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Privatization of Farming Activities in Hungary

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1990
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Agricultural reform in Eastern Europe holds a key to higher export earnings

Throughout Eastern Europe, there is a growing interest in how best to tackle agricultural reform—fast becoming synonymous with accelerating the difficult task of privatization. Agriculture and the food industry account for roughly 16-20 percent of GDP in all but one country (Czechoslovakia, the only non-net agricultural exporter, comes in much lower, at about 10 percent). Moreover, this sector holds the greatest potential for quickly raising desperately needed hard currency, as the industrial sector will have to undergo a much longer, painful process of restructuring.

Of all the countries in this region, Hungary is by far the furthest along in its attempts to revitalize the agricultural sector. The incentives are obvious: besides taking up a sizable proportion of GDP (20 percent), agriculture and the food industry account for 20 percent of total employment and approximately 27 percent of convertible currency exports. But although production increased considerably in the 1970s, there has been little attention paid to the efficiency of the agricultural system. Except for field crops (such as wheat, corn, and sunflower, which are largely fed to livestock and enjoy a comparative advantage), the main export products (pork, poultry, wine, grapes, fruits, and vegetables) have proved to be inefficient, with low labor productivity and very little concern about returns to capital.

One of the principal challenges for the emerging leadership in Hungary—indeed, throughout Eastern Europe—therefore, is to create the conditions that will permit farming to operate as a business, with all the monetary rewards for success and the threat of bankruptcy for failure. Ultimately, three critical issues must be addressed: ownership of land and assets, reduction of subsidies and price controls, and development of the domestic and export markets. The sequencing and pace of reform measures may vary from country to country, but all will have to contend with the changing arrangements in the Council for Mutual Economic Assistance (CMEA, or Comecon)—long their guaranteed regional market—and the need to make inroads into Western markets, particularly the European Community (EC).

Roots of the problem

Traditionally, Hungary has served as a bread basket for its neighbors, with a strong agricultural system oriented toward exports. Until the end of World War II, there were mostly large landed estates and large numbers of landless rural workers, often associated with these estates. But in 1945, the new government initiated a sweeping land reform, which enfranchised a host of landless workers with family plots. This was then followed by first, unsuccessful, and in the late 1950s, successful attempts to coerce farmers into collectives. In return for their allegiance, farmers were permitted to keep title and receive nominal income from their land, work small plots for self-sufficiency, and enjoy guaranteed product prices. A pattern of land ownership was thus established that still carries implications for decisions on privatization of farming activities.

Today, about 20 percent of the farming resources are state-owned (down from the 50 percent level of the 1950s), with the 130 units averaging 5,000-10,000 hectares (far in excess of the large farms in Western countries, which also typically are family-owned). Another 65 percent are cooperatives, with the 1,250 units averaging about 2,000-4,000 hectares. The remaining 15 percent is made up of a growing number of private farmers—embracing some 400,000 rural families—who contribute over one half of the value added in primary agriculture. The head of family spends most of his day as a wage worker or cooperative member on the large-scale farms, but reserves his best efforts for raising livestock and a variety of fruits and vegetables on household plots.

Until the late-1980s, the Communist party not only eroded local control of the cooperatives but also discriminated against all private sector activity. Private farmers were frustrated in a thousand ways from gaining access to inputs, resources, and markets, while the state farm and cooperative managers held virtual free rein on resources, including government bank credit, with little or no accountability. Profitability was no longer a measure of success; state wholesale organizations and foreign trading organizations negotiated “prices” with retail and trading partners; Western-style accounting was dropped; and markets were controlled by the government, as marketing was considered to be an antisocial practice that exploited the population. Interest focused on yields of crops and livestock, and large-scale farms were compensated for the difference between their revenues and costs through subsidies.

This slowly sowed the seeds of inefficiency, leading to a crisis situation, starkly exposed by the adverse world market of the 1980s. While agriculture had performed well in the 1970s, with spectacular achievements in growth and yields, since 1981, agricultural GDP, on average, has been stagnant, and its share of convertible currency exports has declined. Faced by mounting budget and trade deficits, government leaders exacerbated matters by squeezing the sector: prices on commercial inputs were allowed to seek their international levels, but producer and consumer prices were kept below international levels through administrative controls.

Efforts to reform

Over the last five years, the Government has tried to increase the economic and financial efficiency of enterprises in the production and marketing of agricultural goods, and improve earnings from exports in convertible currency markets (mostly fresh and cut poultry, bottled wine, and special pork and beef cuts, as opposed to low-value agricultural commodities, such as frozen broilers, bulk wine, and pork sides). The strategy is twofold: roll back government control of the sector, permitting individuals to acquire assets, including land, and manage them in a profitable manner; and modify or establish new institutions to support farmers in preparing for a market-oriented system.

Underlying this approach has been a recognition that market-oriented policies must be pursued in a more determined manner, and that corporate farming, as practiced in Hungary and elsewhere in Eastern Europe, is inefficient and unable to adapt to a highly competitive world market. At this stage, several forces are shaping the demise of large-scale farming units: (1) firms have become far too big to be managed effectively; (2) annual cash transfers from the government budget to nonperforming large-scale farms are being eliminated, with the subsequent threat of liquidation; (3) excess labor has inflated wage costs, created low morale, and eroded the possibility of incentive pay for high quality work; and (4) given the lack of capital markets, large-scale farms have diversified into nonagricultural activities, which generate over 50 percent of their profits.

Counterbalancing the shrinking of corporate farming has been the emerging importance of private farming, which has not only survived but shone under a hostile domestic environment. Motivated by incentives and profits, private sector farmers pay close attention to detail and try to ensure that products meet quality specifications. But although they enjoy an abundance of labor and buildings, they lack essential capital and land needed to compete as responsible commercial operators.

Agenda for reform

Change and intense follow-up are now required in several key policy areas if the privatization of agricultural activities in Hungary is to be accomplished in the most efficient manner possible.

Ownership rights. The newly elected parliament (June 1990) is in the throes of grappling with the most fundamental issue: creating the conditions for the assignment of ownership rights—an issue in all Eastern European countries, except possibly Poland, where small-scale farms are more characteristic. The actual distribution of agricultural land and assets could take several forms. At this point, 37 percent of the land held in the cooperatives can be claimed by current members, but the balance remains the subject of intense debate. One could imagine the central cooperative unit evolving into a holding company, providing financial, accounting, and perhaps, marketing services to a series of limited liability companies or joint stock companies specializing in various productive activities of the old cooperative (e.g., livestock, crop production, or nonagricultural ventures). Another scenario might be the return of agricultural land to all those who held legitimate claims to specific plots as of 1947, the end of the land distribution program. Still another might be to sell off state farms, either as a unit or subdivisions, to private buyers through the State Property Agency (the official entity charged with evaluating and selling state-owned assets).

Land market development. Despite assertions that agricultural land has no value, commercial banks are regularly using land as collateral for securing loans when they believe it is resalable, and to a limited extent, large-scale farms are renting and selling land to their members and workers, as well as to third parties. Guidelines now need to be refined and published, so that a land market can emerge (this would also enable private farmers to use agricultural land as collateral to obtain commercial bank loans). The first step must be the recognition of land as a productive asset, with its inclusion as a notional asset on balance sheets. Second, a farmland office should be set up to ensure that transactions are made public and transparent.

Debt-reduction program. In 1987, the Government approved a rolling, three-year debt-reduction program, largely for certain cooperative farms, selected on the basis of debt-servicing ability. In order to qualify for some 40-50 percent reduction in their overall debt obligations—essentially a onetime subsidy—participating farms must improve profitability by 20-25 percent and restructure operations. This may include installing a new management team, firing redundant staff, and revising the product mix in line with market demand. Agreements have been concluded with 234 farms, of which 81 began the program in 1987. Results indicate success for the first group, in that 64 cooperatives restructured their operations, while 17 cooperatives failed. The latter must now pay all previously suspended debts, operate without government subsidies, and if found insolvent, submit to liquidation proceedings. The Government has stated that at least ten large-scale farms in the country will be liquidated by June 1991.

Producer pricing policy. Virtually all producer prices of agricultural products have been liberalized since January 1990, and to ensure that farming remains competitive, the Government is also committed to eliminating licenses on imports of most agricultural products, although this effort is only just beginning.

Subsidy reduction program. The Government is committed to reduce agricultural subsidies by one third in 1990, which will remove most of the investment and production subsidies influencing the production of specific crops and livestock at the farm level. Further steps are to be taken to ensure that investment tax credits and income support for farms located in resource poor areas do not unduly influence farmers’ decisions on the product mix.

Domestic trade constraints. The domestic food trading system, which is heavily influenced by administrative controls, has suffered from the lack of a trade law. When enacted, this law will set the preconditions for an efficient marketing system, as participants will be able to profit from the sale, warehousing, processing, and marketing of food and agricultural commodities. Several steps have now begun to be taken, including training executives in marketing, improving the domestic price information system, establishing a commodity futures market, and involving professional groups in market regulation.

Conclusion

Privatization of farming activities in Hungary implies distribution of land to individuals and the development of a policy environment within which the private sector can assume responsibility for its decisions. Through the reorganization of land and farming assets in the country, Hungarian agriculture will be in a more favorable position to respond to the increasingly sophisticated market demands of Western European consumers and the increasingly quality conscious consumers of Eastern Europe. Moreover, additional agricultural export earnings would provide a critical contribution to improving Hungary’s current trade account, and equally important, to reducing the budget deficit. Of course, the easing of barriers to entry into EC markets would help enormously. But even if the status quo remains, Hungary should be able to boost export earnings by shifting away from commodities and bulk-packaged goods to “differentiated” products that would be ready for supermarket sale, such as specialty pork cuts, and branded honeys and pâtés.

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