Missed Changes and New Prospects

The Hungarian economy has lately lost ground to its neighbours and economic rivals – a phenomenon I wrote about recently, when I looked at the very hard landing of the Hungarian national airline (Magyar Szemle, 2012, issues 5–6). So if we ever had the ambition to become the hub of this region of small and medium-sized economies, then we had better wait for a while. Admittedly, it is hard to adequately define the relative weight or importance of an economy in a geographic region. It is a little easier though to grade the international attraction of a city conceptually as well as statistically. Let us ask first: did anyone seriously think that the Hungarian capital, small for a metropolis (although big for a modestly sized nation of ten million people), might emerge as the economic or intellectual centre of the Central and Eastern European (CEE) region?

Well, yes! Two decades ago, we thought in Hungary that of all the capitals of the CEE countries, Budapest came top, on several economic fronts at least. This did not sound like such an extravagant claim then, at least considering the competition. Bratislava, the second capital of the then disintegrating Czechoslovakia and too close to Vienna, hardly seemed a serious rival. Bucharest, stricken with the dismal architectural legacy of the Ceauşescu era, and a city notorious at the time for its legions of stray dogs? Warsaw perhaps? During the communist era, the Polish capital, terribly damaged in the Second World War, was rebuilt into a characterless city. Belgrade? Come on; in the early 1990s it was the capital of rump Yugoslavia, an entity that was falling to pieces in anger. Serbia sunk into a lasting economic, social and political crisis first, before getting involved in bloody conflicts in the region and finally clashing with the West, a conflict during which its Danube bridges were bombed by NATO planes. Zagreb, twenty years ago, was also the capital of a country at war. Ljubljana at the foot of the Alps? Small and not close enough to the key geographical corridors.

Hence Budapest was left standing, and, of course, Prague. But, as the Czechs like to say, Prague is west of Vienna, and more a Central European city than a CEE city. The very region in transition is also entirely located east of Prague. By definition, a regional centre should be somehow in the core geographically, infrastructure-wise and in terms of intellectual richness. A hub is an inner place to which business people, executives, civil servants and politicians gravitate if they want to meet people of influence. It is a place where the moneyed elite and persons of knowledge hang around as a matter of course, a place where important things happen.

You may retort that the really important decisions are not made at all in the CEE region but in distant centres of power: in Brussels, Washington, New York or Berlin. This may well be true in general, but the existence of global centres does not exclude but rather presupposes the existence of sub-centres. In the world economy, it is definitely so: beside the huge, concentrated financial markets (New York, London, Tokyo, Frankfurt), you will also find sub-centres with strong regional influence, such as Milan, Barcelona, Amsterdam or Vienna.

Indeed, sometime after the 1970s, Vienna became a regional hub, close physically and intellectually to East Central Europe – a region which was about to ferment. Although at that time Austria was not yet a member of the process of West European integration (the EEC) – it was only admitted in 1995 – but, after the Soviets withdrew their troops in 1955, it categorically belonged to the West economically as well as culturally. Vienna became an ideal and natural meeting place for investors, analysts and researchers, as well as the intelligence services, all of whom took a keen interest in the neighbouring societies under communist rule, and got prepared for their imminent opening up. It was, in some ways, the last outpost of the West, within touching distance of the semi-open economies of the East. Seen from here, Austria was the first stop in the West: a developed and orderly country that maintained an affinity towards its less fortunate neighbours, perhaps due to the common past and the economic and intellectual framework we had shared in the Austro-Hungarian Monarchy. The Austrian political and business elite had been smart enough to foster their eastern relations since the 1960s, offering for instance commercial loans to the already heavily indebted Hungarian communist regime, or setting up joint ventures. When the political regime change eventually took place, these prior links accelerated market penetration. Austrian banks which had already been eager to manage the assets of some communist clients from the East swiftly seized the moment to establish a strong presence within the region once political changes allowed it.

But let us step back a bit. The post-war economic development of Austria is a real success story: backed by business links with the West German economy, it had been modernised at a fast rate for decades, and maintained the momentum after its accession to the EU in 1995. It is a rich country by European standards: taking the average domestic product of the EU27 as 100 per cent (2011), the Austrian GDP per capita is 129 per cent. This matches the German and Dutch levels, is above the corresponding French, English or Belgian levels, and is double of the Hungarian one. Now, at the time of the regime change, Hungary had not reached even half of the Austrian per capita GDP level. Then we started to converge with our fortunate Western neighbour in the 1990s but – and this reveals Hungary’s weaknesses of recent years – the convergence stopped in the middle of the 2000s. Hungary’s present inability to continue converging with its western neighbour is only a symptom of a bigger problem, namely the loss of impetus of Hungarian society and its economy as a whole. To return to the topic of the essay, Budapest will be unable to flourish if the country as a whole is losing ground, and vice versa: without a successful capital city, the development of a country is uneven at best.

Is there any formula for success? As shown by the example of Vienna and Austria, global mega-processes offer opportunities to those with adaptive capabilities. There seems to be no one particular secret of success or single factor that determines all. What is obvious is that the Austrian economy has kept growing richer in an enviably well-diversified structure. Its manufacturing industry, oil sector, construction industry, winter and summer tourism, rich cultural life, and fast expansion of its banks have together been the building blocks of a successful development course that has lasted for decades.

Right after the opening of the borders in 1989, Austrian banks and insurance companies established their presence in Hungary and points east and south of here at a remarkable speed, taking advantage of a pent-up demand for financial services in the under-monetised former planned economies. Hungarian, Romanian, Slovakian, Ukrainian and Serbian families soon discovered the advantages of consumer loans and mortgages, and learnt to take on debts in the manner of western households – only much faster, and obviously more unprepared. Austrian banks became leaders in offering foreign exchange denominated financial products to CEE customers and derived a high share of their profits from the former communist region. The eastern connection remained absolutely lucrative for the Austrian economy right up to the moment the financial turbulence hit in 2008.

The modernisation pattern though – mutatis mutandis – can be copied. And Hungarian businesses set out to copy it: just as Austria’s oil and gas firm ÖMV entered the hydrocarbon industry of the region, or Raiffeisen and Erste Banks started offering residential and corporate loans throughout the CEE region, the larger Hungarian corporations, and a number of lesser-known small firms started to exploit the economic nature of the region. Hungary’s OTP Bank embarked on an expansion roll-out in the Balkans. The oil and gas group MOL acquired sizeable shares of the oil industries in neighbouring countries, thereby entering into competition with ÖMV. Richter Gedeon and several other Hungarian companies – as well as international companies with headquarters in Hungary – also set out to export capital from Hungary. Foreign direct capital inflows and capital outflows are not exclusive concepts after all; the flows can even intensify each other.

Although at the moment of the political regime change in 1990, Hungarian economic policy makers and top politicians had to struggle with more elementary matters, they also entertained a degree of hope that Budapest would soon recover and even take over certain regional functions from Vienna. After 1990, international interest in our country was substantial, ranging from tourism to manufacturing and financial investments. Although the Hungarian banking sector had a rough time during the first years of the transition process, we still felt confident that Hungary, among all the countries in the region, would be the first to emerge from the economic crisis. It was not unrealistic to hope that the Hungarian capital would become a regional financial centre by the end of the first decade after the changes. Capital is mobile and, if conditions permit, it can flow to promising targets at a high speed. Hungary was listed as a serious target country for investments at the very beginning, and Budapest became home to a dominant share of the foreign capital.

The concentration of capital inflow in a single city can cause problems in certain cases, but in Hungary’s case, the main beneficiary of the economic opening in 1990 was undoubtedly Budapest, and to a lesser extent the Vienna–Budapest corridor. If we look at the big industrial investments, the favoured destinations were the central region and Western Hungary, while financial services and commercial investments flowed in large part to Budapest. Foreign capital largely avoided the eastern regions of the country in the first decade after the regime change, and absolutely disregarded the counties bordered by the troubled Balkans. All the foreign banks, insurance companies, commercial firms and real estate developers entered the country via Budapest.

As a result, there was a huge capital flow into Budapest from the very beginning. At the same time, the capital city pocketed a good share of the public cash transfers, although it did not appear that way in the public image. The Mayor of Budapest habitually claimed that the national government was unwilling to give adequate funds to the capital city. While that was not true at all, a shrewd politician knows well that it always pays to put the blame on other politicians and politics as such.

At this point one cannot avoid personalities and parties: among the many factors behind the failure of Budapest, one has to mention Gábor Demszky, a former dissident who was comfortably elected as Mayor in the first free municipal elections of 1990. A member of the left leaning Free Democrats, and also backed by the Socialist party, Demszky spent two long decades in office, until he got caught up in numerous scandals and fatally weakened by the collapse of public support and implosion of popularity for both his own party and the Socialists. I had the opportunity to see him work in his early years at close hand, and it became immediately clear to me that he lacked the necessary management qualities to lead a big city. On the other hand, it is remarkable that he managed, strongly assisted by supporting circles behind him, to conceal his lack of qualifications for the post from the voters for a very long time by his efficient use of the media. In this single respect, he became so successful that he defeated all his challengers in spite of the fact that his exaggerated election promises and his recurrent outbursts against the governments in office sounded ever more unconvincing as the years went on.

He loved to complain about the parsimonious national governments but the capital city always had a lot of money. True, the mayors of the 23 rather autonomous districts making up what we know as Budapest have always had a big influence on the allocation of the overall funds to the capital city; the particular institutional architecture of Budapest complicates the job of whoever sits in the Mayor’s picturesque chair. Having said that, one must add that the quasi- perennial Mayor failed to present a coherent vision for the citizens of Budapest. This lack of orientation must also surely have been one of the factors behind the squandering of funds and wasting of time. There had always been enough funds around to shore up the development of Budapest, since the income level, employment rate, and entrepreneurial activity are all higher in Budapest than the national average. The local portion of the personal income taxes of Budapest dwellers and the business taxes that Budapest registered firms have to pay would always guarantee a massive inflow of revenues for the capital. Budapest has also benefited from government transfers whatever the political colour of the national government was. Still, somehow the monies disappeared, even if the Hungarian capital did not embark on any big, ambitious, or risky undertaking.

The world exhibition plan (Budapest–Vienna Expo) was abandoned in the early 1990s. Later on, the UEFA EURO 2012 and Summer Olympics ideas emerged and died away. I personally felt relief knowing the administrative capabilities of those who were leading Budapest. That the Budapest council has proved unable to cope with the smaller task of completing the Metro 4 project for a decade now, tells us a lot about why the city has been left trailing by the other capitals of the region, not to mention Vienna. The mere fact that an election promise of the new Metro 4 line exerted such enormous influence on so many voters in Budapest, also speaks volumes about the low standards of our public life. A very costly new underground line is, in fact, no answer to the traffic problems of the capital. Experts have long been aware of this, but even interested laymen understand that the city’s problems call for another solution. It was a long time ago, during the decades of communist planned economy, when a million people had to commute from their council flats in housing estates in the mornings to work in state factories and offices in other parts of the city. The economy, the labour market, lifestyles and shopping habits have all vastly changed since then. Hundreds of thousands of people have moved to the suburbs or out of the agglomeration altogether: the spatial configuration of social life and economic activities has been transformed.

Still, the liberal Mayor of Budapest promised every four years during electoral campaigns that he would build the new underground line – and always out of someone else’s pocket: the State, the European Union, or some other hoped-for donor. At the same time, no action was taken to rationalise the utilisation of the surface railway network, even though the city is full of railway lines. Aware of the calculations of the immensely costly metro project, the first Orbán cabinet (1998–2002) immediately declared that it was unable and unwilling to pick up the huge bill for the metro project in the form that had been so generously promised by the outgoing (Socialist–Liberal) government. This frankness almost certainly cost them a significant number of Budapest voters.

The construction started in the mid-2000s after the return of Socialists to power despite traffic analyses making clear the inefficiency of the project. As time went on, the much-needed external funding sources began to dry up, to the chagrin of business interest groups eager to extract large monies from the infrastructure projects. Once a big vote-buying project, Metro 4 encroaches on our life now only in the form of street closures and congested traffic nodes of the capital. Children who were born when the hole in front of the Eastern (Keleti) railway station was dug have already reached school-going age.

Organisational mistakes and alleged corruption: these phenomena have surrounded the business activities of the capital and its districts for some time. Scandals and corrupt practices happen in other Hungarian municipalities as well, not to mention foreign cities, but it is our problem that obviously hurts us the most. And it especially hurts to see how other capitals have progressed during these decades. Those who have recently been to Bratislava, Prague, Warsaw, or further afield to Saint Petersburg or Moscow, may instinctively sense the backslide of the Hungarian metropolis without having to analyse dry statistical indicators.

It would not be fair, though, to blame only a set of people for the failure: there were political parties behind those persons. The Mayor of the capital, and the majority of the district mayors belonged to left-wing parties for two decades. I do not wish to pronounce judgement on what the Socialists and the Free Democrats did in Hungarian politics, but as far as their activity in managing Budapest is concerned, the results – or I should say the lack of the results – are telling. In running public affairs, both parties were known to make decisions influenced by the wishes of businesspersons behind them (the Socialists had always been like that, while the Liberals soon assimilated). The ruling parties’ supporters in cultural and ideological domains and in the media were always given nice sums from the public purse. The money given away to friends and party cadres, and the amounts linked to actual corruption must have been huge, but the real damage is the extremely high price that Budapest dwellers, the whole country, and the next generation will have to pay because of lost opportunities. The young generation is the real loser as the parties controlling the biggest municipality of the country for long years not only missed chances, but also mortgaged the future. After the 2010 watershed general and municipal elections the political landscape changed. The city is run by a new Mayor, István Tarlós, who has an engineering background, and is known to be an efficient manager. Many infrastructural projects are put on hold now, since the indebtedness of the capital city and several districts is too high, and as a consequence, the current and future leaders of the capital, and eventually the people of Budapest, will face heavy financial problems.

Besides the weak performance of Hungarian politicians, it is also worth mentioning some objective factors. There are several reasons why the Hungarian capital has not yet been able to improve its position in the global competition of financial marketplaces. One of the reasons is related to new trends in the financial world. Two or three decades ago, most market economies had at least one decent stock exchange as well as some market leading domestic banks and insurance companies, but by the beginning of the 2000s an intense consolidation process had begun. Stock exchanges reacted to the new situation created by the information technology revolution by establishing associations, or more directly by merging. Today, the owner of the Budapest stock exchange is Wiener Börse, itself one of the smaller bourses in Europe.

The economic weight of the Hungarian stock exchange is not significant nationally, partly due to the fact that local branches of the big foreign investors do not tend to go public in Hungary. The GE Group, for example, one of the biggest employers in Hungary, has been a quoted company for a century already, but alas, on the American stock exchanges. Its Hungarian affiliates take the form of a closed share holding company, which means their shares are not traded publicly on the Hungarian Bourse. The situation is similar with the big automotive firms who have become key players in the Hungarian economy, but their shareholders live in other countries while their shares are traded in other capital markets. The blue chip papers in Hungary are the shares of the already mentioned OTP Bank, the oil and gas firm MOL, a telephone company and the drug manufacturer Richter Gedeon, but a significant part of their papers too are traded in bigger stock exchanges elsewhere.

One emerging trend in the financial world that holds more promise for Budapest as well as the wider Hungarian economy is the relocation of financial services to Budapest. The operations of banks, brokerage firms and insurance companies that are in direct contact with clients, in other words the front offices, are typically located where the clientele is located, but other important and often labour- intensive parts of the job can also be done in a different location, even in another country. These include invoicing, accounting, HR, taxation and legal affairs, IT support, data storing and processing, analysis and statistics, as well as help desk functions.

Companies typically locate back office activities where human resource supply, tax climate, wage cost level and other necessary local conditions are the most favourable, as there is no necessity to deliver the background services in the same city where the branch office of a bank is located. The CEE region is one of the obvious destination choices: the workforce is generally of good quality, the wage level is much lower than in Western Europe, infrastructural conditions are adequate, and taxation regimes are more favourable than to the west. Although in most parts of Asia the wage rates are even lower and the labour supply is huge, time-zone differences and cultural distance remain serious counter-arguments. Today there are about 40,000 people employed in about 50 shared service centres (SSCs) in Hungary, mostly, but not exclusively, in Budapest. As with the production of automobile components outsourced far away from the head plant, invoicing departments can also be located far from home. Such business service outsourcing to Budapest has already reached a magnitude of macroeconomic significance.

The public benefits from financial service providers coming to Budapest are huge. If a global group decides to bring here operations of critical importance, it amounts to a vote of trust. Such business activities are also significant for local employment: SSCs mostly employ qualified people with university or college degrees. They are primarily not call centre employees, but financial, legal and IT experts, who are adequately paid for their skills. Compared to automotive assembly plants that mainly require semi-skilled workers, the compensation level of an employee at a shared service company is higher, and thus the contribution to national income is much higher too. The significance of this fact is mostly unknown to the public, and sadly, it appears, to the government as well. Otherwise it would not have become a conviction in education policy circles in Hungary that more economists, philologists and lawyers are trained in Hungary than what the economy needs. Employment data reveals that there is indeed much demand for people with legal or economic qualifications, and with good language skills. Education is an important topic in our case. In today’s world, a big city can gain a central position in a given region not only on the basis of its clout in the banking, tourism, manufacturing or processing sectors, but also on the strength of its educational, research and cultural facilities. Top universities are also materially important in a city’s life: tens of thousands of students and academic staff represent a sizable (and stable) consumer demand as well as an intellectual radiation outward from the universities that contribute to service branches across the economy.

Due to the structure of Hungarian higher education, Budapest is a towering education centre with numerous strong universities. But does it have a regional significance in the knowledge sphere, or could it have one? If we consider the number of foreign students studying here, the answer is perhaps. Medical education offers a positive example: Semmelweis University is home to 2,800 foreign students besides 9,000 Hungarian students. It can still be called an exception, but in the past few years, the ratio of foreign students has increased in other institutions of higher education of Budapest too. Of course, one should be careful drawing conclusions about the international educational attraction of our capital city, given that the number of Hungarian students studying abroad is also increasing as it becomes part of educational practice to spend a semester or more abroad.

One can enumerate the social and economic aspects by which the international weight of a big city can be scored in order to see clearly the position of the Hungarian capital compared to others. Budapest still scores well in several respects. Public safety is quite good, and the city is not expensive. Due to earlier motorway and bridge constructions, the infrastructural conditions are relatively good, although the bankruptcy of the national airline has caused an obvious dent in air transportation links. Tourism is strong, including cultural and conference tourism.

The outlook is not rosy though: the indebted Hungarian state and the similarly indebted municipality of Budapest are unlikely to launch large-scale new projects for a while. Private sector investments are stagnating too: housing construction has touched a historic bottom, and the investment mood of companies is generally sluggish. The government has announced a general freeze on supermarket construction, with loopholes for exemptions as always, which is again a disputed measure. Unfortunately, the investment rate of the Hungarian economy has been declining for a longer period now, and this is also true for the capital city. And investments missed yesterday and today are going to weaken economic growth tomorrow.

The prospects of the Hungarian capital can of course improve in the foreseeable future. Long-term forces are on our side: relocation from high wage European economies will continue, a phenomenon Budapest can benefit from. The crisis in the southern part of Europe adds to external uncertainties also in the CEE countries, but this region could increase in significance exactly because of that geographical position. One can reasonably count with the southern expansion of the EU, Croatia being next, and that may generate business for the Hungarian economy and its capital. Whether or not Budapest will be able to profit (more than the other capitals) from the opportunities remains to be seen.

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