Monday, 9 July 2012

Only Government Intervention Can Prevent a Post-Euro Slowdown

So Euro2012 is over. The stadiums have emptied, euphoria subsided, supporters gone home, fanzones dismantled and Spain departed with the trophy. The discussion about the merits and worth of hosting such a tournament will continue, but the real question is what now,  and more precisely what are the prospects for the Polish economy?

Although the government will attempt to maintain the positive feelings surrounding Euro2012, and seek the acclaims for its success, this may be short-lived. All the factors that have been driving the Polish economy are now turning negative and if the Polish government does not act quickly and decisively then we may expect a sharp slowdown in growth and steady increase in unemployment.

On the surface all seems well in the Polish economy. In 2011 GDP growth reached 4.3%, up from 3.9% in 2010. As the Eurozone economies continue to grapple with their unfolding crisis and the USA economy slows once more, so the Polish government’s claim to be the ‘green island’ in a sea of red seems justified. 

Yet the slowdown in economic growth had started even before the first ball was kicked in Warsaw’s new national stadium. In the first quarter of 2012 economic growth slowed by 0.8% (to 3.5%), which is still impressive when compared to most other European countries. Over the past few years Poland’s economy has been driven by increased public investment, rising consumer demand and growing exports. The problem now is that of all these pro-growth elements are starting to dissipate.  We shall look at these in reverse order, leaving the most important – public investment – till last.


In June this year, when Euro2012 was being held, individual consumption increased by just 0.8% from May, falling by 3% compared to June last year. Personal consumption had been rising on the back of increases in real wages. Although wages are still increasing, in recent months this has only been slightly higher and in some cases lower than the rate of inflation (presently standing at 3.6%), meaning that real wages are stagnating. This situation is made worse by the freeze on the salaries of public sector employees’ (who make up a quarter of the workforce), whose real incomes are declining. The decision by the government to raise the minimum wage may have some positive impact, but this will not affect the millions of hourly paid workers or the self-employed. Poland has the highest percentage of workers inside the EU who are employed on so-called ‘junk-contracts’ – soaring from 5.8% of all employees in 2000 toalmost 27% in 2011 (the EU average is 14.1%).

Personal consumption is also being strained by difficulties on the labour market. Despite the positive impact of preparing for and hosting Euro2012, employment has only grown by 0.3% over the past few months. Although we may expect some positive seasonal adjustment over the summer, it is then likely that unemployment will continue its upward trend, possibly reaching 14% by the end of the year.


The mounting economic problems within the Eurozone, not least the slowdown in Germany, are also having a negative impact upon the economy. Poland is less reliant on exports than many of its smaller neighbouring countries (such as the Czech Republic and Slovakia that are heavily dependent upon auto exports) and therefore was not so affected by declining export demand in the aftermath of the global financial crisis. Nevertheless, Poland is deeply integrated into the European economy, particularly as a supplier of goods and components for Germany.

The German government is now predicting growth thisyear of just 0.7%, whilst manufacturing output is slowing and business optimism fallingThis is leading to a reduction in export opportunities for Polish businesses, with export orders falling at their fastest rate in May since June 2009, after only rising during one of the past 13 months. As a result, manufacturing output contracted for the first time in three years and the Purchasing Mangers’ Index (PMI) decreased forthe second month in a row. 

It has been well documented how the global economic crisis has primarily been caused by a collapse in investment, particularlyprivate investment. The economies that have been most successful in overcoming the crisis (such as China) have tended to do so through the government raising its own levels of investment. The recent relative successes of the Polish economy have primarily been a result of an increase in public investment. 

Government expenditures have continued to grow throughout the crisis, rising from €15.1bn  in 2008 to €16.5bn in the first quarter of 2012 , with the level of government expenditure (49% ofGDP)  being slightly above the EUaverage. As a share of Poland’s overall investment, public investment increased from 35% to 43% between 2005 and 2010. This has ensured that although private investment fell sharply throughout the crisis, Poland’s overall investment rate only declined slightly (by 0.08%) in 2009, whilst in other years it has continued to rise. The largest increase in investment has occurred in the area of buildings and infrastructure, which rose from €1.8bn in 2005 to €3.1bn in 2010. (GUS, Rocznik Staystyczny 2011)This upturn in public investment has been made possible by the availability of €67bn in structural and cohesion funds from the EU’s 2007-13 budget, which increases to €82bn (€2,500 per capita) once the designated national government funds have been added.


As Poland emerges from Euro2012 it is highly likely that public investment will significantly reduce. The government has optimistically predicted that investment will still grow by 0.8% in 2013 (down from a predicted 2.7% in 2012), believing that increased private investment will make up for much of the decline in public investment. The government is increasingly coming into line with the accepted economic wisdom in Europe, that seeks deficit reduction through cutting public spending. Since being re-elected in 2011 the PO government has indicated that it is seeking to reduce its  public debt to 42% (down from the present 54%) of GDP by the end of 2015; and its budget deficit to just 1% (down from 5.1%) by the end of its term in office. This deficit reduction is being pursued largely through local governments, which have been required to balance their income and current expenditures from 2011. This is leading to local governments reigning in their spending and reducing investments, that could make it difficult for them to make use of future EU funds.

The problem facing the government is that the slowdown in economic growth and increase in unemployment is placing increasing pressure upon its public finances. Its plans to bring down its budget deficit and debt over the next couple of years are based upon predictions of sustatined economic growth, fallingunemployment and increased wage growth. Yet with all economic indicatorspointing downwards, then we canassume that a plicy of deficit reduction through reducing government spending will serve to depress growth and rather lead to a worsening of public finances. 

The Polish government is now faced with a stark choice. Either it accepts the ideology of cuts and austerity or it learns from the experience of the past few years that government investment can produce economic growth. If the government really wants to maintain the positive atmosphere and feel-good factor associated to Euro2012, then it must increase its investment and expand it into other areas of infrastructure, transport, essential public services and green technologies. 

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