Hungary's Economic Leap

06/23/2014 06:43 am ET | Updated Aug 23, 2014
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In the late 1980s, Hungary was widely considered to be the economic trendsetter in Eastern Europe. The "goulash Communism" of Janos Kadar, introduced at the end of the 1960s, had gradually morphed into a hybrid form of market socialism. I spent a month in Budapest in 1985 and was startled by the profusion of goods in the stores. It wasn't exactly Vienna, but it was a far cry from Warsaw or Moscow.

Given its position at the head of the pack of countries in the region, Hungary was expected to be the first to make the successful transition to capitalism. And indeed, in the early years of the 1990s, foreign investment flowed into the country. But today, Hungary has fallen behind many of the other countries in the region in terms of growth, employment, debt, and other economic indicators. Many Hungarians are left scratching their heads and trying to figure out what went wrong.

When I first interviewed Laszlo Urban, he was a young economist affiliated with Fidesz, at that time a liberal political party. If Fidesz had formed a government in the early 1990s, Urban would have likely occupied a top position overseeing the economic transition. Instead, he went into the private sector, spending more than a dozen years in banking. Fidesz, meanwhile, shifted away from its early liberalism and took over power in 1998 as an avowedly conservative party.

We met again last May in Budapest, and I asked Urban what he thought went wrong with the economic transition. Among other things, he thought that the government mishandled the response to the collapse of the market that had existed in Eastern Europe during the Cold War.

"In order to make the Hungarian economy truly competitive, they had to privatize the majority of the economy," he told me. "As a consequence, at least 30% of the labor force turned out to be unemployable at the inherited wage rate in the new system. What do you do in a situation when 30% of your labor force all of a sudden loses all their jobs or their ability to be employed productively? The way we handled that had a lasting negative impact on the transition. Roughly 30% is just too huge of a blow. In the way the government dealt with the issue, at least one-third of that number just left the labor force completely and was probably not employable productively anyway. But we're talking about another two-thirds that we should have found some way to keep in the labor force. Instead, those people were let go into early retirement or given disability pensions, or in some other way they also left the labor force. This was just too large a percentage of tax-paying, employed workers who disappeared from the labor force."

Practically speaking, the government should have approached privatization differently. "I would have separated the companies that needed to be privatized urgently from those that could have been privatized in a more gradual fashion," he continued. "The more export-oriented enterprises, which needed to be competitive, had to be privatized. The state-owned sector was not competitive, that was clear. I still believe that state-owned companies cannot operate productively and competitively. They could not have survived competition. Nor did they have enough capital for their modernization. So in order to have a chance to stay competitive, those companies had to be privatized. But it is true that those companies that serve mostly the domestic market, particularly service sector firms, their privatization should have been done in such a way that a middle class would have emerged to run these businesses."

The closure of huge numbers of factories and the creation of a large group of people dependent on government programs, Urban believes, are a legacy of the early 1990s that continues to shape Hungarian politics and economics today. This group "became the primary target constituency of any political force that wanted to win elections," Urban concluded. "Budget deficits and increased public debt resulted from the measures to please that particular constituency. It is still a dominant part of politics in Hungary and is even driving what Viktor Orban is doing now. It's not because of his personality, but because he understands the dynamic and has the numbers to prove it. If he maintains his popularity with this welfare recipient constituency, then he will be reelected in 2014."

The Interview

One of the things I asked you in 1990 was about your expectations about Fidesz. It was a rather unusual collection of people with a radical, liberal, and alternative agenda. You imagined that it might hold together for about 10 years. But it began to split earlier than that.

It wasn't really a split. Some people departed for SzDSz. Some of the alternative people who were never an influential part of the leadership also left. But the core of Fidesz stayed together. Actually I would not have thought that Viktor Orban could build such a strong party as he finally managed to do. Of the original group of 50 top people who closely worked together, probably more than 30 are still there. They are in different positions. Some of them are still at a high level, others are more marginal, but they are still Fidesz politicians. This was already the case in the early 1990s but increasingly Viktor didn't care what the others in the party were thinking. He managed to achieve full control over the party and then later the government and then the whole country. That was quite an achievement. I wouldn't have thought that it was possible. I thought that Fidesz needed to align itself with other political forces and form maybe a conglomerate leadership, more like what happened after the 1998 elections.

Orban's economic program was different when he was in opposition than when he was in government, especially in his most recent incarnation. How you would evaluate his economic program today?

There was this episode in 1998 when Fidesz first got into government. I left in 1995, so we were not in contact during these next three years. And yet the economic program of the party was rigged up by Gyorgy Matolcsy already in 1996 and 1997. In the campaign he was the economic spokesperson. And yet when Viktor won the elections, he asked me first to be the finance minister. And I could have become finance minister. I'm not sure how long I would have stayed finance minister, because we probably would have disagreed on some policy issues pretty early on. But the interesting thing was that when he asked me, I said that I'd be happy to work with him, but we needed to agree to certain things and one of them was about reducing the budget deficit. That time it wasn't even that high: about 4-4.5% of GDP. During the next three years, even without me, he followed that policy. He reduced the fiscal deficit every year, and even the debt started to decline. So his economic policy during the first term was pretty close to what I would have agreed to, but it doesn't mean that we would have gotten along easily. The way he governed, even then, was that he could only work with people that didn't set conditions, who didn't even object, and who just executed whatever he said.

But his view about what needed to be done in the economy then was pretty close to mine, although the international environment was also more favorable. So he paid attention to macro balances. Then he tried to stimulate the economy through the housing sector, which was a little bit overdone, and it led him into some difficulty in the last year of his term. But I'm sure that he would have controlled that. Interestingly enough, even now that fiscal discipline still seems to be one of his priorities, partly because Brussels is pushing it. But that's a continuity, in the sense that beyond the pressure from Brussels, Viktor understands that macro-fiscal discipline is important to maintain.

But the major disagreement between what he's doing now and what I think should be done is that he does not seem to accept that the economy is a non-zero-sum game where the major incentive for a lot of people to participate is to gain more than they are putting in: this is what competition and the market economy are all about. For Viktor, the economy is predominantly, like politics, a zero-sum game where a person can win only if he takes away from others, and if others are winning then it is something that is taken away from him. It's a power game for Viktor, and if someone looks at the economy that way, even only a certain segment, then it has much larger repercussions. He just doesn't seem to have an understanding of what this lack of respect for this very delicate institutional and behavioral environment does to the incentives of people. If you want people to behave creatively in order to gain more and if they're all doing the right things to contribute to an overall economic goal - he just doesn't believe that this is what the market economy is about. For him the economy is just an extension of the political sphere where positions can be redistributed. This is what he is doing now, starting with the bigger public procurements all the way down to tobacco shops, which are now being redistributed. It's a redistributive game for him. If someone looks at an economy as a redistributive game and has all the power that he has to rearrange the institutional structure along those lines, then he might get what he wishes for and end up with an economy where there is no growth.

That zero-sum attitude seems to apply to his approach to the EU and his talk of closer cooperation with Russia.

The bureaucracy in Brussels is basically trying to put a straitjacket on all the members. Sometimes this over-regulation is very irrational. But we have to implement the whole acquis communautaire. The fact that all members are contributing to the community project and then funds are redistributed and heavily administered makes everything very slow. Much of the money spent on investment in this economy is coming from Brussels and not much else. So paradoxically, whatever Brussels is doing very often helps his approach, which is that the government drives the economy. It's not intentional. This is just the nature of how the EU is structured. It's a bunch of common regulations and a bunch of money that is being redistributed, following rules and regulation, and with a lot of administration.

When Viktor is talking about the East, Russia and China and some other countries, there are two motivations behind it. One, he recognizes that some of these countries, for different reasons, have foreign reserves which they need to invest in foreign assets. Viktor thinks, "We are not a big country, so if they just put a little bit of their money into Hungarian government securities maybe it will help us to manage our public debt. Or if they don't want to buy our government paper, then maybe they could help finance some infrastructure projects and invest their money in a way that would even open up some of their market." So, in a sense, it is like a technocratic approach.

On top of that, Viktor has made it clear that anyone who wants to do business in Hungary must be humble with him because he can always use a wide array of available means to make their life miserable. It's not necessarily an autocratic regime here, although we have a parliamentary regime where whatever happens basically depends on the leader's own will and he can implement anything that he wants. In that sense, although the fundamental rules of the game are democratic here, the way he operates within that is closer to a Far Eastern non-democratic regime. He likes to be the alpha-male in every respect, not only in politics but also in business. Everyone recognizes that he is the ruler, at least in this small part of the world. These two motivations are skillfully mixed in his messages. It's not so easy to pinpoint whether it's just a pure problem of his personal style because he can wrap it up in rhetoric like "we want to be an export-driven market" and "we want to improve the macro finances."

You said earlier that even before getting involved in the policy world you thought it would be a good idea to have some practical experience in the financial world. How did the opportunity arise, and did the experience meet your expectation?

To read the rest of the interview, click here.