The Transition Experience of Hungary

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The Transition Experience of Hungary

• March 9th
• Matthew Gross

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Background

• Hungary is located in Eastern Europe, near
  several other transition countries.

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Quick Facts

• The private sector now accounts for over 80 of
  Hungarys GDP.
• Industries mining, metallurgy, construction
  materials, processed foods, textiles, chemicals
  (especially pharmaceuticals), motor vehicles
• Population 10,006,835 (July 2005 est.)

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A Glance at Hungary Today, Macroeconomic
Indicators

• Real GDP per capita 5,339 (2004)
• (16,800 when adjusted for purchasing power
  parity)
• Real GDP per capita growth 5 (2004)
• Real GDP 53,775,700,000 (2004)
• Real GDP growth 4
• FDI, of GDP 3 (2003)
• Inflation, of GDP 7 (2004)
• Source WDI

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Transition Under Communism

• Early reforms, called the New Economic Mechanism,
  began in 1968 under communism
• Opened Hungary up to foreign trade
• Allowed for some aspects of the market in
  Hungarys economy
• Allowed a limited number of businesses to
  operate in the service sector

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New Economic Mechanism, Phase II

• Enterprise Economic Work Partnership (EEWP), 1982
• Work subcontracted after normal hours, leading
  to higher wages (and higher incentives)
• Workers become more productive, firms become
  more profitable
• With the help of the IMF, Hungary begins to pay
  off its foreign debt (Today, Hungary no longer
  needs IMF assistance, and has paid off all of its
  debt to the fund)

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By 1989, Hungary had

• Legalized Bankruptcy (1986)
• Instituted a two-tier banking system (1987)
• Started price liberalization, with only 20
  percent of CPI prices controlled by the
  government
• Instituted an income tax
• Joined PHARE

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PHARE

• Pologne, Hongrie, Assistance à la Restructuration
  Economique (Poland, Hungary, Assistance to the
  Restructuring of the Economy)
• Signed in 1989, for the purpose of bringing aid
  from EC to Poland and Hungary
• Poland and Hungary selected because they were
  furthest along in economic liberalization
• Czechoslovakia, Bulgaria, Yugoslavia, and Romania
  are later added to PHARE

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The Collapse of Communism

• Hungary already transitioning slowly towards a
  market economy when communism collapses in
  1989-1990

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Antall Government 1990-1994

• Gradualist Approach to Reforms
• Price liberalization not moving past reforms
  already made under communism, 20 percent of CPI
  prices still centrally controlled through 1997
• Failure to Reform Social Programs causes strain
  on budget deficit
• Trade liberalization CEFTA signed, lowers trade
  barriers 1991 trade agreement with the EC lowers
  trade barriers and allows Hungary to keep its
  protective tariffs for a limited time.

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Problems

• High External Debt Hungary chooses to pay its
  foreign debt in whole, without rescheduling or
  restructuring, in order to improve its
  international credit rating
• High Budget Deficit Government met resistance
  to attempted social benefit restructuring
  deficit exceeds IMF accepted levels

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Politics Impede Reform

• A large portion of Hungarys population is
  dependent in some way upon government social
  expenditures, making reform difficult. Hungary
  spends, in particular, more on public health and
  non-aged related (unemployment, social
  assistance, disability, etc.) programs than the
  OECD average.

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More Problems

• Reduced exports to the former Soviet bloc
• Declining industrial output
• Sharply rising unemployment (12 in 1993)
• High external debt
• Budget and current account deficits approaches
  10 of GDP

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Austerity Program of the Second Democratic
Government, Shock Therapy

• New government elected in 1994
• Economic Stabilization Package adopted in 1995
• Budget spending slashed (15), finally
• Fixed exchange rate eliminated, and replaced with
  a crawling peg
• Currency Devaluation

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Does it Work?

• GDP growth slows, but . . .
• Trade balance improves
• Current account deficit falls 5.6 in 1996
• Government deficit/GDP ratio falls 5.8 in 1996

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FDI

• Hungary traditionally attracts a very high level
  of FDI
• Hungary allows for 100 foreign ownership
• FDI per capita comparison
• Slovakia 169
• Bulgaria 121
• Czech Republic 726
• Hungary 1,519

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Why the Recent Decline in FDI?

• Possible Answers
• FDI has reached equilibrium
• FDI is being impacted by decline in FDI source
  countries (Germany, US) economies
• FDI is being directed to other transition
  countries who are catching up in liberalization
  of foreign trade barriers

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Changes in Trade Partners

• Prior to 1989, two-thirds of Hungarys trade was
  with CMEA countries
• By 1997, trade has shifted primarily to the EU,
  with EU countries making up 70 of Hungarys
  trade.
• Hungarys primary trading partner is now Germany
• The U.S. has made Hungary a most-favored-nation

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Hungary Today

• Joined NATO in 1999
• Joined EU in 2004
• Unemployment rate 7.2 (2005)
• Inflation rate (consumer prices) 3.6 (2005)
• GDP - real growth rate 4.25 (2005 est.)
• Debt - external 42.38 billion (2003 est.)