Case Study Hungary

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Case Study - Hungary

• Week 9

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Background

• Early 1990s
• Rapid institutional change
• Severe economic downturn
• Severe institutional corruption
• Late 1990s
• Imminent accession to EU
• FDI inflow per capita 1,830 USD (highest of
  transition country)
• GNP up 10 on 1990 level
• Private sector realizes 80 of GDP
• Wealthiest transition economy with Czech Republic
  and Slovenia

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Main questions

• Why the early problems?
• How did the change happen?
• What does it mean for business?
• What is the future?

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Why the problems?

• Early privatization attempts generated
• Interlinkage of state/private groups
• Run by former state managers
• Linking of banks, state and private companies
• Results
• Widespread corruption
• Self-enrichment schemes for insiders
• Rent seeking
• Recycling of funds through loosely regulated
  banking system

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Why the problems?

• This was the product of
• Rapid privatization
• Primarily state owned financing institutions
• Lack of corporate governance
• Resulting in
• Financing depending more personal networks and
  politics than transparency and legal structures
• Underperformance and vulnerability to crisis
• Common to many transition economies

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How did the change happen?

• Legal reform package (legislative shock
  therapy)
• Debt restructuring process
• Robust privatization - especially state
  holdings and banking sector
• Hungary now has
• One of the strongest financial sectors in the
  region
• Competitive well-governed market
• Sound legal and accounting regulations

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Lessons

• Outside constraints (large foreign debt) can
  motivate restructuring
• Intelligent incrementalism in place of wild
  large-scale privatization allows supporting
  structures to develop at appropriate pace
• State ownership can be made accountable if
  sufficiently small
• High levels of FDI are crucial to assist
  development of corporate governance and financial
  institutions

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What does it mean for business?

• It is a major feature of high performers that
• Small businesses (employing less than 50) have
  become the major source of employment
• There must be a policy of encouragement for
  SMEs
• Former SOEs must not continue to receive soft
  budget constraints
• In Romania and Bulgaria
• Protection of former SOEs led to many bad debts
  in banking which prevented financing reaching
  small less politically connected enterprises.
• Banking and macroeconomic crises
• Failure of old SOEs frees up labour cheaply for
  new enterprises

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Western integration gives Hungary worldwide focus.

• Example TVK Rt Hungarys largest chemicals group
• Announced in 2002 year EUR 430m project to double
  production capacity by 2004
• It will
• Maintain position as leading regional player
• Strengthen presence in EU
• Increase sales to Russia
• Industry forecasts suggest Europe will need 2-3
  new Olefin units in the next 10 years. This is
  the first.

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Transition economies and dirty exports

• The level of dirty exports to the EU
• Hungarys exports have declined since 1990
• 1990 25
• 1991 21
• 1997 12 stable now at 12

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What drives this?

• EU accession
• Greater world integration
• Outcome A source of income
• emissions trading
• Kyoto protocol
• Legal right to buy and sell the right to pollute
  the air with greenhouse gases

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FDI where does it go?

• Key investments made in most backward
  infrastructure areas
• Telecomms
• This has developed to sophisticated standard
• Provides essential core infrastructure for
  businesses
• Declines noted in Russia, Ukraine and Bulgaria
• High Tech export industries
• In Hungary nearly 80 of FDI goes on industrial
  development
• High-Tech industrial exports increased in 1990s
  from 13 to 25
• Foreign affiliates produce more than 2/3 of
  industrial output and fund 70 of RD

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Pattern over the decade
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And its destination
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Value added per employee (US)Hungary, Poland
Estonia
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Is Hungary the new Germany?

• Finance and banking
• Work practice
• Many German companies are operating in Hungary
• Usually implement most of home production and
  personnel practices to maintain intenal
  consistency
• They invest because of the good macoeconomic
  climate and low labour costs
• They seldom invest to expand market share or
  increase production

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Trading Bloc effect? (2000)

• Top Export Partners
• Germany 37, Austria 9, Italy 6, Netherlands 5
• Top Import Partners
• Germany 25, Russia 8, Austria 7, Italy 7
• Top Exports
• Machinery and equipment 59.5, other manufactures
  29.4, food products 6.9, raw materials 2.4,
  fuels and electricity 1.8
• Top Imports
• Machinery and equipment 51.1, other manufactures
  35.9, fuels and electricity 8.1, food products
  2.8, raw materials 2.1

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4 stage German implementation

• Take key Hungarian employees to Germany for
  training
• Return employees to Hungary with new equipment
  they have been trained on
• German supervisors go to Hungary to oversee
  production
• Hungarian supervisors gradually replace German
  supervisors

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Effects

• Has improved Hungarian workers skill base and led
  to higher wages
• German firms significantly assist in RD
  expenditure
• Has introduced kaisen (continuous improvement)
  techniques to raise product quality
• German companies exact high standards from local
  suppliers
• Anglos go to Hungary for external market
  penetration
• US companies use it as point of entry to EU
  markets

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Is it all good?

• Where does Hungary stand in relation to other EU
  countries?
• Recent research suggests a country has completed
  transition when it reaches the economic level of
  the least developed EU member state
• If transition countries achieve 4.5 - 6 annual
  growth rate
• If low-income EU countries maintain 3 growth
  rate
• Transition will be complete for
• Czech Republic in 10-15 years
• Hungary, Poland and Slovenia in 25-25 years
• Albania in 65-75 years

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But didnt Hungary join the EU last year?

• Yes
• Was it ready?
• Er, No. Actually.

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Indicators
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EU Accession data last report
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Banking Reform - success

• Bank Consolidation
• Cleaning up Portfolios
• Recapitalisation
• Stabilisation
• Privatization

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Portfolio cleansing
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Opportunities Opportunities Lost

• Hungary as Regional Centre
• In 1995 it was hoped that Hungary would be a
  regional hub for banking and finance to serve
  Eastern and Central Europe
• Today listings on Budapest stock exchange have
  dropped from 66 to 50.
• Advantages as regional centre
• Low labour costs
• Tax regime 18 basic Corporation tax
• Large manufacturing investors can get 10 year tax
  holidays
• Firms incorporated in Hungary but based abroad
  get special HOC rate of 4
• (Agreed abolition by 2006)

27
Opportunities Opportunities Lost

• Disadvantages as regional centre
• Labour costs rising
• But not too much
• Business Hungary Survey (2001)..
• Insufficient development of transport links
• Lack of transparenacy
• Reduced labour productivity
• Survey shows 47 of total working hours not spent
  productively
• Globally it is 43
• 60 of Hungarian productivity losses are due to
  organizational weaknesses

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SME sector

• SMEs dynamically developing
• Eva Sandor-Kriszt (1999)
• Government sees importance of SME development
  promotion
• Plateauing and decline of SME registrations
• Underlying this increased gap between registered
  and non-operating SMEs
• Regional disparities
• Infrastructure problems
• telecoms ok
• transportation not so
• Government regional development programme 1998 to
  address

29
Cultural Explanation?

• Malach-Pines et al 2005 Entrepreneurs as cultural
  heroes
• Hungarian/US/Israeli comparison
• Broad findings
• Hungarian entrepreneurs have lower status
• Rate lower on dimensions like challenge,
  initiative and independence
• Less investment in high tech start ups than
  US/Israel

30
Hungarian GDP is slowing down

• Rate of growth for 2001 was 3.8 against
  estimated 4.5
• 2002 outturn of 3.3 against estimated 4
• Industrial production decreased 5.3 last year
• Sales volumes decreased 6.1 last year
• Exports decreased 4.3 last year
• Being so FDI based Hungary is affected more than
  other transition economies by economic downturn
  in advanced nations