Peter Rona published a lengthy study in three parts (Népszava, September 2, 3, and 4, 2008), the first of which I summarized yesterday. The second part's title is "Competition, Capital, Subsidies." The article begins with the economic situation around 2000 when after ten years of rather spectacular economic growth things slowed down. The economic growth of the first ten years was due mostly to an unusual amount of foreign investment. In the region Hungary was the favorite among foreign companies. However, by 2000 or so foreign companies also turned their attention to other East European countries: Poland, Slovakia, the Czech Republic, and (more recently) Romania. Economic growth which at one point was close to 7% slowed considerably by 2000.
The Orbán government's answer to this problem (quite defensible economically) was to increase internal consumption. They doubled the miminum wage, began a program to assist home buyers, and handed out substantial grants to small entrepreneurs. The programs initiated by the Orbán government were followed by the socialist-liberal Medgyessy government's "horn of plenty." They exempted workers earning the mininum wage from income tax, raised the salaries of civil servants and state employees by 50%, and underwrote all sorts of other subsidies. All went fairly well on the surface until the deficit reached almost 10% and the national debt became unbearably high.
Rona focuses on Hungarian tax policy and argues against those who think that simply by lowering corporate and payroll taxes the Hungarian economy will be competitive again. It is not nearly so simple. Competitiveness, Rona explains, depends on the difference between the market price of the product and the price of production. If the difference between these two is about the same as or greater than in other countries all is well. The business tax rate (i.e., income tax) doesn't influence competitiveness because taxes are paid on profit. Payroll taxes, however, do have an effect because they add to the cost of production.
Since the change of regime a dominant theme of government economic policy (endorsed by Hungarian economists) was to attract working capital. To achieve this goal Hungary offered all sorts of incentives to foreign companies. As a result, a foreign company that opens a plant or office in Hungary doesn't feel the sting of Hungary's relatively high payroll tax burden; its competitiveness is not negatively affected.
The government, however, takes a revenue hit on its subsidies to foreign investment; to compensate, it has an outsized payroll tax rate. As a result large multinational companies have a huge advantage over middle-sized, mostly Hungarian-owned companies. According to Rona, the tax burden of large foreign companies is less than half that of small and middle-sized firms.
And here comes, according to Rona, an interesting statistic. The amount allegedly not paid to the state by Hungarian tax evaders is exactly the same as the top 200 companies receive in tax breaks. By giving very generous subsidies to foreign companies, he argues, the government essentially undermined Hungarian companies. Those who do not receive subsidies simply cannot compete against those who do. In order to remain competitive they cheat on taxes.
Hungarian governments in the last twenty years desperately tried to increase competitiveness and therefore gave generous subsidies, but to this day the policy makers do not want to recognize the negative consequences of these measures. It's no wonder, Rona adds, that the European Union is trying to curb incentive programs. And, he says, it is not at all surprising that 66% of Hungarian companies are in foreign hands, way above the European norm.
If subsidies attracting foreign investment have led to the loss of competitiveness of Hungarian businesses, then further efforts in this direction cannot be a remedy. Right now the Hungarian government is making very serious efforts to get more and more foreign investments. Every time a foreign company opens a factory in some other country, the Hungarians are very upset. Rona doesn't say that Hungary should stop trying to get foreign capital because that would be outright stupid. What he says is that only those investments should be supported that have a comparative advantage, defined in economic textbooks as "the ability of a country to produce a specific good at a lower opportunity cost than its trading partners." Rona gives an example: tire production. (And yes, several tire companies have opened plants in Hungary.) Rona says: if there are no tire factories in the region, let's support companies who make tires.
Rona notes that the prime minister rightly acknowledges several components of competitiveness: education, the judicial system, cooperation, the general level of society. But although Gyurcsány's essay makes a stab at leveling the playing field, the multinationals still have a major advantage. Rona suggests that the crusade against tax evasion will be marginally successful. However, he contends that one must anticipate a rise in unemployment as a result of these attempts to prosecute tax evaders. Last year there was progress against the offenders; one of the results: 60,000 fewer jobs.
I don't know whether Rona is right or not, but at least we can have a discussion about his ideas.