A Retrospective Look at USAID’s Role in Hungary’s Transition

Executive Summary

I. Introduction

For the past ten years, the U.S. Agency for International Development (USAID) has supported the efforts of the Government and people of Hungary to make the transition from an authoritarian political system and centrally-planned economy to a democratic state with a market economy. By any measure, Hungary has been highly successful in accomplishing this goal and USAID has been instrumental in facilitating its success. Since there are other countries in the region making the transition with the assistance of USAID and other donors, the lessons of Hungary’s experience and USAID’s role could be useful. This paper does not seek to isolate the causes of Hungary’s success, but rather to focus on the means by which USAID facilitated Hungary’s efforts. It is addressed primarily to the development professionals of USAID and other assistance agencies.

II. Hungary’s Transition

The centrally-planned economies of the communist bloc were imposed on countries that, despite some common features, had different histories, cultures, and resource endowments. Therefore the departure points, strategies, and outcomes of transition across countries varied widely. Before it fell under the hegemony of the Soviet Union, Hungary, like other northern-tier Central and Eastern Europe (CEE) countries, had been part of Europe through the industrial revolution and the political ferment of the nineteenth and early twentieth centuries. Hungary had experienced multiparty democracy and had a growing and modernizing industrial and agricultural economy linked by trade to other European countries. Economically, it was a moderately developed country. Socially, it had an educated population, and a growing, entrepreneurial and professional middle class.

During the period of communist rule, Hungary evolved along a different path from its fellow CEE countries. The Stalinist political, economic and social reorganization of the country according to the Soviet model between 1948 and 1953 was exceptionally harsh. Post-Stalinist efforts to rectify the situation resulted in first, a loosening, and then retightening of economic and political controls. The severity with which control of the economy was imposed combined with historical feelings of national pride provoked the Revolution of 1956. This event made it clear to Hungary’s rulers and their backers in the Soviet Union that they could push the people of Hungary only so far without provoking a response. The ruling elite under Janos Kadar, with the tacit support of the Soviet Union, pursued a more consensus-seeking style of political leadership and sought to gain legitimacy in the eyes of the people through economic reforms that would improve their living standards. In effect, political and economic reforms, under the leadership of the communist ruling elite had already started the transformation process that accelerated in 1989.

Political Transition

In 1989, the reform-minded ruling communist leaders in Hungary saw their self-interest being best served by negotiating a peaceful transition to multi-party democracy. The historic National Roundtable negotiations of June to September 1989 between the incumbents and members of re-emerging opposition parties provided the basis for Hungary’s return to parliamentary democracy and free and fair multiparty elections in 1990. In a remarkably short time, a wide range of legislative actions were taken which restored parliamentary democracy in Hungary. Laws, that included, setting up an independent judiciary, regulating the registration of political parties, restructuring local government, establishing electoral procedures and were enacted by the interim government between 1989 and 1990. National and local multiparty parliamentary elections were held in March/April of 1990–the first free elections since 1945. Since then, two more elections have been held at the national and local levels. Each time the incumbent party or coalition lost its majority, and a peaceful transfer of power took place demonstrating the strength and irreversibility of Hungary’s democracy.

While some NGOs flourished during the early stages of the democratic transition, comprehensive NGO legislation was only enacted in 1997. The number of active NGOs is now large and focus chiefly on advocacy of local issues and the delivery of services. Long-term financial sustainability is the most pressing question for NGOs. Although formal controls over the media were lifted early in the transition, the Government retains considerable control through ownership of media outlets. A Media Law was enacted in 1995 and two TV stations were privatized in 1997. A lively free press and electronic media is evolving. Financial sustainability of local level media still needs to be secured. The court system, while functioning independently, remains inefficient, denying justice through delay. Reforms that created over 3,300 local government units brought government to the people. As a result of the speed of this reform, new administrations were challenged to develop the competence and processes to deliver services demanded by its citizens. While some local governments, with donor assistance, have grown in competence, much remains to be done. The respective roles and relationships between the national and local governments must be clarified and local governments need adequate sources of financing. Although the Constitution guarantees equal rights to all citizens, ingrained attitudes toward minorities, such as the Roma, result in de facto discrimination, and the violation of minority rights.

Economic Transition

While Hungary is generally acknowledged to have started earlier in its reform program, it introduced reforms at a somewhat slower pace than other countries in the region. Despite embarking on transition with a relatively liberalized economy, and despite postponing sharp macroeconomic adjustment until 1995, Hungary was not able to avoid a deep transformational recession. As Hungary began its economic transformation in 1990, its newly elected government was confronted with declining growth, rising inflation, a huge foreign debt, and a large government budget deficit. Real GDP declined by 18 percent from 1990 to 1993. Inflation more than doubled between 1989 and 1991, reaching 35 percent. By 1993, significant deficits had emerged in both the budget (6.5 percent of GDP) and current accounts (9 percent of GDP). Unemployment grew from essentially zero to 12.5 percent. The Government instituted a stabilization program that included tax increases and expenditure cuts, a devaluation of the Forint and tighter monetary policies. It also negotiated a rescheduling of its external debt. It promoted the transformation of the economy by enacting a radical bankruptcy law and began a wide-ranging privatization program. However, the Government delayed implementing critical fiscal adjustment measures and structural reform in the public sector. The initial actions of the first freely-elected government pulled Hungary back from the brink of disaster and produced a 3 percent growth in GDP in 1994. However, the Government’s gradualist approach and unwillingness to tackle some of the urgently needed, but more economically and socially disruptive, reforms led to another crisis and ultimately caused a delay in the resumption of sustained economic growth.

The socialist government elected in 1994 introduced a stabilization package in 1995 that dealt effectively with the macroeconomic realities and laid the groundwork for the resumption of sustainable growth. Measures included devaluation of the Forint and establishment of the crawling peg system for controlling the exchange. A temporary eight percent import surcharge on consumer goods was levied and measures to restrain income growth were imposed. Various steps were taken to increase revenue and decrease government spending. The privatization program was revised and reinvigorated. Consequently, 80 percent of the economy is in private hands, including the banking and energy sectors. The Government also addressed public sector and fiscal reform issues. Over the longer term, a recently enacted state-of-the-art pension system should help to reduce budgetary pressures over time.

The reforms are generally recognized to have quickly reversed the deteriorating economic and fiscal situation and laid the groundwork for sustainable economic growth. GDP growth dipped to 1.5 percent in 1995 and 1996 and finally began to rise again in 1997, reaching 5 percent in 1998. The economy is expected to grow about 4 to 4.5 percent in 1999. Unemployment, while still high, declined to an estimated 7.8 percent in 1998. The current government, elected in 1998, is continuing the policies of its predecessor. There is a strong consensus that accession to the European Union (EU) is a priority and that economic and fiscal policies must therefore be compatible with accession requirements. Accordingly, political support continues for fiscal austerity, government deficits reduction and tax rates reduction.

III. USAID’s Role

U.S. assistance to Hungary was authorized in the Support for Eastern European Democracy (SEED) Act of 1989. USAID, designated as the lead implementing U.S. government agency, worked in collaboration with other U.S. Government agencies, international development agencies, and bilateral donors. USAID employed the services of American contractors and non-governmental organizations who worked in partnership with Hungarian government, private and non-governmental organizations. From the start transition programs were planned to be of relatively short duration. Given the need for a rapid response and recognizing that the political and economic transition process broadly involved the same basic steps, USAID launched regional and multi-country projects to quickly provide expertise in key areas, especially privatization and democracy. Funds were allocated annually on a sectoral basis with no country-specific funding allocations, thus allowing USAID the flexibility to provide and, when necessary, shift resources quickly to address the fast-changing situation in the region.

The program was initially administered from Washington. With experience it soon became evident that the CEE countries were, in fact, economically and politically diverse. Consequently, assistance programs became more tailored to country-specific circumstances. The USAID office in Hungary opened in 1991. The first country strategy for Hungary was prepared in 1993 and country funding allocations were introduced in 1995. Over time, responsibilities were realigned, increasing field mission responsibilities and authorities.

The USAID Program Strategy

USAID’s overarching goal was “to assist Hungary in its national transformation to a democratic society, a market-oriented and private sector-led economy, integrated into key international systems and Western institutions.” Through 1993, initial assistance efforts focussed on three broad Strategic Objectives (SOs): Democratic Governance; Economic Stabilization and Transformation; and Quality Of Life. In 1994, USAID’s strategy and program were revised to reflect a sharpened focus, new priorities and Hungary’s progress. The democracy and government focus remained; direct assistance to Parliament and electoral processes was terminated; and greater emphasis was placed on strengthening local government. Assistance to NGOs and the media continued. The SO for Economic Stabilization and Transformation was revised and while assistance to privatization continued, attention was also directed at the both banking sector and the promotion of SMEs. The SO for Quality of Life was revised to emphasize restructuring of government delivery systems and to develop the capacity of NGO social service delivery.

As part of the USAID reengineering process, the annual Results Review and Resource Request (R4) was instituted. This process formalized the use of Strategic Objectives, Intermediate Results and Indicators to measure the impact of U.S. funded assistance. Country program SOs were required to fit within SOs for the region which, in turn, fit within broader Agency SOs. In 1996, the USAID Country Strategy was again revised to reflect Hungary’s progress and to further sharpen the program’s focus. The overarching goal of the U.S. assistance program remained unchanged: to assist Hungary in its national transformation to a democratic society, and a market-oriented and private sector-led economy, integrated into key international systems and Western institutions. This goal was elaborated in two sub-goals: 1) assist Hungary in achieving sustainable economic reform; and 2) assist Hungary in completing its democratization process. The strategy projected the termination of assistance in 1999. The following five SOs were articulated:

• Increased soundness of fiscal policies and fiscal management practices
• Improved performance of small and medium enterprises (SMEs)
• A more competitive and market responsive private financial sector
• An economically sustainable, restructured energy sector
• Better-informed citizens increase their participation in political and economic decision-making at the local level

In 1997, USAID developed a detailed Closeout Plan that assessed the prospects for achieving the five SOs by September 1999, the target date for closing the Mission. The energy sector SO was found to be essentially achieved with only the completion and termination of activities to be done in 1998. All other SOs were on track and the expectation was that Hungary would graduate from the rolls of USAID recipients on schedule. In 1998, the Mission confirmed that Hungary would be able to complete the political and economic transition without USAID assistance after 1999.

IV. Lessons Learned

Program Design

1. Program planners and their counterparts should break down the reform process into manageable steps. Properly sequencing the steps and the supporting assistance activities is often critical to success.
2. There is no doubt that without “political will” at some point, reform will either not take place or not be sustainable. However, the Hungary experience demonstrates that useful assistance activities in support of reforms can be undertaken regardless of the depth and breadth of “political will” for any particular reform.
3. In Hungary, USAID gave priority to privatization and fiscal reform as these seemed to be the most urgent tasks. It might have been wiser to allow room in the program for the early initiation of assistance to SMEs, which can be the engine of sustainable economic growth and can generate employment. Early support for social reform/quality of life activities, designed to mitigate the negative impact of the transition process, would also have been beneficial in fostering general support for the reform process.
4. The perception that successful activities and models can be transferred from one CEE or NIS country to another because they share a common Communist experience is valid only to a point. Such activities and models must be adapted because of varying historical, cultural and linguistic differences. Also, these activities and models are only transferable with adjustments that take into account differences in economic and political systems and the pace and path of the evolution of these systems.
5. The objective of sustainability is much more likely to be achieved when sustainability is designed into the program from the start and addressed throughout the implementation process. A concrete plan to achieve sustainability must be present on “day one.”
6. Countries in transition have little or no experience in formulating policy in an open and democratic manner. Donor programs have tended to focus assistance on the development of specific policies. Supporting the development of an open public policy dialogue process as part of the overall policy assistance effort can help to institutionalize effective policy making and implementation.
7. At the implementing organization level, it is essential that critical counterparts be committed to reform and to the reform assistance program. Counterparts must include people who are sufficiently high ranking within the organization to bring about change, make decisions, influence policies, etc. It is critical that program designers obtain the concurrence of counterparts in the project scope, objectives, deliverables, duration, and tasks before the project is initiated.
8. Proactive advisors and program designers cannot restrict their efforts to immediate counterparts. They must identify and reach out to other important stakeholders and keep them informed, address their concerns and involve them in the process in order to build consensus and support for reforms. The representatives of political opposition groups should not be overlooked.
9. Objectively verifiable indicators, designed to measure the impact of activities, should be built into activity designs and the activity’s budget must include funding for indicator data collection and analysis.
10. Pilot projects, if properly designed, can be very successful in transition situations. How the pilot activity will be replicated if it is successful must be incorporated into the initial project design.

Program Implementation

1. Flexibility is a necessary watchword in program implementation. The ability to move funding from one sector to another and from one activity to another is critical to ensure assistance is focussed where the prevailing conditions bode well for progress.
2. Flexibility of work plan implementation is essential and should be built into activity designs. It should also be reflected in the willingness of activity managers and implementers to adapt the work plan during the course of implementation.
3. Attempts should be made from program initiation to establish a sense of “community” among assistance providers, partner institutions, and other stakeholders.
4. In countries with functional democracies, it is important to involve representatives of all parties. This involvement can help to counter resistance. Also, governments change, often bringing opposition representatives to positions of authority.
5. Transitions are characterized by rapid change. In a fast changing environment, an in-country office can help an assistance provider to be more responsive to rapid change, better manage the activity, facilitate communication with donors, facilitate greater flexibility in making adjustments, and encourage informed programmatic decisions.
6. If a local office is established, it is imperative that proper management systems and controls be instituted. Local staff must be thoroughly trained as they may not be familiar with donor financial management mechanisms, western bureaucratic standards of ethical conduct, or relevant techniques for delivering assistance (e.g. interactive training methodologies).
7. The development of indigenous, private sector consulting capacity, capable of performing specific tasks, will contribute to the sustainability of the activities.

Democracy and Governance

1. Democracy is a set of ideas and derived principles. The ideas of democracy have demonstrated an unusual power over people and have profoundly influenced the shape of the world today. In the conduct of democracy and governance programs, it is the dissemination and practice of democratic principles that results in the development of democratic institutions and processes.
2. The basic principles of democracy (e.g. transparency in government) can be difficult to teach in the abstract. Utilizing a concrete subject (e.g. the local government budget process) that demonstrates and relies on a democratic principle offers a potentially more successful approach.
3. Targeting assistance on organizations outside the central government and the capital city is critical to supporting pluralism and decentralization.
4. Increased citizen participation and collaboration is impossible to promote directly: enlisting citizens in the pursuit of a common goal, the achievement of which requires participation and collaboration, works better as a motivator and focal point for activities.
5. Public information provided by both governmental and non-governmental organizations is an essential component in democracy and governance programming.

Privatization

1. Six enabling environmental conditions are needed to support privatization and should be encouraged and assisted in parallel with privatization programs: political will; establishment and enforcement of the legal and regulatory framework; tax reform; accounting reform and the development of audit functions; development of capital markets; and reform of the banking sector.
2. Companies that can be profitably integrated into a market economy should be privatized first. Do the easy privatization (i.e. companies with high value assets that will attract good prices from investors who are likely to invest further in the asset) first to gain experience.
3. The banking and energy sector are more difficult to privatize because they have unique features (for example, national interest concerns, natural monopolies) or problems (for example, bad loan portfolios). Having a reformed legal and regulatory framework and an independent regulatory agency in place early in the process is critical to success. The organizations that are charged with privatizing these sectors need specialized skills. Consequently, the privatization assistance organizations must provide highly specific TA with carefully tailored strategies.
4. Privatization should be structured to ensure that companies are in the hands of owners and managers who have the will and resources to make them successful in a free market economy.

Private Sector Development

1. Activities that will promote an enabling environment for SMEs should be started early in the transition because the SME sector is critical to the overall development of the private sector and the growth of the economy, and especially valuable for job creation.
2. Support of multiple business associations and business/entrepreneur training organizations promotes competition, which in turn helps to assure quality and responsiveness to members/customers.
3. To promote the sustainability of organizations that support SMEs, fees should be introduced at an early stage and gradually increased over time.

Pension Reform

1. Private pension funds are not safe or sustainable without the following enabling conditions: privatization has to be fairly advanced; capital market reforms have to be fairly advanced; and there must be macroeconomic stability, i.e. relatively low and steadily declining inflation and real interest rates.
2. It is crucial that voluntary pension funds be allowed to develop before implementation of full-scale pension reforms because this development serves as an important educational and lobbying force for pension reform.
3. Private pension fund regulation is crucial and worthy of significant technical assistance. The development of a regulatory agency must be started as early as possible to assure that private pension funds are properly regulated and supervised.

Energy

A credible, competent regulatory body and a reformed legal and regulatory framework are pivotal to the process of energy asset privatization. Energy privatization is an important element of an overall country privatization strategy, infrastructure development, the stimulation of overall economic growth, pollution reduction and entry into the EU.