PATHS OF PRODUCTIVITY GROWTH IN POLAND A FIRM LEVEL PERSPECTIVE EXECUTIVE SUMMARY This project is carried out with funding by the European Union via the Structural Reform Support Programme and with the support and the partnership of the European Commission's DG REFORM PATHS OF PRODUCTIVITY GROWTH IN POLAND A FIRM LEVEL PERSPECTIVE EXECUTIVE SUMMARY October 2021 This project is carried out with funding by the European Union via the Structural Reform Support Programme and with the support and the partnership of the European Commission's DG REFORM © 2022 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Cover design: Wojciech Wołocznik, Cambridge, United Kingdom Interior design and typesetting: Piotr Ruczynski, London, United Kingdom CONTENTS Background   5 Author’s Note   5 Key Findings   6 Key Recommendations   7 Executive Summary   9 Why Is Productivity Important?   9 How to Improve Aggregate Productivity    11 Heterogenous Productivity Growth     13 Productivity Stagnation in Manufacturing    14 Productivity Volatility in Construction    15 Continued Productivity Growth in Services    16 Smaller and Younger Firms Exhibit Better Productivity Performance    17 Competition and Research and Development Contribute Positively to Productivity Growth     18 Abbreviations and Acronyms    20 References    20 BOXES Box 1  What is Productivity?    13 Box 2  How to Boost Productivity    14 FIGURES Figure 1  GDP Per Capita, 1992 – 2020    11 Figure 2  Labor Productivity as Share of Germany’s, 2018    12 Figure 3  Productivity Growth by Sector (2009 – 19)    16 Figure 4  Manufacturing Sector Productivity Growth Decomposition    17 Figure 5  Construction Sector Productivity Growth Decomposition    18 Figure 6  Services Sector Productivity Growth Decomposition    19 BACKGROUND This executive summary is a supplement to the technical report “Paths of pro- ductivity growth in Poland: a firm-level perspective.” Both documents are the main outputs of Phase 1 of a project, “Technological readiness and management skills — Productivity growth drivers in Poland,” conducted in collaboration with the European Commission (EC) Directorate-General for Structural Reform Sup- port (DG REFORM). The project aims to support Poland’s Ministry of Economic Development and Technology with enhancing the effectiveness of firms’ support systems by providing evidence based on firms’ capabilities, context, and barri- ers to productivity growth. The project consists of three phases: • Phase 1 focuses on understanding firm-level productivity growth and for- mulates policy recommendations to enhance the economy’s productivity performance. • Phase 2 provides evidence based on Polish firms’ capabilities by implement- ing and analyzing a Technology Adoption Survey. • Phase 3 aims to build capacity and support the redesign of instruments to build firms’ capabilities. AUTHOR’S NOTE This executive summary was prepared by the Finance, Competitiveness, and Innovation Global Practice of the World Bank Group (WBG). The WBG team, led by Łukasz Marć (Economist), included Umut Kilinc (Economist), Magda Malec (Consultant) and Bartłomiej Skowron (Consultant). Mirosław Błażej and Mariusz Górajski from Statistics Poland collaborated with the WBG team on the prepara- tion of the decomposition and regression results. 5 Paths of productivity growth in Poland: a firm-level perspective KEY FINDINGS Poland needs to realize substantial productivity improvements to spur eco- nomic growth. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its productivity (Krugman, 1994), and increases in individual firm productivity are the most critical factor con- tributing to economic growth (ILO, 2013). Such within-firm performance can be complemented by the reallocation of resources from less-productive to more-pro- ductive firms and sectors, as well as the entrance of high-productivity firms and the exit of low-productivity firms. Putting productivity at the center of Poland’s growth agenda means designing and adopting an effective mix of policies to im- prove market functioning, create an efficient business environment, and provide incentives for entrepreneurship and firm upgrading. It will require focusing on monitoring and developing programs that support productivity growth (while not disturbing the functioning of the market unnecessarily), with particular at- tention to strengthening firms’ productivity — innovation or adoption of better technologies, digitalization, managerial and organizational talent, and labor skills. Productivity growth in the Polish manufacturing sector has stagnated since 2012 and is significantly lower than in services and construction. The total fac- tor productivity (TFP) growth stagnation in the manufacturing sector in Poland between 2012 and 2019 resulted mainly from a deterioration in the allocative ef- ficiency in the prime manufacturing industries: metals and food and beverag- es. During that period, the largest low-productivity firms in these industries grew and expanded their market share at the cost of more productive firms. Consequently, the productivity growth of the entire manufacturing sector was dampened. This period of stagnation calls for policy attention additionally be- cause the worsening allocative efficiency in manufacturing changed a long-ob- served (since 1997) trend of reallocation of resources from less-productive to more-productive firms and sectors, driving the aggregate productivity growth in Poland (World Bank, 2017). Moreover, labor productivity growth significant- ly outpaced TFP growth, indicating that the expansion of the manufacturing in- dustry came primarily from increasing capital intensity (using more machines per employee) rather than improvement in technical efficiency. Aggregate productivity growth acceleration after 2017 can be credited to im- provements in within-firm productivity performance, but not all industries are benefiting equally. Starting from 2017, productivity growth mainly accelerat- ed due to improvements in firms’ capabilities. However, in civil engineering, the 6 construction of buildings, and the manufacturing of paper, chemicals, and ma- chinery, within-firm productivity worsened, demonstrating a need for strength- ening firm-specific productivity performance in these industries and taking a tailored approach to effective policy design. Moreover, the only two industries with exceptional productivity growth (telecommunications and the manufac- turing of computers and electronics) can attribute their outstanding produc- tivity performance to advances in firms’ capabilities. Small and medium-sized enterprises (SMEs) are the engines of productivity growth in Poland. SMEs are more likely to have substantially higher produc- tivity growth than large Polish firms. Because smaller firms have greater pro- ductivity potential, targeting them with public incentive programs is more like- ly to increase economy-wide productivity and, in turn, lead to higher aggregate growth. At the same time, lower-productivity large firms do not lose market share in some sectors, indicating inefficient reallocation of market shares. The empir- ical analysis also suggests that firms in expanding industries have better pro- ductivity performance than those in other industries. Moreover, even though new firms entering the market begin with low levels of productivity, they grow much faster than older establishments. KEY RECOMMENDATIONS Improve allocative efficiency in manufacturing. Deterioration in allocative efficiency in manufacturing calls for attention to the structure and targeting of incentive programs in the form of tax relief, subsidized credits, grants, and other types of firm-specific interventions. Supporting potential high-productiv- ity producers should not be limited to subsidizing selected growth-enhancing investments but should also include improving the business environment and facilitating access to finance. Enhance firms’ capabilities. Improving within-firm performance means in- creasing the amount of output firms produce with a constant quantity of inputs by, for instance, strengthening managerial skills, workforce skills, innovation capacity, and technology absorption capability. Policy interventions aiming to improve within-firm performance include, for instance, providing business ad- visory and technology extension services, facilitating entrepreneurial networks and clusters, and offering vouchers for training. Labor skills such as digital lit- eracy and leadership are as important as technology itself. 7 Paths of productivity growth in Poland: a firm-level perspective Support SMEs. Empirical findings suggest that there is a need for policy inter- vention to intensify competition in Polish industries by detecting and remov- ing regulations that provide asymmetric advantages to large firms. In addition to reducing barriers to competition, eliminating constraints on the growth of smaller firms, especially in manufacturing, is critical. Improving SMEs’ ability to grow requires facilitating their access to finance, promoting financial mar- ket deepening, and supporting the development of the innovation supply side (for example, dedicated software for SMEs). Policy interventions need to address potential barriers to SMEs adopting technology because their gains from adop- tion may be greater than those for larger establishments. Moreover, facilitating market entry might foster aggregate productivity growth because younger firms tend to have better productivity performance than older ones. Investigate barriers for growth for large Polish firms. Large firms should be in- centivized (though not necessarily financially) to improve their within-firm pro- ductivity performance. Improving the business environment for large firms — es- pecially in the food and beverages, metals, and rubber industries — and targeting elimination of industrial protection could improve their performance, but fur- ther investigation is needed to understand all the barriers to their productivity enhancement. Moreover, because firms in expanding industries had better pro- ductivity performance than other establishments, increasing demand for an in- dustry’s products and strengthening competition could also lead to higher ag- gregate productivity growth. Employ the new wave of productivity diagnostics and improve data accessi- bility. Employing the new wave of productivity diagnostics is necessary to pro- vide a comprehensive understanding of drivers of and barriers to productivity growth and define precise policy recommendations. These approaches require detailed firm-level data on prices, marginal costs, intangible assets, quality, and management. Getting accurate measurements of firm entry and exit, for exam- ple, requires collecting high-quality firm-level data. Consequently, building the institutional capacity of national statistical offices is essential for evidence-based policy design. Moreover, delivering high-quality research depends on govern- ment openness to share data. In this regard, Poland could establish an “Innova- tion and Productivity Excellence Center” or similar entity (see also World Bank, 2019) to provide analytical inputs for designing policy instruments and facili- tate a knowledge platform with a repository of best practices related to policy design, implementation, and evaluation. 8 EXECUTIVE SUMMARY Why Is Productivity Important? After a long period of economic transformation that included introducing a series of market-oriented reforms and joining the European Union (EU), Poland was one of the fastest-growing economies in the world by 2020. The Polish gross domestic product (GDP) per capita increased by 300 percent between 1992 and 2020, and the country reached high-income status in 2009. Despite this remarkable growth, Poland still lags many European comparator countries, with its income per capita currently at three-quarters of the EU average (Figure 1). Factors delay- ing the catch-up with advanced economies include weak innovation performance, insufficient technology adoption, and labor force digital skills that are below the EU average. Because the post-transition (capital-driven) development model might be reaching its limits, the policy focus needs to shift toward different growth engines, such as productivity. With low levels of investment and a shrinking labor force due to population aging, Poland will increasingly depend on productivity advances for long-term growth, likely more so than in other advanced economies. FIGURE 1  GDP Per Capita, 1992 – 2020 60,000 constant 2007 international $ 50,000 GDP per capita PPP, 40,000 30,000 20,000 10,000 0 Poland Germany EU (27) Eurozone Czech Republic Slovakia Hungary Central Europe and the Baltics Republic of Korea Source: Elaboration based on World Development Indicators. Note: EU = European Union; GDP = gross domestic product; PPP = purchasing power parity. Despite Poland’s remarkable economic growth, a manufacturer in Poland still needs almost three times as many employees to produce the same out- put as an average manufacturer in Germany. In 2018, gross value added per 9 Paths of productivity growth in Poland: a firm-level perspective person employed in a manufacturing firm in Poland, a measure of labor produc- tivity (see Box 1), was only 35 percent of the German average and slightly lower than in Hungary or the Czech Republic (Figure 2). Labor productivity across all sectors1 in Poland is substantially lower than in the EU. In fact, an average firm in Poland needs more than twice as many workers to produce the same output as an average EU firm. The gross value added by each sector does not vary much across countries, but the structure of firm sizes is distinctly different (Eurostat 2021). For instance, in Poland, more than one-third of employees work in micro companies (34 percent of the labor force works in establishments with fewer than 10 employees), while in Germany, only 19 percent of workers are employed in micro firms. Much of the German labor force (41 percent) is employed in the largest companies (those with more than 250 employees). FIGURE 2  Labor Productivity as Share of Germany’s, 2018 Germany EU (27) Manufacturing Hungary Czech Republic Slovakia Poland 35% Romania Germany EU (27) Construction Hungary Czech Republic Poland 37% Romania Slovakia Germany EU (27) Czech Republic Services Poland 46% Slovakia Hungary Romania 0 10 20 30 40 50 60 70 80 90 100 Labor productivity (gross value added per person employed), Germany = 100 Source: Elaboration based on Structural Business Survey (Eurostat 2021). Note: Latest available data is for 2018. EU = European Union. Rep. = Republic. 1.  Throughout this note, the word “sector” applies to the three major parts of the economy — manu- facturing, construction, and services. The division follows the statistical classification of economic activities used in the European Union (NACE Rev. 2). We disaggregate the sectors further into indus- tries (level 2 of NACE). 10 Executive Summary BOX 1  What is Productivity? Productivity measures the technical efficiency in production — how the economy transforms the factors of production (for instance, capital and labor) into output. It can be quantified through two main indices: labor productivity and total factor productivity (TFP). Labor productivity indicates how much value added is produced per employee. Thus, it indicates how efficiently labor is employed in production, which also depends on the intensity of capital in the production process. Consider two hypothetical textile manufacturers. The first produces hand- crafted shirts. The second uses high-tech equipment to produce shirts of similar quality. The equip- ment only requires one machine operator rather than several sewers. We can measure labor pro- ductivity in this case as the number of workers employed to produce each shirt. It would be lower for the producer that handcrafts shirts, even though both producers make shirts of the same quality. TFP captures how efficiently firms transform inputs into outputs. Thus, it captures the increase in output that is not attributed to a change in the quantity of factors of production. The higher the TFP, the less input is needed for a given output. TFP can depend on a range of factors, such as skills, organizational structure, managerial talent, and adaptation or innovation of new or better technol- ogies and processes to produce larger amounts or higher-quality products or services with fewer resources. TFP is not observable from the data directly but can be estimated. Realizing substantial economic growth requires productivity improve- ments. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its productivity (Krugman, 1994). A global review by ILO (2013) finds that an increase in individual firm productivity is the most critical factor contributing to economic growth. Putting productivity at the center of Poland’s growth agenda means focusing on monitoring and develop- ing programs that support productivity growth (while not disturbing unneces- sarily the functioning of the market), with particular attention to strengthening firms’ productivity — innovation or adoption of better technologies, digitaliza- tion, managerial and organizational talent, and labor skills. How to Improve Aggregate Productivity Effective policy design aiming to boost productivity requires not only identi- fying aggregate productivity trends but also determining micro productivity drivers. To investigate productivity dynamics across economic segments and to derive policy recommendations to improve the productivity performance of an economy, one needs to build the analysis on firm-level data. Each industry faces unique market conditions and is endowed with distinct technologies and skills. Without comprehensive knowledge about the nature of this heterogeneity, it is difficult to successfully design a cost-effective system of productivity-enhanc- ing incentives. Employing firm-level data enables determining both aggregate 11 Paths of productivity growth in Poland: a firm-level perspective productivity trends and underlying heterogeneity across sectors and indus- tries. Moreover, it allows decomposing productivity growth into four compo- nents — within, between, upscaling, and downscaling — that represent different drivers of productivity growth (Melitz and Polanec, 2015; see Box 2). Further- more, it helps to determine whether potential drivers of productivity growth that are well-known in the literature (such as strengthening competition and in- vesting in research and development) are also effective in influencing the per- formance of firms in a particular country. BOX 2  How to Boost Productivity Aggregate productivity can grow in four ways. One is by firms increasing their capabilities (with- in-firm productivity growth). The second is by the reallocation of resources from less productive to more productive firms (between-firm productivity growth). The third is the entry of more produc- tive firms into the market (upscaling). The fourth is the exit of less successful firms from the mar- ket (downscaling).a The latter two can be considered together as dynamic productivity growth or net entry. Employing firm-level panel data enables decomposing productivity growth into these four components (Melitz and Polanec, 2015). Boosting productivity requires policy actions addressing all components of productivity growth. The figure below presents an exemplary set of policy interventions and programs broken down into the three productivity growth components with which they are typically associated. TFP growth Within growth Between growth Dynamic growth Firm increasing their Allocating resources (capital Entry of high-productivity capabilities by innovating and labor) from less e cient firms and exit of low-pro- and adopting better to more e cient firms ductivity firms technologies Allowing markets to work e cient- Removing barriers to entry and Promoting innovation through ly, reducing distortions and disin- experimentation, reducing the incentivizing R&D investments centives for more productive firms risk of failure by making exit to grow, targeting the elimination and re-entry low cost (simplify- Enhancing technology adoption of labor market frictions, removing ing starting up and restructur- not only by financial incentives industrial protection, addressing ing businesses, streamlining li- but also by strengthening man- market failures (financial market censing, minimizing bureaucrat- agerial capabilities deepening) ic burden on low-risk activities) Upgrading organizational and Strenghthening competition Lowering risk of innovative prod- management practices in firms ucts or risks associated with by improving education quality Strengthening linkages with for- novel business models (finan- and supplying digital and tech- eign markets, reducing transac- cial sector policies, protection of nical skills tion costs for firms to integrate property rights) with larger markets Encouraging entrepreneurship Sources: Cirera and Maloney (2017); Cusolito and Maloney (2018). a. Capturing the contributions of firm entry and exit robustly depends heavily on the quality of the data, particu- larly the reliability of the panel structure. The entry and exit components are computed based on the absence or presence of data rather than information on firm entry and exit. 12 Executive Summary The report investigates differences in productivity dynamics across economic segments and derives policy recommendations to improve Poland’s produc- tivity performance. First, we estimate firm-level TFP, compute labor productiv- ity indices, and analyze the main productivity patterns between 2009 and 2019 (dataset and calculations prepared by Statistics Poland based on firm-level An- nual Enterprise Survey). Second, we decompose aggregate productivity perfor- mance into the within, between, and net entry components using the Melitz-Po- lanec decomposition method to understand the underlying response behind the observed productivity growth in Polish sectors and industries. Even when there is no innovation or adoption of better technology that would increase individu- al firm productivity (within-firm productivity growth), reallocating production factors such as capital and labor from less to more productive establishments in- creases economy-wide productivity (between-firm productivity growth). There- fore, barriers to this reallocation would suppress the productivity performance of an industry and, hence, aggregate productivity growth. However, significant productivity improvements require progress on every front. Even if the busi- ness environment is perfect, there will be no growth if entrepreneurs do not have the human capital necessary to take advantage of it. To support produc- tivity, Poland needs to design and adopt an effective mix of policies to improve market functioning, create an efficient business environment, and provide in- centives for entrepreneurship and firm upgrading. Heterogenous Productivity Growth Despite Poland’s remarkable economic growth, productivity growth in the Polish manufacturing sector has stagnated since 2012 and is significantly lower than in services and construction. The empirical analysis (which was based on small, medium, and large Polish enterprises, without micro firms) in- dicates that economy-wide TFP grew annually on average by 3 percent between 2009 and 2019 (Figure 3). However, manufacturing, construction, and services follow distinctively different productivity trends. There are no significant TFP improvements in manufacturing after 2012. At the same time, the construc- tion and service sectors demonstrate continuous modest TFP growth of 3 per- cent per year. Except for 2012, labor productivity follows an overall increasing trend in all sectors over the entire 11-year sample period. Faster labor produc- tivity growth compared to TFP suggests increasing capital intensity of produc- tion methods between 2009 and 2019. In other words, to a large extent, firms ex- panded their production by using more machines per employee rather than by improving production efficiency. 13 Paths of productivity growth in Poland: a firm-level perspective FIGURE 3  Productivity Growth by Sector (2009 – 19) a. Labor productivity b. TFP 20 20 15 15 Productivity change (%) Productivity change (%) 10 10 5 5 0 0 -5 -5 -10 -10 -15 -15 -20 -20 10 10 18 18 14 16 14 16 19 19 13 15 13 15 12 12 17 17 11 11 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Manufacturing Construction Services Source: Elaboration based on Statistics Poland calculations. Note: TFP = total factor productivity. Productivity Stagnation in Manufacturing Declining efficiency of resource allocation was responsible for the produc- tivity slowdown in manufacturing. (See Figure 4.) Large low-productivity pro- ducers in the two biggest manufacturing industries (food and beverages and met- als) increased their market share over time at the cost of more productive firms within their industries, reducing the manufacturing sector’s aggregate produc- tivity performance. Simultaneously, allocative efficiency improved in some man- ufacturing industries, resulting in significant differences in productivity pat- terns across industries within the same sector. The deterioration in allocative efficiency calls for policy attention because the worsening allocative efficiency in manufacturing broke the long-observed trend of between components driv- ing the aggregate productivity growth in Poland (World Bank, 2017). It points to the importance of removing barriers to the undisturbed flow of production fac- tors and removing regulatory restrictions on competition. Economic policy in Poland would benefit from supporting companies with high potential to inno- vate or grow rather than helping inefficient establishments survive. 14 Executive Summary FIGURE 4  Manufacturing Sector Productivity Growth Decomposition 7 6 5 4 TFP growth, percent 3 2 1 0 -1 -2 -3 -4 2012 2013 2014 2015 2016 2017 2018 2019 Within Between Upscaling Downscaling Net Source: Elaboration based on Statistics Poland calculations. Note: The figure shows the results of decomposing 3-year productivity growth rates using the Melitz-Polanec method, smoothed to represent an annual change. Productivity Volatility in Construction Until 2017 Poland’s construction industry profited from more efficient alloca- tion of resources between firms, but afterward, its TFP growth was primarily driven by productivity improvements within firms. The within and between productivity components in construction followed divergent paths (Figure 5). The between component was positive and relatively high until 2017, while the within was generally negative. Starting from 2017, the situation reversed: the within component remained positive, while the between component was nega- tive for the following two years. This suggests that Polish construction received a positive productivity shock in 2018 that increased firms’ capabilities and, hence, the aggregate productivity growth of the sector. Firms that benefited from this positive shock, however, did not necessarily have large market shares, so the between-firm component decreased by the end of the sample. The construction industry in Poland has a very dynamic structure, with high rates of firm entry and exit from the dataset. The construction sector under- went a disruption in 2010 – 13 due to an unprecedented demand boom related to the Union of European Football Associations Euro 2012 championship and projects co-financed by EU structural funds. The large negative downscaling contribution 15 Paths of productivity growth in Poland: a firm-level perspective in 2014 that is depicted in Figure 5 might reflect this negative shock and the bank- ruptcy wave that followed (Supreme Audit Office, 2018). It is also likely connected to Poland’s lower net inflow of foreign direct investment (UNCTAD, 2013 – 2015). FIGURE 5  Construction Sector Productivity Growth Decomposition 12 10 8 TFP growth, percent 6 4 2 0 -2 -4 -6 -8 2012 2013 2014 2015 2016 2017 2018 2019 Within Between Upscaling Downscaling Net Source: Elaboration based on Statistics Poland calculations. Note: The figure shows the results of decomposing 3-year productivity growth rates using the Melitz-Polanec method, smoothed to represent an annual change. Continued Productivity Growth in Services As in manufacturing and construction, the within-firm component contrib- uted substantially to aggregate productivity growth in services, especially for the later period in the sample (2016 – 19), but unlike in other sectors, the efficiency of resource allocation improved continuously in services. The ser- vice sector in Poland had uninterrupted positive productivity growth through- out the sample period, with an increase in the growth rate after 2016 (Figure 6). In the earlier years, much of the growth came from the entry of new producers to the dataset and efficiency in resource allocation. After 2016, however, firms’ own productivity performance was the main driver of the accelerated aggregate productivity performance. The only negative productivity contribution came from downscaling, indicating that some high-productivity firms exited the data- set, if not the market. The negative exit contribution, however, may be due to gaps in the data for some high-productivity firms. When a data point is missing for such a high-productivity firm, there are two consequences. First, its absence in a given year will be reflected as a negative contribution to the downscaling 16 Executive Summary component for that year. Second, the upscaling component will rise in the next year, when the missing firm is observed again in the sample. Thus, the simulta- neously negative downscaling and positive upscaling components in the ser- vice sector’s productivity decomposition may be mainly due to the unbalanced structure of the sample rather than to actual firm entries and exits. It points to the importance of collecting high-quality firm-level data in order to derive pre- cise policy recommendations. FIGURE 6  Services Sector Productivity Growth Decomposition 7 6 5 TFP growth, percent 4 3 2 1 0 -1 -2 2012 2013 2014 2015 2016 2017 2018 2019 Within Between Upscaling Downscaling Net Source: Elaboration based on Statistics Poland calculations. Note: The figure shows the results of decomposing 3-year productivity growth rates using the Melitz-Polanec method, smoothed to represent an annual change. Smaller and Younger Firms Exhibit Better Productivity Performance SMEs are the engines of productivity growth in Poland. They are more likely to have substantially higher productivity growth than larger Polish firms. Large firms, however, do not lose their market shares in some industries, indicating inefficient reallocation of market shares. These results have three main pol- icy implications. First, empirical findings suggest that there is a need for policy intervention to intensify the competition in Polish industries. Second, remov- ing barriers to growth for smaller firms, especially in manufacturing, seems to be key to accelerating aggregate productivity growth. Enhancing the growth of high-productivity smaller firms can be achieved, for instance, through facil- itating their access to finance, promoting financial market deepening, and sup- porting the development of the innovation supply side (for instance, dedicated software) for small and medium enterprises (SMEs). Third, large firms should be incentivized (however, not necessarily financially) to improve their within-firm 17 Paths of productivity growth in Poland: a firm-level perspective productivity performance and further investigation is needed to understand their barriers to productivity enhancement. Young firms in Poland have faster productivity growth than older firms. The relationship between the ages that a firm operates on the market and pro- ductivity growth suggests that younger firms experience the fastest productiv- ity growth among all companies across all sectors. Moreover, even though new firms entering the market in manufacturing begin with low levels of productiv- ity, their productivity grows much faster than older establishments in the sec- tor. In this regard, facilitating market entry conditions might foster aggregate productivity growth. Competition and Research and Development Contribute Positively to Productivity Growth In manufacturing, intensifying competition (measured by increases in the number of competitors) is positively correlated with productivity perfor- mance, while in services and construction, increases in market concentra- tion are associated with lower productivity performance. This indicates that manufacturing firms tend to have better productivity performance in indus- tries where there is an increase in the number of competitors. Moreover, there is a positive association between productivity growth and increases in the level of market concentration. Also, manufacturing firms in industries with increas- ing average profit margins perform better in terms of productivity. One possi- ble explanation for this is that manufacturing firms that improve their produc- tivity performance tend to occupy more of the market, which leads to a joint increase in productivity and concentration in the industry. This, however, is more likely in industries where concentration is initially low. In services and construction — unlike in manufacturing — increases in market concentration are associated with lower productivity growth. Moreover, the industry-level profit margin does not have any significant influence on firm performance. These results jointly indicate that higher competition leads to better productivity per- formance in construction and services. The difference between manufacturing and the other two sectors is most likely due to differences in the initial levels of competition and market concentration, but further investigation is needed. In expanding industries, firms tend to improve productivity performance over time. This result has several possible explanations. First, higher sales in- dicate the relative size of the sector and potentially higher competition. Second, 18 Executive Summary productivity often rises because of positive demand shocks (Mayer, Melitz, Ot- taviano, 2016). Increased demand leads producers to shift their production to- ward their best-performing products or raise prices, both of which lead to in- creases in labor productivity and TFP. Third, larger sectors can generate higher demand for productivity-enhancing technologies because their market is larg- er (from the perspective of technology providers). The above findings suggest strengthening linkages between Polish and foreign firms because the Polish economy generally benefits from lower barriers to international trade and for- eign markets (World Bank, 2019). Performing research and development (R&D) improved firms’ market share within the industry (between-firm component), but there is no evidence that it also led to firms’ own productivity improvements (within-firm component). This may imply that R&D investments help more productive firms capture larger market shares, which in turn improves allocative efficiency. However, the results on R&D and firm performance are mixed. In the services and construction sec- tors, we do not find that firms’ expenditures on R&D have any significant effect on TFP growth. However, in manufacturing, R&D is significantly and positively associated with firms’ productivity growth. The fact that R&D expenditures and productivity are positively correlated in manufacturing may imply potential pos- itive returns from R&D incentives. One possible reason for inconclusive results regarding the link between R&D expenditures and productivity growth might be the low number of companies reporting R&D expenditures in the panel data- set, especially until 2016. Second, productivity advances in services often hap- pen through investments in intangible assets and measuring them reliably is still a challenge (Demmou et al. 2019). 19 Paths of productivity growth in Poland: a firm-level perspective ABBREVIATIONS AND ACRONYMS DG REFORM Directorate-General for Structural Reform Support EC European Commission EU European Union GDP gross domestic product NACE Statistical Classification of Economic Activities in the European Union R&D research and development SMEs small and medium enterprises TFP total factor productivity WBG World Bank Group REFERENCES Cirera, X., & Maloney, W. F. (2017). The innovation Mayer, T., Melitz, M. J., & Ottaviano, G. I. (2016). paradox: Developing-country capabilities and Product mix and firm productivity responses the unrealized promise of technological catch- to trade competition. The Review of Economics up. Washington, DC: World Bank. and Statistics, 1 – 59. Cusolito, A. P., & Maloney, W. F. (2018). 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