The Transition Experience of Hungary March 9th Matthew Gross
Background • Hungary is located in Eastern Europe, near several other transition countries.
Quick Facts • The private sector now accounts for over 80% of Hungary’s GDP. • Industries: mining, metallurgy, construction materials, processed foods, textiles, chemicals (especially pharmaceuticals), motor vehicles • Population: 10,006,835 (July 2005 est.)
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
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 Hungary’s economy • Allowed a limited number of businesses to operate in the service sector
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)
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
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
The Collapse of Communism • Hungary already transitioning slowly towards a market economy when communism collapses in 1989-1990
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.
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
Politics Impede Reform • A large portion of Hungary’s 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.
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
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
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
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
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
Changes in Trade Partners • Prior to 1989, two-thirds of Hungary’s trade was with CMEA countries • By 1997, trade has shifted primarily to the EU, with EU countries making up 70% of Hungary’s trade. • Hungary’s primary trading partner is now Germany • The U.S. has made Hungary a most-favored-nation
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.)