economic performsnee over the pastears (figure It- GNP growth, which hadercent per year in use, dippedercent annually. Dislocations item mini from tbe rise of Solidarity and Warsaw's financial crisis combined to force average annual declinesercent. Exceptional weather for if riculturc and improved labor discipline helped the economy regain some lost ground as GNP increasedercentercentercentonetheless, in per capita terms, GNPas back only to the levelecade age- JH

Performance of the Polish economy in the second half ofill be closely watched by the USSR and the West. Both sides will monitor the risks of renewed political instability that could resulturther decline in living standards. In addition. Moscow wants to reduce the burden of its economic support to Poland and perhaps even prett Warsaw to begin repaying past aid white assuming more of tbe costs of participating in the Warsaw Pact and the Council for Mutual Economic Assistanceesternbanks and governments will be looking forin Poland's ability to service its bard currency debi

Figure 1

Poland: Growth of

Implicit in Recovery Program

Near nagnaiwn

Return to cmii

io

it

-8 1

Per co i

15

the next five-year plan. It examines the constraints that could thwart economic recovery, our forecasted outcome, andimplica lions for the Soviet Bloc and tbe WestB

aod political shocks suffered by Poland in receot years complicate an asaessment of its prospects for economicarsaw is caught between economic imperatives best accommodated by rapid economic growth and constraints that threaten long-term stagnation. This paper reviews Poland'sproblems and evaluates Warsaw'seans of resolving those problems during

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Economic Imperatircs

Warsaw must come to grips with three economic imperatives over tbe next five years if it is to achieve economic recovery and political stability; increasing consumption, expanding investment, and enlarging its surplus in hard currency trade. The regime cannot postpone dealing with any of these needs in favor of

Poland: Change in Per Capita Using Standards and Meat

the others. The dilemma, however, is that trying to eet any of the requiremcntsconflicts fundamentally with the other objectives.H

ration-

Consumption and Living Standards We believe that improvements in personalare essential to casing social tensions andlabor productivity. Living standards declined during theith the economic crisis and austerity measures imposed under martial law., the regime backed off from its austerity program, giving priority to consumer goods supplies. But the increase in consumer goods did not keep up with increases in real wages, thusuildup of unused purchasing power. This pent-up demand, if not met with increased supplies of consumer goods, will result in rapid inflation or moreng and queues, further eroding worker morale.I

achieve maximum payoff from raisingWarsaw needs to emphasize food availability ahead of other goods and services. Per capita food consumption declined ISpercentnd recoveredercenteat consumption per capita did even worse, droppingercentnd recoveringercent5er capita consumption of other goods and services (excluding housing) fared belter, declining byercentut rebounding byercent

The sharp decline in food supplies helps to explain why the Polish people have not perceived anin living standards despite the statisticalin consumption. In market economics with eroding living standards, the public has more scope to distribute cuts in consumption as they see fit;tend to defer purchases of durables first, luxuries next, and then nondurables. Food is cut last and,esult, accountsrowing sharemaller basket of consumer goods. In Poland's case, however, because of the dependence of food production on increasingly scarce imports, outlays on food declined from more thanercent of consumer budgetso less thanercent4

ta-

:

in vestment

Poland needs to increasesectors that exploit its comparativeto expand productive capacity and to lessen dependence on hard currency imports. Poland's capital stock continued to grow during the economic decline, but this resulted from slashing retirement rates in half to offset sharp reductions in newrowing share of plant and equipment thus is obsolete and must be replaced. This problem was aggravated by the decision of Polish planners to focus investment cutbacks oo sectors vital to capital modernization in order to protect shortrun consumption.he percentage reduction in investment in tbe "productive sphere" was almost twice the reduction inn addition, much of Poland's

' "Productive ipfcere" refer) to ihe producer food*sector*roduce mostly machinery, equipment, and structure! for investment. The "cootumption where" include* these secior^^produce motity for consumption, both private and toc.it

Uilil'l1

stock has beenmuch asercent in someof poorly conceived investment commitments from. Much of this unused capacity consists of Western machinery that needs parts and materials that Poland can no longer afford to import.H

The Hard Currency Trade Balance

Poland mustrowing surplus in hardtrade to restore some semblancearsaw has run trade surpluses large enough to cover the most immediate demands of creditors but insufficient to meet all tnteresrlet alone repayment of principal. While Poland will continue to need reschedulings of principal for the foreseeable future, the regime must cover interest payments and balance its current account for several years before creditors will resume lending on the scale needed to increasemport capacity

i

The gains in hard currency trade1 have resulted mainly from cuts in imports. The reductions fell largely on investment goods to minimize the immediate Impact on production and consumption. But Warsaw must rescind these cuts to sustain growth in output, investment, and consumption over ihe longer term. To afford more imports and increase Its debt servicing capacity. Poland would need to gen* ate substantial growth in hard currency exports]

The Soft Currency Trade Deficitbo under pressure to reduce its soft currency trade deficit with socialbt trading partners This defeat peakedillion rubles1 when Poland's economic crisii prevented Warsaw from cieeting its export cornrtuirncnts and forced the USSR and other East European countries to provide emergency assistance. The USSR shouldered most of this burden by accountingillion rubies of Warsaw's deficit. The revival o( the Polish economy2eduction of the soft currency deficit toillion rubleshe gain has largely benefited the non-Soviet CEMA countrieswhich the Polesurpluiillion rubles last year. Moscow, on the other hand, has

continued to provide economic assistance by allowing Warsaw to run trade deficitsillion rubles annually

Moscow wants its economic relationship with Poland to be brought into balance. While Moscow will allow Warsaw to run trade deficitshe recently concluded Soviet-Polbh trade-protocolalls for Poland to run surplusesarge enough to balance trade for the five-year periodhole. Repaymentillion ruWesowed to the Soviets will be deferred untilH

We do not treat reduction of soft currency deficits as an imperative for economic recovery in our analysis because failure to achieve this goal docs not weaken Poland's growth prospects. On the contrary, theto which Warsaw responds to Moscow's demands may limit the resources available for increasing con-sumption, investment, and hard currency exports.

The PolbhProgram

Inoland gave Western creditora blueprint for dealing with its economic problems io its "Program for Improving the State of Poland'she key provisions of this so-called Recovery Program are reflected in the new five-year plan, but4 Recovery Program that provides the details on which our analysis is based. This Recovery Prograr

|is probably an initial version of the Economic Recovery. While we have little detail on the new programl

labeled itike4 predecessor,6 draft program also calls for full recovery in Poland within five years. This new recovery program.

the five-year plan, and subsequent adjustments to the

plan arc likely to be scaled back versions of4

Recovery Program. |

^ Recovery Program calls for someshifts in prioritiesrom the policies. National income is to grow at an average annual rateerccnt average attained inevival. This target is still optimisticive-year postrecovcry period given5 growth wasercent and6 plan now calls forercent growth. Consumption gains would slow to allow an increase in investment and exports needed to improve Poland's external balance. The trade surplus with the West is projected to rise fromillion5illionl the same time, the ruble trade deficit (essentially tbe trade balance with the USSR) is to fallillion rubles5 to zero.

POLGNP projects larger investment requirements because of its more pessimistic assumption about future capital productivityapitalin Poland declined on averageercent annually even in the growth years; during the crisis period, it fellercent per year. Capital productivityercent. The Recovery Program is banking onthe reversal of this decadclong trend. While the program does notapital productivity target, its investment projection and target forgrowth yield an implicit rise in5 percentage point per year. Our model, by contrast,ecline in capital productivityercent per year under the Recovery Program's target. Even this is better than the average annual declineercent.

analysis indicates that, even under veryassumptions, Poland cannot meet the Recovery Program targets for both economic growth andtrade balances. Any one of four constraints could restrict the rate of economicobsolete capital stock, the poorly motivated labor force, the economy's demand for energy, and the need for high-quality imported materials. Poland must overcome all these constraints to achieve the program's targets, but this woulduch higher level of imports than tbe program projects or than Poland can afford]

Obsolete Capital Stock

The Recovery Program calls for net investment toercent annually insubstantial acceleration from the postcrisis rateercent. Our analysts, based on the POLGNP model, indicates that even this pickup in investment isto meet the economy's needs for rnodern plant and equipment, increased capacity in capital-short sectors, reduction of import dependence, andof bottlenecks in such capital-intensive sectors as electric power, non ferrous metals, and transportation. We estimate lhat the capital stock would have to growercent annually to meet the Recoveryprojectedercent growth in GNP and its emphasis on heavy industry. This would require growth in net investment ofercentover the five-year period. j

Wc are pessimistic about the trend inizable amount of investmentto flow to wasteful projects. Although thereforms2 tried to diminish the role of central planners in allocating resources and to imposecriteria on enterprise investment decisions, little has changed in Poland's management ofThe Poles plan to complete the backlog of unfinished projects even though many are large, capital intensive, and of questionable value. Because ministries and enterprisesested interest in the projects cantrong claim on resources, the projects are likely to be completed regardless of their high COStS end doubtful benents^^

Past trends indicate that Warsaw will have toimports to achieve the needed expansion of capital stock. Nearly half of all investment during the boom of theonsisted directly or indirectly of imports. Tbe dependence on imports was about evenly split between socialist and nonsocialist countries. In the financial crisis period, both investment and hard currency imports. investment recovered impressively without massive injections of imports. But thedoes notermanent reduction in the

Thisercent in Mtriiii national incoctq-ivakmercent in Waters GNP accounting

tK

currency inputs for the domesiic capita! goodsindirectly addercent to the ruble import bill for machinery and equipment

The additional investment needs projected by POLGNP and high import content of capitalboth complete machinery and imported components for domestically producedanimport bill substantially higher than that in the Recovery Program. The program assumesercent average annual increase in total hard currency imports of machinery. Our calculationsthat the Recovery Program would require hard currency machinery imports toercent per year on average.0 tbe annual bill would5 billion5 dollars compared3 billionolish hard currency machinery imports jumpedercentndicating Poland's need to import Western macriincry.H

On the soft currency side, the Recovery Program calls for machinery imports to rise an averageercent per year. Our calculationsrowth rateercent with the annual bill risingillion rubles0 comparedillion rublesoft currency imports of machinery9 percentZi

Labor Productivity

Tbe one major resource in ample supply in the Polish economy is labor, Tbe number of workers required to fulfill the Recovery Program falls within the limits set by past labor participation rates applied toprojectionshe key issue affecting labor is whether the regime can deliver improvements in living standards sufficient to provide adequate, incentives for improved productivity

Despite the importance of rising living standards, the Recovery Program suggests that authorities hope to get away with minimum growth in consumption. Totalandwould growercent perate below

Figure -1

Poland: Labor Supply and

Million -orlcn 19

oland: Growth in Labor

90

7S

90

ercent annual average. Thedoes not specify growth by consumptionbut agriculture is slated to grow byercent per year. Since food exports to marketare protected to increaseercent per year, this leaves little room for increases in domesticwe estimate planned growth in foodto be onlyercent annually. The program doesarget for per capita meat consumption0 it is to5 kilograms persame level as2 but onlyercent of0 high. Per capita meatwas conspicuously omitted from5 plan fulfillment report, and the Recovery Program gives only0 target with no basis from which torowth rale |

The Recovery Program's consumption targets are consistent with past regime plans that typically called for slow growth of consumpt ion in order to increase resources for investment and exports. This pattern reflects planners' preferences as well as an effort to

convince foreign creditors that Warsaw is prepared to accept some austerity in order to improve its balance of payments. The plans, however, have subsequently been adjusted or abandoned under pressure from workers and consumers demanding larger increases in cortsumption The regime remains wary of discontent over stagnant Irving standards and would probably try to boost cortsumption more than planned in theProgram if this seemed necessary to maintain political

In addition to underestimating pressures for greater consumption, the Recovery Program is probablygrowth in supplies, particularly of food. Although modest,ercent growth rate for agriculture comesery high baseesult of exceptionally good weatherouple of years of average weather could reduce growth in agriculture to near tero. Moreover, the regimeto limit the investment and incentives needed to

improve performance in the largely privatesector. For political and ideological reasons,remains reluctant to ensure adequate resources and income for private fafmcfS.M

The questionable projections for growth inand food output cast doubt on the Recovery Program's targets for improving Poland* food trade balance. Rapid growth of consumption and poor agricultural performance produced sharp increases in food imports in the.1 imports of food products accounted forercent of imports from nonsocialist countries while nonfood item* to support domestic food production accounted for an additionalercent of nonsocialist imporU. Above-average crops and martial-law era austerity enabled Warsaw to make deep cuts in agricultural imports and lo turn its food trade balanceIillion deficit1illion surplusgricultural purchases bore the brunt of thein hard currency imports forced by Warsaw's financial crisis, falling to IS percent of nonsocialiit imports

More recently, however, demands for morehave led the regime to make unplanned imports of meat and to divert some domestic production earmarked for export lo the domesticeturn to the situation of tbeeemsthe limits of Poland's financialthe dependence of food consumption on imports, the regime's inability to resist pressures for increased consumption, and ihe reluctance to devote adequate investment to food production and

instead of expanding food consumption, Warsaw could meet the population's expectation of better living standards and hold down imports by improving the supply of housing. Housing, which grewercent per year. is in critically short supply in Poland so the increase in consumerand labor incentives should beirect and indirect bard currency import content ofercent of the gross value of output. Once built, residential repair, maintenance, and administrationard currency import cost ofercent of the value of these activities.

Unfortunately, housing construction must compete for resources with so-called productive investment. In Marxist economic accounting, housing is considered unproductive, so Polish planners are unlikely tothis option.esult, consumer satisfaction and labor motivation will continue to depend on the availability of consumer goods, particularly food.

Energy Requirements

The Recovery Program provides meager information on energy balances. Hard coal production0 is "provisionally estimated"illionmillion barrels per day oil equivalentaboveillion tons producedignite production is expected to increase substantially3 million tons5 toillion3 million bdoc)radein the program call for energy exports to centrjl-ly planned economics to increaseercent per yearith importsercent per year. Projections of energy trade with market ceo mies were omitted from the Recovery Program

Polish energy plans flesh out the productionin the Recovery Program. Natural gas and hydroelectric power are each to provideillion bdoc. and nuclear power is to supplyillion bdoe. In addition, gross energy imports are expected toillion bdoc. This yields an overall supply of energy0illionjust overercent of the domestic energyprojected by POLGNP to ineei the Recovery Program's target- The pUa balances, however, do not lake account of projected energy exports. Even fiat energy exportsould addillion bdoe to overall Polish energy requirements, leadingercent shortfall in energy supplieshe small growth io exports called for in the RecoveryProgram would widen this gap toercent

The Poles are counting on improvements in energy efficiency and conservation to make up the shortfall, but history belies their confidence. The trend in energy productivity of the Polish economy over the

lastears has been erratic, energy productivity improved markedly: energygrew by3 percent comparedpercent increase in GNP., energy consumption increased almost twice as fast as8 percent2 percent. In the crisis years, energy consumption droppedpercent decline in GNP., GNPercent while energyincreased'C| ^

This pattern cannot bc explained by any single cause, but it is related to trends in capital productivity and overall economic efficiency. Transitory developments such as harsh winters and bad weather for agriculture can have an adverse efleet on energy efficiency in any given year. The key factorore extended trend, however, is the relative emphasis given by planners to expansion of energy-intensive sectors such heavy industry, electric power, and transportation.

figure 6

Poland: Growth in Energy

projects energy requirements to grow faster than GNP under the Recovery Program. Theemphasis on heavy industry and the implicit need to expand electric power generation andto meet growth targets seem likely to reverse the trend of improved energy productivity. Our calculations show thatercent annual GNP growth implicit in the program would require energy consumption to increaseercent per year,

Under the Recovery Program's provisions, the Poles plan to increase the use ofonly significant domestic source of energy. But factors affecting both supply and demand are likely to limit tbe annual increase in coal consumption to atercent, forcing other energy sources to increase their share in total energy use. On the supply side, Poland must make large investments in mines, ptocessiog facilities, and transport capacity to boost coal output byercent; still greater expansion probably would exceed the resources available to Warsaw. On the demand side, the Recovery Program's growth targets would require particularly rapid expansion of oil-consuming

g this rate ofifficult

sectors such as truck transport and small-scalegenerating capacity. Poland has increaseduse of coalercent or more in only four yearsnd maintaining this rateof increaseive-year period would bc i

Our model projects primary electricityhydro and nuclear generation less net electricitybc essentially constantevelercent aboveverage. This allows for both some expansion in capacity and restriction of exports to meet domestic needs. We project thermal electricity generation, which is based mostly on coal, to growercento support the Recovery Program'sascouldercent per

'Thermal electric feneration is not Included in energy balances since tbe cnctiy_ft already included in the fuel burned lo produce electricity fljTJj

SeCTTt^

year- The limil on gas consumption is not aiaailabtlity of Soviet deliveries but tbe ability of the Polish eccaomy to switch from oil to gas. Our modelincludes these limits for each sector of thebased on past abilities to switch.f

Oil requirements pose the major need for additional energy imports and could prove to be tbe key energy constraint on the Recovery Program. Even with the projected increases in gas and electricity usage, oil consumption would have toercent per yearillion barrels per daypercent of its previous peakoland's ability to acquire the needed oil depends on availability of soft currency oil from Ihe Soviets and world oil prices. Assuming there will be no additional soft currency deliveries aboveillion barrels per daysupplied by the USSR, tbe extraillion barrels per day required0 would6 billioner barrel. By comparison, Warsaw purchased0 barrels per day on the worid market at an estimated cost0 million

Ei ports

The Recovery Program calls for substantial growth in exports to both hard currency and soft currency markets. The bard currency trade surplus is to rise5 billion7 billion0 on the strengthercent average annual growth in bard currency exports. The program anticipates that bard currency exports of foodstuffs and electrical machinery will grow most rapidly, while fuels and energy will reduce their shares in total hard currency exports. Projected average annual growthercent in soft currency exports is planned to reduce the trade deficit with socialist countriesulliojirubla6 to near zero80 J|

The Poles assert in4 Recovery Program that tbe export-led improvements in both socialist and nonsocialist trade balances can be covered by the widening gap between national income produced and national income distributed. Tbe former is projected

to growercent per year, and the latterercent. Nevertheless, fulfillment of Ihe Recovery Program's export targets rests on several heroic assumptions:

of electrical machinery arc to increase the most in both socialist and nonsocialist trade. This assumes that the electrical machinery sector can accommodate both rapidly growing exports and rising investment in the domestic economy. The increased machinery exports tooo optimistically.less developed countries wil! want io increase their investment, will have the hard currency to pay for machinery imports, and will find the quality of Polish machinery competitive with the exports of newly industrialized countries such as Korea,and Brazil.

second fastest growing export for hard currency is to be food. Growth of this export, however, depends on continued good performance in agriculture and assumes, incorrectly we believe, that ihe population will not clamor for more food consumption.

< Exports of fuels and power, largely coal, are slated to grow the least. This isise decision given the prospects for growing supplies of fuels on international rriarkets at lower prices over the next

An important issue not treated in the Recovery Program is the import content of exports. The Poles release only limited anecdotal information on this reUliomship. but our input-output analysis indicates that the product categories designated for high-export

growthairly high level of imports. It is

difficult to determine ibe import content of products because much of that content is often indirect. For

example, imported chemicals used in metal processing for machinery contribute indirectly to the import

content of exported machinery. Moreover, tbe import

TV actual lurplutaiillion fffj

content of production measures only current inputs. The imported share of the capital stock used in export production by each sector is not

The greatest difficulty in forecasting the importquircmcnts of export industries is allowing for the impact of capacity utilization both in the sector in question and in the other sectors lhat send inputs to it. The import content of domestic products lends to be higher during periods of rapid growth as imports rise to case shortages and break bottlenecks caused by sectors straining to meet high-production targets. If. for example, onlylantsigh level of imported inputs because of theirthe sector's imports may be low until its capacity utilization exceedsercent. Much of the apparent reduction in import dependence in Polish industry since the onset of the financial crisisesult of the decline in capacity utilization. The Poles have reported that some of their highly import-dependent sectors have utilization rates as low asercent. As output levels recover, imports, especially those to support exports that must be of higher quality than goods sold domestically, will rise even faster.

Import Requirements

nterest imat ion of its needs for investment, food consumption, and energy plus Ihe large import requirements of its main export industries mean that Poland would require much higher growth in both hard currency and soft currency imports than the Recovery Program foresees. Tbe Recovery Program calls for hard currency imports toercent annuallynd soft currency imports to increaseercent annually. POLGNP projects that bard currency imports would have to growercent per year with emphasis on oil. metals, processed foods, and agricultural products. Growth in soft currency imports wouldercent per year with emphasis oo gas, metals, machinery, and light industrialhe largest differencestbe Recovery Program's projections and our projections of import requirements center on metals and light industry products for soft currency imports. The program is silent on the product composition of

* Seen (ppcndii (or more deu

haed currency imports. Imports would have to grow faster tban GNP because they are needed to break bottlenecks as capacity utilization rises, particularly as the more import-dependent plants arc used more intensively. Polish planners apparently have omjt these factors in forecasting their import needs.

The divergence between import requirementsd by POLGNP and by the Recovery Program results' from different projections of change in "importthat is, the change in the ratio of GNP lo imports. The Recovery Program's Optimisticabout import productivity are the keystone upon which the goals of moderate growth and improving trade performance rest. If those assumptions are off byew percentage points, the program is infeasible. The economy either would need more imports to meet the program's targets for GNP growth or economic growth would have to fall to be consistent with hard currency and soft currency trade balances. j

The Recovery Program's implicit projections ofproductivity seem much more implausible for soft currency imports than hard currency imports. Our analysisecline ofercent per year in ihe produciiviiy of soft currency imports; the Recovery Program implies annual increases rising5 percent65 percent0he Poles themselves do not calculate these percentages; they are implicit in the RecoveryThe Poles evidentlylow growth in soft Currency import needs to minimize the apparent burden of the Recovery Program on Poland's soft currency tradingthe USSR. Such productivity performance is virtually without precedent at least as far backince that year, the produciiviiy of soft currency imports has increased only four limes;ercentercentercentndercentJ

Our analysis shows the produciiviiy of hard currency importsercent annually while the Polesecline of5 percentoth these estimates are within the range of historical experience. The productivity of hard currency imports

is extremely volatile, rangingigh1 percent1owercentiven this range, our projection and that of the Polish Recovery Program are quite close. The greaterio our analysis hinges on three factors:

Many of tbe opportunities to reduce hard currency import dependence have probably been used up. Further reductions will be increasingly difficult, and projections cannot simply extrapolate recenteven at tbe sector level

Much of the recent good overall performance can be attributed to good weather for agriculture and shifts in the composition of GNP away from uses most dependent on hard currency imports, investment in particular. Our projections are based on onlyweather for agriculture and an increase in the share of GNP going to end uses important for the growth projected in the Recoveryinvestment to replace the obsolete capital stock.

Recovery Program Infeasible

By projecting import requirements in excess of those foreseen by the Recovery Program, POLGNPthat Warsaw cannot meet all its basicmoderate rale of economic growth. restoration of atinimum level of creditworthiness with the West, and balanced trade with the USSR. The Poles, in effect, have drafted two separatefor domestic growth and the other for externalhave failed to link these together. Although our baseline projection shows the program to be infeasible. we are actually

incorporating very opiimiilic assumptions in anto make the domestic and external plansWe assume thai:

the required gross additions to the capital stock can be replaced by improvements in capital produc-

* tivtty beyond those expected, according to past performance

There is no labor unrest, although per capitaof food, especially meat, remains well below historical levels.

At least average conditions for agriculture exist during the rest of the decade.

No difficulties develop in increasing exports, even sales of machinery to developing countries.

There is no further deterioration in the terms of trade.

Any one or moie of these assumptions could well prove incorrect, depressing trade performance still further from our baseline]

Our baseline projection shows that under Warsaw's growth targets the hard currency trade surplus would increase fromillion4 to8 bcllion0 in contrast to the Poles' estimate7he surplus projected by POLGNP would leave Poland's payment capacity well short of the level needed to cover all interest payments on its debt, let alone repayments of principal. Warsaw's inability toalanced current account would force Western creditors to continue rescheduling bothand most interest payments and wouldthe resumption of voluntary lending sought by

The infeasibility of the Recovery Program means that either the Poles must sacrifice their expectation of sustained, moderate growth or Western creditors and the Soviets must temper their demands for netflows from Poland. The range of trade-oris between growth and trade performance isimitless However. POLGNP demonstrates that the range of likely outcomes is limited when bounded by the presumed unwillingness of ihe West and tbe USSR either to push the Polish economy into decline or toarge flow of imports

m

Because haid currency import requirements do not change proportionally with changes in GNP growth, import levels in our simulation initially fall rapidly with relatively small decreases in growth from the Recovery Program'sritical point for the trade-ofT between payment capacity and economic growth occursateercent growth in GNPotential hard currency surplus that could reachillionlowing growthercent adds progressively less to payments because the savings in imports become progressively smaller. At the same lime, the risk of economic collapse with complete loss of payment capacity grows. GNP growthercent, in turn,rogressive acceleration in the growth of hard currency imports and eventually turns the trade surpluseficit.

to increase its import capacity.

The shortfall in Poland's soft currencyeffect its trade balance with tbeeven greater. While Moscow's objective is to stem, if not reverse, the net flow of resources from the USSR to Poland, POLGNP projections show that Poland's soft currency trade deficit would riseo TOO million rubles5illion rubleshis would run counter to the Recovery Program's target to balance tradehe foil that was set by the trade protocolM

' Ttw Poles iocrrauol their0 surplus IO SJ bilbanthat their capon prkca "ill riteercent annually aod iheir import prices by5 percent mmW

If we assume economic growth in the range

percent, the level of hard currency earnings still is short of all principal and interest payments due on

Poland's rescheduling agreements. These payments rise5 billion6 to overillion in

he earnings, however, could be roughly enough to cover interest payments. Warsaw could not reduce its debt, but. by balancing the current account, the Poles could finally halt the increase in their debt. This seems the maximum Western creditors can expect to get. From Warsaw's viewpoint, balancing the current accountew years might cvemually

restore some measure of creditworthiness atidjtn lime

the willingness of Western creditors to

crediu fl

IsssssssssV

Tbe tenor of recent negotiations between Poland and its Western creditors suggests thai the banks and governments want to obtain the largest sustainable net flow of payments possible rather than finance the imports needed for faster growth. While the creditors are resigned to extending more debt relief to Poland, the terms negotiated6 will require Warsaw to pay the0 billion, and the creditors expect to get even more payments in the future. The level of payments ts roughlyillion more than Warsaw can afford under the Recovery Program's growth targets and is roughly consistent with GNP growthci

Warsaw is counting on new credits from Western governments and eventual drawings on theMonetaryF1 and the World Bank to boost its import capacity toward the levels required by the Recovery Program Warsaw's expectation of someillion annually in new credits, however, seems extremelyew West Europeanhave pledged less0 million in new loans over tbe past year, and enthusiasm among other offkul lenders is scant. Current IMF lending limits arc lower iban Warsaw has projected, and tbewill probably insist that this money bc used for additional debt service payments rather than more imports. Warsaw's future access to World Bank loans is uncertain and, if approved, will probably result in less money than the Poles hope. The continuing credit constraint oo imports seems likely to hold Polish econonuegjowth in the rangeercent6

Because of the Polish economy's dependence onimports, the USSR has little prospect ofits economic support for Warsaw. In fact. Poland's deficit with the USSR could bc higher under slow growth than under the Recovery Program's targets With slow growth in the domestic economy. Poland's capacity to expand soft currency exports would be squeezed toward zero while its soft currency import requirements would continue to rise byercent annually. Under tbe Recovery Program's

growth targets, both exports and imports would riseercent annually. Cutting back deliveries to Poland would not benefit the USSR because it would depress Poland's export capacity and could riskcollapse The Soviets probably could press the Poles to redireel some exports from the West to tbe USSR, but this would limit Warsaw's ability to acquire needed Western goods. Even given some scoperade-off between the West and the USSR. Moscow will probably continue putting more into Poland than it will get back.flj

Implications

The POLGNP protections indicate little easing of the problems posed to the West, the USSR, and tbe Jaruzelski regime by Poland's economic and financial weaknesses. Warsaw's continuing failure torigorous adjustment policies and effectiveleaves the country's economic recoveryon the willingness of Western creditors and the USSR to provide more economic support. The West would have to extend more debt relief than it is willing io do and the Soviets would incur larger deficits than they ere prepared to tolerate, in short, neither side seems witling to pay the price required to lift the Polish economy above stagnationJ

Poor economic performance will limit gains in living standards needed to ease tensions between the regime and the population. Polish authorities probably will continue to increase nominal incomes; but failure to meet rising consumer demand with increased supplies will, in our view, leave the regime saddledullen and unproductive labor force. Althoughme of force and intimidation may maintain calm, the mere absence of open hostility alone is unlikely to improve labor productivity, and continued economic problems will erode the longer term political stability that the regime is trying to achieve]

US and other Western creditors will have to wrestle with Poland's debt problem for years to come. The most they can expectmall increase in Poland's

Reform aad Economic Efficiency

he regime adopted an economic reform program designed to encourage enterprise initiative and to expand the use of financialas interest rates and bankplace ofcontrols. Firms were given increased author-ity to set wages and prices, to make decisions on investments and product lines, and to retain hard currency earned from exports. As part of thethe government consolidated several ministries, reduced central staffs, and allowedarger role in setting their own plans. Banks received increased power to extertdcredits and to declare enterprises in

The regime's halfhearted implementation of reform, however, often did little more than cause newEnterprises that took advantage of someprovisions frequently raised prices, wages, and investment much more than planners had projected. Under ihe reform plan, competition and profitability criteria would have limited such Increases. Although ihe regime subsequently put some restrictions on price increases, it did not tighten wage and investment regulations. Reform measures also did not induce enterprises to use labor and other inputs more

efficiently. According lo the Polish press, manyfailed to reduce excessive manpower anduse because these costs continued to be added to product prices^

We have closely monitored Polish economicto identify the overall effects of the reform program on economic efficiency. For each major input into the productionstock, labor, energy, hard currency imports, and sofisignificant portion of the apparent gains in productivity isesult of actualin efficiency buthanges in the composition of Polish GNP. particularly the drop in the share of investment in GNP and of coat In exports. When these effects are accounted for, the picture of Polishefficiency looks much bleaker. We conclude that the Polish reform effort thus far has not resulted in significant lasting improvements in efficiency.given ihe lags between decisions to reform, implementation, and effects on efficiency, we doubt thattronger commitment to reform would substantially alter Polish economic performance over the next few years!

currency payment capacity that still will be inadequate to reduce financial gaps. Even this gain rests on optimistic assumptions about exportimpressments in economic efficiency, andwillingness to give priority to debt service over increases in imports. Even with the maximumpayment capacity, creditors will have to continue rescheduling Poland's obligations and will facecomplicated disputes over sharinglimited payments. The Poles will go slow on making the minimum payments required under their various rescheduling agreements and probably will try to play creditors off against each other by offcrir payments to those willing to extend new credits.I

from Poland and elimination of the Polish trade deficit with the USSR. In our judgment, however, the resource requirements for even minimal growth in exports almost certainly ensure that Poland willa drain on the Soviet economy even as Warsaw directs net payments to tbe WesitiJ

Apart from the cost to the USSR, the Polish turn to the East is likely to remain more rhetoric than reality because of the link between hard currency imports and Polish growth. Warsaw will continue to see the West as vital to its hopes for economic recovery. Poland's decision to make at least small payments to

undoubtedly hopes that its emphasis on modernization, discipline, and tighter management throughout CEMA will pay off in increased exports

Appendix

Details of ihe Polish economy, as described by the POLGNP input-output model, are summarized in the following tables

resents growih and productivity statistic* for Ley inputs Historical figures and projections for the healthy growth and sugneiiori scenarios are presented togethei foiardon.*ju|

The remaining two tables depict the likely trade-offs in Poland between domestic economic activity and import needs under two alternative scenarios: meeting the Recovery Program's healthy growth targets and falling back to the modes: growth rates of aeconomy Tbese tables showtagnating Polish economy is notcaled-back versionrowing economy; it is structurallyifferent pattern of import dependence flflaH

Table 1

Likely Adjustments in the Composition of GNP and Imports Under the Recovery Program Targets, Second Half ofcontinued)

Group

Value-Added

From Market Economics

Impotis From Socialist Fconoraiei

produm

availability of agricultural product* from all sources willper year.

The ilow 11 ii will bein crops, which, withweather, will iacicaKercent at Iht beginning of the period and ilow to onlyerro-thO. Agrl-caliural services irow tasicr. buiercent atercent al Ihe end. Animal products growth drops fromccnt early in Ihe periodercent

Tbe slack will have to be picked up by hard currency imports with overercent at rage annual growih.

Imports of agriculturalfromidingcould decline ai raiei6 percent per year ai twn model' domesiic ouiput grouts substitute! for theand mil of agriculturalavailable from the USSR andropean neighbors.

Original document.

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