Recently Hungary appears much more often in the western media than ever before, usually, in critical articles that mention the Prime Minister Viktor Orbán and refer to the activity of the government and laws adopted by the parliament. The reason for this is the drastic change in Hungary’s policy and the tragic state of its economy.

In April 2010 Orbán’s party (“Young Democrats”, FIDESZ) won the parliamentary election by 53% of eligible voters due to a high rate of abstention and a drastic change in the mood of voters who turned against the socialist-liberals who governed the country. With this number of votes FIDESZ received more than two-third of the seats in parliament, while liberals were voted out, the Socialist Party got only 17% and the extreme right (“Jobbik”) entered parliament by nearly the same percentage as the socialists. The parliament and the government rebuilt the political institutions and rules in an anti-democratic spirit greatly increasing the government’s direct control over the whole life of the country. Some of the most important elements of the introduced changes are: an authority controlling the media has been established; a new constitution inspired by old nationalist and religious (Catholic) ideas came into force on January 1, 2012; a flat personal income tax was introduced decreasing the duties of high-income strata; the system of tripartite decision-making on labour rules ceased, industry-sector chambers run by the rich owners and negotiations behind closed doors increasingly substitute the role of trade-unions; the educational and health systems are being reorganised and are receiving less and less state support and increasing the role of the private sector and churches.

The Orbán government and parliamentary fraction have a double face. On the one hand, they rely on a number of big capital owners who emerged during and after the system change and want to get the support of the higher echelons of the middle class; on the other, they use nationalist demagoguery, anti-communist slogans, pretend to fight corruption but are initiating legal actions with or without any grounds against socialists or simply those who are near to them. In the west most people and even many politicians do not understand the reasons behind such an unfavourable turn and the growing hostility to the EU in Hungary. The case of Hungary is only one example of countries of Eastern Europe that have several different features but are finally facing similar difficulties.

The system change

There is a close connection between the IMF, the World Bank and Hungary’s EU membership, on the one hand, and the transition from a socialist to a capitalist country and the history of indebtedness, on the other. Connections with the IMF and WB began following the second oil price shock that doubled oil prices in 1979-1980. Due to its large energy dependence and previous indebtedness, the Hungarian economy was at the edge of the abyss in 1981. To avoid bankruptcy the idea of entering the World Bank and IMF was raised at the highest decision-making level and, finally, received the support of the leadership of the Hungarian Socialist Workers’ Party.

The official entrance into the IMF and WB occurred in May 1982. Hungary received a warm verbal welcome, being the first Eastern European country entering the two institutions. The country received IMF stand-by arrangements and a number of WB loans that kept the country afloat. Contacts with experts of the WB and IMF became intensive and their influence increased among economists and politicians. In 1987 the IMF imposed severe conditions on the signing of a new arrangement and the government submitted to them. At this moment in Hungary the system change was de facto initiated, though the final political act followed only in 1990.

The IMF and World Bank’s suggestions were an adoption of neoliberal theory, which says in substance: governments should cease direct state economic intervention and open the way for private markets to distribute economic resources efficiently; this way dynamic economic growth will start, from which each member of society will gain. In the spirit of the “Washington Consensus” the IMF and World Bank recommended measures of decentralisation, deregulation, liberalisation and privatisation.

In the period of 1982-1990, to promote the struggle for a system change, the IMF opened four stand-by arrangements with a total value of 1,324 million SDR. After the parliamentary (5-party) election in 1990, the newly formed conservative government received an extended arrangement of 1,114 million SDR in 1991, followed by an arrangement for 340 million SDR in 1993. In the elections of 1994, the socialist government won 72% of parliamentary seats, but formed the government together with the Free Democrats, a liberal party.

Under IMF pressure, the government introduced a stabilisation package in 1995 and following its predecessor’s policy of privatisation and sold the Hungarian trade and credit banking system to big foreign banks. With these actions the system was concluded, and there was no more need for IMF assistance for about a decade.

Hungary also had close contacts with the World Bank in the period of 1982-1998, while the country received 40 loans in a total value of 3.4 billion USD, about half of which were the structural adjustment and reform programme loans. The total 2.8 billion SDR from the IMF and 3.4 billion USD from the WB aimed at direct and indirect support of the system change. The country, further, was not entitled to WB loans and there was a general belief in and outside the country that Hungary would not need IMF contributions in the future due to accelerated preparations for its entrance into the European Union.

The financial assistance of the IMF and WB was far from enough to counterbalance the devastating economic effect of liberalisation and privatisation that set off a deep economic regression later called a “transitional crisis”. The consequences of the system change were the total opening of the internal market to western goods and capital, a destroyed industrial and agricultural structure, a loss of national wealth estimated to be higher than that in the Second World War, and a strong dependence on foreign capital.

Impact on economic growth

In the system change the key factor was the rapid privatisation of state-owned enterprises and the cooperatives. The natural consequence was turmoil in the production sphere, a deep fall of industrial and agricultural output and GDP. At its nadir, in 1993, the industrial output was only 82% of its 1989 level and the output of agriculture 65%. The level of total GDP declined to 82%, the same level as industry, which was explained by a somewhat better than average performance of commerce, the financial sector and other services. Due to the more equalised income level during the years of socialism, few people domestically could participate in the privatisation; the winners were either previously leading professional people or foreign capitalists. Many small shops were established just after the change.

Real growth in industry improved and achieved its previous level in 1996-1997, and industry gradually became the engine of growth again. Transformation opened the way for a dynamic growth of foreign direct investments. The domestic private sector awakened too, though with a time lag and to a lesser extent. Within industry the leading sector came to be the foreign-owned car industry (Audi, General Motors, Suzuki, Hankook Tire, recently Mercedes), surrounded by a number of outsourced workers and ventures. However, the domestic interrelationships of enterprises and sectors were broken and each sector depends on foreign investments, orders and deliveries – and state support to a large extent.

Agriculture was harder and more lastingly hit by the system change than industry; its output varied between its deepest point (see above) and 90%. The food industry was a target branch of foreign owners; many of them purchased enterprises for a small period at a low price either to get rid of them as rivals or to sell off their machinery, sacking the personnel without warning. The general decline of the food industry and the disappearance of some food-industry branches reduced the market for several agricultural products, deprived the national economy of important export goods and necessitated surplus imports for domestic consumption. The high-level state farms that supplied cooperatives and farmers with seed grain and breeding animals closed, and nearly all production cooperatives ceased to exist. A large part of their wealth, cattle and machinery was carried away, with buildings ruined. The technological need for balance between land cultivation and animal breeding changed at an unequal rate; the gap increased to the detriment of animal husbandry mainly as a consequence of the effect of rules and subventions of the EU. Presently, cattle stock is only one third of its past level, causing overproduction of corn with increased state subsidies in good agricultural years.

In the past, members of cooperatives and often also state-farm or industrial workers had a garden around their houses or near to the villages. However, nowadays, possibilities of household gardening or breeding a few animals are limited due to increased input prices, difficulties in getting onto the market with surplus products and lack of incentives and knowledge among young people.

GDP real growth went beyond the 1989 level in 2000 and due to rapid growth of industry and finances achieved a peak in 2008 at 35% higher than the 1989 level, but it fell down because of the strong blow from the world crisis and slow recovery to 30% in 2011. If we take the average annual growth rate of the twenty-two years, it is only 1.2% against the 5.2% in the 1960s and 5.1% in the 1970s.

Unemployment, consumer inflation, wages and pensions

A consequence of the production decline was a steep fall of activity rates and increasing unemployment. In the period of 1989 to 1994 the number of employed declined by nearly 30%, from 5.3 to 3.8 million and did not increase even in the period of recovery. Employment topped in 2006 at 3.93 million; the crisis then caused another decline that pushed figures below 3.8 million. While the EU-27 average rate of employed in the 15-64 age group moved from 60.7% (1997) to 64.2% (2010), the analogous figures in Hungary were 52.4% (1997) and 55.4% (2010).

In the first years after the system change a correct system of handling unemployment was introduced with the assistance of the WB and experienced international organisations. However, as longer-term unemployment increased and increasingly affected the younger generations, the level of services has been diminished several times until it reached an inhuman level in order to decrease budget deficits. In recent years, mass poverty is not only present in regions and villages, where 70% of the working-age population has no work, but also in large towns and the capital.

Inflation played an important role in the increase of poverty too. The socialist consumption price policy kept prices of subsistence goods and services at a low level through less taxation and via subsidies; the reform policy of the 1980s brought price proportions nearer to western standards by inflation. At the beginning of the 1990s inflation plummeted and decreased slowly (see Chart 1, below the article).

Not only did the average rate of consumption prices increase and the currency lost a lot of its purchasing power, but also price proportions turned in a direction that makes simple subsistence much more difficult. The 13-times-higher average consumption price level includes a modest growth of durables and clothing prices, a near average increase of food, alcoholics and tobacco prices, and an extreme take-off in household energy prices that are 42 times higher than in 1989.

In the first period, the change in real wages and in the real value of pensions remained somewhat better than GDP. Managing the system change was not easy politically, because a smooth transition was possible only when people expected rising living standards approaching western levels. Later, in certain years, the national elections influenced the rate of change of wages and pensions, as the vote of pensioners was a determining factor in election results.

The absolute and relative situation of active workers worsened abruptly after 1994; the value of wages in 1996 fell to 26% less than in 1989. In 2010, while GDP compared to 1989 stood at 128, the similar figure for pensions was 119 and for wages 115. Therefore, high wages and pensions cannot be seen as responsible for the economic difficulties, particularly for the increased indebtedness.

Another important factor was a radical change in income distribution. In a short time a stratum of rich people emerged, and the country acquired its own billionaires. Generally, upper middle-class people are also among the winners, but the number of winners cannot be estimated as comprising more than a third of the population and as time goes forward some of them are losing their advantages. At the other end, the number of the system’s losers is estimated at more than one third of the population, among them more than one million suffer from hunger, including about 250-300 thousand children, who can eat only at school mensas. Recently, the number of homeless increased dramatically.

Foreign trade

Hungary has an open economy, which is why the balance of foreign trade was a sensitive factor of economic development and economic policy before the Second World War, just as after it. Sales of accumulated stocks of goods and means produced an active foreign trade balance in 1990, with a small sum in 1992 followed by – sometimes huge – deficit years until 2005. A change in this negative trend started in 2006, and since this time each year’s economic activity has resulted in a larger surplus of exports over imports (see Chart 1, below the article). In 2010 the surplus reached 5.5 thousand million Euros, a significant sum for the country considering the difficulties caused by the crisis.

The graph (in Chart 1, below the article) shows the high rate of imports and exports compared to GDP growth. If we take the 21 years together, then 1% GDP growth combined with 6.5% more import produced (mainly due to the last years) a 7% increase in exports. The country became dramatically more open, but this does not prove the neoliberal doctrine that opening the market is efficient.

The structural changes that occurred increased the import propensity of production and consumption often not due to the efford to achieve higher efficiency but due to lack of domestic supply. But this factor does not explain the dynamics of foreign trade alone. The extremely rapid growth of imports and exports between 1996 and 2006 is mainly due to foreign direct investments that are in very loose linkage with the development of the domestic economy. Foreign direct investments and functioning capital grew dynamically and established a number of large plants in the country that import materials and semi-finished products and export manufactured goods. This is an internal turnover between plants of identical owners. Around 70% of the industrial export is produced by foreign-owned companies that contribute to GDP by about half of the added value of industry and employ only one third of industrial workers.

After the decline of home industry and agriculture a large need for foreign investments developed and as, at the same time, similar problems existed in the other Eastern European countries, a restrained competition evolved among them. Governments tried to attract companies by contributions and making additional investments, giving tax and other exemptions. With 3 to 4 times lower-wage workers, filial companies can send home a much higher profit to their mother country; they have advantages also in forming internal prices and in exploiting exchange-rate differences. When planning new investments they can renew negotiations with the government and, usually, they receive new concessions.

Indebtedness

In the introduction we referred to the very important economic and political role of indebtedness in bringing the IMF and WB into the scene and later on its role in system change. The question of whether the transformation brought the expected solution of the debt problem is an important one.

The data give a negative response to the question. Gross debt was 21.3 thousand million USD on January 1, 1990 and 110.9 thousand million Euros on July 1, 2011. The relevant net debt data are: 11.9 thousand million USD (January 1990) and 53.0 thousand million Euros (July 2011). Several changes took place in the method of accounting and publishing debt data; exchange and inflation rate differences have an influence on the data of gross and net debt, but the difference is so extreme that there is no doubt as to the answer. In 2010 gross debt reached 108.7% of GDP and debt services including instalments took away 19.% of GDP.

We can conclude that the opening of the market, diminishing growth rate and living standard, worsening social situation, increasing poverty, did not improve the country’s debt position. On the contrary, indebtedness is even a larger burden on the economy and finally on the people than it was before. The prospect of a better life for the majority of the population has moved far away from any immediate future.

The case of Hungary in a European context

The Hungarian development is more or less typical of all Eastern European countries. At the beginning of the 1990s they went through a longer or shorter transition crisis, had a better or worse developing period and were hit by the world crisis more or less hard. The table below gives an overview of the development of the three main groups of EU member countries.

Real GDP growth of EU country groups

Source: UN Statistics Department National Account Database (GDP constant USD 2005) and own calculations of weighted averages by population data of countries on the January 1, 2010.

West + North: Austria, Belgium, Denmark, Finland, France, Germany, Luxemburg, Netherland, Sweden, UK
South 5 + 1: Cyprus, Greece, Malta, Portugal, Spain plus Ireland; and the 6th of the South, Italy
East 9: (previous socialist countries): Bulgaria, Czech Republic, Estonia, Latvia, Lithuania, Hungary, Romania, Slovakia, Slovenia; and 10th Poland

Country groups have been selected on a geographical basis also taking into account similarities in the path of development. Ireland’s growth, as a country of the western periphery, shows more similarities with the Mediterranean countries than with the developed western and northern countries. The southern countries and Ireland had a period of catching up between 1994 and 2008. That evolution broke down as a consequence of the world crisis and due to their high indebtedness. It is a question whether they can keep some part of their relative development gain or will fall back in the near future. Italy’s growth was slower than both the western and northern group and that of the other southern countries too; and its weight in the southern group is so large that its slower growth rate would distort the southern average.

During the system change the eastern countries had a deep economic crisis of which 1994 was the worst year in most countries. This period of transitory crisis is often forgotten and mentioned only as a return to parliamentary democracy and freedom. The following years of recovery and development show a rapid upswing. However, if we look at the total of 20 years their growth was somewhat below the western and northern average, and many countries in this group could not counterbalance the initial deep shock and economic fall and the strong effect of the world crisis. Poland is a clear exception; it is the largest country in this group, and therefore it had to be shown separately in order not to distort the average data. Only of Poland can we say that the system change was advantageous from a narrow economic point of view as represented by GDP growth. Among the many reasons for its success we can mention its geopolitical importance in the relations between the western part of Europe and Russia; the remittal of a large part of its debt at the beginning of the change; and also that family farming survived the years of socialist development.

Hungary had a less successful performance among the Eastern economies. An important reason for the poor performance was the high initial indebtedness, while several Eastern European countries (Czechoslovakia, Rumania, Slovenia, the Baltic countries) had no or a very low debt position in 1990. The majority of the Hungarian population expected an improvement over the failures and rigidities of the socialist system and were pleased at the opening of relationships with the western countries, but did not foresee the consequences of the change to a market economy. Only a smaller stratum of the population tried to initiate private enterprise and only a minority was prepared to withstand the strong competition of foreign capital.

Conclusions

The background of the political situation in Hungary has to be sought in its economic development. In the economy the government has to face a huge indebtedness, dependence on foreign financing, and the opposing interests, on the one side, of foreign-owned banks and subsidiaries of multinational companies as the most rich and influential actors of the economy, and, on the other, of larger or smaller domestic entrepreneurs who try to survive in the crisis and enlarge their place within it. The increasing burden of the economic crisis and mismanagement pushes the great majority of the population deeper and deeper into impoverishment. Their problem is that they have no real trade-union support or political representation. Spontaneous protest movements arise in which different strata of the population demand the resignation of the government, an end to austerity policies and real democratic policy changes.

The economic crisis revealed a number of hidden contradictions in the economic policy of the EU, the roots of which go back to Maastricht. Knowing the large differences in the development level of member-states and the force of national traditions, the aim of introducing a common currency was premature. The creation of the cohesion fund could have diminished the problem; however, a real policy of economic integration of the less developed countries was not developed, and the role of the fund remained marginal. The situation further worsened in consequence of the simultaneous decision to start negotiations with countries of Eastern Europe. Enlargements increased the number of countries and population living well below EU average.

The actual intensive work on the European Stabilisation Mechanism and a pact on fiscal discipline aiming at improvement of finances and saving the banking sector by continuing austerity policies will only deepen the economic and financial crisis and the split among different groups of member states. The policy to solve actual problems by jumping ahead, which helped to overcome difficulties in certain cases in the previous decades of the EEC and the EC, will not work under the present situation, which is characterised by precisely overestimated freedom of action and premature decisions. To follow the same policy that caused the problems endangers the very existence of the euro area and the EU itself.