Sunday, October 09, 2005

Poland Shows the Way

Leszek Balcerowicz, the head of the central bank of Poland, had an insightful article in the Wall Street Journal this week (unfortunately subscription only). After decades of first hand experience with the failure of centrally planned economies, Poland knew what to do, and what not to do, after independence. - The Wealth of Nations: "WARSAW -- The failure of various forms of statism in the Third World, the bankruptcy of communism in the former Soviet bloc and China, and the high long-term unemployment and relative stagnation in Western European countries with overregulated economies has forced a revision of the development paradigm in favor of the market and private property -- in short, a more limited state. But the battle over ideas and policies is far from over. As a matter of fact, it will never end, as the forces of statism regroup rather than capitulate. This is why it is so important to analyze which policies work and which ones fail, to generate lasting convergence -- and to bring poor countries out of poverty."
By "convergence" he means the economy of a poor nation catching up to the wealthier nations. The correct path has been demonstred by the excellent performance of Eastern European nations, like Poland and the Czech Republic, that have liberalized, privatized, deregulated and cut taxes.
"In 2004, GDP had increased, relative to 1989, by 42% in Poland, 26% in Slovenia, and 20% in Slovakia and Hungary. In contrast, it declined by 57% in Moldova and 45% in Ukraine. If the shadow economy were included in the calculations, the differences in output would be smaller, but they would still be large."
Sound economic policies have reduced inflation and helped attract foreign investment. They also help in other ways:
"Countries with better economic outcomes tend to achieve better non-economic results as well. For example, between 1989-2001, energy efficiency (GDP per kilogram of oil equivalent) -- an important indicator of environmental impact -- had increased from 2.5 to 3.9 in Poland. In Russia, it rose from 1.5 (1992) to only 1.6 and, in Ukraine, it decreased from 1.6 in 1992 to 1.4 in 2001. Life expectancy has increased in Central and Eastern European countries, while it has declined in most ex-U.S.S.R. countries. For example, life expectancy rose from 71 to 74 years in Poland between 1990-2002, while it declined from 70 to 68 years in Ukraine."
"Countries that catch up with reforms tend to catch up with growth as well. Take Armenia, which has radically enlarged the scope of economic freedom and brought its tax/GDP ratio to low levels, while strengthening fiscal discipline. Its GDP has grown 70% since 1996. This may be another indication that the low-tax model is more conducive to rapid economic growth than are systems with the extensive budgetary redistribution typical of larger Eastern European countries.

Better economic outcomes tend to be associated with better non-economic ones because some reforms are crucial to both. For example, market-oriented reforms sharply increased the overall efficiency of the economy and that both boosted economic growth and reduced environmental pollution. The introduction of the rule of law was important both for long-term development and for the enforcement of environmental legislation. Economic liberalization not only stimulated growth, but also made healthier food more available and relatively cheaper."
We dare to hope that the demonstrated success of free market, low tax policies in the Eastern European countries will turn the rest of the EU toward the path of economic growth rather than redistribution and stagnation.
"The common features of the "miracle countries" include low tax-to-GDP ratios due to a lack of extensive welfare states. This tends to increase labor supply and promote private savings. Growth leaders in the post-communist world which have achieved low tax-to-GDP ratios, in other words, should be encouraged to keep those ratios. An extensive welfare state crowds out the voluntary forms of human solidarity, and -- especially in poorer economies -- can obstruct economic growth. This is a warning to those poorer economies which have now much higher public-spending-to-GDP ratios than Sweden, Germany or France did when they had similar income per capita."
Balcerowicz has to be diplomatic in discussing the anti-growth policies of "Old Europe," but we we don't. Sweden, France and Germany will continue to suffer low-to-no growth and high unemployment as long as they rely on the failed, welfare state model and the high taxes it always requires. We think the Germans, in particular, will eventually realize this and undertake the needed reforms, but until then the EU will have to rely on the leadership of Poland and the rest of "New Europe."

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