Figure 2.9 Ease of doing business score and output resilience

Box 2.14 Poland’s successful weathering of the crisis

In the aftermath of the financial crisis of 2008, all EU countries suffered losses in terms of GDP per capita. The exception was Poland. In 2000, Poland moved from a fixed to an independently floating exchange rate regime. In the run-up to the financial crisis, the nominal exchange rate appreciated with an increase in real wages in Poland relative to other EU countries. However, substantial productivity gains compensated for the exchange rate’s increase, accompanied by large inflows of foreign direct investment. Poland’s growth was not fueled by credit binges and speculative investments. As a result, the Polish economy, including its banking sector, entered the financial crisis in a good condition. Following the outbreak of the financial crisis, there was an immediate depreciation of the Polish zloty as a result of the global contagion, helped by a reduction of interest rates by the central bank. While the devaluation allowed the nominal growth of wages to continue (and avoid a painful cut in nominal wages), real wages and the real exchange rate declined sharply: between Q3 2008 and Q1 2009 real wages fell by more than 15 percent. The floating exchange rate allowed the economy to absorb the shock without an output contraction, with exports driving the economic rebound. Unemployment rose from 8.8 percent in October 2008 to 13 percent in February 2010, but a relatively large shadow economy helped cushion job losses and shore up consumption, while the propitious timing of record inflows of EU funds further helped stabilize the economy.

Source: World Bank and Drozdowicz-Biec (2011).

Obviously, this creates psychological, distributional and political tensions. Other options include reducing working hours or outright dismissal. The latter becomes problematic if the recession is prolonged and workers remain unemployed for long periods, which could lead to a loss of skills and employability and hence to long-term unemployment (hysteresis). All in all, internal devaluation can therefore be psychologically, socially and politically very challenging. This could be the main reason why, on average, the eurozone members and countries that fix their currency to the euro are hit harder and take longer to recover, both with respect to GDP and employment.

However, the benefits of a flexible exchange rate regime as a medium or long-term policy instrument are limited. Devaluation does offer a short-term, effective response to deal with shocks. It creates a rapid, economy-wide stimulus to boost exports which, for an open economy, could set the stage for a quick recovery. And a currency devaluation makes prices of domestic goods and services fall instantaneously and economy-wide, across all relevant markets. Such an adjustment is relatively efficient from the standpoint of transaction costs. Finally, politically, socially and psychologically, the implicit distributional implications of such an adjustment seem less challenging than the adjustment options available under a fixed exchange rate regime. However, in the medium term, the real exchange rate will adjust to the new economic situation, regardless of the exchange rate regime in place. It is in that sense that the choice of exchange rate regime is immaterial.

Trust contributes to the accumulation of social capital, impacting economic performance and resilience91 . Trust lowers the transactions costs of economic agents’ market participation by lowering the costs of information seeking, bargaining and contracting, and monitoring and enforcement. Trust also allows economic agents to take a longer term view of negotiations and contemplate inter-temporal trade-offs that benefit both parties in the long run. The political scientist Robert Putnam famously hypothesized that today’s differences in efficiency between regional governments in Italy were directly related to historical variations in cooperation, participation, social interaction and trust—together