Download Economic Reform in Hungary: A Brief Overview

Economic Reform in Hungary: A Brief Overview
Katharine Cornell Gorka
The Institute for Transitional Democracy
and International Security (ITDIS)
Budapest, Hungary
Summary
The process of privatization and economic reform began in Hungary earlier than in any
other country of the Soviet bloc, dating back to 1968 with the New Economic Mechanism.
For a time, this was advantageous to Hungarians, particularly during the 1970s and 1980s,
because it provided both greater diversity of goods and services and lower prices, at time
when many other communist countries were facing severe shortages. The early
introduction of market reforms was also advantageous in that it placed Hungary in the
leading economic position in 1989, with the highest direct investment and highest personal
income. However, these early reforms were detrimental to Hungary’s long-term political
and economic health. Now, sixteen years after the fall of communism, Hungary has the
highest debt in the region, one of the highest tax rates, high levels of corruption, a deeply
entrenched elite made up of former communists and secret police, a weak and divided
opposition with dim prospects for reform.
Stages of Reform
1968-1989
A wave of protest against the political and economic rigidities of Soviet-controlled
communism swept across Central and Eastern Europe in the late 1960s, culminating in
1968, yet only Hungary was able to institute meaningful reforms, with its New Economic
Mechanism. Trade with the west was expanded, and citizens, who were all ostensibly
employees of the state, were allowed secondary jobs in the private market, which led to a
growth of small businesses such as groceries, cafes, auto mechanics, clothing stores, and
beauty salons. A private economy also emerged in construction and farming. Reforms
were halted in 1972 but then resumed with new momentum in 1978. The 1980s saw
further significant reforms, which saw both devolution of control by the state, putting much
more control into the hands of managers, as well as the emergence of a commercial
banking sector. One of the most important pieces of legislation in this process came in
early 1989 with the Company Act, which allowed managers to become owners. Again,
from a purely economic perspective, this was successful in further enhancing the private
sector--4,225 new limited liability companies were created during this period and by late
1989, the private sector was contributing an estimated 20% to GDP.
However, these economic developments had a significant political dimension, as one study
makes clear:
“In countries such as Hungary, Poland, and Russia, personal enrichment of party
ranks became a semi-official part of the last gasp ‘reform’ policies pursued by the
regime. As the policy increasingly stressed the importance of markets and provided
a limited space for private property, the comrades themselves were, of course, the
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best equipped to take advantage of the new opportunities…The resulting scramble
for riches came to be known as ‘spontaneous privatization.’ Its most notorious
examples were in Hungary in 1988 and 1989, during the last months of the
communist regime, when the authorities introduced new laws allowing a conversion
of state enterprises into corporate legal forms, such as joint-stock and limited
liability companies. Factory managers and their cronies manipulated these laws to
insulate themselves from any eternal control, spinning valuable assets into separate
subsidiaries of which they became part-owners, and leaving the state with empty
shells and liabilities.” (Roman Frydman, Kenneth Murphy, and Andrzej
Rapaczynski, Capitalism with a Comrade’s Face, CEU Press, 1998)
The political aspect of these economic reforms was significant for two reasons: 1) it
greatly affected the way further reforms were carried out. Managers had grown into a
powerful force under state socialism, and a private entrepreneurial class also began to
emerge, which limited the policy options in the post-1989 period, particularly under the
first post-communist government of József Antall; and 2) this early entrenchment of
communist elites led to long-term disadvantages for outsiders or non-elites.
1990 – 1993 1st post-Communist Government, PM József Antall (MDF),
(conservative, anti-communist)
The first post-communist government in Hungary was a centre-right coalition led by Prime
Minister József Antall. In dismantling the communist regime and making the transition to
a market-based democracy, Antall emphasized a gradual transition: one which would
maintain much of the welfare state, while gradually privatizing state-owned corporate
assets. It is important to emphasize that Hungary pursued a route of commercial
privatization, that is, the sale of state assets, rather than reprivatization, as was done in
some other countries, which is the transfer of assets through free distribution to the public.
Again, these efforts were successful in purely economic terms: private sector share in GDP
rose from 20% in 1990, to 33% in 1991, to 44% in 1992, to 52% in 1993. The number of
enterprises privatized also increased dramatically:
Large enterprises
privatized:
1990
1991
1992
1993
27
198
215
434
Small enterprises
privatized:
4,066
3,571
1,428
Yet while ownership was shifted from the state into private hands, the bureaucratic and
fiscal frameworks required for an economy to prosper and thrive were not implemented.
The state maintained extensive control of the economy through regulation, taxation and
bureaucratic controls. Additionally, the state maintained control in virtually every area
besides business and maintained extensive welfare programs, which translated into a high
state budget, high employment by the state, and therefore both high taxes and a growing
budget deficit. By 1993, public sector share of GDP was still 48%. And public sector
employment actually rose during this period, rather than declined, contrary to what one
should expect from a country ostensibly dismantling a socialist state:
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Public sector employment (as a percentage of total employment):
1990
1991
1992
1993
1995
19.0%
19.9
21
23.1
24
1995
24.1
The result was that by the end of Antall’s term (he died of cancer 6 months short of the full
term and the prime ministership was held temporarily by Péter Boross(MDF)), much of the
Hungarian economy had been privatized, but the economy was in a declining state. By the
end of 1993, inflation was at 22%, unemployment at 12%, and discontent with what was
considered the social cost of transition was growing. It should perhaps not be surprising,
then, that Hungarian voters turned back to the communists.
1994 - 1998 2nd post-communist government, PM Gyula Horn (MSzP + SzDSz
coalition) (former communists)
In the second elections after the fall of communism, Hungarian voters followed a path
similar to many in the region—they switched their support from anti-communists to former
communists. The party of former communists (Hungarian Socialist Party) won the
election, and Gyula Horn, notorious for his role as a para-military in suppressing the
revolution of 1956 and with a long career as a high-ranking communist, became prime
minister. An unsustainable external imbalance as well as the overall negative state of the
Hungarian economy led to the introduction of the Bokros Plan in 1995 (named for its
author, then Minister of Finance Lajos Bokros), which cut welfare spending, increased
taxation, devalued the forint, and introduced an 8% levy on imports. The plan did
introduce some necessary austerity measures, but it meant with great social resistance—the
day the plan was introduced is now referred to as Black Sunday, and Bokros was forced to
resigned (though due as well to allegations of corruption). The Horn government moved
ahead with privatization so that by the end of its term in 1998, the private sector accounted
for approximately 80% of GDP. Yet the continued failure to dismantle the heavily
paternalistic state and to cut back on the fiscal and bureaucratic restraints on business
meant the economy remained largely stagnant. The true economic and political health of
the country were further impaired by a series of corruption scandals.
1998 – 2002 3rd post-communist government, PM Viktor Orbán (Fidesz-MPP + FKgP
+MDF coalition) (anti-communists)
Continuing discontent with the difficult social environment along with government
corruption again caused the electoral pendulum to swing. The ostensibly right-wing or
centre-right government of Viktor Orban came into power with policies the Wall Street
Journal called “an improbable hybrid of interventionism and liberalism,” (WSJ, April 4,
2002). Fidesz, the ruling party led by its charismatic young prime minister Viktor Orbán,
promised to help the economy grow by giving the state an active role and at the same time
to reverse many of the Horn’s governments cuts in social spending, most notably, by
abolishing university tuition fees, reversing the Horn governments cuts to child support,
and introducing policies designed to rekindle the desire among Hungarians to have more
children.
From a classical liberal perspective, the Orbán government’s is in many respects the
most difficult to judge. On the one hand, they saw that a significant portion of state assets
had been captured by former communists, and that this economic power was now
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translating into political power. They therefore wanted to regain control of the
privatization process. On the other hand, the Orbán government was and remains firmly
entrenched in the erroneous belief that the state is the most important engine for economic
growth. Orbán stated: "It´s obvious that after the Second World War, the major source
of economic development in many countries was the state. We also looked at the
experience from the beginning of the 1980s, of how Finland, Ireland, Catalonia were
modernized through global capital and the attraction of foreign investors. We have to
combine the role of the state in providing infrastructure for business life and at the
same time attract as many as possible foreign investors to Hungary."
In keeping with this belief, the Orbán government introduced the Széchényi
Plan, which supplemented private sector investment for entrepreneurial initiatives.
This was criticized by free-market proponents as a Keynesian redistributionist
scheme. Indeed the Orbán government continues to grow increasingly anti-capitalist
as more time passes. Starting around 2000, the relative economic growth that had
characterized the 1990s slowed: inflation remained high (down from 15% in 1998,
although remaining high at 10% in 1999 and 9.5% in 2000), and growth fell from 5%
in 1998 to 4% in 1999.
The election of 2002 proved to be the most emotional and heated of the post communist period with a record-high turnout of 74.5%, in which voters again
reversed course and turned back to the former communists.
2002 – 2004 4th post-communist government, PM Péter Medgyessy (MSzP + SzDSz
coalition) (former communists)
Again the government ran on a platform built on growing discontent with the cost of
transition. Calling for an “eco-socialist market economy,” they promised to improve
prosperity through largely statist measures: increased public sector investment and
increased pensions. But the government of Péter Medgyessy was distracted early on by
political troubles—two months into office it was revealed that Medgyessy had been an
officer of the secret police during the communist era. The opposition called for a
parliamentary investigation to look into these charges, and the ruling party set up a counter
committee to investigate the backgrounds of everyone who had served as a minister or state
secretary in the previous twelve years.
When they were able finally to focus on economic policy, the government of Péter
Medgyessy failed to make the necessary reforms: reduction of employment in the public
sector, reduction of spending on healthcare, pensions and social benefits. As a result,
government debt started creeping back up:
General government balance:
1999 2000 2001 2002 2003 2004
-3.7% -3.6 -3.0 -10.0 -7.3* -6.6*
(*adjusted for pension reform)
In May 2003 the International Monetary Fund (IMF) warned, "Rising wages and increased
government spending will further inflate the current account deficit and will undermine
Hungary's competitiveness on world markets." The declining economic situation and
subsequent loss of confidence led to Medgyessy’s early resignation two years into his term
of office. He was replaced by Ferenc Gyurcsány.
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2004 – present 5th post-communist government, PM Ferenc Gyurcsány (MSzP +
SzDSz coalition) (former communists)
The New York Times called Ferenc Gyurcsány a communist outsider, but in fact he has a
solid communist pedigree, having been vice president of the Organization of Communist
Youth for Pécs from 1984 to 1988 and the president of their Central Committee in 1988-89.
He quickly became one of the country’s most successful red capitalists. Within ten years
he was the 50th richest man in Hungary. In becoming prime minister, Gyurcsány promoted
the same fantasy of a social-market democracy as those who went before him—a system
with the social guarantees of socialism, but with the prosperity of capitalism. In his reelection campaign, the MSzP’s party platform, “New Hungary 2006-2010,” called for
“Progress, success and victory. Not for a select few, but for everyone – there can be no
other objective for us.” Again, the outcome was predictable. Since 2003 Hungary has
been one of the worst performers in the region. The current budget deficit is expected to
reach 10.1% in 2006, the highest in the EU, and Hungary’s debt will stand at 71.5% of
GDP by 2007. Outgoing U.S. Ambassador George Herbert Walker III called the budget
deficit “monstrous” and the size of government “appalling.”
Western analysts are starting to speak of an economic emergency in Hungary. In
June of this year Standard and poor’s downgraded Hungary’s debt and the forint fell. The
same month, Gyurcsany introduced a fiscal rescue plan which emphasized hefty tax
increases, rather than spending cuts, and, not surprisingly, the plan has been widely
criticized. It would raise the VAT from 15 to 20%, corporate profits tax from16 to 20%, it
would introduce a property tax starting in 2008, and drastically reduce subsidies of gas and
electricity prices (gas prices have been raised 30% already and will again be raised another
30% in January.) Hungary has been sharply chastised by most Western financial
institutions, from the IMF to the World Bank to the European Union. Perhaps more
importantly, there is growing concern that many Hungarians will simply not be able to
withstand the worsening economic conditions.
Conclusion
The privatization process is now nearly completed. Lower receipts from privatization are
expected in Hungary and across Central and Eastern Europe. A few big ticket items remain
in the hands of the state in Hungary, but because of their sensitive nature, they will either
remain unprivatized or will be only partially privatized, for example the state railway,
MÁV (currently the cargo division is being sold off); the Post Office, the Lottery (although
Prime Minister Gyurcsány has mentioned this as a possible candidate for privatization).
Health care is one big sector which remains in the hands of the state and is by now
notoriously unreformed. It is expected that privately managed insurers will be allowed and
there will also be increased privatization of health-care providers, but to date, little has
been done and further reforms will likely be gradual.
In short, the work of privatization is largely completed. What remains to be done in
order to rescue Hungary from its current state of economic crisis is the much harder task of
weaning its citizenry from its dependence on the state, and convincing its policymakers that
citizens not only can stand on their own, but would indeed carry the country forward to
prosperity and growth if only the state would get out of their way.
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