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MAY 10, 2004
Poland And The EU Will the dynamic Poles energize Europe or sink into a bureaucratic, slow-growth trap? Early on the morning of May 1, Polish Prime Minister Leszek Miller will hoist the European Union's blue flag with gold stars above the arched doorway leading to his vast 19th century office building. Fifteen years after casting off communism and embarking on a process of wrenching economic change, Poland is finally joining the EU -- the ultimate confirmation that it is now a mature, liberal democracy with a dynamic free-market economy. "This is a turning point in our history," says Miller, a former Communist. "At last we are rejoining the West." Poland is by far the largest of the 10 primarily Central and Eastern European countries that will become members of the common market on May 1. With a population of 38.6 million and a gross domestic product of $230 billion, it accounts for over half of the newcomers' population and 41% of their total GDP. To many Western politicians and executives, bringing Poland into the fold is what EU expansion is all about. "Enlargement without the Poles would be unthinkable," says German Chancellor Gerhard Schröder. What happens in Poland will determine whether history will judge enlargement a success or a failure. By dint of its size and the forcefulness with which it has so far defended its interests in Brussels, Poland has something of a leadership role in Central and Eastern Europe. If the country learns to play a constructive part in decision-making and continues growing fast economically, it could help reenergize the EU, which has lost much of its vitality in recent years. Poland's GDP growth, almost 6% this year, is decidedly brisker than anything the old EU has to offer. Reflecting that success, the Warsaw stock index has soared more than 70% in the past year. But there are two Polands vying with each other today, and which one prevails will determine the success of Poland's EU experiment. One is the Poland of scrappy entrepreneurs, hardworking, well-educated factory hands, and eager foreign investors who have poured around $70 billion into the country in the past 14 years. This is the Poland that could give Europe a shot in the arm and shake up things in Brussels -- by forcing the EU to meet sharper competition from the new members. The other Poland is a quasi-dysfunctional political system grafted onto a communist-era welfare state and form-happy bureaucracy. This is the Poland that makes applicants wait up to 230 days to set up a business. The Poland with the biggest budget deficit, as a share of GDP, in Europe (it could hit 7.5% this year). The Poland that cannot even build a decent road from Warsaw to Gdansk. "It's hard to imagine anything worse than the Polish bureaucracy," says Piotr Bielski, an economist at Bank Zachodni WBK in Warsaw. The idea of this overbearing system merging with the faceless bureaucracy in Brussels makes many informed Poles worry whether they can keep up their record of growth and transformation. "The EU offers a chance for us, but it gives no guarantees," says former Finance Minister Leszek Balcerowicz, who now heads the National Bank of Poland. There are precedents for a happy entry into the EU from which Poland is trying to learn. Spain boomed after joining in 1986 because successive governments spent the funds they received from the EU shrewdly, restructured state finances successfully, and continued to liberalize and deregulate the economy. The results were rapid growth, rising living standards, and, after a period of painful restructuring, lower unemployment. Spain's per capita GDP is now about $22,500, almost 90% of the EU average. Polish GDP per capita, in contrast, is less than $6,000. "If we could do what the Spanish did, I'd be very happy," says Janusz Onyszkiewicz, senior fellow at the Center for International Relations in Warsaw and a former Defense Minister. But Poland could just as easily go the way of Greece, which wasted billions in EU subsidies on propping up state-owned companies. The Poles know the economic challenges. But they see EU membership as a way to reclaim their historic place at the heart of Europe. Although Poland ceased to exist as a country for more than 120 years after being divided up among Russia, Prussia, and Austria in 1795, it has traditionally been a powerful, creative force in the Old World. Poles still proudly recite their countrymen's historic and scientific achievements. Europeans thought the earth was the center of the universe before the great 16th century astron- omer, Nicolaus Copernicus, a Pole from Torun, proved otherwise. When Western civilization was threatened by Turkish and Tatar invaders in the late 1600s, Polish King Jan III Sobieski came to its rescue with an army that destroyed the Ottoman forces at the Battle of Vienna in 1683. The first woman to win a Nobel prize was Poland's Maria Sklodowska Curie, who discovered radium in 1898. "Poland is returning to the mainstream of Western Europe by joining the EU," says George Swirski, a director for Central Europe at Advent International Corp., the global private equity firm that has recently moved into the Polish market. "That's something that resonates in the Polish soul." SHOCK THERAPY. It was the chance to rejoin the West that made the struggle against communism -- and the painful sacrifices required to restructure the economy after its collapse -- worthwhile. "Our standard of living fell, and unemployment rose," says Marlena Malecka, a Warsaw secretary who has been unemployed twice -- once for 10 months and once for 6 -- since Balcerowicz launched a shock-therapy economic transformation program in 1990. "But we put up with it because we knew it was needed to bring us back to the West, where we belong." Optimists hope Poland will become an economic and political powerhouse in the expanded EU, which will have 25 members as of May 1. Poland outperforms old-line Europe on many economic measures beyond its brisk growth rate. Its average labor costs, at $5.35 per hour, are less than a sixth of Germany's, giving it a huge edge in attracting manufacturing jobs. Productivity is expected to rise more than 3.7% this year, over twice the existing EU average. Jacob de Tusch-Lec of Merrill Lynch & Co. (MER ) in London thinks taking in Poland and its fast-growing neighbors could radically change Western Europe. "So far, the focus has been on how the West will transform [the newcomers]," he says. "But maybe this is to miss the point." Poland is likely to shake up EU politics, too. Some executives predict the Poles will bring fresh thinking and new ideas to Brussels that will liven up the staid European bureaucracy and shift the EU's center of gravity away from the Paris-Berlin axis. Although its government has yet to tackle its own budget problems, Poland, along with the other Central and Eastern European newcomers, is expected to support British-style, liberal economic policies at the EU level. "The European Commission will be confronted with a new way of thinking," says Michael Rogowski, president of the Federation of German Industry. And growing competition from low-cost but increasingly productive Polish manufacturers will ratchet up pressure on companies in the existing EU to restructure and cut costs. Polish companies were given an extra boost in January, when the government cut the corporation tax from 27% to 19%. "A new wind is blowing that will lead to more competition in Europe," Rogowski says. Accommodating Poland in the EU club, though, won't be easy. Forty years of communism have generated a different set of policy priorities and a different mind-set. That's a key reason why the country is ardently pro-American, something that disturbs France and Germany. It is also prepared to fight hard to defend its interests. Last fall it refused to back the proposed European Constitution because it would have cut Poland's voting power in the EU Council, the most important decision-making authority in the EU. That, too, irked France and Germany, which have dominated policymaking. The big worry is that the enlargement experiment could end up a mess, characterized by slower, more rancorous decision-making in Brussels and resentment and distrust between the existing and new members. Just as Poland is joining the EU, its own political situation is in disarray. Miller is scheduled to resign on May 2, the day after Poland's accession, in a belated response to the Mar. 27 decision by 21 members of Parliament to leave his Democratic Left Alliance and form a new party. For months analysts had been expecting the unpopular Miller, who has presided over rapidly rising unemployment and a widening budget deficit, to go. His Democratic Left Alliance, which rules in coalition with the Labor Union, has been weakened by allegations of corruption, accusations that it is mishandling the economy, and squabbles with its coalition partner and dissident party members. But Miller's departure will add to the political uncertainty. "Poland needs a stable government that will reform public finances, slash red tape, and make sure the transfers from Brussels are used to maximum benefit," says Richard Mbewe, chief economist at Warszawska Grupa Inwestycyjna, a foreign exchange trading company in Warsaw. "But I am not convinced it will get one." That could well prove to be one of Poland's biggest problems, since any new government that is formed will struggle to push through radical cuts in state spending and foster sustainable growth. One rising party, Samoobrona, even wants to reverse parts of the reform process and reexamine the sale of state companies to entrepreneurs and foreigners. In the end, the results of enlargement will be measured primarily in economic terms. On one level, the Poles have done a remarkable job getting ready for entry to the EU. After slowing to a virtual standstill in 2001-02, the economy is growing faster than most pundits predicted, driven by the weak zloty and rapid rises in productivity. Exports have soared to new records as the value of the currency has fallen against the euro. Industrial production was up 18% year-to-year in February on the back of strong demand from abroad. At the same time, the structure of Polish exports has changed for the better. Coal, sulfur, and coke now account for just 4.5% of all exports, compared with about 18% in 1990. Machinery, cars, ships, and home appliance exports have grown strongly. The number of Polish-made Fiat, Opel, and Volkswagen cars sold in the EU was 69% higher in January and February this year than in the same period of 2003. Some 57% of exports are produced by foreign-owned companies, which shows how investment from abroad is stimulating the economy. EAGER BEAVERS. Many companies have dramatically boosted productivity in recent years. Five years ago, Polish workers produced just 40% as much as their EU counterparts. Now the figure is close to 50%. Makers of household appliances, furniture, auto supplies, and steel have improved international competitiveness. Take PKN Orlen, the country's largest energy company. Once a byword for inefficiency, it has been transformed by CEO Zbigniew Wrobel, who has streamlined the management structure, cut costs, and given employees individual performance targets. In 2002, PKN Orlen bought 495 gas stations in Germany and is now acquiring petrochemical company Czech Unipetrol. Meanwhile, Poles are proving eager entrepreneurs. More than 1.5 million small and midsize companies have been formed since the collapse of communism. "Drive across the border into Poland, and the number of billboards advertising the products of small companies is really astonishing," says Dariusz Kociolek, CEO of Bolix, a thriving construction products company based in Zywiec, a town in the south of the country. "Give Polish entrepreneurs a chance, and they'll do O.K." Among the success stories are Air Polonia and Kross Bicycles. Founded in 1990, Kross is now the No. 2 bikemaker in Europe. Delphia Yachts exports more than 90% of its motorboats to the EU. Last year info-tech company ComArch boosted sales of software and systems 30%, to $65 million. Joining the EU should give Poland's self-starters a big long-term boost. To be sure, the Polish economy is already fully integrated into the EU's, and it has been wide open to foreign competition in most sectors for years. But the few remaining tariff barriers -- mostly in agriculture -- will be swept away on May 1, giving Polish farmers unfettered access to the EU's single market. That could triple food exports, to $12 billion, over the next three years. At the same time, customs formalities will be abolished, making it far easier to transport goods to the existing EU. "It can take 10 hours and more to get across the German border, given all the queuing and paperwork," says trucker Dariusz Wojtyna, who regularly drives on the Katowice-Frankfurt route. "Now I'll just have to show my identity card -- so I should be through in a few minutes." Free access to the single market could boost trade up to 4% a year, say economists. Poland also will be entitled to a range of cash handouts from Brussels after May 1. According to the European Commission, the country will get between $14 billion and $16 billion by 2006 in farm subsidies, grants to encourage industrial restructuring, and other payouts. Analysts predict that transfers from Brussels could add as much as 1% a year to GDP growth rates for the foreseeable future. Education will be one of the biggest beneficiaries of the structural funds. That's important because increased spending on education contributed to Spain's and Ireland's success in the EU. On top of that, foreign investors are expected to pump more money into Poland once it finally joins the EU. In the past 10 years, Poland has attracted more foreign direct investment (FDI) than any other country in the region. But on a per capita basis, it is near the bottom of the league, with just $1,277 per inhabitant over the decade to 2002, compared with $1,888 in Hungary and $3,494 in the Czech Republic. And the country is increasingly vulnerable to competition from other countries, including China. It attracted $10.6 billion of FDI in 2000 but just $6.4 billion last year. British carmaker MG Rover, which is negotiating to buy the Daewoo-FSO auto plant just outside Warsaw, says it will go to China instead if it doesn't get the deal it wants. This year should be better for foreign investment. Whirlpool Corp. (WHR ) has decided to invest $120 million in a new factory to make kitchen ranges in Wroclaw, an industrial city in the southwest. Italian white-goods producer Merloni Elettrodomestici and Spanish appliance maker Fagor also recently decided to invest in Poland. Government officials say FDI could reach $12 billion this year. Private equity houses, such as Advent International, which recently paid $40 million for Bolix, are looking for deals. Foreign investors, though, increasingly balk at Poland's bureaucratic hassles. Companies must file tax returns every month, and decision-making can be excruciatingly slow. Drawn-out negotiations with the government over the sale of steelmaker Polskie Huty to Anglo-Indian steel giant LNM Group, may have been a key reason Poland lost a project with Korea's Hyundai Motor Co. in March. Poland hasn't won any of the three largest investments by carmakers in the East in the past three years. Hyundai and PSA Peugeot Citroën opted for Slovakia because of its low taxes and better infrastructure, and Toyota went for the Czech Republic. Foreign investors hope this will be a wake-up call. "This country has so much to offer, it was really criminal that they lost the car plants," says Mark Bardsley, CEO of Provident Polska, a subsidiary of British consumer credit company Provident. Poland will rue the day it lost those plants. It needs all the jobs it can get. Despite rapid growth in the past two years, 20% of the workforce is unemployed because large companies keep laying off workers to improve competitiveness. That does wonders for productivity but boosts jobless rolls. Poland hopes new businesses will soak up the workers soon. But in the meantime, the Treasury is paying out billions a year in jobless and disability benefits. Yet for every discouraging episode, there's another moment that gives Poland hope. Gillette Co. (G ) just decided to concentrate all its European manufacturing and distribution in Lodz: The low costs, high efficiencies, and great labor force were just too attractive to pass up. As it rejoins Europe, Poland has a fighting chance.
 By David Fairlamb, with Bogdan Turek, in Warsaw
BW MALL
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