In both Poland and Hungary, the change of the regime encompassed the complex process of shifting from socialism to capitalism. The transitions took place at political, economic and social levels – changing from central governance to market economy. This meant the expansion of private property through privatization with the emergence of democracy with civil rights.
In 1989/91, similarly to the other post-Soviet countries, the transition in Poland and Hungary resulted in an initial recession in both income and output, as well as in employment and living standards – placing the two countries in a relatively comparable economic condition; after which they have selected their own methods in structural changing and institutional building – which later on led to different economic performances.
The aim of this case study is to explain what were the reasons of such distinctness in the economic performances of Poland and Hungary.
According to the report of the European Bank for Reconstruction and Development (1999) both Poland and Hungary shared the same characteristics at the end of the socialist era, moreover they were both examples of a successful transition in the 1990’s. But by 2010, it clearly showed that Poland – with its constant, good performance- must have done something differently, than the ever instable Hungary – with its varying performance.
A PhD dissertation by Kozenkow (2011) suggests: in the explanation of economic performances, the focus should be on specific determinant factors ofinstitutional differences of the two countries – which were generally ignored by mainstream neoclassical economists – hereby the following question should be raised:
What kind of institutional characteristics caused the difference in the performance of Poland and Hungary?
Former studies by Melo (1996) and Fischer – Sahay (2000) were based on the grounds of the quantitative approach of neoclassical economics – which analyzed the relations among economic growth, liberalization and inflation; applying traditional quantitative indexes such as general government debt, general government balance, GDP rate and unemployment – leading to the least credible description about transition countries.
Since the emergence of new theories from the 1970’s, institutions have become more and more important in explaining economic growth, emphasizing that institutional quality has a great effect on economic performance. Havrylyshyn (2006) and Bönker (2006) integrate formal institutional variables into their analysis to explain the economic performances of the transition countries more comprehensibly. Cernat (2006) analyzes the development of bank sector, the level of state intervention and labor market positions. Opper (2004) examines the effects of property rights through the process of privatization, and Pejovich (2003) studies contract enforcement, independent legal conditions and also individual behaviors and norms.
It can generally be assessed, that the different economic performance of Poland and Hungary, is the result of the different institutional characteristics they have.
New Institutional Economics is the discipline which deals with such complex approach as this, encompassing an interdisciplinary vision constituting of: sociology, psychology, history and other comparative empirical materials; to provide a detailed, wide-angled insight to the reality of the formation of Poland and Hungary after 1989/91. This vision takes opportunism and bounded rationality into account, and recognizes mathematical and statistical techniques as only tools, rather than the essence of explanation on economic performance.
Institutional characteristics of Poland
Barlcerowitz the first finance minister, followed radical decision-making at the time of transition, what polish people supported, and which initially became the result of a stable economy. Regarding property rights, thanks to the early introduction of small scale privatization, private sector was led to a dynamic expansion. Although it has to be outlined that large scale privatization remained erratic, with its 50% still being state property by 2010.
The financial system made huge progress by applying international ruling standards and establishing effective supervisory authorities, though due to later reforms of the tax system and liberalization, control over economic processes was continuously declining.
Reforms implemented in the following 10 years after the change of the regime, advanced much slower – to what the additional weight of the country’s ever increasing budget deficit also contributed.
Polish political institutions were established by the rule of law, through fundamental democratic institutions within the frame of a semi-presidential system. Although the electoral system enables multi-party representations which leads to complications, and frequent changes of governments use to characterize the political sphere, the executive power is exercised by the President and the Council of Ministers. There were – of course- conflicts between the president and the government which set brakes in decision-making, but the implementation of macroeconomic reforms was executed continuously throughout 1991-2010. Polish informal institutions were found to be strong, where social values have a direct positive effect on economic growth. Here values like tolerance and respect should be outlined – which polish people are characterized by-, together with a low level of trust to the contrary.
Institutional characteristics of Hungary
In Hungary, the transformation of property rights had already started in 1968 but the essential expansion of the private sector took place after the transition. Small scale privatization finalized quickly – before the end of the 1990’s- and financial markets began evolving with the establishment of a two-tier banking system (established already at the socialist era), and later on improved constantly through the implementations and regulations adapted from the Western standards. Privatization in the banking sector finished relatively soon, in 2000, with the appearance of non-banking financial institutions.
The Hungarian fiscal control was (and still) strongly linked to the electoral cycles and reflects interest of the actual governments – which makes the fiscal policy and the general government balance one of the strongest influencing powers in the economic performance.
A monetary council aimed primarily at inflation targeting (in 2000) was considered to be inconsistent regardless of including an independent central bank, and the introduction of a floating exchange rate regime only occurred in 2008.
The rule of law was implemented by democracy, based on the legal frames of the Hungarian constitution dating back to 1949, and decisions on macroeconomic policy had the dominant influence on economic performance during given electoral cycles.
Hungarian informal institutions were found relatively strong, and similarly to Poland, values as tolerance and respect were shared among Hungarians, together with a low level of trust towards government and society. Altogether, Hungarian society had a continuous preference on gradualism in the past 20 years, where informal institutions had a strong indirect effect on justification and norms, while a low level of interest was shown in politics.
Institutional differences found between Poland and Hungary
In comparison of Poland and Hungary based on their macroeconomic indexes, the following differences were found regarding institutional characteristics:
In macroeconomic level, regarding fiscal performances, Poland performed better in every aspect after 2000, while similarities were found in economic growth in the 1990’s: where both countries had a relatively high level of average economic growth; inflation and unemployment rates were declining and foreign direct investment (FDI) was flowing into both countries during the entire period of transition.
Regarding institutions, Poland and Hungary were formerly found similar in their system of property rights and financial markets, although differences occurred in fiscal and monetary control, where Hungarian fiscal control was found to be weak.
Regarding political institutions, differences are shown in the electoral system and legal framework of executive power. While Hungary did not change his electoral system, Poland instead did, which led to improvements in political conditions, still: executive power was found wavering in both countries. In case of Poland, the case occurred because of a limited constitutional power together with frequent government changes, in Hungary it was due to inconsistent policy-making, along with a too strong constitutional position of the executive branch.
Regarding informal institutions, only few minor differences were shown in the level of tolerance and respect, and differences occurred only in the regard of emergence: In Poland, a stronger influence of informal institutions occurred due to a lower level of state intervention, while stronger informal institutions developed in Hungary because of the outweigh influence of the executive power.
In quantitative respect regarding formal institutions, correlations were found in Hungary between freedom of property rights, quality of electoral process and quality of executive power – with the economic growth; while neither of the mentioned institutional variables showed strong correlations with the real GDP growth rate in Poland.
Applying the theoretical and methodological foundations of new institutional economics, in the regard of economic performance, it can be confirmed that differences of the economic performance of Poland and Hungary were because of different institutional characteristics. It was found that the asymmetry of economic performance was due to the diverse political institutions, where executive power proved to be the main determinant factor in case of Hungary; and with an additional regard of fiscal control, stable and effective economic institutions contributed to the better economic performance of Poland.
This case study was based on the PhD dissertation of Judit Kozenkow: The role of intstitutions in the economic performance of Poland and Hungary from 1990 to 2010. Budapest, 2011.
Delila Mercedes Horváth
New Institutional Economics 