Is this the end of Hungary's post-1989 era? And if so, what comes next?

With the spectacular meltdown on global financial markets holding world attention yesterday, the especially parlous situation in Hungary has been missed. Beginning in late trading Thursday afternoon, the country’s largest bank, the OTP, and its currency, the Forint, were subject to sustained speculative attack. At the same time the market for Hungarian government bonds effectively dried up. On Friday the Hungarian National Bank – in measures familiar to those who have lived through the early phases of the UK’s past currency crises – intervened to prop up the Forint. Faced with the spectre of being unable to re-finance some of the government debt on reasonable terms, Prime Minister Ferenc Gyurcsány announced a package of emergency spending cuts (which are only likely to pass through parliament, if his Socialist minority government can secure the support of enough of the opposition).

For those aware of both Hungary’s economic fundamentals and the progress of the “credit crunch”, the budgetary and currency problems should come as no surprise, despite the bizarre insistence for most of the year by Hungary’s economists that there was nothing really to worry about! This is going to be a tense and difficult autumn in Budapest – with the rest of the region, in the words of the Guardian’s economics editor Larry Elliot, looking like “an accident waiting to happen”, a sharp slowdown in western Europe affecting Hungary’s export-oriented manufacturing sector, the general impact of the global crisis on Budapest as a regional financial centre, a budgetary and a currency crisis, the economic situation ought to be a cause for anxiety. Politically, Hungary’s Socialist government lacks a parliamentary majority, it faces an opposition that has never shown any sign before of putting an overriding national interest before its own immediate short-term considerations of winning political advantage, and a far right that over the past two years has been prepared to use violent direct action on Hungary’s streets. Against this background, one of the problems Hungary faces in seeking to restore market confidence, is that it is difficult to see how the country will overcome these challenges without some major changes to its political and economic institutions.

Autumn 2008, like 1988-9, looks like it will be one of those key turning point moments. This is because it is difficult to see how Hungary will emerge from the challenges it currently faces without some major surgery to the institutions and practices that have developed in the past nineteen years. As in all such moments, it is impossible to say what direction such changes will take, though the risks are considerable. Much depends on how far the relevant actors, including bodies like the European Union as well as those within Hungary itself, are prepared to show imagination and courage in facing the demands of the moment.

Hungary’s economic performance has been weak for some years. From the beginning of the decade up to 2006 economic growth was only really sustained through accumulating state debt. Hungary’s economists have argued that the road to putting Hungary back on a growth path leads to huge cuts in state expenditures – especially social spending – so that high tax rates can be bought down in order that foreign investors will be attracted into the country. After his re-election in 2006, Gyurcsány accepted their advice. The government’s pursuit of this path has led to a state of virtual economic stagnation, and large-scale popular discontent, which has made this strategy politically unviable. Without an alternative, the government has shown every sign of not knowing what do, and since the spring has fallen back on an endless series of short-term tactical manoeuvres designed to buy time.

The neo-liberal diagnosis of Hungary’s problems was fatally flawed because it failed to address the underlying causes of the country’s budget deficit and debt-related problems. These lie in a crisis of employment and employability – in 2006 only 54.5 percent of the population of working age were active in the labour market. In large part, this problem is a legacy of the state socialist social settlement instituted after the completion of agricultural collectivization in 1961, that was based on the offer of semi-skilled industrial employment and related welfare benefits to the population. People moved into industry, yet remained in the villages – performing semi-skilled jobs. This settlement crumbled in the 1980s, but collapsed during the recession that marked the early years of the transition. Most of these jobs were never replaced, as new employment was concentrated regionally in Budapest and the north-west, while many of the new unemployed lacked the skills, or the economic means to get new jobs. As large parts of eastern Hungary fell into crisis, and huge regional and social inequalities opened up the state budget became an enormous sticking plaster covering the gaping wound of rising social tension. By the turn of the millennium this unequal social structure crystallized, and elections became increasingly competitive making it impossible for political leaders to ignore the demands of many living in depressed regions. At the same time they had to appease the demands of “winners” for tolerable tax rates.

A parallel can be drawn between Hungary and a crisis-ridden industrial regions like north-east England, where governments have sought to replace decimated industries with new greenfield investments like Nissan. While these investments have helped, such regions have remained dependent disproportionately on state expenditure and have high levels of labour market inactivity. The key difference is that the north-east of England receives transfer payments from other regions in the UK, while Hungary has to resolve its own problems, with no transfer from anywhere. No-one has solved these problems satisfactorily anywhere in Europe, and given that Hungary’s problems are not different in kind (though perhaps in extent) to those of all of Central and Eastern Europe’s ex-socialist states, coming up with a solution is now urgent. Clearly these problems require radical changes in Hungarian economic policy. It might be argued that from over-zealous implementation of the bankruptcy law during the recession of the early 1990s, through the Bokros austerity package in 1995, ill-considered increases in the minimum wage under Viktor Orbán, to the unfunded largesse of the Medgyessy years, state policies have oscillated between excessive neo-liberal dogmatism and a series of short-term political fixes that have cumulatively undermined Hungary’s long-term growth prospects. In the medium and long-term increasing employment is the only way of driving forward the economy – the policies required to do this, however, will require resources over a long period of time.

At the moment, however, the financial markets are driving the Hungarian government towards policies that are likely to lead to social, economic and quite possibly, political disaster. To avoid this it is important that the European Union help Hungary finance its debt and its deficit, and that rather than forcing it to accept frankly unrealistic budgetary targets in the interests of monetary convergence, it uses its resources to stimulate growth both in Hungary and in Central and Eastern Europe as a whole. As the post-1989, post-socialist era comes to an end, what is at stake is the nature of the institutions and politics of the next period of the history of the country and the region. As we know from previous financial crises they can result in both catastrophes and opportunities. Let’s try and avoid the catastrophes …….