Friday, 4 March 2011

A Sustainable Course of Economic Growth?

The Polish Statistics Agency (GUS) has recently published its results for the fourth quarter of 2010. Economic growth increased -year on year - by 4.4%, compared to 4.2% in the third quarter. These are again impressive figures for an economy that - unlike its European neighbours - has continued to grow since the outbreak of the global financial crisis at the end of 2007.

Despite the country's positive economic performance the sustainability of this growth is questionable. Increasingly imbalances are observable within the Polish economy - in particular that between rising domestic demand and stagnant private investment. After growing by more than 17% in the first quarter of 2008, the rate of private investment slumped to -12.8% in the first quarter of 2010. Although this improved throughout the year, private investment only grew by 0.9% in the fourth quarter of 2010, despite businesses increasing their own gross accumulation by 8.4%. As in other countries, businesses are hording profits and - despite enjoying preferential tax rates - these increased profits are presently not being passed onto the rest of the economy. Elsewhere this has aptly been termed an investment strike.

So while private investment flounders, the consumer is taking up the slack. In the final quarter of 2010 private consumption increased by 4.1% - continuing its recovery after falling to just above zero during the first quarter of 2009. This is partly being driven by some improvements in the labour market. The amount of people working in Poland increased during 2010 by 1.7% and average salaries grew throughout the year by 3.5%. Both of these figures have obviously contributed to an increase in domestic demand. On the other hand, the unemployment rate continued its upward trend last year - reaching 11.5% at the end of 2010 (up from 10.4% from a year earlier). Also, although salaries have risen during the past year, this has been at its slowest rate since 2005. Furthermore, these wage increases have been exceeded by rising prices, with inflation reaching 3.8% in January this year.

This means that the average wage earner is seeing her living standards at best stagnate if not decline. Also this rise in salaries is extremely uneven. The salaries of those working in sectors such as agriculture, forestry, electricity, education, water/sewage, manufacturing and administration/support rose by at least 5%. However, the salaries for those employed in transport, mining and construction grew by less than 2% - far below the rate of inflation - while salaries actually declined for workers engaged in professional, scientific and technical activities. The salaries of public sector employees rose faster than those in the private sector last year (growing by 4.1% compared to 3.3%). Over 1/3 of all workers are still employed in the public sector in Poland and their average monthly salaries are ZŁ600 higher than their private sector counterparts. Therefore, the government's plan to cut public sector employment and freeze some public sector salaries could have a serious negative impact on domestic consumption.

So, if salaries are growing on average at a slower rate than inflation why has domestic consumption continued to expand by more than 4%? One answer to this can be found in the continuing growth of private credit and debt. Poland came through the financial crisis relatively unscathed partly because its level of private debt was comparatively low. The base interest rate in Poland only fell below double figures in 2003 and banks in Poland continued to 'conservatively' lend. However, all this has changed. Rather depressingly Poland is now trying to make up for lost time and individual debt is expanding at an alarming rate. A recent report by Infomonitor shows that for the first time the number of Poles who are unable to keep up with their credit payments has exceeded 2 million. The total amount of over-due credit payments is now worth more than ZŁ28bn. The average level of debt held by those considered to be in risk by Infomonitor has gone up from ZŁ6,600 in the second quarter of 2009 to ZŁ13,900 in the corresponding period of 2010. Reports have shown that banks are actively trying to entice pensioners to take credits and that the actual costs of taking these credits are hidden from the client - often adding up to nearly twice the sum of the original credit. It really does seem that leopards can't change their spots. With the expansion of credit an essential component of the consumer led growth, the Monetary Policy Council took the controversial decision this month not to raise interest rates.

While this contradiction between private investment and consumption has been widely considered in the media, a third factor has been generally overlooked: public investment. This blog has previously pointed out the important role that the increase in public investment has had on maintaining Poland's positive growth. A recent report from the European Commission into the role of public investment in Poland further underlines this. It points out how the significant increase in public investment - following Poland's accession into the EU - helped to smooth the economic downturn during the crisis and that increasing the extensive use of EU funds as a means to invest in the country's infrastructure would now help to support its recovery. The report also points out that while public investment has increased significantly over the past few years (rising from 3.5% of GDP to 4.5% between 2005 and 2008) this was from an initially very low level of capital expenditure. There had been no investment into the country's infrastructure (such as transport) prior to EU accession, with funds designated to maintaining an infrastructure that was steadily degrading.

It is interesting to look at a graph provided in the report that shows the relationship between public investment and economic growth in Poland. As we can see, the recovery in public spending helped to pull Poland out of the recession it had entered at the beginning of the transition. Then from the late 1990s (during the term of the catastrophic AWS-UW government) public investment fell sharply helping to significantly slow the pace of economic growth. Public investment then began to grow rapidly around 2005 soaring above its pre-EU accession level.

Contrary to the ideologues that have dominated public debate - economic growth has increased when the government has invested more and slowed when its investment has reduced. The danger now is that the government will rein-in public investment as it seeks to cut its public spending. In previous articles I have shown how the government has already started to cut back on its investment in the country's infrastructure and also at how it is compelling local governments to curtail their spending. The policies of the PO administration are therefore threatening the twin pillar's of Poland's positive economic growth: consumer demand (through cutting public sector jobs and salaries and raising VAT); and supply (by reducing public investment).

1 comment:

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