Convergence turned into Divergence and Decline The Example of Hungary

11

Convergence turned into Convergence turned into Divergence and DeclineDivergence and Decline

The Example of HungaryThe Example of Hungary

Lajos BokrosLajos Bokros

Professor of economics and public policyProfessor of economics and public policy

Central European UniversityCentral European University

Member of the European ParliamentMember of the European Parliament

Washington, DC, April 5, 2012Washington, DC, April 5, 2012

22

Lessons from transitionLessons from transition

Development of transition countries is Development of transition countries is cyclicalcyclical Cycles are Cycles are not synchronizednot synchronized among countries among countries Primarily explained by Primarily explained by domestic factorsdomestic factors Predominantly Predominantly economic,economic, political,political, culturalcultural Institutions are weak, reforms are reversibleInstitutions are weak, reforms are reversible Transition is about Transition is about institution buildinginstitution building by by ReformsReforms leading to growth and convergence leading to growth and convergence Reversing reforms and destroying institutions result Reversing reforms and destroying institutions result

in divergence and declinein divergence and decline

33

Hungary & SlovakiaHungary & Slovakiadiametrically oppositesdiametrically opposites

ConvergenceConvergence based on based on groundbreaking groundbreaking reforms:reforms:

Hungary 1990-1999Hungary 1990-1999 Slovakia 1999-2009Slovakia 1999-2009

Divergence and declineDivergence and decline based on postponement based on postponement or reversal of reformsor reversal of reforms

Slovakia 1990-1998Slovakia 1990-1998 Hungary 2000-2012Hungary 2000-2012

44

Reforms in HungaryReforms in Hungary1990-19941990-1994

Establishment of the State Property Agency to Establishment of the State Property Agency to drive drive privatizationprivatization in a transparent way in a transparent way

Successful privatization of thousands of SOEs Successful privatization of thousands of SOEs by traditional methods of auction and tenderby traditional methods of auction and tender

Huge Huge injection of FDIinjection of FDI into the real economy into the real economy Groundbreaking Groundbreaking legislationlegislation in banking, stock in banking, stock

markets, bankruptcy, liquidation, accountingmarkets, bankruptcy, liquidation, accounting Support to fast organic development of SMEsSupport to fast organic development of SMEs

55

Reforms in HungaryReforms in Hungary1994-19981994-1998

Stabilization without recession started in 1995Stabilization without recession started in 1995 Optimal mix of monetary, fiscal and income Optimal mix of monetary, fiscal and income

policies leading to rapid, export-led growthpolicies leading to rapid, export-led growth Social policy reform: shift from entitlements to Social policy reform: shift from entitlements to

need-based targeting of financial supportneed-based targeting of financial support Higher education reform: tuition feeHigher education reform: tuition fee Pension reform: mandatory private fundsPension reform: mandatory private funds Treasury management for the fiscal sectorTreasury management for the fiscal sector Successful privatization of a number of banksSuccessful privatization of a number of banks

66

U-turn in economic policy in 2000U-turn in economic policy in 2000

Instead of continuingInstead of continuing

Export-ledExport-led Investment-drivenInvestment-driven Fiscally neutralFiscally neutral hence financially hence financially

sustainablesustainable growth growth

The only rational policy in a The only rational policy in a small, open, poor, transition small, open, poor, transition economyeconomy

Growth was based on Growth was based on

DomesticDomestic demand demand Driven by Driven by consumption consumption

and importsand imports Fuelled by huge Fuelled by huge fiscal fiscal

overspendingoverspending, hence , hence unsustainable, becauseunsustainable, because

It was supported by foreign It was supported by foreign

borrowingborrowing

77

Reform reversals Reform reversals 1998-20021998-2002

Reducing considerably the contribution rate to the new Reducing considerably the contribution rate to the new mandatory private pension pillarmandatory private pension pillar

Opening up the opt-out option (back to PAYG)Opening up the opt-out option (back to PAYG) 70% salary increase to civil servants, law enforcement 70% salary increase to civil servants, law enforcement

officers and military personnelofficers and military personnel Subsidies and tax credit to mortgage loansSubsidies and tax credit to mortgage loans Eliminating the tuition fee in higher educationEliminating the tuition fee in higher education Eliminating means testing in family supportEliminating means testing in family support Significant increase of the minimum wageSignificant increase of the minimum wage

88

Fiscal profligacy with no reformsFiscal profligacy with no reforms2002-20062002-2006

50% salary increase for all government 50% salary increase for all government employees (3 times more than civil servants)employees (3 times more than civil servants)

1313thth month salary to government employees month salary to government employees 1313thth month pension; increase of survivor pens month pension; increase of survivor pens 20% increase of family allowances20% increase of family allowances 30% raise of stipends in higher education 30% raise of stipends in higher education Full tax exemption to minimum wage earnersFull tax exemption to minimum wage earners VAT rate reduction without curbing expensesVAT rate reduction without curbing expenses Further increase of mortgage loan subsidiesFurther increase of mortgage loan subsidies

99

Fiscal tightening & reforms blockedFiscal tightening & reforms blocked2006-20102006-2010

Tax increases (VAT, PIT, excises, witholding)Tax increases (VAT, PIT, excises, witholding) Reducing price subsidies to energy and drugsReducing price subsidies to energy and drugs First, wage & hire freeze in civil serviceFirst, wage & hire freeze in civil service Reducing the number of budgetary institutionsReducing the number of budgetary institutions Introduction of tuition fee, co-payment in HCIntroduction of tuition fee, co-payment in HC Elimination of all the above after referendumElimination of all the above after referendum Attempts to introduce real estate tax blocked by Attempts to introduce real estate tax blocked by

the Constitutional Court in 2010the Constitutional Court in 2010 Elimination of the 13Elimination of the 13thth month wage & pension month wage & pension

1010

Wholesale reform reversal I.Wholesale reform reversal I.2010-20122010-2012

Nationalization of the mandatory private pension Nationalization of the mandatory private pension system and confiscation of its assetssystem and confiscation of its assets

Members of the mandatory private pension funds Members of the mandatory private pension funds forced to return to PAYG by government blackmailforced to return to PAYG by government blackmail

Regressive changes in tax & benefit systems (OECD)Regressive changes in tax & benefit systems (OECD) Minimum wage rise with selective subsidies to firmsMinimum wage rise with selective subsidies to firms Direct government intervention into labor relationsDirect government intervention into labor relations Increasing state shareholding in selected enterprisesIncreasing state shareholding in selected enterprises Central bank independence severely curtailedCentral bank independence severely curtailed

1111

Wholesale reform reversal II. Wholesale reform reversal II. 2010-20122010-2012

Fiscal council with no resources but excessive Fiscal council with no resources but excessive political power (superimposed on parliament)political power (superimposed on parliament)

Tax obligation on severance payments by retroactive Tax obligation on severance payments by retroactive legislation (legal uncertainty)legislation (legal uncertainty)

Huge and highly distortionary sectoral taxes in Huge and highly distortionary sectoral taxes in banking, telecom, energy and retail tradebanking, telecom, energy and retail trade

Large number of public providers of education and Large number of public providers of education and health care taken from local to central governmenthealth care taken from local to central government

Mortgage loan amortization scheme tailored to help Mortgage loan amortization scheme tailored to help only affluent borrowers and destroying bank capital only affluent borrowers and destroying bank capital

1212

Omnipotent, omniscient stateOmnipotent, omniscient statedistorting and replacing marketsdistorting and replacing markets

Size does matter: general government absorbs Size does matter: general government absorbs and redistributes close to 50% of GDPand redistributes close to 50% of GDP

Predatory and invasive government behavior Predatory and invasive government behavior not respecting private property and contractsnot respecting private property and contracts

Competition rules ignored and/or breachedCompetition rules ignored and/or breached Public procurement rules tailored to favor well Public procurement rules tailored to favor well

connected insiders and special interests connected insiders and special interests Rise in corruption in all levels of government Rise in corruption in all levels of government

1313

Negative results:Negative results:divergence and declinedivergence and decline

Maximum vulnerability: Maximum vulnerability: twin deficit & debttwin deficit & debt Sovereign credit rating declined to Sovereign credit rating declined to junkjunk level level Extremely high bond yields in secondary marketsExtremely high bond yields in secondary markets Protracted Protracted stagnationstagnation despite marked e/r decline despite marked e/r decline UnemploymentUnemployment at 11.6%; on the rise again at 11.6%; on the rise again Credit crunchCredit crunch, negative FDI-flow, capital flight, negative FDI-flow, capital flight DivergenceDivergence from V4 in per capita GDP terms from V4 in per capita GDP terms Destruction of credibilityDestruction of credibility with erratic policies with erratic policies Irrational “freedom fight” against the IMF & EU Irrational “freedom fight” against the IMF & EU

14

0

10

20

30

40

50

60

70

80

90

100

110

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011*

0

10

20

30

40

50

60

70

80

90

100

110

BG CZ HU RO SI PL SK

% %

General Government Gross Debt

15

-20

-10

0

10

20

30

40

50

60

70

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

-20

-10

0

10

20

30

40

50

60

70

BG CZ PL RO SI SK HU

% %

Net External Debt

16

-7

-6

-5

-4

-3

-2

-1

0

1

-8 -7 -6 -5 -4 -3 -2 -1 0 1

-7

-6

-5

-4

-3

-2

-1

0

1

SI

CZ

PLSK

HU

RO

BG

aver

age

budg

et d

efic

it

(199

5-20

10)

%

average current account deficit (1995-2010)

%

Twin Deficit

17

0

10

20

30

40

50

60

70

80

90

0 10 20 30 40 50 60 70

0

10

20

30

40

50

60

70

80

90

SICZ

PL

SK

HU

RO

BG

% %

net external debt (2010)

gros

s go

vern

men

t deb

t (2

010)

Twin Debt

18

Credit Rating of V4 by Moody’s

10

11

12

13

14

15

16

17

18

19

Jan-

89

Jan-

90

Jan-

91

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Jan-

12

10

11

12

13

14

15

16

17

18

19

CZ PL SK HU

Baa2

Baa1

A3

A2

A1

Aaa

Baa3

Ba1

Ba2

Ba3

Credit Rating of the Visegrad Countries (Moody's)

Baa2

Baa1

A3

A2

A1

Aaa

Baa3

Ba1

Ba2

Ba3

junk level

19

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0

2000

4000

6000

8000

10000

12000

14000

BG CZ HU PL RO SI SK

euro euro

GDP per capita

20

89

91

93

95

97

99

101

103

max min 2011Q4

89

91

93

95

97

99

101

103

SK

CZ

BGHURO

SI

Crisis and recovery