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Begegnungen
Schriftenreihe des Europa Institutes Budapest, Band 19:9–16.

ISTVÁN CSILLAG

Hungary’s Economic Policy at the Threshold of the EU

 

My presentation, if I wanted to give the briefest possible summary of it, is about nothing else but whether we would, and would be able to return to the old track. The old track essentially is an export governed, investment-controlled economy, where the extent of state interference is decreasing and what luckily meets the trends unfolding in world economy. Well, that economic policy may result in a relatively balanced, harmonious growth and wellbeing.

 

International conditions, the heritage of economic policy

Our present heritage is not a good one. It means that the Hungarian economy has got into such a condition, partly due to objective reasons, and partly because our economy is of necessity an open one, that we will follow the trend earmarked for us by our international environment. If things go well in our environment, then we will also thrive. This openness has been a characteristic feature of the Hungarian economy for at least thirty years. The liberalisation and structural transformation implemented in the early 1990s has only strengthened these tendencies. Consequently one has to speak about two issues today. One is what is happening in world economy at present? And the second one: are we reacting properly to the events? If world economy is in a bad shape we cannot manage well either. This is one thing we should clearly understand. Therefore it is an unnecessary effort to waste the taxpayer’s money in a small country to counterpoint and counter-balance recession that has unfolded in world economy. At such times it is usually said that when there is no boom one should invest and prepare for tomorrow when things will be better. Therefore economic policy proceeds rightly if it develops its ability to take over the pace of the environment as fast as possible. It should improve its competitiveness, invest and reduce the burden of the business sector.

The heritage we have to face today is the consequence of our openness for several decades and, in addition, of the economic policy of the past period. The effect of that economic policy is mostly manifest in that besides the falling rate of growth business investments have also dropped. And if businessmen are unable or do not wish to invest it is a truly bad sign. It means that the economy of the country is about to decline. And surely it will not reach its peak form when favourable changes unfold in its environment.

The reason why the economic policy of the previous government deserves criticism is that from 2000 onwards it diverted from the direction of the inherited economic policy it more or less followed up to then, while revenues were at its disposal to an increasing extent. These revenues, however, were not spent on the enhancement of competitiveness. It was manifest in two areas. On the one hand it did not reduce taxes, or the charges of social security, so that as many places of work should be created as possible, and it did not start investments into the infrastructure on the other. The government was engaged in other activities. Because it was busy in other things. And this is that gives a real cause to anxiety. In fact it is natural that the rate of growth would decrease in an open economy. The question is whether the period of decrease is utilised by economic policy for enabling our country to participate in the race for capital with the same opportunities as we had when the recession set in, and when the external environment and demand would improve, so that the economy should again be a strong one. During the past one and half years we could see that if investors refrained from investing, if there was no interest, jobs would be closed down. It is not a lasting solution to support housing out of the taxpayer’s money, thus naturally absorbing savings, in the interest of maintaining some growth of investment.

 

Prospects, indications

It is remarkable that while we could see the decline of dynamism in industry in 2001, and something just started to move in 2002, the much awaited unfolding is being pushed to the second part of 2003, obviously under the impact of the war, in our environment. Yet it is a fact that there are indications that if world economy, if the German economy, if European economy recovered we would still be able to set out upwards with them despite the missed investments, if not at a pace examples of which could be seen in the years 1997-98. The trend shows that stagnation is being essentially over in our international environment, which lasted from the last months of 2000 up to the last month of 2002. Therefore if measures of economic policy luckily meet external demand in the gateway of the Union, we may shift back to the track we had followed sometime between 1996 and 2000.

There are favourable and unfavourable indications. The relatively low rate of unemployment cannot be further reduced. We have to state self-critically that the economic policy which had not permitted and encouraged investments would obviously lead not only to not having new places of work created but even to the existing ones being closed down. A direct consequence of the drop in investments is the negative impact of technological rearrangement in our country. Such a rearrangement is in progress in every developed country, with special regard to information technology now, where the change of products takes place in 8 to 10 months, where each and every manufacturer would study if a new product is introduced whether its production should be continued at the same place where the former one had been manufactured. It is conspicuous however, that – in addition to halting the decrease of unemployment – the number of employed has been growing though only moderately. Consequently those who so far have not felt it worth going to the labour market, now in annually increasing numbers, by about 40-50,000 more each year are in search of jobs. It may be a favourable circumstance once the inclination towards investment grows.

 

Inflation

The next issue is that of inflation. It can be stated that while trends strengthening predictability dominated in the Hungarian economy, inflation kept on decreasing slowly but continuously. Harmony between monetary policy that is the policy of the bank of issue and fiscal policy, i.e. budgetary policy is an important indicator of predictability. This predictability was more or less prevalent up to 2000. In the year 2000 the government hindered the modification of the exchange rate system. The exchange rate system proved good up to 1998. But whenever ‘inflation sticks’ the monetary policy carried on should be abandoned, and should be replaced by another ‘regime’. In 2000 this is what the bank of issue attempted to do under the governorship of György Surányi. He was fully justified to do so, as up to 1999 inflation was decreasing annually, in 2000 it could be seen that the monetary mechanism applied, the so-called crawling peg was being exhausted. It essentially served to make the state, the budget, i.e. the taxpayers bear the risk of the exchange rate. It helped the exporters during the period between 1996-99 to focus on technology and development, and removed the cost of the risk of exchange rate from their shoulders.

It was more or less by 2000 that we reached the condition when bearing the risk of the fluctuations of exchange rate was no more proper to be borne by the taxpayer, and when exporters could have been pressed for a more flexible adjustment. Various procedures might be expected from the exporters such as liquidity management, or that they could deal with the personnel of their enterprises more sparingly. One should encourage them to take over the risk of the fluctuations of the exchange rate as well. This is why the exchange rate regime should have been modified as it could have offered a new field to measures against inflation. It is not accidental that inflation remained essentially on the same level for three years as the National Bank changed the exchange rate system only in 2001, this time under the governorship of Zsigmond Járai. What was its outcome? The wasted years and unjustified budgetary subsidy resulted in a high budgetary deficit. If there is no tax reduction during a period when there is income then budgetary expenditure remains on a high level and the various budgetary institutes are not pressed for economizing.

We do not consider either to contribute to the social services by our own supplementary savings as it was done in the pension system. Because a relatively high budgetary deficit was its consequence, topped by the Matolcsy-programme launched in 2001, promising non-refundable subsidies from state resources to all. No matter what is involved, whether it is technology development, engaging expert work, or the development of tourism or technology, or perhaps the enlargement of hotel capacity. It had two major consequences. Partly it diverted attention from the former, never very strong entrepreneurial ethos and conviction that one should basically manage in the market, and suggested that the market was bad at any rate and there was recession. One should survive this period by turning towards the state, feeding on its breasts. Though it is supported by a highly effective propaganda yet if one considers it no political force has purchased an electoral defeat at such a high cost so far. I could compare it to the Polish mounted lancers who attacked the tanks with their lances in 1939. Now we are the Polish mounted lancers and they are the armoured corps but were forced to turn back. They were covered by thick armour, namely by the Széchenyi Plan with lots of applications, but not even that was enough. It was enough to whip up budgetary deficit by expansionist policy. Another result of the Matolcsy-programme was: wrong tracks developed by hard and enduring work, the financing of the building of motorways by the Hungarian Development Bank, which subsequently did not figure in the budget, though it belonged there. (Now this has to be acknowledged as the moment of truth once always comes.) It can be seen that in 2000, when the external situation was also normal and economic policy did not set out along the road of Matolcsy, the budgetary deficit was so low that we could have even met the so-called Maastricht criteria.

It is important to talk about it because it is not abstract theories but practice that is significant. Naturally foreign major investors do inquire about tax reductions as well, but they are basically interested in the so-called macro-economic fundamentals. When the fundamental conditions begin to deteriorate they know for sure that as a consequence state economic policy would be forced to interfere sooner or later. In other words, it would withdraw part of demand from the market, or there would be a lack of demand. There would be no tax reduction for their goods or there would be no tax concessions. Thus they are far cleverer than it was believed by the economic politicians of the previous years. They could precisely see this trend. Surely we can also be blamed for a further growth of budgetary deficit under our government when we increased the salaries of teachers and physicians, and precisely to the extent of these expenses. But the trend was visible already at that time. The growth of budgetary deficit was about 0.9-1%, in other words we have moved from 4.7 in 2001 to 5.9-6.1, currently it is 6.1. It must be acknowledged that we have produced 1% of that 6.1% deficit. But what is watched and studied by everyone is how the fundamentals have deteriorated. In addition there were the elections when one had to face what had happened during the past 4 years.

 

Renewal

Now the most important task is to cut back budgetary deficit. The investors are not stupid. We may make ourselves believe that the deficit may be more even by half per cent. But the investors calculate on the basis of where they think their money is safe. And if we are unable to arrange for that safety then anyone may say anything, the end will be bad.

I wish to call attention to two facts: to the migration of investors and to the falling revenues. Surely increasing the minimal wages and their assertion in wage competition is important. But this is a failure suffered in competitiveness as a result of which investments emigrate from here. Emigration is clearly not accidental, as it is just wasteful spending by the budget that has whipped up consumption. It has pushed incomes high. Its obvious consequence has been that the consumer demand created could only be satisfied by imported goods.

The other fact is that 11 September and the subsequent drop in tourism have had a particularly adverse effect on our country. As a consequence the deficit of our balance of payment further increased and in 2002 it approximated the level of the first successful year after the Bokros-package. It should be remembered that the deficit of the balance of payment was almost 9% in 1994. This is why the Bokros-package had to be launched. Thus now we have reached back to where we had been in the first so-called favourable year after the Bokros-package.

Consequently there must be a shift. This is why we have attempted to implement corrections when assembling this year’s budget. Our objective has been to cut back deficit, to assert a relatively more tolerant yet more rigorous standard in income policy, and to introduce some new incentive elements by which our competitiveness can be eventually improved. In this correction an important element is to assert the predictable decrease of taxes and contributions. It is an important element to introduce new incentives for foreign investors to calm them down. We strive to reorient small and medium enterprises towards the relatively reliable, cheap and long-term loans offered by the financial sector instead of drawing on subsidies deriving from revenues, and to orient them towards the development of the infrastructure.

 

„Smart Hungary”

One means of it is the programme encouraging investments, the so-called „Okos Magyarország – Smart Hungary”. Without getting lost in detail, let me return to the growing uncertainty of investors. It has had three reasons. One reason is self-explanatory: ‘biding the time’ of investors, caused by political changes. In every country, wherever there are elections some biding one’s time can be experienced. The other reason of growing uncertainty is the deteriorating macro-economic situation. We do not speak enough about the third reason, though it is very important. The reason is that Hungary had been the last of the candidate countries that had adjusted its system of tax allowances and investment incentives to the requirements of the European Union. The last but one country was Slovakia in 1999. One should recall how much time is needed until we get used to a singular change in the taxation system, and imagine whether foreigners would believe us that the new, Europe-compatible system of taxation would remain intact?

We have such a system of tax allowances that meets the requirements of the Union since 1 2003 January, and you may rest assured that it will be an enduring one.

All this has proved to be insufficient, this is why we have elaborated the „Smart Hungary” system: that there should be subsidies given to training and there should be a relatively active and reliable economic policy that would arrange state measures in packages and make it clear for investors who can expect what. The objective of Smart Hungary is to divert small and medium enterprises from exclusively state subsidies. I may compare our policy regarding the small and medium enterprises to a tripod. Tax reduction is one leg, subsidies by competitive applications is the second one, and the development of client relations is the third one. We would like to make them adjust to being able to have access to state resources encouraging investments on a business basis. We want to make them adjust to be clients. The programmes of economic policy serve the policy of that ‘tripod’, of which the real novelty is only the launching of the programme of long-term loans. It is undoubtedly a risk on behalf of the budget, because the Hungarian banks by themselves would not grant such long-term loans to companies of relatively short past in the area of credit. One consequence of this programme is the Europe Loan that is launched from the credit funds of the Hungarian Development Bank. Such applications for loan can be submitted to the Konzum Bank of the Hungarian Development Bank. It also indicates the fact that the purification of the Hungarian Development Bank has been completed. In other words, now we can precisely expect such activities from it, namely giving loans for development and not giving out grants, for which that bank had once been set up.

The programme of motorways is a practical measure of economic development. It had to be tenaciously and repeatedly brought to the attention of the government so that motorways should enjoy political priority. There is free labour in Eastern Hungary, there are places of business, and it also derives from the geographic conditions of the country that the so-called Eastern markets are accessible from here. But to have that function operate in Eastern Hungary motorways are needed. And motorways are needed to regional development, to the equalisation of living standards, and so that some regions, such as Eastern Hungary, should not entirely sink. Motorways and enlivening investments are indispensable and important also from the angle of social catching up.

Our economic policy sets out from the question of what other opportunities we could have in comparison to our competitors. In fact our ‘advantages in wages’, namely that wages are lower here than elsewhere, hence it is worth investing here, have been lost. We have lost those 2 or 3 years during which we could have taken precedence over our neighbours and competitors: by tax reduction, or by developing a system of tax benefits in coordination with the Union. We try now to make good for those missed measures. But it would take up some years by the time investors and the society would get used to it. If the investors may plan with Debrecen, Miskolc, or Szeged made also accessible, and from there they could reach the Balkans, or the so-called Eastern markets, they would come to Hungary, to Eastern Hungary. This is why I am happy that government has passed the motorway programme, and the year 2004 would be a decisive one in this respect.

*

Summing up one may essentially say that accession to Europe coincides – accidentally in time – with the correction of our economic policy. Thus we return to the direction of economic policy as followed between 1995 and 1999. What does it mean? It is the acknowledgement of the fact that we are an open country, that we have to produce for exports, and that the tiny domestic market does not offer adequate opportunities from the angle of demand and serial production to the companies located here. Thus our growth can only be export and investment-governed. But to that a predictable economic policy is needed. And the basis of a predictable economic policy is that the budget should be more or less rigorous. In other words, there should be tax cuts, and the efficiency of funds in state expenditure should be measured by various indicators. On this basis it can be expected that we would not fan inflation because we would not flood the market with money. The bank of issue can be expected to support the programme in this effort; hence harmony between the policy of the bank of issue and budgetary policy can be restored. Surely this harmony would be largely promoted if the bank of issue considered price stability as a primary, but not an exclusive one. But to that surely some institutional measures should have been taken in time. Lenin has a saying that: „A defeated regiment learns fast.” One should learn from the minor difficulty created by the bank of issue for itself. In fact it missed to reduce interest rates in time, and thus it let speculation with the forint loose on itself. Hence it has been forced to revise its set of inflationary objectives so far kept. We have to adjust to the fact that we will join the Euro-zone by 2008. It means that one should count with a roughly 3% rate of annual inflation and we have to consider when we can reach it.

Finally: It is seen that the period we live in, and the most difficult year of test of it is 2003, is the period of finding our way and set it right. At the same time we are lucky that presumably the favourable processes will coincide at every level by the end of 2003. Hopefully uncertainties will end in world economy. European economy and primarily the German one are expected to grow. The government’s economic policy is clear and takes the direction of preserving equilibrium. One level lower, on the level of institutions the emergence of institutional stability can be expected also as a result of predictable state intervention, that would operate without violating company autonomy. It can be promoted by a decreasing trend of the levels of taxation. These components jointly may create the same situation we could witness between 1995 and 2000.

This tendency is also strengthened by becoming members of the Union. EU membership will reduce producers’ risks. But surely only if we learn one thing: namely that the ‘West’ is also a market. Long ago there used to be two types of classes for foreign trading companies: the ‘departments of people’s democracies’ and the ‘capitalist departments’. Now we have to learn something else. So far we have only spoken about the existence of Eastern markets. Now it also derives from our accession to the EU that there are ‘Western markets’. Now everything that used to figure as an eastern market will be the external market, and what used to be the western one, would mostly become the internal market. It will be difficult to learn because the necessity of a turn in economic diplomacy also derives from it. But it is already another ‘story’.

 

* Presentation delivered at the Europe Institute Budapest on 4th March 2003. The author is Minister for Economic Affairs of the current Hungarian government.