Instructions for action: Hungary’s reforms (Part 4)

In 1987, in Hungary, a two-level banking system with an autonomous central bank and commercial banks that were able to compete was introduced. In 1988, modern taxation was introduced, including income tax and value added tax. In 1995, direct foreign investment amounted to 4.5 billion dollars. However, in 2008, the state budget deficit increased to 8%, and the country became one of the outsiders of the European Union, reports “Investor”.Even in the Soviet period, Hungary had the most market-oriented economy. Since 1980, the lion’s share of foreign trade was conducted with the countries of Western Europe. Hungary did not have a shortage of food products and even there was a private enterprise.

Thus, favorable starting conditions made it possible to overcome the transitional period relatively easily. To reform the economy and adapt to free market conditions. Active position in the first years of independence led to a fundamental restructuring and privatization of the business sector.

The government has created a strong and independent agency for privatization. This made it easier for potential buyers to negotiate with the authorities and gave them confidence.
Already by 1994, about 30% of the enterprises were in the hands of private owners from Hungary, and another 20% were owned by foreign investors. By 1998, almost all state- owned production had been privatized.

In the early 1980s, liberalization of prices in Hungary led to a long-term prices growth. Only in late 1991 they managed to achieve some reduction in inflation and the growth rate of
prices. Anti-inflationary policies have brought tangible results: a significant inflow of foreign capital, progressive market transformations, effective measures against unpredictable enterprises.

In 1991, the bankruptcy law entered into force. It contributed to an increase of the responsibility of business executives in financial matters. The law established the procedure
for the liquidation of insolvent enterprises: the court determined the terms, procedure, order of repayment of the debt and made a decision on privatization. In 1992, there were 2,300 bankruptcy cases against enterprises and organizations.

In 1992-1993, the creation of a legal framework for a market economy was completed. The infrastructure of the market was formed from banks, exchanges, investment funds, and
others. Internal convertibility of forint was achieved, and the banking and tax system similar to the norms that operated in Western European countries was created. The inflow of foreign capital has grown, accounting for half of all Western investment in the Eastern and Central Europe and the CIS. The share of the private sector (private, cooperative, foreign) has grown noticeably: in 1994 it was 55% of GDP.

At the same time, in the early 1990s, Hungary was experiencing significant difficulties, and the volume of investment shrank while the budget deficit was simultaneously increasing and in 1994 reached 8-9% of GDP. The deficit of trade and balance of payments in 1993amounted to 3.6 billion dollars and 3.5 billion dollars respectively. In 1992, the volume of agricultural production after the abolition of agricultural cooperatives declined by about 25%. Unemployment increased, it was 12% of the able-bodied population.

However, significant progress has been made in reducing inflation. It was gradually decreasing during the 1990s (with the exception of the 1995 crisis). The decline in production in Hungary was also negligible – 14%. At that time in Russia it was 40%, and in Ukraine – 54%. The fall of production was stopped by 1994. And since 1997, its substantial and even growth has begun.

Significant achievement was the reform of health care that since 1993 smoothly translated into the system of compulsory insurance. With the creation of the National Health Fund, the
country has achieved decentralization in this sector, but further changes have ceased and were introduced sporadically over the next 20 years.

The pension reform was not the only major transformation of the late 1990s.

It envisaged the introduction of an accumulation level of the pension system, without abandoning the solidary one. Subsequently, the accumulation system was supposed to completely replace the solidary, private pension funds were created. In addition, the retirement age for women and men gradually rose. Despite some positive effects of the reform, it later became one of the factors of strong pressure on the state budget, increasing the budget deficit and the rate of inflation.

As a result of successful reforms in the early 1990’s, during the accession negotiations with the European Union in 1998, Hungary was among the leaders in the region. At that time, in many countries of the region, structural reforms were only beginning.

In the 2000s, Hungary gradually began to be imprisoned in a spiral of social populism: social payments grew (with any government), and the budget deficit remained steady at a level above 5%. Payments from the state and cheap loans stimulated the growth of demand among the population, rapidly outpacing the growth of the economy and real incomes of citizens.

In particular, salaries to civil servants were increased by 50% (subsequently this was done again) and a privileged class of senior civil servants was introduced. There are 13 pensions
for all pensioners and 13 salaries for all civil servants. Government subsidies for gas, electricity and central heating have been increased. Due to these huge social expenditures, Hungary had the largest deficit in the state budget in Europe in the mid-2000s.

The next false decision was to reduce the VAT rate from 25% to 20%. This was immediately reflected in a catastrophic budget deficit of 10%. In 2006, as a result of populist actions by
the government, the so-called “three symbols of economy” were canceled through a referendum. Namely – a fee of one euro for a visit to a therapist, a payment for hospitalization in hospital and a tuition fee. Similar actions have led to the fact that in 2008 Hungary was on the verge of default, if not for emergency lending from the IMF, the World Bank and the European Commission in the amount of 20 billion dollars.

The next decade brought further decline in the economy. Gradual group rolling back of market-oriented reforms. The government unilaterally liquidated private pension funds. Artificial monopolies in various sectors of the economy were created with the simultaneous raising of taxes for foreign companies. Also, nationalization of assets considered to be strategically important was carried out. These actions led to further growth of the state budget deficit to 8% and public debt to 85% of GDP.

Therefore, Hungary’s reforms demonstrate that even despite positive initial indicators and significant economic growth rates all the achievements can be easily destroyed by unprofessional government activities and populist policies. As a result of these factors, Hungary has evolved from one of the brightest European economies into the subsidy zone for the EU.