Abstract

In view of the impressive accomplishments of the Hungarian economy over the last three years, one might conclude that the transition is by and large complete. In one sense, this is true: virtually all the institutional features of a planned economy have been removed, the role of the State has been greatly reduced, and the economy seems to have overcome the imbalances that had resulted from the transition process. As the European Commission stated in its opinion concerning Hungary’s application for membership to the European Union:

In view of the impressive accomplishments of the Hungarian economy over the last three years, one might conclude that the transition is by and large complete. In one sense, this is true: virtually all the institutional features of a planned economy have been removed, the role of the State has been greatly reduced, and the economy seems to have overcome the imbalances that had resulted from the transition process. As the European Commission stated in its opinion concerning Hungary’s application for membership to the European Union:

Hungary is a functioning market economy. Liberalization and privatization have progressed considerably, and there has been strong growth of new private firms … . Hungary should be well able to cope with competitive pressure and market forces within the Union in the medium term, provided the macroeconomic conditions for strong investment growth remain in place.

Moreover, according to the most recent EBRD, transition report (EBRD, 1997), Hungary now ranks first in all 11 indexes of progress in transition.

Even though the transition toward establishing a market economy has been successfully completed, much remains to be done to consolidate the results achieved, reduce the risks of external shocks to which a small open economy is typically exposed, and bridge the gap with Western European economies. Narrowing this gap will have to be at the heart of the authorities’ strategic agenda for the next few years to set the basis for Hungary’s eventual accession in the European Union.

This agenda will be as challenging as the last one, but will involve a change in the tactical targets pursued by the authorities. Hungary’s external imbalance (as measured by the external current account) has now been brought down to a level that is sustainable over the medium term (Chapter III). The main objective in this area is to consolidate the results achieved in the past. If the external deficit is maintained at a level that is fully financed by foreign direct investment, the net external debt-to-GDP ratio will continue to decline from current levels, and reinforce Hungary’s resilience in the face of external shocks.

With the focus of the external strategy shifting from deficit reduction to stabilization, another economic policy target is likely to come to the fore: inflation reduction. Inflation needs to be brought down decisively into the lower single-digit range—higher inflation would hamper Hungary’s medium-term growth prospects (Chapter VII). The chances of a fast disinflation are good (e.g., a reduction in the inflation rate of 4–5 percentage points a year). The authorities’ credibility in implementing macroeconomic adjustment has been established; a strong supply response is in progress and is expected to continue over the medium term; the strengthening of the external accounts will allow a more aggressive use of the exchange rate anchor; the solvency of public finances has been restored; and the increased flexibility of the banking system makes nominal interest rates more likely to move downward in line with the deceleration of inflation. In these circumstances, the tightening in the growth rate of nominal variables (the growth rate of money, the depreciation rate) that is required by disinflation, is likely to involve limited output costs. The authorities’ achievement of the inflation target for 1998 (13½ percent on average and even less by the end of the year) would be an important step toward disinflation.1

Reducing inflation, maintaining a sustainable external position, and allowing growth of the private sector will require the continuation of the prudent fiscal policies that have characterized 1995–97. Structural reform of public finances will have to continue. The burden of taxation (including social security contributions) should be lowered further, a key step to stimulate the growth of employment in the private sector, which has remained sluggish even recently. Public employment remains high and could be further trimmed down. Subsidies to enterprises are still excessive, and further steps are needed to reform the welfare state. The distortionary and poorly targeted disability pension system requires urgent reform. The health system has to become more cost-effective through the introduction of appropriate economic incentives to allow an improvement in the services provided to the population in the medium term.

An effort in the above-mentioned areas would be important in itself and a way of accelerating the process of convergence of per capita income to western European levels. Before the Second World War, Hungary’s per capita income was about two-thirds of the average in western Europe. As an unwelcome legacy of the planned-economy system, by 1995, relative per capita income had dropped to about one-third of the western European average (Fischer, Sahay, and Végh, 1996). Since then, the authorities’ bold adjustment program has laid the foundations for a permanent reversal of this trend.

References

  • Cottarelli, Carlo, and György Szápary (eds.), 1998, Moderate Inflation: The Experience of Transition Economies (Washington: International Monetary Fund and National Bank of Hungary).

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  • European Bank for Reconstruction and Development, 1997, Transition Report 1997 (London: European Bank for Reconstruction and Development).

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  • Fischer, Stanley, Ratna Sahay, and Carlos A. Végh, 1996, “How Far Is Eastern Europe from Brussels?” (mimeo, International Monetary Fund).

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1

See Cottarelli and Szapáry (1998) for a discussion of disinflation in transition countries, particularly in Hungary.