Eastern Europe and the Former Soviet Union: Class 3

1. Eastern Europe and the Former Soviet Union: Class 3

2. Poland pre-transition • More than 8,000 state-owned enterprises • >90% of output and 80% of empl. • industry accounted for 58% of GDP in 1988. (OECD countries 24%--41%) • almost half of exports and imports with CMEA countries • products of inferior quality • aged capital stock; tech. backward

3. 1990- Balcerowicz PlanShock therapy • Price liberalization • trade liberalization • legal reforms end restrictions on private ownership • tight credit policy to lower inflation and force out loss-making enterprises • restrictive wage policy • ambitious fiscal policy

4. Criticism • Too much; too quickly • Excessive pain on large state enterprises, their employees and local communities

5. Counter-arguments • Necessary conditions for privatization, enterprise restructuring and development of an institutional system compatible with a market economy

6. Pre-Big Bang obstacles faced by private entrepreneurs • Hard to locate space • Difficult to raise capital • capricious tax authorities • Bureaucratic snags • Problem of obtaining materials

7. Immediate results--disappointing

8. Longer term results • By 1994 Poland became the first country to see recorded GDP exceed 1989 level. • Since 1994 • continued GDP growth (6.2% per year 1994-97) • investment growth • export growth • declining inflation

9. Pre-1994 growth was driven mainly by exports (9% per year) • since 1995 domestic demand, led by investment, took over as the driving force • growth in domestic demand has led to increase in imports and a trade deficit • but largely offset by healthy FDI ($5 B in 1998)

11. Unemployment---still a problem • 10-11% 1998-99 • pockets of very high unemployment in regions where agricultural and industrial restructuring is difficult and incomplete

12. What explains Poland’s economic turnaround??? • One perspective focuses on the achievement of macroeconomic stability • Alternative. Look at categories of Polish enterprises (micro level) • state enterprises • privatized state enterprises • new private sector firms

13. Contribution of Privatized SOEs • Very little privatization in early 1990s • took 3 years to work out a Mass Privatization Program • August 1994: only 121 firms actually privatized

14. Exception---Prochnik • Manufacturer of men’s overcoats • privatized in April 1991. Seemed to have unusually good prospects • quickly lost its traditional export markets • collapse of Soviet market • recession in Western markets • competition from East and SE Asia • lost old export subsidies • currency problems cause supply problems

15. Need to devise new strategy • Concentrate on domestic market (and high quality end) • had to create a marketing division • had to create a distribution network • developed broader product line to gain image of garment manufacturer • downsized to reduce production costs • subcontracted out sewing jobs to idle state-owned plants • sold off unproductive assets

16. State Enterprises • Modest contribution: few successful examples. WHY??? • Not much pressure to improve performance. Allowed to default on tax payments to avoid bankruptcy. • “Managerial purgatory”

17. Example of Gdansk Shipyard • Eastern bloc countries were major customers • clients located by central government • Polish government provided all financing • built various classes of boats to maintain full employment • most contracts are unprofitable. Depend on subsidies (no specialization) • Managers focus on getting concessions from government.

18. With collapse of USSR lost major client • refused to reduce size of operation or variety of products • find it difficult to think in terms of profits • tried to increase employment • insisted on continued government support. “We are generating jobs for suppliers.”

19. Exception--Szczecin shipyards • USA Today article. November 9, 1999. • On brink of bankruptcy in 1991 • $600 M of revenue in 1998. (9 times 1991 figure) • new managing director • negotiates write-off of 1/3 of $180 M debt and 5 year extension for the rest (buys time)

20. Focuses on mid-sized container ships • Downsizes. Reduces total employment from 13,000 to 5,000 • implements a performance-based compensation plan for workers • reduced ship production time from 36 to 11 months. • Sheds non-productive assets like workers’ apartment and vacation facilities

21. New private sector firms 35% of industrial employment

22. Limited access to capital • BUT… • Lacked inherited organizational structures • had low fixed costs • had motivation to exit unpromising markets and pursue more attractive ones

23. Source of entrepreneurial skills of managers • Polish cooperatives. A transitional unit of organization • Example of Gdansk cooperative • maintenance services for state-owned enterprises • got into high altitude repair of smokestacks, towers, industrial cranes etc. that had been allowed to deteriorate • accumulated capital and reinvested in specialized equipment

24. Entry point to manufacturing • Move into manufacturing from trading goods

25. Remaining constraints • Raising capital. • State banks were slow to change due to their links to state firms • New private banks reluctant to lend to new private businesses without credit histories or reputations. • High interest rates lead to dependence on retained earnings which slows expansion.