Convergence turned into
Divergence and Decline
The Example of Hungary
Lajos Bokros
Professor of economics and public policy
Central European University
Member of the European Parliament
Washington, DC, April 5, 2012
1
Lessons from transition
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Development of transition countries is cyclical
Cycles are not synchronized among countries
Primarily explained by domestic factors
Predominantly economic, political, cultural
Institutions are weak, reforms are reversible
Transition is about institution building by
Reforms leading to growth and convergence
Reversing reforms and destroying institutions
2
result in divergence and decline
Hungary & Slovakia
diametrically opposites
Convergence based on
groundbreaking
reforms:
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Hungary 1990-1999
Slovakia 1999-2009
Divergence and decline
based on postponement
or reversal of reforms
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Slovakia 1990-1998
Hungary 2000-2012
3
Reforms in Hungary
1990-1994
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Establishment of the State Property Agency to
drive privatization in a transparent way
Successful privatization of thousands of SOEs
by traditional methods of auction and tender
Huge injection of FDI into the real economy
Groundbreaking legislation in banking, stock
markets, bankruptcy, liquidation, accounting
Support to fast organic development of SMEs
4
Reforms in Hungary
1994-1998
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Stabilization without recession started in 1995
Optimal mix of monetary, fiscal and income
policies leading to rapid, export-led growth
Social policy reform: shift from entitlements to
need-based targeting of financial support
Higher education reform: tuition fee
Pension reform: mandatory private funds
Treasury management for the fiscal sector
Successful privatization of a number of banks 5
U-turn in economic policy in 2000
Instead of continuing
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Export-led
Investment-driven
Fiscally neutral
hence financially
sustainable growth
Growth was based on
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The only rational policy
in a small, open, poor,
transition economy
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Domestic demand
Driven by consumption
and imports
Fuelled by huge fiscal
overspending, hence
unsustainable, because
It was supported by
foreign borrowing
6
Reform reversals
1998-2002
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Reducing considerably the contribution rate to
the new mandatory private pension pillar
Opening up the opt-out option (back to PAYG)
70% salary increase to civil servants, law
enforcement officers and military personnel
Subsidies and tax credit to mortgage loans
Eliminating the tuition fee in higher education
Eliminating means testing in family support
7
Significant increase of the minimum wage
Fiscal profligacy with no reforms
2002-2006
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50% salary increase for all government
employees (3 times more than civil servants)
13th month salary to government employees
13th month pension; increase of survivor pens
20% increase of family allowances
30% raise of stipends in higher education
Full tax exemption to minimum wage earners
VAT rate reduction without curbing expenses
Further increase of mortgage loan subsidies
8
Fiscal tightening & reforms blocked
2006-2010
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Tax increases (VAT, PIT, excises, witholding)
Reducing price subsidies to energy and drugs
First, wage & hire freeze in civil service
Reducing the number of budgetary institutions
Introduction of tuition fee, co-payment in HC
Elimination of all the above after referendum
Attempts to introduce real estate tax blocked
by the Constitutional Court in 2010
9
Elimination of the 13th month wage & pension
Wholesale reform reversal I.
2010-2012
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Nationalization of the mandatory private pension
system and confiscation of its assets
Members of the mandatory private pension funds
forced to return to PAYG by government blackmail
Regressive changes in tax & benefit systems (OECD)
Minimum wage rise with selective subsidies to firms
Direct government intervention into labor relations
Increasing state shareholding in selected enterprises
Central bank independence severely curtailed
10
Wholesale reform reversal II.
2010-2012
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Fiscal council with no resources but excessive
political power (superimposed on parliament)
Tax obligation on severance payments by retroactive
legislation (legal uncertainty)
Huge and highly distortionary sectoral taxes in
banking, telecom, energy and retail trade
Large number of public providers of education and
health care taken from local to central government
Mortgage loan amortization scheme tailored to help
only affluent borrowers and destroying bank capital
11
Omnipotent, omniscient state
distorting and replacing markets
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Size does matter: general government absorbs
and redistributes close to 50% of GDP
Predatory and invasive government behavior
not respecting private property and contracts
Competition rules ignored and/or breached
Public procurement rules tailored to favor well
connected insiders and special interests
Rise in corruption in all levels of government
12
Negative results:
divergence and decline
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Maximum vulnerability: twin deficit & debt
Sovereign credit rating declined to junk level
Extremely high bond yields in secondary markets
Protracted stagnation despite marked e/r decline
Unemployment at 11.6%; on the rise again
Credit crunch, negative FDI-flow, capital flight
Divergence from V4 in per capita GDP terms
Destruction of credibility with erratic policies
Irrational “freedom fight” against the IMF & EU
13
General Government Gross Debt
%
110
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011*
%
110
100
100
90
90
80
80
70
70
60
60
50
50
40
40
30
30
20
20
10
10
0
BG
CZ
HU
RO
SI
PL
0
SK
14
Net External Debt
%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010 %
70
70
60
60
50
50
40
40
30
30
20
20
10
10
0
0
-10
-10
-20
-20
BG
CZ
PL
RO
SI
SK
HU
15
Twin Deficit
%
1
%
1
average budget deficit
(1995-2010)
BG
0
0
-1
-1
-2
-2
SI
-3
-3
RO
-4
-4
CZ
-5
PL
SK
-6
-5
-6
HU
-7
-7
-8
-7
-6
-5
-4
-3
average current account deficit
(1995-2010)
-2
-1
0
1
16
Twin Debt
%
%
90
90
gross government debt
(2010)
HU
80
80
70
70
60
60
PL
50
50
SK
40
SI
CZ
30
40
30
RO
20
20
BG
10
10
0
0
0
10
20
30
40
net external debt
(2010)
50
60
70
17
Credit Rating of V4 by Moody’s
Credit Rating of the Visegrad Countries (Moody's)
19
Aaa
19
Aaa
A118
18
A1
A217
17
A2
A316
16
A3
15
Baa1
15 Baa1
14
Baa2
14 Baa2
Baa3
13
13 Baa3
Ba112
12
Ba1
11
Ba2
10
Ba3
junk level
Ba211
CZ
PL
SK
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-89
Ba310
HU
18
GDP per capita
euro
18000
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
euro
14000
16000
12000
14000
10000
12000
10000
8000
8000
6000
6000
4000
4000
2000
2000
0
0
BG
CZ
HU
PL
RO
SI
SK
19
Crisis and recovery
103
103
SK
101
101
99
CZ
99
SI
97
97
BG
HU
RO
95
95
93
93
91
91
89
89
max
min
2011Q4
20