Economic Survey of Poland 2010: Preparing for euro adoption

 

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The following OECD assessment and recommendations summarise chapter 2 of the Economic Survey of Poland published on 8 April 2010.

 

Contents

While euro adoption could speed catch up, policy makers should prepare the economy to contend with the repercussions…

Entering the euro area should enhance trade and financial integration, intensify competition and accelerate convergence in living standards. Reduced transactions costs, the disappearance of currency risk and lower interest rates will all tend to support economic growth. However, the potential gains are not something the authorities can take as given: they must first design the institutional settings that would allow the realisation of these gains and ensure smooth management of the significant impacts of the whole process. In November 2009, the Polish authorities established an organisational structure for euro adoption. Preparing the ground through implementing a series of key structural reforms would enhance real and nominal convergence, thus making an eventual announcement of the date for adopting the euro more credible. Setting another adoption date prematurely risks damaging the authorities’ reputation.


… implying a need to develop alternative adjustment mechanisms…

Given the level of the remaining income gap vis à vis the euro area, the substantial room for further real and nominal convergence raises important issues. Economic catch up tends to be associated with real exchange rate appreciation, thus creating inflationary pressure in a monetary union. Lower real interest rates will boost investment and domestic durables consumption, providing an important demand stimulus that will attract foreign suppliers and investors, leading to a deterioration of the trade balance and possibly a distorted allocation of resources. Closing off the possibility of managing specific shocks via interest  or exchange rate changes puts fiscal policy at the centre of macro stabilisation, while it is up to structural policy changes to ensure the economy can better absorb economic shocks.


… through a more transparent and effective rules-based counter cyclical fiscal policy…

Fiscal policy therefore needs to be made more counter cyclical: at a minimum the working of the automatic stabilisers should not be obstructed and possibly enhanced by measures that would increase progressivity in the tax/benefit system. A rule specified in terms of a ceiling on the structural general government deficit consistent with the medium term objective of the Stability and Growth Pact of a deficit no greater than 1% of GDP could help achieve this by, for example, preventing a pro cyclical easing being masked by exceptional revenues during an expansion. A complementary expenditure rule with multi year limits on the value of general government expenditure, excluding cyclically sensitive items (in particular, unemployment benefits), would strengthen the government’s capacity to stabilise the economy. The creation of an independent fiscal council to monitor and assess the implementation of these rules would enhance the overall credibility of the fiscal framework. Indeed, implementing such a deficit rule would require an analysis of the cyclical and structural components of the overall deficit, which should be kept at a safe distance from potential political pressures, as such analysis raises complex technical issues. Fiscal policy also has to be carried out more transparently. Objectives and communication should not apply only to the state budget, but refer explicitly to the Maastricht definition of the general government balance. Likewise, the consolidated public debt should be monitored based on the same definition as Eurostat. In particular, the National Road Fund, which is being increasingly used to finance the heavy transport infrastructure needs and whose debt might already amount to more than 2% of GDP in 2010, should be included in the national definition.


… through structural reforms in product and labour markets…

More competitive product markets and greater flexibility in labour markets would enable faster price adjustments and reallocation of resources in response to shocks. Stringent product market regulations are restraining competition in various areas, including network industries, retail distribution and professional services. Regulated prices that are below cost recovery levels, especially in utilities, should be corrected and efficient regulation developed to stimulate the needed investments to modernise these sectors. Public ownership in the potentially competitive segments of network industries (electricity, gas, airline, rail and post) should be phased out. In retail distribution, the administrative costs related to the registration and issuance of licenses and permits should be reduced. Finally, regulations on educational requirements and licensing in professional services raise barriers to entry and should be eased.


Reducing wage rigidities will also facilitate any future need to correct real exchange rate overvaluation. Although the labour market is not excessively rigid and the wage bargaining system is largely decentralised, the government remains heavily involved in minimum wage negotiations. Since 2005, the minimum wage has increased by 14% relative to the average wage, leading the ratio between them to exceed the OECD average. Policy makers should refrain from further raising the minimum to average wage ratio and remove the rule that it has to reach 50% in the future compared with 40% in 2009, since the current level may already be harming employment prospects for low skilled workers. Also, given the strong regional disparities in unemployment rates and low internal labour mobility, the authorities should consider introducing differentiated regional minimum wages based on local labour market conditions. Also, while some laudable measures are being taken to deepen the rental market, which will help to stimulate regional labour mobility, more could be done in this direction by continuing to exert pressure on local authorities to develop urban zoning plans.


… and a need to contain the risks of a boom-bust cycle

In the run up to the euro, real interest rates might fall significantly below their natural levels, threatening to destabilise the economy, as the experience of other EU countries suggests. Too low interest rates and a rapid discounting of the resulting permanent income gains by households provide incentives to raise spending significantly, possibly triggering a credit boom through the expansion of consumption and housing loans. Moreover, such circumstances, combined with positive market sentiment and rising inflows of foreign investment, could result in a strengthening of the currency that may be too rapid relative to fundamentals. In turn, this would harm external price competitiveness and, at the same time, distort the allocation of resources towards construction, real estate and other sheltered activities, slowing aggregate productivity gains if competition in these non-tradable sectors is limited. This process could be magnified by the impact of EU transfers if the decision is taken to adopt the euro before implementing the fiscal and structural reforms discussed above.


Some additional changes might offset these destabilising effects of a boom bust scenario. These include policies to promote competition in services. Beyond those, macro prudential regulations could be strengthened to contain uncomfortably high credit demand and supply. This could be achieved through both dynamic provisioning for banks and higher capital requirements, which would reduce the pro cyclicality of credit supply. The probability of a housing and/or consumption boom could also be reduced by: introducing limits on both loan to value and loan to income ratios; removing support for housing demand, such as the reduced VAT rate on new purchases and the tax breaks applying to mortgage interest rates; and by ensuring vibrant competition in construction. Moving property taxes to a market value basis could lead to a useful increase in receipts while providing more efficient market signals to construction activities. However, if all these changes prove to be insufficient, fiscal policy would need to be more pro active.


Public debt and fiscal deficits
As a percentage of GDP

Source: OECD, OECD Economic Outlook 86 Database.
 

How to obtain this publication

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations

The complete edition of the Economic Survey of Poland is available from:

 

Additional information

For further information please contact the Poland Desk at the OECD Economics Department at eco.survey@oecd.org.

The OECD Secretariat's report was prepared by Hervé Boulhol and Rafal Kierzenkowski under the supervision of  Peter Jarrett. Research assistance was provided by Patrizio Sicari.

 

 

 

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