The seeds of every economic downturn are clearly visible at the height of each economic boom.
Poland’s economy is roaring ahead with year-on-year growth around 5%, inflation at 2% and unemployment at a record low (fourth lowest in EU and lower than in the UK). Żyć i nie umierać!
What could possibly go wrong?
We are midway through a business cycle. Wages and raw materials are pushing up prices much faster than most businesses planned for. Right now, country managers of foreign investors here in Poland are doing what they can to keep a lid on costs, but they’re fighting a losing battle. Passing on higher costs to customers? If they can, they will. But their business customers have business plans and budgets too. Eventually, the additional costs of materials and wages will be passed on the end-user, the consumer. It’s inevitable. This is most visible in the construction sector. Say you agreed 18 months ago to build a small shop for 1,000,000 złotys. Your general contractor has budgeted for a 10% profit margin taking labour and material costs into consideration. Suddenly, the contractor cannot find workers willing to work for the money allocated in the budget, nor can building materials be bought for the prices assumed when the budget was being drawn up. So corners are cut, deadlines are missed, profits squeezed, shareholders’ dividends reduced… and at the end of the day, the building will cost more than the million in the budget. Someone has to pay.
The next round of business plans and budgets will take these new realities into consideration. Up go the prices; Poland is quickly ceasing to be seen as a cheap country. Good – but… if growth is to continue, it must be predicated by something other than low costs. Higher value added is the answer – but how? IT is part of this. Newcomers to the Polish market from the UK, US, Japan and other rich countries are setting up IT hubs, drawn by the high reputation that Poland’s programmers enjoy. But there are not enough of them… In 2006, Poland produced 20,000 IT graduates. By 2016, that figure had fallen to 13,000. Demographics is the reason – demographics is a major problem for Poland. The number of young people entering the labour market will continue to fall systematically for the next six years, before a brief respite (the ‘echo boom’).
Avoiding the middle-income trap.
Poland has grown rapidly thanks to wise macroeconomic policies over the past (nearly) three decades that harnessed low labour costs to an increasingly globalising economy. As wealth spreads out across the Polish population, foreign investors no longer choose Poland as a location because it’s cheap. Cheap you want is it? Go elsewhere. But a quality, well-educated, highly motivated labour force? Yes. And still cheaper than Western Europe. But no longer six or seven times cheaper; maybe two or three times cheaper. Poland needs jobs of higher value added; IT, advanced manufacturing, healthcare, not simple contact centres or basic metal-bashing.
Full marks to the Polish government for taking action in this area. Poland has stopped being a low-cost labour market where simple tasks in manufacturing or services are carried out by people happy with a steady job for minimal pay. Technology is coming to the rescue. Robots and algorithms will replace people for high-volume repetitive work. But is this enough?
Immigration: returning home from London on Sunday, I popped into the McDonalds at Okęcie airport, where one of the guys behind the counter was Indian and the other African. Both spoke passible Polish. No big deal in London to see such a scene, but a bit of a culture shock in Warsaw. Later, I was in a Shell petrol station on Puławska, where two Indian guys were behind the counter. Double take. For a second, I was back in the UK – but no, this is Warsaw, 2018. My guess is that Warsaw can accept coloured workers much easier than small-town Poland, where racial integration is harder. The number of young people working in restaurants, shops and bars across Poland with a Ukrainian accent no longer warrants attention – it’s become a fact of life; there’s little problem here.
But long term, is the answer more migration or more automation? Depends where…
To return to the middle-income trap thread; if your factory is knocking out millions of pieces all the same (or nearly the same), robots are the way. Industry 4.0, internet-of-things (IoT) is the answer. You’ll need fewer people, though they’ll need to be retrained from mere operators to mechatronics specialists. If your services centre is processing millions of invoices and receipts a year, artificial intelligence will crunch the data faster and more accurately. The question is – will Poland be able to make its own robots and AI solutions, or will it have to import them? If you are making small production runs with a high degree of customisation, robotics and AI will not come to your rescue. You will simply have to pay your people more. Much more. Compare the cost of a haircut in Warsaw and London.
Poles will have much more money in their pockets. What will they spend it on? Fripperies such as foreign holidays and fancy cars – or will they invest in property, upgrading their quality of life with bigger, better equipped kitchens and bathrooms, bigger living rooms, bedrooms…?
Legal reform and foreign investment
Independent courts: This is not a major worry for foreign investors who have come to Poland to make car parts or process food. If the client/customer is in the private sector, cases involving the state are rare. But foreign-owned construction firms – Skanska, Hochtief, Bouygues, Strabag, Ferrovial, Mota Engil – all of whom are heavily engaged in major infrastructure projects for the Polish state – are concerned that court cases between them and the public-sector contractor might not be fairly adjudicated. There is a feeling that courts where the judges take instruction from politicians will be biased against foreign capital; this will dissuade foreign owned companies from taking on public tenders and leaving them to Polish firms. No bad thing per se, but with less competition on the market, the Polish taxpayer will end up paying more for infrastructure projects of lower quality.
Subject of an Economist piece this week, the government’s overt bias in favour of Polish capital over foreign-owned firms has its pluses as well as its minuses. Although generally an economic liberal, I have long seen the sense of keeping Poland’s strategic companies (energy in particular) in Polish hands – for fear of Russia. Gazprom, a gas company with nuclear weapons, is a nasty player and should be dealt with only by Poles who’ve had the right security training and background checks.
But in the broader economy, the impending lesson that the UK is about to get is that foreign capital is by its nature footloose. The entire UK automotive industry, with the exception of Morgan (production: 1,300 cars a year) is owned by German, Japanese, Indian, French or US capital. Screw up the just-in-time supply chain with a hard Brexit, and BMW, Jaguar Land Rover, Toyota, Honda, Nissan, Vauxhall and Ford will move their factories to mainland Europe. British business owners – shareholders and entrepreneurs alike – have sold off much of what it was that made the UK economy so strong in the past. Cadbury’s, BOC, Freightliner, Dulux, Pilkington – formerly British-owned businesses present in Poland, now owned by American, German, Dutch or Japanese capital.
As Poland gets economically more powerful, Polish capital is now making its way abroad in search of higher returns. The acquisition of JDR Cables by TF Kable, or the acquisition of Webster Drives by SKB Drive Tech S.A., Reserved’s flagship store on Oxford Street (where British Home Stores used to be), the ever-growing network of Inglot cosmetics shops across the UK gives me a sense of pride; the question is to what extent the government should get involved on this process.
Social transfers, consumption and the labour market
Anecdotal evidence from some employers in some sectors suggests that many younger women have detached themselves from the labour market having a comfortable existence rearing small children (which presumably was the intention of the government’s 500+ programme). This exacerbates the labour shortage, bumps up public spending, but boosts consumer spending, which is particularly noticeable in rural- and small-town Poland. The danger of 500+ is the temptation of political parties to use the prospect of increasing it as ballot-box bait. Poland has thus far avoided the creation of a benefits-dependent underclass, but this is how it starts.
Focus on education
Education will be the key to Poland’s continued success. OK, there are fewer children at school, but there needs to be more emphasis on science, technology, engineering and maths (STEM). As one factory manager in Rzeszów told me earlier this year: “We need graduates in engineering, not theology.” Vocation schools need to make a come-back. Not every young person has academic ambitions or abilities, and yet with a solid education in craft skills, they can become far more sought after on the labour market than a graduate with a master’s degree in political sciences, history, French literature or indeed theology. Universities that cannot deliver the courses that create useful employees will find it hard to compete as numbers of young people leaving schools continues to fall.
Government needs to join up the work of all the ministries that can make all this happen. Poland needs to become a digital state, replacing paperwork and offices with online forms and smart contracts; taxation can be made so much simpler through digitisation, easier to collect, easier to identify egregious non-payers or abusers of the VAT system. Schools and universities need closer contact with the world of work, with the economy.
I can see inflation letting rip as we move out of one business cycle and into another. Wages, growing at 8% a year, while general price inflation moves ahead at a steady 2%, is not sustainable. Those wages will be chasing a finite number of flats and houses, property prices will rise and not just because of higher material and labour costs. Until the money from the current EU financial perspective is contracted (to the end of 2020) and spent (to the end of 2022 for ‘soft’ projects and 2023 for infrastructure projects), the construction sector will continue to show signs of overheating.
What next? Depends to an extent on the next EU budget (likely to be without the UK’s input), which in any case will be more generous to the poor South rather than on awkward members like Poland and Hungary. Known unknowns? A war with Putin’s Russia (invasion of the Baltics? Escalation in Ukraine?) A trade war with the US? Less likely now, but could change with a single presidential tweet.
For the time being, make hay while the sun shines.
Author: Michael Dembinski