Six Markets to Watch: Poland

Anyone who knows Polish history cannot help but marvel at the country’s emergence from the ashes of its traumatic past. Over the last 25 years, Poland, after centuries of war and subjugation, has enjoyed peace, a stable and booming economy, and integration with the rest of Europe.

An independent kingdom for the previous 800 years, in 1795, Poland was wiped off the map of Europe and absorbed into three great neighboring powers -- the Prussian, Russian, and Austro-Hungarian empires -- a state of affairs that lasted until 1918. Reborn following World War I, Poland spent a few short years as a democracy before proving ungovernable, succumbing to dictatorship, and then once again being conquered and divided, this time by Nazi Germany and the Soviet Union, in 1939. Over the next six years, Poland found itself at the center of what the historian Timothy Snyder has called the “bloodlands” of Europe; an estimated five million Poles died between 1939 and 1945, more than half of them Polish Jews. The Nazis and the Soviets also wiped out the cream of the crop of Poland’s intelligentsia and clergy. Warsaw was reduced to rubble, and mass graves were sown across the landscape. Then came four gray and sooty decades of communist domination. Only the Catholic Church offered Poles any hope.

Since communism collapsed in 1989, however, Poland has experienced a remarkable reversal of fortune. After leading the protest movement that toppled the old regime, the trade union Solidarity won democratic elections and initiated aggressive, market-oriented economic reforms. The communist Polish United Workers’ Party turned into the capitalist Democratic Left Alliance, which won elections in 1993 and 1995 and led the country into NATO in 1999. And in 2004, Poland joined the European Union as a full member, cementing its close alliance with Germany, its erstwhile antagonist.

The Polish economy, meanwhile, has grown rapidly for two decades -- at more than four percent per year, the fastest speed in Europe -- and garnered massive investment in its companies and infrastructure. Poland’s is now the sixth-largest economy in the EU. Living standards more than doubled between 1989 and 2012, reaching 62 percent of the level of the prosperous countries at the core of Europe. All of this led the World Bank economist Marcin Piatkowski to conclude in a recent report that Poland “has just had probably the best 20 years in more than one thousand years of its history.”

How did Poland manage so decisively to move beyond the repeated tragedies of its past? The question is rarely asked by market analysts, whose sense of Poland seems to go no further back than the economic reforms of the 1990s. Those reforms are indeed part of the story -- but only part it, and focusing exclusively on them obscures the deeper causes of the country’s resurgence. Explaining Poland’s economic boom -- and why it is likely to last -- requires a deeper look into its troubled history.

WESTWARD HO!

For centuries, Poland’s tragedy was one of geography. Situated on the flat, open plains of northern Europe, with no natural boundaries separating it from Germany to the west and Russia to the east, Poland was often torn between the two. From 1569 to 1795, Poland had an eastward-looking empire of its own: the Polish-Lithuanian Commonwealth, which included large parts of present-day Belarus, Estonia, Latvia, Lithuania,  and Ukraine. Today, however, Poland has decidedly joined the West -- so much so that Poles hate when their country is considered a part of eastern Europe, insisting that they live in central Europe. Although some attribute this shift to the warm embrace of the EU, the real author of Poland’s Western transformation was none other than Joseph Stalin.

Stalin’s unwitting contribution stemmed from the way the Soviet leader forcibly reshaped the country’s borders after World War II. His top priority was to expand the Soviet Union, and so he kept all the parts of eastern Poland that he had annexed in 1939 and compensated the country with a large chunk of the eastern German territories of Silesia, Pomerania, and East Prussia. Apart from increasing the size of his own empire, Stalin was focused on punishing the Germans, and indeed, millions of them were expelled from their homes in the new Polish territories. Millions of Poles were then driven from the annexed east into the newly emptied west.

Today, Moscow’s decision to push Poland to the west must seem a massive strategic error. That’s because its long-term effect was to move Poland solidly into the orbit of Germany. Indeed, today’s Poland, to a large extent, is Germany, inhabited by Poles. Since Germany accepted this situation by signing a peace treaty with Poland in 1990, it has sought to draw Poland closer. And Warsaw has proved a willing partner.

Part of what makes Poland such a good place to invest today is the depth of the bond it has forged with Europe’s leading economy. The relationship benefits both countries. A large part of the German export machine is now based in Poland. Poland gets German investment and markets for its goods, and Germany profits from the opportunity to use Poland as a low-cost, high-quality production platform to compete with East Asia. Indeed, some German industries are able to produce goods in Poland for less than what they would cost to make in China. And Poland offers Germany a friendly business climate, plenty of skilled labor, and, above all, proximity.

Germany owes much of the success of its automobile industry to its eastern neighbor. At its factory in Poznan, Volks­wagen employs 6,900 workers who produce intake-pipe modules, cylinder heads, and steering-gear housings, as well as 155,000 commercial vehicles each year. The MAN Group employs 4,000 workers in Poland who build heavy trucks, city buses, and bus chassis at three different factories. Cars and automotive components are now Poland’s leading export, despite the fact that the country has no internationally known brand; a large share end up as German marques. The same holds true for industries as diverse as household appliances and clothing; the German fashion house Hugo Boss, for example, produces its shoes at a factory in the Polish city of Radom.

Because Poland is now a key part of the German supply chain, it has become a great exporting economy -- exports now make up 46 percent of its GDP. A recent Morgan Stanley report estimated that 30 to 40 percent of Poland’s exports to Germany now end up as German exports to the rest of the world. This interdependence explains why Germany is by far Poland’s largest trade partner, buying or selling 25 percent of Poland’s exports and imports, which total about 12 percent of the overall Polish economy.

None of this could have happened if the German-Polish relationship were not embedded in the broader EU. Since Poland joined in 2004, the EU has done wonders for it and the rest of eastern Europe, ensuring democratic freedoms and administrative reforms and helping the region liberalize its markets. In the last decade, the EU has invested nearly 40 billion euros in Polish infrastructure, building the autobahns that Poland never had; replacing its outmoded, overcrowded, and often deadly two-lane highways; renovating its decrepit train stations and train lines; cleaning up its rivers; and setting up broadband infrastructure. In the process, Poland has become Europe’s biggest construction site. Between 2000 and 2013, the aggregate length of Polish highway and express roads grew fivefold, dramatically reducing the cost and the time it takes to transport goods to the west. And the benefits should keep coming: between 2014 and 2020, the EU is expected to pump 106 billion more euros into the country. That infusion of cash will equal nearly two percent of Poland’s annual GDP, a level of funding similar to what Washington provided to Europe under the Marshall Plan.

MANAGING POLAND’S RISE

Because of the centrality of foreign investment to Poland’s economy (most of its major banks and enterprises are foreign-owned), its reliance on foreign trade, and the fact that so many Poles work outside the country, political economists often characterize Poland as a “dependent market economy.” This dependence creates a fundamental dilemma: to attract foreign business and maintain its competitiveness, Poland must keep down its wages, which today stand at about one-third of those in the more developed countries of the EU. But Polish workers live adjacent to the rest of Europe, traveling and working there in great numbers, and thus aspire to a higher standard of living. This fact will make it difficult for Poland to maintain the advantages that come with cheap labor.

Poland should be especially worried about this dilemma given the presence of other low-wage countries in its neighborhood that could serve as manufacturing bases. In 2009, when the computer manufacturer Dell moved its main European factory from Limerick, Ireland, to Lodz, Poland, the mayor of Limerick predicted, with deep schadenfreude, that “Dell will probably head for Ukraine in six to eight years’ time.” One could say the same about the many call centers that have become mainstays of Polish employment.

To overcome this challenge, Poland must rise up the value-added ladder and begin producing more high-tech and knowledge-intensive exports. At the moment, Poland does not invest much in research and development relative to its more developed neighbors -- only 0.7 percent of GDP, compared with about 2.0 percent in the EU as a whole. But there is reason to believe that Poland can change course. The country’s greatest asset is its mass education system. One of the very few benefits of communist rule was that it left Poland with one of the highest literacy rates in the world. And since 1989, Poles have continued to invest heavily in their education, learning English, building new private universities, and participating in the Erasmus student-exchange program among European universities. Poland now has the second-highest rate of college enrollment in the Organ­ization for Economic Cooperation and Development. Meanwhile, as small, innovative Polish technology companies boom, the path to a high-tech future is presenting itself.

Yet the greatest long-term risk to Poland is that its consumption and wages will rise too fast, crowding out domestic investment and deterring foreign business. In managing their country’s rise, Polish politicians must walk a fine line between satisfying voters’ concerns and maintaining the country’s cheap labor costs.

This dilemma of dependence also explains why Poland is unlikely to join the eurozone, at least not anytime soon. Although the Polish government and Polish elites initially clamored to adopt the common currency, the financial and sovereign debt crises changed their minds. Part of the reason Poland weathered the 2008 global financial crisis well was that it was able to devalue the zloty, which helped Warsaw maintain its exports and keep jobs in the country. And when the sovereign debt crisis hit in 2009, Poland relied on devaluation and government stimulus to avoid a recession, making it the only European country to do so. Warsaw knows that keeping its own currency means that investors will pay transaction costs, but it will also help the country keep wages down. So don’t expect to see euro notes on the streets of Krakow or Gdansk until Poland’s and the eurozone’s living standards get much closer to each other.

WHY POLAND?

A final challenge facing Poland, and one potential investors should take note of, is the extent to which it, like other countries in its neighborhood, has struggled to build an effective bureaucracy. Poland still ranks only 41st and 45th, respectively, on Transparency International’s Corruption Perception Index and the World Bank’s Ease of Doing Business Index. Although there is little political risk to doing business in Poland -- especially compared with doing business in Russia -- it can take months to establish a company there. Some businesses complain that Warsaw favors partially-state-owned enterprises, using regulation as a tool to pick winners, or that the government has not worked aggressively enough to remove administrative barriers to growth. Even though opportunities for investment abound, the government is unlikely to help.

Although some other central and eastern European countries offer similar opportunities, Poland is still an attractive choice relative to its neighbors. Its population of 38 million -- approximately four times the population of the Czech Republic or Hungary -- means that it has a large domestic market. Whereas the Czech Republic and Hungary have richer and more open economies, Poland has much lower labor costs and has grown more rapidly. At the same time, its governance structures are more rule-bound than those of its low-wage competitors, such as Bulgaria, Romania, or others outside the EU. All these countries need to continue to move into more technologically sophisticated industries over time, in order to enable their citizens to increase their living standards.

In some ways, Poland is the template for the Europe that German Chancellor Angela Merkel hopes to create. It has carved out a profitable niche in the German production machine, and it can thrive with an export-oriented economy based on a strong currency and dampened domestic demand. This German model has provoked the ire of southern Europe, but for Poland, it works.

Warsaw is sometimes called “the phoenix city” because of the way it rose, like the mythical bird, from the ashes of World War II. Today, many ordinary Poles and investors are wondering just how high the phoenix can fly. Economic projections suggest that Poland’s economy will grow by about 2.5 percent per year through 2030, becoming one of the top 20 economies in the world before eventually succumbing to demographic decline. If the country can create a more hospitable business environment, build a knowledge-based economy, and encourage immigration and higher birthrates, it may keep growing even faster. After all, the Poles have a knack for beating expectations.

CORRECTION APPENDED (January 24, 2014) 
This article has been revised to address errors in the original version regarding Poland's ranking on the World Bank’s Ease of Doing Business Index and regarding the procedures to establish a company there.