During the past two years, Poland has recorded its best economic performance since the late 1990s, with growth exceeding 6%. This was also the second-best performance among OECD countries, allowing for a significant narrowing of the income gaps vis-à-vis the average EU and OECD levels. Since Poland joined the European Union in 2004, GDP per capita has moved from 44 to 48% of the pre-2004 enlargement EU average. Furthermore, after nearly a decade of relative stagnation, employment has finally begun to contribute markedly to gains in living standards, rising by some 3% per year. Meanwhile, labour supply has shrunk, despite a still expanding working-age population. This further decline in labour force participation rates, to especially low levels for older workers and the least skilled, is of great concern. The result has been a spectacular decline in the unemployment rate, from nearly 18% in 2005 to 8½ per cent in the fourth quarter of 2007. At the same time, productivity gains have slowed from the growth rates recorded in the early 2000s.

Poland’s economy has performed well in the last two years. Real GDP has grown faster than in almost all other OECD countries. Unemployment has fallen sharply, as employment has surged while participation has declined. The benefits of this robust growth performance have been shared between capital and labour: wages have picked up sharply. The immediate challenge is to head off overheating by an appropriate policy mix consisting of judicious monetary tightening and a budgetary policy that holds the general government deficit below 3% of GDP. Looking further ahead the primary objective should be to reform labour-market, tax and other structural policies so as to boost effective labour supply in a way that will sustain the process of convergence of per capita incomes with those of the more affluent OECD members. That will mean: increasing labour-market flexibility, further reducing the tax wedge on labour income (especially for the least skilled), closing off the remaining routes to early retirement, and improving labour mobility by strengthening housing markets (particularly for rentals) and enhancing transport infrastructure.

The last two years saw a strong acceleration of economic activity in Poland. With the aim to safeguard the sustainability of economic growth both monetary and fiscal policies were tightened in 2007. Yet, despite an uncertain international outlook, it is clear that monetary and fiscal policies need to be further adjusted to head off overheating in the domestic economy. Although the surge in headline inflation to well above the central bank’s target of 2.5% has been mostly driven by external shocks, as in other countries, a considerable build-up in wage pressures could darken the inflation outlook. Failing to contain inflationary pressures could harm the hard-won credibility of the monetary authorities and make it costlier to achieve their primary objective of price stability in the medium term. Delaying the policy response could increase future adjustment costs in terms of activity and employment and jeopardise the ultimate objective of adopting the euro. A tightening of monetary policy is therefore needed to steer the economy towards a sustainable low-inflation growth path, assisted by any further appreciation of the currency. But monetary policy should not bear the whole burden of stabilising the economy. A significant retrenchment in public spending could considerably improve the policy mix.

The Polish tax system is characterised by high social security contributions for both employers and employees. As a result, Poland has one of the highest tax wedges in the OECD, despite relatively low personal income tax rates. This, combined with a relatively high minimum wage and generous early-retirement and disability benefit programmes, contributes to low employment rates, in particular among low-skilled workers. The system also relies heavily on consumption taxes, whereas relatively little revenue is collected from such bases as environment externalities, inheritances and, in particular, property. One of the key implications of the tax structure is that the system as a whole is one of the least redistributive among OECD countries. This Chapter reviews the main features of the tax system and explores options to improve its efficiency, including possibilities to broaden existing tax bases as well as to shift the tax burden from labour towards less mobile and distorting sources such as property.

Despite a high level of homeownership, the housing market in Poland is suffering from an important shortage. The difference between the number of households and available dwellings, the number of dwellings per thousand inhabitants, and the availability of basic amenities (especially in rural areas) all indicate that significant improvements are needed to catch up to the most affluent OECD and EU countries. The formal rental segment of the market is also underdeveloped, contributing to low labour mobility and persistent disparities in regional unemployment. Given the social, economic and political dimensions of the problem, various housing policies implemented since the beginning of the transition process have aimed to fill the housing gap, though they have been either narrow in scope or have led to unclear results. However, the housing market has been buoyant in recent years, spurred by rising levels of GDP per capita, lower interest rates and the emergence of a competitive mortgage market. Yet a brisk price appreciation has also occurred at the same time, while households’ exposure to interest- and exchange-rate risks has significantly increased and banks’ funding capabilities have shrunk. Although the market has not been directly affected by the recent global financial turmoil, recent information shows that a turn-around is underway, with prices declining in several major cities as sentiment has plunged. This raises concerns about the capacity of the market to achieve a smooth adjustment in the face of a possible downturn.

Following many years of underinvestment, renovating and building new transport infrastructure is an important policy priority that would increase labour mobility and improve Poland’s competitiveness. This goal is all the more feasible given that the country is going to benefit from substantial EU structural and cohesion funds over the programming period 2007-13. On top of the limited timeframe for the absorption of EU funds, the European soccer championship that Poland is going to co-host with Ukraine in 2012 imposes an additional time constraint on many investment projects. The country is heavily reliant on road transport but is lacking an efficient high-speed road network. It needs important renovation investments both in the rolling stock and infrastructure network of the railway sector. It also faces the challenges of revitalising maritime transport as well as extending and upgrading airport facilities to cope with the fastest growing air market in Europe. However, many obstacles remain and hinder the implementation of investment plans and thus need to be resolved rapidly. From the macroeconomic perspective, these are related to rising prices of scarce labour and intermediate inputs, while from the microeconomic standpoint the main difficulties lie in the area of the regulatory framework underlying the provision of physical infrastructure.