What does a smallish Central European country have to teach the rest of the world about inclusive growth, fighting income inequality, and social cohesion, all while steering clear of protectionism and maintaining an open economy – in short, “squaring the circle” of globalization? In the case of Hungary quite a lot, judging by just about any economic metric you care to name.
Hungary has received its share of bad press. Prime Minister Viktor Orban’s repeated calls for “illiberal democracy” are bound to alarm, and it’s not often EU political parties consider expelling national affiliates. On the other hand, the recent surprise defeat of Orban’s Fidesz party in local elections in Budapest suggests democracy is alive and kicking in Hungary, as does an active protest culture.
Moreover the political controversies, while grounded in legitimate concerns, threaten to obscure one of Europe’s economic success stories at a time when much of the rest of the continent is drifting – and might well benefit from policies modeled on Hungary’s economic reforms.
The numbers are clear enough. Hungary’s economy has consistently outperformed its neighbors and the EU at large, posting annual GDP growth of 4.1% in 2017 and 4.9% in 2018, with forecast growth of 4.6% in 2019 per the IMF. That compares favorably with the EU’s record of 2.5% in 2017 and 2% in 2018, and a forecast 1.1% in 2019.
Nor is this simply a result of juxtaposition with developed countries like France, Germany and the UK, where growth rates over larger bases are naturally lower. Focusing on more meaningful comparisons with its nearby neighbors, from 2015 to 2019 Hungary’s economy will have expanded 38.5% in current dollar price terms, compared to 32.5% for the Czech Republic, 25.1% for Slovakia, and 24.2% for Poland.
The roots of Hungary’s resurgence go back to the aftermath of the 2008 financial crisis, when it was forced to accept a bailout from the “troika” of the IMF, European Commission, and European Central Bank, according to László György, Hungary’s Secretary of State, Ministry for Innovation and Technology, who has chronicled the country’s comeback – and its broader lessons – in a new book, Creating Balance, pitched to a global audience. György gave an overview of its success, and the unorthodox economic policies underpinning it, during an interview as part of his book tour in Washington, D.C.
György recalled that Hungary (like fellow bailout recipients Greece and Romania) adopted stiff austerity measures in line with the troika’s demands, predictably leading to widespread privation and anger over plummeting social spending from 2009-2010. But unlike in Greece, where the will to undertake structural reforms has lagged and debt remains a crushing burden, after coming to power in 2010 Fidesz was able to implement a far-reaching shakeup of Hungary’s economy, including a major overhaul of taxation and social spending: “We paid back the credit in advance to the IMF and the EC, and then we started following our own reform program.”
These reforms were not simply following neoliberal prescriptions, György emphasized: “These policies are not ideological, they are neither left nor right. This is pragmatic economic policy. It is based on theory and the current needs, what is best for the citizens.” Many of the theoretical underpinnings were inspired by Western economists like Joseph Stiglitz, a Nobel laureate at Columbia University, and Dean Baker of the Center for Economic and Policy Research in Washington, D.C.
The reforms had to steer a careful path if Hungary was to retain the advantages of globalization while mitigating its negative impacts: “Ten years ago Hungary was one of the most open economies in the world, in terms of foreign investment per GDP. But openness always correlates with vulnerability. What was important for us was to keep our openness, and minimize the vulnerability of the economy.”
Perhaps the biggest changes came in the area of tax policy: while Hungary decreased its corporate tax rate to 9 percent (the lowest in the EU) to all companies to attract FDI and boost investment, some specific surtaxes were levied temporarily on sectors dominated by “monopolies and oligopolies” (many of which had contributed to the original crisis, for example the financial sector with excessive risk-taking): “The Hungarian government was brave enough to tax these companies. We said, ‘we are in a crisis, we have to manage this crisis somehow.’ And we asked them to contribute to the crisis management.”
At the same time the government adopted a flat-rate personal income tax of 15%, a radical measure giving Hungary one of the lowest overall tax burdens in Europe. This let employers reward workers more effectively, increasing competition for labor: “In 2009, if you wanted to increase the wages of an employee with average earnings by $100, $72 were taken away by the government tax, and only $28 went to the employee. That $72 is reduced to $45 today, so $55 goes net to the account of the employee. And if the employee on average wage has three children, only $18 is taken away by the government, so $82 remains with the employee. ”
As a result, György boasted that Hungary was able to “create a balanced budget and put state debt on a decreasing path over the last decade,” while also stimulating consumer demand by leaving more money in the pockets of the middle and working classes, thus returning the economy to a growth path: “We favored all those who can and contribute to the prosperity of the sustainability of the Hungarian economy, society, and environment: wage earning families having children, foreign direct investors creating jobs, and local small and medium sized companies.” As part of this “we more than halved our net foreign liabilities ratio, and we will bring it to zero by 2023.”
This approach has also allowed Hungary to fund a generous pro-family policy through tax breaks, intended to counter the same demographic trend now threatening developed and developing countries alike (although as in other countries with pro-natal policies, it remains to be seen how effective tax breaks are in altering social and cultural phenomena). Looking ahead, the government is considering further lowering the flat personal income tax rate to 9% in 2021.
This multipronged strategy was carefully thought out to address the harmful effects of globalization, focusing on employment to boost demand, György emphasized. For example, while courting “foreign direct investment that creates workplaces in Hungary,” the government has also worked to “create a favorable environment for domestic companies, small and medium- sized enterprises who give jobs to the middle and working classes.” Towards that end, the average tax on value added by SMEs has “fallen from 54% in 2009 to 36% in 2019, is still decreasing and will be 30% by 2023.”
Lower costs and a favorable investment environment mean Hungary is well-positioned to benefit from its proximity to Germany and its high-end manufacturing supply chains: last year Mercedes, Audi, and others produced over 500,000 cars and 2.5 million engines in Hungary, and BMW recently revealed plans for a new plant that will manufacture 150,000 vehicles a year by 2023. With the fiscal crisis past, the government plans to continue unwinding the higher corporate tax rates to encourage continued foreign and local investment.
It won’t necessarily be smooth sailing on the Danube in the near future. Hungary’s involvement in regional and global supply chains means it is still unavoidably exposed to the negative economic currents now circling the globe. With Germany’s export sector slowing sharply amid continuing uncertainty due to Brexit and the U.S.-China trade war, the chill is now being felt in Central Europe: the IMF forecasts Hungarian GDP growth will slow to 3.3% next year (still slightly ahead of 2.5% for the Czech Republic and 3.1% for Poland). But the policies implemented over the last decade should help cushion the impact and make Hungary a source of stability – rather than a liability – for the EU in years to come.
Erik Sass is the Editor-in-Chief of The Economic Standard.
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