Starting Over: Poland After Communism

On January 1, 1990, the Polish postcommunist government introduced one of the most far-reaching and radical economic reform programs ever undertaken in any country during this century. Aimed at quickly transforming a communist economy based on central planning and state ownership into an economy with market allocation of resources and largely private ownership, the Balcerowicz Plan, named after Finance Minister Leszek Balcerowicz, sought to do many things at once: greatly reduce the runaway rate of inflation (which was as high as 50 % per month); decontrol most prices; eliminate shortages; make the Polish currency convertible into other currencies at market rates; cease the subsidization of state enterprises; and remove most restrictions on foreign trade. The government’s actions were intended to stabilize the macroeconomy and to create the conditions necessary for privatization, enterprise restructuring, and the development of an institutional system compatible with a market economy. Because of the speed and scope of the reforms, the impact on Polish markets and enterprises was immediate and profound. Remarkably, the main goals of the program, widely known as “shock therapy,” were achieved within a few months. The scope of the reforms had a profound impact on Polish markets. Despite the initial accomplishments, shock therapy has been widely criticized for being too aggressive and for inflicting excessive pain on large state enterprises, their employees, and local communities. According to the program’s critics, some of the macroeconomic measures may have been necessary, but they should have been accompanied by targeted microeconomic measures as well. Some of the critics argue that direct government intervention in particularly needy sectors of the economy—such as mining, shipbuilding, and steel—would have enhanced the adjustment process. Many maintain that the best course would have been a set of coordinated policies that moved more gradually to bring down inflation and force microeconomic changes. Their complaint about the Balcerowicz Plan was that it implemented strong macro measures without supportive micro policies. In our view, that criticism is mistaken because it fails to recognize the impact shock therapy has had on the fundamental mechanism for microeconomic reform after communism: entrepreneurship. We think the Balcerowicz Plan was appropriate economic policy not because it laid the foundation for restructuring large state enterprises but because its stabilization and liberalization measures created conditions that proved extremely favorable to private business development throughout the Polish economy. Consider Jerzy Siemienczuk. A gifted engineer who was frustrated with his bureaucratic job in the state sector, Siemienczuk quit to set up his own company in early 1988. Communism was still largely intact in Poland, but a recent partial economic reform had allowed some limited opportunities for private businesses. Siemienczuk wanted to be one of the new entrepreneurs. His vision was simple. In a centrally planned economy, there were plenty of market niches where state enterprises had no interest in operating. Siemienczuk wanted to use his experience as an industrial designer to set up a new, more efficient production process for heat-exchange units (devices that transfer heat between a power source and the surrounding environment). The initial obstacles for entrepreneurs like Siemienczuk were enormous. It was hard to locate space and difficult to raise start-up capital. The tax authorities were notoriously capricious. Bureaucratic snags met Siemienczuk at almost every turn. Perhaps the biggest hurdle was getting the supplies he needed in the midst of pervasive shortages. As Siemienczuk told us later, When I started the company, I could sell everything I produced. The problem was obtaining materials. Everything was allocated by the central government, and, of the nation’s limited pool of stainless steel, only 2 % or 3 % was set aside for sale to private firms. This was virtually nothing. I was often forced to buy my steel at high cost from state-owned manufacturing firms that had received large allocations. Siemienczuk struggled through two difficult years, relying heavily on his engineering know-how and his perseverance. And then, on January 1, 1990, the environment in which Siemienczuk did business changed. He could suddenly obtain all the metals he needed because materials were now freely available at prices that were no longer controlled by the state. He also could import machinery to become more efficient. Only one year later, he was able to buy a German production line for the steel pipes his heat exchangers needed. The automated machinery, which cost 1.5 million deutsche marks and was financed out of retained earnings, embodied the latest in Western pipe-production technology. Because it was much more sophisticated than the equipment used in Polish steel plants, it enabled him to increase market share in Poland. In addition, he was able to begin meeting the quality standards needed to crack the Western export market. Two years after the Balcerowicz Plan began, Siemienczuk’s company, SeCeS-Pol, was employing 150 people, producing 10,000 heat exchangers per year, and generating more than $ 1 million per year in profits. Starting Over The growth of SeCeS-Pol illustrates the powerful process that is driving economic reform at the enterprise level in postcommunist countries—a process we call “starting over.” After communism’s fall, Central and Eastern European economies inherited thousands of inefficient state enterprises that employed virtually the entire non-agricultural workforce. Predictably, once economic reforms began, most observers focused primarily on the restructuring and privatizing of existing enterprises. We ourselves, beginning our research in Poland in mid-1990, expected to find that the restructuring of state enterprises was leading the microeconomic reform process and that small businesses had only a secondary role. Our findings were quite different. More than four years into the reform process in Poland, the central mechanism for the reallocation of labor and capital from state to private activity has proved not to be the reorganization and selling-off of large state companies. In fact, relatively little progress has been made in turning state companies into viable competitors on domestic and international markets, and the privatization process for large enterprises has stalled. Instead, what has generated new jobs, created significant wealth, and provided value to a wide range of customers has been the establishment and growth of hundreds of thousands of new private businesses. Our research, based on evidence from nearly 1,000 entrepreneurial companies and several large state companies, suggests three reasons for the crucial role entrepreneurship is playing in the reform of transitional economies. First, the transition from a planned economy to a market economy requires a comprehensive reorganization of work and a complete overhaul of management practice and organizational structures and systems. When the incumbent system features centrally planned production targets and allocations for supplies, artificial prices, little competition, insensitivity to cost and profit, constant shortages, excess demand for everything that is produced (regardless of quality), and government ownership of essentially all nonagricultural enterprises, then the transition to a market economy with largely private ownership involves fundamental change at all levels. Despite some reforms during the late 1980s, nearly all state enterprises find the necessary changes simply too difficult, given their lack of skills and resources. Second, communism created economies of shortage, in which state enterprises failed to produce a wide variety of goods and services consumers wanted. The liberalization of such economies created innumerable opportunities for entrepreneurs to provide products and services that previously had been of poor quality or completely unavailable. Large state enterprises, concentrated as they were in basic industrial sectors, lacking profit incentives and poorly attuned to the marketplace, offered little competition. In fact, the state enterprises often became a market for the products and services new private companies were offering. Third, the rapid changes of an economy in transition offer powerful incentives to entrepreneurs, who have the flexibility to allocate labor and capital to only those activities that are most profitable. Unlike state enterprises, entrepreneurial companies have simple governance structures, little inherited organizational baggage, low fixed costs, the ability to attract the most capable managers and workers by sharing the profits, and the motivation to exit unpromising markets quickly and pursue attractive ones. The rapid changes of a transitional economy give powerful incentives to entrepreneurs. Tremendous reorganization of work is necessary in a postcommunist economy, and the power of entrepreneurship to introduce market-driven change can be stunning. Consider the case of a new private company in the grocery business. Before the economic reforms, shopping in Poland’s state-run food shops was an unpleasant experience. Most goods were stacked on shelves located behind service counters that were usually operated by brusque middle-aged attendants outfitted in food-stained smocks. Customers formed queues and ordered from attendants, who then retrieved items from the shelves. Shoppers had no opportunity to inspect products before making a purchase and often believed that clerks wanted them to know exactly what they were buying before they entered the store. Customers also were expected to bring their own shopping bags. With the Western supermarket concept in mind, a new Polish company called Semeco-Okmess began to open a chain of grocery stores in 1990. Semeco was a holding company that two small Polish businesses, Servomoto and Metal, had formed with Corab, a Swedish trading business owned by Polish emigrants living in Sweden. Semeco-Okmess was the first major venture undertaken by the holding company and was financed mainly by profits that Corab had generated importing Polish produce to Sweden. To attract shoppers in and around Gdansk, the company leased space in colossal blocklike apartment districts. Within two years, it had five Western-style supermarkets. The interior furnishings for the stores—including modern shelving, promotion racks, and conveyor-belt-driven checkout counters—were all imported from Sweden. Additionally, more than 80 % of the items were Western food and consumer products. Using the western supermarket concept, Semeco-Okmess markets became enormously successful. The Semeco-Okmess stores were more attractive and convenient than Poland’s state-run alternatives. The company eliminated the customary service counters that separated clients from products. Instead, customers could walk unhurriedly through grocery-stocked aisles, inspect products, and make their own selections. The predominance of Western foods, still something of a sensation in Poland, was an additional attraction for Gdansk shoppers. Furthermore, the supermarkets were open 24 hours a day, a service concept that contrasted sharply with the more restrictive hours usually associated with Poland’s food retailing industry. Semeco-Okmess supermarkets were enormously successful. Customers flocked to the stores to take advantage of the more leisurely shopping environment, the flexible hours, and the Western groceries. As a result of the stores’ high visibility, the company’s logo became one of the most well recognized in Gdansk. In less than two years, Semeco-Okmess became its parent company’s largest unit, accounting for 35 % of its $ 25 million in annual sales. Its profit margin on groceries was approximately 30 % —well above the industry average for Poland and most Western economies. What was the key to this success? Following the model of Western countries, Semeco completely reorganized the way groceries were sold. Although it didn’t cut prices below those of the state stores, it offered a far better selection of items, a more pleasant environment, and superior service. The reorganization process would have been impossible in a shortage economy and would have been difficult without access to imported products. In the last four years, most Polish retailing has shifted to private stores offering, like Semeco-Okmess, greater value than state stores. Restructuring State Enterprises State enterprises could, in principle, make the changes required to become more competitive. But in practice, major transformations of this sort are remarkably difficult: witness the uneven experience of large-scale Western corporations with greater resources. The challenges confronting state-enterprise managers in postcommunist economies are even more daunting. In the dark humor of the region, “The task may be difficult, but the resources are scarce.” In an effort to understand the practical problems facing state-enterprise managers, we studied two Polish shipyards. We chose shipbuilding because the Polish government considered the industry to be one of the most promising targets for successful restructuring. The results of these case studies shed light on the difficulties of restructuring state enterprises even in the most positive circumstances. Under communism, shipyards were centrally controlled and produced vessels mainly for other communist countries. In the centralized system, each shipyard manufactured a wide range of vessels in order to ensure that all yards would be able to maintain full employment when demands for particular types of ships fell off. But there was a downside to that approach. Because shipyards were forced to maintain such diverse product portfolios, they were not able to develop world-class expertise or manufacturing efficiency in any one particular type of ship. With unfocused product offerings and cost structures that social services for employees had inflated, the shipyards were unable to build ships efficiently and had to rely on government subsidies to meet operating expenses. Because shipbuilding supported thousands of workers, was an important part of trade agreements with the Soviet Union, and had become a point of national pride, the Polish government pumped resources into what was in reality a money-losing industry. Management strategy in such state enterprises was based on fostering government support and had nothing to do with earning profits. With the introduction of the Balcerowicz Plan, however, the shipyards lost their easy access to the government till. To understand the difficulties shipyards and state enterprises in general faced in making the transition, consider the restructuring effort at the Szczecin shipyard, located in northwestern Poland near the Baltic Sea. In 1991, Krzysztot Piotrowski, the general director, introduced a detailed and compelling vision for a competitive shipbuilding operation. Piotrowski, a long-time shipyard engineer, had consulted with Western strategy experts and developed a plan to focus production on midsize container ships to meet the demanding standards of a growing worldwide market. By concentrating a larger number of workers on a smaller number of slipways and by implementing a performance-based compensation scheme, he reduced ship-production time from 36 months to 11 months. Shedding nonproductive assets, such as workers’ apartments and vacation facilities, and reducing the number of employees from 13,000 to 5,000, he slashed operating costs. By implementing performance-based pay, a privatized shipyard reduced ship-production time from 36 to 11 months. Such actions required the backing of the shipyard unions, which he got by forcefully arguing that extreme measures were necessary if the shipyard was to remain in business at all. In the meantime, Piotrowski had to create from scratch a marketing and sales capability that could identify potential customers, set prices, and close deals. Finally, he had to reestablish the shipyard on a sound financial base, which he did through a widely publicized and very controversial reduction and rescheduling of the shipyard’s $ 180 million debt. By threatening to close the yard, Piotrowski persuaded his creditors, many of whom were suppliers, to accept partial, delayed repayment. In many ways, the restructuring of the Szczecin shipyard is a remarkable success story. The other shipyard we studied, the famous Gdansk shipyard, had made virtually no progress toward restructuring, despite initial circumstances very similar to those at the Szczecin shipyard. But even at Szczecin, although there were gains in production quality and operating efficiency, labor productivity in 1993 was still between one-quarter and one-half that of Korea or Japan. And in the fast-growing shipbuilding industries of Brazil and China, newer yards had still better productivity and even lower wage levels. Hence the sobering conclusion: despite extensive reforms and laudable progress in restructuring state enterprises like Szczecin, most will face stiff competition internationally. Indeed, as Piotrowski’s experience demonstrates, it is difficult to make significant changes in state enterprises. As Piotrowski saw it, changing just one or even a few dimensions of a company’s operations wasn’t sufficient. To have any hope of achieving substantial improvement in performance, he had to change the company’s strategy, organizational structure, production methods, incentive systems, and financial practices—and he had to do everything very quickly. Furthermore, each change had to be complementary with all the others if the overall effort was to succeed. The need for complementarity among many radical organizational reforms has probably been the most basic restructuring problem. The convertibility of Polish currency made import businesses relatively easy and potentially lucrative. And, whereas state enterprises had to struggle with reforming their operations and usually lacked the motivation, skills, or resources to pursue new opportunities, new private businesses were able to focus their attention on areas with high and immediate profit potential—markets that didn’t exist before January 1, 1990. The legalization of most private imports and the new convertibility of Polish currency for current account transactions made import businesses relatively easy and potentially lucrative. The Private Sector Advantage Anyone with a small amount of capital, perhaps even a hundred dollars, could travel to the West and bring back goods to sell. Street corners in all the major cities filled up with stalls. Some observers have taken the small-scale nature of this trade as a sign that the microeconomic transformation is only superficial. But it is, in our opinion, a symptom of a deep and productive process of change now under way in other sectors. An interesting case in point is provided by Jarek Poloczanski, who in 1990 entered the banana-import business. Poloczanski was formerly a brigade leader (or foreman) at a private cooperative, where he supervised a work unit in construction and facilities maintenance. Like his compatriots, he was accustomed to severe shortages of basic foodstuffs. He saw that “exotic” fruits such as bananas and citrus fruits were virtually nonexistent: and he saw an opportunity. Because bananas had been in short supply since the 1970s, he decided to concentrate exclusively on the banana market. Calling on his background in the private cooperative, he set out to arrange the right kind of transportation and storage facilities. Exotic fruits like bananas were almost nonexistent. Poloczanski heard opportunity knock. Several large producers, including Chiquita, Dole, and Del Monte—with plantations in Central America, Colombia, and Ecuador—dominated the industry. Once harvested, the bananas were loaded onto specially designed, refrigerated freighters and shipped to produce markets around the world. In Europe, the growers sold the bananas from the docks to large produce wholesalers, who in turn sold smaller quantities to dealers. Poloczanski learned that bananas were not shipped directly to Poland because its industrial ports lacked modern unloading and cooling facilities. If Polish ports had unloaded fragile bananas manually and stored them in warehouses without climate controls, they would have jeopardized entire cargoes. Calling every company in the phone book that seemed as if it might be affiliated with the fruit business, Poloczanski succeeded in locating a Gdansk ripening facility that was part of an immense state-run food-processing concern. Built in the 1960s in Gdansk’s Baltic port, it had the largest cold-storage and fruit-ripening capacity in Central Europe and could accommodate weekly banana shipments of 500 tons. Poloczanski visited the facility in April 1990, and he was surprised at how inactive it seemed. Aside from its limited trade activity in tea and coffee, the place was almost empty, and the state-paid employees had little to do. Poloczanski proposed a deal: if the facility managers would rent him the idle ripening rooms, he would pay workers several times their state salaries to help him unload bananas and oversee the ripening process. And the more kilos they ripened, the more he would pay. Poloczanski also succeeded in persuading the company’s management to rent him cold-storage rooms, a warehouse, and an office. Poloczanski named his company Citrus Wholesale. He hired three administrative workers, ten people to unload banana shipments, and three people to oversee the ripening process. He explained up front that pay would be tied to output. Given the high expectations people in Poland had for free enterprise, Poloczanski had no trouble recruiting employees. Poloczanski spent several weeks preparing for Citrus Wholesale’s first shipment. A refrigerated truck with 18 tons of bananas, packed in 1,000 standard 18-kg cartons, was to arrive from Vienna, Austria. In anticipation, Poloczanski had called every local food shop he knew, and, by the time the delivery truck pulled up, a long queue of excited shop owners had already formed outside the warehouse. The novelty of bananas in Poland was demonstrated best by a young child who turned to his father and asked, “What are these yellow sausages?” Citrus Wholesale paid careful attention to the needs of retail fruit vendors in northern Poland. It quickly became the major supplier of bananas within a 250-km radius of Gdansk, and Poloczanski had a phenomenal first year. In 1990, the company generated sales of $ 4 million and earned a profit of $ 400,000—a fortune in a country where the average monthly wage was roughly $ 150. Poloczanski bought a new BMW for himself, a Peugeot for his wife, a large-screen Mitsubishi television set, and a VCR. In addition, he paid employees bonuses of up to $ 1,000 per month. “For the people I employed, I was a salvation,” he has said. Within a year of Poland’s economic reforms, Poloczanski exemplified the country’s dynamic new class of entrepreneurs. He bought a Peugeot for his wife, a BMW for himself, a TV, and a VCR. The trade boom has brought unexpected benefits to other parts of the economy as well. For example, some businesses that did well in wholesale trade have redirected part of their resources into areas like manufacturing, construction, or retail and other services. Moreover, as employees have learned more about business and have gained familiarity with how decisions are made in a market economy, they have developed new skills for operating successfully on their own or being productive for other employers. Meanwhile, the Balcerowicz Plan has stimulated the manufacture of goods for export, which many economists believe is essential for long-term growth. As soon as international trade restrictions were loosened and Polish currency became convertible into other currencies, private-sector trade activity expanded beyond imports to a growing capacity for exporting products manufactured in Poland. Consider the case of Styl France. Founded in 1990, Styl France began producing high-quality imitation antique furniture in a style called Louis Philippe. The company’s offerings included everything from desks and tables to chairs, cabinets, and wardrobes. One of the most popular pieces was a jam case made of walnut, and by 1992 the company was producing between 400 and 500 of these small chests per year. The company’s products are still made entirely of wood, and, because labor in Poland has been inexpensive, much of the production work is done by hand. Materials, including walnut, varnish, glue, and furniture fittings, are imported from France. Czeslaw Bereza, the man running Styl France, is a self-trained master carpenter, and his manufacturing methods are based largely on intuition and experience. Furniture is manufactured in small batches, with each worker expected to perform a variety of tasks to complete an item. “There was no specialization in the factory,” Czeslaw has said. “Often, a small group of two or three workers would manufacture a batch of furniture from start to finish.” The key to Styl France’s competitive advantage is its effective organization of low-cost labor. In 1992, Styl France paid its workers about 11,000 zlotys an hour, which translated to about $ 1. In France, the total operating cost for furniture production was about five times the level of Styl France. The high labor content of Styl France’s furniture gives it a big advantage in the French market, where handcrafted furniture is highly valued. Although there are several French companies producing similar furniture, costs for the most part are too expensive to permit much handwork. As a result, the French-made furniture doesn’t have the crafted appearance of Styl France’s products. The experience of Styl France illustrates how the liberalization of foreign trade led directly to the development of manufacturing enterprises. The ability to import French materials was a prerequisite for exporting French-style furniture. In the case of Styl France, a foreign partner also helped arrange a profitable distribution channel. But the most important factor in Styl France’s success was Bereza’s ability to identify a promising market and to organize workers for high-quality production. Flexibility Is the Key New private businesses such as SeCeS-Pol, Semeco-Okmess, and Citrus Wholesale have been able to attract talented and enterprising managers and employees by designing performance-based pay systems. Contingent compensation, which can be many times the wages in the state sector, is one of a set of innovative practices that have helped new businesses to remain flexible, minimize fixed costs, and find success in a turbulent environment. Doradca, for example, was a consulting company founded by a number of well-educated young graduates and professors from Gdansk University who wanted to work outside the state sector. Because it was started with practically no capital or financing, the founders didn’t have to worry about paying off loans. Overhead could be held to a minimum, and nearly all costs could be variable. Doradca began with only two full-time employees: Jan Bielecki, who was one of the founders, and a secretary. The strategy was to solicit work from state enterprises, then hire teams of consultants on a project-specific basis. To generate business, the firm relied on the founders’ connections with managers of state enterprises, and much of the initial business was advising state enterprises on how to minimize their tax liabilities. Doradca’s practice of maintaining minimal overhead and using subcontractors on a project-by-project basis proved extremely effective in the organization’s early years. For every project, approximately half of the fees went to pay the consulting team, and the rest was reinvested in the business. The teams were free to distribute the fees among themselves as they saw fit. Beyond its efficiency, Doradca’s system of collaborating with a network of consultants helped it respond to new opportunities in the marketplace. When members found new markets or new products for the cooperative, Bielecki could quickly assemble a group to pursue them. Before 1988, joint ventures between Polish enterprises and Western companies had been nearly impossible because of legal restrictions. When the laws changed, Doradca immediately began working with Western consulting, accounting, and investment-banking firms to locate and evaluate joint venture targets in Poland. Although the communists had ruled for more than 40 years, several of Doradca’s consulting contractors were conversant with Western accounting methods and financial analysis. Joint-venture consulting soon became the largest part of their business. What made Doradca so successful? On one level, its success was based on its being one of the few companies to have a knowledge of Western economics, accounting, and finance, in addition to a familiarity with Polish law and regulations. But its success goes beyond knowledge. In a period of economic liberalization, Doradca was able to adapt. Management created an effective structure that was based on contingent compensation and teams, which helped the company recruit and retain talented academics and consultants. Although there have been many success stories in Poland’s new private sector, not everyone’s experience has been painless. The abrupt changes that the 1990 Balcerowicz Plan introduced have caused some companies to become unprofitable: for example, many that had depended on exploiting the differences between domestic prices and the prices of imported goods. Some new entrepreneurs have made naïve decisions, and their businesses have failed. New businesses without track records or sufficient collateral to raise external financing have had a particularly hard time. For many private-sector companies, the financial squeeze in the state sector has added to the difficulties because state enterprises had been important customers. But companies such as SeCeS-Pol have been remarkably skillful in adapting their product strategies to fit changing market conditions. In response to reduced demand for heat exchangers from Polish state enterprises, the company decided to manufacture other steel-based products in order to achieve further growth. It already owned the appropriate technology and was well connected in the steel industry. As he changed the product mix, Jerzy Siemienczuk also took the opportunity to reorient output to favor exports. In response to an order from a French transportation company, SeCeS-Pol began to produce large rectangular steel containers and reinforced steel platforms used for industrial transport and storage. At the same plant, which was separate from SeCeS-Pol’s main facility and employed 15 production workers, the company also produced a limited number of excavator shovels for export to Germany. Eventually, the plant housed the manufacturing operations for a joint-venture partnership that SeCeS-Pol established with a Danish company to produce plate-type heat exchangers. As his company expanded, Siemienczuk, building on his many years of management in the state sector, changed the internal structure of his company and the way he managed. In the early days, he had personally overseen everything from hiring and purchasing to investment decisions. But as the company acquired remote plants and increased its range of products, Siemienczuk realized that he could no longer control all of SeCeS-Pol’s daily operations. He authorized managers at each location to operate the plants as distinct companies. Each kept its own books, handled its own finances, and set its own production schedules. Plant managers were responsible for making decisions, and the bulk of their compensation was based on factory performance. In January 1992, for example, one of Siemienczuk’s plant managers earned 38 million zlotys, about $ 3,400 at the prevailing exchange rate. Less than 10 % of it was base pay; the rest consisted of various forms of incentive compensation. Siemienczuk’s focus on new markets fed the expansion of the company. For the year of 1992, SeCeS-Pol employed 200 workers and achieved sales of about 50 billion zlotys ( $ 4 million at the average 1992 rate). The company owned three production facilities in Gdansk, operated 20 sales outlets throughout Poland, and had engaged in three joint ventures that marketed its heat exchangers abroad. It had become one of Poland’s largest producers of heat exchangers in an industry that for decades had consisted only of subsidized state enterprises. The Nature of Economic Reform In the past four years, new private businesses, rather than restructured or privatized state enterprises, have emerged as the main engine of reform and economic renewal in Poland. The rise of the new private sector and the decline of the state sector can be confirmed by the aggregate statistics. Very few of the large state industrial companies in Poland have actually gone bankrupt—the legal system and existing property rights do not encourage bankruptcy proceedings for insolvent or troubled enterprises. But employment in this sector has declined by more than 30 % . At the same time, the number of private business incorporations has increased from 1,275 in 1988 to 11,693 at the end of 1989, 33,239 at the end of 1990, and 45,077 by the end of 1991. And those impressive numbers fail to convey the full scope of private business activity because many private entrepreneurs, even those with substantial businesses, prefer to operate as individuals and don’t incorporate. Operating as individuals, businesses find that their paperwork is less complicated and their taxes are lower. It is therefore not surprising that between 1989 and 1991, government statistics showed that the number of unincorporated businesses nearly doubled, from 814,000 to 1,420,000. Official estimates show that by the end of 1991, incorporated private businesses and joint ventures employed about 500,000 people and that individual entrepreneurs employed another 2.5 million. The Polish private sector therefore accounted for roughly 25 % of the 12 million people employed in the nonagricultural sector. In the past three years, growth in all categories of private sector activity has been steady. By mid-1994, close to 2 million private companies accounted for about 45 % of nonagricultural employment and at least 40 % of Poland’s gross domestic product. On the basis of the explosive growth of the new private sector, Poland has become the economic success story of Eastern Europe, with real GDP growth of 4 % in 1993 and expectations of at least that level for 1994. The role of new private businesses in fueling economic growth is not unique to Poland. Although a lack of fundamental macroeconomic reform has severely limited private sector growth in Bulgaria, Ukraine, and Romania, the private sector has grown dramatically in Hungary, Estonia, Russia, and the Czech Republic. Private sector activity is always driven by the same factors: the emergence of many entrepreneurial opportunities, incentives for talented people to work in entrepreneurial companies, flexibility on the part of new private companies in responding to turbulence in the business environment, and the formidable obstacles facing state enterprises. What can the Polish experience teach managers operating in other economies that are undergoing transitions? In our view, many of the most successful entrepreneurs share some common elements. To begin with, they carefully scan domestic and international markets to identify underserved segments where they believe they have a sustainable competitive advantage. For example, at SeCeS-Pol the advantage was based on technical knowledge about steel, whereas for Styl France it was a combination of relatively low labor costs, skill in furniture making, and a profitable distribution system. Unlike many entrepreneurs in Central and Eastern Europe, the managers in these companies resisted the temptation to chase unrelated business opportunities for easy short-term profits and instead strove to improve quality, efficiency, and distribution channels for their existing products. Successful Polish entrepreneurs also have found ways to develop competent marketing and reduced-price sales in a setting where for decades there was no need for either marketing or sales. Developing good products or services is the easy part, however. Positioning and promoting products against high-quality alternatives requires effective marketing and sales performance. By cultivating new groups of customers and new distribution channels, companies like Styl France and Citrus Wholesale have earned respect in the marketplace and growing demand for their products. The companies we have studied have also demonstrated an ability to recruit highly talented employees and managers, pay them more than the prevailing wage, and motivate them to build the business and manage it efficiently. By using pay-for-performance systems, these companies provide clear, powerful incentives and keep fixed costs down. Combining strategy, systems, structures, shared values, and skills—all in tight alignment—they demonstrate the flexibility to meet rapidly changing and unpredictable market conditions. Indeed, in these respects, successful entrepreneurial businesses in postcommunist economies are models of the behaviors in vogue in the West today. Finally, the entrepreneurs we have studied have learned to build their businesses with limited amounts of external capital. Typically, they have begun with something simple—a specialized service or trading activity—that requires little capital. They have reinvested their cash to improve and expand but have often turned to foreign investors or joint-venture partners for help—not only for financing but also for critical resources such as management skills and access to new customers. Policy Implications Our analysis of the emergence of Poland’s small-business sector provides a unique perspective on the Balcerowicz Plan, a policy package that remains extremely controversial—in Poland and in all the post-communist world. Many countries that are weighing how to transform planned economies with state ownership into market-driven economies are focusing on arguments for and against “shock therapy.” Private business has led state-enterprise reform in changing the economy. In our opinion, the spread of private business in Poland is a direct outgrowth of the swift and courageous policies of the Balcerowicz Plan. The slower transition that the plan’s critics advocated would have impeded the development of new private businesses and would have retarded economic transformation. Judging from what has transpired over the past five years, we think the macroeconomic changes in the Balcerowicz Plan were well designed in terms of their effects on the micro-economy. They have triggered a boom in private business and irrevocably changed the organization of work in the Polish economy. Our research suggests that although the problems of privatizing state enterprises in Poland are unfortunate, they do not point to a failure of the economic policy. Certainly, when substantial resources are tied up in state companies and not made available for new private business, the pace of economic development slows. It would be preferable to make a clean break with the previous set of property rights in the state sector and thereby replace the dysfunctional incentives for resource allocation with market-driven incentives. Privatization programs should emphasize getting productive resources into the hands of the private sector as quickly as possible rather than achieving complicated balances of economic, political, and social goals. Although our evidence suggests that private sector development can survive slow progress on privatization, the failure to restructure large state enterprises becomes a worse problem for private companies as the reform process evolves. Privatization should focus on getting resources to the private sector fast, not on balancing complex social and political goals. The importance of new private business raises key issues for financial sector reform. Developing a vibrant private sector requires an efficient system of financial intermediation between depositors and borrowers. Thus far in Poland, the banking system, which remains largely state owned, has not played this role very effectively. However, our research indicates that the most important constraint on private sector borrowing in the years since reform began has not been the banking system but the extremely high nominal interest rates. Faced with an inflation rate that has averaged more than 30 % , nominal interest rates confronting small-business borrowers have often exceeded 50 % . In the meantime, because the prices of many goods and services are constrained by intense domestic and international competition, few entrepreneurs have been eager to borrow at interest rates that have inflation premiums they can’t cover through price increases. In this crucial respect, the microeconomic effects of macroeconomic policy after 1990 suggest that the problem in Poland has not been too much stabilization but too little. If inflation had been brought down to 10 % per year or less, small businesses would have benefited from the resulting affordable credit. With a significant injection of external finance, the crucial process of starting over would have proceeded more expeditiously. Hence, unlike many critics of the 1990 reforms, we believe the Balcerowicz Plan was a very good policy on essentially all counts and could have been even better if it pursued its goals still more aggressively. Vibrant enterprises are emerging that should help Poland achieve a standard of living consistent with its Western European neighbors. As other postcommunist countries watch Poland, they would be well served to learn from a process that, to an unexpected degree, has succeeded by starting over.

Starting Over: Poland After Communism

Partner Center