Balcerowicz Plan


The Balcerowicz Plan, also termed "Shock Therapy", was a method for rapidly transitioning from an economy based on state ownership and central planning, to a capitalist market economy. Named after the Polish minister and economist Leszek Balcerowicz, the free-market economic reforms were adopted in Poland in 1989.
A group of experts, which they formed together with Balcerowicz, including Stanisław Gomułka, and, in September 1989 created a reform plan based on an earlier idea of Jeffrey Sachs, and on 6 October, an outline of this plan was presented to the public by Balcerowicz at a press conference broadcast by TVP. There was a 3 year drop in output. Similar reforms were made in a number of countries. The plan has resulted in reduced inflation and budget deficit, while simultaneously increasing unemployment and worsening the financial situation of the poorest members of society.

Background

The unofficial talks at Magdalenka and then the Polish Round Table talks of 1989 allowed for a peaceful transition of power to the democratically elected government. Initially, it was agreed that the government would be formed by Tadeusz Mazowiecki and the opposition, while the seat of the president of Poland would be given to former Polish United Workers' Party leader Gen. Wojciech Jaruzelski.
The state of Poland's economy as of 1989 was dire. After failed social and economic reforms of 1970s the communist government had secretly declared its insolvency to Western creditors in 1981. Food price increases introduced first in 1970s to preserve the basic cash flow led to social unrest and formation of mass Solidarity social change movement which, by early 1980s had over 10 million members. Desperate attempts to maintain the Marxian-style economy and internal opposition in the Party to any economic reforms that would break this status quo led to the introduction of martial law which further hindered economic growth and resulted in international sanctions. In 1982 the government imposed further large price increases and significantly extended rationing of food and other basic goods.
In the late 1980s, after 45 years of communist rule, Poland's economy was ineffective, paralyzed by central planning and discontent of poorly paid workers. The inflation rate had reached 639.6% and was constantly rising. Foreign debt reached $42 billion. The majority of state-owned monopolies and holdings were largely ineffective and completely obsolete in terms of technology. Although there was practically no unemployment in Poland, wages were low and the shortage economy led to lack of even the most basic foodstuffs in the shops.

The plan

In September 1989, a commission of experts was formed under the presidency of Leszek Balcerowicz, Poland's leading economist, Minister of Finance and deputy Premier of Poland. Among the members of the commission were Jeffrey Sachs, Stanisław Gomułka, Stefan Kawalec and Wojciech Misiąg. The commission prepared a plan of extensive reforms that were to enable fast transformation of Poland's economy from "obsolete and ineffective central planning" to capitalism, as adopted by the states of Western Europe and America.
On 6 October, the program was presented on public television and in December the Sejm passed a packet of 10 acts, all of which were signed by the president on 31 December 1989. These were:
  1. Act on Financial Economy Within State-owned Companies, which allowed for state-owned businesses to declare bankruptcy and ended the fiction by which companies were able to exist even if their effectiveness and accountability was close to none. Removed the guarantee of the existence of all state-owned enterprises regardless of their financial results and production efficiency, enabled the insolvency proceedings against unprofitable enterprises.
  2. Act on Banking Law, which forbade financing the state budget deficit by the national central bank and forbade the issue of new currency.
  3. Act on Credits, which abolished the preferential laws on credits for state-owned companies and tied interest rates to inflation.
  4. Act on Taxation of Excessive Wage Rise, introducing the so-called popiwek tax limiting the wage increase in state-owned companies in order to limit hyperinflation.
  5. Act on New Rules of Taxation, introducing common taxation for all companies and abolishing special taxes that could previously have been applied to private companies through means of administrative decision.
  6. Act on Economic Activity of Foreign Investors, allowing foreign companies and private people to invest in Poland and export their profits abroad, exempting enterprises with foreign capital from paying popiwek tax.
  7. Act on Foreign Currencies, introducing internal exchangeability of the złoty and abolishing the state monopoly in international trade.
  8. Act on Customs Law, creating a uniform customs rate for all companies.
  9. Act on Employment, regulating the duties of unemployment agencies. Formally sanctioning the existence of unemployment.
  10. Act on Special Circumstances Under Which a Worker Could be Laid Off, protecting the workers of state firms from being fired in large numbers and guaranteeing unemployment grants and severance pay.
In late December the plan was approved by the International Monetary Fund. The IMF's support was especially important because the national debt in various foreign banks and governments reached an amount of US$42.3 billion in 1989. The IMF granted Poland a stabilization fund of US$1 billion and an additional stand-by credit of US$720 million. Following this, the World Bank granted Poland additional credits for modernization of exports of Polish goods and food products. Many governments followed and paid off some of the former Communist debt.

Effects

Balcerowicz's policies resulted in a significant reduction of inflation and budget deficit, the elimination of the market deficiency and central distribution of materials, obtaining the agreement of creditors to reduce the foreign debt, and a significant increase in foreign exchange reserves. There is no consensus among experts whether the Balcerowicz plan had a direct impact on the development of entrepreneurship and trade, which had already been liberalised a year earlier by the so-called Wilczek Act, a package of market reforms implemented by Mieczysław Wilczek in 1988. An international Fund for Stabilisation of the Złoty of US$1 billion was established. The exchange rate of the złoty was frozen at 10,000 per dollar for about a year and a half. Later, the crawling peg method was used for several years. Polish złoty was heavily devaluated against the US dollar, which together with additional import levies, became a heavy contributor to inflation.

Privatization

As a result of the bankruptcies and liquidation of many state-owned enterprises and the reduction of employment in those that survived, the unemployment rate after the political transformation reached a level in the order of 16.4% in 1993. Since 1990, there has been an increase in unemployment in Poland - throughout the transformation period it has been at double-digit levels. At the beginning of the introduction of the Balcerowicz Plan, the unemployment rate was only 0.3%, and already in December 1990 it was 12.2%. In the next two years it rose to 16%, as a result of the continued process of liquidation of state-owned enterprises. In 2003, the unemployment rate reached as high as 20%. The drop in unemployment did not occur until after Poland's accession to the EU, when a large group of young, mostly well-educated Poles left for EU countries for work. The privatizations were carried out haphazardly and in a non-transparent way; according to Jacek Tittenburn, "Plants sold were undervalued, well-functioning factories were destroyed, factories competing with Western manufacturers were got rid of." The collapse of state-owned industries and deindustrialization made Poland's greenhouse gas emissions to fall by 28% between 1988 and 1994.
In total, 1,675 industrial plants in Poland were liquidated during the transformation, which amounted to 33% of the total country assets. Polish economist Andrzej Karpiński estimated that about 25% of these liquidations were directly planned by the government, while the remaining 75% were a result of land speculation and hostile takeovers. Karpiński estimated that in case of a strictly controlled and limited privatization process, unemployment would have been 50% lower, and national income 33% higher. Privatization was most aggressive between 1990 and 1994, and yielded underwhelming results in terms of profit. For example, a cost of privatization of 314 Polish enterprises was about USD 710 million. Privatization programs involved high foreign consultancy costs, and were paid for through privatization as well as loans and grants from the World Bank and the International Monetary Fund. Because the Balcerowicz Plan involved austerity, the proceeds from privatization were not invested or allocated into development programs, but were kept in the state budget. Despite the proceeds from privatisation, Poland's foreign debt has increased during the transformation period. Hanna Brauers and Pao-Yu Oe wrote: "Less than 3% of all expenditures on restructuring programmes went to job creation in other sectors. As local authorities, which were meant to create new job opportunities, had little experience with this task and received no support, success in that respect was very limited."

Immediate results

Balcerowicz did assume that the initial effects of his reforms would be detrimental. He estimated that the national income would fall by 3% and industrial production would decline by 5%; he also assumed that about 400,000 workers would become unemployed, and that inflation would fall to a single digit in a year. However, the consequences were about five times more severe than estimated - national income fell by 22%, industrial production declined by 25%, over 3 million people became unemployed, and inflation fell to single digit only after 9 years into transformation.
Poland had a high public debt and budget deficit throughout the entire transformation period - the last positive budget balance was recorded in 1989, in the People's Republic of Poland shortly before the beginning of the Balcerowicz Plan. The plan resulted in a budget deficit through extensive trade with main foreign partners and an "avalanche" of imported goods in Poland through lack of regulation. In 1990, the negative balance of trade amounted to USD 4793 million, in 2000 it already exceeded USD 17000 million, and in 2010 it amounted to USD 13119 million. This negative balance of trade was associated with the shortage of goods on the Polish market a well as cutting off Polish enterprises from credit, most of which were sold of to foreign capital and subsequently liquidated. According to Witold Kieżun, Polish enterprises experienced hostile takeovers by foreign capital - as the result, out of the 100 largest firms in Poland, only 17 are Polish.