Poland Begins Switching to a Market Economy

Date January, 1990

Poland’s attempt to pass rapidly from a socialist to a market economy through an “austerity” program succeeded only in part and brought great hardships to the public.

Locale Warsaw, Poland

Key Figures

• Tadeusz Mazowiecki (b. 1927), prime minister of Poland, 1989-1990
• Lech Wałęsa (b. 1943), Polish trade union activist and president of Poland, 1990-1995
• Jan Krzysztof Bielecki (b. 1951), prime minister of Poland, 1991
• Hanna Suchocka (b. 1946), prime minister of Poland, 1992-1993

Summary of Event

By launching a new economic program in January, 1990, the Polish government of Tadeusz Mazowiecki sought to transform Poland’s state-run economy into one driven primarily by market mechanisms. The bold program registered only partial success, and at very high cost. The so-called Polish big bang thus did not prove itself as an ideal program to carry out the transition from a socialist to a capitalist economy.

Mazowiecki’s program was enacted only shortly after the fall of the Communist regimes in Eastern Europe in late 1989. The fall of Communism meant a new favoring of capitalism and a rejection of state-planned economies, as they had failed to provide standards of living as high as in the West. Poland, in contrast with most of its formerly Communist neighbors, had been pursuing market-oriented policies throughout the 1980’s.

Economic reform had been introduced in Poland as a response to powerful political pressures from the massive non-Communist trade union Solidarity, led by Lech Wałęsa. Solidarity’s goal in the late 1970’s and the 1980’s had been not only to democratize Poland but also to improve the economy and standards of living while explicitly accusing Poland’s Communist regime of having failed to provide for workers’ welfare. Even though General Wojciech Jaruzelski imposed martial law in late 1981 as a means of maintaining control, the Communist leadership in practice admitted its failures in the economic field by accepting introduction of some market-oriented practices throughout the 1980’s, particularly price liberalization. These policies, however, had led to powerful inflationary forces. Mazowiecki and his partisans then argued that drastic measures should be implemented in order to achieve financial stability as a precondition to freeing the Polish economy from state control and inducing a market-driven growth mechanism.

One of the early questions the Mazowiecki government faced was whether Poland’s transition to a market economy should be gradual or rapid. The question was whether bringing about financial stability, with its recessionary possibilities, was a necessary precondition for healthy growth or an unnecessary obstacle in the way of growth. Contrary to widespread press reports, the Polish government’s choice was not an across-the-board “cold turkey” approach but rather a gradual structural transformation along with rapid creation of a realistic market-based price mechanism.

The government decided that the 1980’s process of price liberalization should be extended to key state-controlled (and still protected) sectors such as energy and coal. Elimination of almost all price controls meant that prices would begin to represent actual demand, promote competition, and drive out of the market unsound firms that had survived only thanks to state subsidies. That would then cause a major restructuring of Polish industry along market lines. Although in the short run price liberalization would bring more inflation, ultimately, according to Mazowiecki, sound enterprises would begin to eliminate shortages and fill demand so that inflation rates would dwindle. The program’s original forecast was that monthly inflation rates would drop to about 1 percent by mid-1990.

Mazowiecki sought to counterbalance the powerful inflationary effects with a series of budgetary and monetary measures. The budget deficit would be cut through the slashing of state subsidies, which stood at about one-third of all government expenses. The government also issued treasury bonds that could later be exchanged for equity in privatized enterprises. In order to induce the Polish public to save, the state sought to maintain high and “positive” interest rates—that is, rates that outstripped the rate of inflation. This maneuver would strengthen the Polish currency, the zloty, and seek to discourage the public from buying and holding foreign currencies such as the U.S. dollar. In other words, the policy was designed to achieve internal convertibility of the zloty itself.

Mazowiecki’s government sought to make the zloty internally convertible as well through a large devaluation, meaning that more zlotys would be needed to buy a unit of another currency. The zloty was devalued by more than 50 percent of its black-market value. The idea was to eliminate black-market transactions and have a realistically valued currency. Devaluation would also help increase exports and cut imports, which were already discouraged through high customs duties and other taxes. The latter measures were necessary to help pay interest on Poland’s foreign debt, accumulated before the Communist regime had fallen. Ultimately the plan called for the zloty to become externally convertible at rates that would allow Polish enterprises to be competitive in international, and especially Western European, markets.

Devaluation, however, created yet greater inflationary pressures, as imported goods became more expensive. Coupled with price liberalization, devaluation threatened to cause hyperinflation. As a consequence, the Polish government resorted to a very tough income policy. Polish workers were persuaded that in order to achieve financial stabilization and an internationally competitive economy, they had to bear the brunt of the economic transformation. There was a political acceptance of sacrifices as well, because Solidarity and its leader, Lech Wałęsa, supported market reforms. Wage containment appeared to be the financially soundest manner by which to reduce internal demand. Real wages (wages adjusted for the price level) were therefore allowed to drop sharply. At the same time, the government tried to promote exports and reduce the money supply.

On the international front, the government sought the cancellation of a large part of Poland’s debt and negotiated for new loans through the International Monetary Fund (IMF). The IMF, which itself suggested tough austerity policies, approved Mazowiecki’s program in February, 1990. Several Western countries also canceled part of the credits they could claim from Poland. Finally, the Polish government attempted to create an institutional framework in which market mechanisms could operate freely. In addition to starting a privatization program, the government encouraged the formation of financial markets.

Significance

Mazowiecki’s program definitely had a major impact on the Polish economy and did help transform it into a market-driven system. Many of Mazowiecki’s program targets were not met, however, and the results that were achieved cost far more than had been expected.

It appears that most of Mazowiecki’s figures were too optimistic. Inflation did not settle at 1 percent monthly by mid-1990, industrial production fell by 25 percent rather than 5 percent, the unemployment rate stood at about 6 percent rather than 2 percent, the gross national product fell by 18 percent rather than 3 percent, and real wages dropped by 30 percent, not 20 percent. In addition, there was less foreign investment than expected. The restructuring and privatization process proceeded quite slowly.

Some of the government’s measures assumed different public attitudes than the ones that actually prevailed. For example, tight credit induced only financially strapped enterprises, not households, to convert foreign currency holdings into zlotys. Faith in the Polish currency was difficult to build. Moreover, interest rate hikes were interpreted as a sign that more inflation was expected; therefore, rather than contributing to financial stabilization, high interest rates became part of a widespread inflationary mentality. The government’s control of the zloty was limited because when the reforms were launched as much as 60 percent of Poland’s money supply was denominated in dollars rather than in zlotys.

Forecasts concerning enterprise behavior proved to be incorrect. Confronted by tight credit and a deep recession, Polish businesses did not respond as expected in a market economy—that is, by trying to increase efficiency and become more competitive. On the contrary, they simply tried to make up for losses by increasing prices. The resulting high inflation rates, coupled with constantly falling real wages, made it possible for unsound businesses to continue to exist, causing a result opposite to Mazowiecki’s intention: Basic economic restructuring slowed down. The only positive aspect in this regard was that many of these uncompetitive enterprises were still owned by the state, so their profits cut their dependence on the budget.

The most serious problem caused by Mazowiecki’s economic program was that it alienated the Polish people. In the fall of 1989 and the early months of 1990, Poles were willing to accept falling wages and mounting prices, believing these were a fair price to pay in exchange for future prosperity. By late 1990, however, it was clear that the recession would be far longer and deeper than had been assumed, and political opposition began in earnest. Political dissatisfaction continued to mount, to the point of threatening the position of Wałęsa, who had become president. Numerous strikes broke out, led in large part by trade unions dominated by former Communists. Mazowiecki and his 1991 successor, Jan Krzysztof Bielecki, managed to do what the former Communists themselves had conspicuously failed to accomplish: The failure of reforms rescued some of the Communist regime’s socialist rhetoric.

Not all errors that were made in Poland can be attributed to Mazowiecki and his team. In many cases, the Polish government was advised by Western experts who mistakenly thought they could apply Western advanced industrial economies’ precepts to the Polish economy and other previously socialized markets. The IMF itself, concerned mostly with balance-of-payments issues and not endowed with sufficient capital to aid all Eastern European and former Communist economies, could only advise (and require as a condition for loans) the strict austerity measures imposed by the Mazowiecki government. It appears, then, that Mazowiecki had little choice but to implement an austerity program. Some argue that although shock therapy was definitely necessary, the implementation of the changes was faulty. It has been suggested, for example, that more could have been done to shelter real wages and thus preserve political support.

If Mazowiecki’s work is judged primarily through the matching of economic forecasts with actual results, it would appear that by and large it failed. There were, however, some positive results. These become particularly evident when one considers the extent to which Poland was able to move away from a state-controlled economy to a market-based one. If capitalist restructuring is posited as the Polish government’s principal goal, then definite successes were seen. Among these can be counted a definite switch to trade with the West, with higher export rates and a decrease in foreign indebtedness; far lower inflation rates by late 1991; internal convertibility of the zloty; considerable production increases; and, above all, the establishment of a market-based price mechanism.

The Polish economy was clearly operating increasingly as a market economy, even though the pace of privatization itself was slow. Although in October, 1992, the budget deficit was still projected at 8 percent of gross domestic product (GDP), by February, 1993, the new government of Hanna Suchocka managed to pass an austerity budget that was expected to reduce the risks of renewed inflation. This paved the way for further IMF loans through stand-by arrangements in 1993 and 1994.

Poland’s move toward a market economy proved to be a far more complex and painful process than expected in early 1990. Although the emergence of capitalist mechanisms was unmistakable, Poland continued to struggle because of low standards of living, the resurgence of strikes, and political opposition in general. However, with perseverance, Poland’s economy gradually saw improvement, and it began to enjoy annual GDP growth rates of around 4 to 5 percent in 2004-2006 as its economic situation brightened.

Bibliography

Gomulka, Stanislaw. “Polish Economic Reform: Principles, Policies, and Surprises.” In Trials of Transition: Economic Reform in the Former Communist Bloc, edited by Michael Keren and Gur Ofer. Boulder, Colo.: Westview Press, 1992. Presents a rather technical exposition of Mazowiecki’s and Bielecki’s policies. Explains the considerations behind each of the economic choices made by the Polish government and why alternatives were rejected. Devotes brief discussion to why the targets of the Polish program were not met.

Institute for EastWest Studies. Moving Beyond Assistance: Final Report of the IEWS Task Force on Western Assistance to Transition in the Czech and Slovak Federal Republic, Hungary and Poland. New York: Author, 1992. Addresses the question of foreign, and particularly IMF, assistance to Poland, Czechoslovakia, and Hungary. Useful as a summary of results and as a thought piece concerning the ways in which the Polish and other Eastern European economies could be weaned from foreign assistance.

Jackson, John E., Jacek Klich, and Krystyna Poznańska. The Political Economy of Poland’s Transition: New Firms and Reform Governments. New York: Cambridge University Press, 2005. Somewhat technical discussion focuses on how the entry of new domestically owned firms contributed to Poland’s eventual successful transition to a market economy. Includes tables, figures, bibliography, and index.

Kolodko, Grzegorz. “Transition from Socialism and Stabilization Policies: The Polish Experience.” In Trials of Transition: Economic Reform in the Former Communist Bloc, edited by Michael Keren and Gur Ofer. Boulder, Colo.: Westview Press, 1992. Slightly technical yet readable essay stresses the question of how Poland’s approach was implemented. Does not dispute the necessity of shock therapy but disagrees with several of Mazowiecki’s choices, especially those regarding exceedingly low real wages.

Kolodko, Grzegorz, and Michael Rutkowski. “The Problem of Transition from a Socialist to a Free Market Economy: The Case of Poland.” Journal of Social, Political, and Economic Studies 16 (Summer, 1991): 159-179. Offers a straightforward summary of the Polish crisis and the policy implemented in early 1990. Includes useful clarifying tables concerning recent Polish economic performance.

Köves, András. Central and Eastern European Economies in Transition: The International Dimension. Boulder, Colo.: Westview Press, 1992. Provides an excellent comparative analysis of the different ways in which various formerly Communist countries sought to promote institutional reform, privatization, trade liberalization, and integration. The author is a Hungarian economist, and he offers a rare and comprehensive perspective, a well-informed insider’s look.