The Political Economy of Dual Transformations: Market Reform and Democratization in Hungary

6. Structural Adjustment in Hungary's New Democracy

CHAPTER 6 Structural Adjustment in Hungary's New Democracy As shown in chapter 3, the contradictions of market socialism thwarted the Hungarian Communist Party's structural adjustment program in the 1980s. Market reforms broadened the decision-making power of local agents while inducing those actors to behave in ways contrary to adjustment policy. For instance, the introduction of joint stock ownership into Hungary's financial sector simultaneously enlarged the operational autonomy of bank managers and created incentives for credit officers to channel funds to illiquid enterprises. As the new banks declined to use commercial credit as an adjustment tool, Party officials turned to administrative methods , creating several new state and governmental agencies empowered to oversee industrial restructuring. But far from spurring structural adjustment , these institutional innovations expanded access points for particularistic bargaining and pulled MSZMP leaders into conflicts over the pace and extent of economic adjustment. International and domestic developments after 1989 radically altered the complexion of Hungarian adjustment policy. Externally, the abrupt disintegration of the CMEA and Soviet Union confronted local producers with an ipso facto adjustment. State enterprises, heretofore geared toward ruble-based trade with the socialist countries, suddenly had to reorient production for the far more demanding Western markets. Internally, the political transition dissolved the institutional channels that previously allowed local agents to extract compensation for the distributional fallout of adjustment. The skewing of the electoral system toward a few parliamentary parties, the concentration of executive authority in the prime minister's office, the ascent of saver agencies within the state administration , and the fragmentation of intermediary interest associations enabled the successor government to enact a succession of measures aimed at disciplining producers: deep subsidy cuts, rigorous bankruptcy and accounting laws, antitrust legislation, and rapid import liberalization. But while the external shocks and internal political shifts profoundly changed the competitive environment of local producers, they left a num205 206 The Political Economy of Dual Transformations ber of obstacles to structural adjustment. These developments resulted in a substantial downsizing, but not a significant restructuring, of Hungarian industry. Industrial output declined sharply as a consequence of the loss of the traditional Eastern markets, the elimination ofproducer subsidies, and the bankruptcy law. However, restoring weak enterprises to profitability required not merely elimination of loss-making production lines and reduction of the workforce but also massive infusions of capital to upgrade plant and equipment. The fixed capital investment needed to modernize Hungary's industrial base was not available owing to constraints on domestic capital formation and the unwillingness of Western investors to commit funds to loss-making sectors. As a result, the dominant trend in Hungarian adjustment policy after 1989 was inertia: total industrial production contracted, but what remained of the state sector stagnated because of the acute shortage of investment capital. This chapter examines adjustment policy in postcommunist Hungary, focusing on financial sector reform, industrial restructuring, and privatization . The transformation of the politico-economic environment prompted Hungarian commercial banks to reduce lending to the enterprise sector as a whole. Insofar as allocative efficiency was concerned, this represented an advance over the pre-1989 period, when the perverse incentive structure of market socialism induced banks to divert credit to illiquid clients. Loan officers now exhibited a keen sensitivity to credit risk, rate of return, and other business criteria conspicuously lacking in their earlier lending decisions. But their retreat from the enterprise sector frustrated adjustment policy, impeding the mobilization of domestic capital for industrial restructuring. Continuing problems with the loan portfolios of the banks and delays in bank privatization further hindered the deployment of commercial credit for adjustment purposes. The banks' withdrawal from enterprise lending aggravated the problems of Hungarian industry, already reeling under the impact of shifts in the international and domestic environments. Externally, the collapse of the CMEA and Soviet Union deprived local producers of their once secure Eastern markets. Internally, the termination of industrial subsidies and other measures enacted by the successor government severed the institutional links that previously shielded enterprises from market forces. The postcommunist state's one attempt at a selective industrial policy-a "crisis management" program targeting thirteen firms for special restructuring programs-had virtually no effect, owing to a severe shortage of funds needed to reorganize the companies. Enterprise managers, lacking political means of defending their positions via particularistic bargaining and intermediary representation, turned to individualistic economic strategies. Some producers managed to resume commercial relations with the Soviet Structural Adjustment in Hungary's Nev.' Democracy 207 successor states; others succeeded in reorienting their production lines...