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Is Hungary on ‘The Road to Serfdom’?

12:22 PM, Jan 13, 2012 • By DALIBOR ROHAC
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In 1945, Friedrich Hayek famously predicted that economic interventionism in the West would lead to the erosion of democracy and the rise of authoritarianism. More than sixty-five years later, this prediction does not seem to have been validated.

Hungary

But while Hayek’s gloomy forecast might have been overblown, one Eastern European country, however, seems to be dangerously close to the scenario outlined in The Road to Serfdom. Following a series of policy mistakes by both the socialists and the current government, Hungary’s ruling Fidesz party is now “rebooting the system,” as Zoltan Kovacs, a minister of state for government communication, put it. With the latest constitutional changes, silencing of opposition radio stations, and changes to the electoral and media laws, Hungary risks becoming the first country in Central Europe to transition from a one-party system to democracy and back again.

Such a move would be tragic, especially since Hungary’s economic and political transition away from communism was such a success. Hungary was the first Soviet bloc country to start tearing down the Iron Curtain –as early as May 1988, the country opened its border with Austria. It was among to first liberalize politically – with the personal involvement of the then 26-year-old Viktor Orban. And it was among the leading economic reformers of its region.

The current “reboot” comes at a time when the country faces serious economic problems. Although labeled a right wing party, the governing Fidesz party has been shockingly cavalier about the perception of Hungary by international markets. And while Hungary’s deficit and debt are not quite near Greece’s levels yet, the financial markets have their doubts about the prospects of the country’s public finance. Standard & Poor’s downgraded Hungary to junk status in December, and facing double-digit yields on its bonds, without a clear consolidation program, the government’s fiscal position is unsustainable in the long run.

The present mess is not accidental, nor is it simply a result of the financial crisis that hit Hungary hard, alongside other countries on Europe’s periphery. Back in 2006, long before the crisis hit, the Hungarian government was running a deficit of 9 percent of GDP, which has later been brought down to around 3 percent – a fairly impressive achievement given the current economic environment.

But deficit figures are only part of a country’s credibility. The rule of law and the stability of contracts are at least as important for the quality of the economic environment. And in 2010, as part of the deficit reduction strategy, the government unscrupulously seized 3 trillion forints ($14.6 billion) of privately managed pension assets, following the example of Argentina, which nationalized its pension system in 2005 in order compensate for a fall in revenues.

What lies at the heart of Hungary’s current economic woes is a painful process of deleveraging, following the period of reckless mortgage borrowing in foreign currencies, most notably in Swiss francs. Deleveraging, already suffocating the economy, was accompanied by a series of policy mistakes. From pension nationalization to special taxes on foreign companies and bank profits to the most recent attack on central bank independence, the government seems to be caught in a vicious circle of forcefully trying to bring events under control, while triggering unintended consequences that call for further interventions.

Hungary’s economy is bad but the situation should not be considered hopeless. If the government moved away from its current haphazard approach to economic policymaking, Hungary could regain the confidence of investors and entrepreneurs in no time. A deal with the IMF, and a credible commitment to a predictable economic environment, could go a long way to bringing the country back toward a growth trajectory, notwithstanding the current problems in the eurozone.

The political dynamics of Hungary are thus much more worrying than its immediate economic troubles. With the most recent electoral reform and the crackdown on opposition media, the country is on the verge of moving toward a one-and-a-half party system, of the kind we see in the less fortunate parts of the post-Soviet space. But those dynamics can still be reversed. After all, Hungarians are not applauding, but protesting vigorously against the power grab by Orban and his colleagues.

Dalibor Rohac is the deputy director of economic studies at the Legatum Institute.

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