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Drowning the Tiger:

The Failure of Hungarian Economic Reform 1989 – 2009

Summary

The paper explores Hungary’s steady economic decline in the twenty years since the fall of the communist system. It attributes this decline to an overall failure to disengage the government from a controlling role in the economy and in social welfare, and it examines the historical and contemporary factors that led to this failure.

Introduction

In the space of 20 years, from the end of communism in 1989 to the present, Hungary has fallen from first place to last in economic terms amongst its Central European neighbours. This may not seem like a noteworthy story, given the current global economic crisis. But in fact Hungary’s economy was well in decline by 2006, when neighbouring countries were experiencing notable growth and prosperity. To lose Hungary’s unique story in the broader narrative of global economic downturn would be a disservice to those countries which made the painful but necessary reforms in the immediate post-communist period and which now deserve credit for their success — Estonia, Poland, the Czech Republic and Slovakia. At the same time, failure to understand Hungary's unique story would be to miss critical lessons in one of the most important debates taking place today: how do countries successfully make the transition from authoritarian rule and central planning to market democracy?

Why has Hungary’s story not been told up to now? First, human nature is such that by necessity we simplify. Analysts, policymakers, and journalists, when faced with a canvas of 11 different countries (the Baltics to the Balkans — the canvas becomes much larger if one includes the countries of the former Soviet Union) can only discern so much detail. Many of the finer distinctions among the different countries are lost in the broader strokes. Second, circumstances have served to distract from the drama of Hungary’s fate. Central and Eastern Europe held the eyes of the world for just under a year — from October 1989 until August 1990. Then Saddam Hussein invaded Kuwait and launched the Gulf War and attention was shifted to the Gulf. From there it was drawn to the Yugoslav War, to 9/11, then on to Afghanistan and Iraq. Even the aid agencies and the many NGOs who had committed themselves to a long-term role in assisting the democratic transition in Central and Eastern Europe, setting up local offices and hiring local staff, withdrew in the mid-1990s, having decided that they were more needed elsewhere and that the countries of this region were now successful graduates of transition. Finally, as mentioned above, the current state of the Hungarian economy is being obscured by the larger global economic crisis. Hungary’s leaders are themselves the greatest proponents of this sleight of hand, hoping to raise much needed funds and deflect attention from their bad spending habits.

So in part, the Hungarian story has been lost simply because it is one story among many, and second, because of the way circumstances have transpired and drawn attention and resources away from the region. But there is a third reason as well, and it is to this reason that this paper is primarily addressed. The third reason is that at least a part of what has gone wrong in Hungary has been beyond the measure of easily quantifiable factors. With democratic peace theory at the heart of U.S. foreign policy for the past two to three decades, scholars and policy analysts have expended a great deal of effort to understand how countries become more democratic, and therefore, presumably, less of a threat to the United States and greater contributors to global peace and prosperity. Great strides have been made in this field, to be sure, particularly in understanding the importance of such factors as corruption, civil society, rates of taxation, government regulation, justice and reconciliation, and economic freedom. Progress has been possible because of the many scholars and experts who either have brought a very close scrutiny to their subject, or who have found ways to quantify and thereby measure and compare complex, previously unquantified subjects. The shortcoming is that virtually none of these studies can singly say why in 2006 Hungary saw police and demonstrators clash in the worst violence in 50 years; why in 2007 Hungary had GDP growth of 1.8%, while the smaller neighbour Slovakia had a growth rate of 8.8%, or why Hungary is today on the verge of bankruptcy.

The aim of this paper is to paint that larger picture, with the primary purpose of drawing key lessons about how countries move from stagnant and repressive centrally planned economies to prosperous free-market economies, and secondarily to suggest what Hungary needs to do today to reverse its steady downward course. Rather than provide a strictly historical narrative of Hungary in the two decades following the collapse of communism, this paper will instead highlight five reasons for the failure of Hungarian economic reforms.

None of the five reasons alone can account for the overall failure, therefore there is no effort to rank them in order of importance. Rather, the order is based on their mutability — those factors which are least impacted by human decision-making are listed first. Why approach it this way? Because there are some factors that cannot be changed, no matter how many resources or experts one might bring to bear and yet they are critical to the ultimate failure or success of a transition process. For example, if you do not have a specific individual who has both the force of personality to achieve a major leadership position (ideally prime minister or finance minister) and the education to understand the working of the free market as well as the inclination to be deeply committed to market reforms, then all the other factors necessary for transition are unlikely to come about. The development of a leader can be supported through education and scholar exchange programmes, or through translation of key works into local languages, but if the moment of transition arrives and such a person is not on the scene, he or she cannot be made. Factors such as this, which can be least effected by specific policies or decisions, are therefore listed first because while they may be of great interest to observers or historians, they are less relevant to policymakers.

Other factors central to Hungary’s decline, however, are eminently mutable, and as such, they should be of great interest to policymakers who are today facing the challenges of reform. As of the publication of this paper, Hungary will have a nearly bankrupt economy and a new prime minister. He or she, whether by force or inclination, will have to take an interest in policies that can lead to stabilization and growth. At the same time, leaders and experts everywhere, not least in the United States, are still trying to find that perfect balance between the role of the state and the role of the market. A number of recent cases, notably Ireland, Botswana and El Salvador, have underscored the strong causal link between economic liberalization, with its scaling back of state regulation and spending, and subsequent high rates of growth. As such, they have warranted a good deal of scrutiny and attention.¹ Hungary, as this paper demonstrates, is further testimony to this causality — from the opposite side of the coin: its failure to scale back public sector spending and to reduce and simplify regulations and bureaucracy have led to a steady and prolonged decline in the economy.

In brief, then, the five factors that have led to the failure of economic reform in Hungary over the past 20 years are as follows:

1. the introduction of “market socialism” reforms prior to the free-market stage;

2. the absence of a leader committed to free-market reform;

3) the absence of effective lustration;

4) the choice of commercial privatization over reprivatization of state assets;

5) the failure to implement fiscal and regulatory reforms.

This paper will first examine the nature of the present crisis. It will then provide some background to this crisis, exploring several historical factors which did not directly lead to the crisis but had a significant role, and finally it will explore each of these five causes of Hungary’s economic crisis and in so doing point to some possible solutions.

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