Better Regulation in Poland Needed

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A need for deregulation in Poland is recognized by the vast majority of both experts and politicians. Calls for deregulation echo in subsequent election campaigns, though to little effect. So why, despite a seemingly broad consensus, deregulation in Poland remains a problem? Beside the usual factors like bureaucratic path dependence, the shallowness of this apparent consensus is the critical issue. Although in general nearly everybody agrees that “the economy should be deregulated”, defining these unwelcome regulations, measuring them and setting objectives remains controversial. In this article I set out to clarify the problem of deregulation in Poland by (1) discussing available measures of the regulatory stance in Poland, as well as (2) highlighting areas where reforms are most needed. Findings reported in this article are the outcome of a broader research project by FOR, which has been presented in our report “The next 25 years: what reforms we need to implement to catch up with the West?” (FOR, 2015).

Regulation affects economic activity in at least three ways. First, through the direct cost of paperwork needed in order to comply with state regulations. This can be measured using the standard cost model by assigning monetary costs on the side of entrepreneurs arising as a result of information obligations imposed by state. Second, through restrictions on freedom to pursue competitive strategies by enterprises, which limit competition and distort market outcomes. One of the best measures of the extent of anti-competitive regulations is the OECD PMR index; detailed character of questioners on which it is built, allows to connect aggregate outcomes with particular regulations. However OECD PMR covers only specific sectors, where governmental interventions are particularly plentiful and harmful. Third, through unpredictability, in which creates uncertainty about the rules of the game. In subsequent sections, I describe the above mentioned three aspects of regulation in the context of Poland.

Cost of Bureaucracy – Standard Cost Model

Obligations to provide information required by the government are time-consuming and costly in other ways for entrepreneurs. Standard cost model is a bottom up method of estimating the administrative burden on entrepreneurs. The calculation starts with cataloging existing information obligations – IO (i.e. situation when an entrepreneur is obliged to gather and present to government certain information). In the next step for each IO, the number of affected companies, average time required by each company and average wage of people engaged is estimated1. By multiplying these variables one can estimate overall administrative costs associated with each IO. Their sum represents the cost of bureaucracy incurred by the private sector.

There are several modifications of the standard cost model methodology. Some studies try to distinguish between administrative cost and administrative burden. Such distinction assumes, that some information would be gathered by companies irrespective of formal obligations, for their own use (e.g. bookkeeping). Although such reasoning appears reasonable, its application is a much more complicated matter. Taking into account the creativity and flexibility of the private sector – one can assume that even without formal obligations companies will still keep the books, but without formal restrictions most probably they will come up with more innovative and cheaper ways to do this, than current laws require. Another modification is to take into account not only the time and cost of the private sector, but also the cost of processing this information by the public administration. The most far reaching extension of the standard cost model is to calculate not only the cost associated with gathering of information, but the full compliance cost. However, this entails a herculean task of analyzing the full impact of every single regulation and in practice can only be applied to selected, most important, laws.

Administrative costs for businesses in Poland are high and exceed 5% of GDP, which is much more than in other European countries. A 2010 Deloitte study commissioned by the Ministry of Economy, identified 4 thousand information obligations for companies in Poland2. Using the standard cost model, Deloitte estimated costs for companies exceeding 6.1% of GDP, which is much higher than the average 3.6% of GDP in comparable countries3. It is worth noting, that 44% of administrative costs identified in the analysis were generated by three tax acts: PIT, CIT and VAT. This points to the problem of time consuming and costly tax procedures4. Since the Deloitte’s study, administrative costs in Poland have fallen, but not enough to bring them to the level of other countries in the region. Unfortunately no follow-up for the Deloitte study has been commissioned to fully assess the impact of deregulation. Based on RIAs (regulatory impact assessments) of the four deregulation bills, decline of administrative costs can be estimated at approx. 0.5% of GDP. Nevertheless little progress has been made on the simplification of the tax law.

To sum up: administrative costs of information obligations in Poland are high. Some attempts to reduce them have been made, but without well defined targets or proper monitoring.

Anticompetitive Regulations – PMR

By rendering consumer choices irrelevant, regulations distort market outcomes. This happens in at least three different ways. First, regulations which impose strict standards or prices of a given good or service will lead to the disappearance of differences between the products of different suppliers thus limiting consumer choice. Second, regulations that prohibit market entry and establish monopolies (or oligopolies) will limit the number of producers to one (or few similar) thus again arbitrarily constraining consumer choice. Third, consumer choice can be rendered ineffective, for example, when the state subsidizes state-owned corporations thus preventing their marginalization by more efficient private competitors.

Outcome variables in Poland point to strong distortions of market forces – lack of competitive pressure allows inefficient companies to stay afloat and operate, thus blocking more productive uses of their assets. Paucity of competition in Poland is indicated by – in addition to larger than elsewhere differences of firm productivity – higher mark-ups on costs than in the West and other countries of the region (Egert and Goujar, 2014), lower utilization of production capacity, and greater differences in profitability when compared to regional peers (FOR, 2015) as well as to Germany (Lewandowska-Kalina, 2012). It must be stressed that anticompetitive regulation, besides directly affecting the regulated companies, affects their customers and suppliers. With less competitive upstream sector, companies at the downstream are faced with higher costs and less choice with respect to available services, which also undermines their own business position.

One of the most acknowledged measures of anticompetitive regulations is the OECD PMR index. The index is focused on network industries and selected services (professional services), that is sectors in which governments around the world tend to intervene, even though market mechanisms could operate well without any intervention. Indexes are based on detailed questioners gathered by the OECD, with questions focusing on the different entry barriers, market structure, and restrictions regarding business models and strategies.

In 2013, Poland’s overall score on the PMR index placed it in the sixth place in the EU with most severe restrictions on completion, just behind Cyprus, Romania, Slovenia, Greece and Croatia. Such an outcome was mainly a result of the widely spread public ownership (largest in the EU) and serious barriers in service sectors. Even though public ownership appears a separate issue from anticompetitive regulations, it is not. It is in fact the most severe form of anticompetitive regulation, when the government can influence the behavior of companies by directly appointing their management. The issue of state ownership is also a good example of the superficial consensus on deregulation in Poland – although nearly everyone is in favor of deregulation, most of political parties are, unfortunately, against further privatization.

Figure 1. Public ownership component of the PMR index in 2013

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Figure 2. Barriers in services sectors component of the PMR index in 2013

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Source: Own elaboration based on OECD data

Although restrictions on competition in professional services in Poland remain significant, the OECD index does not pick up the full scope of progress which has been made in the past ten years. Lawyers here are the prime example. Although the overall time of required education and practice (8 years) remains among the longest in the OECD, professional exams are no longer organized by the professional associations of lawyers, but by the Ministry of Justice. As professional associations have an interest in limiting entry, the result has been spectacular. The number of apprentices skyrocketed from only 5 thousand in 2005 to nearly 40 thousand in 2013. Beside the changes in legal professions, several other professions have been at least partially deregulated in the 3 subsequent bills. These opened several professions and made entry into the remaining ones easier.

The overall picture of the current state and perspectives of anticompetitive regulations remains mixed. On the one hand outcome variables indicate substantial distortions which allow inefficient companies to stay afloat and operate. However on the other hand substantial changes (in legal professions particularly) have happened, positively affecting market outcomes. Further liberalization remains worth fighting for, as according to the OECD further liberalization seen in PMR scores can have substantial positive impact on the GDP. OECD estimates that improving Poland’s PMR score to the best practice level could boost GDP by even 10% over the next 10 years (see Bouis and Raising, 20115).

Regulatory Uncertainty

FOR research indicates that the greatest burden for entrepreneurs are not regulations per se, but the frequency and unpredictability of their changes. Regulatory uncertainty is hard to measure and poorly mapped by the available indexes, but it appears to be a major issue in Poland. In our discussions with entrepreneurs, opinions on the cost of the cumbersome process of getting different permits and licenses differed. For some this constituted a serious obstacle, for others one unworthy of mentioning. General agreement was however that regulatory uncertainty has a negative impact on long term planning thus creating distortions.

Problems with uncertainty are particularly visible in the tax law. FOR reviewed 12 different studies of entrepreneurship barriers reported by businesses – complicated tax regulation has been the single most important issue in nearly all of them. It should be stressed that the problems were not regarding the tax rates, but precisely regarding tax regulations. Cumbersome tax regulations are also a factor distinguishing Poland from other CEE countries. Taxes in Poland are not only complicated, but also unstable, which reinforces their negative impact on the economy6. Each of the tax laws and the general tax code were amended on average, at least a few times a year. The Ministry of Finance publishes more than 150 individual tax interpretations daily. Nearly three thousand interpretations a year are appealed before the administrative court, which declares more than half of the complaints as founded. This instability, along with the ambiguity of tax enforcement practices is an essential source of uncertainty with regard to return on investment – which in our opinion is one of the main factors behind the low private investment rate in Poland (on average 10% of GDP for the last 10 years, compared to the regional average of 16%).

 The instability of the tax law is a manifestation of a wider problem of inflation of law, which makes it very difficult for both companies and individuals to assess whether they act in compliance with regulations. Last year, almost 26 thousand pages of legislation entered into force in our country. In this regard we outrun not only Czech Republic, Slovakia and Hungary, but even France or Italy, which are often seen as particularly bureaucratic. If one wanted to familiarize oneself with all the changes in legislation being introduced in Poland in a single year, one would have to spend about 3 hours and 26 minutes each day (Grant Thornton, 2015).

The uncertainty caused by complicated and unstable taxes is worsened by the excessive length of judicial proceedings, which is another topic discussed in the latest FOR (2015) report and will be the main subject of our next report. Though the ineffectiveness of the judiciary is indicated by not a very high percentage of companies (16%) as a serious growth barrier, it is twice that number (35%) among those entrepreneurs who were a party to a judicial process in the last 3 years.

Figure 3. Average time of enforcing contracts

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Source: Own elaboration based on World Bank (2015)

As the judiciary remains ineffective, in case of a dispute, an entrepreneur cannot hope for a quick recovery of amounts in question from the Inland Revenue, even when he believes himself to be right. He is also prone to serious problems with the recovery of debts owed ​​by defaulting partners, which makes it difficult for him to fulfill timely his own obligations, including tax payments. The average duration of debt enforcement differs strongly between regions (ranges from 328 days in Olsztyn to 715 days in Gdansk), but is long everywhere (World Bank, 2015). This diminishes the level of trust between partners, and ultimately discourages specialization and operation on a large scale, where the relations between partners are depersonalized. Research indicates that ease and certainty of debt recovery significantly increases the propensity of companies to invest (e.g. World Bank, 2005).

 Figure 4. Law courts government spending in 2013

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Source: Own elaboration based on Eurostat data

The ineffectiveness of the judiciary in Poland does not result from a low level of financing. In the EU, only three countries: Slovenia, Bulgaria and Croatia spend more (as a percentage of GDP).  The instability of law and judicial procedures adds to the problem. In the period of 2002-2012 for example the Code of Civil Procedure changed 118 times. During that time, there were 65 Constitutional Court’s rulings concerning amendments to the Code of Civil Procedure, which in 25 cases required changes in the Code (World Bank, 2013).

Conclusions

Poor quality and unpredictability of regulatory changes in Poland are a serious obstacle to sustaining high economic growth. Excessive information obligations unnecessarily raise administrative costs for businesses. Regulations that limit competition hamper the growth of the most effective enterprises. Often regulatory changes add to uncertainty, discouraging firms from investing. Problems are further exuberated by lengthy judicial procedures. Although in each of the highlighted areas some progress in recent years has been achieved, still much more remains to be done.

References

  1. Bouis, R. i Raising, D., 2011, Potential growth after the crisis, OECD.
  2. Deloitte, 2010, Pomiar obciazen administracyjnych w przepisach prawa gospodarczego, Deloitte Business Consulting S.A., Ministerstwo Gospodarki.

  3. Égert, B. i Goujard, A., 2014, Strengthening Competition in Poland, OECD Economics Department Working Papers, No. 1125, OECD Publishing.

  4. FOR, 2015, The next 25 years: what reforms we need to implement to catch up with the West

  5. Grant Thornton, 2015, Urzedy zasypuja przedsiebiorców sterta formularzy: Badanie skali obowiazków sprawozdawczych polskich przedsiebiorstw wobec instytucji publicznych

  6. Lewandowska-Kalina, M, 2012, Productivity dispersion and misallocation of resources: evidence from Polish industries​, Applied Econometrics Papers, 7-12.

  7. World Bank 2013, Status of Contract Enforcement in Poland, World Bank Groups, Washington D.C.

  8. World Bank, 2005, Poland: Legal Barriers to Contract Enforcement, World Bank Groups, Washington D.C.

  9. World Bank, 2015, Doing Business in Poland 2015, Washington, DC: World Bank.

1 Process is often done in two steps; in the first step assessments are done less precicely, drawing on expert knowledge of people involved. In the second step those information obligations, which are most likely to be most costly are studied more in deep.

2 Study was published in 2010, but was based on data from 2008.

3 Comparable data was available for: Austria (2,8%), Denmark (3.2%), Germany (4.1%), Italy (4.6%); all data from http://www.administrative-burdens.com/

4 It is worth mentioning that the complicated tax system generates high costs not only for businesses but also for the tax administration. In 2011, expenditure on its maintenance consumed 2.7% of the total tax revenue, while OECD countries average was just 1%. This relationship was worse only in Slovakia.

5 Bouis and Raising give a higher figure, over 15%, but between 2011 and 2013 (latest available data) some liberalization already happened, so the remaining gains are now somehow lower that authors’ initial estimates.

6On the one hand, if the tax system was complicated, but stable, its learning would entail a one-off cost. However if the rules are constantly changed, tracking them has no end. On the other hand, if taxes were often changed, but simple, it would be possible to identify the potential scenarios and prepare for each of them. When the number of parameters in the tax system which are frequently changed is high, an analysis of potential scenarios becomes very difficult, if at all possible. For more on the topic see executive summary of “The next 25 years: what reforms we need to implement to catch up with the West?” prepared by Civil Development Forum (FOR, 2015).

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