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Capitalism is doing well.

Published on November 10, 2010 by: in: Economy

Today, when Poland is recovering after the crisis, when countries of Western Europe are falling into a spiral of debt, where there is a significant expenditure reduction, return of capitalism, which we deal with, is the most spectacular in the history.  I do not remember such a rapid recovery of free-market thinking about the economy on this scale.

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“Liberte!”: Council of Ministers has decided to apply a new rate of VAT next year, which means its growth. Do you think it is the right action?

Ryszard Petru:  In my opinion, the tax rise was not a necessity. It was possible to make alternative arrangements with a similar result. I would like to also emphasize, that the tax rise is not always a bad thing. Although I am not a supporter of this type of procedures, sometimes it is simply the lesser of two evils. Greece, Great Britain or Hungary are currently in such  a situation, where a scale of irresponsibility of politicians was so big and deficits were so high that these countries fell into unimaginable spiral of debt. The situation there is so serious that actions on the side of expenditures only is not enough to avert the crisis. It is hard to find the expenditure savings within one year, for example on the level of 6-8% GDP. In such cases it is necessary to reduce spending as well as raise the taxes.

Currently Poland is not in such a situation as Greece or Hungary. In Poland the scale of changes which are needed in the near term should refer to the expenditures side only. The actions on the income side should rather reduce the tax allowances than raise the main VAT rate.

For average citizen tax allowances are perceived as something positive, because after all it is nice to have them. Most people then have a sense of ‘being ahead’ but it is a false belief.  Tax allowances make the tax system leaky. If they did not exist, the VAT rate would be harmonized and lower than now and the entire system would be clearer. Speaking about the tax allowances, I also mean the allowances for children included in PIT (Personal Income Tax). We are all using it but it does not fulfil its function. Apart from that, it is unfair tax allowance because it benefits the same for taxpayers with high and low income. Calculation of the Civil Development Forum shows that the elimination of this tax allowance could contribute even 6 billion zloty to the budget in 2012. Thus, it can be seen that such a change in the tax system is more desired than increasing the main VAT rate.

This problem is inherently political. Politicians may believe, that raising the VAT rate by one percentage point will hurt less than elimination of the tax allowances. Maybe it is right, however the activities that aim at limiting the consumption of Polish people are not increasing the chances for development of our country. In addition, the tax rise will contribute about 5,5 billion zloty to the budget, which is not enough in proportion to the needs. In fact, to improve the situation of the budget standard VAT rate would have to increase up to 25%. Nevertheless, such a solution would have a huge impact on a consumption and consequently on a growth.

Prime Minister Tusk has announced that the new thresholds are valid for three years, but the law, introducing amendments in the VAT, contains the clause that allows further correction. Professor Krzysztof Rybinski is willing to bet that in one or two years the top VAT rate will reach 25%. Do you share this opinion?

Personally I am not going to bet on this matter, especially since we know less about the future, it is becoming more unpredictable. I do know that 25% VAT rate would significantly reduce the consumption and it would be one of the highest rates in Europe. The example of Hungary shows that it can help to repair the budget deficit, but involves a large economic slowdown. In recent years the Polish economy has grown in scale of 6-7% a year, whereas the same indicators show Hungarian economy in scale of 1-3%.  The chances are good that at the end of this year the income per capita will be higher than in Hungary.  I would like to recall that in 1989 Hungary seemed to be a country of the West for many Polish people, by reason of the Goulash socialism. Today these relations look quite different.

Hungary is an example which shows how much it can be lost by irresponsible policy, deficit expansion and engaging in the economic populism. It has never been that bad in our country. Perhaps it may be related to legal and Constitutional regulations of public debt or to a memory of the Transformational Crisis in 1989. None of the Polish governments has gone so far as both Hungarian socialists and conservatives. The wisdom should be gained by learning from someone’s mistake, not your own.  A lesson should be learnt from what happened and Hungarian mistakes should not be repeated.  From technical point of view, it is possible in Poland to introduce 25% VAT rate, but it would be an act of suicide.

I like honesty of our government about the fact that by this action the government “buys” another year and Minister Boni declares this openly. The case was presented fairly but current actions are not what we expect from such statesmen. I do not know which coalition will win the parliamentary election next year but I am afraid that it might be the coalition of the Law and Justice (PiS) and the Democratic Left Alliance (SLD). However, if the government is based on the Civic Platform (PO), the party must be aware that further tax rising will kill the economy and the one who is responsible for this will end up like Hungarian socialists.

Professor Belka and professor Balcerowicz recommend the government to cut the spending and stimulate the labour market. These solutions appear to be beneficial in the long term and the government needs the extra money right now. What are the other options to obtain a fast income for the budget, excluding tax rise or loans?

It is possible to obtain a lot within short period of time from different kind of actions, other than those mentioned above, but the question is whether the changes are expected to be immediate or well thought and structured. One of these “quick” possibilities is suspending the valorisation of pensions. There are actions, which allow saving a lot very quickly.  If we want to make the structural changes, for instance rising the retirement age, it is necessary to determine how fast this will occur. The same applies to the reform of Agricultural Social Insurance Found (KRUS) and the taxation of farmers. If the present government want to make savings in this friendly to society way, which means less painful, according to Prime Minister Tusk, must remember that is it a long process and it needs to be initiated as soon as possible.

So I have a grudge against the government for accepting the Development and Consolidation of Finance program, which has not been enforced yet. Supposedly, if declared actions were taken in 2010, situation of public finances would be much better.  The savings, as I mentioned before, are accumulating each year, for example in regards to raise of retirement age, every year each age group is working longer.

Poland is not in a bad situation, but we are getting closer to the constitutional barrier of debt. Fortunately, our politicians are responsible enough and do not want to move this up. Therefore, we can commend the government for actually doing things. They could though, not respond at all and let things drift, keep high deficit, wait until the election and then think what to do. Most of the governments, in an election year, act exactly this way. The cabinet of the Civil Platform (PO) and the Polish People’s Party (PSL) decided to take an action, hoping perhaps for re-election and remaining in power.

On the other hand, there is a large group of people accusing the government of too little activity and linger about the economy reformation.

It is because the government indeed is not active enough. I want to emphasize that the government could do nothing but yet is trying in any way to secure the country from the financial crisis, the crisis of debt. Nevertheless, I am not sure whether the way that was chosen by the government is worth anything. I think that sometimes it is better to carry out painful reforms and be assessed by history than be guided by political calculation only.

Jacek Zakowski, in weekly POLITYKA (32/2010) in the article `Four Gentlemen B.`(“Czterej Panowie B.”) describes the ideas and the actions of four the most important Polish liberals: Leszek Balcerowicz, Michal Boni, Marek Belka and Jan Krzysztof Bielecki. Zakowski argues that only professor Leszek Balcerowicz defends the economic neoliberalism and the other three gentlemen left this position. Do you think that Balcerowicz’s way of thinking was defeated?

Today, when Poland is recovering after the crisis, when countries of Western Europe are falling into a spiral of debt, where there is a significant expenditure reduction, return of capitalism, which we deal with, is the most spectacular in the history.  I do not remember such a rapid recovery of free-market thinking about the economy on this scale. Yet the end of capitalism was proclaimed a year ago and today is the return of conservative approach.  I do not know what is going to happen next year, but today politicians and economists have concluded that keeping too low interest rates lead to a disaster. In this context and with a large simplification, I think Balcerowicz’s approach is vindicated. Governments around the world refrain from the interventionism and the fiscal stimulation. In my opinion, if Barack Obama does not choose this way, he will loose the election in two years.

As the chief economist of one of the largest commercial banks in Poland, how do you assess the stress test exercise conducted in July by the European Central Bank (ECB)? Don’t you think that the accepted criteria of the stressors were not stressful enough for the European financial institutions?

Yes, of course. I agree with all of the allegations against the ECB and the stress tests. However, the advantage of these tests was that the banks had to disclose a large dose of information on their portfolio and assets. By publishing this information, a picture of the financial sector became clearer for the investors.  Although there is no evidence, I am convinced that the financial supervision of the EU countries has carried out their own, more rigorous stress test, which has not been published. The institutions which exercise protection over the capital markets have knowledge on how the banks would cope in case of the crisis. Responsible actions of these supervisors should aim at making various financial institutions apply the rules, which could help to pass through a mild slump, such as requirements for assets or liquidity of the banks. I am not too sure if these kinds of tests were carried out but it would be extremely unreasonable to abandon such activities.

Banks, which are in bad situation and barely passed the ECB stress test, should be kept under the close watch of the financial supervision and may be there are actions taken, that we do not know about. I also think that if the ECB did not carry out any kind of tests, it would be too pricy in terms of image as well as finances. The stress tests cleared the atmosphere and prevented the possible threat of a market panic.

Interviewed by Pawel Luty.

TŁUMACZENIE: EDYTA OSTROWSKA

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About Ryszard Petru

Economist, until recently director concerning strategy in BRE Bank. He was also an advisory to Leszek Balcerowicz and a specialist of the World Bank.

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