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1 Convergence turned into Divergence and Decline The Example of Hungary Lajos Bokros Professor of economics and public policy Central European University.

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Presentation on theme: "1 Convergence turned into Divergence and Decline The Example of Hungary Lajos Bokros Professor of economics and public policy Central European University."— Presentation transcript:

1 1 Convergence turned into Divergence and Decline The Example of Hungary Lajos Bokros Professor of economics and public policy Central European University Member of the European Parliament Washington, DC, April 5, 2012

2 2 Lessons from transition Development of transition countries is cyclical Development of transition countries is cyclical Cycles are not synchronized among countries Cycles are not synchronized among countries Primarily explained by domestic factors Primarily explained by domestic factors Predominantly economic, political, cultural Predominantly economic, political, cultural Institutions are weak, reforms are reversible Institutions are weak, reforms are reversible Transition is about institution building by Transition is about institution building by Reforms leading to growth and convergence Reforms leading to growth and convergence Reversing reforms and destroying institutions result in divergence and decline Reversing reforms and destroying institutions result in divergence and decline

3 3 Hungary & Slovakia diametrically opposites Convergence based on groundbreaking reforms: Hungary Hungary Slovakia Slovakia Divergence and decline based on postponement or reversal of reforms Slovakia Slovakia Hungary Hungary

4 4 Reforms in Hungary Establishment of the State Property Agency to drive privatization in a transparent way Establishment of the State Property Agency to drive privatization in a transparent way Successful privatization of thousands of SOEs by traditional methods of auction and tender Successful privatization of thousands of SOEs by traditional methods of auction and tender Huge injection of FDI into the real economy Huge injection of FDI into the real economy Groundbreaking legislation in banking, stock markets, bankruptcy, liquidation, accounting Groundbreaking legislation in banking, stock markets, bankruptcy, liquidation, accounting Support to fast organic development of SMEs Support to fast organic development of SMEs

5 5 Reforms in Hungary Stabilization without recession started in 1995 Stabilization without recession started in 1995 Optimal mix of monetary, fiscal and income policies leading to rapid, export-led growth Optimal mix of monetary, fiscal and income policies leading to rapid, export-led growth Social policy reform: shift from entitlements to need-based targeting of financial support Social policy reform: shift from entitlements to need-based targeting of financial support Higher education reform: tuition fee Higher education reform: tuition fee Pension reform: mandatory private funds Pension reform: mandatory private funds Treasury management for the fiscal sector Treasury management for the fiscal sector Successful privatization of a number of banks Successful privatization of a number of banks

6 6 U-turn in economic policy in 2000 Instead of continuing Export-led Export-led Investment-driven Investment-driven Fiscally neutral Fiscally neutral hence financially sustainable growth hence financially sustainable growth The only rational policy in a small, open, poor, transition economy The only rational policy in a small, open, poor, transition economy Growth was based on Domestic demand Domestic demand Driven by consumption and imports Driven by consumption and imports Fuelled by huge fiscal overspending, hence Fuelled by huge fiscal overspending, hence unsustainable, because unsustainable, because It was supported by foreign borrowing It was supported by foreign borrowing

7 7 Reform reversals Reducing considerably the contribution rate to the new mandatory private pension pillar Reducing considerably the contribution rate to the new mandatory 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 officers and military personnel 70% salary increase to civil servants, law enforcement officers and military personnel Subsidies and tax credit to mortgage loans Subsidies and tax credit to mortgage loans Eliminating the tuition fee in higher education Eliminating the tuition fee in higher education Eliminating means testing in family support Eliminating means testing in family support Significant increase of the minimum wage Significant increase of the minimum wage

8 8 Fiscal profligacy with no reforms % salary increase for all government employees (3 times more than civil servants) 50% salary increase for all government employees (3 times more than civil servants) 13 th month salary to government employees 13 th month salary to government employees 13 th month pension; increase of survivor pens 13 th month pension; increase of survivor pens 20% increase of family allowances 20% increase of family allowances 30% raise of stipends in higher education 30% raise of stipends in higher education Full tax exemption to minimum wage earners Full tax exemption to minimum wage earners VAT rate reduction without curbing expenses VAT rate reduction without curbing expenses Further increase of mortgage loan subsidies Further increase of mortgage loan subsidies

9 9 Fiscal tightening & reforms blocked Tax increases (VAT, PIT, excises, witholding) Tax increases (VAT, PIT, excises, witholding) Reducing price subsidies to energy and drugs Reducing price subsidies to energy and drugs First, wage & hire freeze in civil service First, wage & hire freeze in civil service Reducing the number of budgetary institutions Reducing the number of budgetary institutions Introduction of tuition fee, co-payment in HC Introduction of tuition fee, co-payment in HC Elimination of all the above after referendum Elimination of all the above after referendum Attempts to introduce real estate tax blocked by the Constitutional Court in 2010 Attempts to introduce real estate tax blocked by the Constitutional Court in 2010 Elimination of the 13 th month wage & pension Elimination of the 13 th month wage & pension

10 10 Wholesale reform reversal I Nationalization of the mandatory private pension system and confiscation of its assets Nationalization of the mandatory private pension system and confiscation of its assets Members of the mandatory private pension funds forced to return to PAYG by government blackmail Members of the mandatory private pension funds forced 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 firms Minimum wage rise with selective subsidies to firms Direct government intervention into labor relations Direct government intervention into labor relations Increasing state shareholding in selected enterprises Increasing state shareholding in selected enterprises Central bank independence severely curtailed Central bank independence severely curtailed

11 11 Wholesale reform reversal II Fiscal council with no resources but excessive political power (superimposed on parliament) Fiscal council with no resources but excessive political power (superimposed on parliament) Tax obligation on severance payments by retroactive legislation (legal uncertainty) Tax obligation on severance payments by retroactive legislation (legal uncertainty) Huge and highly distortionary sectoral taxes in banking, telecom, energy and retail trade Huge and highly distortionary sectoral taxes in banking, telecom, energy and retail trade Large number of public providers of education and health care taken from local to central government Large number of public providers of education and health care taken from local to central government Mortgage loan amortization scheme tailored to help only affluent borrowers and destroying bank capital Mortgage loan amortization scheme tailored to help only affluent borrowers and destroying bank capital

12 12 Omnipotent, omniscient state distorting and replacing markets Size does matter: general government absorbs and redistributes close to 50% of GDP Size does matter: general government absorbs and redistributes close to 50% of GDP Predatory and invasive government behavior not respecting private property and contracts Predatory and invasive government behavior not respecting private property and contracts Competition rules ignored and/or breached Competition rules ignored and/or breached Public procurement rules tailored to favor well connected insiders and special interests Public procurement rules tailored to favor well connected insiders and special interests Rise in corruption in all levels of government Rise in corruption in all levels of government

13 13 Negative results: divergence and decline Maximum vulnerability: twin deficit & debt Maximum vulnerability: twin deficit & debt Sovereign credit rating declined to junk level Sovereign credit rating declined to junk level Extremely high bond yields in secondary markets Extremely high bond yields in secondary markets Protracted stagnation despite marked e/r decline Protracted stagnation despite marked e/r decline Unemployment at 11.6%; on the rise again Unemployment at 11.6%; on the rise again Credit crunch, negative FDI-flow, capital flight Credit crunch, negative FDI-flow, capital flight Divergence from V4 in per capita GDP terms Divergence from V4 in per capita GDP terms Destruction of credibility with erratic policies Destruction of credibility with erratic policies Irrational “freedom fight” against the IMF & EU Irrational “freedom fight” against the IMF & EU

14 14 General Government Gross Debt

15 15 Net External Debt

16 16 Twin Deficit

17 17 Twin Debt

18 18 Credit Rating of V4 by Moody’s

19 19 GDP per capita

20 20 Crisis and recovery


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