Poland: Rising Star Of Europe

The fate of most civil engineering grads in communist-controlled Poland was a 6 a.m. to 2 p.m. job in a drab state factory. Not for Jacek and Irena Szot. In the 1970s, when private ventures of fewer than 15 people were allowed to go it alone, the fewlyweds first tried making furniture and then growing flowers in Piaski, their village in eastern Poland. In 1983, they bought some rickety equipment and began stamping out rubber auto parts.

This one paid off. Jacek made dies, Irena managed the books, and they built a $2 million auto-parts business. They sold 49% to foreign venture capitalists in 1992, a move that honed their financial skills. Now, from a blue-and-white shed that farmers in horse-drawn carts can barely spot between wheat fields, the Szots ship to factories across Poland. Some of their parts cost just 10% as much as those from Western Europe. The Szots aim to hit both price and quality levels demanded by General Motors Corp. "We're not afraid. We can meet their standards," Irena says.

Such confidence echoes throughout the country these days. After a difficult start, Poland is emerging as Europe's star performer. Economic growth, at 6.5% this year, is the most robust in Europe. Unemployment peaked in 1993 and, at 14%, is heading down. Inflation, while high at 28%, is sharply below earlier levels (charts). Privatization is moving ahead, and even foreign investment, long lagging behind that in neighboring countries, is picking up steam.

As Eastern Europe's largest country, Poland has the best chance of reaching developed-nation status, many believe. After restructuring its debt in 1994, it has returned to international capital markets and earned an investment-grade rating. Its banking system, long mired in communist-era problems, is transforming itself into a force for rebuilding industry. With a population of 40 million and a central location between West and East, Poland has advantages over its Eastern neighbors as a market and a site for investment. Indeed, as investors from the U.S. to Korea pile in, Poland is becoming a carmaking hub.

The troubled nation has endured one of the most traumatic transformations in the region. Unlike in neighboring countries, early reformers threw open borders, cancelled price controls, devalued the currency, and shackled the budget. Many scoffed that such shock therapy would wreck the economy or detonate a backlash that would jeopardize reform. Instead, the gamble paid off. Economies to the east now regard Poland as a model for growth. For Western European corporations, the country beckons as a low-cost supplier and a potential partner. But some fear it is also becoming a serious competitor--as investment and jobs move eastward.

DYNAMISM. Poland is pulling ahead thanks to its thriving corporate sector. More than 2 million private companies sprang up in the free-for-all after four decades of communism ended in 1989. Spurned by state banks and unable to tap the tightly regulated stock market, most entrepreneurs have financed their initial growth by plowing profits back into the business. Now, more successful companies are turning to commercial paper, floating bonds on the Euromarkets, or winning the backing of foreign venture capitalists. "There's a new class of managers," says Barbara Lundberg, Warsaw director of the Polish-American Enterprise Fund.

Like their more aggressive Asian counterparts, Polish managers are increasingly measuring themselves against global competition. From mom-and-pop outfits to conglomerates, investments have been geared to streamlining operations to meet world standards. Thanks to healthy productivity gains of up to 15%, exports have surged 37%, to $16.6 billion, this year, despite the rising value of the zloty. More than 200,000 companies now export from Poland, up from just 200 five years ago.

POPULIST TILT? Much of the dynamism doesn't show up in statistics. Analysts figure the underground economy represents 25% of gross domestic product. Just take a trip to the Western border, where traffic jams last for hours--as Germans line up to buy gasoline, clothing, and household goods at half what they pay at home. Such trade added $4 billion in mystery foreign exchange to the Polish economy this year. Economists worried, at first, that Poland was becoming dependent on "hot money." But its foreign currency reserves, now at $14 billion, are strengthening the once-feeble zloty even against the German mark.

Of course, there are many rough spots. The state controls 40% of the economy, and a communist-style welfare system created deficits that make inflation tough to reduce. And in an election year, there's always a chance that political pandering could slow the economy's momentum. As expected, the Nov. 5 first round of presidential elections handed a 35% plurality to Aleksander Kwasniewski, head of the ex-communist Democratic Left Alliance (SLD). Lech Walesa, the electrician-turned-President who led the Solidarity movement that ousted the communists in 1989, ran second, with 33%. The two face off on Nov 19.

The risk is that the new regime will have a populist tilt. Walesa has already pulled stunts such as vetoing reform of the pension system to garner votes, even though his veto was overturned by the Parliament. Kwasniewski, who prefers to be called a social democrat, advocates market reform. Yet he may feel obliged to cater to pensioners and others who feel shoved aside by the new Poland. Already, many people fear that too many former communists hold government posts and that such cronyism could grow if Kwasniewski wins.

"ECONOMIC TIGER." But the election outcome won't be a real setback to economic reform. A core of technocrats in the Finance Ministry and central bank are committed to keeping inflation down and reducing deficits. They have done so even through two years of ex-communists' controlling Parliament. Last summer, they engineered Poland's return to the markets--with a $200 million Eurobond that was oversubscribed enough to raise $250 million. Even Leszek Balcerowicz, former Finance Minister and architect of the shock therapy reform, agrees his principles have been kept intact. "Poland has proved it can be an economic tiger," he says.

Investors finally seem convinced. From 1990 through 1994, foreign direct investment in Poland totaled only $5 billion, compared with more than $7 billion in tiny Hungary. Not only did the economy look rocky but Poles were also nervous about too much foreign influence. In just the first half of 1995, however, a further $1 billion in foreign direct investment entered the country. Susanne Gahler, economist at J.P. Morgan in London, predicts that foreign direct investment will grow an additional $3.5 billion by the end of 1996.

The stock market, with a capitalization of $4 billion, is picking up, too. From its low point in March, it has surged 40% this year. Gahler expects portfolio investment to soar to $700 million by yearend, up from $75 million in 1994.

Investment is on the rise because more foreign companies see the potential of Poland's domestic market and its attractiveness as a supply base for both West and East. PepsiCo Inc., for example, is pumping in $500 million to expand its three divisions in Poland: soft drinks and bottling, fast-food restaurants, and snack foods and chocolates. The company employs 6,600, up 90% from two years ago. A number of French and German retail chains have also been quietly positioning themselves to supply Poland's rising middle class.

Korea's Daewoo Motor Co. chose Poland as its beachhead for auto production in Europe. It recently beat out GM by offering more than $1 billion to take a 70% stake in an auto plant near Warsaw. In August, Daewoo also took over a sprawling van production factory in Lublin. By 2000, it will make 40,000 vans a year, half of them for export, as well as assemble 50,000 Daewoo passenger cars.

SHREWD OPERATORS. At the sprawling Lublin plant, where some workers still live in company dorms, many fear a tougher pace under the Koreans. All 6,000 of them are likely to be sent to Seoul for training. "Our workers are as good as the Koreans," says Wieslawa Karykowska, head of the Solidarity trade union at the plant. To build up goodwill, Daewoo has pledged to avoid layoffs for the first three years, and it is giving a raise to all Lublin workers, whose $290 monthly wages are lower than the national average.

Another wave of foreign investment will come as Poles begin attracting capital for infrastructure projects such as toll roads, which are crying out for private financing. The electrical-power grid alone needs up to $1 billion to modernize, estimates David Hunter, Poland manager for ABB Asea Brown Boveri Ltd. So far, investors have been wary because the government hasn't backed projects with guarantees. But it's now working on a law that would protect investors if there are strikes or major political problems.

Meanwhile, ABB has a big order backlog for businesses ranging from turbines to robotics, and it expects annual sales of $1 billion in Poland by 2000, up from $260 million in 1994. The company is using Poland as a platform to expand to the east and west. ABB's workers in St. Petersburg, for example, are trained by engineers from its unit in Poland.

But foreign companies aren't the only engines for Poland's industrial revival. Across a broad swath of Polish industry, several dozen privatized companies are making a comeback. Agros, a food broker, is getting into processing and distribution. Order books are full at Rafako, a maker of steam pipes and water boilers, as Poland renovates its energy-production facilities. Industries such as glassmaking, heavy manufacturing, and tiremaking are posting huge profit gains after investing in computers and manufacturing technology to boost quality for both the domestic and export markets. Even many state companies are profitable.

Corporate Poland is filled with shrewd business types such as Roman Kluska. Even in the old days, the government couldn't control him. As deputy director of a state-owned company that repaired cars and trucks in southern Poland in the mid-1980s, he scrounged the parts to assemble and sell cars, too. Irked that the cost of energy and materials exceeded the value of the company's output, he split the plant into 20 units and promised workers a share of the gains. Profits soared, and salaries shot up, but the communist workers council didn't like it--so they sacked him.

With just $12 in his pocket, Kluska and his wife founded computer maker Optimus in his parents' attic in 1988. As the communist regime unraveled, Kluska leveraged family property in southern Poland for a $25,000 loan at 20% interest a month. Now, he holds 35% of the Polish market with computers assembled from Intel chips, Samsung monitors, and Microsoft operating systems, sold through 1,100 outlets. After hiring top Polish engineers to add features such as portable hard drives, he says he can still undercut imports from Asia by 20%.

NEW AVENUES. Kluska is a hero in the town of Nowy Sacz, where he employs 350 workers. He shuttles from there to Warsaw weekly in his chauffeur-driven Mercedes S-class sedan. Like many Polish entrepreneurs, 41-year-old Kluska pours his cash into new lines of business, such as licensing cash-register technology from Japan to build low-cost models in Poland. Pretax profits are 9% of $95.5 million in sales. "I never dreamed we could abandon the old system so quickly," he says.

In thriving Warsaw, the unemployment rate is only 1%. In the countryside, things aren't as good, but even there, those who were initially hurt by reform are finding new ways to make a living. Bogdan Zajac, 40, lost his job as a carpenter at a state agricultural cooperative when the reforms hit. But he and his wife, Malgosia, had slowly accumulated land in the eastern village of Gardzienice, where they grow wheat, sugar beets, and potatoes. Despite long hours and troubles with middlemen who don't pay on time, they have built a secure life for their three children. "Times are easier now for people who are enterprising," says Zajac, over vodka and sausages in their kitchen.

As it continues to reshape its economy, Poland faces the classic conundrum: how to maintain robust growth without triggering higher inflation. Policymakers will have to attack three areas: privatization, reform of the pension scheme, and development of banking and finance.

Poland has dragged its heels on privatization. A program to sell off hundreds of companies en masse in 1991 was delayed for four years by political infighting and conflicting agendas within the right and the left. A watered-down version of the plan, putting 413 companies under the control of 15 management funds, got off the ground last summer. Yet more than 4,000 factories are still in state hands. And loss-making industries such as coal and steel desperately need to be restructured.

Yet privatization is crucial to boosting productivity. Although many companies began to shape up after the government eliminated subsidies in 1990, they need the discipline of demanding shareholders to make their exports competitive. Economists are telling both presidential candidates that they will have to speed up the sell-offs if they want to keep growth above 6%.

HOT POTATO. But the knottiest problem facing Poland is its giant safety net. Social spending has surged from 8.4% of GDP in 1988 to more than 20% now. Some 9 million pensioners soak up 16% of the budget--a figure high even by European standards, because lax requirements allow many people to retire in their 40s. After ad hoc solutions such as slashing pension spending by 10% a year for three years, the government is now working on a plan that would combine state and private contributions to the system.

It's a political hot potato. Pensioners are suffering most from Poland's economic transformation. Soup kitchens have popped up to help them. Many people, especially in the countryside, feel they were better off under the old regime, when they could build houses with cheap loans and the government bought all their grain crop.

On a crisp autumn morning at the horse market in the village of Piaski, for example, resentment quickly bubbles up. Farmers leading draft horses through the mud glower at a well-dressed middleman buying horse meat for restaurants in Italy--and driving a hard bargain. The reformers "have thrown this country to the dogs," says Boleslaw Nucia, 68, who wants to sell his filly but not at such a low price. Even though he receives a $123 monthly pension, he needs extra money for a tractor to work his 11-hectare farm. "At least the communists gave us the right to a house, a job, and food on the table," he adds.

To continue modernizing the economy, Poland must also overhaul its banking system. While state-owned banks have been cleansed of millions of bad loans, they still have been wary of lending to Poland's cash-hungry private companies. Instead, they use the bulk of their cash to buy up government debt--a safer bet, and critical to help fund social spending.

Now, the banks seem poised to take a more aggressive role in financing the economy. Foreign banks, eager to lend to Polish companies, are strengthening their forces in Warsaw, heightening competition. Citibank and several Dutch and Austrian banks, which have long been active in the market, have expanded from serving multinationals to attracting Polish exporters as clients. In recent months, several German banks were granted licenses or bought stakes in troubled Polish banks, anticipating a flood of midsize German companies into the Polish market.

"TOO-STRONG ZLOTY." Poland's banks are also starting to put together foreign debt offerings for fast-growing companies. The mortgage business is also on the upswing as newly affluent Poles build new houses. "There's big potential in mortgages, with the younger generation a driving force," says Slawomir Sikora, vice-president of the management board at Powszechny Bank Kredytowy.

Can Poland keep up the pace? One fear among international lenders is that Poland could be done in by its own success. As exports surge and foreign money flows in, policymakers will have to cut deficits more quickly or risk an inflationary spiral. Others worry that a strong currency will stifle exports, the heart of Poland's growth machine. "I never imagined our problem would be a too-strong zloty and huge foreign reserves," says Ryszard Kokoszczynski, a director of the National Bank of Poland.

Few would have guessed back in 1990, when prices soared and living standards plunged, that Poland would have come so far. If growth continues, it's likely that Polish corporations will soon be making their mark throughout Eastern and Western Europe. Entrepreneurs such as Jacek and Irena Szot are just getting warmed up.

Behind Poland's Turnaround

The shock-therapy program that Poland launched in 1990 has touched off an economic revolution. Here are the key elements:

EXPLOSION OF PROFITABLE PRIVATE COMPANIES: With wages flat and productivity rising, thousands of new companies have plenty of cash to finance growth.

SURGING EXPORTS: Companies are gearing their output to European and world markets--as exports rose 37% this year. Some 200,000 companies are exporting, up from just 200 five years ago.

BENCHMARKING AGAINST ASIAN TIGERS: Polish companies, taking advantage of falling labor costs, are striving to match the prices of companies in countries such as Malaysia, Singapore, and Taiwan.

VIGOROUS BORDER TRADE: Flourishing towns on Poland's eastern and western borders are bringing in some $4 billion in hard currency a year.

RESTRUCTURING STATE CORPORATIONS: With subsidies eliminated, many outfits have laid off thousands and have become marginally profitable, thus reducing the burden on the state budget.


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