Economic Integration:Poland’s Path to Riches

Edward C. Prescott19 November 2010

20th Anniversary of Poland Chamber of Insurance

Central Europe Catching Up

• 8 European EU that joined in 2004

Percent of U.S. (EU-15 is 70%)

Poland Doing Well

Poland’s Growth in GDP per Person

2008 Q1 6.6%

2008 Q2 6.5%

2008 Q3 5.5%

2008 Q4 3.3%

2009 Q1 1.1%

2009 Q2 1.3%

Key Development Facts

• Prior to 1800, constant living standard that varied little across countries and over time.

• After 1800, living standards began to increase in some countries.

• There was a transition from stagnant income to modern economic growth, which is called the Industrial Revolution.

• With modern economic growth, living standards double every 35-40 years, probably faster.

Explosive Growth Post-1800

Leader's Per Capita GDP Relative to the Pre-1800 level

0

10

20

30

40

2000 bc 1000 bc 0 1000 2000

1

U.S. Per Capita GDP

1880 1900 1920 1940 1960 1980 2000

Source: Maddison

1990

U.S

. $

2,000

32,000

16,000

8,000

4,000

Trend Growthabout 2% per year

Fact: U.S. Overtakes U.K.

GDP per Capita: US relative to UK

1868 79

1888 85

1908 103

1928 123

Source: Maddison

Why Did This Happen?

Answer:

– U.S. became economically integrated because of the dramatic fall in transportation costs – factor of 10

– And because member states had a high degree of economic sovereignty

Poland should preserve its economic sovereignty!

Fact : Original E.U. countries

• Productivity half of U.S. level for the 40 years prior to World War II

• Went from 50% to 100% of U.S. productivity in the 35 years following the signing of the Treaty of Rome in 1957

• Will discuss why the E.U. arrangement fostered this spectacular catch-up

EU-6 Caught Up

Late E.U. Joiners Lost GroundPrior to Joining

1995 Joiners (Austria, Finland & Sweden) and Switzerland Lose Ground

Year

Others Relative

to Original EU

1900 103

1913 99

1938 103

1957 106

1973 96

1983 85

1993 81

Why Is EU-15 GDP per Capita Only 70% of U.S. Level?

Answer: The Europeans have a bad tax system

• The marginal effective tax rate is 60% in Western Europe versus 40% in the U.S.

• If Western Europe reformed its tax systems, it would quickly catch up to U.S.– Don’t need high tax rates for a welfare state

• Mandatory savings and insurance suffice

Predicted vs. Actual Weekly Hours

GermanyFranceItaly

Canada

U.K.

Japan

U.S.Spain

IrelandIcelandNew Zeland

Australia

Denmark

Portugal

Poland

16.0

18.0

20.0

22.0

24.0

26.0

28.0

30.0

16.0 18.0 20.0 22.0 24.0 26.0 28.0 30.0

actual hours

predicted hours

Poland Workers Work Long Hours

Full-Time Workers’ Hours per Year

OECD Average 1766

Germany 1432

Netherlands 1389

United States 1792

Poland 1969

Source: OECD

Poles Retire Early

• This is the reason that hours per person aged 15-64 is not high

• When politically feasible Poland should do more to increase retirement average age

Why Did the Original E.U. Countries Catch Up?

• Answer:

Original E.U. countries became economically integrated in 1957 with the signing of the Treaty of Rome.

Fact : Latin America Is Not Catching Up

Percent of Leader

Why the Failure to Catch-Up?

• Answer: Latin America is not economically integrated.

There Is Hope for Latin America

• Maybe things are changing. Brazil, Mexico, Colombia, and Peru are becoming more integrated with the advanced industrial countries and recently have been experiencing reasonably rapid growth.

• Chile did so early and soon will be one of the rich industrial states.

The Asian Facts

• Some have caught up – Japan, S. Korea, Taiwan, Hong Kong, and Singapore

• Others have narrowed the gap – Malaysia, Thailand, China, and recently India and others

• These countries trade in industrial products

The Asian Facts

• Some have caught up – Japan, S. Korea, Taiwan, Hong Kong, and Singapore

• Others have narrowed the gap – Malaysia, Thailand, China, and recently India and others

• These countries trade in industrial products

• Other still poor Asian countries growing rapidly– They have 40% of the world’s population

Japan, S. Korea, Taiwan, Hong Kong, and Singapore Caught Up

GDP per Capita Percent of U.S. Level

1961 31

1981 58

2001 67

Source: Maddison Population: 200 million

• Empirically – catch-up occurs when an economy becomes economically integrated with the industrial leaders

• By integrated I mean– Produce and trade industrial goods and services– Protect property rights of foreign multinationals – Have multinational corporations

The Degree of Integration Matters

• More integrated, higher relative income

• Less integrated, lower relative income

• An example

Spain

GDP Per Capita Relative to U.S.

Moderately Integrated Before 1930 42%

Not Integrated 1940-54 22%

Moderately Integrated 1965 36%

Becomes EU Member 1981 49.4%

Highly Integrated 2007 61.4%

Set of Industrial Leaders

• Number increased from 14 in 1950 to 32 in 2009

• Early members, Western Europe and its off-shoots

• A number of countries are near joining in Central and Eastern Europe and also Chile

• A set of 5 in Eastern Asia with 200 million people have joined

Will China Join?

• If its per capita income grows at 7% annually for 16 years, it will join the set in 2025

• Over the last decade this growth rate has been nearer to 9%

• China will join if it becomes more economically integrated with the other advanced industrial countries

• And there is some degree of economic autonomy of its provinces

Why Economic Integration leads to Catch-Up

Three reasons

1. Have access to foreign know-how – technology capital

2. Barriers to adopting better technologies are lower

3. More rapid diffusion of knowledge useful in production

Technology Capital Reason

• Multinationals use their technological know-how in their foreign subsidiaries

• This increases productivity and output in these countries– Wal-Mart has a large stock of knowledge that it uses

in all its operations, domestic and foreign

Multinationals Key

• Threat of entry by foreign multinational is often sufficient for increased efficiency

• U.S. Bureau of Economic Analysis (BEA) reports 9.5% return on U.S. foreign direct investment (FDI)

• And only 3.2% on FDI in the U.S.

• Reason is that U.S. has a lot of technology capital, and the implicit rents on this capital are included in the accounting returns

Technology Capital Stock Big

• Technology capital investments– R&D– Developing brand names – advertising and marketing

• U.S. multinationals’ wholly owned foreign subsidiaries have big accounting profits– over 35% of their total accounting profits– but only 10% of their reported investment

• Why? Accounting profits include technology capital rents

The Lower Barriers Reason

• Absent barriers to efficient production, a country will be more productive and richer

• Technological know-how is the Lever to Riches but this lever does not make a country rich unless it is used

• Often better work practices are not used because of barriers to their use

• Groups with a vested interest in maintaining current practices will use the political process to block change

• With economic integration, not a problem

• If productivity-enhancing change is instituted, with foreign markets, output increases by more than productivity and employment increases

• Further, if foreign competition is blocked, foreign countries will retaliate and domestic exporters will be hurt

– These exporters have a vested interest in their country remaining open

Flow of Knowledge Reason

• Samsung Electronics has operations in Helsinki and in Austin, Texas -- why?

• In order to get knowledge from Nokia and Dell.

• There is a flow of knowledge between people in proximity. It is an important positive externality.

Integration Lowers Barriers to Efficient Production

• Some rent-seeking activity is productive – e.g., becoming more productive by acquiring an MBA

• But some is unproductive – e.g., lobbying and paying bribes for regulations that result in monopoly rents

• Some getting the rents are the politicians

Competition Reason

• Competition leads to greater productivity

• An example is what happened in Northern Minnesota on the Iron Range

Minnesota Iron Ore Example

• In 1982 Reagan permitted competition from new Brazilian mines

• Minnesota productivity doubled with no new investment

– Reason: Work rules changed

– Cut employment of skilled machinists in half

• These skilled machinists went to the Twin Cities and quickly found higher-paying jobs

• Example: Power Shifts Away from Unions in Europe (N.E. Boudette, WSJ)

• Concessions by automobile worker unions in Western Europe in response to Greater Openness with Eastern Europe

• Daimler – new engine plant in Kolleda, Germany

• Would have built plant in Eastern Europe if unions had not agreed on flexible work rules that increased productivity

Direct Foreign Investment Overcomes Barriers to Adopting Better Technologies

• States without groups that will be adversely affected by the introduction of some technology and with groups that will benefit want the better technology adopted there.

• Example: Toyota in 1985 located an automobile plant in Kentucky introducing just-in-time production in the U.S. – Kentucky’s people want high-paying jobs– Kentucky’s people want building project

• The same thing happened in Wales in 1990

Technology Capital

• Must be an exporter to be an importer

• U.S. and E.U. and other advanced industrial economies hold foreign technology capital hostage– This protects technology capital abroad from being

expropriated

Conclusion

• Central and Eastern European countries either are or soon will be among the rich industrial countries

• Everyone benefits from the use of technology capital– These countries will benefit from use of foreign

technology capital– Other advanced industrial countries will benefit from

the use of the technology capital of these countries

46

Effective Measures to Improve Economic Performance

• Cut marginal tax rates

• Become more open

• Follow pro-productivity growth policies

• Reform labor market policies so workers move quickly to where they are more productive