Hungary is a fascinating country. The capital is beautiful, the cultural offerings are aplenty, and they have an exciting culinary tradition (though if you order csirkemáj, I recommend lots of pálinka to wash it down with).
The Hungarians can also be proud of their strong economy. In the last decade, Hungary has consistently been a top European performer in GDP growth, with an inflation-adjusted average above 4% per year in 2015-2019. Foreign companies have invested heavily in the Hungarian economy, thanks in part to one of the best tax systems in Europe. Their welfare state has been successfully revamped to help young people form families and raise children.
Like the rest of Europe, Hungary took a beating during the pandemic. The fallout for the economy was not as bad as it was in many other countries, but it was nevertheless disruptive. That, however, has not deterred Prime Minister Viktor Orbán from keeping his eyes on the horizon. In a speech on Saturday, July 22nd, Orbán referenced his long-term plan to elevate Hungary to the European economic mainstream. He explained that his government has “been building our new economic system for thirteen years” and exemplified their achievements to date:
[The] Hungarian economy’s overall performance has trebled: from 27 trillion forints to 80 trillion forints. … our goal is to have a GDP of 160 trillion forints by 2030. … in 2010 we stood at 66 per cent of the European [per capita] average, in 2022 we were at 78 per cent, and by 2030 we want to be at between 85 and 90 per cent.
The HUF80 trillion figure is likely an estimate for how big the Hungarian economy will be for 2023. The prime minister’s desire to double that number over the next seven years is not at all unrealistic, given the strength of the Hungarian economy in the past 13 years.
The only caveat with this measure is that it allows inflation to contribute toward the end result. However, if the currently high inflation rate falls back to normal levels, this will not be a problem.
Orbán pointed to another essential metric for a nation’s economic strength: its workforce participation rate. Here, too, the prime minister explains, Hungary has made strong progress:
In 2010, employment was 62 per cent, today it is 77 per cent, and by 2030 we want to have increased it to 85 per cent.
If the prime minister is referring to the core age group of the workforce, namely those aged 20-64, then he has already achieved his intermediate goal. In the first quarter of this year, the workforce participation rate among this age group was 80.2%. This is up from 75.2% in 2017.
The 85% target is attainable, but not without some difficulty. As workforce participation increases, so does the marginal economic effort to add another percentage point. It is relatively easy to raise workforce participation when 60-65% of the population is working; it is harder to implement the same increase at 75-80% workforce participation. The reason is simple: there is always a segment of the population that will have trouble taking an employed position, full-time or even part-time. Some people are prevented from joining the workforce for medical reasons, whether physical or mental. There are also those who have addiction problems or serious criminal records.
Others have been out of the workforce for so long that their skills are seriously out of date. This is common in countries that have had a high rate of unemployment or a low rate of workforce participation for an extended period of time. The latter does not necessarily imply the former if those who are unemployed transition out of the workforce. For those who do, the path back to employment is often a difficult one, both in terms of professional skills and the social and psychological transition from idleness to a regular work schedule.
The people who are this far away from employment are normally only a few percent of the working-age population. It is unlikely that with 80% of the age group 20-64 being employed, they have run up against this difficult-to-employ segment of the population. They should be able to reach at least 82-83% without much difficulty.
Once there, though, Orbán may find that the last couple of percentage points to reach 85% may only come with significant effort. As of the first quarter of this year, among the 27 EU members, only Czechia, Estonia, Germany, Hungary, Malta, the Netherlands, and Sweden had a workforce participation rate above 80%. The highest rate was in the Netherlands, with 83.4%.
Prime Minister Orbán may have been referring to a larger segment of the workforce (e.g., the age span 15-64). Their current participation rate is slightly below the 77% the prime minister referred to. It is dicey to try to increase workforce participation among this age group since it includes people still in secondary school.
Regardless of exactly what demographic the prime minister had in mind, his ambition to get more Hungarians into the workforce is respectable and deserves support. Of at least the same significance as his ambition to make more Hungarians self-supporting is the fact that Hungary has one of the lowest unemployment rates in Europe.
Figure 1
Source: Eurostat
In terms of GDP growth, capital formation, employment, and consumer resiliency, Hungary has a lot going for itself. However, there are two economic areas where the economy still needs improvements: public finance and inflation.
Starting with the former, Figure 2 reports the consolidated budget deficit as a share of total government spending.
Figure 2
Source of raw data: Eurostat
Superficially, this deficit record suggests that the Hungarian economy cannot pay for the welfare state that dominates government spending. However, there are two reasons to believe that the problem is manageable to the point that it will go away in the next few years.
First, the Hungarian economy is still growing—as opposed to such economic giants as France and Germany—which means that the tax base is expanding at solid rates. The tax burden on the economy has come down gradually in recent years, from 48.4% of GDP in 2015 to 41.3% in 2021. As Figure 2 illustrates, this happened with only a small, temporary effect on the budget deficit. Therefore, we have good reasons to believe that there is considerable underlying strength in the Hungarian economy and that it will be able to keep government well funded in the future.
Second, the deficits after 2019 are in no small part related to the pandemic. This one-time shock to public finances was in no way exclusive to Hungary. The fact that the deficit has shown signs of growing again in the last year is likely not related to any structural weakness in the economy, but more a symptom of the euro-wide economic stagnation spilling over into Hungary. Therefore, this deficit is not structural in nature, but cyclical, and therefore much easier to deal with from a fiscal policy viewpoint.
Another aspect of the Hungarian public finances is that the Hungarian people are a major stakeholder in their own government’s debt. According to MNB, the central bank of Hungary, as of May 2023, households owned 28% of said debt. Financial corporations owned 39% and foreign entities 30%. This is a major shift toward domestic ownership compared to May 2010, right at the start of the Orbán era, when financial corporations owned 47% and foreign entities 46% of the Hungarian sovereign debt. Households only owned 4.6% of it.
The major shift in household ownership is the result of a deliberate policy to give households a safe, reliable savings opportunity. It is also a way to democratize the debt: when people own their own government’s debt, they have an even greater stake in making sure its affairs are handled properly than if they are ‘only’ taxpayers. If they disagree with how government manages its finances, the people can both vote differently and sell the debt.
A massive sell-off of government debt sharply raises the interest rate it has to pay on it, thus causing a great deal of fiscal pain for a careless government.
All in all, the Hungarian government is doing a reasonably good job at managing its finances, but it should not take lightly its ongoing deficits. While the deficit is likely cyclical in nature, it is always good to do regular structural spending reviews in order to make sure that parliament continuously prioritizes the core functions of government. Such reviews also function as bulwarks against habitual fiscal sloppiness (a practice that we American taxpayers are sadly very familiar with).
To the great credit of the Hungarian finance ministry, they have made sure that the structure of their debt is long-term in nature, and therefore stable and predictable in terms of cost. According to data from the central bank of Hungary, the share of the debt that matures in 5 years or more has increased from less than 51% in January 2011 to 78% in May of 2023. By contrast, short-term debt with a maturity of one year or less has declined from 1.1% to 0.7%.
This is essentially the very opposite debt management strategy of the U.S. government, which in the past nine months alone has increased the short-term share of its debt from 15% to 19%. This makes the cost of the debt volatile and less predictable.
Inflation is the other area of the Hungarian economy that is of some concern. After topping out at 26.2% in January, consumer inflation—technically known by its HICP acronym—fell to 19.9% in June. This is a good trend, but it is slow. When I first read that Prime Minister Orbán expressed hope that inflation would be below 10% by the end of this year, I thought he sounded overly optimistic. A simple extrapolation of the current trend suggests an end-of-year rate of 10.9%, but that is based on nothing more than a simple extrapolation.
All other things equal, the performance of the Hungarian economy suggests an end-of-year inflation rate in the 12-15% range. Once we have GDP numbers for the second quarter of this year, we can make a more precise estimate.
At the same time, a comparison of the Hungarian exchange rate and the country’s inflation lends more credibility to the prime minister’s prediction. As I pointed out in January, Hungary’s high inflation is tied to the monetary expansion effects of the high inflow of foreign direct investment, FDI, into the country. The fact that this inflow has led to a depreciation of the Hungarian forint vs. the euro is a sign that the central bank of Hungary has been overly generous in its efforts to sterilize its currency from the FDI effects.
Inevitably, such monetary policies become expansionary and therefore moderately inflationary. Fortunately, since October last year we have seen a reversal of the depreciation of the forint vs. the euro.
Figure 3
Source of raw data: Central Bank of Hungary
A striking correlation emerges when we compare the inflation rate to the exchange rate.
Figure 4
Sources of raw data: Eurostat (inflation), Central Bank of Hungary (exchange rate)
This correlation, which exhibits a brief lag from changes in the exchange rate to changes in the inflation rate, suggests that Hungary’s inflation problem has a monetary root cause. Figure 4 also suggests that the monetary expansion that has driven the exchange rate depreciation may have come to an end. This is good news, as it means that the decline in the inflation rate may actually accelerate through the latter half of this year.
If it does, Prime Minister Orbán may again turn out to have been too modest in predicting the future strength of his nation’s economy.
Hungary remains at the European frontline of economic growth and resiliency. Other countries in the EU have a lot to learn from how the Hungarians manage their country in general and their economy in particular. It certainly helps that Hungary remains outside the euro zone.
