Poland’s miraculous resurgence in the 1990s is among the best-kept secrets of the global economy (Exhibit 1). The former Soviet satellite stands alone in having made the harrowing transition from the managed stagnation of communism to the high-growth mode of capitalism.

Recently, the McKinsey Global Institute undertook a study of the Polish economy—an aggregate survey of the agricultural and manufacturing sectors, as well as a detailed analysis of general-merchandise retailing and of housing construction.¹ The study shows that the country’s success has been founded on tight fiscal discipline, together with capital and product market reforms ensuring that all businesses compete on equal terms and thus quickly capture the benefits of rising productivity. As a result, Poland has attracted a large amount of foreign direct investment, which has propelled its rapid economic growth and gave it the ability to weather the 1998 global financial crisis (Exhibit 2).

Even Hungary and the Czech Republic have seen their per capita gross domestic products decline since the downfall of the Soviet satellite regimes in 1989. But Poland’s per capita GDP has surged by 16 percent (Exhibit 3) and is now nearly 50 percent higher than Russia’s. Unemployment has fallen to around 10 percent, from 14 percent in 1993, and new jobs have been created at a healthy rate of 1 percent a year since 1994. As in all thriving modern economies, the engine of that employment growth has been the service sector; in fact, the manufacturing sector has actually shed jobs since 1994 (Exhibit 4) as a result of a rapid increase in productivity.

Although Poland’s manufacturing productivity is far from world-class, it is moving rapidly in the right direction. This positive dynamic—rising manufacturing productivity displacing workers who are then redeployed in new service sector jobs—is the cornerstone of our optimism about the Polish economy’s prospects for continued success. All of our previous research shows that this is the path to a long-term improvement of living standards and the achievement of social stability. By almost completely opening up the economy to foreign capital and to the transfer of global best practices, Poland is moving up the development path very quickly. Under liberalization, jobs are being created in services fast enough to absorb workers displaced by rapid productivity improvements in manufacturing and agriculture.

Besides measuring and evaluating Poland’s performance, we also used the Global Institute’s previous work on Brazil, France, Germany, Russia, South Korea, and the United Kingdom to determine whether the current economic-policy regime is sufficient to sustain strong economic and employment growth.² Our answer: yes. As long as deregulation, privatization, and openness to outside investment continue—and the government steers clear of the regulatory traps that now stifle employment growth in France and Germany—Poland will continue to prosper by allowing the process of economic evolution to proceed, much as it does in all healthy economies. Old jobs in old industries will go on being destroyed, and new jobs in new industries will more than replace them.

The main issues still to be addressed are related to the land and property markets, which are still plagued by uncertain ownership rights and subsidies to tenants. Our detailed analysis of the retail and housing construction sectors shows that deregulation in these areas would create even more jobs, thus providing for a further reduction in the overall unemployment rate and a faster reallocation of displaced workers from the agriculture and manufacturing sectors.

The vanishing industrial worker

Lower trade barriers, ongoing deregulation and privatization, and the expiration of no-layoff policies are going to drive productivity increases that will continue to cut employment in manufacturing industries from food processing to mining. Indeed, between 1999 and 2005, such losses could accelerate markedly—to as much as 4 percent of Poland’s total manufacturing job base a year, up from only 1 percent a year between 1992 and 1998.

In food processing, the larger nationwide suppliers are going to be the big winners, for they will benefit from a consolidated distribution and retailing sector, which permits them to reap the benefits of their larger scale and to compete successfully with smaller local companies. The current trend suggests that foreign direct investment in existing large domestic players has stimulated consolidation. Foreign companies not only bring capital and know-how but also increase the domestic economy’s competitive intensity, thus creating an environment that promotes continually rising productivity.

Meanwhile, large multinational companies (such as Daewoo and Fiat) in the passenger car and auto parts sector have already invested in Polish plants and claim to have achieved productivity levels equal to those prevailing in their home countries. As these big manufacturers take root, they create real incentives for their global parts-supply networks to invest in Poland as well. Once again, the injection of new capital and knowledge spurs competition, consolidation, and higher productivity.

Surprisingly, we found the position of agriculture to be less worrisome than conventional wisdom would suggest. Most small-plot farming households have managed to achieve relatively high levels of income because their members have found additional jobs (some in the "gray economy") outside of agriculture, mostly in areas such as construction, retailing, social services, and truck driving. By contrast, families holding larger farms—with an average of seven hectares—have succeeded in maintaining their relative income solely through farming vis-à-vis nonfarming groups.

Choking growth

To create jobs for workers displaced by higher manufacturing productivity, Poland must sustain its reform program. But low property taxes in the cities and artificially low rents for commercial and residential tenants now conspire to choke the growth of two of the potentially strongest areas for employment growth: general-

merchandise retailing (see sidebar "An incomplete transformation") and housing construction (see sidebar "Bigger is better"). Adjusting taxes and removing these subsidies would facilitate the entry of global retailers such as Benetton and spur the construction of large developments of single-family homes by Polish and foreign companies.

Although the causal connections among low taxes, rent subsidies, and growth are subtle, they are real

In these two industries, the causal connections among low taxes, rent subsidies, and growth are subtle but very real. Compared with other European countries, and adjusted for the overall cost of living, urban land suitable for retail and housing development is very expensive in Poland because it is scarce (Exhibit 5). It is scarce because property taxes are too low to allow local governments and municipalities to finance the building of the roads and the gas, electric, and sewer lines needed to make more land suitable for building; property developers must bear the cost of this infrastructure. Other problems include administrative red tape, the normal speculative risk of development, and the highly fragmented pattern of land ownership. The cost of development is thus very high—too high for most modern construction companies to make money and for modern retailers to find appropriate real estate.

Subsidized rents and other factors that shelter tenants from market-level prices affect a large share of real estate in Poland, exacerbating the problem. The small traditional merchants who sell clothes, hardware, shoes, and a host of other common products pay something like 20 percent of the free-market rate for their state-owned premises. Although these operations can’t supply their customers with anything more than a modest assortment of merchandise and have low standards of service—as well as no prospects of growth—the subsidy is large enough to insulate these businesses from competition. The only high-productivity stores that can thrive in the current regulatory framework are hypermarkets, which create very few new jobs because the main value they offer consumers is low prices, not service. Given the current restrictions on the expansion of high-service, high-value specialty chains, Poland runs a serious risk of ending up with a retail sector rather like Germany’s: very efficient but with very few jobs and very little service.

Rent subsidies mean that people in Poland have scant incentive to move into new homes even if they are nicer than the old ones

The current housing stock’s limited exposure to market-level prices also blocks the growth of housing construction (Exhibit 6). About 40 percent of urban residents in Poland still enjoy artificially low rents and utility charges—either because of subsidized rents on state-owned dwellings or because the legal status of cooperatively owned dwellings prevents their boards from raising the rents of (or evicting) tenants while hindering the tenants’ ability to capture any market value on the sale of the dwelling. Since these low housing payments are associated with existing apartments, independent of the tenant’s income, people have scant incentive to move into new homes even if they are nicer than the old ones; the difference in price is simply too high. Demand for new housing is therefore low despite increasing prosperity and housing shortages. We believe that exposing residents to market prices by privatizing more state-owned dwellings and resolving the ownership status of cooperatively owned apartments will address the severe housing shortage and increase employment in housing construction by 60 percent over the next six years.

Retail zoning laws can quash growth not only in the retail sector but also in the industries whose growth depends upon retailing

Furthermore, the Polish government should avoid two major policy traps that prevent many Continental economies from becoming world-class engines of job creation. First, zoning laws should be approached with particular care. In France, for example, legislation limits the size and number of retail outlets; in Germany, it severely restricts their location and operating hours. Such laws not only quash growth in the retail sector but also suppress the development of the apparel, electronics, food processing, textile, and all other industries whose growth—and ability to create jobs—depends on a robust retailing industry.

Second, and perhaps even more critical, are the social policies for the bottom end of the wage and skill scale. Today, the cost of employing workers in Poland is low compared with the cost in the member states of the European Union.³ Polish workers will become too expensive as well if the minimum wage rises very quickly and the government pushes workers from the gray market into the formal economy. Higher labor costs could soon affect Polish employment levels in sectors such as retailing and textiles.

If low wages for unskilled workers become a pressing social concern in the near future, it would be far better for Poland to supplement these wages through policies such as the earned-income tax credits of the United Kingdom and the United States than to follow the course set by France and Germany. Tax credits allow wages to remain at levels that make it possible for the economy to employ these workers while adjusting their buying power through the tax system. Society as a whole, rather than specific companies, appropriately bears the burden.

If Poland can avoid the economic-policy mistakes made by France and Germany and maintain the program of reform and privatization, this former communist state should continue to enjoy strong overall economic growth. New jobs will be created—enough jobs not only to absorb workers who lose manufacturing jobs but also to pull workers out of subsistence agriculture and into the modern economy (Exhibit 7).