beyondbrics

By Ferenc Kumin and Tamás Lánczi

The European consensus on Hungary is clear – the country has abandoned the ‘normal’ development path of central European states of integration with western Europe, and gone on a wild adventure of its own.

The consensus is right on facts – but wrong on timing. Hungary has not left the common development highway in the last couple of years under prime minister Viktor Orbán, as is now alleged in Brussels. It did so a long time ago – in 2002, under the former socialist-liberal government. What Orbán is doing is putting Hungary back on the right road.

Over eight long years – from 2002 to 2010 – socialist-liberal governments based their policies on extending social transfers and welfare financed by an ever-growing volume of credit.

This may have been popular with some voters, but it was thoroughly contrary to European Union principles – and contrasted sharply with the market-oriented reforms that the EU supported and that were implemented by Hungary’s peers, including Slovakia, the Czech Republic and Poland.

In Hungary, four successive socialist-liberal governments presided over a fiscal deficit that rose to 9 per cent and plunged the country into trouble, even before the 2008 global crisis. Sovereign debt ballooned from 54 of GDP to 82 percent. Corruption flourished.

After winning at the polls in 2010, Orban’s newly-elected, centre-right Fidesz government had to confront both not just an economic crisis – but a moral and political crisis as well.

Its goal was not merely to deal with the economic crisis, but to finally get rid of Hungary’s post-communist structures – as all other ex-communist states in central Europe had already done.

It did so, because it realized, partly based on the experiences of the 1998-2002 Fidesz administration, that even the best economic policy will be buried by the structural legacies of communism, if they are left unreformed.

Decades old networks, habits, and reflexes, obsolete employment standards and social transfer systems, outdated programmes in schools – these burdens are found in almost every walk of life.

This is why Hungary has chosen its own path at a time of global economic crisis. This may differ from the paths of other countries, and it definitely differs from Greece. Greece got into trouble because its governments failed to act; Hungary came under attack because of its government’s extraordinary energy and its quick responses to a difficult situation.

Let’s look at a few examples from the economic sphere.

At the end of 2010, the government introduced extra taxation for certain sectors – including banking, telecoms, retail, and energy. Now that a little time has passed, we can see that no significant, macro-level, damage has been done. No jobs have been lost; no companies went bankrupt. Most of the companies involved have been reporting nice profits.

Were there alternatives to these selective taxes? Of course: imposing extra taxes on every business and household. What would the government then have achieved? The same budget benefits, yes, but at a price of an excessive cut in domestic demand.

Why is domestic demand so important?

Hungary’s balance of payment is in surplus (1.1 percent of the GDP in 2010, and increasing) because exports are in good shape. But exports are not enough. Domestic demand is critical. Hungarians’ reaction to the crisis has been to cut domestic spending: people who lived under communism know how to save money.

Another big difference with the problematic Mediterranean countries.

It’s not just the historic experience that stops Hungarians spending. Another heavy legacy of the social-liberal governments is a huge amount of foreign currency mortgage debt, mostly in Swiss francs and euros. As these currencies went sky high against the forint, households had to finance unexpected increases in re- payments.

This is why the government chose to fix a below-market exchange rate repayment option for indebted home-owners. This unique piece of legislation offered complete repayment to clients at 180 forints per franc, when the actual exchange rate had been around 240 forints.

The banks had to shoulder the loss, although the government has recently allowed them to write off 30 per cent against tax.

The banks’ cries went around the international media. But isn’t Hungary’s approach the same as the EU’s when it requires private banks to write off Greek debt? Frankly, Hungarian home-owners have a better excuse than Greek governments. Households are not professional institutions. They had the right to believe the sales pitch of banks and politicians.

Was the decision just? If you ask bankers, the answer is a straight no. But from a political perspective the picture is somewhat different. During the social-liberal government, most former home-buying support programmes, including tax breaks, were phased out. But the political leaders wanted to offer something else. So, they foolishly encouraged foreign currency home loans!

Introducing the fixed-rate payback scheme unilaterally was an aggressive step, for sure. But what was the outcome? Householders could keep their homes and reduce repayments to manageable levels.

Householders’ balance sheets have been adjusted, so in the near future they may consider spending a little more – and boost the economy.

Hence we can see that for every Fidesz measure that has come under attack, there is another side to the story. We should not look at these questions simply in narrow economic terms. We’re not economists, we’re political scientists. And in political terms, the Fidesz measures make sense. Fidesz needs to win the next general election.

But not at any cost. At some point, the economic and political analysis must converge – or the government is in trouble.

This common aim is stability. Businesses are just as much interested in stability as political leaders. Hungary these days has to keep its balance on a very narrow path. The extreme-right Jobbik is now polling head-to-head with the formerly governing socialists, though still lagging far behind Fidesz.

If voters come to think that every government decision follows the will of the financial players in and outside the country regardless, it will drive voters straight to Jobbik’s welcoming arms.

That would be bad for Hungary. It would also be bad for the European Union, for bankers and for investors.

By Ferenc Kumin and Tamás Lánczi of the Századvég Foundation, Budapest, a conservative-leaning political and economic think tank.

Related reading
Orban and the EU, FT
Guest post:Orbán’s hazy memory of debts, cuts and economic policy, beyondbrics
Guest post: Orban’s competence not in question, beyondbrics
Guest post: Hungary’s false dawn, beyondbrics