POLAND'S GAMBLE BEGINS TO PAY OFF The Poles have achieved remarkable results in the first stages of their rush toward a free-market economy. Now comes the difficult task of staying on course.
By Shawn Tully REPORTER ASSOCIATES Mieczyslaw Starkowski and Wilton Woods

(FORTUNE Magazine) – FOR POLAND this may be the most dangerous summer since 1939. While their Soviet neighbors fiddle, the gutsy Poles are switching from Communism to capitalism in one stroke. But their boldness has also brought them to a moment of truth. Whether they continue on what has become an increasingly painful course, or junk the quest in favor of who knows what, will almost certainly be decided in the next few months. The outcome will have ramifications far beyond the country's borders, affecting policies not only in the rest of Eastern Europe but in the Soviet Union as well. In the first stages of their rush toward a free-market economy, the Poles have achieved remarkable results. Since January inflation has dropped to 3.4% a month from as high as 250% a month last year. The once barren stores are well stocked with goods. On weekends Warsaw's dusty Praha quarter blossoms into a colorful street market with trucks and stands brimming with everything from beef and apples from local farms to shoes from West Germany and watches from Hong Kong. There has been a harsh side too, and that's where the risk lies. In the same period, industrial production has plunged 30%. Unemployment, officially nonexistent under Communism, has reached 500,000 and could rise to two million, or 12% of the work force, by 1991. With subsidies curtailed, workers find they are spending most of their paychecks on food and rent. To make matters worse, Poland's leadership is threatening to split apart. A battle for control of the ruling Solidarity movement has broken out between Prime Minister Tadeusz Mazowiecki and Lech Walesa, head of the Solidarity trade union. Walesa wants to run for President this year, while Mazowiecki favors holding elections in mid-1991 at the earliest. Walesa's opponents fear that he will try to curry favor with workers by advocating higher wages and looser credit. The good news is that the economic program drafted by Finance Minister Leszek Balcerowicz with the help of Harvard economist Jeffrey Sachs remains amazingly popular. Typical is the attitude of Michal Relewicz, a design engineer and labor leader at the FSO auto plant near Warsaw. He is dismayed by the hard times but still thinks the government should stick with its program. Says he: ''The reforms were needed. They've stamped out inflation and improved our company's performance. At the moment the threat of unemployment appeared, we had a 20% increase in productivity.'' Those ought to be welcome words for reformers, especially coming from a union leader. Still, Relewicz doesn't think the government is doing enough to revive the economy. ''We can't sell our cars,'' he says. ''And 80% of our profits have disappeared.'' To keep workers on its side, the government will have to engineer a turnaround in a hurry. The only way to do that is to restructure companies and attract foreign investment. Fortunately, Poland has a lot going for it: a home market of 38 million consumers, more than Hungary and Czechoslovakia combined, plus skilled workers who are paid an average $1,200 per year. Asks U.S. Ambassador John R. Davis Jr.: ''Where else can you sell your goods at world market prices and pay Egyptian wages?'' POLAND'S FIRST non-Communist government in 45 years came to power last fall with a strong free-market bent. Finance Minister Balcerowicz, 43, a former economics professor who has an MBA from St. John's University in Queens, New York, is known as a disciple of Milton Friedman. Moving at top speed, Balcerowicz put together a crash program aimed at Poland's bogyman, inflation. For years Communist governments had bought labor peace by raising wages faster than prices, printing huge amounts of money to pay the workers and paper over big budget deficits. By last year that policy had led to a vicious inflationary spiral that threatened Poland's economic future.

! On January 1, Balcerowicz put strict limits on wage increases and allowed prices to soar by erasing subsidies for most goods. Rent on a one-bedroom apartment in Warsaw quadrupled to $65 a month, while the price of coal rose 600%. Wages at the FSO auto plant have gone up less than 15%. The shock treatment worked with savage efficiency. Says Balcerowicz: ''Too much money was chasing too few goods. The key was to cut artificially high consumption.'' Companies accustomed to selling everything they produced -- regardless of price -- began fighting for business. Customers suddenly became precious. To cut costs in order to lower prices, enterprises laid off thousands of workers. Battling to survive, the state-owned FSO has trimmed its work force and is pressing suppliers to reduce prices 30%. It cut production of the midsize Polski and relatively upscale Polonez cars 35% to a rate of 65,000 a year. Cheaper parts, says FSO President Henryk Oleniak, could allow price reductions of as much as 20%, lifting sales back to an annual rate of 100,000 sometime in 1991. Since large sections of state-owned heavy industry -- coal mining, steel, and chemicals -- appear headed for bankruptcy, Poland is counting on the rise of private business to revive the economy. Small, privately owned companies were allowed throughout Poland's Communist period and now account for about 15% of industrial output. They have been amazingly durable, considering the handicaps. Companies wholly owned by Polish entrepreneurs were limited to 50 employees and could not sell to state-owned enterprises. Joint ventures with foreign partners escaped the official limits on employees but faced other penalties -- including special taxes and in many cases a ban on exporting. AFTER ALL RESTRICTIONS were lifted last fall, 80,000 new companies sprang up and existing ones began to expand fast. Sofix, a West German-owned maker of athletic shoes, is a good example. This year President Krystian Barcz expects to double sales to around $8 million. A pioneer in the use of TV advertising, Barcz has made Sofix shoes a hit with teenagers. He now also has enough workers to keep up with demand. Though as a foreign- owned firm Sofix was not limited in the number of workers it could have, the company could never find enough. Those it did hire -- mainly ex-convicts -- kept prewritten resignation notes in their pockets. If the work got too strenuous, they simply handed the foreman the note, then strolled out of the plant and into another job. ''My workers used to terrorize me,'' says the flamboyant, silver-haired Barcz, 60. With layoffs creating a growing pool of unemployed, Sofix no longer has to rely on ex-cons. Since January its work force has expanded 60% to 760. Says Barcz: ''Because workers are afraid of losing their jobs, they do what I tell them. Now I really am the boss.'' Even more striking is the new attitude of suppliers. In the past, Sofix often had to wait six months for materials, and deliveries hinged on how much cognac and cash Barcz was willing to provide on the side. Now suppliers who never stooped to visit his plant are begging for orders. He can get most of the supplies he needs in a week, which has allowed Sofix to reduce inventories by half for savings of $200,000 a year. Competition among suppliers has driven down prices too. When the state-owned enterprise that produces the chemical pellets used to make rubber soles doubled prices in January to $2.20 a kilogram, Barcz began buying them from a French company at $1.40. Polish producers are now matching the French prices and offering to improve quality to boot. Says Barcz: ''We've stopped giving presents to our suppliers. But we do buy them lunch. We're a lot richer than they are.'' In Eastern Europe's drive for privatization, Poland is taking something of a middle course. Hungary is embarking on a sophisticated, Thatcher-style sell- off aimed at attracting foreign investment in some of the country's biggest enterprises. The Czechs, who have taken a gradual approach to reform, don't even want to sell shares directly. Instead they favor a plan to give citizens ''vouchers'' enabling them to buy equity in state-owned companies. The vouchers would not be tradable. In July the Polish Parliament overwhelmingly approved a plan that would put shares in the hands of ordinary Poles. Although details are still being worked out, employees could buy as much as 20% of their companies, and foreign investors could buy another 10% without government approval. An additional 20% or so would be reserved for Polish citizens, probably in the form of mutual funds that would have stakes in a wide assortment of newly privatized companies. The government would keep a controlling interest initially but would list its shares on a new stock exchange as early as next year. Once a market price was established, the government could sell the rest of its shares without being accused of selling out too cheaply -- a charge that has marred privatizations from France to Mexico. Another advantage is speed. Balcerowicz hopes to privatize several hundred of Poland's state-owned companies within two years. By contrast, Hungary's elaborate process could take a decade. Foreign investors will be able to own up to 100% of a Polish company, subject to government approval. Says Balcerowicz: ''If the price is right, we have absolutely no objection to foreign control.'' Any new venture gets a three-year exemption from income taxes, regardless of whether it is foreign or locally owned. Starting in 1991, all foreign investors can repatriate in hard currency 15% of their earnings in Polish zlotys. Under a pending treaty the deal for U.S. companies will be even better. Over the next several years American investors will be allowed to send home a rising share of their Polish profits, culminating with 100% in 1996. Rated on generosity to investors, Poland with its new law is behind Hungary but slightly ahead of Czechoslovakia. In Hungary foreign investors can repatriate in dollars or other hard currency 100% of the profits reaped in forints. The slow-moving Czechs are loosening currency restrictions but still offer few tax incentives. However, approval of joint ventures takes less than 60 days in Poland, compared with 90 days in Hungary. Investor interest is rising. Asea Brown Boveri, the Swiss-Swedish producer of heavy electrical equipment, is buying a majority stake in Zamech, Poland's largest producer of steam turbines. ABB expects to thrive on the modernization of Poland's antiquated electric power network. Italy's Fiat has signed a new licensing agreement with automaker FSM -- and is negotiating another with FSO -- to build a total of 280,000 cars a year in Poland by 1993. (Fiat will sell some of the cars in Italy.) Says Francesco Gallo, director of Fiat's international business: ''We're cautiously optimistic. If Poland can get through the difficult days ahead, the car market will grow dramatically.'' Poland is also benefiting from the expertise Polish-Americans are bringing back. Typical is Zbigniew Niemczycki, 43, an electrical engineer who migrated to the U.S. in 1977 and got a job as an electrician's helper, then rose to a top management post at SerVaas Inc., the privately held Indianapolis conglomerate that turns out everything from magazines to auto parts. Returning to Poland in 1983, Niemczycki has set up four joint ventures for SerVaas that will do $100 million in sales this year. His initial coup was exploiting the superb quality of Polish cartoon animation. SerVaas and Hollywood's Hanna-Barbera Productions are part owners of one of the largest animation studios in Europe, which does a brisk business supplying cartoons to the U.S. Niemczycki's lifestyle matches that of most U.S. entrepreneurs. At his palatial home in suburban Warsaw, he treads marble floors and rare Oriental carpets, and unwinds in a redwood hot tub. And Niemczycki is building houses for Polish-Americans who want a retirement home in the homeland. The big investment money won't start flowing until Poland finds a way to work down its huge foreign debts, which could cripple its economy for decades. Since the early 1980s, Poland has paid only part of the interest due foreign government lenders, and all of the interest -- but no principal -- to commercial banks. As a result, the debt rose from $27 billion in 1982 to $40 billion. If forced to pay it all back, Poland would have to raise taxes and restrict imports, scaring off foreign investors. Says David Lipton, an American economist who is a consultant to the Polish government: ''If the debt overhang remains, it will wreck Poland's transformation to a market economy.'' TO GIVE THE COUNTRY some breathing room, Balcerowicz negotiated a suspension of payments until April 1991. Balcerowicz then proposed to settle the debt for 17 cents on the dollar, or about $8 billion. The plan's chances appear increasingly good. Especially sympathetic to Poland's plight is U.S. Treasury Secretary Nicholas Brady, a champion of debt reduction for developing countries. As Poland speeds up and the Soviet Union equivocates, governments are questioning the wisdom of gradualism. Says U.S. Ambassador Davis: ''If Poland succeeds, it will be widely imitated.'' For Eastern Europe, Poland's decision to move fast and stand up to the pain looks like the way to go in the 1990s.