Hungary’s Reform Programme: A Solid Base for Long-term Prosperity

Remarks by Angel Gurría, OECD Secretary-General, at the GKI (economic research institute) International Business Conference

Budapest, 16 November 2007

Prime Minister Gyurcsány, Ladies and Gentlemen,

It is a great pleasure to be here with you at GKI to talk about Hungary’s reform programme. Whenever a government embarks on a tough adjustment strategy, it is a golden opportunity for economists to make a difference. I am sure that your reflections and ideas will make a quality contribution to the future of this country. Thanks for the invitation.

Hungary has come quite a long way catching up substantially with living standards in other OECD countries; even if a large gap remains. Over the past decade, real per capita output growth averaged 4½ per cent. The gap with the United States’ GDP per capita, for example, has declined from about 55 per cent in 1993 to around 45 per cent in 2006. Hungary has also made impressive progress in opening its economy: its external trade now represents 155% of GDP ─a higher ratio than that of most OECD countries with a similar population─, and foreign direct investment accounts for 62% of total value added in manufacturing.

These are all important achievements.
However, a lot of this progress has been offset by unstable public finances, large fiscal imbalances and high government debt. A look to any graph portraying the government deficit as a percentage of GDP during the past 15 years resembles a virtual “rollercoaster”. Hungary’s public finances have been driven out of balance by overspending around elections. This has hampered economic performance, contributing to high interest rates, external deficits and exchange rate volatility. It has also reduced the government’s capacity to foster competitiveness. Fiscal discipline is an essential ingredient to achieve long term economic growth and development. It is time to put the finances in order for good.

The current administration has engaged in a tough but necessary budget consolidation programme, aiming to turn a close to 10% budget deficit to below 3% by 2010. Inevitably, growth will slow down to 2-3% this year and the next, and it might take another couple of years before growth resumes to trend. This temporary period of slower growth is a cost to be paid for the past fiscal laxness. No individual, company or government can progress by spending beyond its means. A sound macro-economy is a sine qua non condition for national prosperity.

When I was Finance Minister in Mexico, nearly 10 years ago, I had to carry out four consecutive budget cuts in a year, as the persistent fall of the international oil prices threatened to drive public finances off track. That effort was mostly based on spending cuts and that did not make me very popular, but Mexico now has sound public finances and a stable macroeconomic ground where it can grow important fruit; and people still credit our administration for building a solid macroeconomic structure that would not collapse in a financial crisis after every presidential election.

So far, Hungary’s programme is on track, with better than expected achievements. After peaking at 9 per cent in 2006, the budget deficit is likely to be between 6 and 6½ per cent of GDP this year, which is below target. It is expected to come down further to between 4 and 4½ per cent next year, broadly in line with target. Monetary policy is also working well. Notwithstanding strong food and oil prices, inflation expectations appear to remain fairly well anchored to the medium term inflation target of 3%. If this stable environment persists, it could create room for a fall in the risk premium on Hungarian assets. Even if there is a long journey ahead, we can say that you have re-established a path towards macroeconomic balance, which is a pre-requisite for sustainable medium-term growth and renewed catch-up.

However, there are two elements that will be determinant in defining the benefits of this fiscal consolidation effort:

First, there are still concerns that, as we move forward, electoral and political considerations may drive the consolidation programme off once again. 2009 is looming. People are looking at the past. The real question is whether there will be the political will to cope with the past. It is of critical importance that Hungary clearly signals continued commitment to budget consolidation. Ongoing political difficulties over emblematic parts of the fiscal programme, like the health care co-payment obligations and the new scheme requiring students to pay a contribution to tuition costs of public universities, should not be allowed to weaken the momentum for budget consolidation.

The announced spending freezes need to be maintained. Stabilising public finances is an indispensable step towards solving Hungary’s main economic and social challenges.

Second, it will be fundamental to stay the course of fiscal consolidation and proceed with the implementation of structural reforms. Just as important as regaining balance of public finances, the country needs to make further progress in equipping its national economy with modern and effective institutions and systems to promote competitiveness, increase productivity and make the most of globalisation. I would even go further than that: there cannot be effective, sustainable fiscal consolidation without reforms and vice-versa. The two things go hand in hand.
And while talking of reforms, let me mention some of the transformations that we, at the OECD, consider essential both for the budgetary consolidation and the achievement of long term sustainable growth:

1. The government is committed to establishing a disciplined budgetary process. The Prime Minister said in a recent Financial Times interview that Hungary has the toughest problem and so that needs the toughest solution. I agree with that. The recent mechanisms established in this area are welcome and we support them.

2. The public administration reform is a constant challenge for any nation. Recent policy actions like the changes to legislation on pay and conditions for parliamentary members, the reduction of ministries from 15 to 11 and the centralisation of services in certain areas should be praised. It is important though that this campaign is extended to subnational governments. The further diffusion of e-government is also essential.

3. Raising the spending efficiency of local governments is also going to be crucial. As we stressed in our last Economic Survey of Hungary, economies of scale on the provision of services by small municipalities must be encouraged further; at the same time there is still scope for streamlining the middle level of government, even though we have to acknowledge that achieving this in practice is not easy. We also see considerable scope for improving the system of financing of local government, which is sometimes overly complex and still in many cases lacks transparency. The central government is making a great effort that should be complemented by efforts at the lower levels of government.

4. There are difficulties in the pensions systems. I told the Prime Minister he was in good company. Every OECD country is faced with this issue. He told me that was of little consolation. It has to be fixed now. The discussions on the budget will pale into insignificance when compared to the long-term impact of an unsustainable pension system.  Both problems should be headed off in the near term through systematic reform rather than through piecemeal, damage-control measures later. We therefore urge the government to pursue its plans for significant alterations to the system.

5. The health care reform should be continued, managing with special attention the delicate relation between efficiency increase and adequate quality services. The debated introduction of a system of multiple insurance providers should include measures to ensure fair competition, while at the same time ensuring that the scale of operation of each new insurer is sufficiently large to prevent excessively high running costs. Governing is always an art of balance.
 

There are also some other areas. Education is one of these. Advancing in this particular reform area is essential to improve economic performance. Tertiary level educational-attainment of the working age population is still relatively low in Hungary. This restrains advances in productivity and the capacity to introduce new technologies. Although, tertiary enrolment rates are rising rapidly, it is important to consolidate the tuition fee system and to continue with curricula reform. That is, the pertinence of what people are taught.

If the reforms make progress, Hungary can become a gateway to Europe for transnational companies from all parts of the world. It is clear that more and more Chinese companies can benefit from investing in Hungary and exporting from there to other European markets. The potential of these flows is huge. It is a question of creating the right environment for competitiveness to flourish in the Hungarian territory. This is why decision-makers often need to think more as gardeners than as mechanics.

At the OECD we have developed substantial experience in helping countries deal with the so called political economy of reforms. We have valuable lessons to share with countries that, like Hungary, are in the process of advancing their structural policies. On several occasions, we are called by our Member countries to support their debates on issues related to growth.

Mr. Prime Minister, while promoting your government’s ambitious and necessary programme of reforms, I want you to think of the OECD as an extension of your own capacities. We are there to help. 

Ladies and gentlemen, let me share one last thought with you. I have been talking to representatives from every political party and Hungarian society it has been fascinating.  I was asked: “What do you think about our crisis?” I said: ”I don’t think you have a crisis. You have a problem. You created it. You can fix it. As long as you recognise the problem, you can deal with it.”

I told them a story which I will share with you. A marketing campaign that the car-hire firm Avis ran twenty years ago. When you went to the counter, all the Avis people wore a big badge that said: ”We’re number two, so we try harder.” This applies nicely to what you are experiencing today. You have to try harder. You will get there. I am sure of that.
Thank you very much.